bne:Magazine - April 2014

Inside this issue: The cost of Crimea Chicken Kyiv Where there's Mucha, there's brass

April 2014 www.bne.eu

Sanader and the ABC Syndrome Educating Raushan

WHO IS HE?

bne April 2014

Contents

Editor-in-chief: Ben Aris (Moscow)

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Managing editor: Nicholas Watson (Prague)

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News editor: Tim Gosling (Prague)

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Eastern Europe: Graham Stack (Kyiv) Anna Kravchenko (Moscow) Central Europe: Jan Cienski (Warsaw) Mike Collier (Riga) Tom Nicholson (Bratislava) Kester Eddy (Budapest) Southeast Europe: David O'Byrne (Istanbul) Ian Bancroft (Belgrade) Bogdan Preda (Bucharest) Guy Norton (Zagreb) Andrew MacDowall (Belgrade) Eurasia: Bureau Chief: Clare Nuttall (Almaty) Molly Corso (Tbilisi)

Alec Egan Business Development Director (International) Design: Olga Gusarova-Tchalenko

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COVER STORY 6 The Insiders

CENTRAL EUROPE 28 Where there's Mucha, there's brass

8 Who is Vladimir Putin? +7 7073011495

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

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12 Perspective 13 Chart of the month

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30 Hungary's war over the economy 32 Front-line Baltics keep wary eye on Crimea 34 Poland shale shocked

EASTERN EUROPE 35 Hungary for residency bonds 14 Cost of Crimea

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18 First Firtash, next…who?

20 Chicken Kyiv 21 Strange bedfellows in East Ukraine

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No liability can be attached to the publisher for these comments, nor for inaccuracies, errors or omissions. Investment decisions or related actions taken on the basis of views or opinions that appear herein are the responsibility of the reader and the publisher, contributors and related parties cannot be held liable for these actions. bne is the property of bne Media Ltd · Reg number: HE 185230 · Michalakopoulou 12, 4th floor, Suite 401, P.C 1075, Nicosia, Cyprus · Postal address: Schluterstrasse 19, Berlin 10625, Germany

22 Russian funds back in the game 24 Moscow's bonne affaire en France 26 How to sell a Russian region

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bne April 2014

Contents

57

40

64

SOUTHEAST EUROPE

EURASIA

36

Local Turkish affairs, regional repercussions

52

Uzbek telecom scandal grows

38

Shipping Ukrainian money to Turkey

53

Tele2 shakes up Kazakh market

39

Go-go Gagauzia

55

A spring broom in Kyrgyzstan

40

A landslide in Serbia 57

42

Kosovo PM rubbishes Crimea comparisons

Mongolian investors hope good times roll again

59

Educating Raushan

44

Sanader and the ABC Syndrome

60

Azerbaijan joins regional Eurobond push

Croatia rethinks Russian welcome mat

62

Anger as Kazakh labour devalued

45

47

Croatia hosts visitors, lacks investors

49

"Bad, bad bank!"

Follow us on twitter.com/bizneweurope

OPINION 64

New Ukraine faces old problems

66

UPCOMING EVENTS

I5

6

I The Insiders

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Emerging Markets In An Upside Down World

Dr Jerome Booth of New Sparta Limited

I

n 2011, I wrote the following about Dead Bodies. The UK has its dead body on the kitchen floor, blood everywhere.

We are trying to clear up the mess: we can see a policy route to macro-economic stability and sustainable debt levels that is painful but realistic.

disease. This is the deep-seated meme that the core (the developed world) affects the Periphery (the emerging world), but that we can ignore the impact of the Periphery on the Core. That the Core is in hock to the emerging markets who own 80% of global central bank reserves is ignored.

In the Eurozone the dead body is not quite as large as in the UK and is around the edge of the room (the Dutch and German parts of the floor are clean). The policy response is akin to covering the body with a sheet and agreeing to deal with it later. Denial is palpable, but the blood is unfortunately spilling out under the sheet and starting to damage Eurozone shoe leather – even threatening a nasty stain on Germany’s clean part of the floor.

At one level this is not too worrying for Germany, as they have plenty of floor cleaning equipment, but they didn’t reckon on cleaning everybody else’s part of the floor as well. If they are expected to do that, they need some new rules established. These need to change the antisocial habits (fiscal profligacy, lying about one's numbers) that caused the current (preventable) deaths.

And the same old promises to be more careful next time are not good enough. The result is a lot of bickering. The outcome so far has been to come up with larger sheets, without much cleaning up going on. Even with the latest bailout, which buys time, Greece’s debt/GDP is unsustainable under any credible fiscal outcomes without major debt reduction.

Commentators and investors belittle these macro-economic imbalances and the risks they pose. In part this is due to intellectual failure in finance and economics. Prejudice about the shape of the (investment) world has caused major distortions in the global allocation of capital, including bizarrely large flows from emerging countries to the HIDCs. For example, if all currencies (developed and emerging) are

However, in the US denial is even more pronounced: the cadaver has been placed in a chair, given a cup of coffee and is being engaged in conversation. The US is assumed by many to be zero risk or "risk free" even when evidence of severe macro-economic vulnerabilities is plain. In the US especially, there are many who think de-leveraging and the pain it involves can somehow be avoided. It cannot, and the denial merely allows the problems to fester.

Since writing the above, there has been some progress in the EU – including the recent agreement on banking union – but denial is still strong, reaction slow and policy inward looking.

The EU and US – the HIDCs (Heavily Indebted Developed Countries) as I call them – suffer not only from very high debt levels which will take years to fix, but from Core/Periphery

"Losses are coming for those foolhardy enough to buy and hold sovereign debt of heavily indebted developed countries" not only volatile against the dollar but also highly correlated, then we think risk is all over the place and retreat to the perceived safety of the US. But we might instead conclude that it’s the dollar which is volatile. We say US Treasury bonds are "risk-free", which is an abuse of the English language.

A move to historical average yields could wipe out a quarter of their value and more could easily be lost through devaluation and inflation. The last time there were major imbalances in the international monetary system and Nixon came off convertibility to gold in 1971, the dollar fell from $35 an ounce to around $195 an ounce by 1974.

Losses are coming Large HIDC debts are not going to be eroded by economic growth alone, but through negative real interest rates – be

bne April 2014

it via financial repression or inflation. That is the historical record post- WWII and in the 1970s. We know from behavioural finance that people don’t mind being robbed slowly, especially if its other people’s money, but losses are coming for those foolhardy enough to buy and hold HIDC sovereign debt.

Such denial is no joking matter and is the tip of the iceberg of faulty thinking when it comes to investing as well as financial and economic policymaking. Denial, hubris and hypocrisy have been in evidence from the West concerning Crimea recently, but they are nothing new, and not restricted to foreign policy.

So I have written a book, "Emerging Markets in an Upside Down World". Or rather it is several books. I found it necessary to weave different threads together in order to lead the reader to my thinking on why asset allocation today is so massively distorted.

I start with a chapter on globalisation and then a history of emerging markets, most especially emerging debt markets.

I have never found a satisfactory history of this elsewhere.

Giving such a huge topic a single chapter rather than a whole book, I have necessarily focused on parts I think particularly relevant for investors and policymakers today. But I do include some broad points about the role of debt in politics historically and how it can improve governance. I also chart some of the twists and turns in the last couple of decades between markets and policy-makers in the (at times painful but also glorious) birth of modern emerging capital markets.

After a chapter on my view of what when wrong in 2008 in the HIDCs comes the destruction job on finance theory. Just as 80% of Keynes’ General Theory is a demolition job on the status quo in order to clear the way for his new invention – macroeconomics – so I at more modest scale provide a critique of finance theory; and especially the concept of risk, which gets a whole chapter just to itself.

After a chapter on Core/Periphery disease, I focus on the structure of investor bases, which affects liquidity, risk and much else. This is followed by chapters of how asset allocation is currently done, how we should think more strategically, and then a check list for the investor.

So the book is an emerging market history, a critique of finance theory, a practical guide for the investor, but also – in the last major chapter – a guide for policymakers. I hope the book will be read by investors everywhere (including those not interested in emerging markets); by students of finance theory, economics, business and emerging markets; and by policymakers. I have avoided equations and made the book accessible to the interested lay reader.

So enjoy!

"Emerging Markets in an Upside Down World" is published

by John Wiley & Sons.

"Prejudice about the shape of the investment world has caused major distortions in the global allocation of capital"

8

I Cover story

Who is Vladimir Putin?

Ben Aris in Moscow

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Cover Story I 9

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W

hen he first assumed power in 2000, the press corps spent the first six months asking the same question: "Who is Vladimir Putin?"

At first the media speculated he was merely a puppet of the oligarchs because he had clearly been handpicked by oligarch Roman Abramovich and Boris Yeltsin's daughter Tatyana Dyachenko, who at that time were effectively running the country. But after Putin moved forcefully to sweep the businessmen out of the corridors of power and return political control of the country to the centre, everyone had to recalibrate.

"Putin arrived at the famous oligarch meeting [in 2001] and figuratively dumped two bodies on the table – Boris Berezovsky and Vladimir Gusinsky [both of whom owned major TV stations].

Then he made his offer," Stephen Jennings, the founder of Renaissance Capital told bne at the time. "Keep what you have, but stop the stealing."

Putin followed this by effectively disbanding the Federation Council, the upper house of parliament, which was stuffed full of oligarch proxies who lobbied for their interests and state contracts. But the international press ignored the obvious corruption and focused instead on the fact the deputies had been elected: Putin may have broken the boyar hold on power and retaken control of the political process, but he left his democratic credentials in tatters.

Now Putin has done it again. Russia has made astonishing progress over the past decade and a half and is today more-orless a normal country. However, with the de-facto annexation of Crimea Putin has destroyed what little international credibility he has built up in recent years.

Behind the headlines about the crisis in the Crimea stands a spectrum of fears: Putin is Stalin and wants to rebuild the Soviet Union; Putin is Hitler and wants

to conquer Europe; Putin is corrupt and wants to steal assets in other countries; Putin is the Party Chairman and wants to right Cold War wrongs; Putin is a macho, homophobic murderer and is just plain evil. But clearly none of these descriptions is complete, although there is probably some truth in all of them.

Politico magazine summed up the West's confusion in an op-ed that asked: "Why are we so utterly perplexed by Vladimir Putin?"

Everyone was expecting Russia to impose economic pain on Ukraine if it chose to go down the European path, but Putin's decision to use force was a shock.

However, the even bigger shock was the West's realisation that there is almost nothing it can do to stop or punish him.

The Russian president has totally wrongfooted everyone and left the press corps once more asking the question: "Who is Vladimir Putin?"

Honeymoon The Chinese general Sun Tzu advised, "know your enemy." So putting aside the rights and wrongs for a moment, try to see the world through the Kremlin's prism to understand how the world finds itself in this mess.

Putin's first term as president got off to a very good start. His first trip in 2000 was to the UK, which culminated in him standing on the floor of the House of Commons with then prime minister Tony Blair to announce the creation of the TNK-BP oil joint

Relations with Washington were excellent too. George W. Bush visited Moscow in 2001 and famously saw Putin's soul. Journalist Ron Fournier asked the US president if he could trust Putin at a subsequent press conference. "Yes," Bush replied, before allowing Putin to answer a separate question. A few minutes later, the US president elaborated: "I looked the man in the eye. I found him to be very straightforward and trustworthy.

We had a very good dialogue. I was able to get a sense of his soul, a man deeply committed to his country and the best interests of his country," Bush said, adding a few sentences later, "I wouldn't have invited him to my ranch if I didn't trust him."

In those early days Putin was trying hard to build a strong, working relationship with the West, even to the point of joining both the EU and Nato.

Putin's former economics adviser Andrei Illarionov told Ukrainskaya Pravda in October 2013: "Putin's personal conviction was that for Russia the most secure and comfortable place would be membership of the western alliance," Illarianov said. "Putin said on several occasions that he wanted Russia to join Nato – both privately and in public. For one and a half years this was Russia's official position."

Putin also secretly knocked on the EU's door, according to reports at the time.

"A few weeks ago, when President

"Putin said on several occasions that he wanted Russia to join Nato" venture – amazingly a straight 50-50 split that caused so much trouble later on. "Russian-British relations have never been so good," a British diplomat gushed to bne at the time.

Putin's visit to Brussels was prepared, his officials asked me what I thought of a possible Russian accession to the Union," then EU president Romano Prodi told Dutch paper De Volkskrant

10

I Cover story

in 2002. "There had been a poll that showed that more than 50% of Russians favoured joining the EU. When President Putin was visiting us, he asked again.

I immediately made clear to him, no, you're too big."

It was the first of several slaps in the face that Putin would receive at the hands of the EU. The honeymoon ended in tears following the arrest and eventual jailing of Yukos' owner Mikhail Khodorkovsky in 2003. You can draw a straight line in the downward trajectory of relations from the storming of Khodorkovsky's plane on the tarmac of

bne April 2014

Yeltsin," writes Stephen Cohen, the veteran Russian scholar at New York University, in his book "Soviet Fates and Lost Alternatives: From Stalinism to the New Cold War". "The Clinton administration adopted an aggressive triumphalist approach to Moscow. That administration tried to dictate Russia's post-Communist development and to turn it into a US client state."

Under Yeltsin, the golden rule was never to listen to what any politician said, but to watch carefully what they did. That changed with Putin, who was arguably the first Russian politician in

"The secret to politics is to make a good treaty with Russia"

Novosibirsk's airport in October 2003 to the annexation of Crimea in March 2014.

The other man's shoes Two themes run through the souring of the relationship between Russia and the West. The first is the latter's refusal to countenance Russia's interests, and the second is its failure to encourage and develop economic ties based on anything deeper than commodities.

It didn’t used to be like that. The West seems to have forgotten the advice of Germany's greatest politician and the newly minted country's first prime minister, Otto von Bismarck: "The secret to politics is to make a good treaty with Russia."

Russia's interests were easy to ignore in the 1990s when the country was on its knees. Yeltsin's administration was living hand-to-mouth on International Monetary Fund (IMF) cash. Putin, who was brought into the administration of Yeltsin in 1996, had a ringside seat to the chaos and the US policymakers' riding roughshod over the Kremlin's wishes. "The White House got used to pushing the Kremlin around under

the post-Soviet era who actually tried to do what he said he was going to do.

Looking back over the last decade, he has consistently stuck to the same message: Russia is back as a world power (albeit still slightly wobbly on its feet) and the rest of the world needs to take its interests into account. As British statesman Lord Palmerston once said: "Nations have no permanent friends or allies. They only have permanent interests." The invasion of Crimea is borne out of Putin's frustration with the rest of the world's refusal to listen to him.

"Russia strived to engage in dialogue with our colleagues in the West. We are constantly proposing cooperation on all key issues... But we saw no reciprocal steps," Putin said in what is already being called an historic speech on March 18 that announced the annexation of Crimea. "On the contrary, they have lied to us many times, made decisions behind our backs, placed us before an accomplished fact. This happened with Nato's expansion to the east, as well as the deployment of military infrastructure at our borders. They kept telling us the same thing: 'Well, this does not concern you'."

Throwing down the gauntlet Putin has been warning that Russia was getting fed up wth being side-lined for years. In his famous Munich speech in 2007, he claimed Nato had promised not to move up to Russia's borders, though in the meantime Bulgaria, Slovakia, Slovenia, Romania, Estonia, Lithuania and Latvia were all admitted into the alliance. Now there is talk of adding Georgia and maybe even Ukraine. "This is a provocation," Putin said in 2007, "yet we have done nothing in response."

The Bush administration made things even worse by first rolling back the 1972 Anti-Ballistic Missile Treaty, "which Moscow regarded as the lynchpin of its nuclear security," says Professor Cohen, and then insisting on building a missile defence system in countries like Poland.

Despite Russia's vigorous protestations and even the offer to use a Russian base in the Mediterranean (that is a lot closer to North Korea than Poland), Washington has simply brushed aside Moscow's complaints.

The election of the more westernfriendly Dmitry Medvedev as president in 2008 was another opportunity to make a fresh start, but US President Barack Obama arguably fluffed his own "reset" by sticking to the same policies of containment. "The Obama administration is squandering the third opportunity to 'reset' by refusing to respond to Moscow's concessions on Afghanistan and Iran with reciprocal agreements on Russia's top priorities, Nato expansion and missile defense," says Professor Cohen.

When Medvedev went to Europe on his first overseas trip in 2008 with a proposal to enshrine the "reset" in a badly needed new European Security Treaty, the idea was politely ignored, according to bne's sources.

Exactly the same thing has been happening in business. The Kremlin was hoping to use its newfound petro-wealth to buy western technology to help modernise its own knackered industrial base. Instead, it was shut out of several strategic deals.

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Germany's state president of Bavaria, Edmund Stoiber, baldly told Putin that the Germans would never sell Russia stakes in sensitive European industries after Russia bid for more shares in the European aviation giant EADS in October 2006. "I asked him to understand that in some strategic industries there are limits to taking reciprocal stakes," Stoiber said at the time. "We must both respect each other's interests."

Putin saw it differently: the refusal was all about Germany's desire to remain top dog in European aviation and ensure Russia couldn’t compete. Putin was forced to do it the hard way, rebuilding the sector from scratch through the creation of the United Aviation Corporation.

The same thing happened with cars. A consortium of leading Russian banks together with Canadian parts maker Magna struck a deal to take over General Motors' struggling Opel subsidiary in November 2009. The German government killed the deal at the last moment.

By 2012, Putin was calling for the G20, which includes large emerging markets, to take over from the G8 as the main forum for discussing key issues in the global economy. "The time has come for the G20 to take on the full responsibility of effective leadership," he told the St Petersburg International Economic Forum in June 2012. "This means that the G20 should not turn into another elite club that cares only about its members. Selfishness and backroom deals do not add to stability and confidence," he added caustically.

Playing domestic politics Russia and the West are speaking different languages. Putin, like any politician, needs to play to the gallery, but as Russia was behind the Iron Curtain in the 1960s-1970s it missed out on the liberal revolution and western values remain alien. Putin is ridiculed in the West for riding about on horses with his top off, but it goes down well with his core blue-collar supporters. Russians are still new to the

Cover story

voting game and let's just say they are not the most sophisticated electorate in the world.

Putin was roasted for the so-called "gay propaganda" law, but numerous surveys show that some three-quarters of Russians agree with it and see homosexuality as a "sickness" or "perversion." Likewise, the punk rock group Pussy Riot has been held up in the western world as dissident heroes, but 80% of Russians are Orthodox Christians and were genuinely shocked by the band's "desecration" of the altar in the Moscow cathedral.

Putin's decision to annex Crimea has been immensely popular at home.

His rating immediately skyrocketed to an all-time high of 75% even as the economy is sinking. At a stroke he has restored Russia's sense of pride after 20 years of shame: the independent Levada Centre found 63% of respondents said modern Russia has regained the status

I 11

Programme upgraded Russia to the "high income" category – putting it into the same bracket as the likes of the UK and the US. But the West continues to treat Russia as a helpless economic basket-case.

The EU's attempt to "take in" Ukraine, in the sense that a deal with the EU explicitly excludes a deal to join Russia's Customs Union, was a bridge too far. Ukraine shares over 1,000 years of cultural, historic and ethnic ties with Russia, while Russia has major economic and strategic interests in Ukraine, most importantly the Druzhba gas export pipeline that runs through Ukraine and carries half of all Russian gas exports to its customers in Europe, and the Crimean base of Russia's Black Sea fleet.

Neither side can claim the moral high ground. The Crimean "independence referendum" was rushed through as fast as the decision by the interim Ukrainian

"The Clinton administration tried to dictate Russia's post-Communist development and to turn it into a US client state" of a superpower, the highest level in the history of the poll.

And the side effect of this groundswell in patriotic fervour is the opposition movement has been side-lined; only one opposition leader, Ilya Ponomarev, voted against the annexation of the Crimea. Putin appears to have recaptured the political initiative that he lost following the street protests of December 2011.

Russia is back What the West has lost sight of is Russia has more-or-less recovered from the collapse of the Soviet Union. Average income levels have overtaken those of Portugal, and Russians are by far the richest population of any emerging market; last year the UN Development

government to sign the EU's Association Agreement a little over a week later.

The dispute between the two sides has long ago turned into a straightforward slugfest of raw geopolitical power. The surprise is that Russia has become a geopolitically significant country again and decided to use some of this power – but that is exactly the point Putin has been trying to make all along.

12

I Perspective

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Soft War Roland Nash of Verno Investment Research

A

s the conflict between Russia and the West for influence in Ukraine unfolded, finance has found itself in the unfortunate position of sitting squarely in the front line. From the acceptance by Viktor Yanukovych of a $15bn loan from Russia to the freezing of oligarch bank accounts in the US and Europe, finance has been used as a tool to push the political agenda of both sides.

The immediate consequence has been a fall in the value of Russian assets, the latest of many that have plagued Russia over the last 20 years. If a market correction is the only impact, recent weeks will prove little more than another example of how Russian markets have a tendency to overreact to newsflow. But there could well be a more far reaching impact – and perhaps with rather different consequences than those intended by the US and EU. In the 14 years that Vladimir Putin has dominated Russian politics, arguably the biggest threat to his authority was the 2008 financial crisis. By suddenly facing the removal of access to financing, Russian businesses and the elites that controlled them found they were unable to meet obligations – not just to the West, but to each other, the Russian public and the Russian government. The equity market lost a $1 trillion in value in the space of three months, western banks threatened to take control of Russian industry in lieu of debts, and the economy declined by 8% in 2009 – the biggest recession of any major country globally. While Putin had created a highly successful power-vertical in Russia, it transpired the whole edifice of the Russian economy could be threatened by what was little more than collateral damage from decisions taken in the US and Europe to support their own economies.

By the same token, the crisis also demonstrated the soft power of western finance in Russia. It is one of the great ironies of Russia’s post-Soviet experience that one of the events that did most to restore the influence of the state across the Commonwealth of Independent States (CIS) was a financial crisis in the West. With the removal of sources of external private finance, businesses, banks, oligarchs and even governments had no choice but to turn to the Russian state for liquidity. Into the vacuum left by western finance walked the only entity that had been saving during the 10-year post 1998 economic boom, the Russian state. Through Sberbank, VTB and VEB, the state provided liquidity and in return gained influence.

The experience of 2008 was a lesson that appears to have been learned by both the West and Russia. From the western standpoint, finance has been chosen as one of the few mechanisms available to apply pressure on Russia in response to events in Crimea. Targeted asset freezes and restricting certain Russian companies' access to finance are measures that appear to be viewed as a surgical way of directly pressuring those making decisions related to Ukraine. Rumours of the threat of wider sanctions abound, with the effect of artificially creating the circumstances that so impacted Russian economic stability in 2008. Actual concrete decisions are not always necessary – rumour alone can be highly destructive.

From the Russian standpoint, just as the lesson from 1998 was not to let government finances ever become over-exposed to the West, so the lesson in 2008 was to limit private sector exposure. Companies and banks have been encouraged to increase domestic borrowing and decrease reliance on the West. Oligarchs have been far more reluctant to leverage their individual holdings through western banks. From a policy standpoint, the Central Bank of Russia has floated the ruble and the Kremlin has been vocal about its awkwardly titled policy of “de-offshorization”.

Both sides are manoeuvring. Russian stocks are particularly vulnerable to geopolitics because so much of the free float is owned by foreigners, creating the opportunity for considerable value destruction if holders become nervous of deteriorating politics. Of the 18% fall in the equity market so far in 2014, at least half can be directly attributable to the impact of events in Ukraine, which would imply a $60bn cost to Russia.

But equally, a collapse in Russian valuations hurts foreign funds disproportionately because they own so much of the market. Indeed, Russian corporates are looking at lower valuations as an opportunity to buy back their stock from foreign holders. A similar trend is underway in debt markets.

Companies that borrowed in western financial markets at 5% are now able to buy back their debt at yields several hundred basis points higher.

