Mirror Images: The Standoff between Moscow and Western Capitals
Mirror Images: The Standoff between Moscow and Western Capitals
Gali market is one of the main destinations for trade between Abkhazia and Georgia-controlled territory.
Gali market is one of the main destinations for trade between Abkhazia and Georgia-controlled territory. CRISISGROUP/ Olesya Vartanyan
Report / Europe & Central Asia 20+ minutes

Abkhazia and South Ossetia: Time to Talk Trade

Informal trade is increasing between Georgia and the breakaway territories of South Ossetia and Abkhazia, and between Abkhazia and countries outside the region. Trade alone cannot transform the parties’ core political differences. But talks among them on mutually beneficial commerce could open lines of communication long cemented shut.

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What’s happening? Informal trade is increasing between Georgia and the breakaway territories of South Ossetia and Abkhazia, and between Abkhazia and countries outside the region. Formalising aspects of this trade is under discussion, but the talks brush against the issue at the conflicts’ core: the breakaway regions’ political status.

Why did it happen? Abkhazia and South Ossetia use the Russian ruble. Its depreciation made imports more expensive. Russia’s subsidy of the breakaway republics’ budgets decreased, in part due to sanctions provoked by its Ukraine intervention and (until recently) falling oil prices. The breakaway regions want cheaper goods; de facto authorities want customs revenue.

Why does it matter? Trade could improve livelihoods and build contacts between communities across conflict divides. Creating a framework for formal trade – together with the increased informal commerce – could improve conditions in the breakaway regions and relations between them and Tbilisi, while opening opportunities for dialogue on areas of mutual benefit, even beyond trade.

What should be done? Tbilisi should offer to speak directly to the breakaway regions, which should develop their own proposals for trade. Because those regions’ status lies at the core of their – and Russia’s – dispute with Georgia, talks should focus on status-neutral options for economic cooperation. Use of confidential back channels could help.

Executive Summary

A decade after the 2008 Russia-Georgia war, and about 25 years after ceasefires in Georgia’s conflicts with the breakaway republics of Abkhazia and South Ossetia, talks in principle aiming to settle those conflicts have made little progress. Nor have relations across dividing lines improved. In recent years, however, informal trade has grown between Abkhazia and South Ossetia, which Russia recognized as independent in 2008, and Georgian-controlled territory; so, too, has trade between Abkhazia and countries outside the region. In a departure from the past, stakeholders are quietly considering options for formalising aspects of trade. In 2017, Georgia and Russia intensified discussions on a trade corridor through South Ossetia, while the European Union began testing options for opening to Abkhaz businesses the free trade agreement it has with Georgia. Prospects of either initiative coming to fruition appear slim, but trade talks are worth pursuing. Together with the present volume of informal commerce, such initiatives can help improve relations across dividing lines and conditions in the breakaway regions.

Informal trade between those regions and Georgia proper is developing apace. Abkhazia and South Ossetia have strong economic incentives for such trade: Russian aid, their main source of revenue, has plummeted due to sanctions imposed after Moscow’s 2014 annexation of Crimea and (until recently) tanking oil prices. Abkhaz and South Ossetian authorities seek to raise duties on trade across the conflict divides, despite nominally prohibiting it, as a means of tapping revenue streams independent of Russia. This trade is one of the few ways for people on either side of the conflict lines to forge links unburdened by politics.

Trade talks are worth pursuing. Together with the present volume of informal commerce, such initiatives can help improve relations across dividing lines and conditions in the breakaway regions.

Over 2017, discussions of two initiatives for formalising trade also appeared to gather pace. The first initiative involves linking Russia and Georgia via a trade corridor through South Ossetia, a faster, wider and, in winter, safer route than the Kazbegi-Upper Lars mountain pass over which most cargo between the two countries travels today. The idea originates in a 2011 agreement between Georgia and Russia, but Swiss-mediated talks on the corridor went nowhere until a landslide in late 2016 closed the Kazbegi-Upper Lars pass and trucking companies lobbied for an alternative. For South Ossetia, Russian business and Armenia – which relies on traversing Georgia for most of its foreign trade – the corridor would likely pay big economic dividends.

The second initiative would involve extending to Abkhaz businesses the benefit Georgia enjoys from the Deep and Comprehensive Free Trade Area (DCFTA), the relationship it has with the EU. European officials have engaged over the past year with the Abkhaz leadership to discuss how that might work. Abkhaz businesses primarily seek cheap foreign imports and investment, which the DCFTA process might stimulate. That in turn would help the Abkhaz increase the quantity of their produce and ensure it meets European standards, thus also facilitating exports.

If the ultimate economic benefits of both initiatives are clear, so, too, are the political obstacles they confront. Neither Tbilisi, on one hand, nor the breakaway republics or Moscow, on the other, will offer any concession that might affect either territory’s eventual political status. Doing so would risk fierce domestic backlash, especially for Georgian and de facto authorities in the Abkhaz capital Sukhumi and the South Ossetian capital Tskhinvali. For the South Ossetia corridor, Tbilisi thus opposes South Ossetian authorities exercising passport and customs controls, which it fears would strengthen the breakaway region’s independence bid and administrative capability. Conversely, Moscow resists any alternative that might undercut either.

For business and political elites in Sukhumi, who complain of being isolated beyond contacts with Russia, the core interest is in opening up the region to links beyond both Russia and Georgia. The sensitivity about Abkhazia’s eventual status complicates discussions about technical EU requirements that would have to be met for the region to benefit from the DCFTA – though pragmatic fixes could arguably be found that are status-neutral. A greater obstacle might be Abkhaz leaders’ and wider society’s refusal to deal with Tbilisi and the reluctance of Abkhaz businesses to make a move, even on status-neutral options, without a green light from the de facto authorities. In Tbilisi, meanwhile, most politicians traditionally have resisted amending Georgia’s 2008 Law on Occupied Territories, which restricts movement to and foreign companies’ business with the breakaway regions; reforms to the law would likely be necessary for either the South Ossetia corridor or the DCFTA extension.

Despite these obstacles, some recent signs are positive. In December 2017, Tbilisi signed a contract with a Swiss company, known by its acronym, SGS, to monitor the South Ossetia trade corridor, one provision of the 2011 deal. In late May 2018 Moscow followed suit. In themselves these contracts do not open the corridor; Moscow and Tbilisi still need to resolve the customs and passport control issues, among others. But were a landslide to again block the regular route – landslides are frequent in the mountains – this step might pave the way for an emergency fix through South Ossetia.

Tbilisi appears likely to be ready to engage in a discussion, though it does not want to lose all of its control over this conflict region.

Meanwhile, the Georgian parliament has started debating a new government proposal that, among other things, seeks to facilitate local trade across the conflict divides. The initiative seeks to entice businesses from the breakaway regions to trade with Georgia proper. While it may also allow for some trade with the outside world, Abkhaz political and business leaders fear this will be done via Tbilisi, something they find unacceptable. Having thus far rejected the initiative, Abkhaz leaders should come up with their own proposals. Tbilisi appears likely to be ready to engage in a discussion, though it does not want to lose all of its control over this conflict region. Status-neutral ideas that would help open up the region could form part of discrete discussions between Georgian and Abkhaz officials.

All sides have cause to keep the door open. The Abkhaz and South Ossetians need the money and seek broader international contacts. Russia, for its part, will not reverse its support for the breakaway regions’ independence, but beyond its economic interests, might see trade as a means of improving conditions in Abkhazia and South Ossetia, while itself incurring little extra financial or political cost. Moscow also might want to show a constructive face in Georgia as it seeks, in Ukraine, to shift blame to Kyiv for the lack of progress in implementing the Minsk Agreements that aim to settle the Donbas conflict. For Tbilisi, while the economic benefits are less clear, its opportunities for direct dialogue with the Abkhaz or South Ossetian leaderships are few and should be developed. Opening back channels could serve to open discussions on interests beyond trade, including the deteriorating situation of Abkhazia’s and South Ossetia’s ethnic Georgians.

All sides should consider next steps in this light. Regarding the South Ossetia corridor:

  • Now that their contracts with SGS are signed, Moscow and Tbilisi should continue talks on how the corridor would operate, particularly how to overcome the challenge of passport and customs controls, first in an emergency, and later routinely.
  • Tskhinvali should for the moment refrain from introducing new regulations along the conflict divide; such measures might scuttle any further discussions about the project.

Regarding the potential DCFTA benefits to Abkhaz businesses:

  • Tbilisi and Sukhumi should establish a channel, likely confidential and with third-party facilitation, for talks on status-neutral options for trade and potentially other issues. They should use that channel to gain a mutual understanding of each other’s red lines and interests, and discuss practical solutions.
  • Tbilisi should offer to brief Sukhumi, either directly or through third parties, on the details of its new initiatives for facilitating trade across the conflict divides. Tbilisi could also illustrate pragmatism, for example, by easing legislative restrictions on business activity, such as those proscribed in the Law on Occupied Territories.
  • Sukhumi, which has rejected Tbilisi’s initiatives, should develop its own proposals for status-neutral options for enhancing trade and economic measures.
  • The EU should continue to help parties develop status-neutral ways of meeting EU requirements.
  • Tbilisi, Sukhumi and Brussels should keep Moscow abreast of such talks and any potential trade mechanism that might emerge.

While informal trade is likely to continue developing, neither the South Ossetia corridor nor the extension of DCFTA benefits to Abkhazia businesses appear likely any time soon. Nor can trade alone transform the conflicts, whose political settlement is a remote prospect, or shift either side’s core political goals. But talks among the parties on increasing mutually beneficial commerce could open lines of communication long cemented shut. If opportunities for formal trade do arise, such arrangements could improve both the lives of those in Abkhazia and South Ossetia and communication between Tbilisi and the breakaway republics. Failure to at least explore such initiatives would risk hurting chances for economic growth in the region and waste potential opportunities for reconciliation.

I. Introduction

Ten years after the 2008 Russia-Georgia war, and a quarter-century after ceasefires in the Georgian-Abkhaz and Georgian-Ossetian conflicts, no resolution to the dispute over the breakaway republics is in sight.[fn]Abkhazia, about 9,000 sq km of land with a lush, subtropical climate, lies along the Black Sea coast on the Russian border. In the Georgian Soviet Socialist Republic, it was an autonomous republic. Before the 1992 conflict, it was home to some 500,000 people of different ethnic backgrounds (primarily Georgian, Abkhaz, Armenian and Russian). Over 200,000 ethnic Georgians were forcibly displaced in the fighting; some 50,000 have since returned. Today, Abkhazia has about 200,000 people and little industry besides tourism. South Ossetia was an autonomous region (oblast) in the Georgian Soviet Socialist Republic. It also borders Russia, but most of its 4,000 sq km territory is landlocked high in the mountains, at a strategic juncture of the North and South Caucasus. Those of working age among its 30,000 inhabitants are employed mainly in agriculture and in support of the Russian military presence there. For details about the de facto entities after 2008, see Crisis Group Europe and Central Asia Reports N°202, “Abkhazia: Deepening Dependence“, 26 February 2010; and N°205, “South Ossetia: The Burden of Recognition”, 7 June 2010.Hide Footnote Long-festering ethnic tensions turned violent as the Soviet Union disintegrated in the early 1990s. Wars erupted in 1991 in South Ossetia and the following year in Abkhazia. In 2008, amid an escalation of political and military tensions between Tbilisi and Tskhinvali, and against the backdrop of a diplomatic crisis between Tbilisi and Moscow, Russia deployed its army into the breakaway regions, as well as parts of Georgia, and recognised the independence of both Abkhazia and South Ossetia. The Abkhaz and South Ossetians, along with the Russians, see this as a result of Georgian aggression, while most Georgians blame Moscow for its military intervention.[fn]The history of the conflicts is contested. For more background, see the report by the International Fact Finding Mission on the Conflict in Georgia, September 2009.Hide Footnote

