Business New Europe magazine August 2012

August 2012www.businessneweurope.eu

Inside this issue:

Russia's tech tycoon

A marathon race for Czech presidency

Romania's great survivor

Fear and loathing in Georgia

Special Report: Frontier Markets

NEW FRONTIERS,

OLD PROBLEMS

Contents I 3bne August 2012

Editor-in-chief:Ben Aris (Moscow) +7 9162903400

Managing editor:Nicholas Watson (Prague) +42 0731582719

News editor: Tim Gosling (Prague) +42 0720180811

Eastern Europe:Graham Stack (Kyiv) +7 9266052742

Central Europe:Robert Smyth (Budapest) +36 19995200Jan Cienski (Warsaw) +48 604994850Mike Collier (Riga) +37 129473192Matthew Day (Warsaw) +48 607291187Tom Nicholson (Bratislava) +42 1907732736Kester Eddy (Budapest) +36 308665550Steven Roman (Tallinn) +372 56665911

Southeast Europe:Justin Vela (Istanbul) +90 5393614470David O'Byrne (Istanbul) +90 5359210950 Bernard Kennedy (Ankara) +90 535 7485120Ian Bancroft (Belgrade) Bogdan Preda (Bucharest) +40 722580137Branimir Kondov (Sofia) Guy Norton (Zagreb) +38 513835929

Eurasia:Bureau Chief:Clare Nuttall (Almaty) +7 7073011495Molly Corso (Tbilisi)Oliver Belfitt-Nash (Ulaanbaatar) +97688113149

Advertising & subscription:Elena Arbuzova +7 9160015510 Business Development Director

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Alec Egan +44 2030516548Business Development Director (International)

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COVER STORY

The Insiders

New frontiers, old problems

Perspective

Chart of the month

EASTERN EUROPE

Russia's banking barbell

Russia's economy - hot or not?

Russia's tycoon of tech

Crunch time in battle for Russian gravel producer

Ukraine becomes First Family affair

Ukraine farming's flash online makeover

Lucas paradox redux

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CENTRAL EUROPE

A marathon race for the Czech presidency

Bidding hello to nuclear

Poland's demographic time-bomb

Storm clouds stack up over Budapest Airport

Latvia peers into the shadows

Big hopes in small town Latvia

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Print issue: ¤68 / year Basic online package: ¤180 p/user, p/year Full subscription package: ¤500 p/user, p/year

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How to invest in Eastern Europeand China

Rather than spending our time in an office, we travel around our region, meeting with over 1,200 companies a year. This tells us more about the markets than any index in the world ever could.

Read more about our award-winning funds at www.eastcapital.com.

Historic yields are no guarantee for future yields. Fund shares can go up or down in value, and investors may not get back the amount invested. Before investing, please read the prospectus carefully. Full information on East Capital’s investment funds such as the prospectus, simplifi ed prospectus and fi nancial reports can be obtained free of charge from East Capital, from our local representatives and are available on the website. Please also note that the funds, or some of the funds, may not be available for sale in your country.

EastCap_ENG_210x280_bne 2012.indd 1 2/10/2012 2:08:52 PM

Contents I 5bne August 2012

SOUTHEAST EUROPE

Romania's great survivor

Fool's gold

A sukuk from secular Turkey

A sea change in Sino-Serbia investment

Serbia's "coalition of nationalists"

Slovenia looks to fix banking Achilles heel

EURASIA

Untested coalition at testing times for Mongolia

Kazakh sukuk

Fear and loathing in Georgia

Not hated in Georgia

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OPINION

Terrorist attack puts Bulgaria in uncharted territory

SPECIAL REPORT

Ruro-zone

Keeping up with the Volga neighbours

Essential kit for the frontier market explorer

Teutonic deals in Mongolia

A prophecy of power

After the music stops in Azerbaijan

Food for thought in Azerbaijan

Sole miner in Tajikistan

Deposits mount in Tajik banks

Under-mined in Kyrgyzstan

Growth in uncertain times for Nagorno-Karabakh

Europe's borderlands

Mission accomplished in Kosovo?

Albania's slicker oil industry

UPCOMING EVENTS

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bne August 20126 I The Insiders bne August 2012

accepting bribes. Corrupt professors were kicked out with a lifetime ban from academia.

But the piece de resistance was Saakashvili’s order to sack the entire 16,000-strong police force on a single day, replacing them with some of the best and brightest university gradu-ates. Today, Georgia ranks alongside Finland as having the least corrupt police force in the world and their standout uniforms are rumoured to have been designed by Armani.

The campaign expanded irresistibly. Tax offices were equipped with CCTV; university exam papers were printed in the UK and held in bank vaults until needed; and offi-cials were constantly tested in sting operations. The proac-tive assault on graft was accompanied by a PR campaign to undermine respect for criminal groups and introduce respect for the law.

The campaign then turned to the sectors. First up was the power sector that was widely used as a cash cow for well-connected oligarchs. In less than a year, Georgia went from a net importer to a net exporter of electricity and the sector became the target of long-term foreign investment.

Tax collection followed. Georgia’s tax base consisted of just 80,000 companies in 2003 and tax collection was a mere 12% of GDP. Saakashvili slashed red tape and introduced flat personal and corporate taxes. Eight years later over 250,000 companies are on the register, paying the equivalent of

25% of GDP. Georgia now boasts one of the most liberal tax regimes in the world, on par with the Gulf states and Hong Kong.

Lastly came deregulation, with many rules and agencies simply abolished, removing channels of corruption in the process. Among other things, car registration became so easy that used cars became the largest export item in 2011. Geor-gia moved swiftly from the bottom of the World Bank’s Doing Business ranking (112) into the top 20 (16) by 2012. Foreign investment followed and fuelled a multi-year surge.

But perhaps, the most lucrative Georgian export would be the fight against corruption itself – from which many states mired in graft could benefit. The Georgians patented a process whose steps are replicable: establish early reform credibility by radical action, launch a frontal assault exclud-ing no sacred cows, attract new blood, limit the role of the state via privatisation and deregulation, use technology and communication to maximum effect, and above all, be bold and purposeful.

Georgia’s close and distant neighbours should take heed. Their prime ministers and presidents have got their jobs cut out for them.

"Perhaps the most lucrative Georgian export would be the fight against corruption itself – from which many states mired in graft could benefit"

"Georgians passed more envelopes to bent officials than the post office does letters"

Plamen Monovski, CIO of Renaissance Asset Managers

When the prime minister comes to sell you an IPO, you, the investor, take the meeting. When that prime minister turns up with no bodyguards and shows

remarkable knowledge of the company he is promoting, you, the investor, take notice. When Nika Gilauri, the former pre-mier of Georgia, tells you that the prosperity of his country has been achieved because it has become one of the “least corrupt” countries in the world, you, the investor, take note.

But it wasn’t always like that. After the demise of the USSR, Georgia was not only one of the most corrupt of the former-Soviet republics, it was one of the most corrupt countries in the world.

Bribe-to-drive was the norm; police stopped cars at least twice an hour to extort a non-trivial sum of money. The then-interior minister infamously quipped: “Give me petrol only. My people will take care of their own salaries.” Being a traffic cop was so lucrative that you had to pay a bribe of between $2,000 and $20,000 to get the job in the first place.

Graft was endemic. Georgians passed more envelopes to bent officials than the post office does letters. Meanwhile the economy crumbled and the state was left bankrupt and powerless.

Shock and aweThe election of Mikhail Saakashvili changed everything. A bold reformer, he was swept to power in the “Rose Revolution” at the end of 2003 by the overwhelming desire for radical change. His closely-knit team is unified by a common vision and supported by a compliant parliament and judiciary.

The new government wasn’t just radical – it shocked and awed. Ministers, oligarchs and officials were sacked or arrested. Those who resisted were dealt with decisively, sometimes brutally. The state confiscated $1bn worth of property. Custom officials bore collective responsibility; an entire shift would be punished if one officer was caught

Envelopes

1 New Zealand 9.5

2 Denmark 9.4

2 Finland 9.4

4 Sweden 9.3

5 Singapore 9.2

6 Norway 9.0

7 Netherlands 8.9

8 Australia 8.8

8 Switzerland 8.8

10 Canada 8.7

11 Luxembourg 8.5

12 Hong Kong 8.4

13 Iceland 8.3

14 Germany 8.0

14 Japan 8.0

16 Austria 7.8

16 Barbados 7.8

16 United Kingdom 7.8

19 Belgium 7.5

19 Ireland 7.5

21 Bahamas 7.3

22 Chile 7.2

22 Qatar 7.2

24 United States 7.1

25 France 7.0

25 Saint Lucia 7.0

25 Uruguay 7.0

28 United Arab Emirates 6.8

29 Estonia 6.4

30 Cyprus 6.3

31 Spain 6.2

32 Botswana 6.1

32 Portugal 6.1

32 Taiwan 6.1

35 Slovenia 5.9

36 Israel 5.8

36 Saint Vincent and the Grenadines

5.8

38 Bhutan 5.7

39 Malta 5.6

39 Puerto Rico 5.6

41 Cape Verde 5.5

41 Poland 5.5

43 Korea (South) 5.4

44 Brunei 5.2

44 Dominica 5.2

46 Bahrain 5.1

46 Macau 5.1

46 Mauritius 5.1

49 Rwanda 5.0

50 Costa Rica 4.8

50 Lithuania 4.8

50 Oman 4.8

50 Seychelles 4.8

54 Hungary 4.6

54 Kuwait 4.6

56 Jordan 4.5

57 Czech Republic 4.4

57 Namibia 4.4

57 Saudi Arabia 4.4

60 Malaysia 4.3

61 Cuba 4.2

61 Latvia 4.2

61 Turkey 4.2

64 Georgia 4.1

64 South Africa 4.1

66 Croatia 4.0

66 Montenegro 4.0

66 Slovakia 4.0

69 Ghana 3.9

69 Italy 3.9

69 FYR Macedonia 3.9

69 Samoa 3.9

73 Brazil 3.8

73 Tunisia 3.8

75 China 3.6

75 Romania 3.6

77 Gambia 3.5

77 Lesotho 3.5

77 Vanuatu 3.5

80 Colombia 3.4

80 El Salvador 3.4

80 Greece 3.4

80 Morocco 3.4

80 Peru 3.4

80 Thailand 3.4

86 Bulgaria 3.3

86 Jamaica 3.3

86 Panama 3.3

86 Serbia 3.3

86 Sri Lanka 3.3

91 Bosnia and Herzegovina 3.2

91 Liberia 3.2

91 Trinidad and Tobago 3.2

91 Zambia 3.2

95 Albania 3.1

RANK COUNTRY/TERRITORY SCORE RANK COUNTRY/TERRITORY SCORE

9 - 10

8 - 8.9

7 - 7.9

6 - 6.9

5 - 5.9

4 - 4.9

3 - 3.9

2 - 2.9

1 - 1.9

0 - 0.9

SCORE

HIGHLY CORRUPT

VERY CLEAN

Source: Transparency International

CORRUPTION PERCEPTIONS INDEX 2011

8 I Cover story bne August 2012 bne August 2012 Cover Story I 9

Halil Matoshi is one of Kosovo’s best known journalists and an outspoken critic of corruption

in the government. In July, he was just leaving a cultural event in Pristina when he was jumped by at least four men who attacked him with knives. Matoshi managed to fight off his assailants and despite being wounded, made it to the local hospital. Dunja Mijatovic, the OSCE representative for freedom of the media, says that Matoshi was lucky to survive, as the attack could have been "fatal" – many journalists working in what investors call frontier markets are not so lucky.

Such incidents are a depressingly – and some would argue increasingly – famil-iar tale from journalists working in these frontier markets of Central and Eastern Europe/Commonwealth of Independent States (CEE/CIS). And Kosovo is by no means one of the worst. In Freedom House's "Worst of the Worst" annual list of the world's most oppressive societies, published in July, two countries from the CEE/CIS region (Turkmenistan and Uzbekistan) appear in the report's total of nine. While two others, Belarus and South Ossetia, are on a further list of 10 countries that are on the cusp of being the worst of the worst.

Brutal dictatorships today rule almost a quarter of the world's population and are deeply entrenched, says Freedom House, meaning that more than 1.6bn people have no say in how they are governed and face severe consequences if they try to exercise their most basic rights, such as expressing their views, assembling peacefully and organis-ing independently of the state. "The regimes, sadly, are very durable. They have lasted on average for more than 37 years without any meaningful transfers of power to competing political parties," says Daniel Calingaert, vice president of policy and external affairs at Freedom House. "Our report serves as a call to action for the international community to focus on the countries that perpe-trate the most egregious human rights abuses."

What is particularly disheartening for the people and businesses in these coun-

Nicholas Watson in Prague

New frontiers, old problems

tries is that all of them have, at some point, showed some signs of opening up over the past decade before reverting to their old ways.

The bad old daysAfter Turkmenistan's late and unlament-ed dictator Saparmurad Niyazov – better known as Turkmenbashi, or "father of the Turkmens" – died under mysterious circumstances in 2005, there were high hopes that the new president, Gurban-guly Berdymukhamedov, would allow some political freedoms and liberalise the economy. However, in February the former dentist was re-elected president with over 97% of the vote in sham elec-tions – a margin of victory that was not that far below Niyazov's 99% in 1992, which led to Turkmenbashi proclaiming himself "president for life".

In what can only be described as a bad joke, the Turkmen government decided to create some political "competition" in May and set up a second party – perhaps as a way to reduce the chances of an "Arab Spring"-style revolution happen-ing – and placed adverts in the national press calling for volunteers, according to RIA Novosti. It is not known how many signed up to the new opposition, but one would have to be a brave soul to show even the merest hint of opposition

tendencies in a country that routinely jails and tortures its opponents. "There is little hope that the newly re-elected Turkmen leader will opt for reforms in his second term," Lilit Gevorgyan, Rus-sia/CIS analyst at IHS Global Insight, believes. "There are no prospects of decentralising political power in the country; both legislative and execu-tive branches will remain firmly under Berdymukhamedov's control. His main

focus will be on developing the energy sector, diversifying energy export routes and dealing with inter-elite rivalry."

Then there's Uzbekistan, which has been under the iron grip of President Islam Karimov since independence in 1991. It had looked as though the regime was making a tentative move towards greater openness when legislation was passed in March 2011 giving more powers to the Uzbek parliament. Yet the government subsequently crushed those hopes over the following months by throwing out an international NGO, forcing several international investors to shut down and denouncing western rock as "devil music". "Uzbekistan's govern-ment suppressed all political opposition and restricted independent business activity in 2011, and the few remaining civic activists and critical journalists in the country faced prosecution, hefty fines and arbitrary detention," Freedom House notes.

This schizophrenic attitude to reform continued this year, when in April Karimov signed a decree, "On additional measures to stimulate foreign direct investments", which includes addi-tional tax breaks for foreign investors as well as a pledge that the government would refrain from interfering in their

businesses. Yet in July, Russia's largest mobile telecommunications firm Mobile TeleSystems (MTS) was forced to stop providing services in Uzbekistan after its licence was suspended for 10 days. The company is also being targeted by the Uzbekistani General Prosecutor's Office, which has issued arrest warrants for the arrest of several top managers at its Uzbek subsidiary as part of a fraud probe.

"The regimes, sadly, are very durable. They have lasted on average for more than 37 years without any meaningful transfers of power to competing political parties"

10 I Cover story bne August 2012 bne August 2012 Cover story I 11

MTS is, incidentally, a prime example of a foreign investor that has taken the plunge into these frontier markets only to have its fingers burnt in Turkmeni-stan and Kyrgyzstan, as well as now in Uzbekistan.

Belarus too had appeared to be on a path designed to rid itself of the label "the last dictatorship in Europe", before President Alexander Lukashenko stole the presidential election in December 2010 and the regime cracked down on the subsequent protests. Most visibly, three former presidential candidates received prison terms of five years or more for their roles in the demonstrations. But Lukashenko managed to alienate everyone by ignoring calls for clemency from all of Europe (including Russia) and ordering the execution of Dmitry Konovalov and Vladislav Kovalyov in March for allegedly setting a bomb in Minsk’s metro on the basis of questionable evidence, according to Human Rights Watch. Belarus is the only country in Europe with a functioning death penalty.

The years since have seen continued political repression, a confused attitude to liberalising the economy, an economic crisis, and growing corruption fed by the state's dominance of the economy and the overall lack of transparency and accountability in government.

The economy has since stabilised, thanks in part to a $3bn bailout from the Russian-led Eurasian Economic Community, a grouping of ex-Soviet

states. However, an annual $2.5bn privatisation programme that was a condition for the aid remains, like all economic matters, under the purview of President Lukashenko, who seems unable to make up his mind on the issue. Apart from the sale of a 50% stake in Beltransgaz to Russian gas giant

Gazprom for $2.5bn in November, the government's plans for the privatisation of major state-owned enterprises remain unclear.

According to bne sources, the Belarusian government drew up a preliminary list of major state-owned assets for priva-tisation that could secure this annual revenue. Publicly this list remains undis-closed – and in May vice-PM Siarhei Rumas denied even the existence of this list, according to BelarusDigest – but sources say it comprises about 20 major state-owned assets, including Naftan oil refinery, Gomeltransneft Druzhba oil pipeline, Krinitsa brewery, Belarusian Metal Plant foundry, BelAZ truck maker, cement plants and the state sharehold-ing in mobile operator MTS.

The governor of the National Bank of the Republic of Belarus, Nadezhda Erma-kova, told bne in May that the govern-ment was ready to embark on the process of selling the country's state-run banks, starting with Paritetbank, the smallest of the four state-owned lenders, in a tender to be held during the second half of the year. The deal could be the first of several in the country's banking sector over the next year. VTB (Belarus), the subsidiary of Russia's VTB Bank, wants to buy the 25.9% interest that the Belarusian state currently owns in the lender through state oil and chemistry concern Belneft-ekhim. Belarus central bank has also suggested that Russia's VTB Bank sell its Belarus' subsidiary, Moscow-Minsk Bank, to the Belarusian government so it can then merge it with state-owned Belin-vestbank to beef up the institution.

However, parliamentary elections are planned for September and few think the government will opt to pursue such a time-consuming and risky strategy as selling off state assets; instead, it appears to be returning to traditional methods of securing an electoral victory by clamping down on dissent and prom-ising dramatic wage increases – exactly the type of policies that could plunge the economy back into crisis.

Yet for all that, there have been hopeful signs for investors elsewhere in the CEE/CIS region.

"This smooth transition once again proves Mongolia's status as the only post-socialist democracy in Asia"

Free and fairThe Western Balkan region is slowly showing signs of normalising, notwith-standing the many issues that still need to be resolved. Serbia in May voted for a president who was a former key member of the country's ultra-nationalist party, yet Tomislav Nikolic ran on a pro-EU platform and a commitment to negotiat-ing a peaceful resolution to the issue of its erstwhile province but now independent Kosovo. In Albania, the parliament on July 19 approved key electoral reforms pushed by the EU that should dramati-cally improve the political climate there.

In June, Mongolia held parliamentary elections that while scrappy, still showed what Julian Dierkes, an associate professor at the University of British Columbia's Institute of Asian Research, called an electorate exercising its rights and institutions that are growing better at meeting people's demands. "While Mongolia's democracy is a work in progress like most liberal systems of governance, many Mongolians continue to be dedicated to the task of building a durable democracy," says Dierkes. "The first thing to note about the vote... is that both the polling and the after-math have been largely peaceful. This is progress compared to the last vote four years ago."

Most encouragingly, he says, the elec-tion results are being honoured by all, with the generally pro-business Demo-cratic Party saying in July it's ready to form a coalition government with smaller populist parties, thus taking over power from the previous coalition led by the Mongolian People's Party. "This smooth transition once again proves Mongolia's status as the only post-social-ist democracy in Asia," says Dierkes.

Over the next four years, the country’s vast mineral wealth will be exploited and the state coffers will begin to fill, making this incoming government key for the economy and investors. "The importance of this next term cannot be overstated," says Travis Hamilton, founder of the Khan Mongolia Equities Fund, who remains bullish overall on Mongolia’s economic and investment future.

Kyrgyzstan too, no stranger to rigged elections and ethnic strife, continues its march toward becoming a parliamen-tary democracy, with the first free-and-fair parliamentary elections held in October 2010 followed by a similarly fair presidential election a year later in October 2011.

Unfortunately, the country epitomises the region's patchy progress in improv-ing conditions for investors amid a more general backward slide. On June 27, the Kyrgyz parliament passed a resolution

to revise the operating licence belonging to the Canadian miner Centerra's flag-ship Kumtor gold mine. Among other things, the resolution calls for changes to the tax regime and concession area at Kumtor, while boosting the govern-ment’s stake in the mine. The resolution followed the release nine days earlier of an 800-page parliamentary report that accuses the mine of environmental dam-age on a massive scale. Centerra CEO Ian Atkinson says the report's findings are "without merit" and the mine has oper-ated in full compliance with Kyrgyz and international standards, "and this has been proven over the years in system-atic audits by Kyrgyz and international experts."

The effect of this continual uncertainty over Centerra's operations (where its title over the mine has been questioned several times in the past) and the reduced output is already impacting on the economy. The mine accounts for around 12% of the country's annual GDP, which shrank by 5.6% on year in the first half of this year.

The uneven nature of this progress can be frustrating for frontier investors. However, regional moves are afoot that could lay the foundations for a more general, widespread and enduring

improvement in the investor environ-ment in the CIS.

Kyrgyzstan is expected to be the next country to join the Customs Union formed by Russia, Belarus and Kazakh-stan that came into being on January 1, 2010. The three members are mov-ing rapidly towards closer economic unity, which will morph into a Common Economic Space (CES) by 2015, where companies will be free to move to any of the member countries and enjoy exactly the same business and trade conditions.

"We are creating a huge market that will encompass over 165m consumers, with unified legislation and the free flow of capital, services and labour," Russian President Vladimir Putin has said of the ambitious plans.

The culmination of this process, Putin declares, will be a Eurasian Economic Union to rival that of the EU. And while the EU's problems today are legion, even its harshest detractors don't deny the benefits the bloc has brought to regional trade on the European con-tinent and as a driver for countries in CEE to transform their economies. If the same can be achieved in the CIS with the Eurasian Economic Union, frontier investors will have to find a new play-ground. That time, though, is still a long way off.

"Belarus is the only country in Europe with a functioning death penalty"

12 I Perspective bne August 2012 Perspective I 13bne August 2012

Private banking's squeezed middle

CHART: Euro road tripEchoing their colleagues in investment banking, private bankers in Emerging Europe see the middle segment of their market being squeezed, with only the biggest and

the boutiques surviving. That has some casting around for new strategies in the region.

In a climate in which bankers' credibility could hardly sink lower, those working in private wealth management enjoy perhaps the meanest of reputations, with hubris potentially seen as their greatest sin. However, with the odd exception at EBCG's "Private Banking in CEE, SEE & CIS" conference in Prague in June – the compere gamely tried to rally the troops against tightened regulation that would "stop us doing business if we followed it" – most delegates and speakers appear ready to respond positively to the challenges facing the industry.

Stephen Jennings, owner of Russian investment bank Renais-sance Capital, remarked in June that his business will increas-ingly resemble a barbell over the coming years, with the mid-sized players falling by the wayside. Leaders in private banking in the region foresee a similar fate. Michael Wodz-icki, head of private banking at Kathrein Privatbank, even put a definitive figure on a place at the larger end of the barbell. "You need €10bn in assets under management (AUM) per banking license to survive over the next few years," he stated frankly. "There are minimum requirements to play: you need huge investment in technology, your network and training; and the regulators will suffocate you."

Reflecting Schoellerbank's conservative background, as well as the reality of the region's markets, potential clients need to already have an account with UniCredit, he pointed out. "Provenance of funds in CEE is key. We will not make any compromise on transparency, and by working with clients we already know through the network, we can keep compliance costs to a minimum."

The effort will be worth it, Maxonus reckons, especially today now the region's entrepreneurs that started businesses in the early 1990s are coming to an age when they want to sell up. It's a trend that private equity investors in the region are also watching closely.

Due to the relatively limited distribution of wealth in the CEE region, clients there tend to have an overall asset base larger than that in Austria and Germany, while privacy and political risk are compelling reasons to look for an asset manager in Western Europe. Hungary under Prime Minister Viktor Orban is a prime example of the latter. "Austrian banks on the border have seen a huge rise in clients coming across the border to deposit assets," Maxonus said. That makes Hungary one of Schoellerbank's top targets in the region, alongside Russia, Kazakhstan, the Czech Republic, Bulgaria and Romania, though he added that, "going further southeast into the Balkans is difficult because the money is not clean and the number of potential clients is low."

