Business New Europe

Inside this issue: Rigged in Ukraine Pirates in Prague An illegal business that's smoking Desert winds May 2012 www.businessneweurope.eu

Special Report: Serbia votes

The new face of Russian business

How to invest in Eastern Europe and China

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bne May 2012 Editor-in-chief: Ben Aris (Moscow) editor@businessneweurope.eu

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Contents

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Central Europe: Robert Smyth (Budapest) +36 19995200 rsmyth_hu@yahoo.com Jan Cienski (Warsaw) +48 604994850 jancienski@ft.pl Mike Collier (Riga) +37 129473192 editor@balticfeatures.com Matthew Day (Warsaw) +48 607291187 mattday@businessneweurope.eu Tom Nicholson (Bratislava) +42 1907732736 tom.nicholson@sme.sk Kester Eddy (Budapest) +36 308665550 kester.eddy@gmail.com Steven Roman (Tallinn) +372 56665911 steven@online.ee Southeast Europe: Justin Vela (Istanbul) justinvela@bne.eu David O'Byrne (Istanbul) davidob@ttnet.net.tr Bernard Kennedy (Ankara) bkennedy@superonline.com Ian Bancroft (Belgrade) ian.bancroft@transconflict.com Bogdan Preda (Bucharest) bpreda@gmail.com Branimir Kondov (Sofia) br_kondov@yahoo.co.uk Guy Norton (Zagreb) norton@bne.eu

15 COVER STORY 6

The Insiders

24

Pirates in Prague

8

The new face of Russian business

25

Czech the food label

27

Ryanair lands in Hungary to much fanfare

29

A much harder Tusk

30

Europe is sure of shale

31

In Veritweet we trust

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Eurasia: Bureau Chief: Clare Nuttall (Almaty) +7 7073011495 nuttall@businessneweurope.eu Molly Corso (Tbilisi) molly_corso@yahoo.com Oliver Belfitt-Nash (Ulaanbaatar) +97688113149 oliver@businessneweurope.eu

Perspective

EASTERN EUROPE

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CENTRAL EUROPE

12

Rigged in Ukraine

15

Avtovaz's last stand

17

Big plans for Moscow

19

Russia's business park life blooms

33

An illegal business that's smoking

21

Da Vinci bets on Russian pension reform

35

Bosnia's economy functional but hamstrung

22

Shutters come down in Belarus

37

About more than just kebab shops

38

Made in Turkey

SOUTHEAST EUROPE

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Contents

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35

66

40

Turkey a fearless investor in the Middle East

52

From conflict zone to tourist zone

42

Croatia's activist investor

53

Fast-food fight in the Caucasus

44

Slovenia's banks on the rack as losses mounts

SPECIAL REPORT 62

Serbian elections to showcase the new normal

64

Serbia's well-defined economic path

SPECIAL FOCUS – AZERBAIJAN

66

Belgrade designers face uncertain future

PASHA Bank – A commitment to quality

67

Local heroes

A makeover based on oil, pomegranates and music

69

CLASSIFIED

70

UPCOMING EVENTS

EURASIA 54 46

Personality trumps policy in Armenian politics

48

Food for thought in Armenia

49

Slowdown in sight for Armenia's banking sector

49

Armenia's rising stocks

50

Desert winds

56

57

Gloves come off in Azeri bank sector

OPINION 59

Putin III – what's in store?

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I The Insiders

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Building a regional powerhouse

making, but it was a quantum leap in our business. With all the reporting requirements, you are really creating a different quality of institution," he says.

The road ahead The biggest headache today is the raft of new regulations being pushed through by governments in the wake of the 2008 financial crisis, which Stepic believes are not being phased in because it would be too difficult a sell to the public.

Nicholas Watson in Prague Herbert Stepic

H

erbert Stepic is in fine fettle. Buoyed by receiving the Grand Decoration of Honour in Gold for Services to the Republic of Austria, one of his country's highest honours for business people, the 65-year-old banker has secured a new five-year contract to run Raiffeisen Bank International and is eager to start work on adapting the bank he has built into one of the region's powerhouses to the post-crisis reality.

"All the work in setting up the bank has been done and our job for the future is to optimise our structures and adapt them to the new market requirements," Stepic tells bne. "Banking will be different in the future, no question. And if capital is becoming scarce and more expensive, you will have to change strategy and adapt it."

"In a nutshell," he concludes, "we have a perfect set-up and strategy to be very successful over the next five to ten years."

The genesis of that set-up began 25 years ago with a joint venture in Hungary in 1987 with a bank then called Unibank.

This was the starting point for a career that culminated in that award, presented to Stepic by Austrian Federal President Heinz Fischer in a ceremony on March 31. RBI was undoubtedly one of the pioneers of western business in the newly opened markets of Central and Eastern Europe, and Stepic the visionary behind that strategic move. "For me, the unification of Europe is something I have been working for all my professional life and finally when in 1989 Eastern Europe opened up, I saw it as a unique chance for Europe and Austria specifically," says Stepic. "Highlighted by President Fischer was my role in safeguarding the financial sector of CEE and by doing so strengthening the role of Austria as a business location."

In hindsight, it's perhaps obvious that Austria would reclaim its role as a major player in its historic hinterland. Yet in those heady days when the Berlin Wall was crashing down and people were throwing off the shackles of communism, no one knew how quickly or deeply the region would grasp the opportunity to remould their economies in Western Europe's image.

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Stepic says he did not meet any great resistance from his shareholders when he acquainted them with his plan to push out into Austria's former imperial lands. For one thing, he explains, Austria was over-banked so the room to grow at home was limited. Second, the new markets were basically virgin territory, giving RBI the chance to offer products and services that were in demand, rather than those it would be necessary to create the demand for. Finally, the shareholders were inclined to back Stepic due to the huge success of the first venture in Hungary.

"With our present geographical setup, we believe we have covered all the interesting markets of the region"

That strategy outlined by Stepic comprised three steps: to first move into Central/Southeast Europe, then to Eastern Europe, and finally to the countries of the Commonwealth of Independent States (CIS). And this is basically what happened, so that today RBI has an extensive network of subsidiary banks in 17 markets serving almost 14m customers through around 2,900 outlets, the vast majority of which are located in CEE. That process has, inevitably, had its ups and downs. Stepic picks Russia's financial crisis in 1998 as a low point. "We were just about to open in Russia and in the time leading up to that we had lost already $150m due to the fact we’d been hedging our shillings and dollars against the local currency."

Set against that are the highlights, such as the bank's IPO in 2005, which saw it raise €1.11bn, the biggest IPO in Austrian stock market history at that time. "It took us two years in the

Chief among them is the regulation from the European Banking Authority (EBA) that obliges banks to increase their core Tier 1 capital to over 9% in a very short period of time.

Raiffeisen Zentralbank Oesterreich, the parent bank of RBI, is required by the EBA to raise its Tier 1 capital above 9% by the end of June. And on April 20, RZB announced plans for a capital increase worth €840m. "With this transaction and in economic terms, RZB's participation capital will be transformed into share capital, in order to meet the new regulatory requirements effective as of mid-2012," the bank said.

The issue Stepic has with the legislation is not the rise in the level of capital per se, but the short duration with which banks had to perform the task in a difficult environment. "This is very negatively affecting the lending activities of major banks, as we are now concentrating on how to create capital in a very difficult time when the capital markets aren’t working well, rather than how we can give loans to the economy."

He adds that this rush to introduce new legislation has led to a situation where the regulators are out of step with each other, so a ruling from one sometimes contradicts the ruling of another. "If you are confronted with this situation, it is very difficult to do business," he sighs.

Staying put Stepic says RBI is currently present in all the markets that it feels are interesting, and there are no plans to enter new ones. "Frankly speaking, with our present geographical setup, we believe we have covered all the interesting markets of the region," he says. "We are present in all the CIS countries including Belarus, and the only geographical areas we have not entered are the Baltic states, which are too small and dominated by the Scandinavian banks, and we have no intention for the time being to enter the Central Asian countries, because we believe the political environment there is not guaranteeing the safe development of banking."

At the same time, neither is RBI planning to leave any existing markets. Russia, for example, is proving to be the graveyard of many western banks' ambitions; the past year has seen Barclays Bank and HSBC among others quit the country, citing the fierce retail competition from the giant state-controlled banks with ties to regulators – Sberbank and VTB Group.

RBI was one of the first western banks to start operations there, and so is much more established than many of its

foreign peers, with over 200 branches in 44 provinces. "We're not just restricted to Moscow and St Petersburg, but in all the large provincial centres… and our standing in the market on this regional basis will allow us to grow with the market."

The same could be said for RBI in Ukraine, another market with its own particular set of problems. RBI led the charge into Ukraine when it bought the country's second-largest commercial bank, Bank Aval, in 2005. That set off a rush by other banks over the following 18 months, which ended with some paying extraordinary amounts of up to 6x book value for local banks.

Unfortunately, the five years following the "Orange Revolution" were, says Stepic, "lost years", as the two main players in the movement, former president Viktor Yushchenko and former prime minister Yulia Tymoshenko, spent most of their time feuding. The jury is still out on the current president, Viktor Yanukovych, who has presided over more political and economic stability, a prerequisite for growth, but needs to address the serious failings in the system such as the judiciary.

The banking sector in Ukraine is still dealing with the fallout from the 2008 crisis and the huge devaluation in the local currency, which left many borrowers of loans in foreign currencies (half of mortgages are forex ones) struggling to keep up their payments. Non-performing loans are estimated at between 25% and 30% of all loans, in some segments even higher.

Even so, Stepic describes Ukraine as "a really important" country for RBI to be in. "We have one of the strongest brands, and one of the largest banks with 900 branches. Even in difficult times, we were one of the most profitable banks," says Stepic.

"If the government is able to offer stability and continue even at the current small pace the restructuring of the economy, then I believe that within the next two to three years the banking industry will see a strong revival."

"For me, the unification of Europe is something I have been working for all my professional life"

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crisis. Rogers clearly underestimated Alimov when locking horns with him.

"I guess I was rather aggressive and for several weeks after the [Vanity Fair] article my apartment turned into a mini PR agency, as I had to answer hundreds of calls and thousands of emails from the media," says Alimov, sitting in a cafĂŠ next to the Stalin skyscraper at Barrikadnaya in central Moscow. "But it ended up doing me a lot of good, as I met several very interesting people as a result."

Facts and a good story The email exchange between the two began politely enough. Alimov sent a reasoned email that went through his counter arguments to Roger's statements, backed up with statistics and citations.

"I am the 'lad' who disputed your factual claims with regard to Russia today," Alimov began, going on to highlight three specific allegations that Rogers had made: people are leaving Russia ("wrong"); Russia's oil production is declining, and oil companies are not reinvesting ("wrong and wrong"); investors are abandoning Russia ("wrong again").

The new face of Russian business Ben Aris in Moscow

L

egendary investor Jim Rogers should rue the day he took on Dmitry Alimov, a 29-year-old Russian MBA student, during a talk he gave at Harvard Business School in 2003.

Rogers disparaged Russia as a hopeless case just as the economy was starting a five-year boom. Alimov stood up at the end of the talk and took issue with Rogers, following up with an email exchange that was so widely circulated it ended up as an article in Vanity Fair. Rogers wrote Alimov off as a know-it-all neophyte, but nine years on and Alimov has just launched a tech fund, and is well on his way to becoming a prominent member of Russia's third wave of tycoons.

Today, Alimov is unabashed about his very public run-in with one of the world's most famous investors. Rogers is best known as a co-founder of the Quantum Fund, which he set up with George Soros and "broke the Bank of England" by forcing the British out of the European Exchange Rate Mechanism in 1992, making the two men billionaires in the process. "Rogers was talking about Russia and running it down. But the problem was not what he was saying, but the fact that he clearly didn't know what he was talking about. So I wrote an email to him to correct the factual errors, copying the email to a few Russian-speaking friends at the school," says Alimov.

The subsequent email exchange was hilarious and as Alimov copied in his fellow Harvard collegues, it quickly spread around the world, reaching trading desks in Moscow, New York and London before the press eventually picked up on the story.

Alimov may have been a student, but he was no greenhorn. He began his career as an analyst with Renaissance Capital in 1998 under the head of investment banking Leonid Rozhetskin (who was later murdered at Jurmala, Lativa in March 2008) before moving on to work for the bank's founder Boris Jordan at the $500m Sputnik Fund after the 1998

Cover Story I 9

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Following Russia's 1998 financial crisis, the devaluation of the ruble had jumpedstarted the economy. GDP growth had turned positive for the first time since the collapse of the Soviet Union and was up 10% in 2000 alone (a record that stands to this day). The oil companies were flourishing with double-digit production growth and in 1999 Lukoil invested more into the sector than the entire sector had ever invested before in a single year. And the tide of portfolio investors had just made Yukos owner Mikhail Khodorkovsky the richest man in the world under 40 years old.

While in 2003 some black clouds had appeared on the horizon (Khodorkovsky was arrested at the end of the same year), when Rogers made his speech Russia had never looked as good since the investment story began in 1991.

"Many people, including future leaders at Harvard Business School, listen to you," Alimov concluded in his email. "It would be very unfortunate if they were misled by your inaccurate statements.

Finally, if nothing else, it is not good for your own public image."

A few days later, Rogers replied, beginning with: "Thank you for coming [to my talk at Harvard Business School] and for writing. I rarely suffer fools gladly and even more rarely bother with chauvinistic know-nothings, but since you sent this ludicrous canard..." He then launched into a furious rebuttal, peppered with phrases like this one as the introduction to a comment on Russia's positive trade balanc: "Oh my. You really should have kept your mouth shut and stopped long ago."

What made this exchange so amusing is that Alimov replied and countered, point for point, with indisputable evidence Roger's attempt to rubbish Alimov's arguments. On the trade balance point, Alimov wrote: "The quote below is taken directly from US Department of Energy website (I hope you at least believe your own government). Or do you think the US government is also lying?"

As the exchange continued, the emails became more and more widely distributed until Rogers, who had made a complete fool of himself, finally gave up

al reserves in the world and a top-three European consumer market, Russia is far from being hopeless, yet it's difficult to get this message out given the very volatile nature of the economy. The problem of senior investment figures like Rogers, who patently haven't done even the most basic research on Russia, blithely condemning the country out of hand on the basis of half-digested impressions drawn largely from reading the international press, is as big today as it was in 2003.

The irony of the whole affair is that Alimov is living testimony to the changes going on in the country. During his time at Sputnik, Alimov was in charge of dealing with the broadcaster NTV that was taken over by Gazprom Media following Vladimir Putin's election as president in 2000 and the subsequent attack on the oligarchs. Gazprom Media was given to Jordan to manage and Alimov did the work. "That was a mad time," says Alimov. "I was in charge of generating revenue, but we had some regions like Novosibirsk, where the local station manager would screen out the ads we sold in Moscow and replace them with

"Rogers was talking about Russia and running it down. But the problem was the fact that he clearly didn't know what he was talking about"

and stopped replying. "I don't know why I even bothered to answer that guy in the first place," Rogers told a Vanity Fair reporter who finally caught up with him.

"Whether oil production is up five or six per cent is pretty meaningless in the context of this discussion, which was, and is, that Russia's a hopeless place to invest."

Where is he now?

The whole Rogers-Alimov exchange highlights a problem that plagues Russia's veteran investors to this day. With the fastest economic growth in Europe, the best performing stock market year to date, the third highest gross internation-

an ad for some local business, like a car repair shop, and pocket the money."

Among the assets Jordan inherited was TNT, a small broadcaster on the brink of bankruptcy. Jordan put Alimov, still in his mid-20s, in charge and within two years he had managed to turn it around.

Today, TNT is one of Russia's leading commercial broadcasters. However, Alimov got bored and after taking a break to study for an MBA at Harvard in 2002, he returned to Russia and was immediately offered a job by one of the "interesting people" he met as a result of his newfound fame from the email duel, Len Blavatnik.

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Blavatnik is a Russian-born US resident who is currently ranked number 72 on the Forbes rich list and his Access Industries is one of the shareholders in the British-Russian oil joint venture TNK-BP. Blavatinik put Alimov in charge of A Media, a TV and film production company. "It was a simple model. We took a successful format in other countries and adapted them to the Russian market. The series was more likely to succeed if it had been proven to work elsewhere, but we always did deals with the owner either as a collaboration or paying a license fee," says Alimov, who remains a close friend of Blavatnik's.

By the time Alimov struck out on his own again in 2006, A Media was turning over $60m a year. Alimov, who had a stake in the company, finally had some real money in his pocket and cast about for something new to do. "My first degree was in computers and maths, so I pretty quickly came to the internet. I had a partner at Sputnik who asked me to come in and run RuNet," says Alimov.