A truce, though often uneasy, has held since then. Russia guards the Abkhaz and South Ossetian sides of the “border-like” conflict divides.[fn]In accordance with their overall political positions, the conflict parties disagree on the nature of the conflict divides. Tbilisi sees the lines as administrative boundaries within Georgia; Sukhumi, Tskhinvali and Moscow insist they are international borders.Hide Footnote The Georgian government, which cut off diplomatic ties with Moscow shortly after the 2008 war, regards Russia’s involvement as foreign occupation. Abkhaz and Ossetians disagree, citing the need for security guarantees from Moscow against Tbilisi. Links between Georgia proper and the breakaway regions are limited. Ethnic Georgians, who inhabit a pocket in each of the entities – the Gali district in Abkhazia and the Akhalgori district in South Ossetia – account for most such cooperation.[fn]Abkhaz refer to the Gali district as Gal. Ossetians refer to Akhalgori as Leningor.Hide Footnote Links between those entities and the outside world beyond Russia are highly restricted, mainly due to Tbilisi’s political sensitivities. De facto officials and residents of the entities criticise what they see as their international isolation.[fn]Crisis Group interviews, de facto officials, civil society interlocutors, professionals in the social and medical spheres, Abkhazia, June 2016-August 2017.Hide Footnote In the past two years, the conditions for ethnic Georgians in both breakaway republics have greatly deteriorated.[fn]Particular problems include restrictions on Georgian-language schooling and on freedom of movement as well as a lack of local documents for ethnic Georgians living in the de facto republics. See Thomas Hammarberg and Magdalena Grono, “Human Rights in Abkhazia Today”, Palme Center, July 2017; “The Human Rights Situation of the Conflict-Affected Population in Georgia”, Public Defender of Georgia, November 2017.Hide Footnote

Gali market is one of the main destinations for trade between Abkhazia and Georgia-controlled territory. CRISISGROUP/ Olesya Vartanyan

Talks to resolve the conflicts are stalled. The main forum, the Geneva International Discussions, convenes Georgian, Abkhaz, South Ossetian, Russian and U.S. participants four times per year under the co-chairmanship of the European Union (EU), the United Nations and the Organization for Security and Cooperation in Europe (OSCE). But these meetings function to manage rather than resolve the conflicts; they are not mandated to deal with issues related to the status of the breakaway regions and in practice discussions often fail to address even issues such as international security arrangements or the return of displaced people. Beyond the Geneva discussions, a bilateral channel linking Grigory Karasin, Russia’s deputy foreign minister, to Zurab Abashidze, special envoy of the Georgian prime minister, is used to discuss economic cooperation and release of prisoners but little else. There are no formal talks between Tbilisi and the seats of Abkhaz and South Ossetian self-rule. Conversations that do take place are ad hoc and usually unofficial.[fn]Crisis Group interviews, Sukhumi, Tbilisi and Brussels, 2017.Hide Footnote

Tbilisi’s chief objective is to reunify Georgia, but in the absence of realistic prospects for that aim, it seeks to secure international support for its view that the two regions are occupied by Russia. Since 2008, it has pursued a so-called engagement policy to support those living in the breakaway regions with medical and education assistance. But in practice its efforts in these areas often collide with or are sidelined by actions it takes to further its non-recognition policy. Georgia’s 2008 Law on Occupied Territories lays out strict penalties for any unauthorised economic engagement with Abkhazia or South Ossetia and imposes restrictions on visits to these regions. For years Western allies have encouraged Georgian leaders to soften the law, in order to afford international humanitarian organisations greater access to the breakaway areas and encourage trade and freedom of movement, but Georgians from across the political spectrum have resisted making any such changes.[fn]See “CDL-AD(2009)051-e Final Opinion on the Draft Amendments to the Law on Occupied Territories of Georgia adopted by the Venice Commission at its 81st Plenary Session (Venice 11-12 December 2009)”. Also “Association Agenda between the European Union and Georgia 2017-2020”, p. 26. “Association Agenda between the European Union and Georgia” (2014-2016), p. 10.Hide Footnote

For its part, Moscow insists its role is to act mainly as a security guarantor and mediator. It tends to deny it is a party to the conflict and even takes the view that no conflict exists and thus Tbilisi should recognise the “new realities” in the region. For the Abkhaz, the core aim is Abkhazia’s independence. Tskhinvali is more interested in unification with Russia’s North Ossetia. Both Sukhumi and Tskhinvali depend on Russian security and financial aid. Abkhaz leaders in particular are growing ambivalent toward the Kremlin and seek more exposure to the outside world, though this should not imply they have an interest in Abkhazia’s political subordination to Tbilisi.[fn]Crisis Group interviews, Abkhazia, 2016-2018.Hide Footnote

The triangular dynamic among Georgia, Russia and the breakaway regions hinders cooperation. Tbilisi blames Moscow for the conflict, though some in Georgia admit the Georgian-Abkhaz and Georgian-Ossetian conflicts would not go away even were Tbilisi and Moscow to find common ground. Tbilisi is loath to put itself on a par with the de facto authorities in Sukhumi and Tskhinvali, whom it views as Russian puppets.[fn]Crisis Group interviews, Tbilisi, 2017.Hide Footnote Moscow, while saying that Georgians, Abkhaz and South Ossetians must work out their differences among themselves, eyes any actual exchanges warily. Sukhumi and Tskhinvali tend to be cautious about direct contact with Tbilisi, both because they have long viewed the Georgian state as an aggressor and because of Moscow’s sensitivities.[fn]Crisis Group interviews, Sukhumi, August 2017.Hide Footnote

Notwithstanding the political gridlock, openings may exist for increased trade between Georgia and the breakaway regions and between those regions and the outside world. For years, goods have trickled over the conflict divides between Georgia-controlled territory and the breakaway regions. But as Russia’s economy weakens and its financial aid to Abkhazia and South Ossetia dwindles, such trickles appear to have become a steadier flow. At the same time, and despite occasional violent outbursts and regular exchanges of hostile rhetoric, fears of major bloodshed have greatly subsided over the past decade. Notwithstanding the distrust among the conflict parties, the relative quiet has prompted thinking about increased cooperation, with trade first on the agenda. In addition to informal trade, the volume of which is increasing, the parties have started quietly exploring, through third parties, opportunities to advance a long-discussed trade corridor from Georgia to Russia via South Ossetia, and potentially to expand the benefits of Georgia’s free trade with the EU to businesses in Abkhazia.

Notwithstanding the political gridlock, openings may exist for increased trade between Georgia and the breakaway regions and between those regions and the outside world.

This report examines and offers ideas on how to advance these initiatives. Research involved interviews with officials, diplomats and analysts, as well as businessmen and consumers, between May 2017-May 2018 in Georgia-controlled territory, in South Ossetia and Abkhazia, as well as in Brussels and Moscow.

II. Trade Despite Restrictions

According to Georgian law, there can be no trade between Georgian-controlled territory and the breakaway republics – or between those republics and the outside world. Since the wars of the early 1990s, Tbilisi has denied the legitimacy of the de facto authorities in Sukhumi and Tskhinvali and refused to recognise their regulations. It rejects the customs declarations, certificates of origin and other paperwork issued by those authorities. Tbilisi does allow goods to pass in and out of the breakaway regions, in order to “leave [the regions’ residents] a chance to earn some money”.[fn]Crisis Group interviews, Georgian officials, Tbilisi, May-July 2017.Hide Footnote But it bans products with Abkhaz and South Ossetian labels from the shelves of Georgian shops because they lack proper documentation, including certificates of origin.[fn]Crisis Group interview, Georgian official, Tbilisi, May 2017.Hide Footnote It also fines anyone selling Russian products that have arrived via the breakaway territories, on the grounds that those goods have bypassed Georgian customs.[fn]Crisis Group interview, Georgian official, July 2017. In one case in March 2017, Georgian officials fined a villager from Tserovani named Olga Pavliashvili for carrying Russian-produced sour cream, candies, canned beef and fruit drink mix from Akhalgori into Georgian-controlled territory. The officials apparently suspected her of intent to sell these products without paying duties. The charges were dropped after media reports prompted higher-level officials to intervene. Locals spoke of other instances when Georgian police summarily confiscated goods. Crisis Group interviews, Olga Pavliashvili, residents of Akhalgori and Tserovani, August 2017.Hide Footnote

According to Georgian law, there can be no trade between Georgian-controlled ter-ritory and the breakaway republics – or between those republics and the outside world.

Tbilisi is likewise tough on efforts by Abkhaz and South Ossetian businesses to make deals with foreign companies, fearing a slippery slope toward recognition of the breakaway entities.[fn]After the war of 1992-1993, Georgia, with the support of the Commonwealth of Independent States (CIS), imposed a number of restrictions on trade with Abkhazia, which prevented the import of foreign products, including from Russia. Russia and other CIS states adopted the sanctions to pressure the Abkhaz side into implementing political agreements, foremost among them the return of displaced ethnic Georgians to the breakaway region. Russia in effect sustained the sanctions until the early 2000s. It resumed official trade in the spring of 2008, five months before the war with Georgia, claiming the Abkhaz side had fulfilled its obligations.Hide Footnote Its 2008 Law on Occupied Territories tightened existing trade restrictions and introduced new ones, stipulating, among other things, that any foreign company wishing to do business in Abkhazia and South Ossetia must obtain a special permit from the Georgian government. Prospective investors in the breakaway regions must also get the permit, as must anyone seeking to transport goods by sea or overland through the de facto entities to Russia. Tbilisi does not see these requirements as onerous.[fn]Crisis Group interviews, Georgian officials, Tbilisi, November 2017.Hide Footnote But according to official data, not a single company engaged in trade has applied for the permit.[fn]According to the public defender of Georgia, in 2008-2016 the Georgian government released 28 permits for economic activity in the breakaway regions. The majority related to the Enguri hydropower plant, the only joint enterprise of the Georgian and Abkhaz sides. “Analyses of the Law of Georgia ‘on Occupied Territories’ and Recommendations”, Public Defender of Georgia, 9 February 2017, p. 29.Hide Footnote Meanwhile, the Georgian government has sanctioned foreign companies opening offices in the breakaway regions without the permit and sought to prevent businesses in those regions from conducting outreach abroad.[fn]In 2009, the Turkish branch of the Italian fashion company Benetton had to cancel the opening of its outlet in Abkhazia after the Georgian foreign ministry summoned the Turkish ambassador amid protests outside Benetton shops in Tbilisi. Since then, nearly all the Abkhaz outlets of famed international brands have been opened by the companies’ Russian branches, with no indication of a local address on the registration.Hide Footnote

Abkhaz and South Ossetian regulations are similarly restrictive. They define goods that cross the conflict divide with Georgian territory into either breakaway republic as “contraband” and the bearers as subject to prosecution. Officially, goods are also banned from moving in the opposite direction. The only exception is Abkhaz hazelnut exports, which the de facto leadership authorised in 2015.[fn]Hazelnuts are the main export crop of eastern Abkhazia. Sukhumi banned this trade in 2007 after clashes with Georgian forces in the Kodori gorge, but informally locals continued to export hazelnuts to Georgia-controlled territory. In August 2015, the de facto president signed a decree authorising collection of fees on hazelnut shipments crossing the checkpoint on the Inguri bridge. See more at: “Нужна инвентаризация ореховых плантаций” [There is a need for inventory of hazelnut plantations], Radio Free Europe/Radio Liberty “Ekho Kavkaza, 23 September 2016.Hide Footnote

Trade between the breakaway regions and both Georgia and the outside world is growing. [...] But because it is all informal, it has fuelled corruption and strengthened grey econ-omy networks.