In Ukraine itself, finance is likely to play a key role as military tensions subside. The West’s arsenal of multilateral lenders is likely to be deployed to prop up the Ukrainian economy and persuade of the advantages of looking west. In Crimea,

Perspective I 13

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Russia is likely to want to illustrate the merits of stronger ties with the homeland and, given the smaller scale of the project and the relative priority of policy, could well prove to be the more successful.

In the longer term, the costs to Russia are likely to prove more substantive. Partly this will reflect a lower availability of financing at a time when Russia needs to be investing. But it's the quality of financing rather than the quantity that may have the bigger impact. Russia is only capital constrained because such a large proportion of domestic savings are exported abroad. Financial markets are global, and if the West is not prepared for political reasons to provide financing, then other sources are likely to take advantage of any improved economics. Organizations like the Russian Direct Investment Fund have already proved successful at both raising and deploying institutional funds in Russia. But if, as is likely, capital deployment in the absence of the West involves greater state involvement, then there could well prove to be an

Punish and be damned

efficiency loss that will cost Russia over the longer term.

From the West's standpoint, financial engagement has been one of the major successes of the integration of Russia into the global economy since the break-up of the Soviet Union.

Incentivizing Russian organizations to adopt the standards and the disciplines that most effectively ensure access to western finance encourages many of the trends that the West should, in their own interests, be working to achieve. Disincentivizing western finance from engaging with Russia may indeed damage Russian growth, but it will also undermine some of the most encouraging trends of the last decade.

There is a feeling in Moscow that the model of finance that has developed in Russia over the last 20 years may have been permanently changed by the reaction to events in Ukraine.

This, like other crises before it, will undoubtedly create opportunities for capital deployment. But it may also change attitudes that will have unintended costs for both sides.

Country

Support for

% of total gas

tougher sanctions

consumption from

on Russia

Russian imports*

Austria

Reluctant

52

Belgium

Supportive

43

Bulgaria

Supportive, but big differences

100

among parties

CHART:

B

eyond the initial slaps on Moscow's wrist, Europeans are increasingly divided over how far to extend sanctions on Russia for its annexation of Crimea.

This month's chart, put together by Carnegie Europe, shows the attitudes of the 28 EU member states toward tougher sanctions on Russia. It also shows the percentage of each country’s natural gas consumption that comes from Russian imports.

As the table shows, the further east one goes, the longer the shadow of Russia, and the louder the calls for Moscow's power to be reined in – despite the greater dependence on its gas.

Bulgaria, the Baltic states and Sweden rely on Russian gas for 100% of their needs yet are the most strident in calling for more sanctions.

Sources: Carnegie Europe, BP Statistical Review of World Energy 2013, Eurogas, Eurostat.

Croatia

Reluctant

Cyprus

Very reluctant

37 0

Czech Republic

Reluctant but will support

80

Denmark

Supportive

0

Estonia

Supportive

100

Finland

Reluctant

100

France

Reluctant

17

Germany

Reluctant but will support

40

Greece

Very reluctant

55

Hungary

Very reluctant

50

Ireland

Supportive

0

Italy

Reluctant

20

Latvia

Supportive

100

Lithuania

Supportive

100

Luxembourg

Supportive

28

Malta

Reluctant

0

The Netherlands

Reluctant

6

Poland

Supportive

52

Portugal

Reluctant

0

Romania

Supportive

24

Slovakia

Reluctant but will support

63

Slovenia

Reluctant but will support

57

Spain

Reluctant

0

Sweden

Supportive

100

United Kingdom

Reluctant

0

14

I Eastern Europe

bne April 2014

The cost of Crimea Ben Aris in Moscow

T

he West is threatening further sanctions now Russia has formalised the annexation of Crimea. There is no need. The crisis has already cost Russia $187bn so far and almost certainly wrecked any chance of economic growth this year. The impact of the crisis could do roughly $440bn worth of damage over the whole year – and that is before the West inflicts a single cent's worth of sanctions, according to bne's (very rough) estimates.

Russian President Vladimir Putin's decision to send in the army to Crimea is a massive own goal as far as Russia's economy is concerned. This was the year Russia was supposed to emerge from the aftermath of the 2008 crisis and grow by up to 3.5%. However, it was obvious

even before the first squaddie climbed into a truck that intervening in Ukraine militarily was going to not only cost a lot of money, but also do enormous economic damage to the already fragile investment climate.

will be incurred over the rest of the year.

While a lot of the estimates are wide open to debate, it is still clear that Russia has inflicted more economic damage on itself than the West could ever hope to achieve with Iran-style punitive sanctions.

"Regardless of the West's response to the Crimean crisis, the economic damage to Russia will be vast. First, there are the direct costs of military operations and of supporting the Crimean regime and its woefully inefficient economy (which has been heavily subsidized by Ukraine's government for years)," exiled Russian economist Sergei Guriev said in a recent article.

The cost so far As Russian troops appeared on the streets of eastern Europe's favourite holiday resort in February, Russia's stock market tanked, losing 15% in a day and wiping an estimated $55bn off the market capitalization at the shaky stroke of a pen. While most pundits were expecting Russia to cancel its $15bn bailout deal for Ukraine and possibly some economic retaliation after the Maidan government took over in Kyiv, no one was expecting the display of force. Running total: $55bn

In this piece, bne attempts to tot up some of the costs already incurred by the Crimean crisis and ''guestimate'' costs that

Eastern Europe I 15

bne April 2014

Equity investors were already unsettled by emerging market uncertainties, with $130m leaving in the week before the Crimean crisis alone, according to Emerging Market Value Portfolio.

But redemptions have probably since accelerated: Let's call it a round $1bn for the whole year to date of redemptions from funds. Running total: $56bn

been under pressure for months. The population were converting rubles to dollars at a record pace in December – about $2bn a month, or a total of $6bn since the New Year, but that too accelerated in March: the CBR was forced to spend $11bn on trying to prop the ruble up in the last month. Running total: $117bn

The same collywobbles will also have accelerated capital flight, which the Central Bank of Russia (CBR) was hoping would slow this year. An estimated $17bn left the country in

And the loss of this money to the economy was before Russia spent a penny on actually running its military campaign, currently estimated to have cost $50bn-70bn – more than it cost

Putin is well aware of the cost of taking on crappy regions: after taking over Abkhazia, a breakaway region of Georgia, Russian grants have now made up 70% of the region's budget for several years – and half of that was stolen by the local elites, according to reports. Crimea is unlikely to be different. Running total: $190bn

"Regardless of the West's response to the Crimean crisis, the economic damage to Russia will be vast" January according to the authorities – the same amount as that month a year ago – but Renaissance Capital's chief economist, Charles Robinson, estimates $50bn has already left in the first quarter of this year. Running total: $106bn The side effect of capital flight is to continue to push the ruble's value down, which fell 10% on the start of hostilities.

Russians were already beginning to panic in December as the ruble has

The most obvious direct cost to the Kremlin of taking over Crimea is Russia is going to have to pay to keep the region going. The Kremlin has already sent a reported $440m in cash to tide Crimea over, but an article in Vedomosti put the annual cost of subsidies, pension payments etc. at $3bn a year.

However, the cost of running Crimea is the least of the Kremlin's worries.

Once the dust literally settles, attention will inevitably turn to the dire state of Ukraine's economy: the country is bankrupt and on the verge of collapse.

It needs billions of dollars of aid keep it running.

to put on the Sochi Olympics. With an estimated 60,000 Russian soldiers massed on the Ukrainian border, that number is climbing daily. Running total: $187bn Rest of this year That bill is only the tip of the iceberg.

Even if a deal with the EU and Maidan government were signed today, the cost from the shock Putin has given the West is going to reverberate all year, if not longer.

Some of Russia's largest banks are exposed to Ukrainian risk directly and via their subsidiaries to the tune of $30bn, according to estimates by Moody's Investors Service. More than half of these exposures ($17.4bn) are via subsidiaries of Russian banks and some or all of this could be lost if the banking sector collapses. Indeed, if the EU "takes" Ukraine, it is not unlikely that Russia will precipitate a collapse on purpose.

Running total: $223bn

Major Subsidiaries of Russian Banks in Ukraine Subsidiary Bank

Prominvestbank

Parent

Vnesheconombank

Subsidiary's Rating

Caa3 negative,

Subsidiary Banks' Total

Subsidiary Banks'

Subsidiary Banks'

Assets, Third-Quarter

Assets as Percent

Assets as Percent

2013, $ Millions

of Group Assets

of Group Equity

$4,849

4.88%

25.45%

$4,046

0.79%

7.30%

$3,506

1.34%

12.71%

E/caa2 stable Subsidiary Bank Seberbank

Sberbank

of Russia VTB Bank PJSC

Caa3 negative, E/caa2 stable

Bank VTB

Unrated

Source: National Bank of Ukraine, OANDA and the banks

16

I Eastern Europe

Almost as much money as left Russia in all of last year ($63bn) had already fled by the end of March and the CBR spent a total $30bn in 2013 defending the currency. This year capital flight is expected to soar to $130bn, says Goldman Sachs, which means the CBR will probably have to double its interventions to some $60bn to keep some sort of currency stability.

"The Achilles' heel of the Russian economy remains the flow abroad of Russian capital following any shock.

We would also think that any sanctions or even the threat of sanctions will be ultimately targeted at these flows," Goldman said in a note. Running total: $283bn Capital flight will only pull the weakening ruble down further, which in turn increases the costs to the budget.

The ruble has already fallen by 10% this year, but Renaissance Capital estimates that a further fall in the ruble's value this year will add another $10bn to the government's costs. Running total: $293bn The incursion into Crimea was as much a shock to Russia's business leaders as it was to the politicians in Brussels and Washington, and is bound to hurt domestic investment. Russia desperately needs fixed investment to rise if it is to have any chance of economic growth this year, but investment had already stalled by last year. Now there is talk of war, Russia's business captains are even

bne April 2014

Russia attracted a whopping $94bn of foreign direct investment (FDI) in 2013, making Russia the third largest recipient of FDI in the world, according to a February ranking by the UNCTAD, although a big chunk of that was part of the TNK-BP/Rosneft deal. But if Russian investors are unnerved, can you imagine how the foreign investors feel? By the middle of March several big deals were already looking shaky.

Again, it is impossible to measure just how many deals-that-might-have-been are now on ice, but some high-profile joint ventures are already in trouble.

Swedish car producer Volvo said in March it was taking a second look at a proposed partnership with Russian state-owned railway equipment and tank maker Uralvagonzavod (UVZ) to make modern armoured cars due to the situation in Ukraine, a deal worth about $100m.

Separately, state-owned oil major Rosneft signed a binding deal to sell its oil-trading arm to Morgan Stanley in December for hundreds of millions of dollars. That deal is now in doubt and may be nixed by the US Foreign Investments Committee.

Assuming a modest 20% contraction in FDI against last year, that would wipe out another $19bn of money lost to the economy.

"A significant decline in FDI – which brings not only money but also modern

"Denying Russian banks and firms access to the US banking system would have a devastating impact" less likely to invest than before. Fixed investment into the Russian economy totalled RUB2.33 trillion ($77.76bn) in 2013, but Bank of America Merrill Lynch forecasts that investments in fixed capital will decrease 3.3% as of the end of 2014, or by about $2.33bn.

Running total: $295bn

technology and managerial skills – would hit Russia's long-term economic growth hard. And denying Russian banks and firms access to the US (and possibly European) banking system – the harshest sanction applied to Iran – would have a devastating impact," says Guriev. Running total: $314bn

The stock market has already been hit, but it could be hit again if its performance in recent years is anything to go by: the RTS index was down by 72.4% in 2008, 21.9% in 2011 and 6.8% in 2013 on crisis-related fears.

Predictions for this year's gains were already modest, but there is a very real chance that Russian stocks will return a loss instead. Assuming a modest 5% year-on-year fall for the full year, that would destroy another $50bn of market capitalization. Running total: $364bn Even if the market remains flat, collateral damage could be a string of IPOs that were on the docket, but are now almost certainly going to be cancelled. Regional shoe retailer Obuv Rossii has already postponed its $55m IPO until the second half of the year (if then) due to the brouhaha. And the IPO plans of much larger companies are in doubt: retailer Lenta, childrens' store Detski Mir, German wholesaler Metro and retail bank Credit Bank of Moscow were all also hoping to get IPOs away this year (and raise $1bn, $440m, €1.7bn and $500m respectively), collectively worth $4bn. Running total: $368bn And those are just the privately owned companies with listing aspirations; the state was hoping to restart its longdelayed privatisation programme in the second half of this year, after an IPO window opened briefly in the second half of last year. Fat chance that foreign investors will fork out billions of dollars for shares in state-owned enterprises now. Given state-owned Sberbank raised just over $5bn last year with a secondary public offering, pencil in the same this year for the non-privatisation programme. Running total: $373bn The bogeyman of financial sanctions has been raised as a possible punitive reaction by the West against Russia's aggression in Ukraine, but actually it is highly unlikely because western banks are so heavily exposed to Russia: according to Bank of International Settlements (BIS) data, European banks have $193.8bn in exposure to Russia, US banks $35.2bn, Japan $17.2bn, Switzerland $8bn, and South Korea $5.2bn. If the West tries to freeze

bne April 2014

Eastern Europe

I 17

repayment burden caused by the ruble depreciation," Moody's said in a report, without putting any actual numbers on the cost. Let's call it another $5bn.

Running total: $433bn

Russian assets abroad, Russia could easily retaliate by refusing to pay these debts back.

at due to the rise in yields caused by the crisis could add at least another $3bn.

Running total: $411bn

Likewise, oil and gas majors Rosneft and Gazprom owe a combined $90bn in debt and bonds with four state banks Sberbank, VTB, VEB, Rosselkhozbank owing another $60bn in foreign credits.

A Kremlin aide has already warned that if financial sanctions are imposed on Russia, these institutions might refuse to pay their loans off.

The spillover from the crisis is also going to hurt the banking sector and cost it money in the form of the need for higher capital and an increase in bad debt. According to bankers in Moscow, corporate non-performing loans are already rising and lending will slow even

But where Russia will be hurt, even without sanctions, is with bond issues.

Russia's sovereign external debt is very modest indeed, but its external commercial debt has soared in recent years (although the maturities now are a lot longer than they were in 2008): Russia's total external debt rose to $732bn as of January 1, 2014, from $636bn a year earlier and $464bn at the start of 2008, according to the CBR, with the bulk of new debt raised by Russian state companies.

"Trade sanctions can be ruled out because Russia carries a very big stick in any trade war"

Although state-owned Gazprom Neft got a $2.5bn syndicated loan deal away in the middle of March, largely financed by a club of European and US banks, plans by another 10 big Russian companies to raise $8bn in loans this month are reportedly in difficulty now. Running total: $396bn At the same time, the cost of these bonds has already increased significantly.

Last year saw a boom in Russian bond issues when yields fell to about the 4% for state and quasi-state issues, but the rates have more-or-less doubled on the government's OFZ in recent months, which broke through 9% earlier this month.

Again it is very hard to guess the value of bonds-that-might-have-been. But given Russian corporates were adding approximately $60bn of debt a year over the last five years, and again assuming a modest 20% reduction in bond issues, the value of bonds that won't be issued will be in the order of $12bn.

Likewise, making a guestimate of the extra cost this borrowing will come in

further: Fitch says that Tier 1 capital could be reduced by up to 2%, which would be worth $12bn. Running total: $423bn Bad loan levels were already accelerating on the back of the economic slowdown, but that problem will get even worse now.

"In light of the potential economic slowdown, we expect nonperforming loans (NPLs) in the system to increase.

Our base-case forecast estimates a system-wide NPL ratio of 8.0%-8.5% this year, and could go higher if the current volatility persists," says Moody's.

The National Collection Service estimates total bad loans have reached about RUB435bn ($12.8bn). And if this only increases by the same 40% that it grew last year, it will be another $5bn lost to the economy. Running total: $428bn Corporate loans will also be affected.

"There is a risk that the currency devaluation will exacerbate negative asset quality trends in foreign currency loans, which we estimate constitute around 17% of the total loan book and are mainly concentrated in corporates.

Approximately 50% of these loans are to borrowers that do not have matching foreign currency cash flows and they would need to absorb the increased

Ironically, trade is probably one area that will be least affected. Indeed, it is the heavy trade flow between Russia and Europe that makes the European powers like Germany so reluctant to

slap sanctions on Russia. About half of Russia's exports go to Europe, but only 3% to the US. Conversely, only 7% of Europe's exports go to Russia (and next to no US exports). But in money terms, the EU exports more to Russia ($264bn) than Russia to the EU ($152bn). The upshot is trade sanctions can be ruled out because Russia carries a very big stick in any trade war.

Whatever happens next, the crisis has already ruined Russia’s chances for economic recovery this year. Last year Russia put in a very disappointing 1.4% growth but analysts were hoping this year would be better, predicting between 2% and 3.5% growth for the full year.

The recovery that should have come last year would arrive this year. Not any more. Goldman Sachs, among many, downgraded Russia’s growth outlook to 1% at best on March 14. Other analysts are speculating the economy may even contract this year. A 0.5% contraction would destroy another $10bn of value.

Total: $443bn.

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events in Ukraine, calling the arrest "a misunderstanding" to be "resolved in the very near term".

First Firtash, next…who?

Graham Stack in Sevastopol

T

he arrest of controversial Ukrainian oligarch Dmytro Firtash in Austria for extradition to the US has sent shockwaves through Ukraine and internationally. The man who for years personified the nontransparency of Ukraine's gas trade may be able to deliver US investigators valuable material for further cases if he cooperates, including perhaps ties to top Russian figures.

Under the terms of a mutual legal assistance act with the US, Austria's Federal Crime Agency said March 13 that Firtash was arrested in Vienna the previous day on charges brought by the Federal Bureau of Investigation.

"As a result of the FBI's years' long investigation and warrant issued by a US district court, Vienna's district attorney issued a nationwide arrest order against the businessman," said a press officer for Austria's Federal Criminal Police Office.

The FBI is charging him with bribery and formation of a criminal association.

Austrian police further specified that the FBI has been investigating Firtash since 2006. The arrest was performed

by Austria's heavily armed special

police unit Cobra, but no resistance was offered.

On March 21, a Vienna court said it had released Firtash on €125m bail. An Austrian court is now deciding whether grounds for extradition to the US exist, for which no specific time frame is defined.

No details have been released as to the specific offences for which the US is seeking Firtash's extradition. According to a statement from Firtash's Group

But the arrest in Austria may be the thin end of the wedge, leading to lengthy jail time in the US. Experts referred to the arrest of former Ukraine prime minister Pavlo Lazarenko in connection with his gas trading activities in Switzerland 1999. Lazarenko remained in jail until the end of 2012. "At first Lazarenko did not believe that it was serious," says Ukrainskaya Pravda journalist Serhiy Leschenko, who has written a book on the Lazarenko case. "But if it is an FBI request for arrest, then it is not a 'small misunderstanding' – it is very serious – so I would advise Firtash to seek a plea bargain with US investigators and to give up to them everyone he can."

Indeed, the Lazarenko case helped the FBI build up expertise relating to Ukraine's corrupt gas intermediaries, strengthening the case against Firtash, said a bne expert source in Washington DC. Murky gas trade Firtash's arrest is being seen as a US blow against Russia in connection with the current international crisis in Ukraine. Firtash first came to the FBI's attention in 2005-2006, due to the activities of murky gas trade Rosukrenergo, which imported cheap gas from Turkmenistan to Ukraine via pipelines owned by Russia's Gazprom.

Later Firtash acknowledged ownership

"Being linked with Mogilevich, a man who has acquired almost mythic status in US perspectives on Russian organised crime, was a major strike against Firtash"

DF quoted by Ukrainskaya Pravda, the arrest is connected to "an investment project in India in 2006 in which Firtash was involved." The statement denied any connection with current

of 50% of Rosukrenergo, together with business partner Ivan Fursin, with Gazprom owning the other 50%.

The huge profits on the trade came from Firtash being allowed to export

bne April 2014

some of the cheap Turkmen gas to the European market for several times the price, according to a report by the NGO Global Witness on the gas trade from 2006.

The gas intermediary business between Turkmenistan and Ukraine was traditionally closely linked to both organized crime and top political offices in Ukraine. At the country's birth in the 1990s, the gas trade prominently featured former prime minister Lazarenko and his associate Yulia Tymoshenko, and was regarded as being protected by Ukraine-born alleged mobster Semen Mogilevich, currently resident in Moscow. After Lazarenko's arrest by the US and the destruction of his business empire at the end of the 1990s, the gas intermediary business passed into hands of businessmen close to then president Leonid Kuchma. After Kuchma left power in 2004, it appears to have been largely monopolized by structures of Firtash, who has close documented links to Mogilevich, including co-ownership of offshores with a wife of Mogilevich. In a leaked US diplomatic cable dating back to 2007, Firtash acknowledged to the US ambassador to Ukraine that he had needed Mogilevich's protection to get his start in business. Firtash later denied making such comments.

Anti-Putin move?

International interest is focusing on Firtash's Russian links, given the current Russian occupation of Crimea and the threats of US countermeasures.

There is an assumption in the West that the gas trade did not just bring huge illegal revenues to top figures in Ukraine, but also to officials at Gazprom and the Kremlin, including even Russian President Vladimir Putin. According to a report on Firtash' gas business from 2006 by Global Witness: "Gazprom has let this lucrative role be taken over by the intermediary companies, some of whom were paid in Turkmen gas which they resold in Europe for up to fourtimes the price. Why would Gazprom, in effect, give up these lucrative markets and their profits to potential competitors?"

Eastern Europe

But whether there is a political component in the timing of Firtash's arrest is unclear. Firtash, a western Ukrainian, has never openly been a pillar of support for the Kremlin in Ukraine, although his TV channel Inter has been. Moreover, Firtash was in conflict with then prime minister Yulia Tymoshenko over the gas price deal she struck with the Kremlin in January 2009, which saw his intermediary business Rosukrenergo removed from the gas trade, and has constantly sought for the Ukraine-Russia gas deal to be overturned. He accused Tymoshenko of being a Kremlin agent, and is believed to have been a driving force behind her jailing in 2011 for having signed the gas agreement with Russia, allegedly without full powers to do so. Tymoshenko was only released from jail on February 22 following Yanukovych's flight from the capital.

The move is indeed likely to further impact in the short term on the already stricken Ukrainian economy, due to Firtash's huge portfolio of assets in Ukraine, consolidated in the sprawling Austria-based Group DF holding. Firtash has all but monopolized Ukraine's chemicals industry, titanium production and regional gas distribution networks; he owns two top-20 banks, Nadra and Pravex, as well as Ukraine's most influential TV station Inter; and has considerable real estate assets. Ownership of all these assets is now up for grabs, and the fighting will not be pretty.

Firtash may have been simply easy pickings for the FBI looking to exploit the political climate that is turning against post-Soviet oligarchs in bed with corrupt and repressive regimes. "Being linked with Mogilevich, a man who has acquired almost mythic status in many US government perspectives on Russian and Eurasian organised crime, was a major strike against him," says Mark Galeotti, professor of global affairs at New York University. "He is high enough profile to be a tempting political target, even though he wasn't on the EU's list of oligarchs and major figures linked with Yanukovych's kleptocracy."

I 19

Putting stock in Putin’s speech Washington may have hated it but investors loved it. Russian President Vladimir Putin's historic speech on March 18 announcing that Crimea is part of Russia (again) sent the stock market soaring by over 10% in minutes.

“The market loved the speech because the focus was primarily on justifying the annexation of Crimea, and he appeared to play down expectations that Russia would look to 'slice n’ dice' the rest of Ukraine,” says Tim Ash, head of research at Standard Bank.

Importantly, Putin said explicitly that Russia was not in favour of the further breakup of Ukraine – a line used frequently over the past six months.