The euro is in crisis, yet that's the currency 332m people have to spend on their summer holiday this year. So for those who holiday outside the Eurozone, where's the best place to go with their rickety currency?

A study by UniCredit Group found that some CEE countries, especially Turkey, offer good value for the euro-holding trav-eller. For those who fancy a trip across an ocean, Brazil offers better value than last year. Asia, though, looks expensive. "If you want the most for your holiday euro, you should travel to some CEE countries, or alternatively Turkey; if you want to go over the ocean, Brazil offers some value more than last year," says Stefan Bruckbauer, economist at UniCredit's Bank Austria. "If you take your holidays overseas, then you feel the pain especially in Asia.

Looking within CEE there any differences, says Bruckbauer. "For a tourist from Italy or Germany, all the countries of CEE offer more value for their holiday euro than at home. The most you get is in Bulgaria and Romania, but also Croatia and Hungary are 'cheap', as well as Poland, even after the Euro 2012."

At the other end, smaller Western European outfits are target-ing Central and Eastern European (CEE) economies to help them survive that coming retrenchment, albeit using widely differing tactics.

Schoellerbank is, in the words of its CEE head Stephen Maxonus, "an old-fashioned and conservative bank," used to looking after generations of old money in Austria. However, just over a decade after being bought out by UniCredit Group, in 2011 it was designated to act as the Italian group's hub for international private banking, especially for clients from CEE. It is now rolling out a fresh strategy to find new business,

leveraging the largest banking network in the region to fish for established private banking clients. "We're not really look-ing for CEE clients new to private banking, but instead plan to take market share from the Swiss banks that dominate many of the markets," he explained.

That final point is one that Hypo-Alpe-Adria, the struggling Austrian outfit that was nationalized in 2009, has made cen-tral to its own low-cost strategy in the region. "We don’t have the resources to roll out a full private banking operation," admitted group head of affluent banking, Jochen Maurer.

Instead, the bank is leveraging an established network in Southeast Europe to attract "relatively high earners" in coun-tries such as Slovenia, Croatia and Serbia, signing them up for enhanced retail banking services, and hoping they grow into "affluent clients" as regional incomes swell. "It's not possible currently to do full private banking in the Balkans," Maurer claimed. "It would cost too much to build the capacity and then spend time persuading clients of the benefits."

Therefore, faced with a young potential clientele – "80% of them are below 40, unlike the far older private banking cli-ents in the West" – who need to have €5,000 on deposit (20% of all clients), Hypo-Alpe hopes to slowly "grow" its own batch of Balkan private banking clients, offering products such as gold cards along the way. "That's a stable business when deal-ing with clients that are wary of investment markets, as they are especially right now," Maurer pointed out. "We decided not to try to teach a fish to ride a bicycle."

Tim Gosling in Prague

"Austrian banks have seen a huge rise in clients coming from across the Hungarian border to deposit assets"

Source: CECD, Eurostat, Statistik Austria, Bank Austria Economics & Market Analysis Austria (own estimates), June 2012

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bne August 201214 I Eastern Europe bne August 2012 Eastern Europe I 15

Ben Aris in St Petersburg

Russia's banking barbell

The Russian investment banking market has been totally transformed in the last year. From

a vibrant playground filled with scrappy and largely privately owned brokerages, it is now suddenly dominated by two state-owned giants, with the rest fighting for the scraps.

VTB Capital (VTBC) was set up just ahead of the 2008 financial meltdown, and hired the bulk of Deutsche Bank’s Moscow team in one lot to kick things off. An offshoot of Russia’s second largest retail and corporate bank, VTBC expanded aggressively, and today is clearly the leading investment bank in Russia.

However, it now has serious competition. Last year, Russia’s biggest retail bank – and one of the biggest in Europe – Sberbank decided it needed to

Sberbank, as that is our competitive advantage: the combined bank lends to the companies but at the same time can now offer investment bank services. Credit is scarcer than it used to be, so now the lender has more power in the game,” Rob Leith, managing director and global head of investment banking and global markets at Troika Dialog, told bne in an exclusive interview during the St Petersburg International Economic Forum.

However, without doing the nuts and bolts business, it is hard to add the fee-paying operations, Leigh points out. That's a dilemma neatly illustrated by the problems experienced by Troika's erstwhile rival Renaissance Capital (or Rencap).

For most of the last decade and a half, these two privately owned investment banks have slugged it out over market share, with Rencap perceived as better with the international portfolio investors and Troika more on top of the domestic scene. However, Rencap has been reeling since the crisis. It nearly collapsed in 2009, when owner Stephen Jennings was forced to sell half the bank to oligarch Mikhail Prokhorov.

It went on to lose about $30m in 2010 and another $100m in 2011. A wave of sackings early this year have stabilised the situation, says Jennings, but he has also talked of a "killing zone" that is appearing in the investment banking sector thanks to the crisis-induced shakeout. It's a theory doing the rounds in many banking segments these days, with the death of all but the very biggest, or the smallest boutique operations, forecast. "The industry will end up a barbell," Jennings predicted at the St Petersburg shindig, "with a small number of these enormous, essentially commercial, banks, which have investment banking operations on one end. On the other, you will have much smaller, primarily private businesses, and the accent will be on relationships, reliability, high levels of service, and entrepreneurialism, which harks back to an earlier era. The killing zone will be in the middle."

get into the investment banking game. It took a slightly different route, buying existing investment bank Troika Dialog, the merger of which was formally completed in May.

Now the game is on to see which of VTBC and Sberbank's new operation (nicked name Sbroika until it is given an official name) will emerge as top dog. VTBC has a good head start, but Sberbank is a behemoth and has significant clout in the worlds of both business and politics.

Time at the barbellAt first glance, the marriage that created Sbroika looks like the Kremlin increasing its clout in the economy again – and indeed that is one of the results. However, it also follows current global trends.

In these lean times, companies are asking themselves why they are paying fat fees to standalone investment banks for services they can now get from their commercial bank. Meanwhile, with margins suffering on the back of new regulation following the crisis, the banks serving the corporate segment are also keen to move into the fee-paying business.

Around the world, banks are beefing up their investment bank services, while investment banks are moving in the opposition direction. For example, Goldman Sachs – the archetypal investment bank – has started to lend its customers money, a very mundane service for such a quixotic entity. The reason is that thanks to the credit crunch, lenders suddenly find themselves in a strong position. "There has to be absolute integration with

Russia's economy - hot or not?

Ben Aris in Moscow

Kolya is back in Moscow for job interviews. A Russian national, he has just graduated from Liverpool University with a degree in business. He also has a long-standing interest in aviation software, and has even sold some of his own developed products to Russian carrier Transaero. So far, Kolya has had eight interviews and received eight offers, despite just scraping a third-class degree from Liverpool.

Apart from his obvious skill in programming (a sellable skill in any mar-ket), Kolya would struggle to get a job in the UK with that kind of degree, even in a boom. God forbid he should go looking in Spain or Portugal, where youth unemployment is at 50%. Yet Russia’s economy is booming, even if its businessmen remain glum due to the never-ending Eurozone crisis.

Unemployment is down to a historical low of 5.4% of the working popula-tion, which President Vladimir Putin pointed out in June means all the production capacity is being utilized. This tight labour market is already sending wages up, which were rising by 14% at the end of the first quarter on an annualized basis. This is feeding into consumer confidence and giving retail borrowing a boost, which was up a whopping 43% in May. All this has economists starting to ask if the economy is overheating. Deputy governor of the Central Bank of Russia (CBR), Alexey Ulyukaev, said that consumer lending growth above 28% is a red flag for the economy – and Russia is well beyond that point.

The black spot is the corporate sector, where companies have already started to de-stock and industrial production is falling. One of the reasons the 2008 crisis was so painful for Russia was that companies were caught carrying high inventory to meet the demand of a booming market. With the crisis struck, they switched off their machines and sold that inven-tory instead. The result was the economy came to a standstill overnight, resulting in contraction of over 7% in GDP in 2009. This time round, fearing another (and possibly worse) meltdown in Europe, companies have already started de-stocking before the crisis has even impacted.

Kolya’s experience and the robust consumer demand means the economy is getting hot to the point where inflation is starting to rise. Price. On the other hand, the behaviour of companies suggests the economy is slow-ing down, with industrial production in Russia taking a nosedive in March. Thus the CBR sits on the horns of a dilemma. Should it increase interest rates to curb inflation – the central bank has said it will struggle to hit its 5-6% inflation target for this year – and cool the economy; or ease mon-etary policy to encourage more investment and growth. The upshot is that the spread of growth forecasts for 2012 ranges far and wide, from 3-5%. When spreads on forecasts get this wide it means the experts are basically clueless about what will happen next.

16 I Eastern Europe bne August 2012 Eastern Europe I 17bne August 2012

Just where Rencap sits in this battle is open to debate. Jennings is in the midst of totally restructuring the bank’s business, according to bne sources - but clearly Sbroika is one of those "enormous, essentially commercial

banks, which have investment banking operations," and would have to do something really stupid not to prosper.

Timely developmentThe merger with Sberbank was timely for Troika; since the crisis broke in 2008, life has been hard for most investment banks, and the ongoing trouble in Europe has only extended the struggle. "In M&A there are notable levels of activity, but the market is very jittery," Oscar Ratsin, deputy head of investment banking and head of M&A and ECM at Troika says. "There were some large cross-border deals last year, but this year there has been a lot less so far. International companies are preoccupied with domestic problems and risk aversion; Russian players have been more active since March 2012, but time slippage on deals is obvious. The pipeline is reasonably full and growing but the risk weighting is high, so the outlook for M&A business in 2012 is still uncertain. A number of big deals have been postponed, but Sberbank/Troika are well positioned for the market comeback with a strengthened team."

The timing of the deal is also pertinent from the perspective of the next likely stage of development for Russia's banking sector. If the 1990s were

marked by deal making in the midst of the cut and thrust of transition, the next decade is going to be all about institution building. In April 2008, the Kremlin launched an overhaul of the capital markets that has already

resulted in the merger of the country's two biggest exchanges: the RTS and Micex. A central securities depository (CSD) has also finally arrived, and a design to create domestic institutional investors could transform the markets. "The challenge is to develop over the next five to 10 years a domestic institutional investor base," states Todd Berman, managing director and head of investment banking at Troika. "This is a big country with 143m people, but the average Russian citizen has virtually no exposure to the equity markets. They don’t invest directly or through the

pension system, so they have no skin in the game. There is a lot of money in Russia today, but it isn’t being funnelled to portfolio investments."

That is where a bank like Sbroika comes in. Investment banking over the last two decades has largely catered to the needs of big foreign portfolio investors or local banks that wanted to take a punt on the

annual Kremlin-sponsored St Petersburg Economic Forum to talk to bne.

It was actually Gorby's glamorous wife Raisa who gave Karachinsky his first big break. A moderniser who wowed the West and ostentatiously went on shop-ping outings during her trips abroad, Raisa wanted to bring Russian women up to date and so encouraged the Ger-

man publisher of Burda Moden, a home design magazine that also carries sew-ing patterns for trendy women's wear, to publish in Russia. The magazine was an overnight sensation. "Burda Moden decided to do a Russian edition because of the first lady," says the bearded and ebullient Karachinsky. "She wanted Rus-sian women to know something about

Russia's tycoon of techBen Aris in St Petersburg

Anatoly Karachinsky has seen it all. A maths and computer whiz who was a product of the Soviet

Cold War emphasis on pure science, he went into business as a young man in 1987 when Mikhail Gorbachev allowed the first private businesses to be set up during perestroika. He attended the famous "oligarch meeting," called by President Vladimir Putin shortly after the start of his first term in office where he laid down the law to the likes of Mikhail Khodorkovsky. And this is his seventh crisis.

From its humble beginnings, Karachin-sky's joint venture Intermicro (joint ventures were at first the only form of private enterprise allowed) eventu-ally morphed into IBS Group, which is today one of Europe's leading software development and IT services providers, with over 10,000 employees in half a dozen countries and annual revenues of $650m. "I went into business at the end of the 1980s, but all I ever wanted to do was write programmes," says Kara-chinsky, who took time out during the

home and family. They had their Ger-man publishing system, but didn't know what to do next so we built the Russian publishing system."

The fall of the Berlin Wall changed everything. As Russia raced to catch up with the West, computerisation was one of the main places where the gap was greatest. Importing computers made the first fortunes for several of today's oligarchs, but Karachinsky went a step further and wrote the code that Russian companies needed to make them work. "The first really big job we had was Sberbank where we built the system that allows cards to be used in ATMs and for the bank to keep electronic records of people's accounts, as before that everything was done on paper. That job covered half the territory of Russia. It took seven years to complete," says Karachinsky, adding that Sberbank remains one of the company's biggest customers today.

But it has not been an easy ride. If anyone knows about the volatility of the Russian market, it is Karachinsky, who has worked through every big crisis that Russia has experienced includ-ing, almost uniquely in the Russian corporate universe, the very first one in 1991 when the Soviet Union collapsed. "There are always crises in Russia," says Karachinsky, who rattles off such years as if they were wine vintages. "1998 was a very tough year, but then so were 1996 and also 1993. But 2004 was okay and 2006-2007 was a good time like 1997,

which was also a great year – before 2008 of course or the struggle in 2009. When there is a boom, everyone forgets the last crisis. When the price of crude is high and the state is not spending, the economy develops well. 2007 was a real boom year, but if there is a boom, then the next year will be a crisis – it is always the way."

"If you were to name the 100 biggest Russian companies, then 80 of them are our clients"

wild, but highly profitable – providing you got your timing right – Russian equities market. No one had a long-term horizon; everyone was a speculator. That left the market volatile and prone to wild swings: Russia’s stock market is only ever in the best three performing markets in the world – or the worst three.

If Russia is to build a fully developed economy, it needs to persuade the population to get involved, and what better institution to do that than an investment bank that has a branch on every corner of every high street in the country, and already holds half of all retail deposits? "Mutual funds, private pension funds, private equity funds and other domestic institutional investors are simply too small in Russia relative to the size of the economy or the country. There are really only a very small number of meaningful professional investors in the whole country," says Berman. "Until Russia develops a substantive base of domestic institutional investors, Russian companies will continue to be

dependent on foreign capital and will go to London or elsewhere to list their shares. There needs to be a fundamental change in the way the market works and the development of local capital – local investors for local companies. You can't finance the growth needs of Russia without domestic equity investment."

"There has to be absolute integration with Sberbank, as that is our competitive advantage"

"The death of all but the very biggest or the smallest boutique operations is being forecast"

Photo St. Petersburg International Economic Forum


Reversing the brain drainDespite the rocky ride, IBS has grown steadily over the last two decades, managing growth of 45% a year even in the current difficult environment. Karachinsky attributes this success to the world being in the midst of the biggest IT revolution in history and the fact that Russia, the first country to put a man into space, has some of the best programmers in the world. "People talk about the brain drain, but in 2002 Rus-sians started to come back home," says Karachinsky. "During 2008 and 2009, we were hiring 500 people a month, while in America unemployment was running at 11%. The market is open and our people didn't leave for good. They are only looking for places to work and will go where the best jobs are. We offer good conditions and so they come back. Russia still has excellent engineers, but where we fall down is on poor management."

The rising standard of living in Russia is making it an increasingly attrac-tive place to live and work. While on a dollar-for-dollar comparison salaries for programmers in Russia are about half those in the US, they are more than competitive when the cost of living is taken into account. Karachinsky says his firm did a comparative study and found that after you take out taxes, food, entertainment, debt and rent, workers end up with more cash in their pocket in Russia than in the US. And on top of that is Russian patriotism: Rus-sians love their country and will return if they can make it work professionally. Karachinsky says these days the prob-lem is getting his Russian managers to go and live overseas, as many of his top people are reluctant to leave their homeland.

IBS has quickly expanded beyond Russia's borders. It has opened offices throughout the emerging markets and is now increasingly moving into developed markets. Karachinsky says he has offices in Ukraine, Poland, Romania and Viet-nam, but also offices in the US, UK and Canada, while Germany is an especially vibrant market for IBS.

Turn on your mobile phone, start your car, take a plane or withdraw some money using an ATM, the chances are the software that makes all these things pos-sible was at least partly developed by IBS.

The outlook for the software business is very good, says Karachinsky. Micro-soft dominates the operating system on PCs, but more recently CPUs (central processing units, the brains of a com-puter) are increasingly finding their way into most gadgets we use everyday, from our phones to our fridges. "The king is dead," says Karachinsky. "For 20 years, Microsoft's architecture has had a virtual monopoly, but now that comput-ing is moving out of computers all the software needs to be rewritten. Think: only 10 years ago most companies had a computer centre and now almost none of them do; everything is quickly migrating into the cloud. The whole set-up is being remade."

Karachinsky rattles off a list of blue-chip clients that make use of IBS' services – both Russian and multinational – which includes Deutsche Bank, UBS, and several other large European and US banks. Providing software for the financial services industry is one of the company's core competences. IBS also writes software for the aviation industry and started working with Boeing 12 years ago. Cars are a more recent addi-

Crunch time in battle for Russian gravel producerAnna Kravchenko and Ben Aris in Moscow

In Eastern Europe, it is not enough to build up a successful business; the trick is hanging on to it once it is

ticking along nicely and making money. That's not an easy task when faced with Russia's venal judicial system and the no-holds-barred approach to business by most of the big players. But when you are facing down Sberbank, the largest financial institution in the country, your chances are poor indeed.

After several years, the fight for control of Pavlovskgranit Group, the second largest producer of gravel used in the construction industry, seems to be com-ing to the end with a defeat for Sergei Poymanov, the CEO and founder of the company.

Pavlovskgranit has been a highly successful company, catering to the construction industry that enjoyed a massive boom years in the years up to the 2008 crisis. Cash rich and profitable, Pavlovskgranit hoped to capitalize on its lead by investing in some German equipment that would allow it to bid for an order from state-owned Russian

Railways (RZD), which needed some specialist gravel for a big project. Like many Russian businessmen, Poymanov went to Sberbank at the start of 2008 to take out a RUB5.1bn ($170m) loan.

Then the crisis hit and RZD cancelled its contract. The construction busi-

ness, like many others, also ground to a halt as everyone sat on every kopeck of cash they had. By the spring of 2009, Pavlovskgranit was hurting and Poy-manov went to Sberbank to see if he could renegotiate the terms of the loan, as his firm was bleeding cash to pay off the high interest rate debt. The company had been in profit from 2007 through

to 2009, but reported its first loss of RUB125m in 2010. "But they didn't want to talk," a spokesperson for the company tells bne. "They were in a win-win situ-ation: if nothing happened, Sberbank would continue to collect the high inter-est payments. If Poymanov defaulted, then they could claim a 36.37% equity stake in the firm that had been used to back the loan. But then things got worse."

Sberbank commissioned a valuation from NEO-Center, a well-respected financial services company that the bank often uses, which also happens to be run by the son of Sberbank chairman Ger-man Gref. That's where the trouble start-ed, as NEO-Center estimated the value of the pledged stake had dropped to RUB1.144bn (€28.7m). Sberbank turned round and insisted that Poymanov sign over control of the company to reflect the lower valuation of his collateral. "The valuation is clearly too low," says the Pavlovskgranit spokesperson. "Just the break-up value of the physical assets are worth more than that and the company eventually got the RZD contract back and is again in profit."

Poymanov refused Sberbank's demands, but he continued to pay the instalments. He even commissioned an independent valuation from a small firm in his native Voronezh, where Poymanov is a regional deputy. This found the stake to be still worth RUB4.6bn.

The argument became increasing vitriolic. Poymanov managed to get the German bank KFV Impex to offer to refinance the loan in October 2011 (on much more affordable terms), but the Germans insisted Sberbank relinquish all claims on Pavlovskgranit, which Sberbank refused to do, thus scuppering the deal. At this point, Poymanov lost all

"People talk about the brain drain, but in 2002 Russians started to come back home"

"Sberbank was in a win-win situation: if nothing happened, it would continue to collect the high interest payments; if Poymanov defaulted, it could claim a 36% stake"

tion; as cars become increasingly com-puterized, IBS already works with most of the biggest European and American automakers. "We offer a global service and we are the biggest implementer of SAP solutions for Russian clients. If you were to name the 100 biggest Russian companies, then 80 of them are our clients," says Karachinsky.

But surely the US is the home of innova-tive software: how can a Russian com-pany compete so well against the likes of Silicon Valley? Karachinsky explains it's down to his 4x4 formula. "What we do, the US companies can't do any more," says Karachinsky. "There is a big differ-ence between innovation that you find in Silicon valley and the industrial projects that we cater to. We use their innovations – and pay for them – but the companies that sell cars, planes and financial ser-vices want better products at a minimum price and that is what we do. We are like a 4x4: we are four-times faster and four-times cheaper than our competitors. It's the cornerstone of the business."

The Kremlin has committed itself to modernising the economy and in Putin's speech at the St Petersburg forum, the president committed himself to increas-ing the share of high-tech business in the economy from 20% to 27% by 2020. That would surely make IBS one of the Kremlin's "dream" companies. "We don't feel like the dream company," says Karachinsky. "There are raw materials at high prices here. Who wants to do anything if you are well off already?" asks Karachinsky. "So the dream of the president will be very hard to imple-ment. I don't believe in the modernisa-tion of the country, as I don't see any signs of it other than the speeches given at conferences."


Ukraine becomes First Family affair Graham Stack in Kyiv

The Ukrainian president's family influence is growing as it takes a tighter grip on the state's finances,

which is having a positive effect on revenues but raising questions about transparency.

The 33-year-old Sergei Arbuzov's appointment to the post of head of the National Bank of Ukraine in December 2010 left many scratching their heads – Arbuzov was a complete unknown in Ukraine's banking world, except for a six-month "internship" in 2010 as chairman of the board of state-owned bank Ukreksimank, followed by a three-month "internship" as deputy head of the central bank, which apparently qualified him for the top role in Ukrai-nian banking. Arbuzov's one redeeming virtue, it seemed, was that his mother was the CEO of a small Donetsk bank owned by his friend, President Viktor Yanukovych's son Aleksandr. Yanuk-ovych Jr is a regional businessman with banking and real estate interests.

Arbuzov's appointment opened the floodgates for further appointments of Aleksandr Yanukovych's and Sergei

Arbuzov's friends from Donetsk to key state finance posts in 2011 and 2012.

Most noticeably, on February 28, Yury Kolobov completed a meteoric rise in the footsteps of Arbuzov by becoming finance minister – Kolobov had previ-ously served as deputy to Arbuzov at Ukreksimbank and then at the National Bank of Ukraine. Like both mother and

son Arbuzov, Kolobov's career started in the 1990s in a regional section of Privat-bank, Ukraine's largest private bank – although they are in no sense linked to the owners of Privatbank.

Yanukovych appointed another unknown young Donetsk friend of his son as head of the state tax administra-tion in November 2011: 31-year-old

Aleksandr Klimenko. A low-level tax official, following Viktor Yanukovych's victory in presidential elections in Febru-ary 2010, Klimenko shot up to become deputy head of the Donetsk regional tax administration, where he worked for less than a year, before being named head of the Ukrainian national tax service. In an interview in Zerkalo Nedeli, Klimenko refused to comment on his friendship with Arbuzov and Yanukovych Jr, saying it had been "politicized" by the media. Instead, he simply called the two "wise men", "who feel the state's pain (at cor-ruption) as their own."

A particular cluster of appointments relate to former employees of the Donetsk office of Privatbank – which according to press reports was headed for several years in the 1990s by Valenti-na Arbuzova, mother of Sergei and CEO of Aleksandr Yanukovych's bank, and where Sergei Arbuzov himself started out. The new head of the Kyiv city tax administration, where the lion's share of the country's tax is paid, is 40-year-old Irina Nosacheva, who worked alongside the Arbuzovs at Privatbank in Donetsk, then in 2004-2008 she worked at Ukrbi-znesbank, a small Donetsk bank of which Sergei Arbuzov was CEO.

Another former employee of the Donetsk Privatbank office, 40-year-old Viktoria Kononykhina, succeeded now Finance Minister Koloba as first deputy head of Ukreximbank – Ukraine's largest bank

by capital and key buyer of government bonds and lender to state companies such as gas monopoly Naftogaz Ukrainy. Kononykhina is regarded as the one pull-ing the strings at the bank.