RuNet was one of the pioneers of the Russian internet and by 2006 the number of users was doubling every 18 months or so. Today, a third of Russians are online, and nationwide broadband internet access with a speed of 50 megabits per second will be available to all Russian homes by 2015, according

"The first entrepreneurs are taking their early steps, but the risk/rewards in Russia are better than elsewhere. What could be more fun?"

to telecom giant Svyazinvest's deputy CEO, Mikhail Leshchenko. Alimov and his partners began developing companies to bring Russia into the 21st century. Their most successful venture was ivi.ru – a site that airs out-of-copyright movies for free, but makes money on the advertising. According to a recent survey, 97% of Russians online use the

internet to watch movies. "The model for this type of business in Russia is a bit different," says Alimov. "Because of the widespread piracy, there is no way to make people pay for access for content (although now we have some Hollywood blockbusters that are paid for), so for most of the films the revenue is generated from advertising, but for the user it is free."

The site has been a smash and is the market leader for legal movie distribution in Russia, although the legitimate business remains dwarfed by the rampant piracy. However, accession to the World Trade Organization in December means the issue of piracy is slowly being addressed.

In 2008, Alimov moved again, cashing out of RuNet in which he held a stake. In January, he launched Frontier Ventures, a fund aimed at Russia's burgeoning e-commerce business that has already raised $50m. "We are looking to invest into five or ten projects and looking for ideas based on an established business model," says Alimov. "These are not clones - that is an over-simplification, as you have to take the ideas and adapt them to the Russian realities."

The timing for the fund is good, as the Russian internet is growing very fast and, according to bne estimates, the e-commerce sector could be worth as much as â‚Ź103bn by 2019. "Now people are not just looking at pictures, but they are spending tens of billions of dollars.

And it is only starting to grow now," says Alimov. "I estimate that the market has another 10-15 years to run before it starts to reach maturity. The first entrepreneurs are taking their early steps, but the risk/rewards in Russia are better than elsewhere. What could be more fun?"

And Rogers? At the start of April, he told a investment conference in Budapest: "I expect the price of gold to decline and when that happens I will buy more."

It may not be a stupid move, but what could be more boring than that?

Perspective I 11

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CEE bank sale ends today!

Tim Gosling in Prague

E

urope's debt crisis has provoked a steady series of large M&A deals in the financial sector of Poland and elsewhere, but that now looks have run its course, suggesting there won't be any more significant bank deals in Central and Eastern Europe over the next 12 months.

says Gunter Hohberger from Erste Bank Group. "They have a huge choice of CEE units that are failing to meet goals.

Perhaps they'd like to get rid of their Baltic operations for instance... but given current pricing, selling these assets right now is not the best option."

Spanish banking giant Santander looks to have book-ended the acquisition spree with its purchase of Bank Zachodni WBK in March 2011, which it will merge with the subsequently acquired Kredyt Bank in February. In between, Raiffeisen Bank International bought Polbank and Germany's Talanx teamed up with Japan's Meiji Yasuda to purchase insurance giant Warta.

Overall, Raiffeisen Research notes in its 2012 banking sector outlook that the banking sector environment in CEE remains challenging, especially in terms of loan demand and funding conditions. "Capital outflow and banking sector de-leveraging is taking place," it says, mentioning in particular Ukraine, Hungary and some Southeast Europe countries where credit growth remains subdued and non-performing loans are still on the rise.

Most of those deals were sparked by problems further west.

Belgian KBC Group sold Kredyt and Warta due to pressure to start getting back into shape following a â‚Ź7bn government bailout; Allied Irish Banks sold Bank Zachodni due to similar problems.

However, elsewhere the pressure has eased, and more deals are unlikely in the short term because the targets are few and far between. In terms of major Polish banks, Millennium BCP was meant to be next on the block, but Banco Comercial Portugues took it off the market after a successful restructuring at the parent. Speculation persists over BRE, but parent Commerzbank has said that it sees Poland as its top overseas market.

Jovan Sikimic at Raiffeisen Research says that according to his sources, "Commerzbank doesn't want to sell, but if forced, will try to maintain German participation, perhaps through a swap deal with someone like Deutsche Bank."

Elsewhere in CEE, there's little reason for the European groups that dominate the conservative Czech and Slovak sectors to exit. With loan/deposit ratios well below 100% and non-performing loans stabilising, growth opportunities may be limited, but boring is good for bankers right now.

In light of that, Sikimic suggests there could be some consolidation of mid-sized banks in Serbia, as it offers better growth prospects than most. "However, we won't see any major acquisitions in [Southeast Europe], even at these rock bottom prices" of 0.2-0.3 times book value There is one pair of non-European suitors with huge resources still sniffing around CEE banking assets, but Russia and China's massive state banks also appear to have their sights set on Poland almost exclusively. Even should they find targets there, the idea provokes stiff resistance in Warsaw.

According to the daily Rzeczpospolita, Poland's internal security agency ABW warned in November of an acceleration in Russian security service activity connected to the takeover of the Polish banking sector. The focus, the intelligence agency warned, is on officials at the financial markets regulator KNF, which has the final say on any potential acquisitions.

Little cash to splash At the same time, the list of acquirers has also narrowed.

Europe's banks are busy scrambling to meet the new European Banking Authority capital requirements and have precious little cash to spare, even on a market as attractive as Poland, where the country's banks are reporting booming profits in the first quarter, even after setting records in 2011.

Russia's state-controlled behemoth Sberbank has made no secret of its desire to expand in CEE following its entry to nine regional markets via the acquisition of mid-sized Volksbank International in 2011. Specifically targeting Poland and Turkey, it has said it will outline plans this summer. Whilst Millennium and BRE look to be off the table, Sberbank has been linked with recent start-up Alior and bne reported in April it's preparing to expand into the markets of the Baltic states, with the first step being its Belarus subsidiary BPS-Sberbank opening a subsidiary in Latvia.

Therefore, there appears little scope for those that might like to shift assets into other CEE markets where growth is stagnant and the banks struggling. "One big question is what the Italian banks are doing with their assets outside their focus markets of Russia, Poland, the Czech Republic and Turkey,"

China has also been flirting heavily with Warsaw, and Bank of China and Industrial and Commercial Bank of China are due to open branches in the country in the near future. However, Chinese officials have been careful to assure KNF that there's no plans to try to acquire a major bank.

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a market capitalisation of around $17bn, which is owned by Norway's richest man, tanker king John Fredriksen, who is chairman of the board.

"That's news to me," said Ikäheimonen of the sale of the former Seadrill rig to CMNG for $400m. "You're telling me the Ukrainian government, who became the ultimate owners of the rig, paid $400m for our rig and had a tender out for similar rigs?" He called the price tag of $400m "ridiculous," but insisted that the company had been unaware of any scandal in Ukraine until now.

Asked why Seadrill had not participated in the Ukrainian tender directly – which could theoretically have netted the company $150m more for the same rig Ikäheimonen said: "We have never even heard of such a tender. If that tender would reappear in front of me, I would definitely be very interested, but also a little suspicious as to why someone pays $400m for something not quite worth it."

Rigged in Ukraine Graham Stack in Oslo

I

nterviews with Norwegian executives shed new light on murky Ukrainian deals in 2011, where rigs sold by Norwegian companies to unknown parties were resold to a Ukrainian state oil company in apparently fixed tenders for enormous mark-ups.

Ukraine's state-owned Black Sea oil and gas driller Chornomornaftogaz (CMNG), a minor and moribund company prior to 2010, became – entirely unexpectedly – one of Ukraine's largest investors in 2011, with a spending spree of about $950m on buying new rigs and support vessels, a large part of which was spent in Norway. The spree was financed by CMNG's parent company, Ukraine's national gas operator Naftogaz Ukraine, which is itself dependent on state cash infusions to stay afloat. Suspicion is strong that CMNG's spending spree was motivated not by the riches of

the Black Sea shelf, but by the opportunity to siphon off hundreds of millions of dollars from the state.

Esa Ikäheimonen, CFO of the world's second largest offshore driller, Norway's Seadrill, confirmed to bne in an interview that Seadrill in April 2011 sold its West Juno rig to a UK shell company Highway Investment Processing for

ently selling for just over $400m the rig purchased for $248.5m from Seadrill.

The news, which broke almost exactly one year ago, and was then followed by a second identical case in October 2011, has sent shockwaves through Ukraine, forcing government officials and state company executives to take to the airwaves to deny the allegations,

"The company you are referring to does not exist"

$248.5m. In parallel to the acquisition from Seadrill, Highway Investment Processing participated in a Ukrainian tender to sell a rig of the same specifications to CMNG – and won the tender, appar-

but largely failing to alleviate suspicions about the affair. In Norway, however, the press completely missed the story – despite the involvement of local heroes of the scale of Seadrill, a company with

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Ikäheimonen said Seadrill had dealt directly with Highway Investment's representatives. According to the Seadrill CFO, the Highway Investment people were "English citizens" to the best of his recollection, but he said he could not name names because he had not met with them personally. He said there had been no involvement of Ukrainian state officials or state company executives in the deal. Seadrill have not disclosed the beneficiaries or representatives of Highway Investment. "What happened subsequently with the rig is not our business," Ikäheimonen said.

The Seadrill executive personally responsible for the sale, Jan Olaf Osthus, told bne that the fact that the rig would be deployed in Ukraine had been "part of the background" to the deal, and that the purchasing structure behind the Highway Investment vehicle had been from the "energy business," but said he could not disclose the identity of the counterparty.

Ikäheimonen said Seadrill had been paid a "good market price" for the rig by the intermediaries, saying the rig would cost $230m drill-ready from the yard, and said the company "felt comfortable with

the transaction." The company's accounts say Seadrill made $23m on the deal.

Investment in the third quarter of 2011, according to company announcements.

Analysts tell bne that Seadrill indeed got a very good price for its rig, but that the concept of a market price is tricky for the illiquid market in jackup rigs, which are mobile rigs with support legs used for drilling in shallow water. The only comparable deal in 2012 was another second controversial Norwegian rig purchase by CMNG, discussed below. "Even a year later, with markets improving, I still view this as a solid price," says Kjetil Garstad of Arctic Securities, referring to the Seadrill sale of its rig.

Ukrainian officials have said that the difference in prices paid for the rig by Highway Investment and then by CMNG is accounted for by extra equipment and accessories supplied to the rig before it moved to the Black Sea. "First, we held a tender observing all of the rules; second, we make no secret of the fact that the cost of the platform's production at the plant is $250m… We took a platform with minimum equipment, and the platform is to have additional equipment installed to operate on the Black Sea," head of CMNG's parent company Naftogaz Ukrainy, Yevhen Bakulin, explained on TV in June 2011, as quoted

by Interfax Ukraine. According to Bakulin, the $150m extra equipment was needed to protect against any environmental disaster such as the 2010 Deep Horizon catastrophe in Gulf of Mexico.

Rigged rig tender Ukrainian media allege the Ukrainian tender was rigged, since the difference between the winning and losing bid was only $10m. Ukrainian law requires stateowned companies to hold procurement tenders with more than one bidder and to publish the results.

Moreover, both the UK vehicle Highway Investment and the New Zealand vehicle Falcona Systems bidding against it in the tender involved the same Latvian nominee directors Erik Vanagels and Stan Gorin in their structure. This points to both vehicles being set up by a company incorporation network run by Latvian boutique banks to launder grey and black money, according to investigations of the network. Highway Investment has its bank account at Latvia's Trasta Komercbanka, according to a copy of its supply contract with CMNG leaked to the press.

Companies involving the Latvian proxy directors Erik Vanagels and Stan Gorin have been publicly named in investigations in 2009 and 2010 into Ukrainian sanctions-busting arms shipments to South Sudan, as well as a Ukrainian flu vaccine procurement corruption scandal. But Ikäheimonen claimed Seadrill had performed "reasonable" due diligence on the buyers, and that the use of special purpose vehicles was common in this branch of the business.

Seadrill announced the deal on April 13 after Highway Investment's Ukrainian tender victory had been published online, and only closed the deal with Highway

Neither tender documentation nor the contract for the rig between CMNG and Highway Investment leaked to the press specify extra expenses besides the cost of the rig. "That would be an enormous amount of money for parts and equipment," Ikäheimonen commented, saying the rig had been sold drill-ready and had already drilled off Burma.

Ikäheimonen, who will quit Seadrill in the second half of 2012, added in later email comments that, "it is my understanding that the subsequent deal included more assets than just the rig."

Hiding Highway Investment Guttorm Bentsen, the broker responsible for the deal at Norway's Platou, the world's largest rig brokers, when asked about Highway Investment by Norwegian newspaper DagensNaeringliv, said: "The company you are referring to does not exist."

Shown documents of payment transfers from Highway Investment to a Platou escrow account, Bentsen explained the difference between the $248.5m purchase price from Seadrill and $400m tender price in an email seen by bne by saying: "In between, there is the upgrade of the rig and transport of the rig. Then

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there is the purchase of a helicopter and supply ships and a few other things.

When you add up everything, and the work it takes, so you get the sum."

The support vessel deal may however add to, rather than subtract from, the murkiness surrounding the CMNG acquisitions.

Ukrainian state tender information shows that CMNG indeed acquired support vessels in March 2011, but did so not as part of the rig deal, but in two separate parallel tenders. CMNG bought two anchor-handling tug ships (AHTS) for $120m and two fast crew supply vessels for $34.7m from a British vehicle Verylux Company Ltd in tenders held late March 2011. Verylux Company bears identical hallmarks to Highway Investment, and is registered at the same UK address.

The AHTS vessels supplied to CMNG for $60m apiece were the Petra Admiral and Petra Majestic, sold by Malaysian operator Petra Perdana Berhad to an undisclosed buyer for an undisclosed sum, according to shipping records that list CMNG as the current owner of the vessels. Neither CMNG nor parent company Naftogaz Ukrainy responded to requests to confirm this information.

According to the shipbuilders Labroy Marine, the order price of the vessels was $45m apiece in 2007 at the peak of the market. Prices then collapsed by up to 50% in 2009 during the economic crisis. Martin Coombe of shipbrokers Marcon International put the market price for AHTS vessels of the same specifications in 2011 at $30m-35m apiece.

The two fast crew supply ships now operating for CMNG, Ocheretay and Kalos Limen, were supplied by Damen

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Shipyards Singapore, according to the company. Damen refused to disclose the original sale price. Captain Tork Buckley, Asia editor of the Superyacht Report, ballparks total price for both vessels at maximum $15m, depending on fitting.

CMNG bought the pair from the intermediary Verylux Company for $34.7m, according to tender documents.

Riglogix, lists CMNG as the new owners of the rig. Keppel-subsidiary Caspian Shipyard Company, who are reassembling the West Juno rig in Turkey after it transited the Bosphorus, also confirmed to bne that a second Keppel rig from Singapor will pass their way moving to the Black Sea in 2012, thus pointing to the Standard Drilling rig.

Bentsen, who brokered the West Juno rig deal in tandem with Platou's Moscow broker Odd Arild Espedal, left Platou in the first quarter of 2011 for reasons not connected with the rig deal, according to Platou. Espedal refused to talk to bne about the deals.

According to Bergland, Standard Drilling sold their rig for $220m. Company accounts show Standard Drilling earned $37m on the sale of the rig.

Standard procedure In September and October last year, Ukraine's CMNG held a tender for a second jack-up rig, with bids again clustered around $400m. The tender was won with a bid of $398m by a small Latvian shipyard, Riga Shipyard, that has no history of building rigs. Payment on the contract in the last quarter of the year caused the Latvian shipyard's annual turnover to more than triple in 2011 compared with 2010, according to the company's financial statements.

In parallel to the tender process in Ukraine, in Norway a smaller oilfield service company Standard Drilling sold a rig similar to the West Juno, but still under construction at the producer Keppel's yard in Singapor, to "an undisclosed UK-incorporated company." The rig sale was announced September 1.

Despite naming a UK company as immediate purchaser of the rig, Standard Drilling sold their rig "to a Ukrainian company," said Platou Markets' head of equity research, Anders Bergland, without naming the buyer. The leading databank for the world's rig fleet,

"You're telling me the Ukrainian government, who became the ultimate owners of the rig, paid $400m for our $248m rig"

Standard Drilling CEO Martin Nes refused to comment on the deal, but confirmed to bne that the sale of its rig was brokered by Guttorm Bentsen, after his leaving Platou earlier in the year.

Bentsen refused to speak on the matter.

Mark A. Jackson, who was CEO of Standard Drilling at the time of the rig sale, resigned suddenly from the company in November 2011. In February, he was indicted in the US for bribery of Nigerian officials in his previous capacity as CEO of US oilfield service providers Noble. "The rig deal had nothing to do with Jackson," Martin Nes insisted, in comments to bne. Jackson refused to comment to bne on the matter.