The markets have further been encouraged by the realisation that the West is essentially powerless to do anything to stop Putin. Nato has ruled out the use of force; despite its backwardness the Russian military remains a formidable force and history has proven time and time again that Russia is hard to defeat in open conflict.

That leaves soft power, but the US does little business with Russia giving them few levers, whereas Europe’s economy is so tightly bound to Russia’s that any real economic punishments would hurt European interest as much as – if not than – Russia.

Still, the damage from the fracas to the Russian economy is very serious. Economist predictions of some 3% economic growth this year have been abandoned. The best anyone is hoping for is about 1% growth and many other analysts believe there may be a recession this year. bne's own estimates put the bill for the identifiable damage by the end of March at about $187bn and estimates the total cost to Russia's economy this year could be as much as $443bn. As for the stock market: it will do well to hold its own this year.

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bne April 2014

that they are trying to so hard to put behind them.

The reason? This correspondent has on many occasions pointed out the political incorrectness of using "Kiev", but editors at most international publications universally come back with the same excuse before running a search/replace on your copy: "It's the chicken thing."

The Russian spelling of Ukraine's most famous dish is so deeply ingrained in the reading public's mind (believe editors) that almost no newspaper is willing to foist the alien looking "Kyiv" on their punters.

That could now change. In its press release of March 6 announcing the imposition of limited sanctions on Russia for its "invasion" of Ukraine, the White House used the "Kyiv" spelling of the capital's name for perhaps the first time.

Chicken Kyiv Ben Aris in Moscow

G

et used to it: from now on you will have to order Chicken Kyiv instead of Chicken Kiev, after Russia's actions in Crimea put Ukraine at the top of the West's foreign policy menu.

Ukrainians have long been irked by the international press' insistence on spelling the name of the capital "Kiev", which is a transliteration from the Cyrillic of the Russian spelling of the name.

While Ukrainian and Russian are very similar, they are two distinct languages (think Spanish vs Italian). To make matters more confusing, Ukraine has its own version of Cyrillic with a few extra letters, one of which appears in the capital's name (an "i" with an umlaut, as in the English word "naive") that doesn't exist in the Russian version of Cyrillic.

And that is where the problem comes in. Since independence in 1991, Ukraine has naturally enough reverted to Ukrainian as its official language (although Russian is still widely spoken by almost everyone). And along with that comes changing the Latin

versions of all proper names to the transliteration of their Ukrainian, not Russian versions.

On the whole, western journalists have not had a problem with this. For example, after some initial confusion, most of the press have adopted

The statement reads: "In addition, the President has signed an Executive Order that authorizes sanctions on individuals and entities responsible for activities undermining democratic processes or institutions in Ukraine; threatening the peace, security, stability, sovereignty, or territorial integrity of Ukraine; contributing to the misappropriation of state assets of Ukraine; or purporting to assert

"It's the chicken thing"

"Tymoshenko" and "Yanukovych" as the spellings of the surnames of the former prime minister and now former president's surnames, whereas the Russian transliterations of their names are "Timoshenko" and "Yanukovich" respectively.

But almost no one has made the change for the spelling of the capital. It irritates the hell out of the Ukrainians, who see it as insulting to continue to read about their capital using a spelling left over from the period of Soviet domination

governmental authority over any part of Ukraine without authorization from the Ukrainian government in Kyiv."

For close watchers of Eastern European politics, this was a watershed moment and says very clearly that the US State Department is aligning itself with the Ukrainian nationalists that mostly live in the western part of the country (and have been doing most of the complaining over the years about the spelling mistakes, as well as much of the demonstrating on Independence Square,

bne April 2014

known as Maidan). Naturally enough, the Russophile eastern regions never had much of a problem with the "Kiev" version of the name, as they both speak Russian and use the Russian version of Cyrillic.

No definite articles please Obviously someone has been boning up on their Ukrainian etiquette - and very recently too. Only last week, the US government came in for a roasting

by Maidan after Congress announced it was holding an emergency meeting to discuss the situation in "the Ukraine".

This is another PC gaffe. The use of the definite article in front of the country's name is also a throwback to the Soviet era; "the" appears in front of regions of a country, as Ukraine used to be in the Soviet era, but sovereign nations almost never use the definite article in front of their name. Ukraine abandoned its "the" in 1991. While "the Ukraine" became "Ukraine" in the European press years ago, the US press, and even the White House, continued to goof on this one regularly.

Now the Rubicon has been crossed sub-editors around the world must be throwing up their hands in despair, as there is a plethora of funny-looking Ukrainian names headed their way: Boris becomes Borys, Sergei becomes Serhiy, Alexander becomes Olexandr, and so on…

Still, if you are hungry for that chicken swimming in herb-butter, you will probably still be able to order Chicken Kiev for a while longer, as few subeditors become restauranteurs and the hospitality industry is not famous for proofreading its menus before printing.

Eastern Europe

I 21

Strange bedfellows in East Ukraine

Harriet Salem in Donetsk Crises often throw up unlikely bedfellows – and Ukraine is no exception.

As rallies continued across eastern Ukrainian cities, pitting pro-Russia supporters against Ukrainian nationalists, in the divided city of Donetsk football hooligans and the predominantly middle class and student-led prounity activists are backing the same team.

Best known for their brutal clashes against arch rivals Dynamo Kyiv and the intimidation of visiting fans during the Euro 2012 football championships, the football hooligans, or "ultras", of FC Shakhtar Donetsk are now on the frontline of a political war to save Ukraine.

Ultras across the country, from Kyiv to Donetsk and Odessa, have put aside their violent disagreements to step into the political arena for the first time as a united force. Instead of fighting one another, these ultras called a truce in January that enabled them to mobilise against a common enemy - the corrupt regime of the now ousted pro-Russian president Viktor Yanukovych. The move was unprecedented: in the past, Ukraine's notoriously violent ultras have eschewed politics. During the 2004 Orange Revolution, the Shakhtar football team even changed their kit colours from orange and black to plain black to ensure they were not associated with the Tymoshenko-led political movement in the capital.

Ilya, a Shakhtar Donetsk ultra, travelled to Kyiv as soon as he saw the violent clashes in the capital on television. There he met with football fans from across the country. "We stood together for the pride of the country," says the 25-year-old. In January Ilya spent six days on Hrushevskoho Street – just round the corner from Dynamo's football stadium – which was the epicentre of the violent clashes in the capital. There, anti-government protesters hurled Molotov cocktails and fireworks at police, who responded by spraying tear gas and rubber bullets into the crowd. "I saw great pride and bravery amongst the people in Kyiv," says Ilya. "Even old women were helping pass bricks up to the frontline." Two died in fights when law enforcement officials are alleged to have used live ammunition. Following the violence, the Euromaidan's leaders embraced the football fans' heroic efforts, reading out a long list of clubs in a message of "thanks."

Now the battle is over in the capital, the ultras have returned home to continue the crusade in their eastern hometowns, many of which contain virulent pro-Russia sentiment. Perhaps nowhere is this more the case than Donetsk, where pro-Ukrainian and pro-Russian supporters have squared up against each other repeatedly during March. Flanking the pro-Ukraine activists, who are mainly drawn from Donetsk's student population and middle-class business owners, was their new surprising ally. "We are just here to make sure that everyone gets home safely," says Ilya, one of 100 Shakhtar ultras who accompanied the demonstration one evening.

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leading online brokerages in Russia, aimed at high frequency traders, and took minority stakes in electronic procurement system B2B Center and debt collection company First Collection Bureau.

Russian funds back in the game

FUNDS:

Ben Aris in Moscow

"B

a price to earnings basis, below 4 times

by MSCI Russia index” says Vladimir Potapov, CEO at VTBC.

Private equity firm Da Vinci Capital (DVC) and financial powerhouse VTB Capital Investment Management (VTBC) both launched funds in February to attract new investors into Russia's super cheap stocks and high yielding bonds as the world slowly moves out of the 2008 crisis.

Tech and debt DVC closed the first round of fund raising for its Da Vinci PE Fund II in February, with the European Bank for Reconstruction and Development – in its only sponsoring of a private equity fund in the Commonwealth of Independent States (CIS) in 2013 – plus five global funds acting as cornerstone investors that contributed $100m. A second round is planned for April, for which Oleg Jelezko, DVC's managing partner, hopes to double that amount.

uy to the sound of cannons, sell to the sound of trumpets," Lord Nathan Rothschild said in 1810. If so, now may not be such a silly time to set up new Russian funds.

The timing may look off. Following Russian President Vladimir Putin's welcoming of Crimea as the latest addition to the Russian Federation on March 18, tensions with the West are very likely to rise further. But then investing into Russian securities has always been a rollercoaster ride.

Russian assets are certainly cheap as chips at the moment. “Russia remains very cheap vs the other emerging markets. China is slowing and banking sector asset quality is at risk. Turkey has got internal political questions.

Russia looks strong and very cheap on

DVC's first fund has a strong track record having been a key investor in the Moscow Exchange, which made a packet for its shareholders. It also invested in the software engineering firm EPAM, which has most of its operations in Belarus. It floated on the New York Stock Exchange in February 2012 and the shares have since doubled in value.

The new fund has already made three investments: it acquired a controlling 63% stake of IT-Invest, one of the

B2B Center is particularly interesting, because as Russia's largest e-procurement player it typifies the country's rapidly developing "new economy". "If Gazprom needs to buy 100,000 pairs of gloves for its workers or 1,000 computers of its offices, then it can put a tender on B2B Center and producers can bid," says Jelezko. "The company can easily set up its own tender, get bids, choose the cheapest one. It eliminates the need for faceto-face meetings, which automatically eliminates the usual kickbacks and bribes."

B2B Center remains a pioneer in the market and it is the very difficulty of working in the CIS that is a big factor in the company's success. It already has over 100,000 registered participants that are offering more than $20bn worth of tenders a year, in which companies typically save 20-30% in costs.

First Collection Bureau (FCB) is also in a particularly attractive sector. Worried by the ballooning levels of consumer lending, at the start of this year Russia's central bank (CBR) introduced strict new prudential rules that have in effect made it very costly for banks to hold bad debt on their balance sheets: the CBR now demands that banks double their provisions from 11% to 22% once a debt is more than 180 days overdue.

The debt collection business was already growing rapidly as consumer debt starts to rise, but the new rules have lead to a boom in the business.

Many banks have just sold their debt to collection agencies.

Banks sell debt at a maximum of 5-8% of face value, or less depending on how overdue the debt is. Despite their "repo man" image, much of debt agencies' work is done over the phone, trying to figure out what the debtor can afford to pay and collecting payments that can be a fraction of the original sum.

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"If someone owes RUB100,000 plus RUB70,000 in interest payment, the question is what they can actually pay," says Jelezko. "A typical deal will be to agree a repayment of RUB2,000 per month over two years, which won't even cover the principle, but it still earns the collection company a profit given the discount they bought the debt for."

VTBC already has some RUB248bn ($7.5bn) of assets under management, the vast majority of it Russian money, but the new fund is aimed at slowly bringing in more international investors. The fund has been set up with best international practices in mind and is targeting bonds in Russia and the CIS.

Jelezko says he hopes that DVC will be able to take at least one of these companies public in the next couple of years, but the global political crisis over the fate of Ukraine has made any talk of Russian IPOs difficult for the foreseeable future.

High rates and rotations The VTB Capital IM Russia & CIS Debt Fund takes an altogether different tack, concentrating on fixed income.

Local investors are still happy with the high rates that Russian bonds are yielding. Unlike most of the rest of the world, Russia's central bank has held rates high in an effort to keep a lid on inflation. Indeed, the CBR hiked rates by 150bp in early March to stave off a drop in the ruble against the dollar following the military incursion by Russian troops into Crimea. While yields remain high, there is little incentive to invest into the more volatile equities.

One of the reasons that Russian equities are so cheap, argues Potapov, is because Russian bonds are still so profitable.

The IM Russia & CIS Debt Fund is the first of a series of funds that the asset management arm of VTB Bank hopes to launch in the coming years. “There is an interest in the fixed income fund

Potapov argues that Russian equities are at the end of a process that sees investors go from developed market (DM) bonds to DM equity and then to emerging market (EM) bonds and finally to EM equity. With interest rates slashed to the bone in the developed world, at the moment the world is still

"It eliminates the need for faceto-face meetings, which eliminates the usual kickbacks"

and lots of interest by both foreign and domestic investors as it has high rates and good credit quality. The Russian sovereign Eurobond curve is trading at 150-250bp spread over its pre-Crimeancrisis levels,” says Potapov.

The fund was also launched in February and seeded with $40m, half of which was provided by a Russian anchor investor. But it is now in the process of raising more money. “We can potentially raise a couple of billion dollars. Just the fixed income market total amount outstanding is about $500bn so we are aiming for $5bn total,” says Potapov.

in the DM equity phase of this chain, but with significant investment also starting to flow into the EM bonds last year. That will change eventually.

“The big question is when is the global rotation finally going to come to emerging markets,” says Potapov, who says VTBC IM will eventually set up a Russian equity UCITS fund and other products. “There is interest in Russia but the rotation has not arrived yet."

"Inflation is still moderate and fixed income real rates are still positive, so there is no trigger for domestic investors to move into equities yet," he adds.

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A club Russia wants no part of "I would never want to be member of a club that wanted me as a member," Groucho Marx once famously quipped.

Russian Foreign Minister Sergei Lavrov adopted pretty much the same line after Russia was suspended from participating in G8 meetings and global leaders cancelled their next meeting that would've been held in Sochi.

"If our Western partners think that this G8 format is out-dated, then let it be so. At least we do not cling to this format and see no problem if it does not convene," Lavrov harrumphed on March 24.

Lavrov added Russia couldn't technically be kicked out of the G8 (currently Russia's participation is only "suspended", according to German Chancellor Angela Merkel), because it is not a formal organization but an informal grouping that meets occasionally.

Bravado aside, Russia really doesn’t care that much about the G8, as it has been hoping to sideline it and make the broader G20 the key international body. Russian President Vladimir Putin said explicitly in his keynote speech in 2012 that it was time for the G20, which includes many of the world's emerging markets, to take over the reins of global coordination, as it fits better with his concept of a "multipolar" world.

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coming cities in the emerging world like Istanbul and Dubai.

Photos Š MIPIMWorld

Moscow's bonne affaire en France BRICKS & MORTAR:

Ben Aris in Cannes

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here is growing tension between Russia and the West, but in the same week that the two sides were trading insults and threats over Crimea, the French Riviera resort of Cannes was packed with Russians chatting merrily with wealthy European investors over glasses of rosĂŠ and plates of oysters. They had come to the annual MIPIM conference, Europe's biggest real estate trade fair, where Russian opportunities were this year's special focus.

Moscow City government was out in force and a pavilion at the entrance to the conference hall held an impressive scale model of the rejuvenated Russian capital city as it will look in a decade's time, if all goes to plan.

Sergey Cheryomin, minister of the Moscow City Government and head of the Department for External Economic and International Relations, didn't seem too fazed by the international brouhaha. "The situation in Ukraine will not affect investment into Moscow's economy at all," he told bne

rather wearily, having just got off a 15-hour flight from Singapore where he was at another investment event.

"We don't have investments there. The trade with Ukraine is tiny compared with somewhere like Germany and like all these crises we have been through in

The number of European investors at MIPIM this year belies the tension in the corridors of power and most investors at MIPIM took a pragmatic view: as long as there are no sanctions on financial transactions, then Moscow will retain its appeal as one of the biggest and fastest growing cities in Europe. Too many investors have already made too much money from investing in Russian real estate to write it off yet. "The budget of the city is over $60bn and just the city procurement programme is $20bn," says the eloquent Cheryomin.

The city budget was equivalent to slightly more than a third of Ukraine's entire economy in 2013. "That creates a lot of opportunity for companies that are providing services, especially those that can modernize municipalities or transport infrastructure."

Cheryomin's task in France was to persuade investors to take a closer look at Moscow, but half a dozen other regions, such as Rostov, Chechnya, Bryansk and St Petersburg, also had stands at this year's show. Part of the pitch is to try to get investors to distinguish between Russian risk and the specifics of investment into Moscow. "There is a big perception gap between the realities of doing business in Moscow and the perceived risks," says

"There is a big perception gap between the realities of doing business in Moscow and the perceived risks" the last two decades it will eventually be resolved. But it does make our lives more difficult."

Competing cities Cheryomin has the tricky task of selling Moscow to foreign investors – tricky not because of the geopolitical situation (although that doesn't help), but because Moscow is increasingly competing with the other up-and-

Cheryomin. "The Asian investors are much more pragmatic. They barely asked about Ukraine at all, but wanted to know instead what our privatisation plans are, if we intend to issue infrastructure bonds, and so on."

Since the change of mayor in 2012, the Moscow government under Sergei Sobyanin has drawn up a new master plan to cover the next decade that will

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comprehensively transform the city.

The new mayor has already introduced initiatives like bus lanes and paid parking in the centre that has reduced traffic by 25% and Moscow's legendary traffic jams. But the main work still lies ahead.

The programme to turn Moscow into an international financial centre (IFC) is a top priority. "We are not trying to replace London or New York, but thanks to our geography there is an opportunity to fill a gap between markets in Asia and Europe.

We will start by developing capital markets for our neighbours in the CIS and Eastern Europe, and go from there," says Cheryomin.

The major change in 2013 was the Russian government's decision to expand the territory of the Moscow City region (along with St Petersburg, one of two cities in Russia to be a region in its own right) by adding a new corridor of land to the south east. "Before we had only 1000 square kilometres of land for over 12m registered inhabitants," says Cheryomin. "It created enormous problems with traffic, housing, provision of kindergartens and the rest.

Now the new territory will take some of the pressure off and also provides tremendous opportunities for foreign investors as the new region will be developed from scratch."

Thanks to the capital's predominance in the Russian economy over the last two decades, doing business in Moscow is already a lot easier than in the rest of the country. Surprisingly, contract enforcement in Russia is already strong, in the world's top 10 according to a recent survey by the World Bank, and the arbitration courts are well respected and considered fair when it comes to dispute resolution.

The arbitration courts were set up in the 1990s to rule on disputes when the legacy Soviet laws were in the process of being rewritten. A recent decision to merge the arbitration court with Russia's supreme court and house the new entity in St Petersburg will not affect the working of the Moscow Arbitration court, says Cheryomin, as the two will remain separate at a regional level. "I should not boast of this, but companies win well over half of all the cases they

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bring against the city government. The legal system has been thrashed out by use over the last years and is very reliable," says Cheryomin.

Perhaps more worryingly is the general economic malaise that has taken hold in Russia in the last year, but Cheryomin points out that the regional economy is performing far better than the rest of the country. "We are expecting growth this year of 1.7-2.0%, which is

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not booming but is more or less stable, and is still better than Russia's growth expectations," he says. "But where we are doing a lot better is on inbound investment: Moscow received $10bn of [foreign direct investment] in 2013, which was 2.4-times more than the year before. That reflects the efforts of the city to create more effective government and the international communality has vote on our success in this task with their money."

"Companies win well over half of all the cases they bring against the city government"

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How to sell a Russian region Ben Aris in Kazan

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atarstan is already one of the three best regions in Russia," says Linar Yakupov, the no-nonsense head of Tatarstan Investment Development Agency (TIDA) in his opening remarks at the "Kazan Winter Investment Summit" at then end of February. "But I don't want to talk about that. I want to talk about the challenges we still face to keep Kazan out in front."

Those remarks seem innocuous enough, but to someone doing business in Russia, especially in the regions, they are revolutionary.

Russian civil servants in general, and regional bureaucrats in particular, are still prone to the Soviet-era habit of bigging up their successes while blithely ignoring their failures, because in the old days to admit your mistakes could get you sacked – or worse...

Having attracted just under half a billion dollars of foreign direct investment (FDI) last year and building an entire automotive hub from scratch, the regional capital of Kazan has a lot to boast about.

An hour from Moscow by plane, the region is booming to the point where it is sucking in internal migrant labour from other Russian regions – including Moscow – looking for work and a better quality of life. The wages in Moscow may be higher, but then so are the prices, the stress levels, the commuting time and the level of pollution. Young families come to Kazan as the quality of life is as good if not better than Moscow, while the pay-versuscost ratio is on a par, or better, than in the capital.

"People come here to work and then decide to stay. We even have our people returning from jobs in Moscow.

There the pay is much higher but so are the costs. And if you consider the

urban nature of life in Moscow – the lack of green spaces, the length of the commute, the problems associated with bringing up children there – then all of that is easier and more pleasant in Kazan," says Yakupov.

But Yakupov chose to focus more on what was not working well; indeed, the whole summit was dedicated to "meeting the challenges of next century". His speech was a textbook example of how to sell a region to the potential investors from Malaysia, Singapore and the Arab countries that packed the hall.

Regional focus This pragmatic approach is a result of the changing nature of investment into Russia's regions. In the 1990s, regions were desperate for any cash they could find. Foreign investors were seen simply as a source of funds – officially via investment, or unofficially via bribes. But now the initial survival hurdles have been overcome and a core of foreign-owned factories are up

economic scene, the capital Moscow was already losing its pride of place before the 2008 crisis, as the regions took over as Russia’s engines of growth. The economic collapse in 2008 was a major setback, but as the world begins to emerge on the other side of that catastrophe Russia’s best regions are once again outstripping the rest of the country in their recovery.

And understanding the problems is the key. Foreign investors are well aware of Russia's attractions: the store of natural resources, the highly educated work force and large consumer population.

What investors want to know is whether they can set up a factory easily, get access to power, workers and markets, and be confident they can repatriate their profits at the end of the day.

Thanks to its Muslim nature (the city’s skyline is dominated by a shiny new mosque inside the ancient Kremlin walls), Kazan has specialized in attracting Islamic investors from Southeast Asia and the Middle East, who like the lack of politics and easy access to the administration, unlike wandering through the halls and mirrors that is doing business in Moscow.

The proof is in the investment numbers: Kazan saw FDI rise from $99m in 2011 to $577m in 2012 – though that fell back somewhat to $408m in 2013 due

"I want to talk about the challenges we still face to keep Kazan out in front" and running, regions are increasingly starting to compete in earnest to build real and vibrant local economies.

"Tatarstan is one of the most dynamically developing regions of Russia and constantly ranked at the top of doing business rankings. But in order to stay competitive we need to be constantly improving. We are not scared to compete," says Yakupov.

After two decades of dominating Russia’s

to the general slowdown in the Russian economy. "The FDI figures last year were a disappointment, but that was not a good year for Russia in general," Yakupov tells bne.

Yakupov thinks they can do better. The current FDI volume could be doubled if the entire local government can be made to pull together as one team, he says. But to go beyond that there needs to be deeper reforms at the federal level.

Eastern Europe I 27 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

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What you need to know

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Where there's Mucha, there's brass James de Candole in Prague

T

he market for expensive artworks is notoriously opaque, and a scandal is brewing in the Czech Republic over who now owns the world's largest collection of Alfonse Mucha posters that was assembled by tennis star Ivan Lendl.

Affichomania, or the craze for posters, has made Jack Rennert a rich man. The son of Austrian parents who fled Nazicontrolled Austria in 1938, Wolfgang "Jacques/Jack" Rennert arrived in the US as a small boy soon after France was liberated in 1944. Today, he is the owner of Rennert’s gallery in New York, and deals in vintage posters.

It was Rennert who built up the world’s largest collection of original Alfonse Mucha posters for his client Ivan Lendl, the former number-one tennis player originally from the Czech Republic who now lives in the US. Whenever an original Mucha poster came onto the market, Rennert would procure it for Lendl.

But sources in the Czech art market believe Lendl secretly sold the collection last year for a reputed $3.5m to a local businessman fronting for an oligarch who is at the centre of several criminal investigations for fraud.

When asked directly who owns the Lendl-Mucha collection, Rennert evades the question, stating only that it is now "under the direction of the Fuxa Foundation in Prague". Likewise, Lendl is unwilling either to confirm or deny whether he still owns the collection that bears his name. All we know is that an obscure Czech businessman called Richard Fuxa now holds the legal right to exploit the posters for commercial ends.