And finally in April, another former manager at the Privatbank Donetsk office, Roman Maguta, became head of Ukraine's state audit chamber – and

"The tightening of presidential family control over state finances that the new appointments represent appear to have paid off"

patience and stopped making the loan repayments. "The situation amounts to corporate raiding," says Poymanov. "The goal of these actions is the seizure of Pavlovskgranit. If a company the size of Pavlovskgranit can be seized like this, then no investment in Russia – foreign or Russian – is safe."

Up against a brick wallThe two sides are now locked in a running legal battle that has become a morass of claim and counter claim. Sberbank has also sued Poymanov, hold-ing him personally liable. In May 2010, Sberbank transferred the loan to its sub-sidiary Sberbank Capital, a division the bank uses mainly to look after distressed assets. Then in January 2011, Sberbank won several key decisions including a decision by the Odintsovo City Court

that awarded the bank RUB4.6bn in damages and passed ownership of a 24.6% stake in Pavlovskgranit to Sber-bank Capital.

From here the story gets confusing and in classic Russian style, moves offshore. In September 2011, Sberbank Capital transferred the stake to a little-known Russian company called Atlantic, which is owned in turn by offshore legal enti-ties Nisoram Holding Ltd. registered in Cyprus and Aletarro Ltd. No one knows who the beneficial owners of these companies are.

Sberbank has been keen on the construction business and in 2009 it announced that it was going to set up its own construction company with Yuri Zhukov, one of the founders and co-owners of construction powerhouse PIK Group, except the obvious monopo-listic power this sort of tie-up would have caused an outcry and the plan was cancelled.

Zhukov has been the head of Sberbank's development subsidiary, Sberbank Development, since 2011 and is also the owner of Pavlovskgranit's biggest rival, National Non-metallic Company (NNC). In 2010, NNC unexpectedly appeared as the only participant of the tender for development of the Gorokhovka granite pit.

Poymanov doesn't appear entirely inno-cent either and whatever else is going on, he remains technically and clearly in default of the loan he took out of 2008. The new shareholders of Pavlovskgranit accuse the company's managers of abus-ing their authority and transferring both assets and cash out of the company.

The Voronezh Investigation Committee has accused Pavlovskgranit's managers of transfer pricing by selling the compa-ny's production to "independent" trading houses at half the market value, accord-ing to Alexei Potolitsin, deputy CEO of Atlantic. "The trading houses belong to unknown persons and have no relation to the new shareholders," Potolitsin says. According to Atlantic's assessment, from July 2011 until January 2012, Pavlovsk-granit's old management withdrew more than RUB1bn of company profits.

The whole story highlights the "legal nihilism" that Russian Prime Minister Dmitry Medvedev had promised to banish during his stint as president, yet clearly failed to carry through. The court cases have been marred by a slew of "dirty tricks." For example, Poy-manov was unable to challenge NEO-Centre's valuation in court because it literally got lost in the post (Sberbank's lawyers presented the court with a stamped and signed confirmation of the loss from the post office) and the copy that Poymanov had was inadmissible under Russian law.

Sberbank's revised valuation of Pav-lovskgranit seems aggressively low, but there is nothing in law to prevent them valuing the company at any price it likes. On the other hand, Poymanov has reneged on his loan agreement and appears to be emptying the company of assets, according to Atlantic. Such is the nature of doing business in Russia.

"If a company the size of Pavlovskgranit can be seized like this, then no investment in Russia – foreign or Russian – is safe"


promptly launched a campaign to expand the remit of the chamber to cover not only state expenditure, even aiming for changes to the constitution.

Revenue boostThe tightening of presidential family control over state finances that the new appointments represent appears to have paid off. State revenues in the first three months of 2012 leapt 16% on the year, helped by GDP growth in 2011 of 4.5%. As a result, the govern-ment amended the budget in late April, raising revenues forecast for the year by a whopping 10%, and promptly boost-ing expenditure by roughly the same amount.

Critics say that the government is using the revenue boost to fuel extra social spending going into what are set to be tough elections in October 2011, and to stay clear of International Monetary Fund (IMF) funding, which comes with strings attached such as painful hikes

to the price of energy supplied to the population. But the government claims boosting state spending is necessary to ward off any slowdown in GDP growth triggered by the Eurozone crisis.

Meanwhile, Ukrainian news is full of reports of companies reportedly "raided" by tax authorities as a prelude to a hos-tile takeover as claimed by the owners, but few such hostile takeovers have as yet been made public, making it difficult to distinguish truth from rumour. Many of the affected businesses are import-ers of household goods and electron-ics, loved by the public for delivering cheap boosts to living standards and so can count on a public vote of sympathy when the tax police come, but also often regarded to be persistent tax infringers through use of transfer pricing in their import operations.

But there is obvious danger from the financial tightening under the control of Yanukovych Jr, taking into account

his considerable, but by no means sufficient, business interests. Forbes Ukraine lists him in 2012 for the first time among Ukraine's richest persons, at 98th spot, with a fortune of $99m concentrated in his Mako real estate holding and a rapidly expanding bank All-Ukrainian Bank of Development, headed by Valentina Arbuzova.

Valentina's son, central bank boss Sergei, also has some question marks in his past – he has publicly acknowledged in an interview with Zerkalo Nedeli in February 2011 that in his early career as banker he went to court to avoid being assigned a state tax ID number. He claims his aversion to having a tax ID was due to strongly held Russian Ortho-dox beliefs: ironically for someone associated with a drive towards fiscal tightening, he shares some Orthodox believers' conviction that the tax ID number is a sign of the devil.

Ukraine farming's flash online makeoverGraham Stack in Kyiv

Ukraine's major agribusinesses, thirsty for international financ-ing, are heading a drive towards

better investor relations, according to a new survey of company websites by Kyiv-based Concorde Capital. Yet even the best still suffer serious shortcomings.

Times were that agriculture in Ukraine was so backward that it seemed to live on in a parallel socialist world of its own. Things have changed – Ukrainian agriculture majors not only rank among Ukraine's most transparent – but also have by far the best internet presence among Ukraine corporates, according to a survey by Concorde Capital.

In a ranking of how good Ukrainian companies are at online investor rela-tions – maintaining websites that provide investors with the information they need in real time – agriculture companies dominate the top 25, taking 15 of the top 25 spots for online investor relations.

Although the overall top spot went to oligarch Rinat Akhmetov's DTEK power holding, places two to six were all

occupied by agriculture holdings: egg producer Avangard, grain producers Kernel, Alpcot Agro and Ukrproduct, and chicken producer MHP. "This reflects the leading role that Ukraine's agribusiness is playing in terms of recent placements and bond issues," says Concorde's Brad Wells, who authored the study.

But while the result at first glance points to Ukraine's agriculture rocket-

ing away from its socialist legacy in the vanguard of transparency, the under-lying reasons are more complex and reflect the impact of the socialist legacy on corporate finances.

Ukraine still does not permit the "alien-ation" of land plots, meaning land has to remain in the hands of the peasants

who inherited it from Soviet communal farms. Agricultural majors have to lease land instead of owning their basic means of production, and so they find it hard to raise long-term bank financing. "A Ukrainian agriculture company may not actually really own anything," explains Renaissance Capital's head of communi-cations, Konstantin Golowinski.

This in turn forces agriculture companies to leverage revenues and turn to equity and debt markets for financing, and thus develop a far higher level of investor relations. Hence the glossy all-singing-and-dancing websites.

Lack of financeThe leap from post-Soviet agricultural collapse to shiny online transparency has been incredibly fast, and is definitely a huge improvement. At the same time, the best suffer from some serious short-comings.

Take the website Concorde singled out for special consideration (one of the study's website evaluators called it "hands down the best site I reviewed for investors"), that for Avangard. For all the wealth of information about the company on offer in real time and in attractive format, there are some notable lacunae.

The website bio provided for the Avan-gard CEO Nataliya Vasylyuk fails to note that she is the younger sister of the majority shareholder and chairman of the board, Oleg Bakhmatyuk, putting a

question mark over management board independence.

The website also states that Avangard "does not produce and does not plan to produce" its own grain – grain costs constituting 80% of egg production costs. Bakhmatyuk's majority stake in Avangard was however transferred to his

"In a ranking of how good Ukrainian companies are at online investor relations, agriculture companies dominate the top 25"


grain producing company Ukrlandfarm-ing, one of Ukraine's largest, in 2011, a fact the website does record. Ukrland-farming itself does not have a website currently at all. Avangard has previously denied purchasing any grain from its sister company.

Another recent transparency glitch among agriculture companies involved grain producer Agroton, which is in the top 25 of Concorde's survey. When Agro-ton's initial auditor complained in May that there was no documentation for a large part of the company's 2011 stated revenues, Agroton simply chose a new auditor and fired their head of investor relations. The episode is, however, docu-mented on their website.

A more general caveat regarding agricul-tural transparency: Ukraine's govern-ment plans to lift the moratorium on land sales in a way that could introduce new restrictions on buying land. This could in turn prevent companies from exercising buyout options for land they currently lease, while undermining their leasing arrangements. So if transparency is a result of lack of land ownership as bank collateral, forcing companies to turn to financial markets, then it may be skating on thin ice if the land market changes abruptly.

For London eyes onlyThe Concorde survey also shines a spotlight on how even Ukrainian companies demonstrating good online corporate relations focus exclusively on international investors: domestic investors have simply dropped off the

radar screen, with the Ukrainian capital markets regarded as good as dead.

Some of the best websites from the point of view of investor relations are even English-only. "Conference calls without local Kyiv dial-in numbers are also a common occurrence," notes another evaluator that helped with the survey, Dmitry Koshevoy of Interfax-Ukraine.

Even where one asset in a corporate group is internationally listed and has a great IR website to show for this, this does not rub off on its domestically listed sister companies, which continue to show no interest in investors, according to the survey.

This may still change if Ukraine allows dual listings – for internationally listed companies to list in Ukraine as well, something CEO Oleg Tkachenko of UX Exchange, the country's leading share trading platform, is lobbying hard for. "With the introduction of dual listing, issuers that already have an established IR strategy will pay attention to keep-ing domestic investors informed," hopes Tkachenko.

No surprises, meanwhile, that the overall winner of the ranking – narrowly pipping Avangard – is Ukraine's rich-est man Rinat Akhmetov's DTEK power group, with his metals holding Metinvest coming in at sixth place and his First Ukrainian International Bank rated just after at seventh. All of these are lining up for potential major IPOs, and Akhmetov has long since installed a slick western PR and IR outfit to run his show.

"All of three companies are lining up for potential major IPOs, and Akhmetov has long since installed a slick western PR and IR outfit to run his show"

Milking it in Russia

Russia's first street milk-vending machines that play mooing sounds when they dispense fresh milk have appeared in the central Russian city of Tambov. So far, regional authorities have installed 10 street moo milk vending machines in the city and plan to install more in the wake of growing demand for the product.

"This is the first 'street' project in Russia," regional administration spokeswoman Natalia Spasskaya told RIA Novosti. "In Zelenograd in the Moscow Region, milk vending machines are installed inside wooden houses and in Voronezh they are placed in hypermarkets."

Tambov milk vending machines look like small newsstands. Inside each there are two 200-litre tanks, which are regularly refilled with fresh pasteurized milk, and a fridge that cools the milk to 4°C to keep it fresh. Milk reservoirs are kept in vending machines for no longer than 24 hours, even though the pasteurized milk selling term is five days. Every 24 hours the remaining milk is sent to a local milk processing plant to produce cheese.

Lucas paradox reduxBen Aris in Moscow

Markets are supposed to be rational – both classical economics and common sense

say capital should flow to wherever the returns are highest. The trouble is the real world doesn't work like that, especially in difficult times like today.

With massive debts on national balance sheets and several rounds of currency-debasing quantitative easing the best solution western governments can come up to solve their woes, the risks are rising fast. Investors have flocked to traditional "safe havens" of the US dollar and US Treasury bills, which Goldman Sachs recently lampooned in a paper as "the assets formerly known as safe."

"The number of 'AAA'-rated sovereigns is declining and in the advanced econo-mies, the number of countries with an 'AAA' debt rating fell from 68% before the 2007-2009 financial crisis to 52% currently. In emerging markets, there are no 'AAA'-rated countries, but an 'AA' rating is held by 15% of countries (up from 10% pre-crisis)," Neil MacKinnon, economist with VTB Capital wrote in a note in July. "International Monetary Fund projections envisage gross general government debt of the advanced economies will reach $59 trillion by 2016 compared to $47 trillion at the end of 2011."

Indeed, things have got so crazy that bond investors are willing to buy German bunds that earn negative real interest and lock in losses rather than snap up the rock solid Russian quasi-sovereign bonds from the likes of Sberbank and VEB that pay at least a 6% yield. Russia has just over a dollar of cash to back every dollar of external

debt (both sovereign and commer-cial), so the chances of default are small, especially when you set Western Europe's macroeconomic problems against Russia's.

Accepting losses when there are relative-ly safe high returns on offer makes no sense. This surprising situation where capital does not flow from developed countries to developing countries despite the fact developing countries have lower levels of capital per worker and so the returns related to the infu-sion of capital are higher is known as the "Lucas paradox", after the Nobel Laureate Robert Lucas of the University

of Chicago, who came up with the idea in a paper in 1990.

Uphill struggleWhat is responsible for this "uphill" flow of capital? The paradox doesn't apply to the flow of labour, as the hordes of immigrants arriving in Russia from the 'Stans last year showed (resulting in growth of the Russian population for the first time in two decades, from 142m to 143m). The US experiences much the same thing with Mexicans sneaking over the border to look for work.

In a conversation with bne, Lucas says he doesn't know the answer, but highlights two areas that he believes could be responsible. The first is simply due to the rudimentary nature of developing economies: the lack of infrastructure and modern equipment, missing factors of production, and poor regulation and low-quality institutions.

His original paper was inspired by Africa's plight in the 1980s: mineral rich in oil, minerals and diamonds, the continent subsisted on international aid and received almost no investment. "In Africa, there were almost no institutions, as the continent was ruled by warlords

and those institutions left by the French didn't function. The experience in India that inherited British institutions was mixed, but somewhere like Singapore, which threw itself into institution-build-ing following independence, has been a remarkable success," says Lucas.

In Russia's case, Lucas points to Presi-dent Vladimir Putin as a problem for investors: "There is real political risk in Russia and Russia under Putin doesn't inspire confidence. It is not an easy place to do business, as the government plays its favourites," says Lucas. "And this is true, not just in Russia, but in dozens of emerging markets. Of course, this raises

"There is real political risk in Russia and Russia under Putin doesn't inspire confidence"


the question of why companies are so comfortable investing into China, which is no different. Is it irrational? There is no obvious answer."

Subsequent research found that the one place where the Lucas paradox didn't work was post-colonial America, where the British institutions were taken over by the founding fathers and improved upon: British capital continued to flow after American independence and financed much of the new country's early growth. (To a lesser extent, British colonialism in the 17th and 18th centu-ry, the golden era of the British Empire, also facilitated capital flows: colonists take their money with them.)

Where's the story?The second group of problems has to do with the imperfections in the international capital markets, the risk of expropriation by the host govern-ment and the asymmetrical nature of information.

The golden rule of investing is "invest in what you know." According to the US Bureau of Labour Statistics, the US press corps numbers about 60,000 jour-nalists – or one hack per 5,300 citizens. By contrast, the entire English-speaking

press corps in Russia (which actually covers the 15 republics of the former Soviet Union) numbers about 300 hacks, according to bne's estimates – or one journalist per 834,000 people.

And that is before you take into consid-eration the space the Russia story gets in the international media: in 2011, the Wall Street Journal published a total of 2,608 stories with the word "Russia"

in them on its website (and only 876 in the print issue), against the 64,336 articles with the word "America" in them (20,384 in print). Yet this is despite the fact that the four BRIC countries already account for 25% of global GDP, 40% of the global population and 50% of global growth.

Another big problem is the flaws in the way capital markets are run. A crisis in, say, Mexico will typically impact a mar-ket like Russia, despite the two econo-mies having virtually no direct links with one another. "Emerging markets tend to move together even when there is no economic connection," says Lucas, speak-ing from his home in Chicago. "Russian bonds and Mexican bonds move together because there is some trader in New York that is trading both of them. The money is not so much moving around the world as around a room."

The Lucas paradox will eventually undo itself as these distortions disappear over time. Since Lucas wrote his paper, Africa has become a lot more democratic and investment has finally started to flow to exploit its enormous natural resources – with much of it coming from Russia, India and China, which are a lot more comfortable working with poor institu-tions and patchy information.

Likewise, as more and more investors travel to the emerging markets (and young Russians in search of a job go the other way), information is becoming more readily available in London and New York, even if it isn't in the main-stream media.

Finally, as emerging markets develop, institutions are being built. Russia has clearly entered a new phase where the government needs to nurture rather than push the economy forward. And the effort to set up supra-regional bodies like the Customs Union, which came into being in January 2010, as well as mem-bership of the WTO will force Russia to improve the quality of its institutions at home as well.

"Russia is not an easy place to do business, as the government plays its favourites, yet companies are comfortable investing in China, which is no different. Is it irrational? There is no obvious answer"

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bne August 201228 I Central Europe bne August 2012 bne August 2012bne August 2012 Central Europe I 29

A marathon race for the Czech presidency

As hopeful suitors line up outside Prague Castle, it is almost like a modern-day fairytale. Only

this time, they are not there to woo a princess, but the populace. And the prize is not happily ever after – it is the Czech presidency.

Early next year, for the first time ever Czechs will vote directly for their president. With the decision about who gets the keys to the official residence in Prague Castle now in the hands of the public, it's no wonder that candidates are already lining up to step into the con-troversial, but certainly big shoes of the outgoing president, Vaclav Klaus.

In the past, the largely ceremonial post of president has been chosen by the politicians bickering in smoke-filled back rooms; besides, the hold on the post by the two giant Vaclavs of the post-communist Czech Republic – Havel and then Klaus – was never really in doubt. This election, therefore, is a seismic change for Czech politics. While

Jennifer Rigby in Prague

the Czech Republic is a parliamentary democracy with ultimate power resting in the hands of the prime minister, the president is still a major figure, particu-larly on the international stage.

Independence is shaping up to be a key theme of this election. Czechs, fed up of

the constant stream of political scandals, are making it clear in the polls that they prefer candidates with no affiliation to the tarnished political parties.

The current clear frontrunner, Jan Fischer, has independence in his bones, and if that perhaps makes this former statistician a little dull, the voters do not seem to mind. Indeed, Fischer's lack of

political bias was one of the key reasons he was chosen as the caretaker prime minister in 2009, when the Czech gov-ernment collapsed in the middle of the country's presidency of the EU. "I do not want to be committed to any political party for supporting me in the presi-dential election. The only commitment

I want to make is to the Czech citizens," he told bne from his office in London at the European Bank for Reconstruction and Development (EBRD).

He's not the only candidate who currently works abroad. Snapping at his heels in the polls is another independent, leading economist Jan Svejnar. He ran in 2008, when only politicians could vote for the

"Zeman is sometimes considered a bit like the dodgy uncle of Czech politics with a fondness for the local tipple Becherovka"

president, but his "US-style" campaign-ing – meeting people around the country – won many admirers. He's clever and resourceful, but there's one stumbling block facing him – he holds American citi-zenship and has lived there since his late teens. For citizens of a small, young, ambi-tious country, this is hard to bear. Svejnar has clearly realised this though, promising to drop his US citizenship if he wins.

The third independent candidate, Vladimir Dlouhy, is taking the race seriously – both politically and literally. A marathon runner, he plans to stage runs across the country as part of his campaign. His name in Czech means "long" and he's even calling his campaign "The Long Run". "Also, metaphorically, it is a long run," he tells bne , "because for me, it starts now and could finish in 2018 [the next presidential election]. I am just coming out of the shadows now, I believe I have a chance but if not, I am here for the long run."

Dlouhy is already well-known in the country, famous (and popular) for being the Czech Republic's first ever trade and industry minister in Klaus's first govern-ment as PM in 1993. "In campaigns, I used to tell people what the political and economic reality would be like in 2000, but I resigned after eight years [in 1997]. I believe I left the work only half done," he says.

While popular in the 1990s, now many Czechs associate Dlouhy with an era of privatisations which did not end particu-larly well. On the other hand, in his day he was known as the "Teflon politician" because nothing stuck to him – a reputa-tion he may perhaps hope to maintain as he defends his work in the private sector since 1997 for clients including public enemy number one, banking giant Gold-man Sachs.

Who's your daddy?But if independence is one theme for this election, age and experience is another. It's the Goldilocks formula: not too little, not too much, but just the right amount.

For example, the Právo newspaper has described Fischer and Svejnar as "good old daddies", a presidential tradition

Tim Gosling in Prague

The three bidders for the tender to expand the Czech Republic's Temelin nuclear power plant submitted their bids on July 2. There appears little to choose between them, save for the fact that only one says it's ready to offer full financing.

After appraisal, state-controlled utility CEZ will enter negotiations on the bids, with a final decision set for 2013. The bidders – the US' Westinghouse (a division of Japan's Toshiba), France's Areva and a Russian consortium led by Atomstroyexport (a unit of state nuclear company Rosatom) were pre-selected in 2010.

CEZ launched the CZK200bn (¤8bn) tender to build two new nuclear units at its 2-gigawatt Temelin plant in 2009. The company says the tender includes an option for it to order another three reactors at sites inside and outside the Czech Republic, which could mean the total investment reaches about ¤25bn.

The three bidders have jostled for position this year, with all three pushing their intention to subcontract the majority of the work to Czech companies. Construction is planned to kick off in 2016. "The construction of new Temelin reactors is a key pillar of CEZ's strategy," CEO Daniel Benes said in a statement. "Today marks a significant step towards ensuring steady electricity supply for Czech customers for decades to come."

However, questions still remain over the fortunes of CEZ, its ability to fund the project, and the overall economic viability of the Temelin expansion. Whilst the company insists it can fund the project itself, it has admitted it would then struggle to realize other projects. In light of that, the company has been lobby-ing to secure government guarantees and feed-in tariffs for the plant's output.

Atomstroyexport in March said it would be ready to offer full funding for the project, and consider any type of strategic partnership, including one that sees it become a shareholder in CEZ itself. The company made the same offer to Hungary in June, as Budapest announced a HUF3 trillion (¤9.9bn) tender to expand the Paks facility.

The Russian offer illustrates the enthusiasm in Moscow to win the Czech contract. As one of its few successful high tech industries, the Kremlin has been pushing Russian nuclear technology across the globe as part of its drive to diversify the economy. Whilst it has seen significant success in winning business across Asia and the Middle East, it has struggled to make an impact in Europe.

Both Westinghouse and Areva insist they won't offer CEZ funding, but believe they can still win the tender. "[Areva] will not be involved in the financing," Areva's director for CEE, Thomas Epron, told a press conference after delivering his company's bid. "We have offered state guarantees for the initial stages however, which should help the project find bank financing… but financing is CEZ's responsibility."

Bidding hello to nuclear

30 I Central Europe bne August 2012 Central Europe I 31bne August 2012

dating back to the first Czechoslovak president Tomas Garrigue Masaryk, in office from 1918-1935.

For other candidates though, a lack of experience is regarded as a weakness. And in the case of 42-year-old left-winger Jiří Dienstbier, the principled candidate of the opposition Czech Social Democrat Party (CSSD), it could be crucial. "He is the most popular politi-cian in the Czech Republic, but that's not sufficient to take office now because the factor of his youth is more important in

this election," says political analyst Vít Kleparnik, co-founder of the think tank CESTA, whose take is backed up by the polls, which show Dienstbier trailing, although his numbers are improving.

It's perhaps the opposite case for another of the candidates, Karel Schwarzenberg,

the aristocratic TOP 09 candidate who is currently foreign minister. "Schwarzen-berg is a man of history – and of the 2010 election – and it will not be a repeat," reckons Kleparnik. After an early surge in popularity in the presidential contest, Schwarzenberg himself has said he will have "little time" to campaign because of the demands of his current job.

Age and experience is also on the side of Milos Zeman, who is running under the banner of his own small party. This former prime minister has already

shown his political nous in his recent attempt to brand the presidential race as a straight left/right contest. There are far more right-wingers in the con-test than left, meaning a vote on those lines could see the rightist vote split, and Zeman reap the rewards.

Czech PM from 1998-2002, Zeman is a well-known name with a real chance, often vying with Svejnar in the polls for second place at the moment despite – as one observer put it – sometimes being considered a bit like the dodgy uncle of Czech politics with a fondness for the local tipple Becherovka. On the other hand, he's the only candidate so far to collect all 50,000 signatures needed to officially register as a candidate, he's won the support of ex-rival Klaus, and his reputation should not be underestimated.