That Ukraine continues to plumb the depths in terms of transparency should come as no surprise to those investors who watch the country with growing alarm. However, Norway normally tops the rankings of non-corrupt places to do business, coming in at 6th place in Transparency International's latest "Corruption Perceptions Index" compared with Ukraine's 152nd place. But bad money drives out good, and the 2011 Ukraine deals may yet cast a shadow over Norway's reputation.

bne May 2012

INTERVIEW:

Eastern Europe

I 15

Avtovaz's last stand

Ben Aris in Moscow Igor Komarov, President, Avtovaz

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vtovaz, based in the Volga basin city of Togliatti (named in honour of the Italian communist who set up Russia's biggest car plant) is the archetypal Soviet dinosaur. The ubiquitous Lada is a knock-off of the Fiat 124 that was fashionable in 1980 and has been losing ground to the flood of foreign brands that are increasingly being assembled in Russia. Igor Komarov took over as president Avtovaz in 2009 and has made dramatic progress in dragging the plant-cum-city into the modern world. But observers worry he is fighting a losing battle, as the automaker will never be able to keeps its head above the rising tide of competition, even with a soon-to-be-concluded deal to sell a controlling stake to Renault-Nissan.

The youthful and ebullient Komarov replaced Vladimir Kadannikov, the chain smoking and stolid boss who'd worked at the company since 1967, and set about modernising the company's mindset. Komarov called in the consultants and drew up a plan of action two years ago that he hopes will capitalise on the advantages that Avtovaz still enjoys. "Russia has a huge potential.

The number of cars on the road is huge, while the number of sales is very low: if you take the ratio of these two numbers, then Russia is well behind the rest of Europe," Komarov told bne in an exclusive interview held at the Adam Smith annual Automotive Russia conference, the industry's premier event.

With a per-capita ownership of some 200 cars per 1,000 people, Russia is half to a third of the European average and even further behind markets like the US.

At the same time, the cars still on the road need replacing. "The car fleet is getting very old. More than half of the cars on the road are more than 10 years old and most don't meet any kind of ecological standard. As the clean air regulations get tougher, sales will increase," says Komarov in good English.

The Kremlin renegotiated its investment deals with five major international manufacturers who have all committed to significantly increase their production capacity over the next few years. With credit increasingly available, the iconic Lada has been struggling to hold its own and is no longer as ubiquitous on Russia's streets as it once was.

With its fixed investment depreciated away decades ago, Avtovaz will keep its cost advantage over the newly built foreign-owned plants for a while lon-

brings out at least 10 new models a year, so Komarov is grasping the bull by the horns. "We want to bring out a new model every six months or so – that's the goal."

But new models by themselves are not enough. Avtovaz has the workforce and the plants; what it misses is the money to invest in developing popular new designs.

Changing perceptions The key to the company's turnaround is improving the quality of its production – and surprisingly it has already made inroads using nothing more than its Soviet-era machinery.

The kneejerk reaction of most observers is to blame Avtovaz's clapped-out factories. But this is a misconception, as most Russian factories already make use of production robots and the technology needed to operate both the

"Russia has a huge potential: the number of cars on the road is huge, while the number of sales is very low" ger, but to survive in the longer run the company needs to introduce new models – and regularly – to stay competitive.

Avtovaz has not been sitting on its hands and brought out two new models in the last year, including the Granta in December, which has already sold out.

A new version of the Niva SUV is also in the works. But a company like Nissan

assembly line and the paint shop is not so complicated. "The main problem we face is to overcome the illusion: by installing new equipment, you can solve all your problems overnight. Maybe it is part of the Russian mentality. We think someone else can fix these things and make life easier. We have to learn from the French and Japanese experience, and become efficient using the exist-

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Out of the shadows You can see why the Kremlin gets annoyed about the perennial griping about Russia's corruption problem. Sure, corruption is a real problem, but analysts at VTB say that for its income group Russia's corruption is no worse than any other's. And that peer group includes countries like Greece and Italy where it turns out that the broader problem of tax evasion is even bigger.

The size of Russia's shadow economy has shrunk to 15% of GDP as of the end of 2011, says the deputy head of Rosstat, Irina Masakova, and has been at about this level for at least three years.

This is a big improvement on the 1990s when between 25% and 50% of the economy was thought to be in the shadows. What really surprises is that on this score Russia's economy looks a lot more civilized than several members of the EU: dodging taxes is a national sport in Italy where 22% of the economy was in the shadows in 2011, according to a report by VISA. And Greece should be reclassified as an emerging market, as 25% of its GDP is generated in the shadow economy. Russia's shadow economy is still more than in France and the UK with 11%, but only just worse than Germany's 14%.

Still, 15% of the Russian economy is a lot of money.

Masakova estimates the value of the shadow economy at about $275bn, or comparable with the GDP of Finland or Ukraine and Slovakia taken together.

bne May 2012

ing equipment, because if we don't, we won't get anywhere," says Komarov amidst the hubbub of the conference, his main competitors swirling around him in the crowd.

Here, the company's partnerships come into their own. Avtovaz set up a joint venture with the US' General Motors in 2001, but more recently has thrown its hat in with the French and Japanese companies Renault and Nissan. Nissan has already been advising Avtovaz managers on work practises and without spending an extra kopeck on capital goods, productivity has already increased by about a third.

"We have already decreased the defect ratio in the supplies by 37% in the last six months and the productivity has increased 34%, without changing a thing. We also measure our performance to benchmarks set by factories around the world and we are already on a par with the factories in places like Romania and Bulgaria, while we have been closing the gap on Europe. One day, we hope to reach the same level as the Japanese," says Komarov , who believes that about 80% of the poor quality and productivity results are simply down to bad management.

But there is more to getting the timeand-motion people in; to create a really

successful car company, you have to build something that customers want to buy. Many industry experts believe that the company's demise is already a fait accompli, as no matter how much reform it manages it cannot match the experience and resources the multinational carmakers have built up over a century or more. "Our position now is very risky and it will be a huge job to become competitive with the other carmakers. However, we have been working on this the last two years and the progress we have already made is dramatic," says Komarov . "The main attraction of our cars is the price, but once you get to a price tag of $15,000, more than half of all Russians are ready to buy a car. We want to move up to higher price brackets, but it's like school – you can't just jump over years. We have no illusions: it will be hard work."

Despite all the progress that Komarov has made, it seems the Kremlin has buckled to the inevitable and conceded the dream of rebuilding a purely Russian car industry is dead. A deal to sell a controlling stake to Renault-Nissan is all but done. "I understand the shareholders – Troika and [state agency] Rostekhnologii – have hammered out most of the details and are due to sign off on the deal in the nearest future," says Komarov .

"We want to bring out a new model every six months or so – that's the goal"

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I 17

and credit him as the force behind the slowly emerging changes to Moscow.

With his short cropped, greying hair and a no-nonsense, down-to-business manner, Sharonov is very different to his predecessors. Under Luzhkov the deputy mayors were cut from the classic "red director" cloth and clearly spent more time enriching themselves than worrying about clogged-up roads, dilapidated city services or the total absence of parking at the Moscow City development that is home to many of Russia's biggest banks.

Big plans for Moscow Ben Aris in Moscow

S

ince Yuri Luzhkov was ousted as Moscow mayor in 2010, the development of Moscow has been on hold. No new construction permits have been issued and real estate prices climbed slowly as a result. But the new administration under Mayor Sergey Sobyanin is busily working on a new plan and in the next six months Moscow City Hall will go into action. Muscovites, used to ignoring traffic rules, parking on pavements or condemned to hours-long commutes on the trolley bus, are going to be in for a shock if half of the new measures work.

The changes put in place by the new team have already paid dividends.

Moscow jumped up six places in AT Kearney's "2012 Global Cities Index", the biggest increase of any city in the world. New York, London and Paris stay at the top three places respectively, but Moscow moved up to 19th place from 25th last year out of a total of 66 cities surveyed. Beijing took 14th place overall, up one rung from 2010, while Sao Palo was ranked behind Moscow in 33rd place, up two places from the last survey. Mumbai was ranked in 45th place.

Expect further improvements in next year's ranking after Moscow's new development plan is approved this September.

At the end of 2011, City Hall put out a tender to private firms to draw up a new development plan for the city and more than 200 firms – Russia and foreign – bid.

The city has awarded 10 contracts to companies from around the world, with some local representatives, to work out the details. "The strategy will be ready in September, which has to be then presented to the city government. But the main conclusions are already apparent," Moscow's deputy mayor, Andrei Sharonov, tells bne in an exclusive interview.

"There are both risks and opportunities.

The biggest risk is the gap between the economic opportunities the city offers as

Sharonov identifies four key areas where the city needs to be brought into the 21st century: traffic, tourism infrastructure, environment, and heath and education.

"Moscow used to be one of the greenest cities in the world, a third of the territory was forest and parks. But today many of these areas have decayed and are unavailable for the people to use," Sharonov says in his clipped English, starting with the environmental problems.

But fixing Moscow's problems – with 15m inhabitants, easily the largest city in Europe – means having to clean out the Aegean stables. One famous example of the problems is the cost of building a road. In Germany it costs about $5m per kilometre to build a road, but the same road costs $50m per kilometre in Moscow to construct. The difference is not corruption (well, not just corruption), but the main cost comes from the higgledy-piggledy way the city was developed under Luzhkov. "We have to deal with the poor heritage, as there is no complete set of information on how the city was devel-

"We have to deal with the poor heritage, as there is no complete set of information on how the city was developed until now" one of the globe's 10 biggest metropolises. But the risk is the quality of life is still mired in the 70s or 80s. The quality of life is too low for a city of this size."

Four key areas Many real estate participants have been buoyed by Sharonov's appointment

oped until now," says Sharonov, who tactfully refrains from blaming the old team directly. "We have started the process, but there are so many problems lying underneath the streets. The main part of the $50m/km cost is the law requires you to rebuild any infrastructure assets that you discover in the course of construction."

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In a survey in May 2011, Muscovites named the poor state of healthcare as their top concern along with the high cost of living (but ahead of corruption), and on this score the federal government has been very active. But more than anywhere else, the new team has to make a dent in Moscow's horrendous traffic problems if it is to win the public's confidence.

Sharonov says the city has rejected the idea of a congestion charge and instead is going to impose stiffer fines combined with economic incentives to leave cars at home to tackle the issue.

From July, parking fines will soar from

bne May 2012

year another 300,000-400,000 cars are added to the existing pool, so the priority is to develop the metro and rail network."

Another way to ease the pressure on the centre is to expand the metro and rail network. Stalin, who opened the first 11-km stretch with 13 stations in 1935, oversaw the original construction of Moscow's metro. As of 2011, it is the fastest metro in the world, carrying some 8m people to work everyday through 185 stations and over 305 km of track. Sharonov says as the metro already accounts for 40% of the volume of commuters, it is already overloaded.

"Quality of life is still mired in the 70s or 80s – the quality of life is too low for a city of this size" RUB300 ($10) to RUB3,000. More importantly, the traffic police's power to collect these fines (which they usually just pocket) will end. "Police cars will be equipped with cameras that will automatically send their data through the internet and offenders will receive the bill. The police will have nothing to do with the process," says Sharonov.

At the same time, large car parks will be created in the suburbs next to metro stations and suburban residents encouraged to take the metro or trains into the centre. "The problem with Moscow is the planning was mainly done in the 19th century. The road network was built to cope with the assumption of a density of three cars per 100 people. Today we already have 30 cars per 100 people and this number is still climbing," he explains.

The low density of roads in Moscow – one of the lowest of any major capital – means that it only takes 450,000 cars to bring the city to a standstill. With total car ownership in the city of 3.5m, the road transport system collapses regularly. "It is impossible to develop the road network to meet the needs of so many cars," says Sharonov. "Every

Nevertheless, the city intends to build 75 km of new lines over the next five years and add a few more stations as part of the new development plan.

One of the easiest developments the city can do is make more use of the rail network. The length of the rail and metro track in the capital is about the same, but trains only carry 2% of the total traffic each day. There are even plans for a light railway that could be built on the basis of the limited tram network that still operates in the capital.

Industrial parks While traffic is the most obvious of Moscow's problems, in the long term City Hall will also have to develop the local economy, even though the capital is already the richest city in the country.

Under Russian law, companies have to pay corporate taxes where their headquarters, not their production, are located. And as every self-respecting company has its main office in Moscow, the capital collects some 85% of all corporate taxes.

The Moscow city budget revenues of $38bn in 2011 (about half of New York's revenues of $64bn) would make it the

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Eastern Europe

38th largest country in the world, on a par with Ghana, and bigger than many Commonwealth of Independent States countries, but a large part of this money is ultimately from raw material extraction going on in the hinterland.

The city is holding 209 industrial zones covering 7.7m hectares in reserve, which it wants to develop together with private developers and entrepreneurs. The city will promote these developments by setting up various technology and industrial parks around the city that sport lower property taxes and cheaper land.

From the 7.7m reserves, a survey last year found about a tenth of this land was devoid of buildings, used for open-air markets or otherwise undeveloped, and the city is proposing converting those hectares into industrial and innovation development zones.

One of the most obvious projects promoted by the previous administration is Moscow City, the Russian equivalent of London's Canary Wharf. However, Sharonov says the city has no plans to continue promoting a financial district.

"We don't see the need to concentrate the financial district all in one place.

It will be up to the banks where they want to have their headquarters and this could be spread out over the city. If the developers want to build more buildings at Moscow City, then this should be a commercial decision, not something dictated by the City government," he says.

Much more ambitious is the plan to develop a new corridor into the city's southwest into the Moscow oblast and create a second centre at the heart of this corridor. Many of the government buildings will be moved to act as "seeds" for the development that will bring in workers and new businesses. Moscow will get an additional 144,000 ha of land in the southwest starting July 1, compared with its current 107,000 ha, after outgoing Russian President Dmitry Medvedev initiated the project to expand the city boundaries last year. "This will be a strategic reserve for the city that will serve for decades to come. It will also hopefully develop into a second centre and so take the pressure off the traditional centre," says Sharonov.

I 19

Thanks to the port, St Petersburg is an obvious location for any manufacturing company, and both foreign and Russian firms have flocked to the city and its surrounding region. Both the city government and Leningrad region (which have different administrations) have set up several parks, including the Tosno industrial park in the Leningrad region, which has made St Petersburg Russia's leading manufacturing and automotive hub.

Russia's business park life blooms Ben Aris in Moscow

R

ussia's business environment can be harsh, but investors have been flocking to the balmy islands of industrial parks that are springing up around the country, where there is little red tape, no corruption and every sort of infrastructure a factory manager could wish for.

The federal government passed laws to create Special Economic Zones (SEZ) several years ago in the hope of repeating China's success at attracting foreign manufacturing by offering a raft of tax breaks and incentives. However, the success of Russia's parks has more to do with the energy of the governors that set them up, rather than any fiscal bribes the federal government can offer. "There are three types of park: those that have been set up privately with privately funded investment; those that are a project of the local governor and run as a special purpose vehicle; and the federally backed Special Economic Zones," says Maxim Ivanov, chairman of the Russian Association of Industrial Parks, which is attempting to coordinate their development. "However, three-quarters of the investment into industrial parks don't go to the SEZ but the regional or privately run parks. The key for a company is if the park offers

what it needs to work, rather than any tax breaks."

Suits you, sir Industrial parks appeal to investors, as they offer a highly localised investment climate that is very different from Russia as a whole. Most regions have a "onestop shop" for investors into a park that cuts through the bureaucracy and brings corruption in the parks to "zero", says Ivanov. With the Russia-specific problems removed, companies are left with

There is nothing special about Kaluga, but located only 182 kilometres from Moscow it has emerged as the country's second largest automotive hub simply on the back of the hard work of the governor, Anatoly Artamonov, who should be more appreciated than he is.

According to foreign companies working in region, Artamonov hands out his mobile phone number with invitations to call anytime the company has a problem it can't solve. The local business climate is so convivial that increasingly privately run parks are also appearing like the Finnish-owned Lemmikäinen park, which also has a branch in St Petersburg.

Probably Russia's most proactive and business friendly place Kazan, the capital of Tatarstan, is further away from Moscow (863 km), but within a 1,000-km circle live over 80m people of the Volga basin, equivalent to the size and population of Germany. The government has set up the Alabuga

"The key for a company is if the park offers what it needs to work, rather than any tax breaks" simple business considerations when choosing which park best suits them.

Typically, companies first look for basic things like infrastructure, then being close to both their customers and suppliers. Amongst the most successful regions in Russia are Kaluga and St Petersburg, which have both been pro-business and enjoy a large customer base on their doorsteps.

Special Economic Zone in an example of an industrial park that is both park and SEZ. Likewise, Kazan has attracted significant foreign investment and is home to both the Russian truck maker Kamaz and a Ford plant, which form the core of its emerging automotive hub.

The region also has significant aviation and agriculture production, as well as a highly educated population thanks to its well-respected local universities.

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bne May 2012

These are all well-established industrial parks, but new players are entering the game. An up-and-comer is the Kuznetskaya sloboda industrial park in the Lipetsk region, famous for Novo Lipetsk Metal Kombinat (NLMK), Russia's most profitable steel mill. And Moscow is preparing a string of business and technology parks as part of its new development strategy that will be ready at the

emerging as a key to success, as increasingly the regions are finding themselves in competition for inbound investment," says Ivanov. "They have to work hard to persuade an investor to set up shop in their region."