Others like the painter’s grandson, John Mucha, claim that the collection has been sold. "The question is not whether the collection has been sold. I can state categorically that it has. The question is who now owns it, and whether the new owner is reputable.” That's something John Mucha is concerned about as president of the Mucha Foundation, a charity that works to preserve the artistic estate of Alfonse and his son, the writer, Jiri Mucha, who Lendl says inspired him to start his collection.

Poster boy Uncertainty over who owns the collection today is feeding speculation that Fuxa is acting as cover for the true owners.

Fuxa runs and part owns a local outdoor advertising firm in Prague called BigBoard. According to Lendl, it was Fuxa who came up with the idea and the funds to bring the collection to Prague from Lendl’s home in Connecticut, and to exhibit it in public for the first time.

In May 2013, the City of Prague staged an exhibition of the Lendl-Mucha collection in the Municipal House, an Art Nouveau building controlled by municipal politicians that houses a concert and exhibition hall. The exhibition was produced and promoted

by Fuxa’s BigBoard. Its main sponsor was CEZ, the country’s state-owned power utility. CEZ’s management is so intertwined with local politicians that some have rechristened this country the "CEZ Republic".

Surprisingly, the massive publicity drive behind the 2013 exhibition made no mention of the Mucha Foundation.

The complete absence of the family foundation in the promotion of the exhibition is astonishing given that Lendl is one of its honorary patrons.

“We only learnt that the collection had been sold after the event,” says John Mucha.

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The Prague exhibition has now ended, but the commercial exploitation of the Mucha brand by Fuxa has only just begun. As Rennert indicates, Fuxa has set up a Czech-registered foundation named after himself, the purpose of which is to promote the collection, both here and abroad. He has plans to take the collection on tour, with China and Japan rumoured to be early destinations. In addition to touring, BigBoard is mass marketing Mucha merchandise on its giant billboards lining Czech motorways.

There are those, such as Rennert and Fuxa, who want the world to believe that the collection is still owned by Lendl, and that the tennis star has merely relinquished to the Fuxa Foundation the commercial rights to exploit it. The website still lists it as the "Ivan Lendl: Alfons Mucha" collection, using the Czech spelling of the artist's first name. Then there are those, like Alfonse’s grandson who insist that the collection has been sold. But it is impossible to find anyone who regards Richard Fuxa as the only or even the principal investor in the project.

In Prague at least, it is assumed that Fuxa is, as it were, a poster boy for a local oligarch called Martin Roman. For the last ten years Roman was running CEZ, the main sponsor of last year’s exhibition, until he gave up his position in the company in October 2013. The Czech police are currently investigating four CEZ transactions that took place under Roman’s leadership.

Rennert says, "I do not have the pleasure of knowing Mr Roman." Perhaps not, but Roman certainly has the pleasure of knowing the people behind the Fuxa Foundation, which now curates the collection that Rennert built and curated on Lendl’s behalf until last year.

An oligarch’s art curator Local media report that Roman is a substantial hidden investor in BigBoard, 80% of which is owned by a Cypriotregistered firm called JOJ Media House, with the rest owned by Fuxa. Roman and Fuxa are established business partners in other projects: PORG (a private Czech school controlled by Roman) and Cteni

pomaha (a charity he set up aimed at encouraging children to read) are heavily advertised on billboards owned

by BigBoard.

There are other noteworthy connections between them. The Fuxa Foundation is administered by Karel Srp, the former artistic director of the City of Prague Gallery, who now curates the LendlMucha collection on behalf of the foundation. Srp is described in Prague art market circles as "the curator of Roman’s private art collection". He has recently become a member of the board of the Czech Visual Arts Foundation, the charitable body which runs the Manes exhibition hall, a landmark functionalist building that straddles the Vltava river.

Roman has been attempting to take control of the foundation since 2010. In 2013, he offered it $5m in exchange for the right to nominate a majority of its board members. He was rebuffed.

Milan Bufka is another of Roman’s "cultural ambassadors at large". Bufka also sits on the board of the foundation that runs the Manes exhibition hall.

But the relationship between Bufka and Roman is built on something more solid than a mutual love of the visual arts.

that Roman retained close ties to the group long after leaving it to run CEZ. Given Bufka’s professional background as a bankruptcy receiver, it came as a surprise when, in 2008, he was chosen by the Prague city government to be the director of the City of Prague Gallery.

Karel Srp, who you will recall is known locally as Roman’s private art curator, had been appointed as the artistic director of the gallery a month earlier, and had enthusiastically endorsed Bufka’s candidacy, despite his incongruous background. Both men were eventually removed from the leadership of the gallery in mid-2012, after the politicians close to Roman who had appointed Bufka and Srp in 2008 were replaced.

The Lendl-Mucha collection is sitting today in the City of Prague Gallery's depository. How long it will remain there depends upon whether it was imported into the Czech Republic, or whether it was declared as a visiting exhibition for customs purposes, in which case it will have to leave the country again soon.

It is to be noted that the key to unlocking the secret of who now owns the LendlMucha collection is held by two men

"The question is who now owns it" The relationship goes all the way back to 2002, when, as managing director of the sprawling state-owned engineering conglomerate Skoda Plzen, Roman was preparing the bankrupt business for sale.

Bufka was the state-appointed receiver working alongside Roman. And it was Bufka who helped determine the price at which Skoda Plzen would be bought by a murky Swiss-registered firm called Appian in 2003. The sale price was so favourable to Appian that the transaction forms part of a longrunning criminal investigation by the Swiss authorities into suspected money laundering. Documents later leaked to a Czech newspaper purportedly showed

subject to the jurisdiction of the US Foreign Corrupt Practices Act. Rennert and Lendl both hold US citizenship. No reputable art dealer these days can risk handling a high value transaction without knowing the source of the funds. So it is safe to assume that Rennert, if indeed he did handle the sale on behalf of Lendl, is aware of who owns the collection today.

If, as many suspect, the collection has been sold to a Czech billboard business with murky ownership, then many will be appalled that a substantial part of the work of a Czech national hero and world class painter, rather than being bequeathed to the nation by another of its most famous sons, is now in unknown hands.

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economy grew by 2.7% in the last quarter of 2013 (giving growth for 2013 of 1.1%), headline inflation is close to zero, credit – especially if obtained from the central bank's "Funding for Growth" scheme – is cheaper, and while independent experts question whether the budget deficit target can be met in the wake of a flurry of pay rises for state employees, they agree it should not be significantly above 3% of GDP. The current account, boosted by manufacturing, is posting record surpluses, and unemployment stands at a little over 9%.

Photo: Gergely Botár

Hungary's war over the economy

But contrary to the prime minister's assertion, opposition and independent critics queue up to contest "the facts".

The problem, they argue, is that government policies have all too often been aimed at short-term gain – such as the mandatory utility price cuts – or, in the case of taxes, at specific, mainly foreign-owned sectors, which has both undermined business confidence and resulted in cost increases passed on to customers, as in the banking sector.

Kester Eddy in Budapest

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ungary is "standing on its own two feet" and it has achieved this "without the help of anyone else" – so Viktor Orban, Hungary's fiery prime minister, declared March 19 in a self-congratulatory address to the Hungarian chamber of commerce.

"The economy is growing, the debt's been cut, energy is cheaper, credit is cheaper, inflation is lower and exports are expanding: nobody can contest these facts as far as I'm concerned," he told the assembled captains of Hungarian industry.

The former anti-communist student dissident has been touring the country for the past month in a frenzy of ribbon cutting, foundation-stone laying and touting the successes of his Fidesz government, in a campaign to win another four years in power when the nation goes to the polls on April 6.

His summary of the party's programme? "We will continue," he said, although he outlined a

10-point economic policy plan for good measure. This includes targeting an increase in domestic sources for government debt, a commitment to "re-industrialisation", at least 50% of

Bernadett Szel is an economist and MP for the small green LMP party, which has refused to join the main opposition alliance. Nonetheless, she speaks for many regarding what she sees as unsustainable, populist government

"What they are doing is not sustainable"

the banking sector to be in Hungarian hands and further reduction of taxes on labour.

At most events involving the prime minister, no questions are allowed: Orban avoids situations where he is liable to be robustly challenged – hence his refusal to take part in any preelection television debate with Attila Mesterhazy, his main challenger from the left-liberal opposition alliance.

Yet the statistics that Orban alluded to largely underpin his claims: the

policies. "The rezsicsokkentes [utility price cuts] cannot continue. It is all about the elections. They use this in every interview, in every speech, but when Fidesz came to power, the prices were raised, and now they are [only] returning to earlier levels. But what they are doing is not sustainable," she tells bne.

Indeed, Fidesz tax policies have, on balance, left many households poorer, certainly among the lower-income groups, Szel argues. "They started all these taxes, and because of all the mess

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of taxes, household expenditures have actually gone up," she says.

As for the "successes" regarding jobs, these are largely the result of government work programmes and Hungarians working abroad continue to count in the domestic employment numbers.“There are actually fewer private sector jobs in Hungary now compared to when Fidesz came in,” she argues. Indeed, the latest statistics reveal there were 29,000 more jobs in the competitive sector in 2010 than in 2013.

Plugging holes Independent analysts point out that the government has done little to reduce government spending, so promises of reduced labour taxation in the 10-point programme inevitably means additional taxation elsewhere.

Andras Balatoni, senior economist with ING Bank in Budapest, says the Fidesz government has certainly reduced personal income tax revenues, but to ensure a balanced budget has been forced to levy "distortive taxes on the corporate sector."

He points to OECD data that reveals special taxes on the Hungarian banking, energy and retail sectors that amounted to HUF676bn (€2.2bn), or almost 2% of GDP last year. "I believe that the resultant economic impact is near zero, or even negative. Thus, without decreasing the expenditure side of the

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budget, it [reducing taxes on wages] is not an option, without increasing other taxes," he says.

Such criticism is mild compared to Orban's most strident opponents, such as Balint Magyar, a former liberal MP, who accuses the prime minister and a coterie of his allies of creating a "mafia state," channelling millions of euros into companies controlled by Fidesz-linked oligarch interests via state and municipal tenders.

Despite all these attacks, Orban and his government remain popular with the middle class and wealthier segments of society, the beneficiaries of Orban's "flat tax" scheme, while his campaign on utility prices has won supporters in all income segments.

Given the government control over much of the media, Orban's popular, nationalistic rhetoric and the wall-towall advertising campaign insisting that "Hungary's Performing Better" – along with a series of timely scandals damaging the disjointed opposition alliance – it is little wonder that opinion polls reveal that 48% of decided voters support Fidesz. Representing a 17-percentage-point lead over the opposition alliance, it points to a second consecutive turn in office for the Fidesz leader – and, quite possibly and most worryingly for the opposition, with another two-thirds "super-majority" in parliament.

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Russian in Prague?

In evident protest against Russian expansionism exemplified by the annexation of Crimea, several streets in the Czech capital of Prague carrying the names of regions said to be vulnerable to Russian expansionism have been covered with stickers carrying the inscription "Ruska?" (Russian?).

Worries have grown over all Europe following Russia's move to annex the Ukrainian region of Crimea following a March 16 referendum in which 97% of voters apparently chose to rejoin Russia. The Baltic states in particular are wary of Russia's actions in the former Soviet Union, which the Kremlin says is motivated by a drive to protect ethnic Russians.

Latvia and Estonia have large ethnic Russian minorities, which have restricted citizenship rights.

A tram stop was rechristened – from "Crimea Street" to "Russia Street" – several days prior to the referendum. "If we continue watching inactively, further stops can be renamed similarly anywhere along the East-West line," an accompanying poster in the centre of Prague warned.

Scattered around Ruská ulice (Russian Street) in the Prague neighbourhood of Vršovice, a number of streets whose names are tied to the Soviet era – Sevastopol, the Black Sea and Estonia, among others – then had the stickers slapped on them.

Jan Charvat, spokesman for the Prague 10 district where the streets are situated, told CTK no one had informed the town hall about the incident so far."

After we find the streets in question, we will seek a remedy," he said.

If the street signs have been heavily damaged, the Prague 10 town hall would have to file a criminal complaint against the unknown perpetrator, the spokesman said. However, he added that because it appeared they only had been covered with stickers, the authorities are not expecting a big bill. Nor perhaps will there by any sanctions on the individuals involved.

"I believe that the resultant economic impact is near zero, or even negative"

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Passport to perdition Russia's argument that it moved into Crimea to defend "compatriots" is particularly worrying for ethnically mixed Latvia, where 27% of the population is ethnic Russian (against 25% in Estonia and 6% in Lithuania).

"It's unclear what they mean by this word 'compatriots'," Artis Pabriks, a former Latvian foreign minister and until the end of January its defence minister, points out. "Does it mean citizens of Russia, speakers of Russian, former countries of the Soviet Union or countries that were unwillingly forced into the USSR, such as Latvia?"

Front-line Baltics keep a wary eye on Crimea Mike Collier in Riga

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ith the Russian military on the move westwards again for the same sort of ''invited annexation'' that saw Estonia, Latvia and Lithuania lose their independence in 1940, it's hardly surprising the Baltic states are watching events in Ukraine's Crimea warily. Upcoming elections as well as nationalist parties playing to the gallery will create plenty of flashpoints in these countries that have large ethnic Russian minorities.

Former Georgian president Mikhail Saakashvili – who knows a thing or two about Russian invasions – warned that if Russian President Vladimir Putin gets his way in Ukraine, next it will be Moldova and the Baltics. "Okay the Baltics are members of Nato, but will they apply Article 5?" he told Bloomberg in Kyiv on March 5. "If he invades somewhere in the Baltics, lots of Europeans will say we still need Russian gas, is it really an aggression? Does he have legitimate interests? They are big debates and those are small countries."

Outside the train station in the central Latvian town of Sigulda, people say experience has taught them to be wary of Russia rather than outright fearful.

Smartly-dressed pensioner Anna, a resident of the town, tells bne: "The situation in Ukraine is bad and I fear it will get even worse. Putin is thinking only of himself. He will stop at nothing to get what he wants." However, Latvia's status as a Nato member since 2004 makes a big difference, she says. "It is very important that we are members of the European Union and Nato. Nato is strength."

That strength was further bolstered on March 6 when Nato added six US F-15 fighter jets to the four already on duty in the Baltics. Based at the former Red Army base of Zokniai in Lithuania, they have become a regular sight – or rather sound – in the Baltic skies, joined by refuelling craft and AWACS surveillance planes in response to increased Russian buzzing of the borders. And on March 18 the UK did likewise, saying it would send its own formidable Typhoon planes to back up Poland's stint policing Baltic airspace.

Last year's ''Steadfast Jazz'' Nato military exercises that simulated the defence of the Baltics against a thinly disguised Russia in retrospect look far more important than the PR play they seemed at the time.

"By doing this I think the Russians are shooting themselves in the foot. Maybe there will soon come a time when China uses the word 'compatriots' to talk about people living in Siberia," Pabriks adds.

At the open-air market on the other side of the rail tracks in Sigulda, Russian-speaker Leonid is one of the Soviet-era economic migrants who stayed on in Latvia after the restoration of independence in 1991. As a result, he is classed as one of around 300,000 "on-citizens" – regarded by Latvian nationalists as a potential fifth column.

Despite speaking good Latvian, Leonid has never bothered to take the naturalisation tests required to gain citizenship, yet notably he refuses to conform to the pro-Kremlin stereotype often foisted upon Baltic Russians.

"Military force is not right. Other methods should have been used to solve this dispute. It is a tragedy, a real tragedy, that we have Russians and Ukrainians against each other when we are brothers," he tells bne.

This restrained unease expressed by most ordinary folk is in stark contrast to the outspokenness of the political classes, which have been among the most vocal and virulent international critics of Putin's actions in Crimea.

All three Baltic capitals have witnessed fairly large – numbering hundreds rather than the usual few dozen – demonstrations outside their Russian embassies. At one such demonstration

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in Riga placards clearly showed another meme of the Baltic take on Ukraine: comparisons between Putin and Stalin or Hitler. Pabriks argues the comparison is justified. ''At first there were similarities in Crimea with [the Czechoslovak German-speaking] Sudetenland, now it's already getting similar to the Anschluss of Austria,'' he tells bne.

Latvia's 300,000 "non-citizens" such as Leonid plus a similar number of Latvian Russians who do have citizenship would be classed as ''compatriots'' by the Kremlin and therefore entitled to military protection – a fact effectively confirmed by Russian ambassador to Latvia, Alexander Veshnyakov, on March 7 when he suggested such non-citizens should apply for Russian passports to "save them from poverty by giving them citizenship and a pension without having to stay in Russia."

Yet there is another dimension to take into account when considering the hardline and vocal response from politicians in the region. Latvia will have parliamentary elections in October and Lithuania will have a presidential election in May alongside European elections, in which Pabriks himself is standing.

It would be wrong to say the anti-Russia rhetoric is simple electioneering, but there is an onus on politicians to be seen as tough on what is after all an issue everyone here understands all to well.

With each party trying to out-tough the others, the rhetoric gets ever more strident; there are now calls for tough sanctions interplaying with warnings about the damage sanctions would have on economies with huge Russian trade interests.

A hastily-called demonstration March 6 by the Non-Citizens Congress, an organisation claiming to represent the 300,000 "non-citizens", against government proposals to restrict the use of Russian in state schools from 2018 saw the situation in Crimea playing a role as well as education issues. "The speaker of parliament said our demonstration shouldn't take place because of Ukraine.

Some people stood on the other side of

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the street and shouted: 'This country will never be yours'," one of the organisers, Elizabete Krivcova, said.

In the Latvian parliament on March 3, the opposition Harmony Centre party, which is supported mainly by ethnic Russians and has a cooperation agreement with Putin's United Russia party, refused to back an outright condemnation of Russia, saying both sides shared the blame for events in Ukraine. "We are firmly opposed to any use of violence in Ukraine by either party. The solution of any problems in modern Europe by force is unacceptable.

It is just as unacceptable to interfere in the internal affairs of sovereign Ukraine," the party said in a statement on March 5.

More strikingly, a couple of pro-Russia demonstrations have also taken place.

Though each was only a couple of hundred strong and led by well-known Kremlin lovers such as MEP Tatjana Zdanoka, the sight of Russian flags being waved alongside placards denouncing the US and EU would have been near-

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as a result of events in Ukraine. Latvian banks have successfully attracted large numbers of Russian depositors by promising to help supply a Latvian – and therefore EU-wide – residence permit in exchange for sizeable deposits or investments in real estate. Latvia is also an important transport corridor to Russia and sanctions would have a real impact on Latvian hauliers and exporters.

Polarising parade Some Baltic politicians may be accusing Putin of acting like Hilter, but accusations of fascism cut both ways. On March 16 (the same day coincidentally as Crimea's referendum on joining Russia), Riga's notorious annual parade to honour members of the Latvian Legion – part of Hitler's Waffen-SS divisions – took place too.

Thankfully, there were no clashes thanks to some canny policing that kept opposing sides apart, but the event played big with Russian media after Einars Cilinskis, the environment

"I think there is a whole geopolitical game happening on both sides which none of us know about" unthinkable until Vladimir Putin started peddling his new form of supra-national nationalism.

Standing outside the German embassy in Riga on March 10, while her supporters rather unfortunately chanted “No to fascism!”, Zdanoka – who later popped up in Crimea to say how free and fair the referendum was – told bne: “The EU is responsible for the situation in Ukraine by using double standards, creating tensions between the EU and Russia using the Eastern Partnership countries.

Ukraine became a scapegoat but the target was Russia.”

The right-wing National Alliance political party – one of four in the current government coalition – has reacted in kind, calling for a halt to the issuing of temporary resident permits to Russians

minister, ignored Prime Minister Laimdota Straujuma's ban on ministers attending the event. Cilinskis was promptly fired (after just two months in the job), allowing his party to depict him as a principled patriot while the country as a whole enjoyed a PR disaster – particularly with Riga the EU Capital of Culture for 2014.

In such a context it's nice to meet someone like Rinalds, another Sigulda resident. Waiting to pick up a friend at the station car park, he says his grandfather actually served in the Latvian Legion but he had no intention of getting mixed up in the war of words. "Of course Russia will say we are all fascists and so on. What Putin is doing is wrong, but I think there is a whole geopolitical game happening on both sides which none of us know about," he says.

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Poland shale-shocked Nicholas Watson, Tim Gosling in Prague

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oland's drive to develop its shale gas resources has been a mix of confusion, incompetence and hype. But any whiff of Russian imperialism can concentrate minds in this part of Europe.

On March 11, the Polish government finally approved draft legislation that is designed to encourage more investment in the country's nascent shale gas industry. Ever since this unconventional source of gas, which is trapped in shale formations deep underground, transformed the US gas industry and large reserves were also identified in Poland, Warsaw has trumpeted shale gas as the key to ending its dependence on oil and gas from Russia, with which it shares an unhappy historical past and is still deeply suspicious of.

The draft bill is designed to relieve investors from Poland's special taxes on shale gas in a bid to speed up exploration work, which has lagged since a huge push was announced in 2011 after US Energy Information Administration (EIA) estimates (later downgraded) put Poland's shale gas reserves as the largest in Europe. Under the new regime, taxes on exploration will not begin until 2020.

Tusk also promised the new regulations would simplify and accelerate licence procedures. Currently, the environment ministry grants separate concessions for prospecting, exploring, and exploiting hydrocarbons. Under the new legislation, it will be possible to obtain one joint concession for all of the above, while performing geophysical research will be subject only to notification of the ministry.

This new approach, it is hoped, should reduce the administrative burden and encourage entrepreneurs to conduct

prospecting. "The idea behind the draft law is to make possible intensive exploration and extraction of shale gas," Polish Prime Minister Donald Tusk said.

Tusk said the fast-tracking of the bill, which could take effect as soon as this year, was down to the dangers of relying too heavily on gas imports from Russia – something that has been thrown into stark relief since Russia's annexation of Crimea and its renewed threats to turn off the gas to Ukraine, through which much of Europe's gas from Russia transits. "Today gas security is a fundamental prerequisite of sovereignty of every European country, including

unfolding drama in Ukraine – Tusk had claimed his government would approve new investor-friendly shale gas regulations within a fortnight. While the delay might be slight, it reflects the confusion in Warsaw over the country's energy strategy. Investors have been demanding clarity – especially concerning shale gas regulations and taxation – for some time.

Tusk offered another hostage to fortune on March 11, when he insisted the draft bill would be sent to parliament within a fortnight, and said he hoped for "speedy proceedings," especially given the tensions in next-door Ukraine. As of writing, the legislation had not been sent.

This is not new. On the back of estimates in 2011 that it held technically recoverable shale gas resources at 5.3 trillion cubic metres (cm) of gas, compared with proven conventional gas reserves of 164.2bn

"Companies cannot change ‘Mother Nature’, but they can lobby for a better law and lower taxation"

Poland," the PM said, insisting that Warsaw would do all it can to be free from "gas blackmail" by Russia, from which it imports around 60% of its annual gas needs.

A day earlier, Tusk had criticized Germany for its over-reliance on Russian gas. He insisted that the issue impinges on EU sovereignty, since this energy dependence is widely regarded as being behind the EU's reluctance to impose heavy economic sanctions against Moscow for its annexation of Crimea.

A new day But the Polish government's newfound drive to reduce its dependence on Russian gas belies its fairly inept and confused attempts to exploit its shale gas reserves over the past few years.

In early February – ahead of the

cm, Poland excitedly proclaimed its dreams of becoming a major gas producer within a few years.

Foreign investors snapped up exploration licences that were being hawked, but the enthusiasm soon waned as reserve estimates were slashed and test drilling disappointed. Displaying an all-too-often frustration with investors and the vagaries of foreign investment, the Polish government turned to pushing state-controlled companies into the fray, but simultaneous demands for these firms to make huge investments in new power plants made that difficult.