The remainder of the field – includ-ing the Civic Democratic Party (ODS) candidate, Premysl Sobotka; President Klaus's assistant, Ladislav Jakl; and anti-European Sovereignty party leader and TV presenter, Jana Bobosiková (the only woman in the contest) – look unlikely to challenge the big beasts already listed.

For now, most of the candidates are content with collecting signatures, rais-ing funds and preparing for battle. But with a field like this, it is going to be an interesting few months. As Schwarzen-berg himself put it: "the fun will start in autumn."

"Schwarzenberg is a man of history – and of the 2010 election – and it will not be a repeat"

Poland's demographic time-bombBogdan Turek in Warsaw

Poland's population is declining year by year and demographic experts say the number will

dwindle from 37m to 31m by 2050 unless it creates incentives for foreigners to settle. That will be hard for a country not known for its welcoming attitude to immigrants.

"The decreasing population trend of the Polish nation cannot be resolved only by incentives to have more children," says Krystyna Iglicka, an expert on immi-gration problems at Warsaw's Lazarski University. "We should focus on immi-grants."

Russians, Ukrainians and Belarusians, who are culturally close to Poles, would be the best bet, but existing bureaucratic barriers and lack of legal protections for foreign-born residents scare them away. This can be seen in the statistics, which show that the number of "mixed" marriages has dropped by 10% and the

number of children born to such couples fell by one sixth over the last two years.

Iglicka says immigrants from the east do not want to settle in Poland, primar-ily because of discrimination against them on the labour market. "Polish managers have usually two kinds of offers: house cleaning, or work in so-called social agencies – or broth-els – despite the fact that many of the women are graduates of higher estab-lishments and speak Polish," Iglicka says. "Poland is a difficult country for immigrants, and the stay here often turns into economic degradation."

Demographic experts warn that Poland will be short of some 5m-6m workers by 2060, for which formulating a decent immigration policy, with incentives to settle in Poland, could be a remedy. "A quick system should be introduced for recognizing foreign diplomas," says Miroslaw Biernacki, an expert in the Institute of Public Affairs. "The compli-cated recognition procedures of diplo-mas deter engineers or doctors from coming come to Poland."

Yet even ethnic brothers such as the roughly 70,000 Poles who were deport-ed to Kazakhstan under Stalin during World War II don't appear particularly welcome in their homeland. The Polish statistical office GUS says that only 5,200 have resettled to Poland in the last 10 years. Svetlana Kot, who married a Pole and got Polish citizenship, says her mother is still stuck in Kazakhstan. "She knows how difficult it is to prove that that she has Polish roots, so she decided to stay for the next five years to reach retirement age and get a pension in Kazakhstan," she says. "Then, after coming back to Poland, she will not be a financial burden for her family."

The media recently highlighted the case of Olech Zych, a 50-year-old monk of Polish descent who was born in Ukraine and whose mother was Polish and father Ukrainian. The authorities rejected his application to get Polish citizen-ship because the birth certificate of his mother did not specify her nationality, although she had another official docu-ment issued by Ukrainian authorities

saying she was Polish. The monk had to leave Poland to avoid deportation. "There is little time left to change Polish immigration policy," Biernacki says. "Foreigners are simply discouraged from settling in Poland."

The number of naturalization documents issued since 2005 is low. Only 6,937 peo-ple, chiefly Ukrainians and Belarusians, got Polish citizenship from 2005 to 2009. In 2010, 2,019 naturalization documents were issued and in 2011, a total of 2,375.

Back homeStill, there are some encouraging signs. In 2011, John Abraham Godson, a Nigerian who has lived in Poland for almost half his life and is a Polish citizen, become the first black man to become a member of parliament in Poland. Godson's success has been hailed as a landmark in a country where there are just 4,000 black people.

The huge outflow of people from Poland when it joined the EU has also abated and even reversed as the economic crisis in Western Europe deepens.

GUS, the statistical office, estimates that over 1.7m Poles left Poland in the six years after Poland joined the EU in 2004, most to the UK and Ireland. But Angel Gurria, OECD Secretary-General, said in June that her organisation has noted significant re-flows of migrants back into Poland from places hard hit by the crisis. Once a magnet for migrant workers and particularly Poles, Ireland has witnessed a dramatic reversal in migration trends, with around 34,000 people emigrating in 2010 as well as in 2011 – equal to 1% of its national population.

One new trend among Poles is not to emigrate far away from home, but only to settle across the Polish–German border. There are about 460,000 Poles living in Germany now. The German Institute of Public Affairs says that some 4,500 Polish families bought houses or apartments in the Mecklenberg region near the Polish city of Szczecin. "The number of settlers doubled in the last seven years and is growing," it notes.

"Polish managers have usually two kinds of offers for immigrants: house cleaning, or work in so-called social agencies – or brothels"


Storm clouds stack up over Budapest Airport

Kester Eddy in Budapest

The international consortium operating Budapest Airport has had a bumpy ride this year, and

is threatening action against what it claims is unfair treatment at the hands of the state. However, not everyone is sympathetic.

The corporate mood at Budapest Airport at the start of the year was triumphant, epitomised by an early January press release headlined: "Budapest Airport 2011: All traffic records beaten!" Buda-pest Airport, the operator of Franz Liszt International – essentially Hungary's sole international airport – had regis-tered in 2011 "an amazing 8.9% traffic increase and recorded an all-time high of 8.92m passengers," the statement read.

After opening SkyCourt – a gleaming new state-of-the-art terminal building – earlier in the year, and scooping the European section of the World Routes Airport Marketing Awards – a coveted industry prize – in October, it seemed

nothing could stymie the airport's march onwards and upwards. Jost Lammers, CEO of Budapest Airport, boasted at the time that passengers were being offered a "much higher standard of service" than

previously, and that the operator's four-year investment programme was "now starting to pay off."

Yet less than a month later, on February 3, airport staff were scrambling in the pre-dawn gloom to re-direct thousands of potentially stranded passengers as a result of the insolvency of the airport's

principal customer, Hungarian flag carrier Malev. Losing an airline that constituted around 40% of passenger traffic was a massive blow for Budapest Airport, a consortium headed by Hoch-tief of Germany that bought the operat-ing rights from the state in 2007. Yet the problems are continuing to stack up.

Taxing timesNot two months after the Malev col-lapse, the Hungarian parliament modi-fied the airport's land categorization, in a move that more than tripled land taxes to HUF2.25bn (€7.6m) per year. Outraged, Budapest Airport claimed the move would cause further damage to the Hungarian aviation and tourism sectors, and warned it would need to pass on costs.

On June 29, Budapest Airport announced it will appeal the tax hike to the Hungarian constitutional court, arguing that it has been subjected to a "disproportionately large increase in land tax… that violates the constitution-al principle of the proportionate sharing of public burdens."

In addition, in response to emailed questions, Lammers tells bne that the operator plans to raise landing fees "from the end of October" by an unspeci-fied amount. "Consultations have just started. [It should be] no surprise there will be an increase in airport taxes since

the airport has suffered a double blow from the collapse of Malev and the increase in land tax," he insists.

Lammers expects aircraft movements to be down by almost a quarter this year, with passenger numbers touch-ing just 8m in "a best case scenario." Despite beating that number by almost

"It should be no surprise there will be an increase in airport taxes since we suffered a double blow from the collapse of Malev and the increase in land tax"

1m in 2011, Budapest Airport says it lost HUF8bn before tax last year. Compound-ing this, the latest crises have provoked the company into shedding 250 jobs in 2012 – reducing staff from 1,050 at the start of the year. In addition, the closure of the communist-era Terminal 1 earlier this year is expected to save €2m annu-ally, Lammers says, whilst the airport has put its €50m "Cargo City" investment project on hold.

Budapest Airport is pushing the scenario that its struggles will only have a ripple effect on associated industry. "Cargo City is now expected to commence in two years' time, [but meanwhile] this will have a negative impact on the construc-tion industry and jobs in that sector," Lammers states. "This €50m capex was in addition to the €261m commitment undertaken as part of the airport priva-tisation [agreement], which has already been fully delivered."

The tourism sector, suffering in par-ticular from a drop in high-spending conference and business visitors in the

wake of the Malev grounding, appears sympathetic to the cause. "The increased network and frequency of the budget air-lines is bringing additional visitors, but it is hard or nearly impossible to replace a national airline," Akos Niklai, vice-president of the Hungarian Hotel and Restaurant Association, says.

The tourism lobby also praises Budapest Airport for continuing development when the economic recession hit Hun-gary, with the airport remaining one of the few major investments in Hungary, fully carried out on time. However, not everyone is so sympathetic.

Rakosmente council, one of the districts set to benefit from the increased land tax payments, has no truck with the operator’s arguments. "Hungarian airports are subject to the legitimate decisions of the Hungarian parliament. People and companies in Hungary pay taxes… the vast majority of foreign investors in large companies do so with-out complaint. But Budapest Airport is trying to avoid this duty, like a whin-

ing kitten, trying to avoid its commu-nity responsibilities," it said in a stern response.

Despite Lammers' assertion that the airlines using the airport "have shown a great deal of empathy" to what he terms "the impossible situation" caused by the increased tax burden, there is resistance to that line from at least one major bud-get carrier. Asked by bne for the view from Ryanair, CEO Michael O'Leary roundly condemns Budapest Airport's efforts to raise landing fees, saying the operator has suffered no "double blow" from the Malev collapse. "Ryanair and others have responded with new routes, increased flights and more business, while the airport has shut Terminal 1 to save even more money," he insists. "We will be making submissions to the Hungarian Civil Aviation Authority to reject this unnecessary and unjustified airport fee increase, particularly when Budapest Airport has failed to demon-strate or deliver any cost reductions [to airlines]."

Latvia peers into the shadows

Mike Collier in Riga

With cash a scarce commodity these days, policymakers are rummaging through the

cutlery drawers and feeling down the back of the sofa for any spare bits of revenue they might have misplaced during the boom years. Latvia is hoping to find something more valuable than breadcrumbs and old buttons – instead, a carrot-and-stick policy to rein in the shadow economy.

Shadow economies matter for several reasons. Most obviously they make no

contribution to the official statistics on growth, consumption, taxation and so on, skewing results and giving a false picture of what's really happening on the ground. If everyone buys their strawberries from stalls by the side of the road in preference to a registered grocer, the official figures say no one is eating strawberries – even though sales of cream have mysteriously rocketed.

Economies can end up in a vicious cycle: individuals go underground to escape taxes and social welfare contributions,

eroding the tax and social security bases. That, in turn, causes increases in tax rates and budget deficits, pushing even more production underground.

In Central and Eastern Europe, the assumption has always been that the shadow economy is large compared with economies further to the west, partly as a hangover from the Soviet era, when getting hold of many goods and services was a case of knowing the right person in the right job, and partly an understandable reaction to taxation systems that often demand a lot but give little in return. Research by Friedrich Schneider released in December stated frankly: "The new European Union members… have higher shadow economies than the 'old' European Union countries."

Trust in the figuresAccording to Schneider, in 2012 the Bulgarian shadow economy will be worth 32.3% of GDP. It is followed by


Romania at 29.6%, Croatia (29.5%), Lithuania (29.0%), Estonia (28.6%), Turkey (27.7%) and Latvia (26.5%). In contrast, the grey economy in Germany equals just 13.5% of GDP, with the UK at 10.5% and Switzerland 7.8%.

However, new research by Latvian academics Talis Putnins and Arnis Sauka challenges those figures, and

seems more persuasive, partly because it shows subtler variations, but also because it's based on direct interviews with hundreds of businesses rather than relying purely on macro data. "We've seen big differences between Latvia, Lithuania and Estonia over several years, so I no longer have any doubts they exist," Sauka tells bne. "If we can't trust what entrepreneurs are actually saying, then we definitely can't trust macro data. I might trust such data from Sweden or Germany, but I wouldn't necessarily trust it from Central and Eastern Europe."

According to Sauka and Putnins, the size of the shadow economy in 2011 was notably higher in Latvia (30.2%) than either Estonia (18.9%) or Lithuania (17.1%). Although all three Baltic countries decreased the size of their shadow economies from 2010 to 2011, the reduction in Latvia (8.6 percentage points) was much larger than those seen in its neighbours (1.7 pp and 0.5 pp, respectively). Meanwhile, Lithuania and Latvia share the similarity that the size of their shadow economies actually expanded from 2009 to 2010, followed by a contraction in 2011, whereas in Estonia it has followed a more consistent path of modest contraction in both 2010 and 2011.

Sauka says Latvia's recovery from crisis was the main reason it managed such a marked decease last year. "When an economy gets back to normal, the figures of the shadow economy should

also get more normal, although if you are talking about one third of GDP it's still a lot. Another explanation is that the minister of finance has been implementing a lot of action. However, I don't think this is directly impacting the figures yet; that may happen after a couple of years as they tend to be long-term measures."

Trust in the authoritiesAlso worthy of note are some startling variations between Latvia's regions. In 2010, more than 40% of Riga's economy was unreported, compared with just 17% in the northern Vidzeme region. A key aspect is people's perception of the likelihood of getting caught. "Latvian entrepreneurs still believe that they won't be caught, and in particular small companies feel they are protected because no one really cares about them. This shows in the data: bigger companies have reduced their share in the shadow economy, but micro-companies are still much more involved," Sauka asserts.

"The level of trust businesses and entrepreneurs have in the government and institutions is also crucial," Sauka says. "It is of utmost importance that

entrepreneurs feel the tax system is fair, that it won't change and is predictable. This is also one of the things that explains the huge difference between Latvia, and Estonia and Lithuania, where entrepreneurs seem to trust the government more and perceive tax policies as fairer."

The good news for Latvia is that Finance Minister Andris Vilks consistently tops polls of the most trustworthy politicians in the country. Vilks admist to bne that the shadow economy figure of 30% of GDP is "realistic," but stresses that crucially the situation is improving. "We are getting results, partly because we opened a real dialogue with businesses," he says. "It's very important to keep this trend as there is still a significant gap between us and our Baltic neighbours. We need to get the figure down to 20% and things like the Latgale development plan [which aims to boost jobs in a region more in shadow than most] could be crucial. I am quite confident, if we can keep good growth in the economy this year and next. It would be good to see the figure down to around 25% this year and maybe hit 20% in three years' time."

"A stick and carrot approach should give results," the minister continues. "We're proposing reductions of the tax burden which should be very helpful to entrepreneurs, and we're trying to deliver much more transparent distribution of tax revenues. But punishments should also be very strict. Fines should be much higher and that would send an important signal to all tax cheaters."

However, not everyone is convinced. As one self-styled "businesswoman and entrepreneur" asked at a sparsely-attended May 30 conference on the shadow economy run by the Latvian Chamber of Commerce: "This is all very

well, but look around you. Why isn't anyone here? Because they're all out working, a lot of them in the shadow economy."

"The new EU members have higher shadow economies than the 'old' EU countries"

"Why isn't anyone here? Because they're all out working, a lot of them in the shadow economy"

"We have a saying that Riga is too close to Cesis, but Cesis is too far away from Riga"

Big hopes in small town LatviaMike Collier in Riga

Talk about the "green shoots of recovery" is one of the more obvious phrases encountered

during any economic cycle. Not only is it a cliche, it's usually also fairly inappropriate, being applied to big businesses, macroeconomic data and the like – more re-growth on the big branches than green shoots from fertile soil. But to cram in another cliche, if you want to see the green shoots, you need to bend down to the grassroots level – and they don't come much greener than the leafy town of Cesis (population: 15,000), 100 kilometres from Riga in the heart of Latvia's rural Vidzeme region.

Far from relying on the forestry, dairy products and other agro-staples that are the most obvious economic activity hereabouts, Cesis and towns like it provide ample evidence of entrepreneurship as compelling as anything you might see on the BBC's "Dragon's Den" programme. In fact it was a notorious BBC news story from 2011 that depicted Cesis as a stereotypical grey, post-Soviet ghost town. A former resident who moved to the UK to find work was pictured revisiting her dingy, abandoned school and bemoaning how awful life was. It

neglected to mention, though, the brand new school that had recently opened or another one that regularly tops school ranking tables.

The report clearly still rankles with Cesis mayor Girts Skenders, who is the

very personification of the bustling local busybody. "Walk around any town in Europe on a rainy Sunday in October and you will probably notice there is no one in the streets!" he tells bne exasperatedly. "To say nothing is happening is very unfair."

An audacious bid to be a European capital of culture in 2014 fell only at the final hurdle when the organisers opted for the "safe" option of Riga (probably because Vilnius and Tallinn have recently had the accolade too). "We have a saying that Riga is too close to Cesis, but Cesis is too far away from Riga,"

quips Skenders, on the decision. "But we still have our annual art festival and opera festival, both of which have an international reputation."

He might also have added Fonofest to the list, a rock festival that organiser Janis Sildniks admits was born simply so his own band would have somewhere to play. This year's event, the eighth, takes place July 13-14 featuring bands from Australia, the UK, Finland, Hungary, Russia, Sweden and the Baltics, as well as headline act The Asteroids Galaxy Tour from Denmark. Last year's event attracted a crowd of 4,000 – a big improvement on the 500 who showed up to the first one. "Crowd numbers certainly didn't get bigger during the crisis years, but they didn't drop either and the festival continued to develop," says Sildniks.

What started as a one-day event is now a two-day festival and the aim within the next few years is to have a three-day event with multiple stages. It is some measure of Sildniks' entrepreneurial acumen that he was prepared to make the ultimate sacrifice of pulling his own band from the bill to concentrate on running Fonofest, along with his music venue Fono Klubs. "The last time we played was three years ago. I remember

playing drums and all the time looking at my mobile phone. That's when I realised we couldn't play any more," he laughs.

Magnus opusThe nexus of Cesis entrepreneurship is Agris Lapins who heads the Magnus business incubator – one of nine in the country, each of which has at least one smaller subsidiary. He is currently helping around 80 new businesses establish themselves, 25 of which have already left the cheap office space in the town centre that houses the incubator. "For some people there is no choice but to start their own company. If they lose

Cesis

36 I Central Europe bne August 2012

South of the border, down Latvia way

Time was when Americans keen to lay low would head down to Mexico for a few weeks of tequila and tacos. But Chihuahua doesn't seem as far away as it used to, which may explain why Nasdaq OMX chief Robert Greifeld took the opportunity to make himself scarce in Latvia in June ostensibly to check out his huge company's tiny Baltic bourses.

Riga offered some refuge from journalists pursuing him over the botched $100bn IPO of Facebook on May 18, which has already gone down in history as one of the investment world's biggest cock-ups. And in contrast with recent visits by Christine Lagarde and Hilary Clinton, Greifeld's official media opportunity consisted of two questions in a corridor with Latvian Prime Minister Valdis Dombrovskis. Even then, the head of the Riga bourse stepped forward to answer on Greifeld's behalf when asked if the Latvian central bank's refusal to allow euro-denominated trading was hurting investment flows in an equity market that in June was handling just 40 trades per day worth ¤80,000.

With the press call over, Greifeld headed out the doors and strolled towards lunch, giving bne an opportunity to harass him further as he walked, which he took in good humour. During this brief promenade, he speculated on the possibility of future listings of state assets, suggesting a "hybrid model" might be best. "Here is Riga you have more SOE (state-owned enterprise) companies for the given size of the market than you'd expect. Our experience globally is that SOEs benefit when they even have some additional capital raising, where the government still owns and controls it. But even if there's 10% in free float, it changes the nature of the company where it has to operate as a public company with public company discipline," Greifeld said.

their job, they spend a while looking for a new one then come to the conclusion that no one else is going to give them one," says Lapins, whose laid-back style is probably exactly what start-ups need to give them confidence.

One of his greatest success is the Karumlade cafe, which recently moved from tiny premises on a Cesis backstreet to a larger site on the main shopping street. The owners, Vineta Zamoidika and Alla Oldermane, began baking their cakes and confectionery at home after putting their children to bed and got such good feedback (their carrot cake is almost worth a trip to Latvia on its own accord) that they summoned up the courage to set up shop.

According to Lapins, the cafe provides a perfect example of how to tap into small-town potential. "I met with the ladies and we discussed the possibilities, but I told them we would need to work out some figures," Lapins says. "Only then did they nervously hand me a sheet of paper on which they had written all the costs of making each cake, what price they had been selling them for and

so on. At a glance I could see we had a viable business. They had been keeping accounts without even thinking about it – we just needed to turn that into regular book-keeping."

Oldermane tells bne that launching right at the start of crisis was naturally scary. "But after taking expert advice about our prospects, we felt a bit more confident. Within two years it was clear we needed a bigger place."

Sitting in one of the incubator's offices is lawyer Juris Baranovskis who set up his own legal practice in 2011 and actually moved from Riga to Cesis for what he says is a better quality of life, part of an increasing trend among Riga's

upwardly mobile young professionals. The possessor of two master's degrees, in his spare time he also runs an NGO promoting environmental protection. "The crisis made people more creative. This is a good time and place to set up a company," he insists, citing the introduction in 2011 of micro-business legislation giving start-ups a tax regime in which they pay just 10% of their turnover as crucial in his decision to strike out alone.

"I regard the micro-business legislation as practically a gift from our government," he says. "Under the main tax code [which sees more than 40% of an individual's wages disappearing in income and social taxes], it would have been impossible to set up a business."

Perhaps the most eye-catching example of a cosmopolitan start-up is 22-year-old Marta Matisone, owner of a company making hand-painted handbags. At around €60 per bag, they are luxury items in a country where the average gross monthly wage is €670, but each bag is made to order and Matisone says her customers love that no two bags

are the same. "Prada has beautiful bags but there are thousands of each one, with the same logo. You go to a party and there are hundreds of girls all with the same bag. So women with more personality come to me and ask me to make them a bag – and I can make anything that they can imagine."

An unabashed Francophile, Matisone divides her time between Cesis and Paris. A "Teach Yourself French" book lies propped open on her sewing machine while she and two employees are busy stitching. "I spend two weeks in Latvia then two weeks in France. Latvia is a good place for business, but France is where I feel truly at home," she muses. So much for small town attitudes.

"For some people there is no choice but to start their own company"

bne August 2012 Southeast Europe I 37

Romania's great survivorPhil Cain in Graz, Austria

T he referendum on July 29 to impeach suspended President Traian Basescu looks to have

failed, but the manner in which he survived will almost certainly mean there's no end in sight to the viscous power struggle that has destabilised the country for months.

With his popularity at a low point, Basescu had little chance of victory in the referendum. An exit poll for TV news network Realitatea said as many as 86.9% went against him. More important to Basescu's survival was whether the turnout reached the 50% threshold needed to validate the result. In this, Basescu's thinly-veiled call on his dwindling support to boycott appears to have paid off. The Central Electoral Commission estimated 45.92% of the electorate turned out, with a 3 percentage point margin of error, based

on data collected from a sample of 2,889 polling stations.

The Social Democratic-led governing coalition is still clinging to the faint hope

that the number of mobile and overseas votes would bring the turnout up to 52%. "Basescu will not return to [the presidential palace] Cotroceni!" said a Social Democrat spokesman.

Prime Minister Victor Ponta took a line that will probably be maintained in the

post-referendum battle, claiming the poll represented a moral victory if not a legal one. "If Basescu thinks he can just ignore the will of almost 9m Romanian voters, he's completely detached from reality."

A low leuThere seems little chance the final result will relieve the political turmoil which has weighed heavily on the economy for months. Basescu seems set to remains in office but severely weakened, while his Liberal Democratic Party can expect little joy

"If Basescu thinks he can just ignore the will of almost 9m Romanian voters, he's completely detached from reality"

www.presidency.ro

38 I Southeast Europe bne August 2012 bne August 2012 Southeast Europe I 39

The hand that rocks the cradle

Andrew MacDowall in Belgrade

A freshly-appointed prime minister presiding over a country in dire economic straits much in need of international good will: this is the situation in which Romania's Victor Ponta found himself when he took office in early May. And yet the fresh-faced premier, rather than setting about the country's many issues and preparing for an expected landslide election victory in autumn, has plunged the country into political crisis to a chorus of condemnation.

With EU officials apparently "flabbergasted" at Ponta's actions to remove President Traian Basescu, the question on everyone's lips is why would a leader, backed with public goodwill and with much to do, set about attacking his beleaguered and discredited opponent, and taking to task several of the key institutions of state? Some see the hand of tycoon Dan Voiculescu, one of Romania's richest men, at work.