Maxim Ivanov says that part of the association's job is to tour the regions and set up seminars to share with the

"With the Russia-specific problems removed, companies are left with simple business considerations when choosing which park best suits them" end of this year. However, in Moscow's case the tax breaks will be more key, as the cost of labour in the capital is up to six-times higher than in the rest of the country. "The character of the region is

less advanced regions the incentives and deals that the more successful have offered. From this, regional clusters are emerging: at the annual Kazan Investment Summit last year, amongst

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Eastern Europe

Russia's financial infrastructure are still very low and Jelezko predicts that investors in the new fund can look forward to tripling their investment in the next five years.

the biggest of the region investment conferences, the administrations of neighbouring Ulyanovsk and Bashkortostan sent delegations to showcase their investment story to the assembled foreign investors. All three administrations are hoping the Volga basin regions will emerge as an industrial powerhouse that will serve the whole CIS region.

"Industrial parks have come a long way in the last two years and there has been a dramatic change in the way they go about attracting business and creating a new corporate quality of life in Russia regions," says Ivanov. "We won't be able to change everything overnight, but we are very optimistic. The fact that most of the investment is not going into the SEZ, but choosing parks on the basis of their benefit to a business should be taken as one of the most encouraging signs, as promoting normal business is the whole point of the parks."

Da Vinci bets on Russian pension reform

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One of the most exciting opportunities is in the non-state pension funds. Typically, Russians don't think much about their retirement (and until recently the life expectancy of men at 56 was so short that few would actually reach the retirement age of 60). Indeed, a recent study found about 80% of Russians don't expect the government to provide them with any sort of liveable pension at all and intend to work until they die.

But that is beginning to change. "Most people in Russia are ignorant about pensions, but they are starting to think," says Jelezko.

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I 21

"P

ensions is an idea whose time has come," says Oleg Jelezko, managing partner at Da Vinci Capital. "This year and next, the reforms will start in earnest and then it will grow much faster than people expect."

The Kremlin has balked at restarting pension reforms since it fluffed the first attempt in 2002. Russia has currently $38bn in private pensions savings, according to Renaissance Capital, or just 3% of GDP. By contrast, following Chile's pension reform (which Russia copied), that country had assets worth 65% of GDP at the end of the first decade. And with the gap between Russia's state pension funds obligations to the population and the amount of money it has under management already gobbling up a quarter of the federal budget, the need for reform is becoming pressing.

In January, Da Vinci launched a second financial institutions fund that is already investing into pension fund managers.

The first highly successful financial institutions fund became the biggest

private investor into Russia's RTS stock exchange and made a packet when the exchange was merged with Russia's other large exchange Micex last summer.

Now Da Vinci wants to plough some of that money back into a second fund that

The fund has already bought into the non-state pension fund Electro Energetika, which holds the pensions for the utility firms like United Energy Systems, Rushydro, and used to handle the pensions for dairy and juice producer WimmBill-Dann until it was bought by PepsiCo in December 2010. "This pension fund has been growing organically, distributing its products through banks. It has also been investing into IT, which remains an issue in Russia, and set up strong corporate governance rules. For instance, agents give the fund names, but they

"Most people in Russia are ignorant about pensions, but they are starting to think" extends the logic of the first fund, and will invest in a more diverse set of assets that depend on the ongoing development and reform of Russia's capital markets. "We have a good team and we see a lot of niches. The crisis in 2008 hit the financial sector hard, but it was also the first sector to rebound and it turns out that it is quiet resilient to the volatility," says Jelezko.

Pillars The valuations of assets involved in

check to make sure every name is a real person and last year there was only 1% of fraudulent claims," says Jelezko.

Da Vinci has already tied up with some leading western pension companies that are interested in breaking into the Russian market, which have been sharing their risk and portfolio management systems. "The pension fund system correlates with GDP and the amount of disposable income people have – and both these are rising fast in Russia," says

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Jelezko. "We are betting that Russia's pension system will converge with Europe's and we believe the demographics will improve in Russia."

At the time of the fall of the Soviet Union, there were two workers to sup-

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and there is currently a debate over where population numbers are headed.

The UN is pessimistic and predicts Russia is on course for a demographic disaster, whereas other economists – Da Vinici included – believe the situation is man-

"We are betting that Russia's pension system will converge with Europe's and we believe the demographics will improve in Russia" port each pensioner, but due to the collapse of birth rates during the chaos of the 1990s that ratio has almost reached one to one. More recently, birth rates began to recover in the summer of 2008

ageable. "We think that the population will go back to growth, as the birth rates are rising fast. We also have investments into retail and especially kids' clothes where sales are booming," says Jelezko.

If there is a link between pensions and selling children's goods, then Da Vinici is onto a good thing, as in 2011 Russia overtook Germany to become Europe's biggest market for kids' products.

"Demographic growth will drive the revenues of the pension business."

It seems that personal time horizons for Russians are starting to reach the 30-year mark, as the volume of mortgages is doubling every 18 months or so.

And Jelezko argues this is now spilling over into pensions, which have largely been ignored until now; assets under management in pension funds are rising by 20-30% a year says Jelezko. "We can grow faster than the market, as we are more market orientated and so hope to take market share from the smaller companies," says Jelezko, who estimates Da Vinci's fund already controls 10% of the market.

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ast year's economic meltdown in Belarus amid a serious shortage of hard currency reserves pointed to the government having to step up its privatisation efforts. But since the sale of a 50% stake in Beltransgaz to Russian gas giant Gazprom for $2.5bn in November, the government's plans for the privatisation of major state-owned enterprises remain unclear.

Shutters come down in Belarus Sergei Kuznetsov in Minsk

The annual privatisation of $2.5bn worth of state assets in 2011-13 is one of the conditions that the government agreed to as part of the $3bn loan from the Eurasian Economic Community (EurAsEC). The privatisation proceeds are expected to be channelled to the country's international reserves alongside the loan.

To meet this condition, the Belarusian government drew up a preliminary list of major state-owned assets for privatisation that could secure this annual revenue in 2012 and, possibly, in 2013. This list remains undisclosed, but sources close to the government tell bne that it included about 20 major state-owned assets, including Naftan oil refinery, Gomeltransneft Druzhba oil pipeline,

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Krinitsa brewery, Belarusian Metal Plant foundry, BelAZ truck maker, cement plants and the state shareholding in mobile operator MTS.

mainly Russian, with most of these failing because of the unfavourable terms put forward by the Belarusian side, usually over the price.

The list was submitted to President Alexander Lukashenko for approval, but during a government session held on March 30, Lukashenko rejected the very idea of the list. He explained that any enterprise in theory could be privatised, but that there would be no wholesale privatisation. "Privatisation should be carried out on a case-by-case basis, if the state needs it, and all Belarusian enterprises can be privatised for the right price," he said.

It looks like EurAsEC is also disappointed with Lukashenko's position.

The governor of Belarus' central bank, Nadezhda Ermakova, said at a pressconference on April 4 the EurAsEC wanted Belarus to redouble its efforts "in terms of privatisation". She did not elaborate, though.

Lukashenko also gave instructions for the government during the second quarter to work out "a single comprehensive document to regulate the entire privatisation sphere." He did not specify which provisions should be included in this document, but judging by what he said, it should be a traditional set of requirements that the Belarusian authorities impose on large investors. "We should definitely stipulate that the enterprise has to be modernised, stipulate what products will be made, how people will be employed, salaries, taxes and so on.

After that, we can go ahead and allow privatisation," Lukashenko said during the government meeting.

Government officials did not comment on the results of the meeting with the president for almost two weeks; only as late as April 12 did Belarusian Economy Minister Nikolai Snopkov address the issue, telling reporters the privatisation process might not necessarily need specific lists of companies that should be privatised. "Privatisation is possible, and it is underway, it depends on prices and terms offered by investors," he said.

Disappointment Lukashenko's decision to give up on having a list of specified assets to be privatised will disappoint many potential investors who had hoped for a more rigorous privatisation campaign. In fact, this decision means that everything in this sphere will likely stay just as it has for the last few years, when the authorities were involved in sluggish negotiations with several potential investors,

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Roman Osipov, director of UNITER investment company, tells bne that Lukashenko's decision leaves no doubt that the pattern of privatisation of the major state-owned assets in Belarus will remain the same as it has for the last decade. "Privatisation is only possible on a case-by-case basis. And it will depend on how much a potential investor is interested in some asset, and whether the authorities are ready for cooperation," he explains. "The level of decisionmaking on the sale of major assets remains very high. All transactions are to be considered at the level of the president, as it has been before. Nothing has changed compared with previous years."

He adds that the main message to potential investors who would like to purchase large assets in Belarus is that they "can discuss specific assets, but the authorities will insist on laying down their conditions."

This is confirmed by the postponement of Lukashenko's annual address to the nation and the parliament, originally scheduled for April 19. The president turned down the initial version of the speech and sent the draft back to the government for revision. Specifically, Lukashenko told the government to finalize the clauses concerning state property privatisation, instructing "the state bodies to focus on the matters of principle: to rule out excessive 'liberality' in state property sales, avoid mass privatisation, ensure the protection of the interests of workers and regular citizens of Belarus during the possible privatisation of companies," official news agency BELTA reported, quoting presidential spokesman Pavel Lyogky.

"All transactions are to be considered at the level of the president – nothing has changed"

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to start a new political party: a software pirate debate in the EU, a copyright monopoly law in Sweden, and a data detection directive in the EU. "With the copyright monopoly in Sweden, it would have made all downloading illegal, but there's no way to know if where you are downloading from is a legal source – it struck at independent artists," Falkvinge says. "Everyone was debating this but the politicians, and I found it very odd they had such a blind spot – what does it take to get them talking?"

The Swedish Pirate Party has spawned similar parties in more than 50 countries around the world. Not all may be registered parties in their country, however elections aren't the most important thing for Pirates; campaigning and raising awareness is. In Slovenia, the party is not registered but its president, Rok Dezelak, estimates it has about 5,000 followers. "The conference has been quite exhilarating, and many decisions were made to make the party work even better and I believe it will," Dezelak says. "We have a new board, more activities, plus new members to prepare ourselves on a larger scale – EU policies and abroad – there are pressing issues regarding transparency and its effect on democracy."

Pirates in Prague Jacy Meyer in Prague

W

ith a name like the Pirate Party, one doesn't expect much in the way of serious politics. But addressing issues ranging from transparency in government to corruption, the Pirate Party is actually a solid, growing international movement that has big plans for Europe.

The Pirate Party International (PPI) General Assembly was held in Prague April 14-15. More than 200 representatives from 24 countries attended, with many more watching the events from home being live-streamed. Typically thought of as a party for 20-something tech geeks, the weekend gathering, while dominated by males, also had women and a range of ages in attendance.

While Pirate Parties from different countries focus on a number of issues,

those most important to the party as a whole include civil rights, direct democracy, copyright and patent law reform, data privacy, and open sharing.

And to help push these agendas, the

in Sweden in 2006 by Rick Falkvinge.

Sweden currently has two Pirates in the European Parliament and in September, the German Pirate Party entered the Berlin Parliament with nearly 9%

"The Swedish Pirate Party has spawned similar parties in more than 50 countries around the world" representatives agreed at the conference to prepare a joint platform and campaign for the elections to the European Parliament in 2014.

Initial successes The party has had a variety of successes since the first Pirate Party was formed

of the vote. Further success for the German Pirates came in March when they scored an upset in the Saarland regional elections with more than 7% of the vote.

Falkvinge says that there were three things that motivated him back in 2005

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One of the major issues discussed at the general assembly was the 2014 EU parliamentary elections and how the party should react and prepare for them. An idea of a European Pirate Party was floated and Dezelak for one is behind it. "I'm a strong supporter for a EUPP to take a stand and deal with the daily pressing issues from parliament and the whole structure of the EU and the Slovenian Pirate Party will definitely be very supportive in that sense," he says.

Dezelak believes the issues affecting Slovenia parallel those concerning Europe as a whole, like human rights, transparency, e-government, reform of the copyright system and open standards. Slovenia voted in a new government about six months ago and Dezelak would like to see a bit more action from them compared with the previous government. "We had a left govern-

Czech the food label

Jacy Meyer in Prague Slow food, go local, agri-chefs – food trends are all about eating from your own backyard. In the Czech Republic, the movement is no different, with 47% of Czechs preferring domestic goods to imported ones, according to a 2011 survey by research group MML TGI. But with heavy supermarket competition, recent media reports of past "use by date" food being relabelled and rising food costs, Czech consumers are having to keep their eyes open to feed their stomachs.

The Czech Ministry of Agriculture commissioned a survey in late 2011 specifically to gauge how safe Czechs believe their food supply is. "The research objective was to determine how important for the consumer is food quality and safety, how consumer shopping habits were changing and how much they understood food labelling," says Jindrich Fialka, director of the Agriculture Ministry's food production and legislation department.

The survey found about two-fifths of the population look at information about a food's origin. Some 73% of the respondents believe Czech food is safe, compared with 43% for imported food. When it comes to food quality, 71% believe Czech food is good, while 43% believe imported food is not high quality. Compared with a similar survey in 2005, foreign food has lost credibility by as much as 27%.

Ales Kotera, executive director of Cesky Grunt, a line of small shops selling Czech-made food products from small and medium-sized farmers and producers, says Czech producers are fully capable of producing high quality products. Cesky Grunt opened in 2010 and already has nine shops throughout the country, with plans for additional growth through franchising. The shops sell exclusively made Czech smoked meat products, other meat, dairy products, bakery, fruits, vegetables, ciders, wines and more. While declining to give specific numbers, Kotera said Cesky Grunt has enjoyed double-digit growth since opening, despite overall food sales in the Czech Republic remaining constant, or in some cases even dropping.

Overall, Czech production of food, beverages and tobacco accounted for 2.65% of GDP in 2010, a slight decrease from 2.87% in 2009, according to the Agriculture Ministry's Fialka. Less than 40% of the fruit and vegetables consumed in the Czech Republic are domestic. "About 75% of the retail sector is in about 10 retail chains, and their policy is often to import," he says. "On the other hand, producers aren't always able to meet stores' expectations regarding deliveries, etc."

Countering this problem has been the explosion in farmers' markets in Prague since the first opened in 2010. But there's not a lot the Agriculture Ministry can do to promote Czech products further, due to EU law. One of the problems that local producers face is cheap competition from abroad.

"The difference in price is determined by the difference in quality and by the amount of subsidies provided by different countries," Kotera of Cesky Grunt says. "We are attempting to support local producers of high-quality products by expanding the market for their goods."

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ment before, now we have a right, and I believe the new government is still pragmatic about making decisions on these issues, like the [Anti-counterfeiting Trade Agreement]," he says. "We would like more expressed opinions, not just waiting for EU decisions."

The Anti-counterfeiting Trade Agreement, or ACTA, is currently being reviewed by the European Court of Justice on whether or not the act violates EU human rights and freedoms.

Many countries that had initially signed the treaty, including Slovenia, Czech Republic and Bulgaria, have delayed ratification due to public protests. "The most important thing is that we aren't sleeping," says Ivan Bartos, president of the Czech Pirate Party. "People may not see it because the media covers things that just happened and it is hard to present the constant work that the Czech Pirate Party does all the time."

The Czech Pirate Party has participated in every municipal and parliamentary election since 2010, and currently has three members serving at the municipal level. They are now gearing up for regional elections in the fall as well as the EU election. Bartos says the Czechs would prefer an EU-wide platform, rather than a European Pirate Party.

"The Czechs are of the opinion that we should identify people to coordinate our approach to Brussels as one power," he says. "A EUPP in my opinion is too much bureaucracy, and there's not enough time. We prefer a platform, a dynamic environment, and media spokespeople to discuss a commonly agreed upon programme."

"If you follow the trajectory of movements before us, they started as protest movements"

Bartos adds that each party has their own channels in their countries covering their population, but acting as one party and presenting the party's ideas.

"Good results in one country influences the results in another," he says. "The real advantage would be a media face and informing people of the Pirates' goals."

Anna Troberg, leader of the Swedish Pirate Party, agrees with the format.

"We want an EU platform for all parties; it would always vary locally, but agree

on five to ten points like more openness, more democracy at the EU level," she says. "We benefit from helping each other, we are not a movement with a lot of money – we rely on donations and people working in their spare time."

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I 27

Ryanair lands in Hungary to much fanfare INTERVIEW:

As the oldest Pirate Party, she says locally they are working on broadening their platform. "Integrity, culture, knowledge is our main perspective and we are working in Sweden on broadening the platform both on the local and EU level," she says. "We realized our political core is applicable to other areas which we haven't explored before."

Opportunity and expectations Founder Falkvinge sees two big challenges for the movement as a whole – one political and one philosophical.

"Our political challenge is getting reelected – it's one thing to get elected, another to get re-elected," he says. "I predict like the Green Party went in, went out, then went in and stayed in, I think that's what we'll do too."