So this year Poland launched a new charm offensive to persuade those foreign investors still on the ground to stay and raise their efforts, and others to take another look at the opportunities

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on offer. This has been helped by an announcement from London-listed San Leon in late January that it's close to producing "the first commercial shale gas flows in Europe".

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Hungary for residency bonds

Recently appointed Environment Minister Maciej Grabowski has been drafted in to spearhead the renewed push to bring in more foreign cash, technology and experience in drilling for shale gas. While about 55 drillings have been made in Poland so far, the industry reckons that at least 200 are required to assess the true scale of the country’s shale gas reserves. Industry players regard the low number of drillings mainly a consequence of the unclear legislation that had covered the sector so far. "This year, I think at least 30 wells for shale gas will be made," Grabowski said in February. "To date there were 55. This year will be a turning point for shale gas."

Kester Eddy in Budapest

The "six-year tax break" in particular is supposed to be "a huge incentive" to drill faster, Tusk said. Poland has two special taxes on oil and gas production – one fixed on the value of production, one that takes production costs into account – which add up to a rate of no more than 40% of revenue. That regime will now be delayed until 2020.

And the deal? Punters stump up ¤250,000 for the bond, redeemable in full after five years. They receive no yield, but gain eligibility for themselves and immediate family for temporary residence in Hungary. After six months in the country, they then become eligible for fast-track permanent residency.

However, as Tamas Pletser at Erste Bank points out, Warsaw can offer whatever regulatory and tax temptations it likes, but that won't change the fact that test drilling suggests many Polish shale gas deposits are not commercially viable.

Industry players have indicated that the cost of drilling for shale gas in Poland is likely to be almost three-times as expensive as it is in the US. "The new law was missing for a long time, but what we really miss is the good results of the fracturing," Pletser says.

"It seems to us that Poland cannot meet earlier expectations, even though new technologies may result in a breakthrough a few years from now," he says. "We believe that the companies cannot change ‘Mother Nature’, but they can lobby for a better law and lower taxation."

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The opaque Hungarian State Special Debt Fund (HSSDF), which has the exclusive right to sell so-called Hungarian "residency bonds" in China, is targeting sales of “a minimum ¤500m” to 2,000 individuals and families, Lian Wang, HSSDF chief executive, told a press conference in Budapest in February. Wang was less forthcoming, however, on the ownership and governance of the fund.

The ¤500m target represents a doubling of the sales rate for the fund, which began operations only in the middle of 2013. In its first six months, HSSDF targeted sales of 400 bonds, but outperformed by selling 415 bonds and raising almost ¤104m in debt finance for Hungary's state coffers.

In 2014, despite the dearth of economic activity in China during its New Year holiday, the fund had so far received 160 applications and sold 70 bonds. "We expect activity to pick up significantly, starting from March… we are very confident that this will be a good year,” Wang said.

As the Hungarian state does not pay for the marketing costs – these are covered by a separate, non-refundable ¤40,000 registration fee – it takes on none of the marketing risk. “In order to get serious people coming to Hungary, our agents have to do a lot of marketing. About 90% of the time they are talking about culture, history, tourism and local products. I'm certain that at almost every event they mention Tokaj wine,” Wang said, adding however that since many of the would-be emigrants are entrepreneurs and small business people, the state of the economy and government relations are also “very important.”

In this respect, potential bond buyers have been reassured by the flurry of high level bi-lateral visits of late, including Hungarian Prime Minister Viktor Orban's delegation to China earlier this month, he stressed.

The residency deal looks good for Hungary on an economic level, says Balint Hada, head of research at Quaestor, a Budapest-based financial advisory.

“This fits the strategy that the government is trying to finance the budget more and more from the public [rather than institutions], making it less vulnerable to market swings. If you consider Italy and Spain, the former has, or had, more debt than the latter, but Italy is more indebted to the public, so investors are not [so] concerned,” he says.

Some journalists at the press conference were somewhat less confident in the setup, however. Who exactly owns the management rights to the HSSDF (which is registered in the Cayman Islands)? one asked. Are there, for example, any Hungarian owners? The Fund is fully transparent and compliant, Wang insisted, and all information regarding the investors and owners is provided to the Hungarian government.

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Local Turkish affairs, regional repercussions David O'Byrne in Istanbul

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ne of the truisms of Turkish politics is that with local government funded almost exclusively by central government, voting in local elections is conducted almost exclusively on national issues.

Even before the corruption investigations launched back in December, Turkey's local elections on March 30 were always going to be a referendum on the 12 years of rule by the Justice and Development Party (AKP) of Prime Minister Tayyip Erdogan, focused firmly on the presidential elections scheduled for August this year and a general election in June 2015.

August's presidential election is being viewed by many as a watershed for Turkish politics, not just because it's the first time in Turkish history that the

electorate has been offered the chance to elect the head of state, but also because as such it will likely set the tone of Turkish politics for far longer than the four years the elected president will serve. Not for nothing was Erdogan last year trying to build cross-party support for amending the Turkish constitution to allow a French-style executive presidency.

The graft probes launched at the end of last year seem to have ended that hope, despite them having apparently been stymied by the sacking and transferring of dozens of senior police and prosecutors, and the passing of new legislation that makes the judiciary answerable directly to the government.

Now, following a stream of leaks of illicit telephone recordings allegedly featuring

Erdogan, members of his family, senior ministers, bureaucrats and prominent businessmen, all implying improper or illegal behaviour and many suggesting corruption on what, even by Turkey's poor standards, purports to be an entirely unprecedented scale, he is left fighting for his political life.

Challenged With the AKP almost certain to retain control of Turkey's two biggest cities Istanbul and Ankara and by far the largest proportion of the vote in the local elections, the focus is on whether the party will poll well enough to avoid a challenge against Erdogan's leadership from within the AKP. "This election alone won't change anything – one way or another," says Cengiz Aktar, professor of political science and senior scholar at Istanbul Policy centre, suggesting that

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Erdogan's primary aim is to "cover up the allegations and continue business as normal".

However, Professor Aktar doesn't believe that will be possible. "There is no quick fix, and we may have some very shaky months ahead," he explains, pointing out

gendarmes by Albanian Islamist fighters returning from Syria.

What is clear is that whoever leads the AKP into next year's general election will need to face up to not just a growing lawlessness and an apparent flood of unregulated arms, but also an economy

"Markets tend to buy single-party governments and sell coalition governments" that it is far from clear who from the AKP will contest the presidential election in August.

According to Oral Calislar, veteran political commentator and columnist on Turkish daily Radikal, polling less than 40% will present the AKP with the major headache of whether to risk trying to get rid of Erdogan and his acolytes. But over 40%, he suggests, and the party will be happy to have Erdogan as its candidate in the August presidential election, with current president and AKP founder, Abdullah Gul, returning to lead the party. "We will see a change in style," says Calislar. "Gul is a very different politician, less confrontational."

A more pragmatic style may help defuse tensions in Turkey, but it remains to be seen whether it will enable the government to fully address the graft allegations or repair Turkey's international image, which even before the corruption probes and the Twitter ban had been badly tarnished.

As recently as two years ago Turkey was still being touted as a model for how a majority Muslim country can operate as an effective parliamentary democracy to the "Arab Spring" states newly emerged from the yoke of tyranny and corruption.

But Turkish policy on Syria has left the impression of a country unwilling or unable to face up to the spread of violent Islamic extremism across its borders even when it explodes in violence with its own borders – as it did in March within the killing of two Turkish

that increasingly appears to be headed for a hard landing.

Landing with a bump Economists concur that while fourthquarter GDP growth figures due out on March 31 will confirm that the Turkish economy grew by just over 4% last year, government projections of 4% growth for the whole year are wildly optimistic. A central bank survey of analyst projections produced an average of 2.65%.

According to Inan Demir, chief economist at Turkey's Finansbank, 1.7% is more realistic. He points to a combination of the US Federal Reserve tapering its quantitative easing programme affecting Turkey's traditional dependence on external financing and Turkey's domestic political problems. "The news flow from

the government, with Finance Minister Mehmet Simsek warning in a recent interview that a bad local election result for the AKP could affect the government's 4% growth target.

Lower growth from lower investment would also reduce the government's ability to finance its existing current account deficit, hence limiting the scope for increased government spending ahead of the presidential poll in August and next year's general election. This could prove crucial given that many Turks vote less on party loyalty than on short-term economic gains – a factor that apparently played a part in a decision to impose a ceiling on the retail price on transport fuels less than a week before the local polls, in a move one fuel importer described to bne as "irrational and purely political."

But the prospect of falling support for the AKP is one that could bring mixed results. "Markets tend to buy singleparty governments and sell coalition governments," warns Demir.

However, he adds that a collapse in support for the AKP and the country moving towards elections that result in a potentially unstable coalition could mean the government emerges from the local elections emboldened. "Instead of being more inclusive in their policies, [the government] could choose to be more isolationist and confrontational – that could equally unnerve investors," he cautions.

"Erdogan's primary aim is to cover up the allegations and continue business as normal"

Turkey is confusing to say the least – it's a much less attractive market for investors than it was a few years ago," he says.

The possibility of continued political instability affecting the economy is one that has apparently also occurred to

Equally too, it could have repercussions far beyond Turkey's borders, with the Russian invasion of Crimea and the worsening situation in Syria signalling that the coming period will not be an easy one – even before any further instability Turkey's domestic issues may cause.

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Shipping Ukrainian money to Turkey Graham Stack in Pendik, Turkey

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kraine's new authorities are moving against alleged massive corruption at state energy company Naftogaz carried out during the presidency of Viktor Yanukovych. bne's own investigations have traced nearly $50m in suspicious payments by Naftogaz made to a one-man ship repair business in Istanbul, Turkey.

Traditionally every change of power in Ukraine leads to the swift arrest of the incumbent management of state energy company Naftogaz - and 2014 and the fall of the Yankovych regime is no exception. On March 21, masked and heavily armed special police swooped on Naftogaz headquarters and marched out long-serving CEO Yevhen Bakulin, whom acting Interior Minister Arsen Avakov accused of complicity in the theft of over $4bn from the company.

On the same day as Bakulin's arrest, a long way from Kyiv in the Pendik port area of Istanbul, Murat Bayrak looks nervous and knocks his fork onto the floor when he hears of the arrest. Bayrak runs a small portside ship-engine repair outfit called Emarine. He says he has spent the day up to his elbows in oil on an engine repair operation, and displays photos on his smartphone of the rusty "patient". But in the evening, he shows himself to be a convivial 30s-something with perfect English.

Murat does not hide his surprise to have a British business visitor. "I only have had the website up since 2013 and you are the first person to have contacted me via it," he says over dinner at a quayside fish restaurant. "You are also probably the first person to have ever simply come by my office without an appointment," he adds, which is unsurprising given that a local taxi driver had difficulty locating the small premises that lack of a nameplate on the intercom, let

alone a sign. "It is a small company," acknowledges Murat. "For instance, I don't have my own workshop."

Emarine's share capital totals just over $30,000, and Bayrak's is the only name and face featured on the Emarine website.

But over a six-month period in late 2012 and early 2013, Emarine hit boom time – $46.5m was paid to its Turkish account in multiple instalments by a UK company called Northsale Logistics from a Latvian bank account, according to extracts from the accounts seen by bne.

Northsale was a subsidiary of Latvia's Riga Shipyard, and the $46.5m paid to Bayrak came out of $400m paid by Ukraine's Naftogaz to Riga Shipyard for supply of an offshore drilling platform.

Given Emarine's tiny size, the $46.5m that flowed to Bayrak, out of the $400m paid by Naftogaz to Riga Shipyards, looks suspiciously like part of the $4bn allegedly siphoned from Naftogaz during the presidency of Viktor Yankovych 2010-2014.

Rigged in Riga Riga Shipyard used Northsale – a company set up only in 2011 – to handle the controversial $400m deal that saw it supply Ukraine's Naftogaz with a semi-submersible offshore drilling platform. The deal was controversial because Riga Shipyard had acquired the newly built B319 rig from Norwegian leasing company Standard Drilling for only $220m weeks earlier. Riga Shipyard played no further significant role except as intermediary; the company claims it made only around €5m on the deal.

Even allowing for cost of transport from Singapore to Ukraine, engineering work needed to transit the Bosphorus and extras such as a helicopter, the $180m discrepancy in prices was so enormous as to raise more than just eyebrows.

Given the reputation of Naftogaz as one of the world's most corrupt companies, the smell of dodgy dealing was strong.

But apparently all of officialdom in Latvia was holding its nose – the signing ceremony in Ukraine was even attended by the then Latvian economy minister, who later told bne he hoped the deal would boost Latvia's economy.

In fact the opposite has happened.

Riga Shipyard, one of Latvia's largest companies with workforce of around 600, may be nearing bankruptcy and is rapidly turning into a political hot potato. Former member of the management board Igor Komarov was quoted by local press in early March as saying there remained just "three to six months" until the shipyard went bankrupt. Riga Shipyard dismissed these comments and other reports as "informational attacks with the purpose to discredit the oldest company in the country."

Riga Shipyard has also consistently denied any wrongdoing in connection with the Naftogaz deal, referring to the fact that in Ukraine no enforcement action has been taken over it. "The authors of this wrong information are fulfilling someone's order," says the company.

Straitened circumstances Bayrak says he received the funds for work he had performed "according to his business profile," but says he cannot speak about the contract due to confidentiality clauses. Bayrak denies that there was anything improper about his receipt of $46.5m and says his company has been independently audited with no questions from Turkish authorities. He hints that he may have forwarded the funds to unspecified "subcontractors".

The logic of using a Turkish company for the siphoning of funds from Naftogaz's deal with Riga Shipyards appears simple – the rig transited the Bosphorus on its way to Crimea, involving extensive transport and engineering work, which were used to justify the payments to Emarine. The Northsale accounts also show smaller direct payments being made to genuine suppliers such as Singapore's Keppel Fels.

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Some details suggest the firm may have been primed to transit funds. Although Bayrak founded the company in 2008, it was only in 2013 that he launched the amateurish website – perhaps to satisfy cursory anti-money laundering checks.

Since November 2011, Bayrak is no longer Emarine's owner or manager on paper, with some partners taking over those roles, although he left no doubt in the interview that Emarine is his company.

Bayrak says his career got off to a promising start, heading the diesel engine sales division in Turkey of German engineering giant MAN, while studying for an MBA. But after a dispute over allegedly misappropriated money, he left the company in 2008. "It was impossible for me to work in a Turkish company after this, and so I had no choice but to start my own business," he explains. Bayrak declined to say where his contacts to Riga Shipyard come from.

Loss of "Independence" Naftogaz renamed the B319 rig "Independence" upon its entering service at its offshore drilling unit, the Crimeanbased Chornomornaftogaz. The name Independence referred to the high hopes placed on the rig, and a sister rig B312 purchased earlier, which centred on reducing Ukraine's dependence on Russian gas by exploiting domestic reserves in the Black Sea. But since Russia's blitzkrieg annexation of Crimea, Chornomornaftogaz and its new drilling platforms have been "nationalised" by the secessionist Crimean government, and in a bitterly ironic twist of fate are now under Russian control.

On March 23, Ukraine's energy minister from 2010-2012, Yury Boiko, said on television that any corruption schemes at Naftogaz had cost the country "100 times less than the loss of Crimea".

Boiko – widely regarded as the mastermind behind the Naftogaz schemes – blamed the loss of Crimea on the Maidan anti-corruption protests that ousted president Yanukovych in February and on Ukraine's new government that came to power on an anti-graft ticket.

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Go-go Gagauzia

bne The March 16 referendum in Crimea that resulted in 97% voting to leave Ukraine to join Russia was actually preceded by another referendum that was even more pro-Russian, in the little-known Moldovan region of Gagauzia.

As well as the breakaway Transnistria region to the east of the Dniester River, which the Economist calls a smuggling racket with a piece of land attached, Moldova has another autonomous pro-Russian region in the south of the country called Gagauzia, which is inhabited by an Orthodox Christian, Turkic-speaking people of Turkish or Bulgarian origin, who have been living in the area for about two centuries and are distrustful of the central government in Chisinau.

On February 2, the Gagauzia regional authorities carried out two simultaneous referenda. In the first, local residents – who number about 160,000 (or 4.5% of Moldova’s total population) – were asked to declare their support for the country’s integration either with the EU or with the Moscow-led Customs Union. The second sought their opinion on the draft law, "On the deferred status of the Autonomous Region of Gagauzia", which proposes that if Moldova were to lose its sovereignty (for example, through the unification of Moldova and Romania or through Moldova’s further integration with the EU), the autonomous region would automatically become the independent Republic of Gagauzia.

According to the results released by Gagauzia’s Central Electoral Commission, 98.5% of the voters supported Moldova’s integration with the Customs Union, while 98% voted in favour of the "deferred independence" bill.

That Soviet-like result is, just as in Crimea, probably the true result.

According to Kamil Calus of the Centre for Eastern Studies (OSW), "The primary reasons for such an unambiguously one-sided result are: the traditionally pro-Russian attitude of the local population; a fear of the potential unification of Moldova and Romania (fuelled by local officials and compounded by statements released by Bucharest); a fear of a further drop in trade with Russia and restrictions on access to the all-important Russian labour market; and also poor knowledge about the European Union and the process of European integration."

What the EU will or even can do about this rapidly deteriorating situation is open to question.

Russian President Vladimir Putin is clearly seeking to redraw the European map to expand Russia's borders. However, unlike Ukraine, whose ousted president Viktor Yanukovych sealed his fate by failing to sign the previously agreed free trade and association pact with the EU, Moldova did sign it in November, making plain that it believed such a move would provide a bulwark against just the sort of Russian action that Ukraine has suffered from.

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former party, the Democrats (19 seats).

Three small ethnic minority parties will also be represented: Sulejman Ugljanin's SDA SandĹžak (3 seats), the Alliance of Vojvodina Hungarians (6 seats), and the Riza Halimi-led Party for Democratic Action (2 seats).

A landslide in Serbia Andrew MacDowall in Belgrade

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o the gamble of Serbia's popular and energetic deputy prime minister, Aleksandar Vucic, has paid off. Final results from the March 16 snap election show that Vucic's Serbian Progressive Party (SNS), the largest party in the previous parliament, won with a massive 49% of the vote, or 158 seats in the 250-seat parliament, more than even the most optimistic polls were predicting. This gives Vucic a mandate for sweeping reform, will realise his aim of becoming prime minister, and could potentially allow his party to rid itself of its current coalition partner, the Socialist Party of Prime Minister Ivica Dacic, which won around 44 seats.

The result will also vindicate Vucic's decision to call the snap elections in a country pretty tired of them (turnout was around 52%); his party of former ultra-nationalists converted to the cause of EU membership have always felt they underperformed at their first outing at the polls in 2012 and wanted to build on the great strides the country has made since then, which includes signing a deal over the country's erstwhile province of Kosovo, starting EU negotiations and launching a wide-ranging corruption campaign.

The Progressives could form a government on their own, but Vucic has indicated that with painful reform measures in store, the party will seek coalition partners after the election to build a broad-based government. Vucic said after the results were becoming clear that that he will put a limit of May 1 on coalition talks. "The programme for a new government will be drawn up over the next few days, and all the work will certainly be completed by May 1," Vucic told a news conference at the SNS headquarters. "Rather, the SNS is willing

Bratislav Grubacic, a political commentator and a member of the Progressive Party's board, tells bne that there are three main candidates for coalition partners, any or all of whom could be brought into the government: the SPS or the NDS. Both have been making overtures to Vucic, and all could bring benefits to an SNS-led government, but all also have potential pitfalls.

Partner problems Many assumed that the election was originally called so the SNS could rid itself of the SPS, which given its ties with state-owned companies and its conservative voter base is not a natural ally for reform. But the famously tenacious Dacic, a kingmaker in the two previous governments and head of the powerful interior ministry, will certainly look to dig his heels in and bringing the party in would boost the parliamentary majority.

Tadic has international credentials and enjoys the favour of many in the SNS hierarchy – Bosko Jaksic, an editor at Politika, Serbia’s oldest daily newspaper, said that Progressive party leaders were

"The programme for a new government will be drawn up over the next few days, and all the work will certainly be completed by May 1" to extend its hand to everybody and to hear ideas and suggestions about how something good can be done for Serbia."

The other parties that cleared the threshold to enter parliament were the NDS of the pro-EU former President Boris Tadic (18 seats), and Tadic's

anxious that the NDS enters parliament in the hope it would prove a pliable partner. But the former president is tainted by the economic problems of his spell in power and splits in his party.

Beyond the nitty-gritty of parliamentary horse trading, other serious questions

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remain: most importantly whether Vucic really has the stomach for painful economic reform, and whether Serbia risks concentrating too much power in the hands of a man with an authoritarian past.

The outgoing government has the historic pluses of a landmark deal with Kosovo and the start of EU accession negotiations to its name. It has also signed important deals with the United Arab Emirates (UAE), including a $1bn loan (part of a package of up to $3bn, the government hopes) inked in early March, an agreement on arms industry cooperation, and the sale of 49% of the national airline to Abu Dhabi-based Etihad, which has taken management control of the re-branded Air Serbia and already appreciably improved services and connectivity.

But otherwise its economic record is less than stellar, with the deficit set to grow to the largest in Europe this year, and debt above 70% of GDP (the theoretical legal limit is 40%). The government could rightly say this was partly the legacy of its Tadic-led predecessor.

But its commitment to the sort of root-and-branch reform and fiscal consolidation the SNS is promising was seriously called into question by the January resignation of technocratic economy minister, Sasa Radulovic, an economist and Silicon Valley entrepreneur appointed in September.

Radulovic resigned over lack of progress in labour liberalisation and privatisation, and said in a statement that: "the chief obstacle to all reforms was and remains the office of the first deputy prime minister [Vucic]".

Those reforms include the sell-off of around 100 state companies; changes to the laws on labour, privatisation and bankruptcy; and public sector cutbacks that could affect 300,000 to 500,000 workers, as Vucic told local media in October. But actually implementing the tough measures is likely is likely to prove much harder than rhetoric suggests.

A Belgrade civil society figure tells bne

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that even if Vucic does want reform, powerful vested interests in Serbia, including within his own party, will be difficult to face down. Party activists and backers may seek sinecures and favours. "That's the way it's always been done – and if Vucic wants to use his mandate to change that, he will face serious opposition from within the SNS and all but one or two other parties", the figure says.

Critics say that the government, like its predecessors, seems too willing to attack and marginalise its opponents through the press. Vucic has an uncomfortable history in this area – he was minister of information under strongman Slobodan Milosevic, including during the Kosovo War, when he imposed stringent controls on the media – though few expect a return to this era, particularly now Serbia is on EU tracks.

But in a statement to bne, Vucic's spokesman strongly rejects the idea that the SNS leader's commitment to reform is only skin-deep. "Regarding reform, the SNS and Vucic have proved in the past year that they are tough enough to have initiated the fight against corruption and to make the necessary decisions in order to open accession talks with the EU," he says. "They also took the necessary decisions last November to raise VAT on high public salary earners and begin a balancing of the state budget. So any opposite claim on that issue is simply ridiculous."

Jaksic feels that Vucic is indeed committed to taking the country by the scruff of the neck, but echoes concerns by some figures that imperial overstretch could be a risk. "He does have something messianic, wants to get job done and is very keen that the job is done, but at the same time I think he faces the problem that he doesn't have enough real professionals around him that he can rely upon, and that's the reason that he is slowly taking care of everything – there's a danger of concentration of power and the cult of the personality. He must be careful."

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Kosovo PM rubbishes Crimea comparisons INTERVIEW:

Andrew MacDowall in Pristina

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ussia's annexation of Crimea and Kosovo's secession from Serbia cannot be compared "in any circumstances" and recent attempts to draw parallels between them are "unsustainable", Kosovo's prime minister, a key player in talks that ended the Kosovo War and who signed Kosovo's declaration of independence from Serbia as premier, told bne in an interview.