Professor Tom Gallagher, a British Romania-watcher, suggested in an article on The Commentator that Voiculescu, a media tycoon and an eminence grise in Romanian politics for more than two decades, is behind the government's actions. The stand-in president (and candidate to replace Basescu), Crin Antonescu, is a Voiculescu protégé. On May 1, Vociulescu said that Basescu should be impeached if he didn't resign within 60 days; in the end, the suspension came after 59 days.

According to Gallagher, "after 1989, [Voiculescu] had acquired enough money to launch a media empire which he placed at the service of whichever party was most actively opposed to genuine change in Romania. This was usually the heirs of the Communists, the Social Democratic party [of which Ponta is leader]."

Voiculescu, as well as being a proven Communist-era informer, also allegedly did rather well out of privatisations in the 1990s under the post-Communist successor governments.

Romanian journalist Dan Tapalaga concurs with Gallagher, and points out that Voiculescu was coming to the end of a trial for corruption (specifically involving underpriced land) – a trial that could be cancelled if Ponta is successful in displacing Basescu and replacing prosecutors at the National Anti-corruption Directorate (DNA), an organisation that has been praised by the EU for its efforts. "The origin of what is happening lies in Voiculescu and his interests," Tapalaga tells bne.

But he is not the only figure who stood to lose if Basescu's targeted anti-corruption efforts continued. Several of Ponta's deputies face investigation – and the recent conviction of ex-Prime Minister Adrian Nastase and other senior figures indicates that the DNA is willing to go to the top. "After Nastase was convicted, people started getting scared," says Tapalaga. "So the likes of Voiculescu decided to do something about the last institutions to oppose abuses of power. Half of Ponta's support comes from allies of Voiculescu and people with interests to defend. He is their prisoner."

There were other barriers to Basescu's impeachment, according to the SAR report. The electoral register may be far larger than the actual voting population, meaning that it is actually more than 50%. The electoral register currently reflects the census done in 2002, which put the Romanian population at 21.7m, nearly 3m more than counted in a census last year.

CakewalkThe Social Democrats had always looked likely to walk the parliamentary elections in November, having won a little over 50% of the vote in local elections. Now after the impeachment vote, they look even more of a shoo-in. But if Basescu is able to keep dodging impeachment bullets, the power struggle could go on until his term expires in 2014.

This scenario would do little to reassure currency and bond traders, or investors. Raiffeisen does not, however, "attach a high probability" to Romania failing to stick to IMF/EU bailout before the parliamentary elections in November. Nevertheless, it said, the "risk increased" because a budget in May "showed signs of weakness" and the reform agenda is running late.

Romania is failing on other fronts. The European Commission earlier in July chose to extend its period of post-accession monitoring to make sure Romania meets benchmarks that were set up when it joined the EU in 2007. This monitoring was to have ended this summer, but the Commission cited specifically the recent events, which "have shaken our trust," said Commission President Jose Manuel Barroso.

"Challenging judicial decisions, undermining the constitutional court, overturning established procedures and removing key checks and balances have called into question the government's commitment to respect the rule of law. Party political strife cannot justify overriding core democratic principles," Barroso said.

Romania's bid to join the passport-free Schengen zone is also in the balance.

The already poisonous political atmosphere seems set to become more poisonous still, heightening a sense of nervousness among investors about the country's economic trajectory. The referendum and its aftermath are only likely to jangle more nerves.

"Recent events have shaken the European Commission's trust in Romania"

in the next parliamentary elections in November.

Since the latest episode of the long-running political soap opera started in late April, the leu has fallen 6%, touching historic lows against the euro. "The adverse political events are the main forces behind the current leu weakness," according to a report by Austrian bank Raiffeisen, which says there is a "low probability" that the currency can reverse these recent losses.

The level of the leu is more than just a matter of pride, because most public and private debt is euro denominated. A falling leu raises default rates and potentially destabilises the banking sector. "That is the last thing Romania needs right now," says Martin Prochazka, a independent analyst. Some €2bn left the country in May, according to a report published by the Romanian Academic Society (SAR).

PM Ponta's coalition government suspended Basescu on July 6 for, it claims, acting unconstitutionally during his presidency. During his eight years in office, Basescu has made a habit of second-guessing ministries by taking the chair of presidential policy formulation committees. This presidential meddling in the running of government reached boiling point when a fresh round of defections from Basescu's unpopular Liberal Democrats saw Ponta's Social Democrats take power in a coalition with the centre-right National Liberals in early May. Ponta's government moved swiftly to prise Basescu's fingers from the government's business by suspending him and calling the referendum. The action prompted something close to outrage in Brussels.

Ponta also used his emergency powers to scrap a law lowering the bar for removing the president to a simple majority of those who vote. However, the Constitutional Court struck that down, bringing back the threshold which states that at least 50% of the electorate plus one voter was needed to take part to make the referendum valid – something which appears to have saved Basescu.

Turkey guzzlers

Warnings have been issued about whether Turkey can sustain its meteoric economic growth. However, the country has weightier problems to deal with right now.

According to the government, a little over one out of every three Turks is obese – a ratio that's even higher for women. As such, the health ministry is rolling out publicity spots on television and in newspapers, in an attempt to change people's lifestyles that doctors believe are bulking up the 73m population.

"35% of the population is obese," Health Minister Recep Akdag, who himself recently set an example by losing 22 pounds and recommends a walking regime of 10,000 steps a day, was reported by AFP as saying.

In Turkey, the world's 17th biggest economy, the number of people treated for diabetes has gone up 90% in 12 years, Yunus Yavuz, a specialist in metabolic diseases told AFP.

But there is hope: as a Mediterranean country, Turkey has all the vegetables, fruit and fish required for a healthy diet.


gas and oil, given the isolation of the Iranian banking system, if not in gold.

As a private company, Tupras is free to make commercial decisions as it sees fit, but state-owned Botas is governed by strict controls. "As a state company, Botas has neither the leeway nor the expertise to start buying gold," a Turkish official tells bne.

Indeed, a banking analyst at an Istanbul brokerage calls buying tonnes of gold and trucking it to Tehran "just silly." He points out that both companies were, prior to the implementation of sanctions, making payments to Tehran using Turkey’s state-owned Halkbank, which has its own office in Tehran and is ideally placed to handle such transactions, and is widely reported to have been facilitating payments for Turkish companies permitted to trade with Iran.

Although neither company, nor Halk-bank itself, are commenting on how they are facilitating payments, the bank is widely believed to still be able to facilitate money transfers despite the isolation of Iran's banks.

All of which makes the strenuous denial by Turkish Energy Minister Taner Yildiz that Turkey is paying for its oil and gas in gold, all the more believable. Both companies, he said, continue to pay in the currency they contracted to buy in; for state company Botas that's US dollars; for private company Tupras, Turkish Lira.

Western sanctions against Iran have been generating frenzied media coverage since long

before their final implementation on June 28; the heady combination of the deeply unpleasant regime of President Mahmoud Ahmedinejad and its unwillingness to compromise over Iran's nuclear programme allowed the West to draw a metaphoric and literal line in the sand: those countries supporting sanctions are with us, those who don’t are against us. And supporters of the sanctions have been quick to seize on any evidence purporting to show which side of that line various countries are on.

In light of this, the stories that surfaced in mid-July alleging that Turkish gas importer Botas and the country’s sole oil refiner Tupras were circumventing sanctions by paying for Iranian oil and gas in gold bullion were perhaps understandable. After all, figures produced by Turkey’s own state statistics office clearly show a leap of over 800% in

Turkish gold exports to Iran, from $1.7m to $1.39bn (at $51,000 per kilogram, that's 27 tonnes), between February and May. Given that Turkey is a country with a moderately Islamist government which has consistently declined to implement its own sanctions against Iran, this could only mean one thing.

Or could it? In fact, the reality, as ever, is more prosaic and considerably simpler.

All that glittersThe sanctions implemented by the US and the EU oblige those countries subscribing to them to end imports of crude oil from Iran, and has ensured their implementation by isolating the Iranian banking system from the international Swift payment system. But they do not cover gas imports, which leaves Botas free to continue importing Iranian gas under its 1996 contract for 10bn cubic metres a year – good news for Turkish consumers for whom there are no alternative gas supplies available.

The sanctions also allow for exceptions to be made – as with China and India, both of which are allowed to continue importing Iranian crude, so Turkey’s Tupras, which last year sourced 51% of its crude from Iran, was granted a 180-day waiver by the US, allowing it to continue importing Iranian crude until late December.

So much for the legality, but why is Tur-key sending all that gold to Iran for if it isn’t being used to pay for oil and gas.

To begin with, the gold isn’t exactly Turkish. Just as Turkish gold exports to Iran have been rising this year – with only minimal domestic gold production – so have Turkish gold imports. Of the 27 tonnes of gold exported to Iran in May, 19.5 tonnes were imported, much of it coming from Dubai. Imports rose again in June to 24 tonnes.

And as one Turkish official points out to bne, even these figures are not high. In mid-2008, prior to the global crisis, Turkey’s gold imports hit a monthly record of 48 tonnes, of which over a third was reckoned to be re-exported to neighbouring countries – including Iran, where gold imports are controlled by the central bank and sales are heav-ily taxed.

With the Iranian banking system all but closed off from the Swift network, it's little surprise rich Iranians and Iranian companies have been investing in a commodity that allows them to easily transport large amounts of value in a comparatively small space, and will – most likely – keep its value.

Which just leaves the matter of how Botas and Tupras are paying for their

Fool's gold

David O’Byrne in Istanbul

"As a state company, Botas has neither the leeway nor the expertise to start buying gold"

"Buying tonnes of gold and trucking it to Tehran is just silly"

A sukuk from secular Turkey

bne

The government of Turkey is close to clearing the way for Turkish banks and companies to access Islamic funding by issuing its own debut sukuk sovereign bond. The move is partly motivated by recent difficulties that investors have had in raising funds to take part in infrastructure projects and privatisations.

According to newswires in July, Turkey is set to mandate HSBC, Citigroup and Deutsche Bank to manage the sale of its first sukuk, expected to be worth about $1bn. The issue would set a benchmark for Turkish borrowers looking to tap a global sukuk market estimated at more than $100bn, allowing the Muslim, but secular, nation to diversify its fixed-income investor base. A sukuk is structured to comply with Sharia law by not paying interest to investors but giving them a share of the revenues from certain assets that are placed in a special-purpose vehicle. Analysts see a likely "sukuk premium" of as much as 1 percentage point in the interest rate Turkey will have to pay.

As the global credit crunch persists, Turkish borrowers have found it increasingly tricky to raise cash. This lack of funding has been blamed for Ankara's difficulties in attracting investors for infrastructure projects such as the beleaguered North Marmara Project (which will involve the construction of a third bridge over the Bosporus Strait), as well as recent failed attempts to sell off state assets.

Deputy Prime Minister Ali Babacan has been predicting a sukuk sovereign issue since early in the year, and has overseen work to put the necessary legislation into place for several Islamic financial instruments. "We find [developing the sukuk market] important in terms of the diversification of financial sources and investment options for both national and international investors," Babacan told reporters in April. "Market conditions will determine the amount of the issue, and the sukuk may be lira, dollar- or euro-denominated and will attract investors from both Turkey and abroad."

Babacan also believes deepening the sukuk market is important for Istanbul's bid to become an international financial centre. "We think it will not be only a national market, but a regional and global market."

Turkish Prime Minister Tayyip Erdogan's government has shied away from Islamic finance, fearing it would provide ammunition to critics who accuse his Islamist-rooted AK Party of seeking to roll back secularism by stealth.


Chinese private sector investment in Serbia has failed to keep pace with the large-scale infrastructure

deals signed between the two countries. However, the commercial relationship between the pair is on the verge of a sea change, with the Balkan country increasingly regarded as a potential manufacturing hub.

Despite excellent political relations, private sector links between China and Serbia have flagged in recent years as the crisis tightens its grip on the Serbian economy. However, the resultant high unemployment and low wages are likely to be a key factor in any future upturn in Chinese investment.

Aside from the state-led infrastructure deals, probably the largest investment in Serbia from the Asian emerging giant to date is the China Trade Centre Zmaj, a wholesale trading centre in Belgrade built with an investment of just $35m. Chinese telecommunication companies ZTE and Huawai have also entered the Serbian market, but in a limited way.

However, the once healthy trade in Chinese consumer goods has actually declined since the onset of the crisis. Previously, shops selling cheap Chi-

nese products had mushroomed across Belgrade, fed from the massive Chinese wholesale market hosted in a warehouse in New Belgrade known as Block 70. Now, with a strong yuan and a weak dinar, Chinese goods are no longer so cheap, and many of the outlets have been forced to close down.

Within this dynamic, new opportunities are starting to emerge. Beijing's recent changes to labour laws and the

strong yuan have increased costs, and companies based in China, once the low-cost manufacturing workshop of the world, are now looking for cheaper locations to manufacture abroad.

Factories are already opening in Asian locations such as Indonesia and Vietnam, but with salaries in southern

Serbia now only slightly above those in China, the Balkan country can offer added benefits. Factories in Serbia would have the advantage of easy access to the EU, Southeast Europe, Turkey and the Customs Union of Russia, Kazakhstan and Belarus, with which Serbia has a free trade agreement. With Serbian unemployment now at 23%, there is no immediate prospect of an increase in salaries, and some predict an investment boom from Chinese manufacturers. "I expect to see small-scale investment to fall, but large- and medium-sized investment to grow," forecasts Ivana Kopilovic of Belgrade-based law firm Kopilovic and Knezevic, who says that Chinese manufacturers have already started scoping out the Serbian market. "I expect medium-sized Chinese investors will start to come to Serbia, for example importing materials and manufacturing goods here for export to the EU and Russia. We have seen similar steps taken by European companies such as Fiat who want to take advantage of low labour costs in Serbia."

Friendship bridgeTo date, Chinese investment in Serbia has followed a tried-and-tested model for Europe, with the only large-scale investment taking place being govern-ment-level infrastructure deals. Back in 2009, Chinese President Hu Jintao and former president Boris Tadic signed a framework agreement under which

China is expected to invest $1.25bn into the Serbian infrastructure sector over a 15-year period. The first project to go ahead was the construction of the 1.5km Zemum-Borca bridge connecting a pair of Belgrade suburbs across the Danube. China Road and Bridge Corporation (CRBC) started building the "Friendship Bridge" in July 2010.

A sea change in Sino-Serbia investmentClare Nuttall in Belgrade

"Chinese factories in Serbia would have the advantage of easy access to the EU, Southeast Europe, Turkey and the Customs Union of Russia, Kazakhstan and Belarus"

Serbian "coalition of nationalists" forms new govt

bne

A coalition government of four Serbian parties was approved by Parliament on July 27, bringing to end over two months of negotiations since the elections. The government led by the Serbian Progressive Party of President Tomislav Nikolic and Socialist Party Prime Minister Ivica Dacic has 140 seats in the 250-member parliament – and it will need all the firepower it can muster to save the country from an impending financial crisis and economic recession.

Perceived as a coalition of nationalists, some of whom were in the former dictator Slobodan Milosevic's government of the 1990s, the coalition is being viewed warily by Serbia's neighbours, the EU and the US. Indeed, Serbian media reported that the US distrusted Dacic and that US Deputy Assistant Secretary of State Philip Reeker had made a visit to Belgrade to lobby for a coalition of Nikolic's Progressive Party and Tadic's Democratic Party. The official US explanation for Reeker's visit to Belgrade, however, was that it was routine with no specific objective.

"The composition of the new coalition may give the US, EU and Serbia's neighbours cause for concern, yet it is unlikely there will be any significant change in Serbia. Even if there are those in Serbian government circles with nationalist inclinations, the new coalition inherits a plethora of political, economic, and social problems that will limit its room for manoeuvre on domestic and regional issues," notes IHS Global Insight.

Even so, the populist Dacic is already raising concerns by threatening the independence of the central bank. In mid-July, the PM designate told the Tanjug news agency that the central bank governor, Dejan Soskic, could be replaced before his term in office ends in 2016 if he doesn’t support the new government’s economic growth policies. In the same interview, he also took a swipe at the country's banks, the majority owned by foreigners, accusing them of siphoning assets abroad and “robbing the people."

More positively, Finance Minister Mladjan Dinkic said he will “immediately” invite the International Monetary Fund for talks about Serbia’s public finances. The IMF suspended a $1.3bn stand-by loan programme in February after evidence emerged the previous administration was slipping on budget and debt targets.

China has also targeted the energy sector, starting with a $300m low-interest loan for the reconstruction of the Kostolac coal-fired power station, with Chinese companies employed as sub-contractors. In the same sector, Environmental Energy Holdings and the Shenzhen Energy Group are in talks on developing the Nikola Tesla coal power plant, at an estimated cost of €1.5bn.

These infrastructure investments are part of the clear trend in recent years for Chinese capital, usually in the form of long-term soft loans, moving into countries across Southeast Europe. While the Balkan countries are not well endowed with natural resources, they are in need of infrastructure investment. As the Eurozone crisis deepens, China has also become an increasingly attractive source of finance for southeast Europe.

For Beijing, the benefits are both financial and political. There is speculation that China is wooing Serbia not just as the largest Balkan economy, but as a country just a few years away from EU membership. Given the strong political relationship between Beijing and Belgrade, establishing an economic foothold would give China an even stronger bond with a sympathetic ally within the EU.

Building such strategic alliances has been a key part of China’s foreign policy. "China spends a lot of time on building relationships even with relatively small countries, because it sees the importance of such alliances in a world over-whelmed by US influence," says Kerry Brown, head of the Asia programme at Chatham House. "However, things are changing, as China has leapt from part of the developing world to a major world power, at the same time becoming more arrogant and status conscious."

Marta Szpala of the Centre for Eastern Studies (OSW) believes that the significance of the relationship between China and Serbia has been exaggerated on the economic side. "There have been a lot of meetings but nothing has happened. Europe remains the main source of foreign direct investment for

Serbia," she says. "There is a theory that China is increasing engagement with Serbia and wants good ties with the political elite because Serbia is moving towards the EU, but Serbia is small; there are bigger countries already inside the EU that need Chinese money." Chinese government officials are also understood to have been frustrated by delays in making decisions within Belgrade, especially with the

uncertainty surrounding the May 2012 parliamentary and presidential elections.

However, with several major projects in the pipeline, and China promising to invest €10bn in the CEE region (includ-ing Serbia) in the near-term through soft-loans, most forecast Serbia can expect an upturn in investment from China. "Serbia is a perfect fit, as it sees

www.ctc.rs


foreign investment as the main driver of its economic development in the near future," argues Dragan Pavlicevic, a research associate at Nottingham Uni-versity’s China Policy Institute. He points out that "now-departing Foreign Minis-ter Vuk Jeremic suggested recently that China may become the biggest foreign investor in Serbia 'within a year or two'."

Competition further westThe two countries already have an excellent political relationship, dating back to the cultural revolution, when Yugoslav films were the only foreign films permitted in China. Beijing has consistently backed the Serbian stance on Kosovo, while in 2010 Belgrade was

one of few European governments to join the boycott of the Nobel Peace Prize ceremony for Chinese dissident Liu Xiaobo, which so outraged Beijing. This has given Serbia a higher profile among the older generation of Chinese investors than other economies of its size.

Despite this relationship however, Pavlicevic acknowledges that the advantages, the state of Serbia's infrastructure and its level of retail sector development remain challenges to realising the country's potential as a destination for Chinese manufacturing.

"In the current climate, where Chinese cash is seen as a potential saviour of

Europe, and China is presented with many opportunities for investment in developed countries, it will be increasingly difficult for Serbia to offer attractive projects ... Serbia needs to fend off competition from the likes of Romania, Bulgaria, Hungary," says Pavlevic.

Indeed, as the Eurozone plunges further into crisis, China increasingly has the option to go directly to Western Europe. The Chinese government has already set up a fund for investment in Greek shipping companies, while Chinese firms have been snapping up Italian luxury brands.

Just days after the EU signed off on the first tranche of a €100bn bank-ing sector bailout package for cash-

strapped Spain in early July, speculation has been mounting that Slovenia might become the latest Eurozone member state to ask for funding to prop up its faltering economy and in particular its heavily indebted banking sector.

Both Bloomberg and the Financial Times fingered Slovenia as the next suspect for

an economic rescue package from Brus-sels in the wake of growing problems at the country's banks. At the heart of the sector's problems are the growing level of non-performing loans that, accord-ing to a recent report from Raiffeisen Research, are now running at 16-18% of total lending – sharply up from 11.5% at the end of 2011.

While the analysts at Raiffeisen believe there is no immediate likelihood of

Slovenia seeking a Spanish-style banking sector support package from the EU, they do believe that financial problems at the country's banks will impact on the country's economic performance: "From a macroeconomic perspective, the bank-ing sector weaknesses and constrained lending will be a drag on investments and economic growth going forward."

Press speculation about Slovenia's mounting financial woes prompted a quick rebuke from the country's finance ministry: "There is no need to ask for aid from European financial mechanisms, either due to bank capital adequacy or due to fiscal reasons," read a state-ment. It added that as well as addressing capital adequacy issues at state-owned banks, the Slovenian government was working hard to put its own finances in order, with the budget deficit set to be cut from 6.4% of GDP at the end of 2011 to 3.6% of GDP this year and below 3% in 2013.

Red alertNevertheless, there is growing concern about the ability of the country's lead-ing banks to attract sufficient capital to patch up their balance sheets, which have been savaged by the financial melt-down of many of the country's formerly successful corporates. For example, the European Resolution Capital Fund, which recently conducted due diligence

Slovenia looks to fix banking Achilles heelGuy Norton in Zagreb

at Nova Ljubljanska Banka (NLB), the country's biggest lender, reported that the bank has around €1.5bn of so-called "red category" loans, which will prob-ably never be repaid. That means NLB will likely need yet another round of recapitalisation by the end of 2013, with Slovenian business daily Finance claiming the bank might possibly need to raise as much as €2 billion if its finances continue to deteriorate.

At the start of July, the Slovenian government injected €383m into NLB, which controls a third of the country's banking assets, so the bank complies with the European Banking Author-ity (EBA) stress test requirements that stipulate a minimum core Tier 1 capital adequacy ratio of 9%.

Ultimately, the government had to stump up all the funds for the recapitalisation after the bank's second largest sharehold-er, Belgium's KBC, declined to partici-pate. KBC had been expected to contrib-ute €61m to the fundraising, but pulled out citing concerns that its participation could have jeopardised its own receipt of state aid as part of a strategic plan agreed with the European Commission, under which it has agreed to divest non-stra-tegic investments such as its sharehold-ing in NLB. The latest injection of funds follows an earlier €250m recapitalisation of NLB in March 2011. Although the European Commission gave its approval for the latest fundraising, it announced it was opening an in-depth investigation into the bank’s restructuring plan that was submitted after last year's recapitali-sation. "At this stage, the Commission has doubts that the plan adequately addresses the causes for NLB's distress or foresees sufficient safeguards to limit the distortions of competition created by the state support."

Meanwhile, the authorities in Ljubljana are working on a potential solution to the banking sector's problems in general, with plans for a new institution that could assume bad loans from state-owned banks. The proposed Slovenian Sovereign Holding (SSH), which Finance Minister Janez Sustersic hopes could be established by the autumn, would be a super-custodian of assets that would

assume the role of the Capital Assets Management Agency and bring a troika of para-statal funds under one roof.

According to Sustersic, the SSH would assume bad loans from the banks at fair value, thus cleansing them of NPLs in one fell swoop rather than through periodic writedowns. "This cabinet is under no illusion that the situation will fix itself," Sustersic told news agency STA, but claimed that Slovenia had the financial wherewithal to fix its banking sector problems on its own rather than apply for an EU bailout.

While welcoming the concept of the SSH and its potential role in resolving the problem of the estimated €6bn of bad loans in the banking sector, Igor Masten, a former member of the supervisory board of NLB, told Slovenian daily Delo that he believed the authorities were guilty of failing to admit the scope of bad loans as soon as the crisis kicked in in 2008 and taking timely action to tackle the problem. Masten, who advo-cated the establishment of a so-called

bad bank back in 2009, claimed that previous governments failed to address the NPL issue, "because the admission of bad loans would mean acknowledge-ment of mistakes brought about by the concept of national interest."

Wearing thinThe increasing use of state funds to plas-ter holes in state-owned banks' balance sheets is proving politically controversial however, with hard-pressed Slovenian taxpayers growing tired of the con-tinuing series of government-funded bailouts.