Falkvinge likens what the Pirates are doing to past political movements and this is where the philosophical challenge comes in. "Look at movements before us – Liberals, Workers, Green – cycles that re-conquer democracy happen about every 40 years," he says. "If you follow the trajectory of movements before us, they started as protest movements, and then formulated an alternative to what they were protesting and moved from that to a deeper ideology.

The Workers had solidarity, the Greens had sustainability. We are wording the policy we have; we share a common goal and are putting it into text."

So what does Falkvinge think the Pirates "word" might be? Empowerment is his guess. "The net is a great equalizer – everyone's voice is worth the same and it's absolutely beautiful," he says. "The empowerment issues are the most important. The net changes power structures at the core and our policy and organization reflects that."

Kester Eddy in Budapest Michael O'Leary

J

ust hours after news broke on February 3 that Malev, the former Hungarian flag, had flown its last, the fast-moving Celts of Ryanair had ramped up earlier plans to reopen a base in the Hungarian capital, adding 26 new routes to the five already in the pipeline, and were being hailed in the media as a vital player in the recovery of Hungary's air transport and tourism industry.

After a whirlwind weekend of planning – a case study if ever there was one of how to pick low-hanging fruit on the run – the Irish low-cost carrier was interviewing former Malev cabin crew and maintenance staff to man the expanded operations. As of early April, "something over 100" former Malev pilots were on the Ryanair books, Michael O'Leary, the carrier's outspoken chief executive, tells bne in an interview.

But if the Hungarian cabin crew thought the new jobs meant "business as usual," they were in for a shock. For a start, most will not initially be flying from Budapest. "This is a new base, and people at our new bases have to have been with the company for at least 12 months. It's an operational thing. The Malev pilots will be mixed across the fleet," O'Leary says.

And, "even if they come in with 5,000 flying hours" experience, all new recruits

fly with training pilots for their first month. "Our flying is very tightly controlled. We have Formula 1 data telemetry on all our aircraft. We track around 60 [parameters], heights, track deviations, turbulence – everybody has to fly by the book. We don't need fellahs who

term for no-frills) operation panning out? Budapest is "probably the most successful start-up ever for Ryanair, with load factors in March at 76%, and 82-83% in April," O'Leary declares.

Sure, some destinations such as Palma had "crap" advance bookings, but "we

"I find them very strange; they are all supportive, but nothing gets done, it's all meetings"

fancy themselves as jet jockeys, breaking land speed records," says O'Leary.

Ryanair is not alone in employing Operational Flight Data Monitoring (OFDM), the system which tracks the vast array of flight data; but according to O'Leary, at most airlines these all-revealing records are controlled by pilots' unions – a total anathema to the Dublin-based carrier, which evaluates the downloaded flight data every night, and debriefs crews over any infractions the next morning. All part and parcel of "flying the Ryanair way," says the former accountant.

Wooden bench-mark So, just over six weeks since the inaugural flight in February, how is this "wooden bench" (to use the Hungarian

chopped and changed about four routes" to adjust to the travel realities. "Funnily enough, Thessaloniki is our best performer, it has the highest advance bookings. Perhaps Hungarians go to Greece traditionally?" he enquires.

The launch has been far from plain sailing, though – not all Magyars, nor all Magyar institutions, are used to doing things "the Ryanair way." In particular, for several weeks Hungarian border controls insisted that incoming cabin crews disembark for passport checks, making the critical 25-minute aircraft turnaround time – a cornerstone of Ryanair's business model – impossible to achieve and exasperating the carrier's management. "These were Budapest-based crews. They have been cleared going out in the morning. They

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"Budapest is our most expensive airport in Central Europe" are not even technically entering the country. It makes no sense. We don't have to do this at any of the other 170 airports we fly to in Europe!" says an incredulous O'Leary, adding that after a meeting "with the minister," this issue has at least been "temporarily" resolved.

The carrier is now in negotiations with Budapest Airport to station two more aircraft and add more routes, possibly from the next winter timetable, but to do that O'Leary expects a better deal from the airport operator. "Budapest is our most expensive airport in Central

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ment has always been strong due to the weakness of their opposition and despite the political fracas on pension reform, that hasn't changed," writes Mujtaba Rahman, an analyst with the Eurasia Group, a think-tank. "Although the pension reform debate has been noisy, no credible opposition challenge to Tusk and/or this coalition look likely."

heard of it. "That's stupid, it's a bit like the British introducing the APD [Airport Departure Tax] and raising it this year. It's making the UK uncompetitive," he says.

Europe. There was not a lot of time for negotiating discounts because of the Malev collapse. We are talking to the airport about more growth, but for that we have to get a bigger discount, otherwise they won't get it," he says, bluntly.

That may not be so easy, given that the Hungarian parliament has just voted on re-assessing the land tax at the airport – more than tripling the tax bill for the foreign owned Budapest Airport from €2.4m in 2011 to €7.9m this year. For an airport struggling to cope with the loss of its biggest customer, that is some kick in the teeth. And it's the first O'Leary has

Yet while dealing with Hungary has been difficult – "I find them very strange; they are all supportive, but nothing gets done, it's all meetings" – the Irish carrier is at least flying to Budapest, unlike neighbouring Bucharest. "We talk to them, but it's a complete bloody mess. They have not really established what their airport policy is. They are closing Baneasa [to budget airlines], so everyone has to fly to Otopeni, and they won't give any discounts. So if we don't get a discount, we have no interest. It will come in time, but it's not a market of any interest to us at the moment."

A much harder Tusk Jan Cienski in Warsaw

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www.bne.eu

I 29

D

onald Tusk is suffering through some of the toughest times he has experienced since becoming Poland's prime minister in 2007 – which doesn't mean that there is any viable alternative to the rule of his centrist Civic Platform (PO) party.

Tusk had long been the affable man of Polish politics – shying away from taking on painful economic reforms while quickly swooping in to grab telegenic issues like sending the police out to shut down semi-legal drug shops. But the second wave of the economic crisis has made his second term in office much trickier than his first 2007-11 stint.

Pushed by ratings agencies, Tusk has embarked on a host of needed changes – especially tightening the tax code to end popular loopholes and moving to increase the retirement age to 67 from its current 60 for women and 65 for men. The result has been an outcry, with thousands of workers taking to the streets around parliament, and threats from unions that they may disrupt the

European football championships being played in Poland this June. "They're going to work us to death!" said Elzbieta Sienkiewicz, a school teacher taking part in a recent protest in central Warsaw.

"I want to retire after working 40 years and see the world, but that's going to be impossible. The government's proposal is just shocking."

Tusk's PO is now sagging in opinion polls, at one point falling below 30% for this first time since 2007, and controversy over the pension changes caused visible tensions in the coalition with the

No opposition The reason that Tusk is managing to soldier on despite polls showing opposition to pension reforms above 90% is the enormous weakness of the conservative opposition Law and Justice party (PiS), which is much less concerned with actuarial tables than with the April 2010 air crash that killed the Polish president, Lech Kaczynski, and many other senior officials. That's because Lech Kaczynski was the twin of opposition leader Jaroslaw Kaczynski, who is still in mourning over his brother's death.

Although official investigations conducted by Polish and Russian authorities placed the bulk of the blame for the crash on the undertrained military pilots, who tried to land the Russian-built Tu-154 airliner in a dense fog at a degraded military airport near the Russian city of Smolensk, Kaczynski is increasingly giving air to the view that his brother's death was no accident. "I have a feeling my brother was murdered," Kaczynski told the Onet internet portal.

Kaczynski's supporters give full-throated approval to that view. A parliamentary commission looking into the crash and filled largely with PiS loyalists is mulling the idea that the plane was brought down by two explosions as it was coming in to land. Other more outlandish

"I would rather have never been born than build my political career on the graves of the dead" smaller rural Peasant's Party. But in the end, Tusk managed to keep the coalition together and the reforms looked likely to go ahead. "Tusk, PO and this govern-

theories have posited that the Tu-154 crash-landed in Smolensk, but that the survivors were assassinated by Russians, that the Russians artificially generated

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Europe is sure of shale

Bogdan Turek in Warsaw The European parliament is expected to approve a resolution in June, basing its decision on an environmental impact report, that will reject arguments by lobbying groups in Russia, Germany, France and Poland who say extraction of shale gas is damaging the environment.

Boguslaw Sonik, Polish vice-chairman of the EU Parliament's Committee on the Environment, Public Health, and Food Safety, told reporters on April 2 that the report on the environmental impact of shale gas and shale oil extraction, which he carried out in cooperation with a large group of experts, is ready and will be debated for about three weeks starting April 25. A resolution regarding the findings is to be considered in June. "We asked the experts preparing the report whether the current regulations are sufficient to assure safe excavation of gas," Sonik said. "The answer was positive on condition that the extraction process will be closely monitored, as Europe does not have experience in this area."

The EU report will follow a similar one commissioned by the UK government, which on April 17 said shale gas "fracking", a process where pressurised water and chemicals are pumped underground to fracture and open up shale rocks and release trapped gas, was safe to resume with tighter rules on seismic monitoring and drilling surveys.

Poland, like the UK, is looking to develop its significant shale gas reserves as a way to diversify energy resources. A recent survey showed 70% of Poles favour shale gas exploration in the areas it was discovered as it could help lower gas prices. But Poland's energy policies have become a target of attacks both by German environmental groups that oppose Poland's building of its first two nuclear plants, and by French and Russian groups that oppose shale gas exploration. The Russian company Gazprom is said to consider EU shale gas competition for sales of Russian gas. The attacks intensified when an April 2011 study by the US Energy Information Administration (EIA) confirmed Poland has large stores of shale gas. Of the 1.92 trillion cubic metres of unconventional gas thought to be available in the country, 346bn to 768bn cm appears exploitable - that would meet 35 to 65 years of demand for gas in Poland. "We cannot succumb to the lobbying groups," Sonik says. "No coal, no shale gas, no nuclear energy – so we should have only wind farms?"

Sonik said that various green groups have urged the EU to adopt a single law for the whole EU on shale gas extraction to end wide divergences in member states' treatment of the issue. "Formation of one law for the whole EU as regards shale gas exploration would be unjustified and timeconsuming," Sonik said, adding that it is the leading theme of the report which will be approved in June. "Every country has the right to decide which kind of energy it should use."

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ment," Gailums explains. "Social media were growing fast, so we started looking at that sector and saw Twitter had a problem with authentication of its users.

There were lots of complaints from celebrities and other people about being impersonated. I was at a Twitter development conference in San Francisco in 2010 and realised that verification is very valuable to social networks, so we set about building an extra security layer for Twitter."

the fog, that the airliner's controls were jammed as it tried to land, or that mysterious equipment injected helium into the air, changing its density and causing it to crash.

For Kaczynski's supporters, the idea that an airliner carrying many of the country's most important people – on their way to commemorate the wartime murder of Polish officers by the Soviets in the nearby Katyn forest – ploughed into the ground because of pilot error is impossible to accept. "Look at the whole of Polish history, the Russians have always been trying to destroy us – this is more of the same," said Eryk, a young man in a black leather jacket taking part in a recent PiS rally.

A protest outside the Russian embassy on the eve of the second anniversary of the crash had demonstrators hang Tusk and Russia's President Vladimir Putin in effigy – accusing Tusk and Polish President Bronislaw Komorowski of colluding with Moscow to kill Lech Kaczynski.

It is an open question whether Kaczynski – an intelligent man who served two years as prime minister – really believes that his brother was assassinated. A former close aide interviewed by the Polish edition of Newsweek accuses the PiS leader of being a cynic playing the issue for political gain.

That is Tusk's conclusion as well. "I would rather have never been born than build my political career on the graves of the dead," Tusk thundered in parliament on April 10.

"It is your fault," riposted Kaczynski.

"Everything that happened before the catastrophe is your fault… In a political sense you bear 100% of the responsibility for the catastrophe."

The political fireworks have captivated the Polish media – but Kaczynski continues to appeal to only about a quarter of voters and is widely seen as unelectable, as even people dissatisfied with Tusk are unlikely to throw their support to PiS. That leaves Tusk able to push through his economic reform programme despite his party's loss of support.

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In Veritweet we trust Mike Collier in Riga

T

he best business ideas are often those that provide a satisfactory answer to a simple question – in which case Latvia's Veritweet should be onto a good thing. If someone asks you if you trust what you read on Twitter, chances are you will answer "No" – unless you are the sort of person who believes the moon landings were faked

by Lee Harvey Oswald from his base in Atlantis. Veritweet lets you answer "Yes" without the danger of being dragged away by men in white coats.

The company is the brainchild of Latvian entrepreneur Rihards Gailums. Like any self-respecting internet player, he checks his iPhone throughout his conversation with bne at Riga's trendy Birojnica, a bookstore-cum-cafe-cum-open-officespace where one gets the feeling the clients are all putting the finishing touches to their own billion-dollar business plans as they sip espressos and prod iPads.

In essence, Veritweet is a service "broadcasting Twitter for a niche market," Gailums says. Users all have verified identi-

ties, be they individual or institutional, so Veritweet tweets have an official stamp that is all too rare in cyberspace.

Such verification would have helped news outlets in Australia avoid the problems they got into in April, when they

Raising money was a problem, Gailums admits, particularly if investors gained the impression they were talking to a European start-up that was hoping to expand into the US, rather than a US start-up that just happened to have its research and development offices located in Europe. "Keeping in mind the lessons we were learning in Silicon Valley, we made a business plan here in Europe and raised our first seed money from local venture capital company Imprimatur Capital. They had access to the [EU's] Jeremie fund to support small businesses, so we managed to raise €100,000 for the development project and have been working on it very heavily during the last year."

"From the very beginning, the concept was developed as the opposite of Google," Gailums says. "Our system doesn't collect a person's data. You

"Social media were growing fast, so we started looking at that sector and saw Twitter had a problem with authentication of its users" relied on a fake Twitter account claiming to be from Zimbabwe's ruling Zanu-PF party to debunk stories about Robert Mugabe being on his deathbed.

Money matters Gailums' first thoughts about the concept date back five years, but only in the last two has the idea grown into a fully-fledged business. "It's a simple concept, but quite difficult to imple-

control your digital identity, we just tell the rest of the world that it is really you and that you have paid for it, whereas Google will take your private data and earn money [from that]. The problem is that Google has taught people that everything is free, but really it is [charging] the price of all your tracking data."

Gailums suggests that ultimately a figure of around $20 per year for a

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secure digital profile is reasonable, in the same way that a domain name needs to be renewed on an annual basis. "We really think it's a niche for the future.

In 20 years, every human being on the planet should have some sort of digital identity, so the potential is huge. Just think of what's happening in India or China: India is trying to introduce a programme right now because they don't even have personal, unique IDs for all of their people. This is a huge problem in a region where the internet still isn't very common."

"We basically work with sectors in which you need to know if the person tweeting is a real person. One of those

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a customer base. To prove the concept we're trying to align it with business-tobusiness services."

Despite their incredible popularity, social media are notorious for failing to return a profit. Even the titanic Facebook has yet to earn a penny despite being "worth" between $75bn and $100bn if valuations of its forthcoming IPO are to be believed. Yet one statistic Gailums calls up live on screen indicates the size of the niche Veritweet could fill. Of the 140m people Twitter claims as users, a paltry 26,000 have been verified by Twitter's own system.

Everyone else could in fact be Lee Harvey Oswald tweeting from Atlantis.

"In 20 years, every human being on the planet should have some sort of digital identity, so the potential is huge"

sectors is governmental, so the first person we authenticated was the prime minister of Latvia, Valdis Dombrovskis. We have a system where it's also clear whether a tweet is coming from someone's personal or official stream," he says.

It has been a happy coincidence that Latvia's current cabinet has more than its fair share of young ministers who are comfortable tweeting, including Foreign Minister Edgars Rinkevics and Economy Minister Daniels Pavluts, as well as Dombrovskis – all of whom regularly update their feeds.

Private business Gaining the trust of public bodies while demonstrating that Veritweet is robust and reliable will help sell the concept to the private sector, believes Gailums, who is currently seeking investors to ramp up Veritweet's reach. "Working with just the private sector you would never get back your cash flow in the first year. It's the same problem for internet start-ups everywhere: you can't monetise it straight away even if you can get

That suggests that Twitter itself or an established IT security company might be the best investor or even buyer for Veritweet, using it to bolster Twitter's questionable reputation for veracity and security.

But equally importantly, Veritweet can also add functionality to Twitter by allowing users to attach PDF files to their tweets and follow live video streams, opening up a range of possible applications from e-voting (useful in a country with a penchant for frequent referenda) to e-education via live broadcasts of lectures. A pilot scheme Veritweet is running in Sweden is already providing four online members of the audience for every one sitting in the lecture hall itself; students may never have to get out of bed again.