Despite these constraints, trade between the breakaway regions and both Georgia and the outside world is growing. The uptick is largely due to rising demand for cheap consumer goods amid the economic downturn in Russia. Abkhazia and South Ossetia use the Russian ruble, which has declined in value with the fall in oil prices and the sanctions imposed on Russia in 2014 due to its intervention in Ukraine, thus diminishing the purchasing power of Abkhaz and South Ossetians. The breakaway regions traditionally have relied on locally produced goods or Russian imports, both of which are more expensive than commodities from elsewhere. The increased trade supports links between individuals and communities in Abkhazia and South Ossetia and Georgia-controlled areas. But because it is all informal, it has fuelled corruption and strengthened grey economy networks.[fn]Crisis Group interviews, diplomats, current and former local officials, Tbilisi and Sukhumi, 2017 and 2018.Hide Footnote

A. Local Trade Across the Conflict Divides

Ten years ago, no one wanted to marry Vato.[fn]Not his real name. Crisis Group has not used real names due to interviewees’ fears of losing access to the breakaway region and the risk of arrest or pressure by the South Ossetia security forces.Hide Footnote Back then he was hauling firewood in an old truck, the sole breadwinner for his elderly parents and siblings, poor ethnic Georgians living in South Ossetia. Today, he is one of the wealthiest people in the settlement of internally displaced persons (IDPs) where he lives. Every day, the 40-year-old climbs into his van and delivers some three tonnes of food from markets in Georgia to customers in South Ossetia. In one day he can earn twice what his friends make in a month. He and his wife have two sons and a savings account; they own two apartments in a fashionable Tbilisi district and a small house in the IDP settlement. He made his fortune in trade that, officially, does not exist.

Tserovani IDP settlement emerged after the 2008 Russia-Georgia war. It is now a home of ethnic Georgian IDPs, who account for most of increasing trade cooperation between breakaway territory of South Ossetia and Georgian proper. CRISISGROUP/ Olesya Vartan

As Vato’s story shows, laws do not stop trade across the conflict divides; they simply shove it into the shadows. Trade has been rising since 2015 at the only crossing for motor vehicles between South Ossetia and Georgia proper, connecting the South Ossetian town of Akhalgori to the Mtskheta-Mtianeti region of Georgia.[fn]The South Ossetian authorities’ name for Akhalgori district is Leningor – dubbed as such after Vladimir Lenin’s death. Most of the district was under Tbilisi’s control before the 2008 war. Since 2010, de facto authorities have worked hard to integrate the region by building highways, repairing local government institutions and issuing South Ossetian identity papers. Akhalgori is the only South Ossetian district with an ethnic Georgian majority. It has some 2,300 residents, about 1,000 of them in Leningor town, and most past the age of retirement. Crisis Group interviews, local residents, Georgian officials, June-July 2017. See the 2015 census of de facto South Ossetia: http://ugosstat.ru/wp-content/uploads/2017/06/Itogi-perepisi-RYUO.pdf. The checkpoint itself is near the village of Mosabruni (South Ossetians also call it Razdakhan). It is manned by Russian border guards as well as locals. Georgian police are stationed about 2km down the road near the village of Odzisi, but they only occasionally stop passing vehicles. There are three pedestrian-only crossings, two in the north-west, between the villages of Perevi and Sinaguri, between Perevi and Kardzmani, and the third in the south between Khelchua and Zardiantkari.Hide Footnote In 2017, commerce boomed: long queues of trucks were common, particularly during the summer harvest.[fn]Crisis Group interviews, businessmen and local residents, July and August 2017.Hide Footnote An average of twenty per day were passing through the checkpoint to deliver goods from Tbilisi to South Ossetian markets, which have no other source of affordable food. Georgian comestibles cost two or three times more in South Ossetia than at Tbilisi markets, but they are still up to five times cheaper than Russian imports.[fn]Crisis Group interview, residents of Akhalgori and Tskhinvali, July 2017.Hide Footnote Nearly 1,500 tonnes of cargo arrive in Akhalgori each month, with only a negligible portion going on to Russia.[fn]Crisis Group interviews, businessmen and product suppliers, July-August 2017. According to Russian Federal Customs Service statistics, imports of fruits and vegetables via South Ossetia have risen since 2010, including citrus from outside the region. “Внешняя торговля России“ [Russian Foreign Trade]. Local entrepreneurs say the biggest exports to Russia are herbs, blood oranges and mandarin oranges. When produce arrives in Akhalgori, it gets local labels that say it was grown in the de facto entity before it is transported across the state border to Russia. Crisis Group interviews, businessmen and local residents, July-August 2017.Hide Footnote Some of the truckers are Akhalgori residents, and others are IDPs now living in Tserovani, a fifteen-minute drive from Tbilisi.[fn]Tserovani is a settlement of nineteen rows of identical one-story houses – 2,ooo in all – built by the Georgian authorities. Almost 70 per cent of the population are natives of the Akhalgori district. Former Akhalgori residents also live in the neighbouring IDP settlements of Tsilkani (353 houses) and Preseti (264 houses). About 6,500 Akhalgori natives live in the territory under Tbilisi’s control. Crisis Group interview, leaders of the Akhalgori region in exile, July 2017.Hide Footnote

According to South Ossetian regulations, each person going through the crossing leading to Akhalgori may carry up to 50kg in personal belongings.[fn]Постановление №26 об организации пересечения государственной границы Республики Южная Осетия с Грузией в упрощенном порядке от 15 февраля 2011 года” [Decree N°26 on Rules for Simplified Crossing of the State Border of the Republic of South Ossetia with Georgia Released on 15 January 2011], RES, 29 August 2011.Hide Footnote Taking advantage of a loophole, drivers used to take passengers in the cabs of their trucks or vans, using each person’s quota to fill the vehicle with what was in fact commercial cargo. In response, in the spring of 2017, the de facto authorities tried to introduce new weight limits. Drivers retaliated with a series of short boycotts that emptied South Ossetian markets. The restrictions were lifted, and guards stopped blocking overloaded vehicles.[fn]Crisis Group interviews, businessmen and local residents, June and August 2017.Hide Footnote

Detailed map of the South Ossetia conflict region Boundaries are not authoritative. Geographical names follow pre-1990s usage © Mike Shand/International Crisis Group, 2018

In late 2016, South Ossetian authorities tasked a special commission with calculating the revenue from the informal trade with Georgian-controlled territory. The estimates were not made public. But they appear to have influenced the December 2017 decision by Tskhinvali – after a lengthy debate among politicians – to open a customs post at the crossing leading to Akhalgori.[fn]Южная Осетия открывает на границе с Грузией таможенный пост «Раздахан»” [“South Ossetia opens customs point Razdakhan at the border with Georgia”], RES, 27 December 2017.Hide Footnote Local businessmen contend the post is as likely to fuel corruption as it is to fill Tskhinvali’s coffers. They will pay informal duties to de facto South Ossetian officials – informal because trade with Georgia proper remains illegal according to the breakaway region’s laws.[fn]Thus far, there has been no discussion in South Ossetia about legalising this trade, in part because local officials have no idea how to proceed with this task without, for example, recognising Georgian certificates of origin for imported products. Officials also fear that if the trade is formally regulated it would force up prices. As a result, their actions are half-hearted – charging duties to send money to the treasury but not strictly enforcing regulations that could limit or even end the trade with Georgian-controlled territory on which many South Ossetians depend.Hide Footnote But they say that they expect also to pay bribes on top of those duties, costs they will then pass on to consumers. “Goods will be like fire – you won’t be able to touch them”, said a Georgian supplier.[fn]Crisis Group interview, local businessman, July 2017.Hide Footnote

Similar patterns are evident in Abkhazia, where informal trade has not paused since the 1994 ceasefire, not even during the clashes in 1998 or the tension that accompanied the 2008 war over South Ossetia. According to the Abkhaz authorities, 150 tonnes of commercial cargo cross the conflict divide daily, in both directions.[fn]Crisis Group interview, high-level de facto official, August 2017.Hide Footnote The freight’s annual value ranges from $7 to $15 million, according to International Alert studies conducted in 2010-2015.[fn]Natalia Mirimanova, “Abkhazia: Regulations for Trade with Disputed Statehood”, Politorbis, vol. 60, no. 2 (2015), p. 12.Hide Footnote Processed food and furniture made in Georgia enter Abkhazia, while citrus and hazelnuts grown in Abkhazia exit (in 2014, Abkhaz hazelnuts made up 10 per cent of the total quantity of the nut exported from Georgia).[fn]Trans-Ingur/i economic relations: A case for regulation – Volume 2”, International Alert, 2015, p. 21. In 2016-2017 the hazelnut trade fell off sharply due to the closure of crossings in Gali and an infestation of marmorated stink bugs, which reportedly destroyed about 80 per cent of eastern Abkhazia’s produce. Crisis Group interviews, Abkhazia, August 2017.Hide Footnote Georgian products are found in Abkhaz markets close to the conflict divide, in Sukhumi shops and in the tourist spot of Gagra, a town 30km from Sochi, the main Russian Black Sea resort. Most of the products come without labels to hide that local merchants are doing business with Georgia.[fn]Observations made since 2010.Hide Footnote

“Ingur” is the only Abkhaz checkpoint for motorised transport between the breakaway region and Georgia proper.[fn]The river that runs along the south-western portion of the conflict divide is called Ingur in Abkhaz and Enguri in Georgian. Georgians also call the crossing Rukhi, after the last Georgian village on the road to the conflict divide.Hide Footnote Russian and Abkhaz guards inspect documents, while Abkhaz customs officials check bags, sometimes inviting travellers into their office for further checks.[fn]Observations made since 2010.  Hide Footnote There are customs forms, but traders expect to pay bribes in addition to an exit tariff, which de facto laws prescribe only for the main local produce – hazelnuts.[fn]Crisis Group interviews, businessmen and residents of villages near conflict divide, 2010-2017.Hide Footnote Abkhaz leaders reportedly have tried to instill order in their customs controls.[fn]Crisis Group interviews, former de facto Abkhaz officials, August 2017.Hide Footnote After a six-month anti-corruption campaign, the customs revenue in Sukhumi’s budget grew eleven-fold in 2014-2015, but then fell again after the official in charge of the campaign was murdered.[fn]Убит начальник управления таможни города Гал Беслан Маландзия” [“Head of customs office for town of Gal Beslan Malandzia killed”], Sputnik (Abkhazia), 2 October 2015.Hide Footnote De facto officials estimate that the tariffs collected at the “Ingur” checkpoint contribute $780,000 to the coffers of de facto Abkhaz authorities per hazelnut harvest – nearly eight times all other revenue from this section of the conflict divide.[fn]Crisis Group interview, former high-level de facto Abkhaz official, August 2017. There used to be six crossings along the de facto boundary with Georgia-controlled territory. Trade in hazelnuts was possible at each. By March 2017, the de facto authorities had closed four of the crossings, formally allowing trade only at the Inguri bridge.Hide Footnote

While there may be political will to promote more transparent and effective gov-ernance, the Abkhaz and South Ossetian leaders lack the necessary expertise to re-form their systems.