A recent survey by Delo revealed that just 23% of respondents supported the use of tax receipts to prop up the banks, while 49% wanted to see the banks

attract funds from foreign investors instead. Unsurprisingly, the govern-ment is hoping that the country's second biggest lender, Nova Kreditna Banka Maribor (NKBM), which is also major-ity owned by the state, will succeed in attracting foreign capital when it attempts to secure funds for its recapi-talisation later this year. "On NKBM, our message is clear: the state will rescue the bank only as a last resort, in the event the security of deposits or stability of the banking system is jeopardised," Suster-sic told STA, adding: "We recommend that the NKBM supervisory board find private solutions for recapitalisation."

Under the current restructuring plan, NKBM is looking to offload its majority stake in insurance company Zavaroval-nica Triglav as well as increase its core capital by issuing €20.4m in new shares. NKBM's last capital-raising exercise in April 2011, when it became the first Slovenian company to be listed on the Warsaw Stock Exchange, provoked fierce controversy when the Capital Assets Management Agency ordered

three state-owned companies – Posta Slovenije, Gen Energija and ELES – to buy the majority of the shares in the €104m offering.

The move prompted Fitch Ratings to downgrade NKBM from 'A-' to 'BBB+' in May 2011, citing "conflicting policy statements during the capital raising with respect to maintaining the state's stake in the bank, as well as a lack of clear strategy from the government regarding NKBM's future ownership structure."

NKBM has since been downgraded further by Fitch to 'BBB' as a result of further asset deterioration. It's not only the weary Slovenian taxpayer whose patience is wearing thin.

"NLB has around ¤1.5bn of so-called 'red category' loans, which will probably never be repaid"

46 I Eurasia bne August 2012 bne August 2012 Eurasia I 47

The DP is known for its progressive pro-business stance, but has historically been the weaker of the two major par-ties, originally formed as a unification of many pro-democracy factions after the fall of socialism in the early 1990s.

The next biggest party in the coalition is the controversial Mongolian People's Revolutionary Party (MPRP), a splinter

group from the old communist party. This is led by Nambaryn Enkhbayar, who was arrested before the election on corruption charges and is to be tried at the end of July. The MPRP's aggressive policies on national ownership of the country's coal, copper, uranium, gold, zinc and lead mines has worried some investors that the new government may further lean away from luring foreign investment. They are due to take four or five of the 18 ministries on offer, and analysts predict that a member of this party could take the finance minister position, key to the country's investment agenda.

These two may seem like an unlikely pair for a coalition, but both can agree that the old communist party, the Mongolian People's Party or MPP, has had its turn and must now make way. While there prom-ises to be some heated debates over the plan for the next four years, the DP have stated that any coalition partners must fol-low their lead. The DP are clearly pushing to make this government their own, and this will be their chance to shine.

Money & miningOver the next four years, the country's vast mineral wealth will be exploited and the state coffers will begin to fill, putting the new government in a strong but testing position.

"The importance of this next term can-not be overstated," says Travis Hamilton, founder of the Khan Mongolia Equities Fund. "The stakes are a lot higher now, and the actions over the next four years will determine the coming decades. Mongolia is still heavily dependent on foreign investment, but when they run at capacity they will be able to go on their own. The country is on the precipice of financial independence."

The issues of natural resources, invest-ment and wealth distribution are some of the most important campaign issues for the public, and now the DP must prove they can spend the mining rev-enues responsibly.

The new prime minister, Norov Altanhuy-ag, is an ex-physics professor-turned-revo-lutionary in 1989, and has been fighting as an underdog ever since. He speaks calmly

Untested coalition faces testing times for MongoliaOliver Belfitt-Nash in Ulaanbaatar

Three weeks after winning 31 out of 76 seats in the Mongolian parliamentary elections on June

28, the Democratic Party (DP) said it has formed a coalition with a number of smaller parties in order to secure a majority. This untested party will over-see a crucial period in Mongolia's post-communist history as large resource projects come onstream.

and confidently, his words well-rehearsed. "In the last four years we have just started to use our mining resources, but the coming four years is a tipping point," says Altankhuyag. "We have huge discussions on how to use the mining wealth."

There is already a mechanism being developed that allows the government to dish out shares of major mining proj-ects to every member of the public. The country's largest coking coal mine, Tavan Tolgoi, is due to be listed next year in Hong Kong and London with potentially over 2m shareholders ready to trade. This ambitious scheme has caught the attention of many investors watching for the next opportunity, and will be a pillar event for the coalition. Unfortunately, the deal came to a halt last year over an international dispute on who should part-ner with Mongolia to develop the mine. China's Shenhua, a Russian consortium, US' Peabody, South Korean and Japanese players are all in the bidding war for this huge deposit. "There is still a question on how we will collaborate with foreign investors in all sectors," says Altankhuy-ag. "Some we can do ourselves, some we can cooperate with investors."

Standing firmAs with all coalitions, there is a threat that the decision-making process will be fragmented. The DP itself is comprised of many different factions, some more radical than others, and the coalition partners could pose problems for Altan-huyag and his party. The opposition MPP, on the other hand, enjoys a consolidated, experienced group of political veterans ready to pounce on the DP should they falter over the next four years.

As a response to this, Altanhuyag has stated that the others must follow his lead if they are to participate in the coali-tion – a welcome remark for analysts who feared an indecisive leadership. The DP pledges to focus on education and infrastructure, while nurturing the cash flows from the mining sector. It will be a hard test for the newcomers, but one that Altanhuyag is willing to take.

"I am a team player," he says with a chuckle. Presumably, though, he's the captain.

Kazakh sukuk

Clare Nuttall in Almaty

The Development Bank of Kazakhstan (DBK) has launched the country's first Islamic bond. The quasi-sovereign issue could set a benchmark for Kazakh sukuk, opening the way for corporate Islamic bonds.

The paper, issued in Kazakhstan and Malaysia, has a value of MYR240m ($76.6m). Halyk Finance, the bookrunner for the issue, says the bond has been placed for five years and has a yield of 5.5% a year. Some 38% of the issue was placed within Kazakhstan, with the bulk in Kuala Lumpur. The majority of buyers are based in the global centre for Islamic finance, with 62% of the issue being purchased by Malaysian investors. Overall, 82% of orders came from pension funds, according to C-Bonds. "The DBK has become the first bank in the post-Soviet space to issue sukuk in accordance with the norms of Shariah law. This is a serious achievement for the bank and Kazakhstan in general," DBK's deputy CEO, Zhaslan Madiyev, said in a statement.

The DBK decided in March to place medium-term Islamic bonds, denominated in Malaysian ringgit. The bank's board has agreed a programme with a total value of $500m. The issue is an important step for development of Kazakhstan's Islamic finance market, as the quasi-sovereign sukuk from state-owned DBK sets a benchmark for future corporate issues, the bank claims. "We are confident that the transaction will pave the way for other similar issues and serve to diversify Islamic financing in the region," Madiyev said.

However, despite calling it a "very positive step," Prasad Abraham, chairman of Kazakhstan’s first Islamic Bank, Al Hilal Bank Kazakhstan, told bne in June that in view of DBK's government backing, a pure corporate issue on a similar scale is unlikely. "Within Kazakhstan, there is a group of very strong top-end companies, many with a degree of government ownership, that are being targeted by all major banks. At the other end of the scale, small and medium-sized companies are still struggling for money, as the banks are being more conservative,” he suggested.

The Kazakh government's interest in establishing an Islamic finance sector grew during the first wave of the 2008 crisis, when finance from traditional sources dried up. Although the majority of Kazakhstan’s population is Muslim, many – though by no means all – have embraced western credit culture. However, Astana is looking to diversify its funding sources, and interest in Islamic finance remains high.

48 I Eurasia bne August 2012 bne August 2012 Eurasia I 49

Fear and loathing in GeorgiaMolly Corso in Tbilisi

Newly appointed Prime Minister Vano Merabishvili appears to have slid into his new post

with ease: in office less than a month, the former head of Georgia's policing ministry has already named a new cabinet, unveiled a new four-year economic programme and made his first trip abroad. But even as the move from siloviki (those with ties to the security services) to premier has seemed an easy one for Merabishvili, there are growing concerns in Georgian civil society that his appointment means President Mikheil Saakashvili is circling the wagons before October's parliamentary elections.

Merabishvili, one of the president's closest allies and advisors, was picked to replace former prime minister Nika Gilauri as part of a surprise cabinet shuffle on June 30 – a move that has been widely read to signify that the ruling party is gearing up for a tough campaign to hold on to its majority in parliament.

The October elections are regarded as a vital race that will set the stage for next year's presidential elections

and, presumably, what the Georgian political scene will look like after Saakashvili leaves office, which he is constitutionally required to do after serving two terms. By keeping its majority in parliament, the ruling

centre-right United National Movement party will be in a position to allow its founder Saakashvili to "do a Putin" and take over as prime minister.

Formally the head of the Ministry of Internal Affairs (MIA) – an umbrella bureaucracy that oversees all the policing functions in the country – Merabishvili has repeatedly been ranked as the country's most popular minister, famous for the radical police reform that was credited with transforming Georgia's corrupt police into a modern crime fighting force.

The ruling party has praised his appointment as a necessary measure, bringing an experienced "top manager" to combat the country's unemployment crisis and its lifeless agriculture sector.

Giorgi Margvelashvili, a political scientist, says Merabishvili is popular for a number of reasons – including his reputation for caring for his staff. "He is popular, especially with the police because he treated his staff – no matter how big it is – with great respect and care. He took care of their families, he took good care of these people," he says. "He is [also] considered to be a doer, no matter what you put into that word – doing bad or good things – he is considered to be a doer."

Done and dustedIt is his reputation as a "doer" that appears to concern Georgian civil rights watchdogs, who worry that Merabishvili, charged with numerous human rights violations during his tenure at the MIA, will use his new position to consolidate power in the months before the October elections.

Adding to their fears was the appointment of former defence minister Bakho Akhalaia – also known

for allowing serious abuses among the prison population during his time as the head of the penitentiaries – as Merabishvili's successor at the MIA.

Both men, in their new posts, are in a position to influence the vote, and Merabishvili has made some moves to increase the power of his post over the past few weeks, including placing him in charge of the chancellery, which allows the government to regulate its own decision-making process.

Iago Kachkachishvili, a professor of sociology at Tbilisi State University,

"No matter what you put into that word 'doer' – bad or good – he is considered to be a doer"

notes that by appointing Merabshvili, Saakashvili is sending two messages to the public: one, that a proven reformer can ease the country's epic unemployment problem; but two, by tapping a man known for his power and ruthlessness, people know there is steel beneath those promises, as "Merabishvili is responsible for creating this kind of total scary [environment where] people… cannot speak freely on the phone."

And allegations that Merabishvili is not afraid to abuse his power continue to dog him in his new position. Since his appointment, efforts to marginalize the country's leading opposition group, Georgian Dream, and its billionaire leader Bidzina Ivanishvili have picked up speed.

The ruling party, which according to a June survey by the National Democratic Institute enjoys 36% support compared with 18% for Georgian Dream, has repeatedly accused Ivanishvili – who earned his wealth in Russia – of using his money to influence the election.

On July 12, the government took partial control of two banks reportedly owned by Ivanishvili, naming a temporary manager to oversee 100% of Cartu Bank and 21.7% of Progress Bank. The move was part of a months-long campaign of fines and other measures officially aimed at stopping the billionaire from misusing his vast resources to influence the vote.

Ivanishvili has already been fined GEL148.68 m (€73.84 m) – roughly 2.1% of Georgia's total budget revenues for the year and 1.4% of Ivanishvili's wealth. The billionaire has denied any wrongdoing, and has repeatedly appealed the fines. In addition, three of his activists were arrested on July 17, allegedly for participating in a scam to avoid limitations of party donations by individuals.

Not hated in Georgia

bne

Two banks connected to the billionaire leader of Georgia's leading opposi-tion party may have become hostage to Bidzina Ivanishvili's battle with the government ahead of the elections, but Georgian banks in general are flex-ing their lending muscles as public trust and demand for loans grows.

While the rest of the economy has struggled to match levels seen before the 2008 war and financial crisis, the banks have enjoyed steady growth since 2009 – unlike their counterparts in Europe and the US.

A large demand for loans from both retail and commercial clients is the driving force behind the growth, notes Macca Ekizashvili, head of investor relations at Bank of Georgia’s London office.

According to Ekizashvili, Georgia has a low loans/GDP ratio for the region, somewhere around 30% of GDP, with household loans making up less than 10% of GDP. That leaves a lot of space for individuals and corporates to borrow. Total loans by commercial banks increased 14% on year in June to GEL5.41bn (¤2.69bn), helping to make the banking sector the third fastest growing sector in the first quarter with 16.7% year-on-year growth.

Bank of Georgia, the first Georgian bank to list on the London Stock Exchange, on July 9 raised $250m by placing five year Eurobonds at 7.75%. Ekizashvili says the funds will help the bank continue to increase its loan portfolio. "The loan book has been increasing by 20% for the past year," Ekizashvili says.

The increased demand for loans comes at a time of solid economic growth, when the banks are playing more of a part in the economy then they used to. While Georgia suffers from high unemployment (officially said to be 15.5%, but independent estimates put it at 34%), the economy in the first quarter grew 6.8% on year.

Deposits are up across the board for banks in Georgia, including the country’s micro lenders. National Bank of Georgia data shows that micro lending jumped 41% over the past year, from GEL241m (¤120m) in the first quarter of 2011 to GEL341m (¤170m) in the first quarter of 2012. The jump is a strong signal that lending demands have not been met in agriculture and small businesses, the target audience for micro-finance institutions.

bne August 201250 Opinion Opinion 51bne August 2012

Fundamentally, this attack was about politics in the Middle East, rather than Bulgaria. But it will leave deep scars on the Balkan country nonetheless. "Bulgaria was probably chosen as the weakest link," Petar Karaboev, a Bulgarian journalist, tells bne

The country has a strong reputation as a cheap beach and ski tourism destination, and attracted 8.71m foreign tourists last year – a figure that is probably inflated by Turks of Bulgar-ian origin visiting family and shuttle traders, but one that is nonetheless impressive for a country of just over 7m people. Tourism directly and indirectly contributes upwards of 10% of GDP. The country is particularly popular with Europeans on budget package holidays.

Tourist arrivals last year included 138,613 Israelis, up 6% on 2010, according to official figures. According to Karaboev, Bulgaria is particularly popular with Israelis for a number of reasons, including that many Israelis of Eastern European ori-

gin are familiar with the country from Communist-era visits. Bulgaria is seen as a cheap place to gamble for some, while it has also established a reputation as a low-cost place to have a Jewish marriage. The recent worsening of relations between Israel and Turkey, particularly over the 2010 Gaza flotilla raid has also led some Israelis to opt for Bulgaria instead.

"Frankly, this is something very new for us, and I could only speculate about the effects of this act,” Daniel Smilov of the Centre for Liberal Strategies, a Sofia-based think-tank, tells bne. "This seems to be different from other acts of international ter-rorism in Europe. Thus far, such acts have taken place in cosmo-

bne

July 18's deadly terrorist attack on buses carrying Israeli tourists is grim new territory for Bulgaria. The country has been deeply shaken by the tragedy, and its reputa-

tion as an ultra-safe and carefree tourist destination – one of the few bright spots of its beleaguered economy – will take time to recover.

By the next morning, July 19, at least eight were confirmed dead and 34 injured after a blast on a bus at the airport in Burgas, a city on the Black Sea coast that is an important entry point for nearby resorts. Investigators were working on the theory that a suicide bomber was responsible.

Israel has immediately blamed Iran for the attack, which came 18 years after the bombing of a Jewish community centre in Buenos Aires, Argentina that was blamed on Hezbollah and Iran.

Bulgaria had stepped up security for Israeli visitors recently after a suspicious package was allegedly found on a bus car-rying tourists from Israel in the country in January.

Bulgaria’s president, prime minister and interior minister all swiftly arrived on the scene. Interior Minister Tsevtan Tsvetanov said that the authorities had had no warning of the attack.

Weakest linkPolitical terrorism has been unheard of in Bulgaria in the post-Communist era. Clashes between the government and the Turkish minority in the 1980s led to a number of bombings, which have variously been blamed on Turkish terrorists or the Bulgarian security services, but tourists have not been success-fully targeted before. Small bombs have been placed in the country in recent years, but these were linked to mafia turf wars and caused very few casualties. The country has a fearsome reputation for organised crime, but this never impacts on tour-ists. Violent crime is negligible, and violence rare – in four years living in Bulgaria, your correspondent saw not a single fight.

Terrorist attack puts Bulgaria in uncharted territory

"Bulgaria was probably chosen as the weakest link"

politan cities, capitals of big European states, and so on. With the act in Burgas, it is obvious that the target has been chosen on the basis of vulnerability and security considerations. If this is really organised in one way or another by Iran, this will be the first internationally sponsored terrorist act on the territory of Bulgaria (at least since the times the Communist International was influential in the country in the 1920s and 1930s). We of course fear a negative impact on Bulgarian tourism, but these are rather secondary considerations for the moment."

That the attack is likely to have been a one-off may not filter through to the tourism industry and prospective visitors. Cancellations are likely. Bulgaria suffers from the fact that its tourism proposition is not unique and tends to compete largely on price: sun, sea and sand, and skiing are available elsewhere. Cultural, outdoors and spa tourism, while they have great potential, are underdeveloped and largely limited to a minority of adventurous visitors.

In time, the sector should recover, though a repeat of the July 18 attack, while unlikely, would be disastrous. The Bulgar-ian government, and the tourism sector, will have its work cut out reassuring the world that the country remains an extremely safe place to visit. Bulgaria was also one of July 18's innocent victims.

"With the act in Burgas, it is obvious that the target has been chosen on the basis of vulnerability and security considerations"

bne August 201252 I Special report bne August 2012 Special report I 53

Special Report: Frontier Markets In June, Russian Prime Minister

Dmitry Medvedev called for the introduction of a common currency

for the union of former Soviet countries as a hedge against growing volatility in global financial markets. Given the mess the Eurozone is in, why would Russia even contemplate the idea of linking its ruble to currencies like the Belarusian ruble or the Kazakh tenge?

If it comes at all, the "ruro" will not arrive any time soon. Medvedev went out of his way to point out that creating a common currency in Russia's neighbour-hood is a long-term project; the Eurasian Economic Union (EEU) that it would serve is not expected to start function-ing until 2015 at the earliest. But he also insisted that it's time "to think ahead."

Therefore, the project is being seriously studied by the Centre for Integration Studies, a body attached to the Eurasian Development Bank, which in turn has been tasked with building the infra-structure of the EEU. That body will be an extension of the Customs Union that came into being on January 1, 2010. The three members – Russia, Belarus and Kazakhstan – are moving rapidly towards closer economic unity.

Ben Aris in Moscow

The final club will almost certainly be enlarged by the membership of several other former Soviet states, although the likely status of Ukraine remains the biggest unknown. Already one of the biggest partners for intra-regional trade, Kyiv has said European Union accession remains its top priority, and that would very likely preclude it from membership of the Eurasian club. In the meantime, however, the academic work on the benefits of a single currency includes the possibility that Ukraine will join.

Avoiding a Greek dramaDr Eugeniy Vinokurov, director of the Centre for Integration Studies, says that whatever happens, the members will move slowly towards unifying their cur-rencies. "The results of modelling a sin-gle currency for the three countries (our calculations concern Ukraine as well) suggest that the approach to its creation should be careful and gradual. The structures of the economies involved are cardinally different, which give their currencies different trajectories."

Indeed, Russia and Kazakhstan are oil exporters, which makes them beholden to the vagrancies of the international

commodity markets. By way of contrast, Ukraine and Belarus are manufacturers and oil importers, which means their currencies go in the opposite direction to the ruble and tenge when oil prices go up. The way out of this dilemma is to try to fully integrate the three (or four) economies. Only by the free flow of capital and labour can these basic dif-ferences be ironed out – and full macro- and micro-economic integration has already emerged as a key goal for the EEU. "If efficient coordination mecha-nisms at the level of the ministries of finance and economy are not put in place the common economic space will break," says Vinokurov. "We don't need our own Greece. Only when this is done, can we think about launching a single settlement currency."

However, inequalities between the countries are not so big, Vinokurov claims, pointing out that levels of productivity in Russia, Belarus and Kazakhstan are more-or-less the same, although Ukraine lags.

The first steps have already been taken. In January, the three initial candidate countries signed an agreement compa-rable to the Maastricht Treaty, which sets

Ruro-zone


maximum levels for debt/GDP, inflation, and budget deficits. "But there is still no mechanism of coordination on these points like the European Stability Pact," Vinokurov notes. "Now they are working out the mechanism of coordinating fiscal policy between the countries that will include punishments for those that break the rules. The plan is to have this ready by 2015 when the Eurasia Economic Union is supposed to be introduced."

Fiscal union keyThe "ruro" – or perhaps "altyn", a term used for centuries to mean "gold" or "money" in both Slavic and Turkic languages – is likely to start life as a settlement-currency in mutual trade deals. That, of course, is the whole point of united currencies in the first place, given that they remove foreign exchange risk and reduce transaction costs.

Whilst the levels of mutual trade already flowing inside the region suggest that setting up a settlement currency should be relatively easy to achieve and offer sig-nificant advantages, Vinokurov expresses doubts about longer-term, full monetary union. "The biggest question remains if a common currency is beneficial at all," he says. "The preliminary studies suggest that this is not necessarily the case, as the member countries are so different. Really, it comes down to how enforceable the rules to maintain economic stability are once the single currency has been introduced. Maastricht has been in place for 20 years and it has brought problems – at least at the fringes of the Eurozone. Clearly the mechanisms that force mem-bers to stay within the agreed limits are key; which amounts to fiscal – as well as monetary – unification."

While the euro may be proving, for now, a mounting disaster, the European Union is not. Vinokurov points out that all the members have enjoyed huge ben-efits from the trading club, noting that the majority of exports sent out by EU members head to peers in the bloc. On the back of that, the level of prosperity in the EU has risen across the board, and members that were less developed when they joined – such as Spain or Ireland – have rapidly closed the gap.

every other type of investible economic activity needs to be connected to a grid if it is to be competitive in the global marketplace. And this is a very much more complex undertaking.

That Europe and the US were able to harness Faraday’s discovery to drive their economies was largely due to their relatively high levels of political and social development. Electricity is a capi-tal-intensive, long-term business and not susceptible to quick-fixes. A government with vision, long-term commitment and concern for the next generation is essen-tial, both to see plans through to fruition and to create a financial environment that achieves the low cost of capital needed to make electricity affordable. Leaders should also have a broad man-date that does not leave them reliant on the support of self-serving lobbies. All nations have suffered at some time dur-ing their histories from the consequences of unbridled political patronage, but the form is important. Dispensing largesse from the public power sector must surely be one of the most injurious.

The Rule of Law is needed to safeguard the electricity sector’s assets and, once they are built, the cash flows. A compe-tent, committed government is certainly a good start, but it won’t achieve much if grids are pilfered as soon as they are built. And neither will a sparkling, new public power network be viable for very long if users bypass their meters, or don’t pay economic rates for their supplies. Many governments favour subsidising

Readers may be familiar with an advertisement for a financial institution, widely featured on

London’s black taxis, that praises a stout pair of shoes as an essential piece of kit for their investment managers. Another advertisement, for a different investment institution, features a hand compass – presumably used to navigate difficult terrain while seeking out hid-den corporate treasures. My own piece of advice to investors venturing into unfamiliar territory would be to arm themselves with a report on the state of the local electricity system.

To get the idea, try to imagine your world without electricity. Too tiresome? As a shortcut, think of life in Europe or the US in the early 19th century, before Faraday discovered that moving a magnet could induce an electric current in a coil of wire. No electric lights, no phones, no computers. Without power, Western Europe and the US could not have achieved the high levels of output and efficiency that now define them as developed markets. The steam engine may have kicked-off the industrial revo-lution, but it was sustained by electric power.

It requires no great level of sophisti-cation to buy a diesel generator and order-up a supply of fuel to be delivered by lorry. This is standard operating pro-cedure for mining enterprises located in some of the earth’s most remote and inhospitable regions. If crime is a problem, build a fence around the installation and hire guards. Electric-ity produced in this way is expensive, but the cost can be offset against the high gross margins characteristic of extraction businesses. However, almost

Essential kit for the frontier market explorerDerek Weaving of Renaissance Capital

Keeping up with the Volga neighbours

Artem Zagorodnov in Ulyanovsk

"We're not just the birthplace of Lenin, but of Kerensky too," Governor Sergei Morozov told guests at an investor conference in the Volga city of Ulyanovsk in June, referring to one of the leaders of the Russian Provisional Government, which was overthrown in the October Revolution.

