Caucasus countries Georgia and Armenia, whose economies unexpectedly boomed in the wake of the war in Ukraine, are now facing the prospect of Western retaliation following a spike in trade with Russia.

The two former Soviet states near Russia’s southern border surged to double-digit growth last year as an uptick in Russian workers, wealth and trade supercharged their wider post-Covid recoveries.

Georgia’s economy grew 10.1% in 2022, while Armenia’s jumped 12.6%, according to International Monetary Fund data. In 2023, their growth is set to slow to around 4% and 5.5%, respectively, reflecting a general moderation across the wider Caucasus and Central Asia region, the U.N. agency said.

Still, analysts say the fundamental growth drivers “haven’t disappeared,” and could put those countries under the international spotlight.

“The reason we haven’t decelerated as much as we could have is that we took advantage of Russia being sidelined by the rest of the world,” Mikheil Kukava, head of economic and social policy at Georgian think tank the Institute for Development of Freedom of Information, told CNBC via zoom.

Western leaders have raised alarm bells this year that certain traders are using countries such as Armenia, Georgia, Kazakhstan and Turkey to evade sanctions on Russia.

In its latest economic outlook, the European Bank for Reconstruction and Development noted that such countries were becoming so-called intermediated trade partners for the isolated state.

“Exports from the European Union, United Kingdom and United States to Central Asia and the Caucasus [have] increased dramatically, hinting at the rise of ‘intermediated trade,’ whereby goods are being exported to Central Asian economies and are then sold onwards to Russia,” the EBRD said.

This year, Russia has emerged as Georgia’s second-largest trading partner by imports and its third-largest trading partner by exports, according to preliminary data from Georgia’s National Statistics Office, Geostat. Through 2022, Russian imports into the country rose 79%, while exports to Russia were up 7%.

Meantime, Russia is Armenia’s largest trading partner in terms of both imports and exports. Kyrgyzstan, Tajikistan and Azerbaijan, as well as other countries in the region, have also recorded a surge in trade with Russia over the past year, IMF data shows.

“Changing trade patterns in the region are an opportunity, but also a risk,” Subir Lall, the IMF’s deputy director of the Middle East and Central Asia, said during a briefing earlier this month.

Spokespersons for the Georgian and Armenian governments did not immediately respond to CNBC’s request for comment on the uptick, nor did they provide a breakdown of the specific goods traded with Russia.

However, Geostat data showed that cars, petrol and unspecified “other commodities” accounted for the vast majority of Georgia’s trade on a general basis. Of particular note, the number of vehicles, aircraft and vessels exported to Russia quadrupled in 2022 and is currently around double 2021 levels.

“I can’t remember a time when Russia was Georgia’s leading trading partner — both in import and export. Some items saw a 1,000% increase or 500% increase. That’s suspicious, right?” Kukava said.

“Even though there’s nothing illegal here — they’re not sanctioned goods — we suspect that it’s dual use items, like washing machines, that can be put to so many uses,” he added, who noted that the parts from such items could be repurposed in military and microchip products.

The burgeoning trade flows have prompted calls from the European Union and allied nations to either get such countries on board with sanctions, or slap those countries themselves with secondary sanctions.

A spokesperson for the European Commission, the EU’s executive arm, told CNBC that it is currently working to “spot the redirection of trade flows from certain third countries acting as possible gateways to Russia.”

That follows comments earlier this month from European Commission President Ursula von der Leyen, who said the group’s 11th package of sanctions against Russia would focus on “cracking down on circumvention” in coordination with Group of Seven nations.

The EBRD now estimates that such “intermediated trade” accounts for around 4-6% of annualized gross domestic product in Armenia and Kyrgyzstan. That, in turn, is boosting the countries’ “burgeoning logistics industries,” and underpinning the appreciation of local currencies, it said.

However, Armenia’s central bank Deputy Governor Armen Nurbekyan insisted that authorities are observing the country’s trade patterns on a weekly basis to ensure businesses are not falling foul of the embargoes.

“For Armenia, being compliant with the sanctions is an absolute priority,” Nurbekyan told CNBC. “We are in a region which is very turbulent, so we know what it means to be around countries which are under sanctions, and I think we have been quite successful in steering our economy in a way that we stay away from the problematic cases.”

Nurbekyan noted that trade increases had been seen “across the board” — including in food processing, agricultural goods, and cars — as domestic businesses have taken advantage of increased demand following the exodus of Western businesses from Russia.

He acknowledged that the percentage increase in demand for advanced technology parts, in particular, had been “quite big,” but said that was because levels had started from a low base.

“No one is so naive to assume that given the size of the sanctions, given the size of the flows, that anybody can avoid any risks. That is never the case. But our modus operandi is always that … we ensure that compliance in our financial institutions and more generally is of a higher standard [to other countries]. We not going to be opportunistic, in short,” he added.

Western allies have not yet specified what their next round of sanctions will look like, nor when they might come into effect. However, some analysts say that the prospect of them could push affected countries to rethink their allegiances.

“We need to wean ourselves off this dependence on the Russian economy,” Kukava said.

“This is a pariah country and economic dependence on them means we won’t be able to trade with the EU and the U.S. and the Western countries. The growth needs to come from trade with them, rather than with Russia,” he added.

That’s especially true for nations that aspire to EU and NATO membership.

Georgia applied for EU membership in March 2022, one week after Russia’s full-blown invasion of Ukraine, and is working toward candidate status. The country, alongside Ukraine, has declared its aspirations to NATO membership.

Georgian public support for EU membership has resurged over recent months, with four-fifths (81%) of the population currently in favor joining the bloc, according to a recent poll from U.S.-founded non-profit the National Democratic Institute. Three-quarters (73%) continue to support NATO membership.

Armenia, meanwhile, has never submitted an application for either membership, and other Central Asian countries would not be eligible to join the EU.

“We are adding fuel to the fire by intensifying this trade relationship with Russia. The geopolitical context with which we [Georgia] are now thought of is with other Central Asia countries. But they don’t have EU membership as a target — we do,” Kukava said.

https://www.cnbc.com/2023/06/07/georgia-armenia-economies-at-risk-over-russia-trade-sanctions.html