Trade between the breakaway territories and Georgia proper continues to grow even as those territories’ budgets shrink, explaining the authorities’ desire to raise tariffs and introduce more effective customs mechanisms. Importantly, the increased trade is one of the few ways for residents of Abkhazia and South Ossetia to forge links across the conflict lines. But because the trade is informal, so, too, are the relationships it helps strengthen. Thus far, the growing commerce has not improved ties or even opened fresh lines of communication between Georgian and Abkhaz or South Ossetian authorities. Unregulated, it has fuelled corruption in the breakaway regions, where vested interests have developed around the informal cross-boundary trade.[fn]Crisis Group interviews, diplomats, officials, de facto officials, residents, businessmen, Tbilisi, Sukhumi, Tskhinvali, 2017-2018.Hide Footnote While there may be political will to promote more transparent and effective governance, the Abkhaz and South Ossetian leaders lack the necessary expertise to reform their systems.[fn]In late February 2018 South Ossetia reported the death in detention of Archil Tatunashvili, an ethnic Georgian IDP said to be involved in trade. According to Western diplomats and Georgian officials, he had been jailed, along with two associates, allegedly after refusing to pay an increased bribe to a de facto official. Relatives and local journalists claim he was tortured. Tskhinvali denied these allegations, said the cause of death was a heart attack and accused the deceased of involvement in a Georgian terrorist plot that was to be carried out before the March 2018 Russian presidential election. South Ossetia handed over Tatunashvili’s corpse to Tbilisi authorities only about a month later, after receiving results of a postmortem inquest from local and Russian experts. “Гражданин Грузии, подозреваемый в геноциде осетин, скончался в Цхинвали”, [“Citizen of Georgia suspected in genocide of Ossetians died in Tskhinvali”], Sputnik (South Ossetia), 23 February 2018; “Власти Южной Осетии передали Грузии тело Татунашвили” [“Authorities of South Ossetia handed over corpse of Tatunashvili to Georgia”], Sputnik (South Ossetia), 20 March 2018. Crisis Group Skype interviews, residents of South Ossetia, Western diplomats, Georgian officials, March and May 2018.Hide Footnote

B. Trade Beyond the Region

Despite Georgia’s legal strictures, the breakaway regions have developed trade with the outside world, though the Abkhaz have had more success doing so than the South Ossetians.[fn]The Abkhaz authorities believe there is more trade than what official documents show. Local legislation leaves private companies room to avoid declaring all of their income. Crisis Group interviews, current and former officials, Sukhumi, August 2017.Hide Footnote Russia remains the main trading partner of both. Russian products comprised 80 per cent of Abkhaz imports in 2015-2016, while Abkhazia sent 60 per cent of its exports to Russia in the same period.[fn]According to data provided by the Chamber of Commerce and Industry in Sukhumi.Hide Footnote In South Ossetia these proportions are even higher.[fn]According to the statistics of the Russian Federal Customs Service published by “Внешняя торговля России” [Russian Foreign Trade].Hide Footnote The biggest exports from the breakaway territories to Russia are citrus, nuts, fish, alcoholic beverages, raw wood and lumber. Imports are oil, tobacco, flour and other consumer goods.[fn]Ibid.Hide Footnote

Only the few countries that recognise Abkhazia accept its customs documents and product certificates.[fn]Only four UN member states recognise Abkhazia: Nauru, Nicaragua, Russia and Venezuela.Hide Footnote The main import deliveries thus go through Russian intermediaries. Outgoing cargo is registered in Russian towns before continuing on its way west. The use of middlemen doubles, or in some cases triples, the cost of doing business, but it remains the safest means of transporting goods.[fn]Crisis Group interviews, suppliers and de facto officials, Sukhumi, August 2017.Hide Footnote

In Turkey, the Abkhaz diaspora helps businesses back home register subsidiary companies.[fn]Crisis Group interview, Abkhaz businessman engaged in trade with Turkey, August 2017. Turkey is second to Russia as an Abkhaz export market, according to Sukhumi’s Chamber of Commerce and Industry.Hide Footnote Unlabelled cargo from Abkhazia is delivered by sea to Turkish ports, where the subsidiary registers it for sale in local markets.[fn]Mainly fish and hazelnuts. Crisis Group interview, Abkhaz businessman engaged in trade with Turkey, August 2017.Hide Footnote A similar scheme is used for imports to Abkhazia from Turkish companies, which are major suppliers of cheap building materials.

Abkhazia and South Ossetia use the Russian ruble. As the ruble depreciated in 2014-2016, due in large part to the drop in oil prices and Western sanctions related to Russia’s interventions in Crimea and eastern Ukraine, Abkhaz businesses intensified their search for alternative routes for Western imports.[fn]Crisis Group interviews, suppliers in Abkhazia, August 2017.Hide Footnote Sukhumi-based suppliers reportedly have quietly sought partnerships with European companies ready to accept either Georgian or Russian customs codes for shipping by land via Russia or direct by sea to Abkhazia.[fn]Crisis Group interview, officials and entrepreneurs, Sukhumi, August 2017. See also Crisis Group interview, EU official, December 2017.Hide Footnote According to the Chamber of Commerce and Industry in Sukhumi, imports come through companies registered in sixteen EU member states.[fn]The main suppliers in 2015-2016 were based in Bulgaria, Greece, Lithuania and Portugal. Crisis Group email correspondence, Chamber of Commerce and Industry in Sukhumi, August 2017.Hide Footnote

Wary of the Georgian authorities, most Abkhaz engaged in trade with Western countries prefer not to discuss details of whom they partner with. As a local economic analyst put it: “Trade with the West is possible, but with too many headaches”.[fn]Crisis Group interview, Sukhumi, August 2017.Hide Footnote Abkhaz entrepreneurs and officials note that Georgia has moved to limit their international business ties. After Georgia passed its Law on Occupied Territories in 2008, European partners began to break contracts with Abkhaz companies, as did Russian firms anxious to avoid problems with Georgia’s Western allies.[fn]Crisis Group interviews, Abkhaz businessmen, August 2017.Hide Footnote Those Russian companies sanctioned by Western governments in 2014 – and thus less concerned about Western opprobrium – began to explore options in Abkhazia that same year. But according to Abkhaz officials, their investment has been small.[fn]Crisis Group interview, Sukhumi, August 2017.Hide Footnote

Without more formal arrangements between Georgia and the de facto authorities, [...] opportunities for trade with the outside world, [...] may be growing but nonetheless are likely to remain limited.

In view of these problems, the Sukhumi authorities continue to prioritise, for Abkhaz exports, neighbouring Russia’s multi-million-dollar market, which is open to Abkhaz products almost without restriction, though they would be keen on diversifying the links beyond Russia.[fn]See “Договор между Российской Федерацией и Республикой Абхазия о союзничестве и стратегическом партнерстве” [Alliance and Strategic Partnership Treaty], 24 November 2014.Hide Footnote In terms of imports, local businessmen hope to develop routes for European goods, which tend to be considerably cheaper than their Russian equivalents. Some also wish to export specific Abkhaz produce, for example hazelnuts, which reportedly fetch almost five times the price in the West than in Russia.[fn]Crisis Group interview, Abkhaz hazelnut entrepreneur, August 2017.Hide Footnote But the interest in diversifying trade relations does not equate to an openness to developing political ties with Tbilisi. Abkhaz businesses tend to agree that new contracts should be established only with the Sukhumi leadership’s agreement. Abkhaz merchants are careful not to undermine the state-building project lest they appear insufficiently committed to it. Without more formal arrangements between Georgia and the de facto authorities, in other words, opportunities for trade with the outside world, particularly lucrative European markets, may be growing but nonetheless are likely to remain limited.

III. Prospects for Formal Trade?

Beyond the informal trade, two projects for formal trade involving the breakaway republics are being explored. The first envisages a trade corridor between Georgia and Russia through South Ossetia. Negotiations over the corridor, which was initially foreseen in a 2011 customs agreement between the two countries, had stalled for years. But at the end of 2016, a landslide blocked the main transport route between Georgia and Russia, prompting regional business leaders to lobby the Russian and Georgian governments to open the route through South Ossetia as an alternative. Since then, Swiss-mediated talks between Russia and Georgia on the corridor have proceeded fitfully, though some recent developments suggest a breakthrough might be feasible.

The second trade project relates to Georgia’s Deep and Comprehensive Free Trade Area (DCFTA), a part of Georgia’s Association Agreement with the EU, which was provisionally applied in 2014 and came into force in 2016. As it stands, the deal does not apply to either breakaway republic. But there are indications, albeit for now tentative, that DCFTA benefits might at some point be offered to businesses and consumers in Abkhazia, were Abkhaz leaders and Tbilisi to agree on specific status-neutral modalities, notably with regard to certification of the origin and quality of goods, which would make Abkhaz participation possible. (Thus far, no such extension is being considered for South Ossetia.) The past year has seen EU representatives visit Sukhumi to discuss how that might work.[fn]Crisis Group interviews, EU officials, July and December 2017.Hide Footnote In a parallel development, a new Georgian package of initiatives and legislative changes, “A Step to a Better Future”, currently being discussed in the Georgian parliament, also contains provisions relevant to cross-boundary trade, and by extension potentially to the applicability of the DCFTA to Abkhazia. The prospect of that extension is still far off, however, and the Abkhaz have thus far rejected the package.

A. Trade Corridor through South Ossetia

Map reflecting coordinates for three trade corridors described in the 2011 customs agreement Boundaries are not authoritative. Geographical names follow pre-1990s usage © Mike Shand/International Crisis Group, 2018

In 2017, Georgia and Russia intensified discussions around a customs agreement they reached in 2011 as a condition for Georgian support for Russian accession to the World Trade Organisation (WTO).[fn]The official title of the customs agreement is the “Agreement between the Government of Georgia and the Government of the Russian Federation on the Basic Principles for a Mechanism of Customs Administration and Monitoring of Trade in Goods”. WTO talks between Georgia and Russia continued for almost ten years. Tbilisi halted the talks in the spring of 2008, when Russia dropped its economic sanctions against Abkhazia. Talks resumed in 2010.Hide Footnote The 2011 agreement foresaw the establishment of three “trade corridors”, including one each through Abkhazia and South Ossetia (the third and shortest corridor, which is already functioning, transits the Kazbegi-Upper Lars crossing on the Georgian-Russian border and is the main artery linking the South Caucasus to Russia). For the Abkhazia and South Ossetia corridors, the deal envisaged international observers monitoring customs procedures at the corridors’ entry points.[fn]The monitoring of cargo would be voluntary; only those companies that declared an interest in being registered by the international monitors would participate. Thus, a lot of cargo passing between Russia and South Ossetia could remain unregistered. The agreement did not envision registration of military cargo, which in principle would pass without scrutiny.Hide Footnote Electronic devices would be used to track via satellite the movement of goods along the corridor, with both Georgia and Russia enjoying access to the data.

Having helped the two sides reach the 2011 agreement, Switzerland became the deal’s international guarantor and the main mediator between Georgia and Russia on the corridors. At the time, a Swiss company, known by its acronym SGS, was selected to carry out some of the agreement’s provisions, namely the monitoring of cargo entering the corridor.[fn]Switzerland bears legal responsibility for selecting SGS (which was formerly called the Société Générale de Surveillance but today goes by the acronym alone). According to the 2011 agreement, Russia and Georgia are to cover monitoring expenses, something Tbilisi is trying to avoid, inviting the EU to share the bill. Crisis Group interviews, EU officials, December 2017.Hide Footnote Technically, the agreement could be activated once Georgia and Russia each signed a contract with SGS, permitting the company to monitor goods entering at their respective ends, though in reality both states would have to agree on a number of other procedures, including those related to customs and passport controls, before the corridors opened.

A South Ossetian corridor would be of vital interest to businesses in neighbouring Armenia and Turkey, both of which, like Russia and Georgia, transport high volumes of goods through the South Caucasus. For landlocked Armenia, whose only viable route for trade to Russia runs through Georgia, the corridor would be especially beneficial.[fn]Pending the opening of corridors in Abkhazia or South Ossetia, the road through Georgia is the only one Armenia can use for land transit to Russia. The roads through Azerbaijan remain closed to Armenian vehicles due to the conflict over Nagorno-Karabakh. Armenia also makes shipments to Russia by sea from the Georgian port of Poti.Hide Footnote Neighbouring Azerbaijan, mired in a decades-long conflict with Armenia over Nagorno-Karabakh, lobbies against it, however.[fn]Crisis Group interviews, diplomat, Brussels, May 2018.Hide Footnote The route’s location is central, close to Georgia’s main east-west highway, and the road linking South Ossetia to Russia through the Roki tunnel is shorter, wider and safer in winter than the mountain pass on the road through the Kazbegi-Upper Lars crossing. If it came to pass, the South Ossetia corridor would help not only to smooth the movement of goods but also to open up South Ossetia, isolated since the 2008 war, to the outside world.