Morozov's point is that the city and surrounding region of Ulyanovsk, known more as a communist backwater, offers much more than first meets the eye, and has by all accounts come on leaps and bounds during his eight years in charge. And he remains confident enough in Ulyanovsk's future to politely deny a recent job offer in the federal government.

Until now, though, despite its strategic access to over 40m consumers in and around the Volga River, Ulyanovsk has very much lived in the shadow of its larger and more prosperous Volga neighbours, Kazan and Samara. The numbers speak for themselves: in 2009, the region attracted RUB49bn (¤1.25bn) in fixed-capital investments, compared with RUB268bn and RUB110bn in neighbouring Kazan and Samara respectively. Average monthly wages stood at around $330, versus $520 and $600 in the latter two.

Living standards and services remain poor, which is proving a problem when attracting increasingly demanding foreign investors. Julia Stephanishina of Ernst & Young points out that compared with 10 or even five years ago, international investors are asking more and more about how comfortable a region is for relocation. "They used to be interested in power connections and access to water; we'd basically just drive out into a field in a jeep accompanied by some suspicious-looking characters in dark suits," she says. "Nowadays, the companies coming here are interested in the availability of English-language schools and healthcare, nice places to live and go out, and direct international air connections from the local airport."

Unfortunately, Ulyanovsk still scores badly in all these aspects when compared with Samara and Kazan. While the latter have fully functioning international airports with regularly scheduled flights to several European capitals by leading international carriers, Ulyanovsk authorities are only now considering setting up such routes

An aviation museum stands as a monument to better times past. Hopes that a revival of the Ruslan An-124 jet aircraft project (one of the largest cargo carriers in the world) pending a Nato order would rejuvenate the local Aviastar aviation plant proved premature: economies-of-scale didn't match up (ie. the plane was too expensive to produce without a larger order).

However, the Aviastar aviation plant is also evidence of a brighter future. Germany's Gildemeister recently announced the construction of a $25m machine-building tools plant outside Ulyanovsk, the first such foreign-owned plant in Russia, which will cater for Ulyanovsk's aircraft and auto-manufacturing hubs. The deal constitutes a major nod toward the potential of the Aviastar plant, which plans to launch major production of the Ilyushin Il-76 and Tupolev Tu-204 SM jets in the near future.

Source: OECD, Eurostat, National statistics offices, Renaissance capital estimates

Electricity as both indicator and catalyst for economic development


energy supplies for the socially-disad-vantaged, but funding the subsidies from within the power sector is a fast route to a dilapidated electricity system.

The message for investors is that the condition of a nation’s public electricity system is an accurate and robust indica-tor of a nation’s economic, social and political sophistication. It is an indicator

that is impervious to short-term oil price fluctuations, to exchange rates and even to the latest data on the level of consum-er confidence in the state of Minnesota.

Few economic activities and no econo-mies can flourish without access to reliable and affordable supplies of electricity. My piece of advice to an investor exploring new horizons would

be to ask three questions. 1. How much electricity does the local economy have? 2. What is being done to develop what they have? 3. What is the probability of success? If the answer to question 1 is “not much”, the answer to question 2 is “quite a lot” and the answer to 3 is “quite high”, you may have the beginnings of an investment opportunity. Conversely, if the answer to 1 is “quite a lot”, to 2 is “not much” and to 3 is quite low, it may be wise to pack away the walking shoes and compass for another day.

Derek Weaving is Head of Utilities Research, Renaissance Capital

There is also booming demand for cars in Mongolia, thanks to the increase in incomes, Nemitz adds. And Mongolians are no different from other people in emerging markets, who regard a German car as an important status symbol.

Merkel in MongoliaIt's clear the German government has explicitly identified Mongolia as a target country as it aggressively pushes German business interests in emerging markets beyond the so-called BRICS. In October 2011, German Chancellor Angela Merkel became the first leader of an advanced industrial country to visit Mongolia in six years. Crucially, the cornerstone of the event was the signing of lucrative intergovernmental contracts between Berlin and Ulaanbaatar.

They included a deal that gives the German-Australian consortium BBM Operta and Macmahon access to 15m tonnes of coal from Tavan Tolgoi

mine in Mongolia, the largest deposit of coking coal in the world, in a deal estimated to be worth $2bn. The two sides also signed a promising resources partnership agreement that brings Germany one step closer to securing ready access to Mongolian natural resources, including the holy grail of rare earth metals, which are crucial for various high-tech products that Germany manufactures, from iPods to wind turbines.

Moreover, Merkel's visit was recip-rocated in March by the Mongolian president’s tour of three German cities, which culminated in the signing of several Memoranda of Understanding, including one for a coal dilution and fuel manufacturing project, and another for the construction of a new coke plant.

"Many Mongolians studied in East Germany and have good knowledge of German"

"The condition of a nation’s public electricity system is an accurate and robust indicator of a nation’s economic, social and political sophistication"

And the accompanying infrastructural development and swelling of the wealthy class in Mongolia's urban centres offers the prospect of mouth-watering develop-ment contracts and export opportuni-ties, which is attracting multinationals from a long list of countries. For these reasons, Mongolia is set to be one of the most interesting and exciting emerging economies of the 21st century.

Yet even though the rising interest in Mongolia is a global trend, Germany in many ways seems a step ahead of its European competitors. Export figures are revealing. In 2011, Germany was the leading European exporter to Mongolia; according to the Mongolia's statistics office, in 2011 Mongolia imported goods worth $272m from Germany. Other European countries managed to export considerably less: France, the second-largest European exporter to Mongolia, shifted only $97m worth of goods; the UK, at $47m, managed less still.

It is Germany's manufacturing edge over its European counterparts that ultimate-ly explains its significantly more impres-sive bottom line, according to experts. "The industrial goods that Germany produces are needed by Mongolia," says Fabian Nemitz, a Mongolia expert at Germany Trade and Invest. "These are primarily investment goods like machin-ery and equipment."

Mongolia's growing economic clout is no secret, but evidence points to Germany being more privy to

the Central Asian country's potential than most of its European counterparts.

There has been a powerful global shift in the way Mongolia is perceived, beyond Orientalist fantasies of the steppe and

Genghis Khan; when it overtook Qatar last year as the world's fastest-growing economy, people took notice. Moreover, Mongolia's growth is being fuelled by the exporting of its treasured stockpile of natural resources, including copper and rare earth minerals, which are cov-eted by many nations. It has the world's largest untapped coal reserves.

Teutonic deals in MongoliaSherelle Jacobs in Cologne

A prophecy of power

Nicholas Watson in Prague

A growing number of Mongolians may want to limit the amount of foreign control over their natural resources, but the country is in dire need of investment in its absent or crumbling infrastructure, and foreign investors will be crucial in achieving this.

Prophecy Coal, a diversified thermal coal production company that controls two large coal deposits in Mongolia, is one of these investors. In May, the Canadian-listed company announced it had signed a deal with the Energy Authority of Mongolia to bring its planned 600-megawatt (MW) Chandgana Power Project online by 2016, and is currently trying to finalise an agreement over power purchases with Mongolia's national grid.

"It's taken us about two years to get to where we are, where the project is fully permitted… and we're very optimistic about reaching a power purchase agreement with the government this year, so we can start construction next year," John Lee, Prophecy Coal's CEO, tells bne.

Not a moment too soon, say analysts. Mongolia is facing a critical power crunch as domestic demand booms from a combination of a growing and increasingly affluent population, rapid urbanisation, and industrial production that has gone through the roof as giant mining projects are developed. Between 2007 and 2011, electricity consumption in Mongolia increased on average by 6% per year, but the Ministry of Mineral Resource of Mongolia estimates that demand will grow by 14% a year in the future. "The economy has grown at double-digits pretty much for the last decade, but no power infrastructure has been built – it's in dire need of power," says Lee.

It's for this reason that projects like Prophecy Coal's, designed to directly benefit the Mongolian people, differ from those that seek to exploit the country's resources for export, like the recent attempt by Aluminum Corporation of China (Chalco) to acquire a controlling stake in SouthGobi Resources, which so riled the politicians that parliament adopted a new law on foreign investment in May that limits foreign ownership in strategic industries such as mining to 49%, unless the buyer obtains parliamentary approval.

As such, projects like Prophecy Coal's remain largely outside the resource nationalism debate. "We're not saying that there aren't challenges to working in Mongolia, but our power plant project will be built in Mongolia for Mongolians," says Lee. "Domestic issues are going to receive a much greater share of politicians' time as they begin to understand the dire need of infrastructure improvements, particularly power."


goods increases it is set to become a net importer by 2014. Mongolia will be a central target source. And with China already Mongolia's largest trading partner by far (92% of Mongolia's exports go to China), Beijing is especially well positioned to achieve its objectives.

Several other non-European countries also continue to outshine Germany in Mongolia. Although Russia's influence in the country is arguably in long-term decline, it still supplies just over 30% of Mongolia's imports. The US also exports twice as much as Germany does to the country. Japan and South Korea also perform slightly better in the same stakes.

It is a sobering reminder of just how competitive and saturated international trade and business in the emerging markets are set to become, even in previously obscure places like Mongolia. Yet just as is the case in several other traditionally overlooked but fast-growing economies in the developing world, Germany looks set to put up a good fight for its share of the market.

It is important to note that Germany's approach to Mongolia seems to fit within a wider strategy to prise open new trade and investment opportunities outside of the BRICS. Other tradition-ally overlooked countries Germany has worked hard to nurture relations with range from Kazakhstan to Slovakia.

Despite the fruit that Merkel's efforts in Mongolia bore, curiously other Europe-an countries do not seem to have taken note. The UK is a good example – even now, British Prime Minister David Cam-eron, despite his emphasis on boosting British exports to encourage economic recovery, has failed even to schedule a trip to Ulaanbaatar. And although the Mongolian president visited the UK in November to meet Cameron, business-focused negotiations were notably absent from the dialogue. This stands in stark contrast to its exchanges with other BRICS nations like China or India, where the UK government's emphasis has been on commercial contracts.

Another respect in which Germany's relations with Mongolia have an edge is

perhaps less immediately obvious – solid economic relations are underpinned by deeper cultural links dating from the Cold War, when the German Democratic Republic and Mongolian People's Repub-lic enjoyed close ties. "Another aspect to the positive relationship between Germany and Mongolia could be the good general relations between the two sides. Many Mongolians studied in East Germany and have good knowledge of German," says Nemitz.

Rare competitionNonetheless, Germany's impressive assertiveness in Mongolia needs to be contextualised. Although access to Mongolia's rare earth metals is the country's main aim, it has yet to conclude a concrete contract for their exploitation. And Berlin faces stiff competition from non-European competitors, specifically China, which represents formidable long-term competition.

Although China is currently one of the world's largest producers of rare earth metals, as its consumption of high-tech

is a certain element of disillusionment in people. The euphoria around the Eurovision soon wore off and people saw it for what it is – a music festival with an international crowd," says Rasul Jafarov, a coordinator for Human Rights Club.

The event also put an uncomfortable spotlight on the country's pretty dreadful record on human rights and freedom of speech. There were some much publicised forced evictions of Baku residents to make way for the $134m Baku Crystal Hall where the Eurovision was held (the construction of which, according to an investigation by the Organized Crime and Corruption Reporting Project (OCCRP) and RFE/RL, personally profited the family of President Ilham Aliyev. Forced out of their homes by property developers, evicted residents claim that the compensation they were offered for their properties was 30% below the market value. Plucked out of their communities, jobs and schools, many had to move in with relatives or go abroad while waiting for their court appeals. Others could only afford to buy houses on and beyond the outskirts of Baku.

Meanwhile, attacks on journalists and opposition groups, which had subsided during the run-up to the event, resumed soon after. On July 4, police charged a prominent Azeri journalist and human rights activist, Khilal Mamedov, who is from the Talysh region that borders Iran and is home to several hundred thousand ethnic Talysh who speak their own language, with treason and "fomenting national strife", adding the charges to a previous one of drug possession in a case his lawyers say is politically motivated. "Mamedov was involved in cooperation with Iranian special services since 1992… He was giving information that could be used against Azerbaijan to Iranian intelligence," the Interior Ministry and Prosecutor-General's office said in a statement.

Mamedov faces life imprisonment if found guilty of all charges. Mamedov's lawyers call the case "absurd."

Tourists with benefitsBeyond the politics of the event, local businesses, such as taxi companies and restaurants, thrived on the sudden influx of foreign visitors to the capital. Frequented mostly by business travellers, Baku’s hotels had their chance to learn what it is like to manage large crowds of tourists.

Over 30,000 credit card terminals were introduced around the country, 93% of those in Baku. "Many [local banks and

businesses] knew that foreign visitors were unlikely to carry wads of cash with them," says Zohrab Ismail, director of PAAFE. "As a result, banks are now com-peting on transaction charges."

However, visa regulations, loosened during the Eurovision, were tightened soon after the event. "This cannot be helpful for our tourism industry. The sky-high visa fees and tight regulations are deterring potential tourists from coming to Azerbaijan. We need to work towards a sustainable, rather than one-off tourism," says Zohrab.

The economy certainly needs a boost. The oil and gas-rich country held up well during the economic crisis that hit in 2008, though has struggled as oil prices fall and European demand for its for exports decline due to the crisis there. According to the latest figures from the Azerbaijani State Statistics Committee, the country's GDP in the first half of 2012 increased by 1.5% on year, a pick-up from the first-quarter growth of 0.5%.

The non-oil part of the economy on the whole saw its total production grow by 11.3% on year in the first half of the year, whereas decreasing oil

Azerbaijan is an infuriating country for investors. The economy of this energy-rich, mainly Muslim

nation managed to grow 9.3% even during the depths of the global economic crisis in 2009, though it's ruled over by an authoritarian regime that stamps down on any dissent and the drumbeats of war with Armenia continually rumble in the distance.

Certainly, hosting this year’s Eurovision Song Contest in May helped give the country a boost to its international profile. Costing the organisers around €300m and creating a 5% "hole" in country’s budget, according to a report from the Public Association for Assistance to Free Economy (PAAFE), this year’s Eurovision was the most expensive in the contest’s history.

Now that the stage lights are off and the last plane with Eurovision fans has departed, what’s left behind? "There

After the music stops in AzerbaijanJahan Hoggarth, Clare Nuttall and Nicholas Watson

production contributed to a fall of 3% on year in total industrial output. Oil and gas condensate output in the first half of 2012 fell by 7.1% on year, while natural gas output increased by 3.1%. "The cautious upward trend [in GDP growth] is likely to continue. However, it still does not look likely that the official GDP growth projection of 5.7% for this year will be achieved. Base effects will provide some support for annual growth in the second half of the year, while at least the growth of gas

production is relatively encouraging," IHS Global Insight notes.

Jaw-jaw better than war-warA constant backdrop to all this is Azerbaijan's fraught relations with the ethnic Armenian breakaway region of Nagorno-Karabakh and its backer Armenia.

Tensions mounted again in July as Nagorno-Karabakh held presidential elections that were slammed by Azerbaijan as a "provocation". As voters in the tiny unrecognised republic voted for sitting President Bako Sahakian over his challenger Vitaly Balsanian, the wider outcome of the election was a further increase in tensions in the volatile South Caucasus region.

The day before Nagorno-Karabakh's 98,772 registered voters went to the polls, Azeri Foreign Ministry spokesman Elman Abdullayev issued a statement saying that the election "is completely contrary to the efforts of Azerbaijan and international organizations for peaceful resolution of the conflict."

Under international law, Nagorno-Karabakh remains part of Azerbaijan, although it has been de facto

"The euphoria around the Eurovision soon wore off and people saw it for what it is – a music festival with an international crowd"


independent since the early 1990s, when forces backed by the Armenian army fought off an attempt to bring the enclave back under Baku’s control. Although a ceasefire agreement ended the bloody war in May 1994, Armenia and Azerbaijan have never signed a peace settlement, and there is a continued threat that small-scale border skirmishes could escalate into a full-blown conflict once more.

The EU High Representative Catherine Ashton also criticised the poll. "I would like to reiterate that the European Union does not recognise the constitutional and legal framework in which they will be held,” she said in a July 18 statement. "These 'elections' should not prejudice the determination of the future status of Nagorno-Karabakh in the negotiated general framework of the peaceful settlement of the conflict.

Fears of a new outbreak of war increased in the build-up to the vote. Nine soldiers were shot dead in a series of border clashes between Armenian and Azeri soldiers on June 4-5. Although there have been no further shootings since then, a higher-than-usual level of activity was reported along the line dividing Nagorno-Karabakh from Azerbaijan proper. On July 11, Azerbaijan started a week of military exercises near Nagorno-Karabakh. Speaking to APA on July 17, a spokesperson for the Azerbaijani State Civil Aviation Administration reiterated a threat to shoot down any planes violating Azeri airspace by flying to the republic's newly reconstructed Stepanakert airport.

That is a clear warning against any wider recognition of the July 19 election. Cautioning against engagement with the separatist republic, Abdullayev said that anyone visiting Nagorno-Karabakh to monitor the elections would be added to the Foreign Ministry's blacklist.

That list of enemies, both domestic and foreign, grows longer by the day.

Food for thought in Azerbaijan

Jahan Hoggarth in Baku

Economic diversification is high on the priority list for oil-rich Azerbaijan. Keen to reduce its dependency on oil and spread the benefits to rural areas, the government recently introduced a programme of regional development aimed at developing agriculture and the food processing industry, as well as renewal of infrastructure, promotion of exports and the development of greenfield projects.

Azerbaijan has long been a major agricultural producer. Traditionally strong thanks to its diverse climate, Azerbaijan's agricultural sector fell into a state of disrepair after the collapse of the Soviet Union. In post-Soviet times the huge state subsidies and guaranteed regional export markets disappeared, leaving behind deteriorating infrastructure, irrigation and transport systems.

All this is changing rapidly, and growth in the sector is gaining pace. As a result of the Azerbaijani government's land reforms and increased investment in rural infrastructure, the agricultural sector accounted for 5.5% of the country's GDP in 2011. Azerbaijan's principal employer (over 30% of the population), the agricultural sector is now the third biggest after the oil and construction industries.

Leading the initiative is Azersun Holding. Boasting 100 hectares of greenhouses, modern fields, regional and international exports, land reclamation and farming projects, the company is spearheading the modernisation of Azerbaijani agriculture.

Starting out in 1991 as a Baku branch office of the Turkish food production company Intersun, Azersun now comprises 17 food manufacturing, packaging and distribution companies spread across the country.

Working in partnership with some of the world's largest manufacturing companies such as Unilever, Azersun has invested heavily in food production, including tea, cooking oil, salt and sugar. Equipped with cutting-edge technology, Azersun operates 21 food factories and canneries across Azerbaijan. These high-capacity plants allow Azersun to produce more than enough to meet the country's domestic demand in many product areas. For example, ADIB, Azersun's salt manufacturing plant, produces 90,000 tonnes of salt – over 30% more than the Azerbaijani market needs. Similarly, the Edible Oil Factory produces 300,000 tonnes – three times the amount required. Selling 40% of its produce to regional and international markets, Azersun is now the biggest exporter in Azerbaijan.

inevitably low, as only a relatively small number of companies, most of them focused on Latin America, specialise in developing silver-lead-zinc deposits. The contenders have been gradually whittled down, with three initial bidders failing to qualify and two Chinese bidders – Ziti Mining and Sichuan Group – later withdrawing. BHP is understood to have withdrawn for strategic reasons rather than because of issues specific to the Tajik project; under current economic conditions, the company has been scal-ing down investment projects and focus-ing on cost control.

Kalon Konimansur is expected to cost the successful bidder around $3bn to devel-op, including the huge but necessary infrastructure investments. The poor state of Tajikistan's transport and energy infrastructure means that substantial investments will be needed in roads and – unless Tajikistan can ensure a stable power supply – power generation.

Another issue is that the deposit is situat-ed directly under the town of Adrasmon, near Tajikistan's border with Kyrgyzstan, requiring the relocation of some 13,000 people. This would be one of the largest relocations ever carried out.

However, should development of the deposit go ahead, it could transform the economy of Central Asia's poorest country, boosting export revenues for 30-40 years given that Kalon Koni-mansur contains around 1m tonnes of

ore, and estimated silver reserves of around 70,000 tonnes. It would also help to address chronic unemployment in Tajikistan, by providing work for around 10,000 people who would be employed during the construction phase and steady jobs for another 2,000 after production begins.

BHP Billiton, one of just two companies left in the running to develop Tajikistan's largest silver

deposit, pulled out of the race in July, leaving the future of the tender in doubt. Finding a company with the resources to develop the Kalon Konimansur silver-lead-zinc deposit is of vital importance to Dushanbe, as it would have a transfor-mative effect on the Tajik economy, but BHP's withdrawal has ended Tajik hopes of impressing investors with the Central Asian region's first open competitive tender for a major mining project.

Only one bidder, a consortium led by Kazakhstan's Kazzinc that includes Kazzinc's parent company Glencore International, as well as Konimansur and Adrasman, now remains in conten-tion to develop the deposit – a project that is expected to cost around $3bn. A decision on the tender was due to be made in September, but after BHP's withdrawal it might be brought forward.

A source close to the process tells bne that a bid from the Kazzinc/Glencore consortium would still be considered by the Tajik government provided it complies with all tender requirements. "However, much also depends on whether the government sets the minimum bid price at a reasonable level. If they go excessively high, then the consortium will not be able to submit a bid," the source says.

A blow to prestigeBHP's decision to withdraw is clearly a blow for the Tajik government, which had hoped the tender would help put the country on the map for international investors. Dushanbe had rejected earlier offers from Russian mining companies to develop Kalon Konimansur in favour of a competitive process.

This would have been the first time an open tender has been used for a mine development project of this scale and complexity in the entire Central Asian region. Dushanbe had been working for more than a year with the World Bank's International Finance Corpora-

tion to ensure the process was fair and transparent. While the contract may still be awarded to the Kazzinc/Glencore consortium, its rival's decision to quit the race means it will no longer make the same impression on investors.

The number of potential bidders was

Sole mining in TajikistanClare Nuttall in Almaty

"Much depends on whether the government sets the minimum bid price at a reasonable level. If they go excessively high, the consortium will not be able to submit a bid"


7.4% in 2011, and the International Monetary Fund expects it to grow 6% in 2012. "Another important reason for the increase in deposits is the flow of remittances," says Ponosov. "Many migrants save for major ceremonies or purchases that require a lot of money, of course they are saving for months, if not years. Thus, migrant workers realise that they can safely stash their savings and additional revenue in deposit accounts with the banks."

However, Tajikistan still has a low level of banking penetration, with much of the 6.8m population keeping their sav-ings "under the mattress", especially in rural areas. And even given the recent upward trend in the banking sector, according to the European Bank for Reconstruction and Development's "Transition Report 2011", Tajikistan's banking sector remains very fragile and financial intermediation very shallow. "This reflects continued directed lending practices and other forms of excessive state interference, which have negatively affected capitalisation and the ability of banks to lend to the real sector," the report says.

The low level of banking penetration means there is room for the country's banks to expand, but how quickly will depend largely on external factors. Moody's Investors Service says that, "Despite the challenging economic environment, opportunities are being created for local banks aided by the low level of financial intermediation in Tajikistan and low competitive pres-sures in the domestic banking sector."

Tajikistan is still at risk from outside shocks, especially due to its dependence on the Russian economy, Moody's warns. "Given the country's heavy dependence on remittances from Russia... the local economy and the banking sector are highly vulnerable to external shocks," Moody's analyst Lev Dorf says.

Tajikistan saw bank deposits grow by 20.5% in the first five months of 2012, reflecting the expanding

economy and rising public confidence in the banking sector. This trend is expected to continue, but given the Tajik economy's vulnerability to exter-nal shocks, the speed with which the banking sector develops will depend on the international economy, especially events in Russia.

According to data from the National Bank of Tajikistan, corporate deposits reached TJS1.7bn ($366m) and individual deposits TJS2.6bn. This followed an increase in deposit levels of around 28% in 2011, and deposits have continued to build despite relatively low interest rates; on July 10, the central bank reduced its main refinancing rate to the five-year low of 6.8%.

