Armenia and Azerbaijan facing growing economic, political and security risks as the Iran war enters its third week, according to a report published by Carnegie Endowment for International Peace.

The report, “Iran’s Northern Neighbors Are Facing Fallout From the War, Too”, said “the shockwaves are already racing across its northern frontier, placing Armenia and Azerbaijan on the front line of regional instability” as US and Israeli strikes on Iran intensify.

In Azerbaijan, tensions flared after “a drone launched from Iranian territory hit the airport and a school in its exclave of Nakhchivan” earlier this month, triggering a brief escalation in rhetoric between Baku and Tehran.

Despite the incident, the situation stabilised quickly following direct talks between leaders. The report, by Zaur Shiriyev, a nonresident scholar at Carnegie Russia Eurasia Center, noted that Azerbaijan’s response — seeking clarification rather than retaliation — was “clearly an attempt to keep the incident from spiraling”.

The vulnerability of the Nakhchivan exclave, which depends heavily on transit through Iran, has reinforced Baku’s cautious approach. While an alternative route through Turkey exists, it remains limited.

Economically, Azerbaijan could benefit from higher oil prices, with the report estimating that “a sustained $20–$25 rise in Brent crude would generate an annual export windfall of roughly $6bn to $7.5bn”. However, it warned that “the benefits come with costs”, including rising inflation driven by more expensive imports.

A longer-term concern for Baku lies along its 700-kilometre border with Iran, particularly the future of Iran’s large ethnic Azerbaijani population. The report stressed that these communities “are often misread by outsiders” and that while some fringe groups support secession or the regime, “they are not dominant”.

It added that “many view Iran as their own country and are represented across multiple levels of political, military, and economic decision making”, suggesting limited appetite for fragmentation unless there is a collapse of the Iranian state.

Such a scenario could prove destabilising, with the report warning it “would create new fault lines rather than resolve existing ones”, especially given overlapping claims by other ethnic groups such as Kurds.

For Armenia, the fallout presents a different set of challenges. Although it shares a short border with Iran, the report said a prolonged conflict would disrupt trade routes and push up costs, particularly along its southern corridor.

“While not instantaneous, a prolonged war would bring higher energy and import costs, reduced trade flows, and rising inflation,” it said.

At the same time, the crisis could drive closer regional cooperation. Energy links between Armenia and Azerbaijan may gain importance, potentially easing long-standing tensions.

Politically, the timing is sensitive, with Armenia heading toward parliamentary elections in June. The report said the conflict could reinforce Prime Minister Nikol Pashinyan’s strategy of cautious diplomacy and regional normalisation.

By avoiding direct involvement, the government may be able to “present its cautious foreign policy as effective and portray Armenia as carefully navigating the crisis”. The report also notes that pressure on Iran strengthens arguments in Armenia for reducing reliance on Russia, whose support has been limited.

Meanwhile, a prolonged conflict could delay key regional infrastructure plans, including a US-backed transit corridor linking Azerbaijan to Nakhchivan via Armenia. The report argues that “the project’s future — and much else in the South Caucasus — will hinge on developments inside Iran,” highlighting the region’s deep exposure to the evolving conflict.