For years negotiations on the corridors went nowhere, due to misgivings on both sides.[fn]Crisis Group interviews, analysts and negotiators, Tbilisi and Moscow, May, June and August 2017, and January 2018.Hide Footnote But in November 2016 the idea of opening a trade route through South Ossetia resurfaced after a landslide (which followed a series of small avalanches in preceding years) closed the Georgian military highway leading to the Kazbegi-Upper Lars crossing. Trucks queued for kilometres along the road for a month and lost large amounts of cargo to spoilage.[fn]Export by sea to the Russian port of Novorossiysk was impossible due to stormy weather. Transit through Azerbaijan was significantly more expensive, and it was impossible for Armenian cargo due to Armenia’s decades-long conflict with Azerbaijan over Nagorno-Karabakh.Hide Footnote “Every day we lost somewhere between half a million to a million dollars of revenue”, said the founder of a Georgian transport company.[fn]Crisis Group interview, businessman, July 2017.Hide Footnote

The alternative route across South Ossetia was only kilometres away, but no truck could use it, because people without the de facto South Ossetian documents had been unable to cross from Georgia proper into the breakaway region since the 2008 war. Following the landslide, a group of Russian businessmen approached the Russian prime minister’s office asking for help opening the South Ossetian route.[fn]Crisis Group interview, member of a lobbying group, July 2017.Hide Footnote Armenia championed the idea.[fn]Armenian officials have lobbied Tbilisi to open the transit route, directly and through foreign diplomats. A U.S. diplomat in Yerevan confirmed that Armenian officials asked the U.S. for help in “putting more pressure on” Tbilisi. “Our message [to the Georgian government] was that it was their decision, but they should also consider the idea”, said the diplomat. Crisis Group interview, Yerevan, December 2017.Hide Footnote In February 2017, representatives of the Georgian prime minister and the Russian president announced negotiations about a South Ossetian transport link, which they agreed would best be formalised by launching the corridor defined in the 2011 customs agreement.[fn]Отношения России и Грузии заводят в коридоры” [“Relations between Russia and Georgia lead to corridors”], Kommersant, 7 February 2017.  Hide Footnote

Talks initially sputtered, despite both Russia and Georgia having an interest in making them work.[fn]For the Russian position, see “Григорий Карасин: Киев отводит миротворцам ООН в Донбассе роль «оккупантов»” [“Grigory Karasin: Kiev assigns the role of occupiers to the UN peacekeepers in the Donbas region”], RIA Novosti, 10 November 2017.Hide Footnote This may have been due, at first, to the parties’ divergent goals. Russia was mainly interested in facilitating the transit of Armenian cargo through South Ossetia.[fn]Crisis Group interviews, Russian diplomat, Yerevan, December 2017; Crisis Group interviews, Russian analysts, Moscow, January 2018.Hide Footnote Georgia, on the other hand, primarily hoped to strengthen its claim against what it considers the illegal Russian occupation of the breakaway regions. According to Georgian officials, were the corridor to open and the monitors to register little cargo entering from Russia, Tbilisi could ask the WTO to initiate proceedings against Moscow, claiming it is implementing in bad faith a deal that was a prerequisite for Georgian support to Russia’s entry into the world trade body.[fn]Crisis Group interview, Georgian officials, Tbilisi, July and November 2017.Hide Footnote Georgian officials say privately that their foreign ministry sees the corridors mainly as a political tool.[fn]Crisis Group interviews, Georgian officials, Tbilisi and Brussels, November 2017 and February 2018.Hide Footnote

During subsequent meetings, however, Russian and Georgian negotiators reached agreement on all practical issues related to the corridor except two, both linked to South Ossetia’s eventual political status. The first relates to discussions over which trade would be subject to “international monitoring”. Georgian negotiators insist that commerce between Georgian-controlled territory and South Ossetia is “domestic trade” – and thus is not subject to such monitoring. The second area of disagreement involves determining who would carry out the customs and passport control on the South Ossetian sections of the border with Russia. Georgia insists that all cargo pass through (or at least be registered online with) Georgian customs before crossing the border. That would mean trucks entering from Russia would be required to leave the other end of the corridor to complete passport and customs control procedures on Georgian-controlled territory.[fn]Crisis Group interview, Georgian official participating in the negotiations, August 2017.Hide Footnote

Initial signs suggested that the sides might be able to find a way around the first issue. From the very beginning, Russian representatives reportedly were open at least to considering the Georgian demand to waive the monitoring of trade between Georgia proper and South Ossetia, as Moscow’s main interest lies in the transit of cargo through South Ossetia, rather than in local trade.[fn]Crisis Group interviews, mediators and Georgian officials participating in the negotiations, May, June and August 2017; Crisis Group interviews, well-connected Russian analysts, Moscow, January 2018.Hide Footnote

On the second issue – related to passport and customs control – space for compromise appears slimmer. Moscow rejects Tbilisi’s demand that Georgian authorities exercise all passport and customs control, which in effect would undermine Russia’s recognition of the breakaway territory’s independence. Presumably, the de facto South Ossetian authorities also would protest were Moscow to consent to such measures.[fn]In July 2017, after talks at the Russian foreign ministry, Dmitry Medoev, the de facto foreign minister of South Ossetia, said Tskhinvali would insist on “equal participation” in the transit project. His statement at the press conference starts at 7:01 in the YouTube video “Пресс-конференция по итогам переговоров Д.Н. Медоева и С.В. Лаврова” [Press conference about results of negotiations between D.N. Medoev and S.V. Lavrov], 11 July 2017.Hide Footnote In turn, Tbilisi opposes having de facto officials conduct “passport control” or collect what they might call “customs fees”. It sees both activities as legitimising South Ossetia’s claim to statehood and strengthening its administrative capability.[fn]Crisis Group interviews, Georgian government representatives, May, July and December 2017.Hide Footnote In other words, a deal that is potentially beneficial to all sides thus far has run aground due to all sides’ reluctance to compromise on any step that might influence South Ossetia’s eventual political status.

One provision of the 2011 agreement related to passport and customs control reportedly has proven especially challenging. This provision requires the incorporation of the corridors into the “respective national law by the national customs officials” of the signatory countries.[fn]Annex I to the 2011 agreement, p. 8.Hide Footnote After the 2011 agreement’s conclusion, however, Georgian legislators made no changes to their laws on the breakaway regions. The Georgian position is thus based on the 2008 Law on Occupied Territories, legislation that is not only restrictive but, because of the enormous sensitivity on the breakaway regions in Tbilisi, a political minefield to reform.[fn]Crisis Group interviews, Georgian officials, politicians and analysts, 2017.Hide Footnote For its part, Russia, seeking to enhance its control over Abkhazia and South Ossetia, signed strategic treaties with each in 2014-2015, linking them to substantial aid packages for the breakaway regions. It also adopted two separate packages of laws in the sphere of customs. These include provisions that not only ignore the corridors but actually make their implementation more complicated, by defining closer cooperation with Abkhazia’s customs office and a full integration with the South Ossetian customs office by 2020.[fn]Russia signed the Alliance and Strategic Partnership Treaty with de facto Abkhazia in November 2014, and the Friendship, Cooperation and Mutual Assistance Treaty with de facto South Ossetia in March 2015.Hide Footnote

At first, no way out of the impasse was evident. One Georgian participant in the talks, convinced in the summer of 2017 that the process was futile, said, “we are just counting down the clock” until the end of meetings.[fn]Crisis Group interview, Georgian official, July 2018. In 2013 the Georgian parliament tried to adopt a number of amendments to the Law on Occupied Territories to introduce milder punishments for those illegally crossing Abkhaz and South Ossetian sections of Georgia’s state border with Russia. But even that small step proved too contentious: parliament was forced to suspend deliberations due to opposition protests and discord in then-President Mikheil Saakashvili’s cabinet. The amendments stipulated lesser punishments for illegal crossing of the state border. See “Bill partially decriminalizing illegal entry in breakaway regions passed with first reading”, Civil.ge, 18 May 2013.Hide Footnote But after nearly eleven months of intense talks, in December 2017, Georgia unexpectedly signed its contract with SGS – though Georgian negotiators had not reached agreement with their Russian counterparts on the thorny issue of passport and customs controls.[fn]Statement of the Georgian Foreign Ministry on the signing of a contract with the Swiss SGS Company, 19 December 2017.Hide Footnote

Some Georgian officials told Crisis Group that they were ready to continue talks over that question and other standing provisions necessary to make the corridor operational.

In May 2018, Moscow, too, announced that it had signed its contract with SGS, though whether this means it plans to advance implementation of the corridors is unclear – again, because the signing of the SGS contracts in itself does not resolve the question of passport and customs control.[fn]О подписании российско-швейцарских документов” [About signing Russian-Swiss documents], Ministry of Foreign Affairs of the Russian Federation, 19 May 2018.Hide Footnote Some Georgian officials told Crisis Group that they were ready to continue talks over that question and other standing provisions necessary to make the corridor operational. Their only concern was the potential politicisation of these issues in Moscow and Tskhinvali, or by the Georgian opposition, which could derail the talks.[fn]Crisis Group interview, Georgian official, May 2018.Hide Footnote The de facto South Ossetian leadership was quick to state that it expected its interests to be protected in any talks.[fn]Цхинвал: транзитный коридор заработает только при учете интересов Южной Осетии” [“Tskhinval: the transit corridor will start operating if only the interests of South Ossetia are taken into account”], RES, 21 May 2018.Hide Footnote

That Tbilisi and Moscow have signed contracts with SGS is significant, notwithstanding the issues still to be resolved. During a late December parliamentary hearing, Georgian Prime Minister Giorgi Kvirikashvili said the Georgia-SGS contract created space for activating trade corridors “in a force majeure situation”.[fn]PM Kvirikashvili on Geneva talks upgrade, Georgia-Russia trade monitoring agreement”, Civil.ge, 22 December 2017.Hide Footnote Moreover, Georgian procedures in accordance with the Law on Occupied Territories can be simplified in an emergency.[fn]Crisis Group interviews, current and former Georgian officials, November-December 2017.Hide Footnote Given the frequency of landslides and avalanches in the mountains along the Georgia-Russia border, such an occasion could feasibly arise at any point. The Georgian and Russian contracts with SGS increase prospects that the corridor through South Ossetia could come into being in such a situation; pressure from Russian and Georgian businesses could create incentives for the sides to find a way around the thorny issue of passport and customs controls. An emergency launch of the corridor might open the door to more permanent arrangements.

B. The DCFTA in Abkhazia

The second tentative trade project foresees offering the benefits of Georgia’s Deep and Comprehensive Free Trade Area (DCFTA) accord with the EU to Abkhaz businesses and consumers. In 2014, Georgia signed the EU Association Agreement, which came into force in 2016. The DCFTA is a part of that agreement; it gradually introduces free trade between the EU and Georgia but does not currently apply to the breakaway republics.[fn]Article 429 in EU/Georgia Association Agreement, signed in June 2014 and came into force in July 2016.Hide Footnote There are tentative discussions, however, about opening the agreement to businesses in Abkhazia. EU representatives visited Sukhumi twice in 2017 to discuss how such an arrangement might work.[fn]Crisis Group interviews, EU officials, July and December 2017.Hide Footnote If at some point Sukhumi wants to use the opportunities the DCFTA offers, European officials are prepared to mediate direct talks between it and Tbilisi.[fn]Ibid.Hide Footnote

In a separate development, the Georgian government has recently revealed a package of legislative initiatives that, if enacted, would facilitate Georgian engagement with populations living in the de facto entities.[fn]‘A Step to a Better Future’: Peace Initiative, Facilitation of Trade Across Dividing Line”, Office of the State Minister of Georgia for Reconciliation and Civic Equality, 2018.Hide Footnote These initiatives include provisions that might in practice facilitate the extension of DCFTA benefits, though this is still far off. That the engagement foreseen under these initiatives would primarily proceed via Tbilisi is anathema to the Abkhaz, who thus far have rejected it.

The main obstacles to the DCFTA offer are political: in Sukhumi, the extreme sensitivity for Abkhaz leaders or businesses of engaging with Georgian authorities, which would be necessary to arrive at any deal, and their likely rejection of any step that could set back Abkhazia’s independence bid; and in Tbilisi, the resistance to any concession to the breakaway republic perceived as improving prospects for its independence.