According to Anton Ponosov, marketing director at Tajikistan's fifth largest bank Eskhata Bank, the main reason for the increase of deposits is higher confidence in the banks. "Many people were afraid to invest their money in banks because they were afraid of a repeat of the situation in the 1990s. Now it has been long enough for banks to prove themselves. Clients realise that by opening deposit accounts, they will receive income without the risk of losing their deposits," he tells bne.

Tajikistan's economy has also being growing steadily. GDP expanded by

Deposits mount in Tajik banks Clare Nuttall in Almaty

"Tajikistan is still at risk from outside shocks, especially due to its dependence on the Russian economy"

second revolution in 2010 was followed by the immediate nationalisation of numerous assets judged by the interim government to have had connections to ousted president Kurmanbek Bakiyev and his family. Combined with illegal property seizures by a volatile and highly politicised population, this raised fears of expropriation among investors, who put new projects on hold until more stable times. With the peaceful handover of power to President Almazbek Atambaev in 2011 and the formation of a new coali-tion government, there were widespread hopes of more stable times. But growing resource nationalism has been a contin-ued source of concern for investors and the attack on Kyrgyzstan's largest investor has shattered hopes that the country has entered a new and more stable era.

Aside from the situation at Kumtor, smaller mining companies involved in Kyrgyzstan have also suffered. Talas Gold, a company developing a deposit in the high mountain Talas region, had its operations attacked twice in 2011 and

suspended work after its mining camp was torched by armed horsemen.

The Kyrgyz government does, however, appear to be divided over the line to take on foreign investors in its natural resources sector. The author of the report on Centerra, Zhaparov, is the leader of the nationalist Ata-Zhurt party, which is currently in opposition, although his stance is backed by some members of the ruling coalition. On the other side of the debate, Deputy Prime Minister Djoomart Otorbaev said on June 14 that there would be no changes to the Kumtor oper-ating agreement. Officials from Atam-baev's office have also spoken out on the damage they say the decision will cause to the economy, with one official claiming to Reuters that it could cost Kyrgyzstan "millions of dollars."

Actually, it already has.

The Kyrgyz government's decision to revise its agreement with Cen-terra Gold on the country's largest

gold mine, Kumtor, has been a blow to hopes of a stable regime for inves-tors following the 2010 revolution. Not only is Toronto-listed Centerra entering a new period of uncertainty while a government commission decides how to revise the agreement, other investors have been spooked by the resurgence in resource nationalism in Kyrgyzstan.

The Kyrgyz parliament voted on June 27 in favour of revising the agreement on the Kumtor gold mine in order to get a better deal for the impoverished Central Asian country. MPs want to see Kyrgyz-stan increase its stake in Centerra above the 33% it has held in the Toronto-listed company since 2009, claiming the coun-try should have greater control over the largest foreign-owned gold mine in the former Soviet Union.

Under the new parliamentary decree, the Kyrgyz government is required to revoke decrees and licences relating to Kumtor. A special commission, compris-ing members of the parliament, govern-ment and presidential administration as well as independent experts, is being set up, with the intention of submitting a revised agreement by November 1, local news agency Kabar reports. A crumb of comfort for Centerra was that the parliament stopped short of backing an expropriation proposal put forward by MP Sadyr Zhaparov, whose committee had prepared a highly critical report on Centerra's management of the mine.

Centerra issued a statement immediately after the parliament vote saying that it believes the resolution is "not legally bind-ing on the Kyrgyz government", and that the government and relevant state agency "cannot revoke its decrees and licences without meeting the relevant criteria for

revocation set out under applicable law". "Centerra believes that the parliamentary report's findings are without merit," Cen-terra president and CEO, Ian Atkinson, said in the statement. "Kumtor has oper-ated in full compliance with Kyrgyz and international standards and this has been proven over the years in systematic audits by Kyrgyz and international experts."

Economic falloutThe drop in production at the Kumtor mine in the first half of this year has already damaged Kyrgyzstan's econo-my. After a revival in growth in 2011, Kyrgyzstan's economy contracted by 5.6% in January-June, following a fall in production at Kumtor, which accounts

for about 12% of the country's total GDP. This was partly for technical reasons, but a 10-day strike in February and a blockade of the only road leading to the mine in May have also hit production.

The investment bank Visor Capital says that although no final decision has been taken by the Kyrgyz government over the Kumtor mine, it reckons Centerra will have to agree with at least some of the proposed changes to the investment agreement. Visor Capital also warns that in a climate of growing resource nation-alism, where the Kyrgyz parliament is currently trying to revoke other licences owned by foreigners, "we can't rule out that it might also consider revoking Kumtor's mining licence."

The decision to revoke the Kumtor agreement has also alarmed Kyrgyzstan's small investor community. The country's

Under-mined in KyrgyzstanClare Nuttall in Almaty

"Centerra believes that the parliamentary report's findings are without merit"


This will depend on maintaining invest-ment, which so far has been concen-trated in the mining sector. "The mining sector is the largest in our economy. Millions of dollars worth of investments are planned for 2012 and 2013, which will result in new working places, higher tax revenues and other macroeconomic effects," Jesayan says. "Agriculture, the first sector of the economy from the end of the war until the late 1990s, was the fastest growing sector in 2011, and there is still huge potential for development of agriculture and food processing."

Sahakian's rule has, however, been marred recently by a rise in corrup-tion, which helped rival candiate, war commander and former Deputy Defence Minister Vitaliy Balasanyan take a respectable 32.5% of the vote. The president's commercial interests are understood to include several lucra-tive businesses including the Embala shopping centre, a taxi firm and one of Stepanakert's largest restaurants.

Outside helpPart of the reason for Nagorno-Kara-bakh's rapid growth in recent years is that it started from an extremely low level, Masis Mayilyan, chairman of Stepanakert-based think-tank Council for Security and Foreign Policy, points out. "The government is doing a lot to encourage investors. The tax regime now offers a lot of benefits, but there are legal risks because the country is not recogn-ised internationally," Mayilyan says.

As in Armenia, the diaspora has been highly important in providing aid and later infrastructure investment. The

main highway from the Armenian border to Nagorno-Karabakh's capital Step-anakert is lined with billboards listing the donors that funded its construction. But while Armenia now has a diversified

The tiny, self-declared republic of Nagorno-Karabakh has seen rapid economic growth in recent years,

as the mining sector expands and the government launches new incentives for investors. However, the ethnic Armenian enclave has never achieved interna-tional recognition of its independence from Azerbaijan, and despite an 18-year ceasefire its population lives under the persistent threat of a new war.

Nagorno-Karabakh's uncertain status was highlighted in July 2012, when the July 19 presidential elections, which resulted in the re-election of Bako Sahakian, were slammed by Baku as a "provocation". The international com-munity also dismissed the election as illegitimate, with the EU High Represen-tative Catherine Ashton, saying on July 18, that the "European Union does not recognise the constitutional and legal framework in which [the elections] will be held."

Sahakian has presided over five years of double-digit growth, which peaked at 13% in 2009. While GDP per capita is still at the modest level of $2,500, Nagorno-Karabakh's isolation from the international economy, coupled with rising investment, allowed GDP growth to continue while other countries were in the depths of the crisis. The current government forecast is for growth to

continue at 9-11% for the next few years. "It's very important for us to maintain this momentum," Economic Development Minister Kazen Jesayan tells bne.

Growth in uncertain times for Nagorno-Karabakh

Clare Nuttall in Stepanakert

"There is still huge potential for development of agriculture and food processing"

activity in the border areas is reported, and the Nagorno-Karabakh election and a threat from Baku to shoot down any planes flying to or from Stepanakert have kept tensions riding high. "The conflict around Nagorno-Karabakh risks spinning out of control if the current unconstructive dynamics in Armenian-Azerbaijani talks continue. Although the conflict seems rather localized, reopening of a new war will have far-reaching impact beyond the boundaries of South Caucasus region," Lilit Gevorgyan, Russia/CIS country analyst at IHS Global Insight, writes.

There is also a new threat on the horizon that could bring changes to the long-standing status quo in the region. People across the south Caucasus are anxiously watching the situation in Iran,

which borders Azerbaijan, Armenia and Nagorno-Karabakh. If there is a war in Iran, the south Caucasus can expect at least a humanitarian crisis, with a flood of refugees. More than that, however, war in Iran could also destabilise the fragile balance that has endured in the region for almost 20 years.

investor base, Nagorno-Karabakh con-tinues to rely on Armenian and diaspora investors like Vallex.

An important step forward was the IPO of Artsakh HPP, the main genera-tor of hydropower in the republic on the Armenian stock exchange in March 2009. "Artsakh HPP was quite a success-ful issue. A lot of non-resident inves-tors, both diaspora investors and other foreigners, participated, which was very interesting," says Aram Kayfajyan, CEO of Armenbrok, the adviser and underwriter for the IPO. Thanks to the funds raised in the IPO, construction of new hydropower plants is going ahead and Nagorno-Karabakh will be energy independent by the end of 2013.

"The legal status of the [republic] prevents us from establishing normal international diplomatic and trad-ing relations. However, where things seemed impossible, we have found a way," says Jesayan. "Perhaps the best evidence of this is the development of the real estate market. Our mortgage lending programme is in its fourth years, and the property and mortgage markets are growing steadily, which is a great indicator of economic stability."

The buildings have been given a facelift in central Stepanakert, where the republic's commercial and political life is concen-trated. The police headquarters overlooks the blatantly copyright-busting Prada shoe shop, and smart young Stepanaker-tis gather at the local branch of Russia's Tashir Pizza chain, just a few doors down from the burnt out children's drama the-atre. New buildings are going up in all the streets around the city centre.

Stepanakert resident and coffee-seller Anni says that most buildings damaged in the war have recently been rebuilt. "In the early days we didn't do much because there was no money and we didn't know what would happen in the future. But we decided not to wait for a peace agreement to be signed – we must rebuild and believe they will not be destroyed again," she says.

Calm but no closureSecurity is light in Stepanakert – while

there is no shortage of soldiers strolling around the town, the parliament is guarded only by a young soldier busily texting, and teenagers rollerblade outside President Bako Sahakyan's official residence. But if reminders of the recent war have been removed from the capital, the nearby town of Shushi, where some of the most intense fighting took place, is only now being rebuilt. The town's Soviet-era apartment blocks have been patched up with corrugated iron and breeze blocks, and there are visible scorch marks on walls and roofs.

18 years on from the bloody war between Nagorno-Karabakhis backed by Armenia and Azerbaijani forces, stability has been maintained in the volatile south Caucasus region, but a peace agreement has never been signed.

This leaves Nagorno-Karabakh in an uncertain position. It has been de facto independent for nearly two decades, but under international law remains part of Azerbaijan, and has never gained recog-nition as an independent state.

Relations between Armenia and Azer-baijan have improved somewhat with the election of new presidents in both countries. Armenia's Serzh Sargysyan and Azerbaijan's Ilham Aliyev have met several times since Sargysyan came to power in 2008, under the aegis of the Russian government. At a meeting in January, both men said they were willing to speed up settlement of the conflict. But even with the recent slight thawing in relations, little concrete progress has been made.

The situation worsened in June 2012, when a series of border incidents resulted in the deaths of nine Armenian and Azeri soldiers on June 4-6. While there have been no further deaths, a higher than usual level of military

"We must rebuild and believe they will not be destroyed again"


in line with their imperatives. Though weaker than when they were empires, Russia and Turkey are experiencing a resurgence. The traditional powers are particularly active in the economic sphere where Austria maintains a strong banking presence in the Balkans, Russia is very active in the energy sphere and Turkey is one of the region's largest trad-ing and investment partners. This trio's financial and economic interests will continue to intersect in the region, just as they have for centuries.

The broader Western power is more complex since it is comprised of multi-state entities, with the US being the primary driver in Nato, and hence in all things security, and Germany and France the primary drivers in the EU, and hence in all things political and economic. Complicating matters, both the EU and Nato are being transformed by the many pressures each bloc faces. For the past 20 years, Europe has been reshaped by the enlargement of Cold War-era institutions, most notably the EU and Nato, into the former Warsaw Pact and non-aligned countries of Eastern Europe and the Balkans.

The Serbian exceptionThough technically part of the Bal-kans, as a member of the EU and Nato, Slovenia is oriented much more strongly toward its Central and Western Euro-pean neighbours than it is toward Serbia or Macedonia. Croatia, a Nato member set to join the EU in July 2013, shares a similar orientation. Serbia, however, is different due to its central geography and legacy of intra-Balkans population movements. It has one eye on the West and the other on Russia, while internally it is consumed with issues in Bosnia-Herzegovina and Kosovo.

Serbia does share a desire to integrate more closely with Europe and with its other Western Balkans neighbours, pri-marily in the form of EU accession. But given the current economic and political uncertainty in Europe, Croatia's impend-ing membership to the EU and Brussels' demands for Serbian concessions in Kosovo, the EU is looking less and less attractive to Serbia. Indeed, Serbia's troubled economic position was one of

The Western Balkans, a sub-region of the wider European border-lands, historically has been a

power vacuum filled by larger states or empires. The end of World War I saw the dissolution of the Austro-Hungarian and Ottoman empires, the states that traditionally had dominated the Western Balkans. Serb-dominated Yugoslavia emerged from within the region to dominate the Western Balkans during the 20th century.

Twenty years after the dissolution of Yugoslavia, the states of the Western Balkans – Serbia, Croatia, Slovenia, Bos-nia, Montenegro, Macedonia, Albania and Kosovo – are back to the traditional model of being shaped less by internal dynamics and more by external powers: namely, the West, Turkey and Russia. The changing nature of these external powers, particularly the EU and Nato, but also Turkey and Russia, will be the force that drives the Western Balkans.

Outside powersThe critical driving force of geopolitics is the nation, regardless of whether the nation also takes the form of a nation-state. The European borderlands, which encompass Central Europe, Eastern Europe and the Balkan Peninsula, is comprised of smaller, more numerous nations than Western Europe. Unfavour-able geography largely explains this. A lack of access to the sea, numerous internal mountain chains, insufficient natural barriers and proximity to Asian powers define the region. These fac-tors have hampered the formation of powerful states in the region, providing an opportunity for outside powers to dominate the nearly two-dozen smaller states of the European borderlands.

The traditional external powers of the Western Balkans – Austria, Turkey and Russia – are not as active in the region as during their imperial phases, but they still have designs on the region

COMMENT: Europe's borderlandsStratfor

the primary drivers behind the recent victory of Tomislav Nikolic – whose interest in EU accession is unclear – over Boris Tadic in the presidential elections. For its part, the EU is in no rush to admit Serbia given all of its internal economic and political woes.

In the security sphere, Serbia remains the strongest military power within the Western Balkans, but Nato countries like Croatia and Albania, which joined in 2009, surround Belgrade.

Military action initiated by Serbia against its Nato-shielded neighbours is unlikely in the short- to mid-term. The potential for instability and small-scale conflict remains in the region, particu-larly in Kosovo. But the degree to which these low-level conflicts become more serious depends less on Serbia than it does on the outside powers that have interests in Serbia and elsewhere in the Western Balkans.

Ultimately, the region revolves not around Serbia, but on the push and pull of outside powers. As a borderland, the external is primary. Right now, the main definer of the region is the EU. A decade ago it was Nato. Before then it was the US-Soviet confrontation, and before then it was Austria, Turkey and Russia, and so on.

The Western Balkans is a region that does not mould itself. It is moulded and remoulded on the broadest level, retaining its regional integrity to some extent. The era of Yugoslav primacy was the one period in which the Western Bal-kans were autonomous. The autonomy was imposed as a neutral zone between the two blocs of the Cold War, but the internal dynamic was shaped by Serbia. After 1991, Serbia was no longer the one to mould the region.

Therefore, as with most of the countries of the European borderlands, the region will be shaped more by external forces than by its internal dynamics. The Western Balkans cannot be seen as a self-enclosed geopolitical sphere, but as a borderland shaped by outside forces.

Mission accomplished in Kosovo?

Ian Bancroft in Belgrade

The organisation charged with overseeing Kosovo's democratic development declared on July 2 that international supervision of Kosovo had come to an end, four years on from its unilateral declaration of independence from Serbia.

With the planned closure of the International Civilian Office (ICO), which retains executive powers to ensure full implementation of the "Ahtisaari Plan", in September, Kosovo will assume full sovereignty – supposed recognition of the progress that the state has made under international tutelage.

However, in many respects, the ending of supervision is the international community's "mission accomplished" moment in Kosovo – ie. raising the victory flag whilst many serious underlying problems remain. Indeed, recent speculation suggests the EU is pushing for its rule of law mission, Eulex, to be included in Kosovo's constitution, in order to give its continued presence a sound legal basis.

Yet Eulex itself has been heavily criticized for its failure to make significant progress in the fight against organised crime and corruption – the twin scourges that continue to inhibit Kosovo's transition – and there are fears that any further progress will be severely constrained, particularly after a recent downsizing of its operations.

One of the main challenges concerns the north of Kosovo, where Serbs refuse to recognise the legitimacy of Pristina's institutions – a view confirmed by a referendum earlier this year. The north has witnessed makeshift barricades and sporadic outbreaks of violence since attempts to forcibly install Kosovo customs officials on the administrative boundary line with Serbia last July. Though Pristina recently opened an Administrative Office for the north, its presence and authority remain extremely limited.

The recent death of Dino Asanaj, the head of Kosovo's Privatisation Agency – who allegedly committed suicide by stabbing himself eleven times, amidst suspicions of corruption investigations against him – has re-focused attention on Kosovo’s privatisation process. Riddled with mismanagement and corruption, privatisation remains contentious. Serbia continues to assert ownership of many state-owned companies and has called upon the UN to block the transfer of funds from privatisations to the post-independence Kosovo Privatization Agency, whose legitimacy Serbia does not recognize.

The Trepca Mine in Kosovska Mitrovica – which once upon a time employed 23,000 people – provides an important example of the ownership quandaries. Trepca is essentially two separate companies – one managed by Albanians, the other by Serbs. The latter, which employs around 3,500, continues to be hit by economic sanctions imposed by the Kosovo government. The Tax Administration of Kosovo has seized bank balances, whilst the Privatisation Agency of Kosovo refused to provide customs clearance for exports.


since amended twice – foreign investment has returned to the sector, helping to raise production considerably. There are now two foreign companies extracting in Albania, in partnership with Albpetrol, and one more expected to start producing in the next few years. Canada's Bankers Petroleum produced 13,000 b/d in 2011, up from 600 b/d in 2004, and now aims to increase its output by a further 30% this year, according to Popovici. Stream Oil and Gas, another Canadian firm, which has four development and extraction agreements with Albpetrol, was producing 2,000 b/d at end-2011 and has been averaging 2,500-3,000 b/d this year, which it aims to raise to 14,000 b/d in 2015. Albpetrol's output from its own fields is not as certain.

In February this year, Petromanas, a third Canada-based firm, announced that it had formed a 50-50 joint venture with Royal Dutch Shell for the explora-tion of two onshore blocks near Berat in central Albania.

Including Petromanas/Shell, there are currently seven exploration agreements active in Albania. Popovic reckons that even without Albpetrol's uncertain con-tribution, Albania's oil output could easily total 40,000 b/d in 2015, just overtak-ing the 38,400 b/d consumption seen in 2011, and boosting export potential.

Popovici sees four competitive advantages on which the Albanian energy sector can capitalise (and now is capitalising): existing fields in need of investment; unexplored (mainly offshore) fields; a fairly stable environment for hydrocarbon investors, regardless of who is in power; and its proximity to import markets look-ing for diversification, particularly Greece, Spain and Italy. Government figures also like to trumpet Albania's respectable performance on the World Bank's "Doing Business" surveys and similar studies.

On the flipside is a lack of infrastructure and capacity – roads, pipelines, storage and export terminals and particularly refineries. Albania's two existing refiner-ies, at Fier and Ballsh, have a combined capacity of 30,000 b/d and are greatly in need of modernisation. Currently, much of Albania's crude oil is sent abroad for refining, and Albania is a net importer of

The otherwise plain rolling hills south of the central Albanian city of Fier are remarkable for

two main reasons. First, the fascinating Greco-Roman ruins of Apollonia and Byllis, the latter spectacularly set above a bend in the river Vjosa and beneath the lowering mountains. Second, the nodding-donkey oil pumps dotted over the grey-green landscape – for this is the heart of the Albanian oil industry.

Over the past half-decade, the Albanian hydrocarbons sector has undergone something of a revival (even though the suggestion that such a thing would exist would prompt guffaws in some less-informed quarters). International firms are involved in exploration, extraction and export; production has almost doubled since 2005; both the expansion of the oil products industry and the development of energy transit routes through Albania are on the cards.

Certainly, this is good news for the Albanian economy, which is poor by European standards and with few sectors of note on a regional, let alone international, level. But let's not get carried away – Albania is hardly a new Abu Dhabi, due largely to its limited resources as well as its well-publicised problems with sclerotic infrastructure and dysfunctional administration.

Heavy oilAccording to official figures provided to bne by the Albanian Prime Minister's Office and Albpetrol, the state-owned oil company, Albania produced 891,264 tonnes of crude oil in 2011, almost exactly twice the output of 446,990 tonnes in 2005. Albania's oil is heavy and needs special facilities to process, and thus tends to trade at two-thirds to three-quarters of the price of Brent crude. Estimated crude reserves total 437.645m tonnes, while proven oil reserves total around 198m barrels, accounting for a 58% of the total in the Balkans – pretty remarkable given Albania's small size.

As Vlad Popovici, energy editor of Balkananalysis.com, notes, bitumen has been extracted in Albania since Roman times, and modern oil extraction started in the 1930s, relatively early for Europe. By the mid-1970s, production ramped up to a peak of 43,000 barrels per day (b/d) under the supervision of its ally China (having split with the Soviet Union, Albania – never one to hew to the norm – sided with Beijing). The loss of Chinese support in 1978 and the disintegration and collapse of the communist system saw output slide to 9,500 b/d by 1994, at which point the industry "seemed on the brink of extinction," in Popovici's words.

Now, thanks to the 1993 Petroleum Law –

Albania's slicker oil industryAndrew MacDowall in Belgrade

refined products. The weak supply chain means that Albania has relatively low value-added in the hydrocarbon sector.

Ariana Cela, economic advisor to the Alba-nian prime minister, tells bne that "increas-ing refinery capacities is of interest to the government," but gave no further details. As she points out, more progress has been made in increasing terminal capacity. In June 2009, two new terminals were opened under concessions: one is "Porto Romano" near Durres, on the coast just west of Tirana, and the other "Vlora Bay" just north of the coastal city of Vlora.

Between them, they can discharge 17,000 tonnes of oil and 6,500 tonnes of LPG per day. Vlora Bay is expected to expand over the coming years, while the authori-ties are also looking into Seman, near Fier, as a possible site of another facility, according to Cela. These investments are encouraging, and if matching develop-ments take place in other supply chain infrastructure, will help increase Alba-nia's export potential. Popovici thinks

that this can be increased from 10,000 b/d to 20,000 b/d in the medium term. A nice little earner for Albania in an energy-hungry region certainly, though a tiny proportion of consumption even in the Adriatic region, let alone internationally.

Gas projectsBut Albania is not putting all its energy eggs in one basket. Cela highlights a num-ber of more concrete upcoming projects in the sector over the next five years, most of which focus on gas transit and storage, leveraging the country's strategic position.

The development of the Western Balkan Gas Network is a priority; this scheme is intended to support regional economic growth and energy cooperation, while increasing European energy security. It includes two main pipelines. The first is the 800-kilometre Trans-Adriatic Pipeline (TAP), which is in the engineer-ing and planning stage and reaches from Komotini near the Greek Aegean coast through Albania and under the Adriatic to Italy. TAP will carry 10bn-20bn cm of

gas a year to the Western Balkans, Italy and thence potentially beyond, and will be supplied from Azerbaijan, potentially providing an important alternative to Russian gas in Europe. The second is the Ionian Adriatic Pipeline (IAP), which has only reached the stage of preparation for a feasibility study. The bi-directional IAP would run 520 km or so from Split in Croatia to link with the TAP in Fier.

To complement the IAP and TAP, Albania is investigating the potential for under-ground gas storage, which would allow it to hold gas for distribution along the pipelines at periods of peak demand. Thus far it has identified two potential sites: a depleted gasfield and a salt dome, with potential capacity of up to 3m cm.

The resuscitation of the Albanian hydro-carbon industry has been one of the country's post-communist success stories. And while the country is no energy giant, oil and now potentially gas could make a useful contribution to the broader region's energy supply and security.

70 I Events bne August 2012 bne August 2012 Events I 71

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