The technology has been used to provide coverage of conferences and seminars in Latvia with the local American Chamber of Commerce streaming a series of its events live. Veritweet has also been used to provide live feedback from viewers of TV shows. Early broadcasts saw

comments scrolling across the screen dominated by a handful of users, but they did show the system worked and that by having only verified users, abusive comments and trolling miraculously disappeared.

Noticing Latvia's lack of an official presence in Silicon Valley, last year Gailums was instrumental in founding the Latvian American Business Association of California (LABACA) to help promote the Latvian tech sector in the world's most important shop window for IT investment. "It's a complete contrast with Estonia, Lithuania, Ireland, Finland... our investment agency is more interested in bringing investment companies into Latvia, not in tech companies going abroad. It's a pity.

We're really trying to push them so they understand this is an important thing for any small economy. If you want to expand your economy, you need to be in some of the hubs to pick up contacts and investors."

The importance of a credible Silicon Valley connection cannot be overestimated, Gailums believes. Veritweet is technically a wholly-owned subsidiary of his US-registered company e-TAG and the ultimate goal is to break into the US, following the lead of Lithuania's hugely successful app store GetJar. Gailums is under no illusions that the US market is easy to crack, particularly given the fact that Americans are so much more reluctant than Balts or Scandinavians to carry out all their banking online (Veritweet uses bank IT systems as one of its verification methods). Nevertheless, he is optimistic about future prospects, including back home in Latvia, citing the success of TechHub Riga, the first international expansion of the London-based TechHub space for IT entrepreneurs.

"A couple of recent start-ups will be moving out this year," he says. Their destination? Silicon Valley.

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bne May 2012

An illegal business that's smoking Phil Cain in Sculeni, Romania

"Y

ou have to look people straight in the eye," says Vasile, a seasoned Romanian border guard. The driver of a pick-up truck crossing from Moldova has flunked the eye-balling test and stands watching a team of mechanics dismantle his vehicle. In the fuel tank is a vacuum-packed consignment of "Plugarul", a Moldovan cigarette brand.

Moldova – along with Belarus, Russia and Ukraine – is the origin of the largest number of illicit cigarettes entering the EU, according to expert Luk Joossens. Romania's long land borders with Moldova and Ukraine help explain why perhaps a third of cigarettes there are illicit in one way or another. All four smuggling centres are involved in smuggling the three main types of illicit cigarette: cigarettes manufactured in the EU which never

arrive at their stated destination and so go untaxed; faked established brands; and, increasingly, "cheap whites", like Plugarul, local brands mainly produced for smuggling.

The success of campaigns to stop corruption among Romanian border guards has led to the rise of an alternative method of getting the product through, "ant-smuggling", where loads are broken up into smaller consignments to be taken over the border in little pieces. The man with

the tank full of Plugarul was most likely one of a few hundred "ants" hired to move a truckload of cigarettes.

Less covert methods of overwhelming the border operate elsewhere along Romania's border, with people simply lobbing bundles of cigarettes over a wire fence.

Taxing times The European Commission puts EU tax revenue losses from illicit cigarettes at over â‚Ź10bn a year, but no one really knows the real amount

"The biggest smuggling in the EU is going on in the Baltic countries because they are squeezed between Russia, the Russian enclave of Kaliningrad and Belarus"

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bne May 2012

because the smugglers are averse to transparency. Those monitoring it have their own reasons either to exaggerate or diminish its significance. But the decline in cigarette smoking seen in many European countries could be

"Cheap whites have filled a gap in the market"

being outweighed by an unrecorded rise in illicit cigarette smoking, according to Professor Ernesto Savona, director of TRANSCRIME, a joint research centre on transnational crime.

The business has changed over the last decade or so. Back in 2000, the bulk of illicit cigarettes used to be legally produced within the EU only to "fall off the backs of lorries" during their tax-free transit through places like Montenegro, where they would be loaded onto speed boats bound for the coast of Italy. But these days Zelenika, once jostling with cigarette smugglers' boats, is tranquil once more. Andorra too has seen its once-thriving illicit cigarette trade dry up, partly because of political pressure on the political elites who prospered from smuggling and partly because big tobacco companies tightened up their supply chains.

Cheap whites, like Moldova's "Plugarul" and the much better-known "Jin Ling" from the Russian enclave of Kaliningrad, now account for around a fifth of seizures in the EU. This new manifestation of the trade may be more difficult to stamp out. "You are not confronting Andorra or Montenegro any more, you're confronting Russia, one of the superpowers," says Joossens.

The decision to establish their own illicit brand, rather than directly undermine the brand or reputation of a cigarette giant, may also help sidestep legal attention. "Cheap whites have filled a gap in the market. After you've

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filled a gap, you establish a market," says Professor Savona.

Counter-intuitively, illicit cigarettes have carved out a bigger share of the markets of poorer countries rather than in, say, Norway or the UK where the cost of a packet of cigarettes is sky high, according to Joossens. "The biggest smuggling in percentage terms in the EU is going on in the Baltic countries because they are squeezed between Russia, the Russian enclave of Kaliningrad and Belarus." A wellequipped factory can make a pack of cigarettes for just a few cents, so being able to sell them for just €1 across the border is already a highly attractive prospect. In some regions bordering one of the main illicit cigaretteexporting countries, the local people are thought to smoke 90% of the illicit cigarettes that arrive.

Selling them for perhaps €9 in the UK or Norway is more attractive still, but comes at substantially higher risk.

Nevertheless, there will always be those prepared to take the extra risk and the phenomenal rate of return that might come with success. You might make a million on one container making it into the UK. Once you have managed to get cigarettes into a Schengen country where there are no further routine border checks – like one of the Baltic states, Poland, Czech Republic, Slovakia or Hungary – contraband can be moved with relative ease. "Law enforcement prefers to go after drugs because cigarette smuggling is not a sexy topic. It is more sexy to go after drugs or human trafficking," says Professor Savona, who argues that EU policy should be based on an assessment of its impact on crime as well as on public health.

I 35

most of the rest of Europe. Average net salaries are just over €400 a month, according to official figures, but staggeringly high unemployment, at around 40%, means that many households scrape by on considerably less.

Bosnia's economy functional but hamstrung

Andrew MacDowall in Belgrade

A

pril has seen an avalanche of articles on the Bosnian War and the Siege of Sarajevo, which started 20 years ago. Correspondents who were in the country during the conflict have dusted off old war tales, reminding us of the horrendous death toll and the atrocities committed, as well as their own experiences of the Holiday Inn bar and close shaves with snipers and mortar rounds.

As most reports have noted, the country is still divided between two "entities" – the largely Bosniak (Bosnian Muslim) and Croat Federation, and the Serb-dominated Republika Srpska, each of which have a great deal of autonomy.

But these days for the vast majority of Bosnians, day-to-day and indeed year-to-year life goes on much as it does elsewhere in Europe. The Bosnian

economy, while horribly shackled by the structures left by the post-war settlement, it is essentially functional.

And if – admittedly a sizeable if – the country can cut through the political arrangements that clog its economic arteries, some promising sectors in which the country has a competitive advantage could start to gain a little momentum.

In order to catch up with even the Central European EU member states, Bosnia would need an emerging-market pace of growth. It achieved this in the latter part of the last decade, with GDP expanding by 5%-plus for several years.

But the economic crisis has hit hard, and after a recession in 2009, growth has been sluggish; a November report by the International Monetary Fund (IMF) estimated annual growth at 1.7% in 2011, falling to just 0.7% this year, noting that even this modest recovery was "at risk of being derailed".

In April, Moody's Investors Service downgraded Bosnia's credit rating from 'B2' to 'B3', dragging it deeper into junk status, and put it on review for another downgrade. The agency cited a deteriorating fiscal position, the possible effects on its debt-servicing position of "antagonistic political dynamics" and a poor growth outlook.

The country is caught in a squeeze between low levels of domestic demand and a difficult external situation, the Eurozone crisis having dampened exports as well as foreign direct investment.

The convertible mark's currency board with the euro (effectively a peg) gives Bosnia a degree of monetary stability, particularly useful for a country with low institutional capacity and little experience of independent monetary

"Bosnia is not doing very well in making itself well-placed for the investment it needs to take off" Dismal data Bosnia's macroeconomic figures make for depressing reading. While by global standards an upper-middle income economy, Bosnia is poor relative to

management. It also makes later entry into the Eurozone somewhat easier, though that is a distant prospect. However, the fixed exchange rate makes it impossible for the mark to devalue and

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make Bosnian exports more competitive. In any case, Bosnia has precious few effective export-oriented industries.

The internal business environment has been hamstrung by stagnant or falling real incomes and low consumer confidence, as well as a terribly weak business climate. And these challenges are due in no small part to the country's divisions. After the October 2010 general elections, it took 16 months for a government to be installed, leading to a lack of clear policy-making during a difficult time for the economy.

A sense of direction in economic policy is desperately needed. Reform is vital both to secure a potential new deal with the IMF to sustain the country's financing needs, and to get the domestic economy moving again. Red tape is endemic. Bosnia currently languishes at 125th in the world (out of 183) on the 2012 Doing Business rankings published by the IFC and World Bank.

"Long-term issues include an inhospitable business climate," Milen Cuc, the IMF resident representative for Bosnia and Herzegovina, tells bne. "Regulations are onerous, and Bosnia is not doing very well in making itself well-placed for the investment it needs to take off.

That needs to be addressed as a matter of urgency."

Private investors are also frustrated by the lack of pro-growth strategy from the government. Nicholas Penny, managing director at Banjalucka Pivara, a brewery in the Bosnian Serb capital of Pale that's majority-owned by London-based investment fund Altima, tells bne there's not much stimulus or a proactive approach to encourage job

bne May 2012

creation and local business growth.

"There's a need for some coherent policies to develop key parts of the economy," he says.

Penny asserts that the authorities are not actively obstructive, and that investors who want to set up shop are able to. But buck-passing between the multiple layers of government and a lack of institutional capacity make the process "painful"; establishing a business can take four months.

This is a particular challenge in the Bosnian Federation, which is divided into cantons, adding a third layer of administration below national and entity level. Indeed, of late the Bosnian Serb entity has advertised itself as the preferable investment destination in the country due to its relatively centralised decision-making.

Divided along ethnic lines As well as institutional complexity, ethnic divisions also make the domestic market rather peculiar; Penny notes that Croats tend to favour goods imported from Croatia and likewise Serbs those from Serbia. In his industry, for example, the former often opt for Croatia's Ozujsko or Karlovacko beers, while the latter drink Serbian Lav or Jelen. Politicians, trading heavily on communal vote-banks within their own entities, see little interest in promoting nationwide industries.

Bosnia also suffers from other strategic disadvantages – it is mountainous, has few natural resources and has a small population. But the country is not without potential. As Cuc points out, Bosnia has at least secured reasonable macroeconomic stability. The govern-

"Energy and forestry are two areas in which Bosnia has competitive advantages"

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ment is displaying some fiscal restraint in its 2012 budget – despite caving into public pressure on war veterans' pensions – and the financial sector is sufficiently capitalised and is reducing the non-performing loan ratio from a peak of 12%.

Progress in the middle of the last decade shows that reform can be implemented.

Bosnia's access to markets in the former Yugoslavia and beyond, relatively low overhead costs and signs of development in some sectors point to some opportunities for restoring economic momentum – given a degree of political will. "Energy and forestry are two areas in which Bosnia has competitive advantages," says Cuc. "But development will involve freeing them up to foreign investment.

The public sector is not in a position to provide the resources needed for modernisation and expansion, so privatisation efforts are required."

Penny argues that Bosnia needs support from international bodies such as the World Bank and EU to build capacity in government, giving the administration the scope to streamline business regulation and target support at strategically important industries.

While some international observers seem to find it impossible to see Bosnia other than through the prism of war, for the vast majority of Bosnians, the most pressing issues are economic rather than ethnic. But their leaders still work through institutions and mores shaped by the conflict's aftermath. Not quite being an economic basket case is no longer enough – Bosnians of all stripes deserve better.

I 37

the 'ethno-market' for Turkish products – restaurants, retail, travel agencies and tailors," says Ahmet Güler, a representative from the European Confederation of Turkish businesses (BTEU). "Secondand third-generation entrepreneurs are now found to be the same as your average German entrepreneurs."

He adds that a higher level of education and vocational training has become noticeable in new German-Turkish startups, and while most still operate on a micro-level employing fewer than three people, one-tenth now have a workforce of more than 10.

About more than just kebab shops Sherelle Jacobs in Cologne

M

ore than 50 years have passed since the first Turkish guest workers touched down in Germany, after the two countries signed an unprecedented labour agreement.

Their experiences have become the stuff of folklore – scores of young Turkish men would disembark from special trains, known as the "kara tren" or "black trains" in reference to the fears and uncertainties felt by those aboard, which snaked their way arduously from Ankara and Istanbul. They would then take up modest posts as unskilled labourers in Germany's coal mines and steel factories, becoming a vital (if undervalued) cog in the country's postwar economic machine.

Fast forward to the 21st century and a drastic transformation has occurred.

The Turkish population in Germany is now 2.5m-strong, by far the largest Turkish population in Western Europe.

And, crucially, as the Turkish population has exploded, so too has Turkish

entrepreneurship. Between 1985 and 2000, the number of Turkish selfemployed multiplied by 170%, and more than a decade later, over 80,000 Turkish businesses are now in operation across the country.

Intriguingly, stereotypes of Turkish entrepreneurship consisting of kebab chains and greengrocers, although not

Indeed, German-Turkish entrepreneurs have moved into a number of cuttingedge new areas that are a far cry from catering or retail. In fact, 20% of Turkish businesses in Germany are now active within the service industry. One particular trend is increased activity in the ICT and technology sectors. Take Exitcom, a leading company in the field of recycling electrical and electronic equipment. Since the company was launched in 1999 by Murat Ilgar, a Turkish entrepreneur living in Germany, it has expanded at a rapid pace, securing new profits and investments and recently expanding operations to Turkey.

Another high-profile success story is the video game company Crytek, which was founded by three Turkish brothers, Cevat, Avni and Faruk Yerli in Coburg, Germany in 1999. Having been involved in the development of a number of popular games, the company now has around 600 employees and subsidiaries in Ukraine, Budapest and South Korea.

"Second- and third-generation entrepreneurs are now found to be the same as your average German entrepreneurs"

obsolete, fail to do justice to the increasingly varied array of sectors that Turkish entrepreneurs have broken into. "[The first] generation were only involved in

Risk-takers The reasons for the successes of Turkish entrepreneurs in Germany is multi-layered and complex, according to experts.

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Made in Turkey

bne On April 5, the Turkish government revealed details of a highly anticipated manufacturing incentive package for the country, which includes policies to attract new investments to 15 of Turkey's less-developed eastern provinces.

The incentive package is aimed at taming Turkey's massive current account deficit, which currently comes in at about 10% of the country's GDP. With the incentive package, the fourth since it came to power in 2002, the government aims to reduce imports on intermediary goods. Incentives will be offered to increase the production capacity and competition of sectors the government believed to be most responsible for the current account deficit: iron and steel production, the automotive sector, machines and manufacturing, chemical production and textiles, and food production and agriculture.

Raising the level of education and skills around the country is still needed to produce qualified workers for further research and development, but the government is taking steps to change the types of products that are made in Turkey.

These are the kinds of steps that numerous observers, including bne, have been advocating for some time. Turkey has been enjoying 8% growth in 2011, far superior to anywhere else in Europe. However, the nature of this growth, dependent as it is on short-term inflows of foreign money and a credit boom, is unsustainable. The country needs to adjust the fundamentals of its production methods by developing more advanced types of products, expanding exports, increasing education and stopping the mad imports of energy and basic materials.

As one Turkish expert recently commented to bne, the government purposely raised energy prices to lower the current account deficit, but this would also contribute to this year's expected slowdown as industrial production is likely to suffer. Some of Turkey's main exports are white goods that are shipped in vast quantities to countries such as Iraq. If prices for these goods go up, Turkish white goods will face increased competition from white goods made in China.

The products are of the same basic quality and nature, yet China's white goods are cheaper. If Turkish industrial production falters and prices go up, Turkish businessmen may start hawking Chinese white goods on the Iraqi bazaar.

Turkey's eastern regions are a fabled bread basket. Situated at the edges of what was once Mesopotamia, vast tracks of dark, fertile earth lie empty.

The under-use is blamed on years of drought and conflict. The Turkish government continues a 30-year conflict with Kurdish militants in these lands, keeping investors away. The incentive package is the latest attempt to economically invigorate these areas.

However, it will ultimately take much more than another new incentive package to attract foreign investors to this region. The possibilities for agriculture there are huge, but the southeast has languished, a constant victim of more talk than action. "When one considers the projected 'general, regional, large scale and strategic investments' within the framework of the stimulus package, one notices that a long-term, regional and small and medium-sized enterprises (SME)-based approach is absent," the Turkish columnist Cengiz Aktar says.