The political challenges – particularly those related to sensitivity about Abkhazia’s eventual status – complicate a number of technical EU requirements that would have to be met for the region to benefit from the DCFTA. For European officials, the three most important of these technical criteria are:

  • Local products would have to have Georgian certification of origin. To many in Sukhumi any such formal subordination to Tbilisi is a non-starter. Options that are “status-neutral” are, however, quietly being explored by Europeans, Abkhaz and Georgians. Abkhaz producers might, for instance, apply locally for a certificate of origin of goods with a code identical to the code assigned to Georgian goods, while listing an Abkhaz town, rather than Georgia, on the packaging as the place of origin. The parties also would need to agree on the institution that would issue certificates; options could include third parties, for instance an international company.
  • The goods would have to meet European quality standards, requiring inspection and certification. One option that could circumvent status dilemmas would be to make Abkhazia’s Chamber of Commerce – a non-governmental body – the authority responsible for certification rather than empowering an Abkhaz government institution to fulfil that role.
  • Abkhaz de facto authorities would have to ensure unencumbered and regular verification of compliance with whatever procedures are agreed for issuing certificates. Since, first, Georgians have limited access to Abkhazia and, second, Sukhumi would not accept Tbilisi’s verification, independent experts, such as an EU-certified foreign company, could undertake this role.[fn]This list of requirements is based on Crisis Group interviews and discussions with European officials and experts in August-September and December 2017.Hide Footnote

Sukhumi authorities have not yet taken a position on any of these issues. Their meetings about trade with European officials are strictly confidential. Any public stance Abkhaz politicians do take is likely to be negative, though behind closed doors some members of the political and business elite appear more pragmatic.[fn]Crisis Group interviews, Abkhaz officials, businessmen and analysts, August 2017.Hide Footnote

As a model, some European and Georgian officials have considered another de facto republic in the post-Soviet space, Transdniestria, which declared independence from Moldova in 1991. No UN member state recognises the Transdniestrian claim, not even Russia, with which the de facto republic shares no border. But Transdniestria does trade actively with Moldova and, through it, the EU. Had Transdniestrian business elites refused to adhere to the requirements of Moldova’s 2014 Association Agreement with Europe, including the DCFTA (during negotiations for which Transdniestrian representatives were present as observers) they would have forfeited access to a large market. In other words, economic motives were paramount: benefiting from the DCTFA allowed Transdniestria to increase its GDP by 3.6 per cent rather than watch it decline by an estimated 5.2 per cent.[fn]The Impact of the EU-Moldova DCFTA on the Transnistrian Economy: Quantitative Assessment under Three Scenarios”, Berlin-Economics, 2013.Hide Footnote Those same motives arguably informed Moscow’s decision not to object when Transdniestria accepted DCFTA conditions.[fn]In 2015, with the mediation of European diplomats and trade specialists, Moldova and Transdniestria managed to compromise to meet requirements for connecting the region to the DCFTA. From the beginning, politics were put aside when discussing technical details of new trade prospects. Crisis Group interview, European expert, September 2017. As a result, all negotiators and mediators agreed on the Trade Road Map (the official title is “Action Plan on Implementing Measures on Facilitation of Trade with the European Union”), which lays out the schedule for attaining the norms necessary to ensure free trade. The Trade Road Map provides expert European assistance to the de facto authorities in carrying out a number of reforms in certification, customs control and quality control (Crisis Group was allowed to read a copy of this document). The Map “is a good prospect for cooperation”, said a European expert. “It is reintegration [with Moldova] through the back door”. Crisis Group Skype interview, September 2017. One European diplomat said the Transdniestrian de facto authorities kept a line open to Moscow when in talks with Moldova, but the EU discussed the DCFTA with the Russian authorities only when all the details had been clarified between Moldova and Transdniestria. Crisis Group interview, Brussels, January 2018.Hide Footnote

Transdniestria is an unlikely model for the Georgian breakaways.

But Transdniestria is an unlikely model for the Georgian breakaways. Moscow recognizes Abkhaz and South Ossetian independence, which raises the stakes for all parties concerned. The breakaway republics’ status thus overshadows any discussion among Abkhaz, South Ossetians, Georgians and Russians, even on humanitarian issues. Abkhazia and South Ossetia also border Russia, their main political, security and economic guarantor. They have less trade with EU countries and produce less than Transdniestria, which is heavily industrialised, so the economic incentives are smaller. For Abkhazia in particular, its commitment to its independence and the grievances on both sides related to the conflict pose a serious obstacle to its joining the DCFTA or any projects that imply Tbilisi exercising sole control.

Even before EU officials started their quiet talks with Sukhumi on the DCFTA, the Georgian government launched preparations for its own package of initiatives and legislative changes related to Georgian engagement with the Abkhaz and South Ossetian populations (the package of laws is explored in more depth in section IV). Presented in April 2018, it has a strong emphasis on facilitating trade.[fn]‘A Step to a Better Future’: Peace Initiative, Facilitation of Trade Across Dividing Line”, Office of the State Minister of Georgia for Reconciliation and Civic Equality, 2018.Hide Footnote Some of the officials involved with the initiative cite the Transdniestria model, which allows Transdniestrian businesses to develop trade with the EU by registering companies on territory controlled by Moldova.[fn]Crisis Group interviews, Georgian officials, May and December 2017.Hide Footnote The initiative floats the idea that Abkhaz businesses could apply for registration in Georgia proper and thus benefit from the DCFTA. Thus far, however, the Sukhumi authorities reject both that idea and the broader package of initiatives, which they do not see as genuinely status-neutral.[fn]Sokhumi, Tskhinvali authorities reject Georgian government’s peace initiative”, Civil.ge, 6 April 2018.Hide Footnote

IV. Restraints and Policy Options

In principle, some incentives exist for all sides to reach deals – on the South Ossetian corridor and the DCFTA extension to Abkhazia businesses – that could work to all their benefits. First, the breakaway regions need the economic dividends such agreements would bring. The main source of their budgets is financial aid from Russia, yet over the period 2012-2016, Russian inflows have dropped by almost half (see graphs below). While the de facto authorities’ red line on any step that could influence their final status remains unchanged, the economic decline has nudged them to seek new ways to generate revenue.

On the South Ossetia corridor, the Tskhinvali leadership has a strong interest in making it work as a way of resuscitating economic activity in the region and raising money for its budget. Russia, too, is in principle keen to launch the corridor to support increasing trade with Armenia. That said, neither Moscow nor Tskhinvali want the corridor so badly as to agree to measures that could undermine the breakaway region’s prospects for independence.

Some incentives exist for all sides to reach deals – on the South Ossetian corridor and the DCFTA extension to Abkhazia businesses – that could work to all their benefits.

Abkhazia’s inclusion in the DCFTA is more complicated. The question of cooperation with Georgia is highly sensitive in Sukhumi. Abkhaz leaders would risk talks with Georgian officials over free trade with the EU only if they saw a real prospect for mechanisms that are genuinely status-neutral.[fn]Crisis Group interviews, former de facto Abkhaz officials, August 2017.Hide Footnote Russia does not see prospects for an increase in trade and contacts between Sukhumi, Tbilisi and the EU as realistic; as a result, it has thus far taken a hands-off approach. For Georgia, economic incentives for introducing either the South Ossetia corridor or the DCFTA extension to Abkhazia, are less clear, but both initiatives could help develop bilateral contacts between the breakaway republics and Tbilisi. For pragmatism to prevail, leaders on all sides must see that gains from formalised trade outweigh the risks and explain the potential benefits to their respective societies.

A. Continuing Georgia-Russia Talks on the South Ossetia Trade Corridor

Unlike Abkhazia, South Ossetia has few natural resources and no tourism or other industry. The budget is composed mostly of dwindling Russian transfers. Facing this reality, Anatoly Bibilov, president of the de facto republic, has expressed readiness to open access through the territory, including to truck drivers with Georgian surnames – a step that is extremely unpopular among South Ossetians.[fn]See, for example, “Сто дней, уместившиеся в полтора часа” [“The hundred days that lasted an hour and a half”], Radio Free Europe/Radio Liberty “Ekho Kavkaza”, 28 July 2017.Hide Footnote Transit trade could bring substantial cash flows to the region.[fn]In the early 2000s, the transit of goods from South Caucasus countries to Russia supplied a significant portion of the revenue in the de facto South Ossetian budget.Hide Footnote

Moscow, too, would stand to gain from a trade corridor. In 2016-2017, trucks travelling between Armenia and Russia made up more than half of the total of those crossing the Georgia-Russia border.[fn]In 2016, 51,134 of 92,018 trucks crossing the Georgian-Russian border were going between Russia and Armenia. In January-September 2017 that proportion was 53,179 of 103,918 trucks. Crisis Group email correspondence, Georgian Revenue Office, November 2017.Hide Footnote For Russia and its ally, Armenia, the economic benefit of opening the route through South Ossetia would be significant, though Moscow also needs to consider Baku’s sensitivities. On the Georgian side, many politicians in Tbilisi voice strong opposition to any concession to South Ossetia; some argue that Georgia should not compromise for a deal that in their view serves Armenian, not Georgian, interests.[fn]Some also insist that the 2011 agreement did not cover transit, but that it was intended mainly to reinforce Georgia’s territorial integrity by establishing WTO-facilitated monitoring at the South Ossetian section of the Georgian border with Russia. Former Georgian foreign minister Grigol Vashadze, a member of the opposition United National Movement, voiced a similar criticism in a television interview. “ოკუპირებულ ტერიტორიებზე ტვირთების გატარების შეთანხმება – გარიგების დეტალები გასაიდუმლოებულია” [“Agreement for cargo transit through the occupied territories – details of the deal stay secret”], Rustavi 2, 27 December 2017.Hide Footnote Others, however, appear more pragmatic and believe the government should display greater flexibility.[fn]Crisis Group interviews, Tbilisi, 2017. For example, one former Georgian official said South Ossetian passport and customs controls are “non-existent” in Georgian laws, which could allow Tbilisi to turn a blind eye to the de facto operations. Crisis Group interview, Georgian former official, December 2017.Hide Footnote A deal on the corridor could work to Georgia’s advantage. It could help unlock the region, which has remained isolated since the 2008 war and highly dependent on Russia’s security support and anti-Western policy.

Whatever the benefits, the challenge of hammering out an agreement on the main sticking point of passport and customs controls remains. For Tbilisi – even for Georgian politicians more inclined to compromise – permitting Tskhinvali to open full-fledged customs posts is a non-starter.[fn]Crisis Group interviews, Georgian officials, Tbilisi, December 2017.Hide Footnote Nor will Georgia tolerate passport inspection by the de facto authorities in South Ossetia. Georgian officials believe that even tacit consent to such measures would bolster South Ossetia’s claim of sovereignty. In turn, Moscow will not undermine its key foreign policy principle in the region – the recognition of Abkhaz and South Ossetian independence – to do so.[fn]Crisis Group interviews, well-connected Russian analysts, Moscow, January 2018. In an interview, Grigory Karasin said Russia was preparing to sign the SGS contract. According to Karasin, the corridors are to open despite political disagreements between Russia and Georgia. “Мы хотим восстановления добрососедства с Грузией, но не за счет интересов Абхазии и Южной Осетии” [“We want to restore good neighbourly relations with Georgia, but not at the expense of the interests of Abkhazia and South Ossetia”], Kommersant, 25 January 2018.Hide Footnote It will compromise only if Tbilisi does, too.[fn]Григорий Карасин: Киев отводит миротворцам ООН в Донбассе роль «оккупантов»” [“Grigory Karasin: Kiev sees ‘occupiers’ in UN peacekeepers in Donbas region”], RIA Novosti, 10 October 2017). Some Russian diplomats see geopolitical implications in the uncompromising Georgian position. One said the U.S. was pressuring Tbilisi not to open corridors, so as to hamper the potential increase in Russian-Iranian trade. A U.S. diplomat said it was a sovereign Georgian decision. Crisis Group interviews, December 2017.Hide Footnote Similarly, South Ossetian leaders are likely to resist any measures that could impact the breakaway region’s eventual status, whatever the economic benefits.