Hashim Thaci, a former guerrilla leader, also rubbished claims he was once head of a criminal gang that was involved in human organ trafficking as "science fiction" and "re-writing history", and also promised further improvements to the investment environment, with the state taking a smaller role in the economy and a continued fight against widespread corruption.

Thaci, speaking in a wide-ranging interview with bne, said that there were no "legal, political or historical" comparisons to be drawn with Russia's unification with Crimea on March 18.

"Under no circumstances can the cases of Kosovo and Crimea be compared," Thaci told bne in the main government building in Pristina, Kosovo's capital, just as Vladimir Putin was sitting down to accept Crimea into the Russian Federation.

"Not in legal, political or historical circumstances. We didn't change the borders, we had our borders before.

Kosovo was created after genocide was committed by Serbia, after the deportation of 1m citizens of Kosovo, which was done by Serbia. After the humanitarian intervention of Nato,

after the peace talks in Rambouillet, but also from the dialogue that culminated in [agreement with] the US and Russia, too," he said. "This means that Kosovo's independence was created after negotiations which followed the war. Therefore comparisons between the Kosovo and Crimea case are not sustainable at all."

Thaci's use of the world "genocide" and many of his arguments would be rejected by most Serbs, and doubtless the Russian government, amongst others.

But the Kosovan PM is adamant in his determination to quash the suggestion that his country's independence, still contested by Serbia, unrecognised by nearly 90 countries and blocked at UN level largely thanks to Moscow, set a dangerous precedent for Crimea.

He pointedly adds that Russia has a substantial non-Russian population.

Under investigation Thaci was senior leader of the Kosovo Liberation Army (KLA) that fought the Yugoslav (effectively Serb) authorities in the 1990s; Balkan correspondent Tim Judah says that the organisation, which secured western backing later in the decade, was "one of the most successful guerrilla movements in modern history".

To others, it was a terrorist organisation funded by foreign backers and nefarious activities.

Thaci emerged as its most powerful figure in 1999 as a Nato bombing campaign forced a peace deal leaving ethnic Albanians, and particularly the KLA, dominating the province. He

became prime minister a second time in January 2008, and the following month Kosovo declared independence, with the support of the US and some leading EU member states.

The KLA was back under the spotlight in March as reports emerged the international community wants to establish a special tribunal outside Kosovo to investigate war crimes allegedly committed by the KLA. These would almost certainly include allegations made

by Swiss senator Dick Marty in a report for the Council of Europe that Thaci headed an organised crime ring that was responsible for trafficking harvested organs, amongst other crimes.

But the PM firmly reiterated his rejection of these claims, and Kosovo's willingness to cooperate with international investigators. "Dick Marty's claims are science fiction," he says. "They have caused collateral damage for Kosovo, and the aim was re-writing history. We have nothing to hide. We believe in justice and truth. We have given full support to investigations – Kosovo's government has closely cooperated with them. We believe in the conclusion of this investigation as soon as possible. Kosovo is a good example of cooperation with The Hague."

The tall, tieless Thaci, who was speaking after a European Investment Bank conference in Pristina, cuts a relaxed figure in comparison to many of his dour European counterparts. Critics suggest that Kosovo is economically backward and has a serious problem with organised crime and corruption.

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Average wages are just over €360 a month, according to official figures.

Transparency International ranks the country 111th in the world for corruption perceptions, and it is certainly many years from EU accession.

Nonetheless, Thaci is keen to emphasise an image of a free-wheeling market economy and a European country that has made big progress in healing the wounds of the war, bridging deep ethnic divisions and moving towards international acceptance. "My goal is to strengthen the economy," he says.

"We have a goal of 4% of economic growth [for 2014, high by European standards], we have a stable banking system. Different foreign investments are coming in from EU member states, India and China as well. We want to do more in this direction in order to create favourable conditions for investment, while also creating favourable conditions for the small and medium business sector." The latter will involve the forthcoming launch of a $1bn investment fund to lend to small businesses at low rates, financed from assets that Kosovo holds abroad.

Privatisation and empowering the private sector will be at the centre of future liberalisation, and he wants to see less political interference in the economy. "The legislation is adequate, but we have to work on a mental transformation – the mentality of the centralised economy," he tells bne.

Recent evidence shows there's a long way to go. Only as recently as January the potentially lucrative but controversial privatisation of incumbent telecommunications firm PTK collapsed; critics say it was poorly-structured and lacked transparency. Yet Thaci insists that the privatisation process is independent and established by the international community, and argues that the country benefits from its legacy of international rule and influence in the years since 1999 in a range of fields, including its legal system and the fight against corruption. "The system in Kosovo in the last 15 years is led by the international community, free of political influence, independent,

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effective, at one time was led by the UN and now led by EULEX and did good work."

EULEX, the EU Rule of Law Mission in Kosovo which has responsibility for high-level corruption, has in fact been widely criticised, and its mandate ends later this year, when it will take a more advisory role. Thaci says that Kosovo authorities are ready to take over – "this battle should be done by us and won by us, I am determined to continue and there is no force that will stop me in this direction". On March 14, Balkan Insight reported that state prosecutors had raised nearly 200 corruption indictments since November in a push to address the problem.

Administrative capacity and official will to tackle graft on the ground is notoriously weak across the region. In its most recent progress report on Kosovo, the European Commission said that "anti-corruption legislative framework is largely in place", but "the main issue of concern remains the implementation of the legal and policy frameworks".

Minority report In April last year, Thaci signed a landmark EU-brokered deal with Serbian Prime Minister Ivica Dacic, once spokesman for Slobodan Milosevic, in an agreement that had an air of Nixon-to-China, or at least McGuinness-and-Paisley. The deal is

I 43

his foes. There are around 120,000 Serbs in Kosovo, around a third in four northern municipalities in which Pristina's rule is still staunchly opposed; local elections there in November were largely boycotted, despite Belgrade government officials urging (and in some cases cajoling) Serbs to vote.

Thaci argues that Pristina has "broken the iceberg of the boycott and broken the fear of integration", and lists a number of successes since the April agreement: that elections were at least held on the whole territory of Kosovo for the first time, which saw four mayors elected in the north; 300 Serbs brought into the police force in the north under a Serb police chief; Kosovo customs officers on the border; progress on normalisation of the justice system.

"Whatever makes them [Serbs] feel better, to have a more comfortable life, we will realise," he says. "I'm fully convinced about integration. It offers difficulties and challenges, but we will have success. In five to seven years the topics that we are discussing now will be [regarded as] ridiculous. The borders will be open and they will lose the meaning that they currently have for the people of the Balkans and we will have a region based on the European model."

Kosovo's charismatic premier certainly talks a good game, as other international leaders and many Kosovars appreciate

"Under no circumstances can the cases of Kosovo and Crimea be compared" intended to pave the way for Pristina effectively to take control of the whole territory – and for Kosovo to start talks on a Stabilisation and Association Agreement (SAA) with the EU, the first step to joining the bloc. Serbia started full membership negotiations in January. The deal was seen as a significant step for a man who made his name fighting the Serbs, and Thaci is most animated when talking about integrating Kosovo's Serbs – once

– he seems likely to be re-elected at the next election, in the absence of any rival of similar stature, despite nationalist rumblings about his overtures to Serbia.

Thaci's image of his country sometimes seems to overlook the fact that it is still divided, rather poor and unproductive, and weakly-administered. And his genial demeanour contrasts with his position as a highly controversial figure in the region and beyond.

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own lavish personal lifestyle as well as render illegal financial support to the HDZ party, which was also found guilty of acting in connivance with Sanader's wishes.

Sanader and the ABC Syndrome Guy Norton in Zagreb

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ust as surely as night follows day, political hubris is more often than not succeeded by nemesis – as former Croatian PM Ivo Sanader is finding out.

Little more than a decade ago Ivo Sanader was the undisputed heavyweight champion of Croatian politics. He had secured a comprehensive victory in the parliamentary elections of November 2003 for his conservative Croatian Democratic Union (HDZ) party, which had ruled Croatia for the first decade of its independence, but which had been ousted from office in 2000 after Croatian voters had tired of the increasingly autocratic ways of Franjo Tudjman, founder of the HDZ and the country's first democratically elected president.

Having purged the HDZ of its extreme nationalist elements and successfully engineered its return to power three years later, Sanader cut an increasingly

assured – some would argue arrogant – figure and was lauded as the darling of the once-again politically acceptable face of right wing politics in Croatia.

In the course of two terms as prime minister until his surprise resignation in July 2009, he was widely feted by politicians across the EU and

After a near two-year trial, Zagreb County Court judge Ivana Calic condemned Sanader as having colluded with a number of fellow HDZ party members to extract funds from state-owned companies via contracts concluded with marketing firm Fimi-Media, which gave the name to the much followed trial which featured over 130 witnesses.

According to the first instance verdict, which still requires final confirmation following an automatic appeals process, Sanader was adjudged to have illegally benefitted to the tune of HRK15.27m, while the HDZ was judged to have reaped HRK24.25m in unlawful gains. Finally, the owner of Fimi-Media Nevenka Jurak was blamed with retaining just over HRK2m in illicit revenues, which has been seized; she was sentenced to two years in prison. Former HDZ treasurer Mladen Barisic and chief accountant Branka Pavoševic, who assisted in channelling funds to the HDZ, received three-year and 18-month jail terms respectively. Finally former HDZ spokesman Ratko Macek was sentenced to 12 months' probation, suspended for four years.

While Sanader and his close family members have been stripped of HRK15.2m in savings and artworks that are alleged to have been illegally gained,

"Facts? Who cares about facts? Justice?"

undoubtedly did much to set Croatia firmly on the path to the bloc, which it joined in July last year.

But in the latest in a series of trials Sanader was on March 11 sentenced to nine years in jail, having being found guilty of masterminding a joint criminal enterprise that extracted more than HRK70m (€9m) from public companies that was used to fund both Sanader's

the HDZ will have to repay almost HRK20m to the state.

According to the evidence presented by anti-corruption agency Uskok at the Fimi-Media trial, during his time as prime minister Sanader systematically abused his position to secure funds to finance a lavish lifestyle, which included luxury trips to the US as well as the purchase of suits from Brioni – the mega-

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expensive tailoring brand so beloved of celebrities such as billionaire property developer Donald Trump.

In his closing statement to the court, Uskok director Zeljko Mostecak, who had pressed for a 15-year sentence, claimed that through his actions Sanader, "indisputably committed an extraordinary abuse of power and office, solely for the purpose of acquiring money and maintaining power with an absolute absence of any responsibility."

In his defence, Sanader claimed that he was a victim of a political witchhunt ordered by Jadranka Kosor – his successor as prime minister and leader of the HDZ – and that the prosecution's case was based on completely unsubstantiated accusations. "Facts?

Who cares about facts? Justice?"

The guilty verdict was just the latest in a number of legal hammer blows that have shattered Sanader's image as a highly-respected politician who restored Croatia's international credibility after the war-torn, hatred-ridden 1990s.

In November 2012, Sanader was sentenced to a combined term of 10 years in prison following the conclusion of two concurrent corruption trials.

In the first ever trial in Croatian legal history for war profiteering, Sanader was found guilty of soliciting an illegal €500,000 commission from Austria's Hypo Alpe Adria Bank in 1995 – an offence which occurred during Croatia's 1991-1995 Homeland War (as the former Yugoslavia dissolved).

He was also condemned for accepting a bribe of €10m from Hungarian oil company MOL in 2009 in return for ceding it management control over Croatian oil company INA, which is co-owned by the government. Both verdicts are currently being appealed by Sanader.

Putting the past behind it Although Sanader was thrown out of the HDZ in 2009, the March 11 guilty verdict against its former leader and the collective guilt ascribed to the HDZ will rub further salt into party’s political

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Croatia rethinks Russian welcome mat

Joseph Orovic in Zadar Ripples from Russia’s actions in Crimea have reached the shores of the Adriatic. Western sanctions on Russia will likely scupper any plans by Rosneft to take control of Croatian energy company INA, while the crisis has also refocused US attention on the Balkan country's potentially huge oil and gas reserves.

Reports emerged in February of plans by Rosneft to acquire the 49.1% stake in INA owned by Hungary's MOL, as well as some of the Croatian state’s 44.8% stake in order to gain control of the oil and gas company. Rosneft is also considering a possible bid for Slovenia’s Petrol to increase its reach into Southeast Europe's energy markets.

The possibility to buy into INA exists because of the strained relations between its two main shareholders, which has hobbled the company's growth and threatens to stymie the development of potentially huge oil and gas reserves located off Croatia's coast in the Adriatic Sea. MOL and Croatia have been at loggerheads since the Hungarian company was granted management control of INA in 2009. Both sides accuse each other of not having lived up to agreements, and relations reached a nadir in October last year when the Croatian police issued an arrest warrant for MOL's chairman and CEO, Zsolt Hernadi, over accusations he had bribed former Croatian prime minister Ivo Sanader to gain management control of INA. Hernadi has since been removed from Interpol’s “wanted” list, but there are few signs an amicable settlement to the feud is close.

Given Croatia lacks the financial resources to buy MOL's stake and invest properly in the company, the acquisition by a cash-rich Russian major would have solved many problems, but since the Crimean crisis few believe it's an option any more.

In March, US Deputy Assistant Secretary for Energy Diplomacy Amos Hochstein, who is helping to broker a deal between MOL and Croatia, urged both sides to reach an agreement.

If this cajoling fails, local reports say US firms are eyeing up the possibility of taking management control of INA ahead of the tenders for licences to develop offshore gas and oil reserves in the central and southern Adriatic, which are expected in the second quarter of this year. Exxon Mobil has already reportedly expressed interest in exploring in Croatia's offshore waters, with the daily Vecernji List revealing the US oil major has expressed interest in buying a stake in INA as well. "If these tactics of Russia succeed, then this will de facto mean a total failure of the Eastern Partnership, force the EU to deeply revise its European Neighbourhood Policy and lead to the necessity of a full redefinition of its entire security policy in the region," says Calus. "For the Kremlin, each of these three results would be a success."

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Heat in Romania It was one of the most audacious heists in living memory and now the story of how a group of high-ranking Jewish members of the Communist Party in 1959 robbed RON1.6m from the Romanian National Bank in broad daylight is coming to the silver screen.

Nae Caranfil’s “Closer to the Moon” offers an absurdist take on the event and the subsequent propaganda film that Romania's feared internal security agency, the Securitate, forced the six protagonists to make, after the group had been given a show trial and sentenced to death.

As Balkan Insight relates, "Prior to the execution, they were made to reenact the heist in a propaganda film designed to show how decadent, cosmopolitan people (in this case of Jewish origin) were robbing the Romanian people, and how they were punished for not respecting the state's authority."

There are still questions about what motivated the robbers: during the trial, the prosecution claimed the group tried to steal money in order to fund Zionist organizations; others suggest the group was trying to expose the lies and misconduct of the Communist regime with which they had become disillusioned.

The result is a “surprisingly entertaining black comedy”, a “curious testimonial to the past and its myriad interpretations”, Variety magazine writes.

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wounds. While the corruption charges levelled against Sanader and other HDZ officials were a key factor in the party's defeat in the December 2011 parliamentary elections, the HDZ under new leader Tomislav Karamarko has worked hard to distance itself from its shady past under Sanader.

In the course of the Fimi-Media trial, however, the HDZ was shown to have used its ill-gotten gains to buy a luxury bulletproof 7-series BMW limousine for use by Sanader and other senior officials, to hire Croatian singers Marko Perkovic Thompson, Misha Kovac and Nina Badrić to perform at HDZ election rallies, as well as purchase shares in local television stations as part of an attempt to gain favourable media coverage. A number of HDZ members were also granted underthe-table cash handouts as a reward for their political loyalty to the party.

With elections for the European Parliament coming up in late May, the guilty verdicts against the HDZ and the string of one-time senior HDZ officials couldn't have come at a worse

the constitutional rights of the country's Serbian minority – all highly emotive issues in socially conservative Croatia.

However, the SDP has been beset by a number of scandals that have called into question its own particular set of political ethics. For example, Marina Lovric Merzel, the SDP prefect of the Sisak-Moslavina county in central Croatia, is currently under investigation by the anti-corruption police on the back of allegations that she has misused public funds to pay for private parties for her family and friends and to purchase expensive gifts for herself and political supporters.

The graphic reminder of the often venal nature of Croatian politicians provided by the conclusion of the Fimi-Media trial may therefore also serve to hurt the electoral chances of the SDP in the upcoming European poll, as the disillusioned Croatian electorate may judge that the SDP is just as corrupt as the HDZ. As a result, the two traditionally strongest players on the Croatian political scene could find that

"It included luxury trips to the US as well as the purchase of suits from Brioni" time for a political party that is trying hard to convince voters that it can be trusted again. At a specially convened press conference, a visibly distraught Karamarko rejected the guilty verdict applied to the party and claimed that the judgment would undoubtedly be overturned on appeal.

At first sight the convictions against Sanader and his HDZ colleagues might seem to be a godsend for the current centre-left coalition headed by the Social Democratic Party. The SDP has been struggling to turn around the Croatian economy that has been in recession since 2009 and whose overall confidence has been sapped by having to fight a series of bitter ideological battles over issues such as gay rights, sex education and

they lose support to a number of newly formed parties that are as yet untainted by accusations of graft.

Meanwhile, the conclusion of the latest corruption trial in Croatia – more graft cases are in the judicial pipeline – could once again serve as further ammunition for critics who questioned the wisdom of the EU's decision to accept Croatia as a member last July.

Last and by no means least, the problems of graft combined with rampant red tape and a tax-heavy business environment could further depress investor interest in the country and exacerbate what has been coined the "ABC Syndrome" – Anywhere But Croatia.

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No surprise then that the government's proposal to sell Petrokemija to a strategic investor was broadly welcomed. "There's really no case to make for the state owning a fertiliser firm, especially a loss-making one," says Michael Glazer, a Zagreb-based consultant for business advisory firm Wyn River.

Croatia hosts visitors but few investors Guy Norton in Zagreb

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ccording to the epigram of Roman poet Marcus Valerius Martialis: Fortuna multis dat nimbus, satis nulli (Fortune gives too much to many, enough to none). Almost two millennia after those lines were first penned, the Croatian government is no doubt rueing its own particular lack of fortune after the country's latest failed privatisation sale – one of a depressingly long and still growing list.

On March 12 the deadline for binding offers to buy a controlling stake in Croatian fertiliser firm Petrokemija passed without any concrete bids from the troika of preferred bidders – Borealis from Austria, Nitrogenmuvek from Hungary and Agrofert from the Czech Republic. As a result, the authorities in Zagreb are still saddled with a loss-making firm whose Yugoslav-era industrial facilities are in desperate need of investment to be competitive and meet the exacting environmental standards laid down by the EU, which Croatia joined on July 1 last year.

The much-heralded sale of Petrokemija – attempts at full-scale privatisation date back all the way to 1998 – was supposed to show that Croatia was fully committed

to restructuring what remains of its devastated Yugoslav-era manufacturing base, some 80% of which has collapsed since the country declared independence in 1991. It was also an important element of the current centre-left coalition government's plan to boost budget revenues so that it can avoid having to make damaging job and welfare cuts.

Last year the general government deficit is estimated to have been around 6% of GDP. Consequently, Croatia has been forced to join the EU's excessive deficit procedure mechanism, whereby it will

When the idea of selling Petrokemija was revived in March 2012 it was enthusiastically received by stock market investors, whose optimism that a strategic investor could help to restore Petrokemija's fortunes lifted the Zagreb Stock Exchange-listed shares to an all-time high of HRK272 (€35.50).

But confidence in the Petrokemija restructuring and privatisation story has since evaporated into thin air, with the shares slumping over 41% in the year to March 12 and they were languishing at a price of HRK97 when it was announced that none of the three bidders for a controlling stake in Petrokemija had actually made an official offer.

Part of an unhappy trend The conundrum now facing the Croatian government is what to do with a company that for much of the recent past has been a drain on the state's finances, but which requires billions in investment for it ever to be profitable.

Worse, Petrokemija is far from being the only financial headache the government is suffering.

In recent months the authorities have failed to secure new strategic partners

"There's really no case to make for the state owning a fertiliser firm, especially a loss-making one" have to cut the country's fiscal gap to 3% of GDP by 2016. But slashing public spending is no easy task in a country with a rising unemployment rate that is fast approaching the 20% mark, and with an estimated 25% of the 4.3m population living in poverty according to internationally accepted criteria.

for a number of often loss-making businesses. "Privatisations have not moved along anywhere near as smartly – in every sense of the word – as the government had hoped and that's really beginning to hurt on the budgetary side," says Wyn River's Glazer.

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An attempt to privatise Croatia Airlines in November last year failed after foreign carriers showed zero interest in bidding for the government's 49.5% stake in the flag carrier, which in 2012 recorded a loss of €62.6m, its worst result on record. However, the government is looking to resume the privatisation process in the second half of this year on the back of the publication of Croatia Airlines' 2013 financial results.

Given the obvious politico-economic rivalry between Croatia and Serbia, Zagreb is under pressure to find as attractive a strategic partner for Croatia Airlines as the government in Belgrade did last August when it secured Ethihad Airways as a strategic partner for its flag carrier, Jat Airways. This has since been rebranded as Air Serbia complete with new planes and routes, while Serbia is receiving a huge boost as it becomes a European hub for Etihad.

Meanwhile, in December last year the sale of the government's 99.13% stake in Hrvatske Postanska Banka failed after Croatia rejected the only binding bid, filed by Erste Bank. The Austrian lender offered HRK789m or HRK905.71 per share, which was HRK232.29 a share lower than the non-binding offer it lodged in October. "The offered price is below what we expected for a bank which has been successful in recovering from losses it made in 2009 and 2010," Finance Minister Slavko Linic told a cabinet session. "I assume that, after due diligence, they [Erste Bank] concluded that there are too many lawsuits present as well as placements [loans] that require reservations [provisions]."

Linic's reasoning received partial confirmation last month when HPB reported financial results for 2013 that showed a near 30% increase in provisioning costs totalling HRK262m, which resulted in net profit slumping by 58% to HRK43M. Critics have thus questioned the wisdom of putting HPB up for sale in the first place when there are still many unresolved legal issues surrounding the actions of its former management. A number of former HPB officials, including its one-time chairman Josip Protega, face criminal

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charges in the so-called "ATM trial", which alleges that between 20042009 they damaged HPB to the tune of HRK667m by granting risky loans to favoured clients who failed to pay them back and of illegally boosting management bonus payouts based on false reporting of profit levels at the bank.

Another state disposal that fell through involved freight train operator HZ Cargo.

Talks between the Croatian transport ministry and Romanian company Grampet over the sale of a 75% stake in HZ Cargo for a total of around HRK1.3bn broke down irrevocably at the end of January amid recriminations that each side had negotiated in bad faith. Shortly after the talks failed, Gruia Stoica, owner of Grampet, was arrested by the antigraft office in Romania on charges that he had bribed a lawyer to gain access to confidential data that enabled his firm to secure a coal transportation contract for Romanian energy company Complexul Energetic Oltenia.

Though the failure of the HZ Cargo sale may be a blessing in disguise – "It certainly looks as if the government may have had a lucky escape," says Wyn River's Glazer – HZ Cargo is a loss-making firm burdened with over HRK1bn of debt that faces the unwelcome prospect of its monopoly position in the Croatian rail freight transpiration market being abolished on July 1 this year, when, under EU competition rules, the market has to be opened up to foreign operators.

One gets through the gate Finally, the sole successful privatisation in recent times, the sale of the country's leading insurer Croatia Osiguranje (CO) to local tobacco-to-tourism Adris Grupa, has attracted its own fair share of criticism.