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Some commentators draw on cultural factors: "To be a self-employed 'saint' is a status symbol to aim for in Turkish culture," says Güler from the BTEU. "The Turkish entrepreneurs are brave and willing to take risks."

assert that German Turks have the best of both worlds because it is sometimes an advantage to be from the West; Turkish consumers are said to exhibit a strong preference for products and services associated with the West.

The cultural proclivity of Turkish communities to help fund the businesses of those close to them has also provided many Turkish start-ups with vital finance. "They have capital support from family and friends," Güler explains.

Nonetheless, deeper research suggests that such advantages may have their limitations. It has been suggested that being perceived as western can constrain German Turks in their business activities at times: "Turkish citizens in Germany are often labelled as Almanyal or Almanc," explains Bettina Schulte in a compelling paper on the topic. "The latter has a rather negative connotation in Turkey, which is rooted in certain behaviour of Turks from abroad when coming back for holidays, mostly labelling those that left Turkey as rather simple farmers from Anatolia in the 1960s that would eventually return."

Some observers also note that the lack of conventional employment opportunities for Turks in Germany has acted as a powerful force propelling Turkish people towards starting up their own businesses; unemployment rates amongst the Turkish community have consistently been the highest amongst all the country's minority groups.

Interestingly, the dramatic economic rebirth of Turkey itself has opened up lucrative new opportunities for Turkish entrepreneurs. The exciting growth of a wide range of sectors in Turkey, including textiles, automotive and ICT, has been noted by German-Turkish businessmen; stories of such businessmen finding new commercial ventures and contacts when visiting Turkey on holiday are increasingly common.

These entrepreneurs become involved not only in traditional operations of importing Turkish products such as textiles to Germany, but also the inverse – many Turkish businesses are seeking to profit from the demand by Turks for western products and services by exporting German goods to their market. A reflection of this is the recent proliferation in Turkish-owned consultancy firms in Germany; Turkish entrepreneurs have spotted the demand from German companies for help breaking into the tricky Turkish market and have set up agencies to offer such services.

Limitations Experts note that German-Turkish entrepreneurs see investment in the Turkish market as carrying less risk because of their knowledge of the language and local culture. Some businessmen also

I 39

"To be a self-employed 'saint' is a status symbol to aim for in Turkish culture"

Schulte also cites differences in German and Turkish business culture and habits as potentially hazardous for German Turks, who can struggle to effectively balance the two. "One of the perceptions is that Turks from abroad are much softer in their interactions and they are not aware of some of the conventions like respecting the elder generations," she explains.

Moreover, Turkish businessmen also still face serious challenges in Germany itself, with many complaining that banks are reluctant to give them loans.

On the other side, German businesspeo-

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

ple claim the founders of Turkish startups are less likely to seek advice or carry out effective risk analysis in advance of investing in their businesses, a potentially costly strategy. "The Turkish entrepreneurs have to adapt themselves more to the German economy," says Güler.

It may have been more than half a century since their forefathers first touched down on German soil. But today's Turkish-German entrepreneurs display a similar stomach for venturing into the unknown. And it seems they too have some formidable obstacles to clear on their paths to prosperity.

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bne May 2012

Exports to Libya also fell from $1.9bn in 2010 to $748m in 2011. Turkish companies stayed on in Tripoli until the last minute, but were eventually forced to pull out as the civil war spread. "We nearly lost $1bn in exports to civil war," says Soybilgen, adding that postconflict Libya has been a priority for Turkish business.

Talk of customs unions and free trade zones may have receded as the region has descended into civil strife. But the consistency of Turkish business remains clear.

Turkey a fearless investor in the Middle East Justin Vela in Istanbul

E

ven as the turmoil from the Arab Spring drags on, Turkish businessmen are already setting out to reestablish themselves in the region.

While most remain wary, the Turks consider the Middle East and North Africa (MENA) to be their backyard market.

"They are sophisticated enough to manage risk very well," says Mouayed Makhlouf, MENA director for the World Bank's International Financial Corporation (IFC), adding that Turks have close cultural ties to the predominantly Arab region and understand the local way of thinking and doing business. "They understand the risk and the potential of the region very well. That makes them a little bit different than other investors from Asia or even Europe. For Asian investors, MENA is a completely unknown territory; for Turkish investors it is almost a home market."

The chaos in many of the region's nations from the various revolu-

tions has had only a limited effect on Turkish trade, according to a study done by Istanbul's Bahcesehir University Center for Economic and Social Research (Betam). Exports to Egypt rose to $2.7bn in 2011 from $2.2bn

No fear Turkey's desire to increase business with MENA is no mystery. Its market of Europe is suffering as the economies there stagnate. European Central Bank forecasts put average annual real GDP growth for the Eurozone at between -0.5% and 0.3% in 2012. Turkey has to increase its exports to finance a massive current account deficit, which registers around 10% of the country's $772bn annual GDP, and so is trying to look beyond Europe.

Soybilgen says Turkey can continue to grow its exports to the MENA region, where many countries, recovering from the effects of the Arab Spring, are beginning to show growth. "We expect that exports [to the MENA region] will increase. Europe is a declining export area for Turkey," he says, adding that the

"For Asian investors the Middle East and North Africa is a completely unknown territory; for Turkish investors it is almost a home market."

in 2010, despite the sustained civil unrest. Exports to Iraq also increased to $8.3bn in 2011 from $6bn in 2010.

"Our exports to these countries mostly increased, except to Syria, because of continued civil disorder and we expect that it will decline more," Baris Soybilgen, a researcher at Betam, tells bne.

country knows it can increase its exports to MENA and that it has a "technological advantage" over these countries.

The IFC's Makhlouf explains that his organisation has a strategy for "southsouth" investment. Essentially, this is one emerging market country investing

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"We expect exports to the Middle East and North Africa will increase. Europe is a declining export area for Turkey"

in another and furthering its development. "Turkey fits into the strategy because one of our main strategies has been to increase the flows of investment from the most developed to the least," he says.

There is a very little foreign direct investment (FDI) in MENA, so the IFC has a goal to increase FDI and further regional integration. "This is where Turkey comes into the picture" he says.

Turkey is strong in the manufacturing, textile, construction, and infrastructure sectors. Makhlouf wants to bring Turkish firms that are already well developed at home to assist in growing those sectors in MENA. The region is made attractive by its strong labour force, good energy resources, along with geographic proximity to Turkey. These are all factors that can be attractive to Turkish investors.

Some of the last to leave Libya, Turks were also some of the first to return. Libya, famous for its massive oil reserves, has huge possibilities for Turkish investors. It is also seen as an access point for the rest of Africa. "We have started looking into Libya now," says Makhlouf.

"We want to partner with a regional client that we know well, that we feel comfortable with. We aim to promote trade finance in Libya and are looking for a banking partner [to do that]."

Turkish Airlines was the first international carrier to restart flights to war-torn Tripoli. The Libyan National Transition Council and civil administration officials are in talks with Turkish TAV to repair the damaged runway at Tripoli International Airport.

In January, Turkish Economy Minister Zafer Caglayan declared that Turkey would provide $750m in loans to Tunisia and Libya. Turkey has already signed a $500m loan agreement aimed at helping the Tunisian economy recover from the impact of the 2011 revolution. The partnership between the countries will be further strengthened by planned agreements in industry, tourism and other sectors, according to Egyptian media.

Turkish tradesmen also did not hesitate to return to Egypt after Hosni Mubarak was ousted. Egyptian Minister of Industry and Foreign Trade Mahmoud Eissa says that Turkish companies will pump in over $1bn into Egypt over the next few years.

He also stressed the importance of a quick launch for the planned shipping trade route between the port of Alexandria and Mersin, on Turkey's Mediterranean coast.

The black sheep among a region of expanding partnerships is Syria, the country with which Turkey shares its longest border. Turkish exports to Syria fell by 77% in March compared with the year-earlier period. And Turkey's government has burned its bridges with the regime of Bashar al-Assad and hosts opposition forces on Turkish soil, looking to benefit as a top priority partner if and when the regime is overthrown.

I 41

Local hires If you're a company in the West looking to cut your staff costs, the best place to set up shop in the EU is Romania and Bulgaria apparently.

According to latest figures from the stats office Eurostat, hourly labour costs in the EU in 2011 stood at ¤23.10 per hour on average in the EU27 and ¤26.70 per hour in the Eurozone. However, that hides a wide range of rates: Bulgarians and Romanians got just ¤3.50 and ¤4.20 respectively an hour, but a worker in Belgium made on average 10 times as much at ¤39.30 per hour.

The 2011 labour costs were up slightly across both the EU27 and the Eurozone from the year before, with the ¤1 increase per hour or less more or less uniform across the EU, with only Ireland – which is suffering a hangover from a massive financial crisis – recording a slight decrease in hourly labour costs from 2010.

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INTERVIEW:

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benefits of state ownership. But it's an idea whose time may have come, as the centre-left government that came to power at the start of this year seems to agree with Bakic and is reported to be contemplating the sale of at least part of its 51% stake in Petrokemija.

Croatia's activist investor

That almost revolutionary development, which Bakic says is nothing more than Kismet, has exposed him to widespread opprobrium. And not just from union leaders defending the cushy status quo at Petrokemija, but also from sections of the country's business media as

Guy Norton in Zagreb

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edly hopes for a quick-fire payback on his investments, he's more than willing to tough it out over a number of years in order to see a return on his cash. "I always hope that my investments will prove profitable quickly, but I have a lot of stamina when it comes to fighting for my rights."

Bakic proudly boasts that in contrast to the country's often passive pension fund managers, he has no qualms in defying convention and firing off volleys of awkward questions at annual general meetings, which traditionally in Croatia have

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The art of stealing The last two of four paintings sensationally stolen from a museum in Zurich in 2008 have been recovered in Serbia and returned to the owners, the Zurich cantonal prosecutor’s office said in April.

"Count Lepic and his Daughters" by Edgar Degas and Cézanne’s "Boy in the Red Vest" (valued at $110m) were recovered in Serbia a few months ago, but both pictures were damaged. Lukas Gloor, director of the Buhrle Foundation which owns them, said repairs would take time, but they can probably be restored to their former condition.

Nenad Bakic

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It speaks volumes about Croatia's topsy-turvy transition from Yugoslav-style socialism to Western European-style capitalism that a casual stroll along any high street in the soonto-be EU state reveals an inconvenient truth: namely, you're far more likely to walk past a string of sports betting shops before you happen upon a stockbroker's office.

Your average Croatian, it seems, still places more faith – and more importantly his/her hard-earned cash – in the ability of Barcelona's superstar footballer Lionel Messi to deliver them better financial returns than the chief executives of the country's leading corporates or its mutual fund or pension fund managers could ever do.

No surprise then, that the country's narrow clique of stock market enthusiasts, much less the successful ones, are often viewed as being more financially suspicious figures than members of Croatia's betting mafia who regularly make headlines with their match-fixing activities around the globe. Nobody more so than Nenad Bakic, arguably the country's most successful share punter, whose investment acumen has helped to propel him into the ranks of Forbes magazine's top 50 richest Croats.

In most countries that performance would rank as an accolade, but truth be told he's often widely portrayed in parts of the Croatian media as being analogous with the notorious Miroslav Kutle, the politically well-connected

Herzegovinian-Croat businessman who asset-stripped his way through the Croatian economy in the 1990s with the gusto of the proverbial plague of locusts. Kutle's criminal activities – he's currently a fugitive from Croatian justice in neighbouring Bosnia-Herzegovina – left tens of thousands of Croatians facing financial Armageddon and the dole queue. They're also arguably why many Croatians have so little faith in privatisation, which in the 1990s at least resulted in economic devastation rather than development.

In contrast, Bakic, a former maths professor at Zagreb University, contends that an equal number of his fellow

Nevertheless, as he freely admits, "Probably 99% of Croats still think that investing in stocks is a worse gamble than sports betting."

Suspicious wealth Casually sipping a Coke Zero on the terrace of Gradska Kavana, an upscale café bordering Zagreb's Ban Jelacic central square, Bakic cuts a confident figure, totally unfazed by the media mauling he has received of late. His crime, in the eyes of certain sections of the Croatian press at least, is to have the temerity to suggest that historically poorly managed and loss-making statecontrolled companies such as fertilizer firm Petrokemija should be auctioned

"Probably 99% of Croats still think that investing in stocks is a worse gamble than sports betting"

countrymen and women will ultimately enjoy both monetary rewards and job security from his pioneering activist investor activities. "I don't want to be the only winner from my investments, I want everyone to be a winner," he says, claiming that the well-run, profitable companies he wants to see emerge from his investments will ultimately benefit the country as a whole and not just a select moneyed elite, himself included.

off ASAP at the highest possible price to private sector bidders, so as to ensure that they are managed far more efficiently and profitably in the future.

That investment thesis, a reasonable enough call in many countries around the world, still widely ranks as the equivalent of financial heresy in Croatia where the economic orthodoxy still largely extols the questionable

"The mindset in Croatia is still generally that making a profit is bad, but that making a loss is good"

well, which claim that Bakic is simply intent on pursuing short-term personal financial gain at the cost of the longterm economic interests of Croatia as a whole. "The mindset in Croatia is still generally that making a profit is bad, but that making a loss is good," says Bakic, for whom investing in Petrokemija is emblematic of what he terms his "deepvalue activist shareholder approach."

Value investor While some observers dismiss Bakic's terminology as nothing more than neoliberal capitalist claptrap, he claims that his allegedly selfish aims are at heart simple, equitable and transparent ones.

Namely, buy into a cheap, underperforming stock and then make enough of a nuisance of yourself so that the company's management actually makes the required changes in terms of both improving corporate governance and financial results so that other investors are willing to co-invest into the company, thus driving the share price up.

"I typically take a 1-5% stake, looking for a minimum 300-400% return," says Bakic, adding that while he unasham-

consisted of five minutes spent rubberstamping management decisions before everyone heads off for the day to quaff gallons of the local brandy and stuffing their faces with spit-roasted lamb.

Having bought a 4% stake in Petrokemija in 2008 at an average price of below HRK150 a share, Bakic has reaped a rich return from his bloody-mindedness. The stock trading was at HRK340 in early April, on the back of a return to profitability and the now widespread expectation that at least a part of it may be sold off to a foreign bidder that would vastly improve its financial performance, which has traditionally been a profit margin average of just 2-3% of total turnover.

"I've been handsomely rewarded for swimming against the tide," says Bakic.

And it's this kind of return, he claims, that's attracting other Croatians to his cause. His blog Eclectica now regularly attracts 20,000 visits a day, which he says indicates there is now a growing public interest in his allegedly selfinterested approach to playing the Croatian stock market.

The two paintings were stolen along with Claude Monet’s “Poppy field at Vetheuil” and Vincent van Gogh’s “Blooming Chestnut Branches” during a robbery in which they were cut out of their frames.

Those two pictures were discovered in a car parked at a mental hospital in Zurich shortly after the robbery, while the Swiss and Serbian police collaborated in the search for the other two missing pictures, which at times involved investigators from six countries. Undercover agents were also brought in.

Four men – three Serbians and a Montenegrin – are currently in custody in Serbia in connection with the robbery.

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tion mechanism has produced a weak and unaccountable banking sector."

Spruk adds that the only viable option to liberalise the banking sector would be through the wholesale privatisation of the state-owned banking sector to foreign institutional investors. "Yet the degree of systemic and hidden corruption in the Slovenian financial sector is so high that privatisation to domestic owners would not resolve the inefficiencies produced by 20 years of state ownership."

Slovenia's banks on the rack as losses mounts Guy Norton in Zagreb

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hese are trying times for Slovenia's banks, not so long ago regarded as being amongst the best managed and most financially stable in Central and Eastern Europe. That upbeat view has changed radically as a result of the euro debt crisis, which has taken a heavy toll on the Slovenian economy and caused bad loans to rise as high as 20% of total lending at some banks.

The trials and tribulations of Slovenia's financial institutions are now increasingly regarded as stemming from the country's halfhearted move from a Yugoslav-style command economy to a Western European capitalist model.

As Dutch academic Rok Spruk from Utrecht University recently noted in a

research paper for the London-based think-tank, the Centre for Research into Post-Communist Economies, entitled "After 20 years of Status Quo: The failure of gradualism in Slovenia's Post-Socialist Transition", the Slovenian banking sector remains largely a pawn of the country's domestic political players, with the government still owning roughly two-thirds of the country's banking assets. "A concerted effort to boost far-reaching privatisation and systematic restructuring has failed, mostly because of the pervasive influence of a network of former-communist politicians and businessmen. They favour direct influence in capturing the banking sector so as to establish and secure favourable lending relationships. So far, the absence of a privatisa-

Arguably a direct result of Slovenia's imperfect economic metamorphosis is the fact that in 2011 the country's banking sector reported a record loss of €356m and was forced to put aside €1.1bn to cover impaired lending to cash-strapped Slovenian corporates, especially those owned by domestic tycoons who have racked up the bulk of those debts as the economy has tanked.

The Slovenian economy is now firmly entrenched in the second phase of a double-dip recession, with GDP forecast to shrink by at least 0.9% this year, following a 0.2% contraction in 2011.