Russian financial assistance to Abkhazia (in million USD) Including budget transfers and pension payments to residents with Russian citizenship
Russian financial assistance to South Ossetia (in million USD) Including direct budget transfers only

In discussions with Crisis Group, Georgian and de facto officials and businessmen have identified two ways to break the deadlock. A first option would involve Russia and Georgia hiring a private company to collect customs fees. This company might also arrange security for freight convoys traversing the breakaway region so that neither South Ossetian or Russian security forces would have to do so.[fn]Crisis Group interviews, Georgian and de facto officials and businessmen, Tbilisi, Skype calls, July, September and November 2017; February and May 2018.Hide Footnote The contracts Russia and Georgia sign with this company could set terms for transferring customs revenue to the de facto authorities. This would offer South Ossetia economic benefit without allowing it either to take measures, like stamping passports or customs documents or providing security, that are the preserve of states, or to develop administrative capability to perform such functions. Such an option is not discussed widely in Tbilisi, but some Georgian analysts quietly suggest it might be feasible.[fn]Crisis Group interviews, Georgian analysts, December and February 2018.Hide Footnote

A second option would involve transferring customs control fully to Russia.[fn]Crisis Group interview, high-level Georgian official, Tbilisi, August 2017.Hide Footnote In 2016, Moscow signed an agreement with Tskhinvali to fully integrate the de facto and Russian federal customs services by 2020.[fn]Соглашение между Российской Федерацией и Республикой Южная Осетия об интеграции таможенных органов Республики Южная Осетия с таможенными органами Российской Федерации” [Agreement between the Republic of South Ossetia and the Russian Federation on the Integration of the Customs Authorities of the Republic of South Ossetia with the Customs Authorities of the Russian Federation], 19 April 2016. In 2013, Russia signed agreements with Abkhazia allowing Russia to open customs offices anywhere on its territory.Hide Footnote Georgia does not recognise this agreement, but some officials in Tbilisi – albeit a tiny minority – express the view that since Russia is the occupying power, it might as well assume responsibility for customs.[fn]Crisis Group interviews, Tbilisi, August 2017.Hide Footnote

For now, neither Georgia nor Russia have published their contracts with SGS, and those contracts’ provisions remain confidential. But, as described, the contracts do appear at least to open the possibility of operating the corridors in emergencies. All sides would still need to get around the issue of customs and passport control, but perhaps in an emergency the urgency for Russian businesses and Armenia to open a transit route would be so great that Moscow might persuade the South Ossetian de facto authorities to forego their own customs procedures – a long shot but one that cannot entirely be ruled out. In the meantime, Georgia and Russia should continue their talks on how trade through the corridor might work in non-emergencies. No side should take any step that erects further obstacles to reaching an agreement. In particular, the South Ossetian de facto authorities should develop their own proposals for status-neutral economic exchanges and refrain from opening new customs offices at entrances to the corridor or along the conflict divide; Moscow should discourage them from doing so.

B. Direct Tbilisi-Sukhumi Talks on Economic Issues and the DCFTA

There have been no formal statements or decisions from Tbilisi, Sukhumi or the EU about reversing the earlier EU-Georgia agreement that the DCFTA would not be applied in the breakaway territories. In conversations with Crisis Group, de facto Abkhaz officials expressed cautious interest in the idea of extending the DCFTA but, despite the outreach by EU officials, lament the lack of information from the EU that Abkhazia would need for them to enter deeper talks. Both Tbilisi and Sukhumi share a common fear – that the other side will use the project for political gain, which would in turn expose them to domestic criticism.[fn]Georgia-related issues provoked two recent political crises in Abkhazia. In 2014 protests about illegal distribution of Abkhaz passports to the ethnic Georgian population led the de facto president to resign. In early 2018 there were larger protests, and a parliamentary investigation, over the de facto leader’s pardon of an ethnic Georgian prisoner.Hide Footnote

Abkhazia’s exports to Russia (2015-2017) Yearly average export (about 40 million USD) according to Russia’s Federal Customs Service

For their part, European officials are cautious not to step too far ahead of what allies in Tbilisi will support. The recent EU outreach to Abkhazia would likely remain symbolic if the de facto leadership tries to advance status-related issues in the discussions. “We want to avoid headlines that the EU intends to sign an agreement with Abkhazia”, said one European official. At the same time, that official suggested that the EU could help the Georgian and Abkhaz sides reach a compromise, including on documentation for products, as detailed in section III.B. “We can play with it”, the official said.[fn]Crisis Group interview, EU official, Tbilisi, August 2017.Hide Footnote

The recent EU outreach to Abkhazia would likely remain symbolic if the de facto leadership tries to advance status-related issues in the discussions.

In principle, Abkhaz de facto officials would welcome discussions over trade with the EU. But their primary concern lies in the political ramifications. A number of high-ranking Abkhaz are worried about the EU’s unequivocal support for Georgia’s territorial integrity, and they are adamant that trade cooperation not be a way to return the breakaway republic to Tbilisi’s fold.[fn]Crisis Group interviews, Abkhaz officials, Sukhumi, August 2017.Hide Footnote The intense political sensitivities also mean that even those Abkhaz businessmen who may be interested in developing such business links will make no move without consent from the top. “Our competitors will destroy us in a moment”, said one hazelnut exporter. “We need an okay from the authorities; otherwise, no way”.[fn]Crisis Group interviews, entrepreneurs in Abkhazia, August 2017.Hide Footnote

As for Russia, in initial unofficial conversations between Russians and Abkhaz that broached the topic of the DCFTA extension, the Kremlin – according to Abkhaz officials – reportedly showed no resistance to the continued visits of the EU officials to Abkhazia and their meetings there.[fn]Crisis Group interviews, Abkhaz officials, Sukhumi, August 2017.Hide Footnote Moscow apparently sees the extension as too unrealistic and remote a prospect to be worth worrying about: Abkhazia has insignificant export potential, and talks with Georgia and the EU may take years before real trade starts.[fn]Crisis Group interviews, European and Russian officials and analysts, April 2018.Hide Footnote They also note that the development of local commerce might lift some of the Russian burden in sustaining Abkhazia financially.[fn]Crisis Group interviews, Russian officials, Moscow, April 2018.Hide Footnote

Overall, the Abkhaz are more interested in exploring the deal’s potential for importing European goods to the breakaway territory than for exporting Abkhaz goods or produce to Europe. For the moment, export potential is low, and entrepreneurs have even less to export that meets EU standards. That said, Abkhaz businessmen are keen on getting access to foreign investment, for example in loсal agriculture, that could increase potential for export. They also may be ready to invest in new standards of production and registration, were EU markets to open up. Europeans are considering such investment and have started conversations about it with Tbilisi, where this issue is sensitive.[fn]Crisis Group interview, European official, December 2017.Hide Footnote Tbilisi and Brussels would have to fit it into the framework of the EU’s existing non-recognition and engagement policy toward the breakaway republics. Among other things, they would have to find a way to ensure that trade between Abkhaz and EU firms, or investment in Abkhazia, would not be subject to sanctions under Georgian legislation but would be status-neutral enough to work for the Abkhaz. Authorising the movement of goods by sea and over land from Russia, as well as banking and other activities tied to trade, would also be necessary.[fn]Crisis Group interviews, entrepreneurs in Abkhazia, August 2017.Hide Footnote

The Abkhaz are more interested in exploring the deal’s potential for importing Eu-ropean goods to the breakaway territory than for exporting Abkhaz goods or pro-duce to Europe.

For Georgia, the political hurdles are just as challenging. Extending the applicability of the DCFTA to Abkhazia would almost certainly require, like the establishment of the South Ossetian corridor, amendments to the 2008 Law on Occupied Territories, to open more prospects for investment, financial and other trade-related operations. Indeed, the Association Agenda between the EU and Georgia – the roadmap for reform within the framework of the Association Agreement – refers to the need to review that law “to promote trade, travel and investment across the administrative boundary lines”.[fn]“Association Agenda between the European Union and Georgia 2017-2020”, p. 26; “Association Agenda between the European Union and Georgia 2014-2016”, p. 10.Hide Footnote But the Georgian government stresses that this rule is non-binding and, according to officials, sees no reason to change the law until it feels a “real need”.[fn]Crisis Group interviews, Georgian officials, Tbilisi, November 2017.Hide Footnote Its resistance to reviewing the law has been backed by politicians across the political spectrum, most of whom fear that Russia might exploit any softening of the law to reinforce its “occupation” of Abkhazia and South Ossetia. In interviews with Crisis Group, only a handful of ruling-party politicians acknowledged the need to amend the law so as to promote cooperation with people from the breakaway regions.[fn]Crisis Group interviews, Georgian politicians and analysts, April, May, July-August, November-December 2017.Hide Footnote

Parallel – but unrelated – to the EU’s quiet diplomacy with Abkhazia on the DCFTA extension, in early April 2018, the Georgian government presented a package of initiatives and legislative changes that lays out options for trade in goods across the conflict divide.[fn]“‘A Step to a Better Future’: Peace Initiative, Facilitation of Trade Across Dividing Line”, Office of the State Minister of Georgia for Reconciliation and Civic Equality, 2018.Hide Footnote The initiative invites businesses from the breakaways to apply in Georgia proper for an identification number, which would allow them to sell their products both in Georgia-controlled territory and abroad. They can also apply for tax breaks and investment funds. All trade is to take place in a special zone near the checkpoint at the Inguri bridge, which will start functioning after the Georgian parliament approves a number of amendments and the president signs the bills into law. The draft initiatives propose some limited amendments to the Law on Occupied Territories regarding local trade, but they leave in place the current regulations for economic activity in the breakaway regions. In other words, foreign companies still will need to apply for the Georgian government’s special permit to conduct trade legally in Abkhazia and South Ossetia.[fn]Footnote number 5 in “‘A Step to a Better Future’: Peace Initiative, Facilitation of Trade Across Dividing Line”, op. cit.Hide Footnote

The package of initiatives is currently being debated in parliament, where a range of political parties has expressed support.[fn]Crisis Group interviews, government officials and parliamentarians, Tbilisi, May 2018.Hide Footnote A number of Georgia’s Western allies have also backed the package for being the first clear proposal for engagement in the last five years.[fn]United States welcomes govt’s peace initiative”, Civil.ge, 4 April 2018; “European Union: Georgian govt’s peace initiative ‘can benefit citizens’”, Civil.ge, 4 April 2018; “Four more countries welcome Georgian government’s peace initiative”, Civil.ge, 5 April 2018; “Polish Embassy welcomes govt’s peace initiative”, Civil.ge, 6 April 2018.Hide Footnote The Abkhaz, however, were quick to denounce it, saying that no representative of the de facto leadership took part in discussions of the proposed package.[fn]Crisis Group interviews, Sukhumi, Tbilisi and Brussels, March 2017-April 2018.Hide Footnote Sukhumi received a short description of the proposed package about a month before it was made public and some informal conversations took place between Georgian and Abkhaz interlocutors in the margins of ongoing track two initiatives.[fn]Crisis Group interview, foreign diplomat, Tbilisi, March 2018.Hide Footnote From Abkhazia’s perspective, however, the proposals fail to consider its main interests – access, not under Tbilisi’s tutelage, to cheaper imports and more funds for its shrinking budget. Russia’s Ministry of Foreign Affairs has not formally reacted to the package of legislative changes, but a spokesperson did say that, by proposing residents of the breakaway regions go through status-neutral registration of their companies, Tbilisi was acknowledging that they are not Georgian citizens.[fn]Foreign Ministry’s Spokesperson Maria Zakharova’s answers to Dozhd television channel’s questions on the state of Russian-Georgian relations, Ministry of Foreign Affairs of the Russian Federation, 22 April 2018.Hide Footnote

Sukhumi should develop its own status-neutral proposals to contribute to discussions of economic issues. Tbilisi and Sukhumi should consider setting up a direct discussion channel to focus on status-neutral approaches to economic and trade issues. Practical elements of both Tbilisi’s current and Sukhumi’s potential proposals could inform such confidential discussions between them, with some engagement by the EU, on economic issues and the DCFTA. Were Tbilisi prepared to offer a direct discussion with Sukhumi authorities, that could discourage them from penalising local businesses willing to take advantage of the Georgian offers and access to European markets.[fn]Crisis Group interviews, EU officials, December 2017.Hide Footnote Such meetings might allow the sides to discuss options for meeting the requirements of EU regulations. The dialogue should also reflect the interests of businesses already engaged in informal trade across boundary lines and with foreign companies. It could also broaden the existing possibilities for opening up the breakaway region. While talks inevitably will be sensitive – and keeping them under wraps is essential – in themselves they do not necessarily imply concessions on status or future formats of potential engagement. Exploratory consultations could help both sides understand which issues they can agree on quickly and which should be deferred.