On December 18, the Croatian government said it had accepted Adris' offer of €970.45 per share for a 39.05% stake of CO and a capital boost of €110m that will raise its stake to 60%. But one local banker, speaking on condition of anonymity, described this as a "sweetheart" deal. He cited the example

of Austrian insurer Uniqa, which last October was prepared to pay roughly €71m to acquire a 100% interest in the Croatian business of Switzerland's Basler Insurance, which had a market share of just 4.5%. Given that CO has a market share of just over 30%, the banker argued that on an admittedly simplistic like-for-like comparison, the value of the total CO business was in the region of €500m. Under the terms of the deal, Adris has agreed to pay the equivalent of €230m for a 60% stake in CO – roughly €70m less than the €300m valuation implied by the terms of the Uniqa/Basler insurance deal.

The still-to-be determined details of the recapitalisation have provoked some controversy as well. According to reports by Croatian business daily Poslovni Dnevnik, speculation that Adris may bring in outside investors to help fund the recapitalisation – both the European Bank for Reconstruction and local pension funds have been mooted as possible business partners – has apparently prompted indignation among CO management and workers who supposedly feel that they should be offered the chance to participate in the recapitalisation. Adris itself has previously allowed its employees to buy into the firm under the auspices of an employees share ownership plan (Esop) and Poslovni Dnevnikhas claimed that CO staff feel that they should be offered an Esop option as well.

On a separate issue, Ozren Matijasevic, leader of the Croatian Association of Trade Unions, whose members include CO staff, has expressed concerns over provisions in the privatisation contract that could allow Adris to claim up to a 15% discount on the contracted purchase price for CO if there are any financial skeletons in the insurance company's closet. According to Poslovni Dnevnik, Matijasevic believes that cashrich Adris has effectively been granted a low-cost, low-risk option on buying a prime government asset.

So even when the Croatian authorities actually manage to successfully close a sale, it seems that fortune still fails to smile on them.

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manoeuvre in seeking additional funds and diminishing the probability of the government losing access to the private debt markets," Moody's said.

Moody's assessment that Slovenia is finding it easier to convince investors of its credit-worthiness was borne out in mid-February when it received $16bn worth of orders for a dual tranche bond, comprising $1.5bn of five-year notes and $2bn of 10-year notes. Subsequently, yields on Slovenian sovereign debt have hit a four-year low on the international markets, with the country's 4.625% September 2024 benchmark issue trading at a yield of 3.9% by the end of the first week of March, sharply down on the 6.3% level Slovenian debt was trading at in November 2012 when investor concerns about the general health of the country's economy were at their height.

"Bad, bad bank!"

Guy Norton in Zagreb

W

hile 2013 was characterised by on-off bouts of panic about whether the Slovenian authorities could act decisively enough to quell fears of a meltdown in the financial sector – something they eventually achieved – the goal this year will be to press on with rehabilitating the banking sector so it acts as a driver rather than a drag on economic growth.

But as criticism of the "bad bank" set up to deal with the problem loans shows, bumps are likely along the way.

Increasing clarity over the actual final price of the stabilisation of the financial sector – likely to come in at a total cost of €4.8bn, or 11.1% of annual GDP, based on the findings of a banking system stress test and asset quality review completed in December 2013 – has helped to rebuild confidence in Slovenia among both credit rating agencies and investors. Although the €4.8bn worst-case scenario estimate was four-times the government's overly optimistic €1.2bn prediction, it was

nevertheless less than half the €10bn figure that some pessimistic analysts had forecast.

As a result of growing confidence in the country's economic future at the end of January, Moody's Investors Service revised the outlook on Slovenia's 'Ba1' sovereign rating outlook from negative

But at the same time there's growing criticism about the Bank Assets Management Company (BAMC), the so-called "bad bank" that was established last year to oversee the rehabilitation of the banking sector's non-performing loan (NPL) portfolios.

In February, senior officials at the BAMC convened a special media briefing to address the concerns expressed by the press, which included claims that it had been slow to start work, it had employed too many foreigners, had hired an excessive number of consultants and its operating

"To be honest, the international credibility of the financial system in Slovenia was very low"

to stable, even though economic growth is likely to remain in negative territory until 2015 at least. "As the uncertainty surrounding the size of the banking system's capital shortfall receded, yields on the sovereign's debt securities and liquidity pressures have fallen, allowing Slovenia more room for

costs had been too high. In a robust defence of the BAMC's actions to date, its leading managers claimed that contrary to popular belief in the media the bad bank has already proved to be a great success and helped to greatly improve investor confidence in Slovenia and its banking sector.

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Lars Nyberg, chairman of BAMC's management board, a veteran Swedish banker who masterminded the establishment of the BAMC in March 2013, claimed that despite assertions to the contrary, the body had been readied for action in an amazingly short period of time. "When you establish a company like this it normally takes nine months to a year, because you have to recruit the people and establish the policies and all that," said Nyberg, adding that within two months of its establishment the BAMC had been ready to accept the transfer of NPLs that had been demanded by government ministers.

Given the initial tight deadline set by the Slovenian authorities, Nyberg said the BAMC was effectively forced to bring in consultants at very short notice to conduct all the necessary technical analysis in order for the envisaged transfer of assets to take place at the end of May. In actual fact the delivery of bad loans was delayed until after the

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Responding to criticisms that BAMC had favoured hiring foreigners over Slovenians for most of the senior positions on its full-time staff and the alleged excessive use of consultants to work alongside them, Nyberg said: "Having been here [in Ljubljana] for a year now… I can say it's not true what is said in the papers sometimes that the necessary skills were available in Slovenia. They were not and we had to bring these skills in from outside."

He added that the use of experienced, highly qualified consultants had been necessary to instil some much-needed belief in BAMC's institutional capacities.

"To be honest, the international credibility of the financial system in Slovenia was very low and the consultants helped us to bring the credibility… that was necessary for the European authorities to say, 'This looks OK'."

According to Nyberg, the advice and knowledge imparted by consultants

"That's been costly, no question about that"

conclusion of a banking stress test and asset quality review in December that had been requested by the European Commission.

Nyberg said that while the BAMC had expected to be able to complete the transfer of assets by the middle of this year, it was actually told to complete the task before the end of 2013, which effectively involved two weeks of frantic activity before the Christmas period. "I've never experienced anything like this… [in terms of] the changes from month to month and the demands placed on the organisation and the flexibility following that."

to BAMC staff, which numbered 20 at the start of 2014 and will increase to around 70 by the second half of the year, has helped to develop skills that will remain in Slovenia long after the BAMC has completed its mandate and helped to resolve the crisis in the banking sector.

In terms of the costs and hours billed by consultants, Nyberg claimed the lack of complete information and data supplied about the assets that have been transferred to the BAMC has led to consultants having to conduct a lot of unnecessary and time-consuming analysis themselves. "That's been costly,

no question about that, and partly unnecessary as we could have been given the information by the commercial banks and the central bank, but this was not the case."

Regarding the BAMC's operating costs to date, Nyberg claimed that the €5m in total staff and consultancy costs in the course of the BAMC's nine months of operations from March-December 2013 were a fraction of the more than €20m paid in consultancy fees on the banking system stress test and asset quality review last December. "That's a huge cost and you can certainly question what you [Slovenia] got out of that compared to what we got out of our consultants… We have done what was not expected to be possible in such a short period of time and that was the successful transfer of assets from the banks to the BAMC." Furthermore, that €5m figure represents just 0.2% of the costs compared with the €1.5bn worth of assets that had been transferred to the BAMC by end-2013. Nyberg added that as a direct result of the successful completion of the asset transfer to the BAMC, rates on Slovenian government bonds fell by 100-150 basis points (bp) and claimed that would translate into lower overall borrowing costs for Slovenia in the future. "A 100bp [reduction in yield] will mean €300m a year in saved costs. I can assure you that if we had failed with the transfer, the rates would not have fallen in the way they did," Whether BAMC's management has successfully mollified public concerns about its role remains to be seen. But no matter how successful the bad bank proves to be, the hard-pressed Slovenian taxpayer is still looking at a multi-billion-euro bill to put right the wrongs of Slovenia's banking sector past.

Southeast Europe I 51 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

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Uzbek telecom scandal grows Clare Nuttall in Astana

T

he parent companies of Uzbekistan’s two main mobile operators, Scandinavia's TeliaSonera and Russia's VimpelCom, are under investigation in several international jurisdictions over their dealings with an offshore company linked to Uzbekistan’s “first daughter” Gulnara Karimova. The scandals that have engulfed Uzbekistan’s high risk but lucrative mobile telecommunications sector coincide with Karimova’s dramatic fall from power.

TeliaSonera and VimpelCom announced separately in March that investigations were underway in the US and the Netherlands, in addition to an ongoing investigation by Swedish prosecutors into TeliaSonera’s Uzbek operations.

Nasdaq-listed VimpelCom said March 12 that it is under investigation by the US Securities and Exchange Commission (SEC), and that its Amsterdam headquarters had received a visit from public prosecutors in the Netherlands, where it is “the focus of a criminal investigation”. “The

investigations appear to be concerned with the Company’s operation in Uzbekistan,” the statement explains.

TeliaSonera, which owns Coscom, the main rival to VimpelCom’s Unitel in Uzbekistan, has been under investigation in Sweden since journalists at television channel SVT revealed in 2012 that the company had paid around

insufficient effort had been made to investigate its local partner in Uzbekistan. Other senior officials dealing with the Eurasia region were replaced in 2013.

Power struggle Meanwhile, Swiss prosecutors confirmed on March 12 that Karimova, the daughter of Uzbek President Islam Karimov, is

"Operators will continue to take a risk by investing into countries like Uzbekistan and Turkmenistan" $350m to Takilant, a Gibraltar-based company linked to Karimova, to obtain its Uzbek 3G licence.

Since then, the scandal has claimed the heads of several top TeliaSonera executives including former CEO Lars Nyberg, who resigned in February 2013 after an investigation commissioned by TeliaSonera criticised the company's investment process and said that

an official suspect in an investigation connected to a “Swedish telecoms firm”, according to the BBC, while VimpelCom’s minority shareholder Telenor has been asked to submit documents to Norway’s financial police.

The turmoil in Uzbekistan's mobile telecom sector coincides with a power struggle within the Uzbek elite that has seen Karimova, once one of the

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country’s most powerful oligarchs, lose her business empire and power base.

Dubbed Uzbekistan’s “robber baron” in US diplomatic cables published by Wikileaks, Karimova used her position as the daughter of Uzbekistan’s authoritarian president to build an empire spanning sectors including banking, cement production, retail and telecoms.

Karimova was once considered a potential successor to her father, who has ruled Uzbekistan since independence in 1991. However, Karimova has publicly fallen out with her parents, while other members of the Uzbek elite, including National Security Service chief Rustam Inoyatov, are also ranged against her. In 2013, Karimova’s businesses within Uzbekistan were shut down and her overseas assets frozen, including CHF800m ($916m) in Swiss banks. Independent Uzbek news site Uznews reports that Karimova is now under house arrest in Tashkent.

Karimova and her associates were deeply embedded in the mobile telecoms sector, and as her influence has plummeted within Uzbekistan and abroad this has caused a seismic shift in the sector. As well as the scandals involving Takilant, Karimova is also rumoured to have been behind the shutdown of Uzbekistan’s third major mobile provider, Uzdunrobita, a subsidiary of Russia’s MTS, in 2012.

Uzdunrobita was the largest operator in Uzbekistan until July 2012 when its operating licence was suddenly suspended by the telecom regulator. In September 2012, the Tashkent Criminal Court ruled in favour of a government request to confiscate Uzdunrobita's assets. While, the ruling was overturned on appeal, MTS was ordered to pay around $600m in damages.

Coming back for more MTS has been particularly unlucky in Central Asia, suffering expensive reverses in Kyrgyzstan and Turkmenistan as well as Uzbekistan.

The situation in Uzbekistan may be an extreme example, but the high profits to be made in Central Asia’s

Tele2 shakes up Kazakh telecom market

Clare Nuttall in Astana Tele2 is a relative latecomer to the fast-growing CEE/CIS telecommunications scene, compared to the big Russian operators and rival Scandinavian firm TeliaSonera. The company’s strategy has therefore been to carve out a share in markets already dominated by the other big players – an approach it has successfully deployed in the Kazakhstani market.

It took until December 2013 – almost four years after Tele2 entered the Kazakh market through its takeover of struggling local network NEO – for Tele2 to reach positive Ebitda (the amount of cash the company generates annually) in the country.

When Tele2 took a majority stake in NEO in March 2010, the Kazakh operator's original owners had been on the market for some time, having made little headway against the dominant players in the Kazakhstani mobile telecom market, TeliaSonera’s Kcell and Vimpelcom.

Over the next four years, Tele2 spent over $600m building up its network, as well as rebranding. “In three years we increased our market share from close to zero to 12%. We are still not satisfied with this level; our long-term target is 30%,” Tele2 Kazakhstan CEO Pietari Kivikko tells bne. Currently, Kcell and Vimpelcom have market shares of around 50% and 35% respectively.

“The strategy of breaking monopolies or oligopolies is one that Tele2 has successfully used in several other markets including the Baltic states. We have so far invested $600m in our network, which was a huge financial burden, but Kazakhstan offers a great opportunity. Now we have come a long way and we will continue to expand. With sufficient effort it is possible to break a monopoly,” Kivikko says.

This is a strategy that Tele2 has already used in other markets, notably the Baltic states – its point of entry to the region ten years ago. As in Kazakhstan, Tele2 was a late entrant to a market where TeliaSonera was the largest player. Today Tele2 is the market leader in Lithuania and is one of the major operators in the other two Baltic states.

In Kazakhstan, Tele2 plans to continue its geographic expansion, aiming for coverage of well over 90%. The company is also working to lure more customers away from its rivals, and taking advantage of the rapid growth in data communications.

However, further growth in voice communications especially is partly dependent on regulatory steps in Kazakhstan. The unusually high cost of call termination in Kazakhstan was one of the biggest challenges for Tele2 as a newcomer breaking into a market where most of the population already had a mobile phone.

“Kazakhstan is different from other countries in that it has very high mobile termination rates, a situation that has been supporting and protecting the existing players. For a long time Kazakhstan’s mobile telecoms market was a duopoly,” explains Kivikko.

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mobile markets have made them all magnets for graft. The structure of the industry, with cash-rich international companies paying substantial one-off fees to obtain licences for 3G and other services, also creates big opportunities for corruption.

Despite the drawbacks, Uzbekistan’s mobile market is one of the most attractive in the region due to the

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attractive market, so I don’t think anyone would like to just give it up,” says Anton Pogrebinsky, analyst at Moscow-based consultancy AC&M. Even MTS, which wrote off its Uzbek business in 2012, has not ruled out a comeback. However, unlike in Turkmenistan where MTS successfully negotiated a return after its yearlong absence from the market, the

“It does look like Uzmobile is going to take substantial market share" country’s large population, which at over 30m is the third largest in the CIS after Russia and Ukraine. “Obviously there are huge political risks that existed before, just as they remain now and will continue in future. Operators will continue to take a risk by investing into countries like Uzbekistan and Turkmenistan. However, it’s still an

company would most likely have to start from scratch in Uzbekistan, since its equipment was handed over to Uzmobile, a subsidiary of state-owned UzbekTelecom, in December.

Tashkent initially tried to find a foreign strategic investor to take over MTS’ assets, but perhaps deterred by the fate

of the Russian company, there were no takers. The Uzbek government has now announced plans to turn Uzmobile into a major national mobile operator to rival Coscom and Unitel – essentially replacing Uzdunrobita as the third of the big three operators. “It does look like Uzmobile is going to take substantial market share. In my opinion Uzmobile is going to play a significant role and it’s going to play it soon, though how soon is hard to say,” says Pogrebinsky.

By 2015, Uzmobile will install almost 2,000 base stations across the country, to cover Tashkent and other major urban centres. In the following two years, the company will add a further 4,000 base stations, covering smaller settlements in Uzbekistan, Uzdaily reported. Uzmobile will have billing systems in place for two million numbers, mainly in the Tashkent area this year, increasing this to eight million numbers in other parts of the country in 2015.

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Old accusations The accusations against Satybaldiyev hark back to the events directly following the 2010 revolution that ousted the corrupt regime of Kurmanbek Bakiyev. Ata Meken alleges he misused funds when head of the State Directorate for Reconstruction and Development of Osh and Jalal-Abad – an agency set up to help the south recover from deadly ethnic violence following the revolution.

A report from a parliamentary commission on the directorate's work was issued in February.

A spring broom in Kyrgyzstan byline should be Clare Nuttall in Astana

K

yrgyzstan's three-party ruling coalition collapsed on March 18, stripping the government of its parliamentary majority. The resurrection of political uncertainty comes at an inauspicious time of the year.

The collapse was provoked when the socialist Ata-Meken, the smallest of the three parties in the ruling coalition, announced that it was quitting the government. The party accused Prime Minister Zhantoro Satybaldiyev of abuse of office and corruption. While Ata-Meken has just 18 MPs, without its support the remaining members of the coalition – President Almazbek Atambaev's Social Democratic Party of Kyrgyzstan (SDPK) and Ar Namys – can no longer command a parliamentary majority.

President Atambaev signed a decree dismissing the government on March 19, according to a statement on the presidential website. Under the Kyrgyz constitution, Satybaldiyev will continue as acting prime minister until a new government is formed. The next step will be for Atambaev to nominate one of the five parliamentary parties to

form a new government. The chosen party will have until April 9 to agree on a parliamentary majority and select a prime minister. If the parliament fails to elect a new government after three ballots, Atambaev has the power to dissolve the parliament and call an early election.

Speculation has long linked Ar-Namys leader and the head of the now defunct coalition Felix Kulov – among others – with ambitions to occupy the PM's office. Kulov told 24.kg on March 19 that he expects a new collation featuring

"[W]e believe that as the Prime Minister of the Kyrgyz Republic Zhantoro Satybaldiyev has exhausted his moral and political resources and cannot continue to occupy this high political office," the statement reads. "In this regard, the Ata Meken faction... decided to withdraw from the Yrys aldy Yntymak parliamentary coalition."

Bad timing The collapse of the coalition leaves the country once again in a state of political disarray after almost two years of relative stability. Since the 2010 revolution, Kyrgyzstan has built the first parliamentary democracy in Central Asia. The 2010 parliamentary election and 2011 presidential election were heralded by the Organisation for Security and Cooperation in Europe (OSCE) as the most open the region's history.

However, with at least three parties needed to form a coalition, it has proved difficult to form a stable government.

"Prime Minister Zhantoro Satybaldiyev has exhausted his moral and political resources and cannot continue to occupy this high political office" four parties. "I think three factions will definitely enter it, SDPK, Ar-Namys and Ata Meken, plus, probably, one more faction," he said. "But I don't know whom the President Almazbek Atambaev will entrust to form new alliance to, I don't tell fortunes."

Since the post-revolution parliament was elected in 2010, several different configurations have been tried and ultimately failed. Satybaldiyev, a neutral candidate, took the role of prime minister in 2012. During his term, the economy has seen steady improvement.

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Turkmen online The similarities between the US First Lady and the incongruous autocrat who runs Turkmenistan may not at first be obvious, but both have come out recently on the side of giving everyone access to the internet.

On a visit to China, Michelle Obama declared March 21 that access to the internet should be a universal right. A few weeks earlier on February 22, President Gurbanguly Berdymukhamedov, dubbed an "enemy of the internet", called for the internet to be made available to all 5.1m of Turkmen citizens.

Ashgabat has already launched a programme to develop the communications sector, which includes modernisation of internet connections to be carried out by 2016. The deputy chairman of the cabinet, Satlyk Satlykov, told a February 22 cabinet meeting that under the programme 60 automatic telephone exchanges and 63,264 telephone points will be put into operation. Of those new facilities, 26,944 will be connected to internet services. Turkmenistan is also planning to launch its first satellite in cooperation with France's Thales Alenia Space by the end of this year.

However, Turkmenistan remains one of the most authoritarian nations in the world, with access to independent news sites and international media is blocked. While the population should soon be able to get online then, it remains unclear if that access will be unfettered.

According to Reporters Without Borders (RWB), which includes Turkmenistan in its list of "enemies of the internet," only 2.2% of Turkmens have internet access. "Turkmenistan, one of the countries most hostile to freedom of expression, is still technologically and financially blocking the growth of the internet and imposing drastic censorship, resulting in a "Turkmenet" purged of any political or social topic," RWB wrote in March.

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According to the National Statistical Committee, GDP growth accelerated to 10.5% in 2013.

The collapse of the government also comes at a crucial juncture for the country, with Bishkek close to sealing a deal to increase its holding in the Kumtor gold mine – the most divisive political issue in Kyrgyzstan currently – as well as heading towards entry to the Russian-led Customs Union, which is competing with the EU for new members such as Ukraine.

Satybaldiyev has also been the driving force for a speedy negotiated settlement of the Kumtor issue. The government has been trying since 2012 to increase the state's shareholding in the gold mine, which accounts for around 12% of Kyrgyzstan's GDP. The mine's owner – Toronto-listed Centerra Gold – has agreed to deals that would hand the state a larger stake, as the PM has sought to hold off nationalists in order to avoid further erosion of investor confidence in the country. A March 2014 survey by Canadian think-tank the Fraser Institute rated Kyrgyzstan the least attractive international destination for mining companies, mainly due to the high level of uncertainty and political risk.

Kumtor is currently the largest foreignowned mine in the CIS region, and the government has faced heavy pressure from the nationalist opposition – as well as on the streets – to nationalise the asset. Numerous protests and rallies have been staged, both around the mine and in Bishkek and other cities, with some resulting in violent clashes.

There was a breakthrough on February 6, when the parliament voted in favour of a deal with Centerra that would give Kyrgyzstan a 50% stake in a new joint venture that will own the mine – despite voting down a similar deal in October.

The lower house gave the government up to four months to complete a draft deal on the creation of the JV. To what extent Satybaldiyev's exit will affect the deal is unclear. However, a lengthy hiatus while a new government

is formed is likely to result in delays, while the formation of a nationalistleaning coalition could spell even more trouble for the Canadian miner.

New club Other key issues under discussion in Bishkek include Kyrgyzstan's entry to the Customs Union and reforms to the energy sector. Although it was the first country outside the three founders – Russia, Belarus and Kazakhstan – to agree to join the Moscow-led trade club, Kyrgyzstan has been dragging its feet lately.

Adding his voice to those of other senior officials recently, Atambaev indicated in December that Bishkek is unhappy with the accession roadmap.

He told journalists Kyrgyzstan will not join the bloc using a roadmap that "someone else has laid out," and insisted his country will join "only if all the requirements of Kyrgyzstan are taken account."

Bishkek also broke rank with the rest of Central Asia in March to strongly criticize Russia's military incursion into Crimea, despite Moscow's growing role in the Kyrgyz economy since it backed the 2010 revolution. Russian companies have taken over Kyrgyzstan's gas distribution monopoly and one of the country's largest banks since 2012.

Moscow has also pledged to co-finance two major hydropower projects – a major issue for Bishkek. A hike in electricity prices triggered the 2010 revolution, and successive governments have repeatedly delayed introducing reforms due to fears that a rise in tariffs would be politically unacceptable.

Meanwhile, the timing of the government collapse is inauspicious.

The spring has previously proved a volatile time of year for Kyrgyzstan.

Demonstrations and protests have been frequent in recent years, and often erupted into violence. The country's two revolutions took place in March 2005 and April 2010, and the tense negotiations over a new coalition may well be accompanied by more unrest.

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deterred him. Rio owns 66% of the mine indirectly through its majority owned subsidiary Turquoise Hill Resources, while the government owns the remaining 34%. Under McRae's watch, in August last year Oyu Tolgoi suspended the next stage of the mine's development – where it says most of the deposit wealth will comes from – because of disputes with Mongolia's government, mainly concerning development costs. Given Oyu Tolgoi's importance to the wider economy, hiccups in this project have tended to have big knock-on effects on investor confidence and the wider economy.