V. Conclusion

Since the 2008 war, Georgia and the breakaway republics have lived in relative stability, though the conflicts that have divided the region since the early 1990s remain intractable and Russia’s presence in Abkhazia and South Ossetia has steadily increased. Disagreements over the breakaway regions’ political status will not be resolved anytime soon. But that has not stopped Georgian, Abkhaz and South Ossetian entrepreneurs from exploring avenues for informal commerce. Given the scarcity of ties across the conflict divides, this trend is positive. But it brings risks. Because it is informal, trade has fed corruption. Moreover, absent formal arrangements between Tbilisi and Sukhumi and Tskhinvali, the growth in trade can only go so far.

If pragmatism wins out, trade might promote reconciliation in this part of the Caucasus and reduce the chances of future deadly conflict.

That said, seeking to formalise trade also could be risky. Because political sensitivities are so acute, any attempt to reach such deals could fall apart, fuel greater animosity and lead both sides to clamp down on the informal trade that already takes place. Overall, however, the potential benefits of pushing for some formal agreement outweigh the costs. Increased attention to two formal trade projects – the South Ossetia transit corridor and the DCFTA applicability to Abkhaz businesses – comes as de facto authorities are seeking new ways to generate revenue and diversify links with the outside world. For the first time in ten years, Tbilisi has a genuine opportunity to establish direct contacts with Sukhumi and Tskhinvali on substantive issues, even beyond trade, that are of interest to all.

Exploring such channels will not resolve the conflicts. But doing so might help build relations between Tbilisi and the breakaway regions, improve the lives of inhabitants of those regions and those living in Georgian-controlled areas nearby, and even open a channel to address other sensitive issues. If pragmatism wins out, trade might promote reconciliation in this part of the Caucasus and reduce the chances of future deadly conflict.

VI. Appendix A: Data Research Methodology

This section provides details on the data included in the report and context for understanding it.

Data collection methods

Figures for Russian assistance and pension payments have been extracted (or extrapolated) primarily from official Russian sources, and then checked against data published in local media in the de facto entities or mentioned by authorities in Sukhumi and Tskhinvali. The archives of websites related to these territories, including the websites of local news agencies and de facto authorities, have been text-mined in order to parse them using relevant keywords and to find additional references and data points.

Data on the budgets of the de facto states and Russian assistance are based on figures published by the respective authorities after budget revision, which usually happens months after the end of a given year.[fn]For example, Russia’s federal budget for 2016 was approved in its final version only in September 2017. Implemented budgets of the Russian Federation are available online on the website of Russia’s treasury. See more at “Федеральный бюджет” [Federal Budget].Hide Footnote Accordingly, as of this writing, only the data through 2016 can be considered final. Figures for subsequent years are based on the official projected budgets.

Currency issues

Data on Russian assistance to Abkhazia and South Ossetia are published in U.S. dollars. Because the ruble lost nearly half its value against the U.S. dollar between 2013 and 2016, presenting data in rubles would have provided a misleading picture, as the figures would have hidden the decrease in purchasing power. Inflation figures calculated by Russia’s statistical office confirm a substantial decrease in the ruble’s purchasing power during the period under analysis: as of 2016, on average, 162 rubles were needed to buy what would have cost 100 rubles in 2010.[fn]See the World Bank’s indicator “Consumer price index (2010 = 100)”.Hide Footnote In other words, if Russia had kept constant its level of budget assistance to Abkhazia in line with its own inflation statistics, it would have offered 8 billion rubles in 2016 to match the 5 billion rubles it transferred in 2010.

For consistency and clarity, however, all other graphs and figures included in this report have been presented in US dollars only. This choice reflects the impact of currency volatility and points at overall trends of decreasing purchasing power felt by both authorities and residents of these territories.

Russian transfers to Abkhazia and South Ossetia – in billion RUB

Direct budget assistance

Russia began to provide assistance to Abkhazia and South Ossetia after recognising their independence in 2008. Before that, the budgets available to the de facto authorities were tiny, as a consequence of both limited economic activity and fiscal capacity.

Abkhazia’s budget expenditure (in million USD) According to Abkhazia’s statistical yearbook and budget plans for recent years

Moscow’s budgetary assistance to authorities in Sukhumi and Tskhinvali is transferred in two ways: an investment program and socio-economic development aid.[fn]The exact labelling of the two components in the official budget of the Russian Federation has changed slightly over the years, yet the components have remained separate and distinguishable.Hide Footnote Both tranches of money enter the budgets of the de facto authorities, but they are not fully under the entities’ control, as related expenditures are also formally agreed upon jointly with Russia through a dedicated inter-governmental commission and other mechanisms.

The investment program is mainly focused on building and renovating infrastructure. For the period 2017-2019, for example, Abkhazia’s investment program lists renovation of roads and repair of electricity and water distribution networks, as well as construction of kindergartens and schools.[fn]Abkhazia has published a detailed table of the construction works to be financed. See “Инвестиционная программа содействия социально-экономическому развитию Республики Абхазия на 2017-2019 год” [“Investment Program to Support the Socio-economic Development of the Republic of Abkhazia in the Years 2017-2019”], Abkhazia’s Ministry of Economy.Hide Footnote The program is agreed upon through a similar process in the case of South Ossetia. It includes construction of new housing and a park in Tskhinvali, as well as renovation of roads and the water distribution system.[fn]For more about planned projects in South Ossetia, see “Что из себя представляет новая Инвестпрограмма? 51 мероприятие за два года” [“What does the new investment program have to offer? 51 initiatives in two years”], Yuzhnaya Osetiya, 16 December 2017; “Новая Инвестпрограмма: что построят в Южной Осетии в 2018-2019 годах” [“The new investment program: what will be built in South Ossetia in 2018-2019”], Sputnik (South Ossetia), 19 December 2017.Hide Footnote

The socio-economic component goes to cover regular expenditures upon a range of government activities, including education, health and police protection. These expenditures are also made jointly with the Russian government. For example, in Abkhazia, starting in 2015, the salaries of public sector employees, including doctors and teachers, as well as the maximum number of employees in each of these professional categories, have been agreed upon bilaterally, and must be officially approved by the Russian government.[fn]For details, see “Распоряжения от 3 апреля 2015 года №591-р, №592-р” [Russian Federation’s Government Order 591-p, 592-p], 3 April 2015. Figures are updated yearly through similar decisions. See, eg, “Распоряжение Правительства Российской Федерации от 22.07.2016 г. № 1577-р” [Order of the Government of the Russian Federation 1577-p], 22 July 2016.Hide Footnote

Pension payments

Pensions for residents holding Russian citizenship have represented an important source of income for thousands of households in Abkhazia and South Ossetia since well before 2008. Thousands of elderly residents have been receiving pensions through the office of the Russian pension fund closest to the border (in the Russian towns of Adler, for Abkhazia, and Alagir, for South Ossetia).

Only starting in 2012 were recipients of Russian pensions living in Abkhazia asked to update their residency status with an Abkhaz address,[fn]Жители Абхазии, получающие российские пенсии, будут зарегистрированы по месту фактического проживания в республике” [“Residents of Abkhazia receiving Russian pensions will be registered in their actual place of residence inside the republic”], Apsny Press, 4 May 2011.Hide Footnote and until 2014 they continued receiving pensions that on average were about 40 per cent lower than in the neighbouring Southern Federal district of Russia.[fn]Пенсии живущих в Абхазии россиян станут выше” [“Pensions of Russians living in Abkhazia to grow”], Parlamentskaya Gazeta, 25 December 2015.Hide Footnote In line with article 15 of the Treaty on Alliance and Strategic Partnership between Russia and Abkhazia, and the ensuing implementation agreement,[fn]Договор между Российской Федерацией и Республикой Абхазия о союзничестве и стратегическом партнерстве” [Treaty between the Russian Federation and the Republic of Abkhazia on Alliance and Strategic Partnership], 24 November 2014; “Соглашение между Российской Федерацией и Республикой Абхазия о пенсионном обеспечении граждан Российской Федерации, постоянно проживающих в Республике Абхазия” [Agreement between the Russian Federation and the Republic of Abkhazia on provision of pensions to citizens of the Russian Federation, who are permanent residents of the Republic of Abkhazia], 14 April 2015.Hide Footnote all residents of Abkhazia receiving a Russian pension below the average level recorded in the Southern Federal District were due to see it grow between 2015 and 2018.[fn]As a consequence of this agreement, about 29,000 pensioners in Abkhazia (out of a total of about 32,000 who receive a Russian pension) had their pensions increased. See “Сурен Керселян: доплату к российской пенсии в РА получат 29 тысяч 147 человек” [“Suren Kerselyan: 29,147 people in Abkhazia to receive increase in their Russian pension”], Apsny Press, 17 February 2016. According to Abkhazia’s statistical yearbook, as of 2016 there are in total 50,400 pensioners living in Abkhazia.Hide Footnote The steep increase in payments determined by these agreements has largely counterbalanced the drop in the exchange rate; as a consequence, the estimated total expenditure of the Russian pension fund directed to residents of Abkhazia has remained broadly stable in recent years.[fn]The Russian pension fund does not publish total figures for all years, but it is possible to extrapolate relevant figures from other official sources. The data presented in the graph are based on total figures quoted by Abkhazia’s authorities in 2012, on official total figures published by the Russian side in 2015, and on official data regularly published by the Russian pension fund on the total number of Abkhaz residents receiving a Russian pension, as well as on the average change of pensions in the Russian Federation and details on the increase in the component dedicated to residents of Abkhazia included in official negotiation documents as well as in the Russian federal budget. See “В Абхазии проведут параллельную перерегистрацию пенсионеров, получающих российские и абхазские пенсии” [“Parallel re-registration of pensioners receiving Russian and Abkhaz pension to take place in Abkhazia”], Apsny Press, 6 November 2012; “Пенсии живущих в Абхазии россиян станут выше” [“Pensions of Russians living in Abkhazia to grow”], Parlamentskaya Gazeta, 25 December 2015; “Общая численность получателей российской пенсии, проживающих за границей” [Total number of people living abroad receiving a Russian pension], Russian Pension Fund, 10 November 2017.Hide Footnote

Total expenditure of the Russian pension fund in Abkhazia Estimates based on official sources, in million USD

It is more difficult to reach meaningful estimates regarding the total number of pensioners in South Ossetia, and how much exactly Russia is spending to support them, largely because a substantial number of them have yet to re-register in South Ossetia and are continuing to receive payments in Russia’s republic of North Ossetia, which does not figure in statistics.[fn]For example, when South Ossetia’s de facto prime minister Erik Pukhaev presented the latest increase in pensions for residents with Russian citizenship, he referred to the beneficiaries as “citizens of the Russian Federation residing in South Ossetia, with the exception of those citizens registered as residing on the territory of the Russian Federation.” See “Пенсии для граждан Российской Федерации, постоянно проживающих на территории Южной Осетии, будут повышены, – Эрик Пухаев” [“Pensions for citizens of the Russian Federation who are permanent residents of South Ossetia to be increased – Erik Pukhaev”], RES, 18 February 2016.Hide Footnote As of 2016, 646 people were registered in South Ossetia and receiving their pension directly from the Russian pension fund.[fn]See “Общая численность получателей российской пенсии, проживающих за границей” [Total number of people living abroad receiving a Russian pension], Russian Pension Fund, 10 November 2017.Hide Footnote Approximately 4,000 others were instdead registered with the pension fund of South Ossetia, receiving on average about $90 per month.[fn]See “Правительство Южной Осетии одобрило проект закона Республики «О бюджете пенсионного фонда Республики на 2016 год»” [“The government of South Ossetia has approved the draft law of the Republic ‘On the budget of the pension fund of the Republic for 2016’”], RES, 23 December 2015.Hide Footnote

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