Mongolian investors hope good times will roll again Terrence Edwards in Ulaanbaatar

M

ongolia doesn't attract the same amount of foreign investment as it used to and many investors have cut their losses and left. But some high-profile executives are standing their ground with the expectation that the good old days will return soon.

"There's a lot of money that needs to come into Mongolia, and it's not going to come in by itself," says Cameron McRae, who took on the role of executive chairman to Ulaanbaatarbased investment and advisory firm SkyPath Partners after nearly three years as the country manager for Rio Tinto in Mongolia, where he headed the giant $6.5bn Oyu Tolgoi copper-gold mine in Mongolia's Gobi desert.

McRae says he decided to stay on in Mongolia after stepping away from Oyu Tolgoi and Rio Tinto last November to see the country's fledgling mining industry meet its potential.

He also expects the emergence of new industries in Mongolia to contribute to the nation's growth.

But the money coming in today is far less than in 2011, when economic

growth peaked at 17.5%. Mongolia saw a 36% decline in foreign direct investment at the end of January from the year before. This has impacted on the economy; the Mongolian currency, the tugrik, depreciated 19% last year, which is partly responsible for a rise in inflation to 12.3% because the country

But Mongolia is now trying to make amends with investors. In November it enacted its new Investment Law, which removed the legislative hurdles put in place in mid-2012 that most agree were the reason that investment started fleeing Mongolia. The country at the start of this year also introduced laws that create a better regulatory system for the country's capital market and better environment for institutional investors in which to operate.

However, what may be keeping investors at bay are the continuing disputes the government has with Rio Tinto and other mining outfits. Another unresolved issue is the 106 licences that

"In one respect you could say part of Ulaanbaatar has been built on the confidence of the Oyu Tolgoi project" is so heavily dependent on imported fuel and food. Growth fell to 11.8% in 2013, but the 9.8% growth projected by the International Monetary Fund for this year puts the country among the highest growing economies in the world.

McRae has spent much of his career in Mongolia as a peacemaker managing the fraught relations between the government and Rio Tinto over Oyu Tolgoi, but his past struggles have not

Mongolian courts ordered cancelled because of criminal charges against the officials that had approved them.

McRae is advising Kincora Copper, which had to explain to investors a C$7m write-down because of the cancelled licences. He thinks the Mongolian government understands investors' gripes, however, and it is doing its best to build the kind of environment required to flourish. "I say often it's not about having good

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philosophy for your laws, they've got to be competitive to other jurisdictions and also want to get that same money streaming into their country, and I think the government is coming to grips with the need to have that competitive environment."

Real estate bull McRae is not alone in his optimism about Mongolia. Property development veteran Paul Byrne is CEO of the commercial real estate-focused Mongolia Growth Group. His resume boasts eight years leading commercial real estate development activities for the $3.2bn Hong Kong International Airport

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The country's frothy real estate markets have suffered since the global economic crisis. The office market began to recover began in 2010, however, and a 2014 report by another Ulaanbaatarbased properties firm, Asia Pacific Investment Partners, showed an approximate 14% rise in office rental prices to about $24.50 per square meter for top-tier space. Unfortunately, a lot of newly built office supply coming onto the market won't help demand.

But Oyu Tolgoi could be a game changer. The signing of an investment agreement for Oyu Tolgoi was largely responsible for the resurgence of

"You've got a huge wealth of infrastructure that needs to be built in the country" and client representative to the New York Port Authority for reconstruction of the World Trade Center.

While the $80m that Byrne says Mongolia Growth invested pales in comparison to the multi-billion-dollar projects and company portfolios he's worked with in the past, he sees more growth potential in sheer scale here.

The western market "doesn't see step changes like emerging markets," says Byrne.

Byrne is tasked with taking his company from one focused on second-tier commercial space to the country's "preferred real estate company and the dominant one." Up until now, Mongolia Growth has focused mostly on renovations and providing westernstandard office and retail space in a city where most construction projects forego international standards for design and safety. The next step, says Byrne, will be the development of entirely new properties while maintaining the same strategy employed in their renovated properties. "Our point of difference would be to build better standard buildings going forward, run them better, and managing them better."

economic growth in 2010, and analysts anticipate a similar scenario if the current issues surrounding Oyu Tolgoi are resolved. "There was a lot of OT [Oyu Tolgoi] money for secondary circulation that was being used to invest in real estate," says McRae. "In one respect you could say part of UB [Ulaanbaatar] has been built on the confidence of the OT project."

Made in Minegolia Nicknamed Minegolia for its heavy economic dependence on its minerals – copper, coal, iron ore and oil products represent about 77% of exports – Mongolia is utilising new tax stability incentives designed to encourage investment in areas other than resource extraction and in locations throughout the vast country. The government is also teeing up the infrastructure projects for transportation and power that the country sorely needs.

McRae intends to help investors learn how they can participate in the massive reconstruction effort, as well as other basic societal needs missing in the remoter corners of the world's most sparsely populated country. "You've got a huge wealth of infrastructure

that needs to be built in the country – whether it's replacing power stations, or extending the grid nationally," he says. "You can talk about schools and hospitals as government responsibility, but the private sector can play a very significant role in building and funding these projects."

Mongolian Prime Minister Norov Altankhuyag is making the transition from an import-oriented nation to one that can produce its own goods for domestic consumption and export a principal focus of his government. The PM has ordered that $230m of a $1.5bn sovereign bond issued in 2012 be used to finance the establishment of at-home industries for downstream processing of the minerals mined here, as well as agriculture, light industry and the production of materials for home and building construction.

Opening up new industries for clean energy generation, oil shale exploitation and coal-to-liquid fuel production are also long-term goals. In March, the Mongolian government announced it was pressing on with a joint venture with China's Sinopec to commission a gasification plant for Mongolia's reserves of lignite, also known as brown coal, by 2018.

And that's just where the country should be headed, says Byrne. Today, Mongolia is still vulnerable to external market influences. For example, the country's National Statistical Office reported an 11.8% decline in coal revenues in February from the year before, which is due at least in part by a 24% price decline at the border for coal products and weakening demand from China. Creating a more complex market that includes the production of diverse goods will mitigate these risks for the future.

"Sometimes what you see in emerging markets is, until you get enough critical mass on the bones, the peaks and troughs are very big," says Byrne while recalling his experience with economic crises throughout Asia. "Once you have a bit more meat on the bones, the peaks and troughs are less."

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Eurasia

Educating Raushan Naubet Bisenov in Almaty

W

hen a bank and pollsters planned a nationwide survey to measure the financial literacy of Kazakhstan's population, little did they know how handy the findings would be in helping to explain the financial panic that gripped the nation in February. Apparently a lack of financial awareness worsened the situation, leading to a run on several banks, explains the head of Kaspi Bank, a major Kazakh retail bank that helped organise the survey.

Kazakhstan's National Bank announced on February 11 a devaluation in the tenge which would allow the exchange rate to drop from KZT155 per dollar to KZT185, precipitating a 19% plunge in the value of the national currency. Some owners of tenge-denominated deposits rushed to withdraw their savings or convert them to foreign currency, mostly dollars or euros.

Further panic gripped the nation a week later when rumours started circulating via text message about the imminent bankruptcy of three Kazakh commercial banks – Alliance Bank, Bank CenterCredit and Kaspi. The three banks dismissed the rumours as "provocations aimed at destabilising Kazakhstan's financial system", while Kaspi announced a KZT100m ($540,000) reward for any information leading to the source of the rumours.

The rumours resulted in customers withdrawing about KZT40bn (some $220m), or 10% of total deposits, at Kaspi alone, forcing its controlling shareholder, private equity firm Baring Vostok Capital Partners, to provide the bank with $300m to meet the demand for cash.

Kazakhstan faced the threat of a bank run and potentially a systemic failure reminiscent of the country's banking collapse as the subprime crisis unfolded

in 2007, which saw BTA nationalised in February 2009 and sovereign wealth fund Samruk-Kazyna taking majority stakes in BTA subsidiary TemirBank and Alliance Bank, as well as minority stakes in Kazkommertsbank and Halyk Bank.

Need to know The overreaction by the general public has been blamed on the generally poor level of financial literacy among the Kazakh population, as shown by the survey conducted by the Almaty-based International Centre for Financial Literacy jointly with Kaspi between January 27 and February 12.

The poll of 1,200 people aged between 20 and 80 showed that only 6% of those surveyed knew that the Kazakhstan Deposit Insurance Fund provided 100% coverage on deposits of up to KZT5m

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organisations to help promote financial literacy among the population.

Lomtadze also cited the poll findings that almost half (44%) of Kazakhs with spare money kept it at home "under the mattress" and fewer than one in 10 (just 8%) deposited it in banks. "We hope that our 'Simply about Finances' educational programme will improve these indicators and people's interest in bank deposits will grow," he said.

Lomtadze's Kaspi is a significant player on the Kazakh consumer loan market, and as a result of the global financial crisis the bank decided in 2009 that it would operate its consumer loan business in tenge only so that the bank's clients would not have "to bear any foreign currency risk because they receive income in tenge, which is why we issue retail loans in tenge".

In an interview with bne, Lomtadze says that because of this the February devaluation of the tenge had no impact on Kaspi's clients. "As a result of the change in the exchange rate in February, the payments on our loans will not

"What should be changed in the Kazakh banking sector is that banks should be allowed to write off non-performing loans" ($27,000) held at banks participating in the scheme. "Only every second person knows that the deposits are guaranteed and only 6% know the maximum amount of guaranteed deposits stands at KZT5m," Kaspi's chairman, Mikhail Lomtadze, told a news conference in Kazakhstan's financial capital Almaty on March 13. "This explains why the February 2014 devaluation caused panic among the population. We should put more effort into increasing financial literacy."

For this purpose, under its "Simply about Finances" educational programme, Kaspi announced that it would invest $1m in competitive projects devised by individuals and

increase and our customers continue payments on their loans in tenge as they did in the past," he says.

At the same time, Lomtadze claims that Kaspi's loan portfolio isn't in a worse state than those of other Kazakh banks. The share of non-performing loans is around 5%, well below the industry average, despite the fact that Kazakhstan's legislation doesn't provide adequately for writing off loans. "What should be changed in the Kazakh banking sector is that banks should be allowed to write off non-performing loans. This will considerably clean up banks' balance sheets. Now, when you look at a Kazakh bank and compare it to a Russian bank which is able to write off bad loans, it

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Azerbaijan joins regional Eurobond push

Clare Nuttall in Astana Azerbaijan raised $1.25bn in a heavily over-subscribed debut Eurobond issue on March 10, shrugging off worries over the deepening crisis in Ukraine.

Kazakhstan could follow suit with a Eurobond later this year.

The bond saw strong demand totalling over $4bn for the 10-year bond. That saw pricing tighten from initial guidance of low to mid-200 basis points (bp) over US Treasuries to set a final yield of 5%. The Ukraine crisis had seen the yield on the 10-year Treasury hit 2.82% on March 7, its highest level in six weeks, while spreads on Russian, Ukrainian and Kazakh debt also widened considerably.

Azerbaijan is rated at the lowest investment grade by both Fitch and Standard & Poor's. In October, Fitch affirmed Azerbaijan's rating at 'BBB-', with the rating agency citing stable oil production and a sovereign balance sheet that is "one of the strongest among rated sovereigns".

There were suggestions as Azeri officials met with investors the week before the bond priced that the timing of the issue could depend on a resolution of the crisis in Ukraine. However, according to Clemente Cappello, founder and CEO of Sturgeon Capital, feedback from investors remained “pretty positive”. “From a financial standpoint, I don’t see any issues with risk. If there is concern, it would come from the political side, whether it’s perceived instability on the back of Ukraine or renewed tension with Armenia over Nagorno Karabakh,” he told bne.

The growing rift between Russia and the West could actually create more opportunities for Azerbaijan as an alternative energy supplier to Europe.

The risk of interruptions to Russian energy supplies that transit through Ukraine has the EU looking to accelerate efforts to secure alternative sources.

Azerbaijan is a major oil and gas producer and a key strategic export opening.

The consortium developing the second phase of the giant offshore Shah Deniz gasfield announced late last year it would send 10bn cubic metres of gas a year to Europe by 2019 through a new pipeline that will transit Turkey.

The main motivation for Azerbaijan's Eurobond was to set a benchmark for future corporate borrowers. State energy firm Socar has already successfully placed two Eurobond issues, raising $500m in 2012 and $1bn in 2013, and has signalled it may return to the international market in 2014 with an issue of up to $3bn. And the country's largest bank, International Bank of Azerbaijan, is considering a $500m issue.

Kazakhstan has also announced plans for a Eurobond this year. Finance Minister Bakhyt Sultanov said Astana hopes to raise $1bn via its first sovereign Eurobond for more than 13 years, after plans to borrow in 2013 were put on hold. However, while Baku’s debut into the international capital markets was largely to establish a benchmark, for Kazakhstan the motivation is different. "They probably do need the money in the short to medium term, but they don’t need to do a benchmark because Kazakhstan is already much more visible than Azerbaijan,” says Cappello.

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seems the share of non-performing loans in a Kazakh bank's portfolio is higher than in the portfolio of a Russian bank, but the actual difference is small."

Lomtadze says that even though Kaspi is heavily dependent on deposits as a source of funds, the bank also raised money from bonds on the domestic and international markets. "Last year we were the first Kazakh private, non-state-run bank to issue Eurobonds since the global financial crisis. The sum wasn't large – $200m. We wanted to re-introduce Kazakh banking and Kaspi Bank to international investors," Lomtadze says.

Kaspi is upbeat about its place in Kazakhstan's financial market, and Lomtadze believes his bank has been strengthened by the recent troubles: it now has a loyal customer base and a strong team with tested resilience.

As a bank focused on retail banking, Lomtadze says Kaspi places great value in people, both clients and staff: after the bank run, Kaspi decided to reward clients who decided to stay with it with a loyalty bonus of 1% of their tengedenominated deposits, and each member of staff received a bonus of KZT100,000 ($550) for their dedicated work during the 72-hour-long period of panic. Like workers at many industrial enterprises and public sector organisations, following the February devaluation Kaspi's staff received a 10% pay rise.

Changes within the competitive landscape of the Kazakh banking sector, with Kazkommertsbank acquiring the ailing BTA and HSBC quitting Kazakhstan altogether, don't seem to trouble Lomtadze much, and at the moment Baring Vostok had no plans to reduce its shareholding. "I see a disadvantage in foreign banks leaving the market in that they take together with them international experience. It is good to have them as competitors, as they bring to market new products and practices used in other international markets. It is interesting to compete against them."

While some foreign investors may be considering leaving emerging markets, Baring Vostok is there to stay with Kaspi in Kazakhstan, Lomtadze says.

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anger, and there has been widespread coverage of the likely impact on the cost of living. As a result, we could see workers demanding price-indexed wage rises," he says.

Anger as Kazakh labour devalued Naubet Bisenov in Almaty

K

azakhstan's mining sector stands to benefit from the February devaluation of the national currency. But fears that higher inflation and falling living standards could worsen simmering grievances of miners against their employers have forced some companies to pledge a 10% wage hike.

Kazakhstan's central bank devalued the national currency from KZT155 to KZT185 to the dollar on February 11, in an effort to counter a gradual 10% decline in the value of the Russian ruble since late last year.

Russia is Kazakhstan's largest trading partner, accounting for over a third of Kazakhstan's imports, and Kazakhstan's trade deficit with Russia stood at around $12bn last year.

In the short term at least, the devaluation will certainly favour Kazakhstan's mining companies, which mostly export their output. This should translate into a windfall for the Kazakh government; since oil and gas and other raw materials account for over 90% of Kazakhstan's exports, and are priced in dollars, the budget will receive more cash in tenge terms for its commodity exports.

"In general, we believe the devaluation is a positive phenomenon for the mining sector because mining is labour intensive, while revenue from it is in hard currency. That is why since most production costs such as wages and taxes remain in tenge and revenue in dollars, we expect profit margins to go up because of the devaluation," Leila Kulbayeva, a mining analyst at Almaty-

Indeed, pressure could build on Kazakh mining companies to do more to improve labour relations. Fearing job cuts, workers at Kazakhstan's major copper producer Kazakhmys and steel giant ArcelorMittal Temirtau have staged protests against poor working conditions and low pay in recent months, and the rising cost of living is seen provoking social discontent among Kazakh miners if their employers fail to meet their expectations.

Nice points to the need for Kazakh mining companies to cut costs to make their output competitive, which would mean reducing the workforce, but this is opposed by the government.

"Some Kazakh mining companies are still suffering from a problem of excess capacity. The devaluation will have provided some respite, but the companies remain in a difficult position because there is pressure from the government to avoid redundancies," Nice says. "The authorities seem to be taking a dual approach to the issue.

On the one hand, they are exerting pressure on companies (particularly

"The devaluation created a lot of public anger"

based investment bank Visor Capital, tells bne. "However, the devaluation will not have an impact on output figures in the mining sector, as output depends on production capacity and the global demand. The global markets are quite volatile now and as a major consumer of metals China has not shown signs of increasing demand."

However, Alex Nice, a Kazakhstan analyst at the London-based Economist Intelligence Unit, reckons any competitive gains could be short-lived.

"The devaluation created a lot of public

those which are foreign owned) to avoid redundancies and maintain wages; at the same time, there are proposals to amend the labour law to make it harder for unions to organise strikes."

Playing to the gallery Since the violent protests in the western oil town of Zhanaozen in December 2011, when Kazakh security troops killed 15 people, the government has taken seriously the grudges of local miners, who believe the country's growing prosperity is being built at their expense. After the devaluation

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in February, President Nursultan Nazarbayev personally urged the mining companies to increase pay by 10%. "The Kazakh government is acutely sensitive to labour unrest, particularly following the 2011 unrest in Zhanaozen," says Kate Mallinson, a Kazakhstan analyst at the London-based GPW consultancy.

"Many of the country’s cities and towns were built around mine sites and corporate social responsibility expectations remain high. In light of the recent devaluation and the concomitant inflationary pressure, the government is likely to increasingly put the burden on large mining companies to address the situation with increased salaries."

The Kazakh government does not tend to alienate foreign investors, but occasionally plays to the gallery: it openly criticised pay policies at ArcelorMittal Temirtau, whose billionaire owner Lakshmi Mittal is reported to have made additional investment conditional on further cost savings.

Eurasia

Kazakh Deputy Industry and New Technologies Minister Albert Rau claimed at a parliamentary conference on labour relations on March 14 that ArcelorMittal Temirtau did not remunerate workers properly for their qualifications. "At Arcelor, shame to point out, the difference in pay for qualifications is pennies. Of course, it is easier [for workers] to create noise than work on improving their qualifications," Rau said. "On this, to tell the truth, we do not have a good understanding with the management."

The government, aware of the problems in a sector that has been stagnant for several years due to sluggish global demand, is working on improving the business climate. "In spite of Kazakhstan’s mineral pedigree, many deposits are underinvested as a result of various issues including the bureaucratic nature of approval and regulatory processes. Recent initiatives to liberalise the sector and encourage foreign investment are a positive step to increasing output," says Mallinson.

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The potential for social unrest linked to the February devaluation in Kazakhstan will rise further if, as expected, more economic and political sanctions are imposed by the US and EU on Russia for its annexation of Crimea. A further fall in the Russian ruble could quickly eat up the estimated 10-percentage-point spare room that Kazakhstan's National Bank gave the tenge in dropping its value by a fifth, and some argue it might have to devalue the currency again.

"When the trade balance worsens, this affects the exchange rate. Theoretically, if the Russian ruble depreciates for a long time – for, let's say, six months – this will represent risks of further devaluation for the tenge," Visor Capital's Kulbayeva says.

Despite the short-term benefits of the devaluation for Kazakhstan's mining companies, they may yet find themselves in an awkward position because of the very source of these benefits.

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New Ukraine faces old problems

Ben Aris in Moscow

T

he interim Ukrainian government signed off on the long-mooted Association Agreement with the EU in March, setting the impasse with Russia in stone.

However, the "Maidan" government baulked at signing the economic part of the deal. Is the new administration about to find itself in exactly the same place as that of ousted president Viktor Yanukovych: refusing to sign the full agreement with the EU unless it gives Ukraine more money?

That would be ironic.

Ukraine is bankrupt and needs billions of dollars fast to prevent a full-blown financial crisis. The problem is the EU is not in good financial shape either and cannot afford to bail out yet another country.

With the EU already having in one form or another bailed out Ireland, Greece, Cyprus, Portugal and Spain, the question is whether it can justify shelling out the $35bn (just for this year) that the Ukraine government is asking for. It would be an extremely hard sell, as Europeans are tired of being asked to pay for other countries (and banks) while their own living standards fall.

Yet this is where Europe is heading. So far, the EU's game to take Ukraine from Russia has been all tactics and no strategy. The money on the table is simply not enough to even get Ukraine through this year, let alone pay for the deep structural reforms and recovery the country requires.

The EU added another $1.4bn to its bailout package in March, bringing the total on offer to around $15bn over several years. “Over $2bn will be transferred to accounts of the Ukrainian government to stabilize the economic situation in Ukraine. The deadline for the transfer is late April or early May,� interim PM Arseniy Yatsenyuk said.

At the same time, the US has almost voted through $1bn in credit guarantees to help Ukraine get through this rough patch. But this money is laughably insufficient.

Hard numbers Run through the numbers. Ukraine has between $12bn and $15bn (depending on whom you ask) in hard currency reserves, or less than two months' import cover, which is not enough to maintain the stability of the currency. Moreover, the economic damage done by the three months of protests almost certainly guarantees the economy will contract this year.

In terms of outgoings this year, the state has some $7bn worth of debt redemptions, including payments due to the International Monetary Fund (IMF). Russia is almost certain to increase the price it charges Ukraine for gas from the "special price" of about $260 per thousand cubic metres to around the $400 it was charging under the terms of the deal cut by former PM Yulia Tymoshenko in 2009. It has even suggested the price could be increased to $500. This price hike will cost Ukraine an extra $7bn a year in fuel bills. That's $14bn right there, all of Ukraine's reserves, and that is before you spend a penny on pensions, teachers or new power stations.

Add to this the $2bn that Ukraine owes Russia's Gazprom for gas deliveries this year and an unpaid gas bill of $7bn from last year. If you include the $3bn of Ukrainian bonds that Russia bought in December, Russian Prime Minister Dmitry Medvedev said Ukraine's total debt to Russia is about $16bn – more than the country's entire hard currency reserves.

EU foreign policy chief Catherine Ashton voiced deep concern on March 22 over the fragility of Ukraine's economy and said a short-term budget deficit problem had to be

Opinion

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resolved "relatively quickly". But while there is a lot of talk about rallying the global community to bail out Ukraine, there's so far very little in the way of actual commitments.

An IMF team was in Kyiv in the second half of March to assess the situation and work out the details of a new stand-by loan programme. The IMF earlier said that no IMF money could be released until April, though last week admitted that even this date would probably be missed.

have been signed now and the political part, that sets Ukraine in permanent conflict with Russia and ignores the interests of the population in the east of the country, should have been signed after the presidential elections when those people actually have some representation in the government.

For its part, the EU also said that it would accelerate dropping some of its trade tariffs immediately. Under the terms of the Deep and Comprehensive Free Trade Agreement (DCFTA), Ukraine was due to drop its barriers immediately, while the EU would drop its own barriers "eventually" depending on Ukraine's progress with deep and painful structural reforms. The concession to drop more barriers early sounds good, but economists say it is actually worth about $200m over five months.

Yatsenyuk said the economic part of the agreement, rejected by the previous government over fears of significant economic losses, will be signed only after the presidential election due on May 25. But arguably, it should have been the other way round: the economic part of the deal – the whole point of signing up to the EU in the first place – should

“Over $2bn will be transferred to accounts of the Ukrainian government to stabilize the economic situation"

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