According to recent statements by the central bank governor, Marko Kranjec, Slovenian banks face an even tougher 2012 due to a combination of government spending cuts, growing unemployment and rising personal as well as corporate bankruptcy rates. This will all inevitably lead to lower domestic demand for banking services, while the sector's weakening ratings profile means that the supply of hitherto plentiful, cheap funding from abroad will be severely reduced.

That's also the view taken by ratings agency Moody's Investors Service, which has posted a negative outlook on the prospects for the Slovenian banking sector. "Asset quality pressure and the euro debt crisis are weighing on the sector's solvency and threaten its ability to continue to access private funding markets," says Moody's.

Off with his head The deteriorating conditions in the Slovenian banking sector have increasingly

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led to a growing number of casualties among the country's leading bankers in recent months, who have been forced to resign as a result of a toxic cocktail of political and business scandals.

In December, for example, Bozo Jasovic, chief executive of Nova Lju-

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stepped down amid suspicions over his dealings with construction company Konstruktor, one of NKBM's major clients. At the heart of the alleged scandal surrounding Kovacic is the 2009 sale of his apartment to Prava Pot, a company that took out a loan from Konstruktor to buy the property for €300,000. The

"A concerted effort to boost privatisation and restructuring has failed because of the pervasive influence former-communist politicians and businessmen" bljanska Banka (NLB), the country's leading lender, stepped down amid the political controversy of state-owned NLB's role as the head of a shareholder consortium that was proposing to sell a majority stake in Slovenia's leading supermarket to Croatia's Agrokor, owner of rival retailer Konzum. The main challenge facing his successor, who is yet to be appointed, is where to find €400m of fresh capital to improve NLB's core Tier 1 capital ratio to above the 9% minimum required by the European Banking Authority.

Recently installed Finance Minister Janez Sustersic has announced that the government is looking to cut its stake in NLB from 55% to 25% in the next few months precisely so that the cash-strapped Slovenian government will not have to make a major contribution to NLB's planned recapitalisation, which it is reportedly looking to delay until later in the year in order to give it a better chance of finding a buyer for its stake. NLB recorded its third consecutive loss last year, ending up €239m in the red after putting aside €480m to cover bad loans.

Meanwhile, the country's second biggest lender, Nova Kreditna Banka Maribor (NKBM), has had no less than three chief executives in almost as many months. In December, Matjaz Kovacic, who had run the bank since 2005,

money was never repaid to Konstruktor, which is now in receivership. NKBM board member Andrej Plos was then named as Kovacic's successor effective from January 1, 2012, but lasted little more than six weeks in the job before tendering his notice.

As of mid-March, the bank, which is 51% state owned, has been being led

He added that NKBM would also be more engaged with potential investors and existing shareholders to ensure the bank's future attractiveness for investment following a €104m secondary public offering on the Warsaw Stock Exchange last year.

The raft of poor financial results and resultant rating downgrades in the sector has inevitably taken its toll on the investment attractiveness of the banking sector, as evidenced by the failed sale of a majority stake in the country's third largest lender, Abanka Vipa, earlier this year. A consortium of shareholders with a combined stake of 75.7% had been looking to exit the bank since November 2010, but with conditions in the sector deteriorating and potential buyers increasingly thin on the ground, in January the group accepted the findings of investment bank ING which had been advising it on the sales process that no binding bids for the stake would likely be forthcoming in the foreseeable future. Abanka Vipa reported a loss of €119m last year, giving wannabe investors little incentive to buy into an already financially embattled institution.

"The degree of systemic and hidden corruption in the Slovenian financial sector is so high that privatisation to domestic owners would not resolve the inefficiencies"

by Ales Hauc, the former boss of postal operator Posta Slovenije, who is in no doubt that things will have to change at the bank. "Non-performing activities will be eliminated," he announced on taking the helm at NKBM, adding that in future the bank will have to work harder to win both new business and investor confidence. "The times when companies came to the bank are over, now the bank needs to actively market its services."

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value for the party," he said according to local press.

However, "Armenia has politics of personality rather than policy," Richard Giragosian, director of the Regional Studies Center in Yerevan, tells bne. "We are now seeing negotiations between [two former presidents and the current one] … Ter-Petrossian is in dialogue with Sargsyan against Kocharyan. The government wants to weaken [PA] and bring in the opposition."

All change Kocharyan and PA backed the candidacy of his former prime minister and fellow Nagorno Karabakhi Sargsyan when he came to the end of his second term, and under Armenian election rules was unable to stand again. However, since then Sargsyan has increasingly distanced himself from Kocharyan politically – most importantly through his decision to start a dialogue with Azer-

Personality trumps policy in Armenian politics Clare Nuttall in Yerevan

S

uspicion is building that Armenian President Serzh Sargsyan is looking to make a break with the past, hunting for new allies to replace current coalition partner Prosperous Armenia after parliamentary elections on May 6. The potential change illustrates the supremacy of personality over policy in Armenian politics.

Featuring many supporters of former President Robert Kocharyan (19982008), Prosperous Armenia – which originally helped Sargsyan into office – looks to be facing a tough fight to maintain its position in the upcoming elections, as relations with the ruling Republican Party of Armenia (RPA) have deteriorated recently. Sargsyan's move to reach out to bitter rival – and Armenia's first president – Levon Ter-

Petrossian, as well as other opposition leaders, illustrates the seriousness of the threat to the junior partner's role in the government.

was much larger and higher profile than the RPA's opening shot. The senior coalition partner launched its campaign in a low-key event on April 9.

Reflecting that challenge, Prosperous Armenia (PA) was first out of the blocks

Speaking in Abovyan, Tsarukyan said PA will focus on social issues, job creation

"Sargsyan and Kocharyan were born at the same time, in the same place but they are very different men" in launching its campaign for the forthcoming vote, hosting a rally on April 8 in Abovyan – home town of leader Gagik Tsarukyan. It's notable that the PA event

and reducing emigration. He also called on voters to judge the party on its record in government. "A task well done, rather than friends in high places, is the main

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baijan, including regular face-to-face meetings with Azeri leader Ilham Alilev.

He has also tried to build relations with Turkey, with the aim of re-opening the border between the two. Success would provide a huge economic boost for Armenia, although the process has stalled recently.

"Sargsyan and Kocharyan were born at the same time, in the same place but they are very different men," says Giragosyan, contrasting the charismatic sports-loving former president with the low-key style of the chess-playing incumbent. "Sargsyan came to power with a tainted legacy because of the events of March 2008, which happened because of decisions made before Sargsyan came to power. So there was a divide from day one."

When the result of the February 19 election was announced in 2008, it gave Sargsyan a 52.8% majority. The opposi-

tion, led by Ter-Petrossian, took to the streets, and two weeks of mass protests later, demonstrators were violently dispersed by police, resulting in the deaths of at least 10 people. The rift between the government and opposition has persisted since, but could now be healed, with regular dialogue between Sargsyan and Ter-Petrossian underway.

The upcoming vote will be Armenia's first general election since February 2008. In addition to opening dialogue with the opposition, both Sargsyan and Prime Minister Tigran Sargsyan have promised the most free and fair elections ever held in Armenia. However, it is not yet clear whether the transparency promised at the top officials will be adhered to at the local level, with recent local elections reported to have maintained the use of ballot-stuffing and other irregularities.

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Small focus Since GDP per capita in Armenia remains relatively low – at just under $5,500 in 2010 according to the World Bank – Star's strategy has been to focus on small stores.

"Smaller is better because purchasing power is still very low in Armenia. The average transaction value in bigger stores is just a little bit higher than in our stores, so it doesn't make sense for us to invest into big stores," Kerobyan tells bne.

Food for thought in Armenia Clare Nuttall in Yerevan

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rmenia's retail sector will see some dramatic changes in 2012 as the country's the largest local chain Star Supermarkets prepares to almost double its number of stores, while French hypermarket giant Carrefour takes a final decision on whether to enter the market.

When Star was launched back in 2004, it was the first formal retail chain in Armenia. The next eight years saw the emergence of fellow supermarket chains Galaxy, SAS and Yerevan City as Armenia made a gradual transition to a modern retail sector. However, the share of organised retail, as opposed to open-air bazaars and street vendors, remains low at just 10-12% of total turnover.

Now the process is starting to accelerate.

Star's executive director Vahan Kerobyan points out that "the first 10-15% is the most difficult" in the transition to a modern retail sector. Given Armenia's large shadow economy, formal retail chains are not competing on a level playing field with private vendors, who are mainly operating in the shadows themselves.

Retailers in Armenia also face challenges on the logistics side, since two of the country's four borders (with Azerbaijan and Turkey) are firmly sealed. Of Arme-

nia's other two neigbours, Iran's future is worryingly uncertain. Some 80% of Armenia's trade is channeled through Georgia, which acts as both a source of goods and a conduit for Russian trade - though the troubled relationship between Georgia and Russia raises questions over the future of this route too.

Domestic sourcing is therefore important for Armenian retailers, and under pressure from Star and other chains the goods available domestically have improved dramatically in recent years.

Kerobyan notes that back in 2004, 90% of locally produced items did not even have barcodes; most items are now of a good standard. New segments of the

In September 2011, Star took over its direct competitor Fresh, which added six stores to its mainly Yerevan-based network, bringing the total to 28 as of early 2012. This year will see the opening of another 20 stores in and around Yerevan. "We think this is the right time to make a big move – the market is ready," says Kerobyan, citing the growing purchasing power in the country.

To fund the expansion, Star was initially considering an IPO, but given the turmoil on international financial markets coupled with Armenia's location in the increasingly volatile south Caucasus and the elections scheduled for May this year, these plans have been put on hold.

An IPO is now not anticipated before 2013 or 2014, while Star will use its own resources for the expansion, as well as looking for a strategic investor.

Today, Star accounts for around half the turnover in Armenia's formal retail sector, with local rivals SAS, Galaxy and Yerevan City its main competitors in a market as yet largely ignored by international retailers. That, however, is set to change before long, as France's Carrefour is now looking at the Armenian

"Since GDP per capita in Armenia remains relatively low, Star's strategy has been to focus on small stores" food processing industry have grown up in tandem with the retail sector. Eight years ago, for example, 90% of the fruit juices Star sold were imported and 10% locally produced; these figures have now been reversed.

market. Already established in neighbouring Georgia, Carrefour is understood to be in discussions with two malls due to open in the near future.

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Slowdown in sight for Armenia's banking sector Clare Nuttall in Yerevan

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rmenia's banking sector has been growing much faster than the rest of the economy, but with strong competition between the banks in a small economy, the pace of growth is expected to slow.

While Armenia's economy grew by just 4% in 2011, the banking sector expanded by over 30%; assets were up 37% and deposits 36%. Data from the Union of Banks of Armenia (UBA) shows that there was growth across both consumer and corporate segments, with lending to the construction sector (up 36%), the

industrial sector (up 30%) and services (up 26%) all growing strongly.

Admittedly, the main driver for this growth was the demand left over from 2009, when the Armenian economy contracted by 15% and banks slowed their activities in response. "There has been very strong growth especially on the lending side in 2010 and 2011, because there was a lot of pent-up demand," says Astrid Clifford, CEO of HSBC Bank Armenia, which almost doubled its commercial loan portfolio in 2010.

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Bankers are now waiting to see what impact the ongoing crisis in the Eurozone will have on Armenia's economy.

The banking sector still has little direct exposure to international capital markets, and is tightly regulated, but some impact is expected. "We expect growth will continue if we have stability in Armenia," says Seyran Sargsyan, executive director of the UBA. "There may be some indirect influence from the crisis in the Eurozone. We are more integrated with the Russian economy, so problems in Russia would affect Armenia. However, all these risks are manageable."

Search for new business Whatever the events in the Eurozone, within Armenia the catch-up effect from the previous crisis has been used up, and banks are having to look for new business beyond their existing client bases, which are generally concentrated in Yerevan and other major cities.

Armenia's rising stocks

Clare Nuttall in Yerevan The Armenian government is offering incentives to companies to become more involved with the capital markets, but the shadow economy looms large here and many managers prefer not to open up their affairs to the kind of scrutiny this would entail. The head of Armenia's stock exchange believes that situation should change for the better over the next five years.

Nasdaq OMX Armenia – OMX acquired 100% of the Armenian Stock Exchange in January 2008, before merging with Nasdaq the following month – finds itself in a similar situation to that of stock exchanges in many of the small post-Soviet republics. It saw a brief spurt of interest in the mid-2000s when investors turned to frontier markets like Armenia, but things have been quiet since 2009.

2011 actually saw trading on the stock market increase by 57% on year to a still modest AMD200.3m ($511m), with market capitalisation reaching AMD53.8bn by the end of the year. Trading in corporate bonds amounted to AMD708.98m in 2011, and government bonds AMD5.37bn. But unsurprisingly, given the impact of the crisis on the Armenian economy and trends in emerging market investments in general, there have been no new IPOs in Armenia in the

last three years. The CEO of Nasdaq OMX Armenia, Konstantin Saroyan, notes that recently Armenian companies have started talking about potential future IPOs and bond issues, but given the current uncertainty in global financial markets, these are unlikely to take place this year.

This is not for want of support from the government or the central bank, both of which, Saroyan says, have been "very supportive". The government currently offers a range of incentives for companies hoping to list on the exchange including a 50% discount on profit tax. Nasdaq OMX Armenia is also working with the government and the central bank on ways to encourage international investment into listed companies. Saroyan also wants the international financial institutions active in Armenia, which are supporting the banking sector, to consider supporting Armenian companies via the stock exchange, but has so far has not been able to bring this about.

Perhaps the biggest stumbling block in persuading more companies to turn to the exchange is the need for transparency. Even though Saroyan says the requirements for listing in Yerevan are not very tough, with the shadow economy accounting for 50-60% of Armenian GDP, it is clear that many companies are deeply entrenched in the grey economy.

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Banking sector penetration is still relatively low in Armenia, where many people, especially in rural areas, still prefer to store their savings under the mattress. The shadow economy is also large – although this is starting to change. As of 2011, 51% of Armenia's adult population had a bank account, according to the UBA, up from 30% in 2006 and just 13% in 2000. "Unfortu-

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such as agriculture, where lending was up 36% in 2011. This could become a key sector," he says.

There are growing concerns that in a market until now characterised by conservative lending policies and strict regulation, banks could turn to riskier clients. Some banks are reported to be being less demanding in terms of secu-

"It is a small market so we are all targeting the same people"

nately, penetration has not reached the whole population, although there has been a steady increase in recent years," Ashot Osipyan, president of the UBA and CEO of Araratbank, tells bne.

He points out that banks have been increasingly moving into rural areas.

"Banks are also looking at new areas

rity and collateral in order to bring in new business.

Armenia's banks have typically been conservative in their lending; non-performing loans (NPLs) are low compared with other countries in the region.

However, with competition becoming more intense, and many companies

already quite highly leveraged, things may be changing. Given the small size of the Armenian economy, banks are forced to compete for a small pool of potential clients. Clifford notes that interest rates have fallen as competition has increased. "It is a small market so we are all targeting the same people.

These days we are seeing more refinancing than new loans."

However, bankers say that a big more towards riskier lending is unlikely. Tight regulation has also ensured that no single bank or group of banks has ever had more than 10-12% of total market volume or dominated Armenia's small but competitive banking sector.

Osipyan, for one, reckons the country has one of the best regulated banking sectors in the world. "With strong regulation, you can have a very competitive bank system with small size," he says. "In a liberal regime, you get big banks and aggressive growth, but the crisis showed it is more important for both the banking system and the country to have strong regulation."

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y the autumn of this year, 31 state-of-the-art wind turbines will dot the horizon 70 kilometres from the capital of Mongolia. The farm's 50-megawatt (MW) capacity will represent just half a percent of the country's growing electricity demand, but from these humble beginnings could develop an industry with the power to radically alter Asia's energy future.

Desert winds Oliver Belfitt-Nash in Ulaanbaatar

Mongolia's abundance of space and 300 days of sun and consistently windy steppes create an ideal environment for renewable energy. As such, the gears are already turning for a project 200 times the size to stretch across the Gobi desert, aiming to export clean energy across an "Asian Super-grid" all the way to Japan.

"Mongolia is an energy heaven – and not just for coal," says Bayanjargal Byambasaikhan, CEO of Newcom Group, one of the country's leading conglomerates.

"We have rich energy sources below ground, but also above the surface."

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Mongolia's coal exports rose 26% from the previous year, delivering 21.1m tonnes to China out of its estimated 160bn tonnes of reserves. Thermal coal provides almost all of the domestic energy demand, and is the go-to fuel for stoves in the traditional ger houses that surround the capital city. For miners, the cash comes thick and fast, but for the residents of Ulaanbaatar the costs are all too clear, with 1 in every 10 deaths attributed the thick winter smog.

Developing cleaner energy resources like wind is a priority then. $120m is being pumped into this wind project, with $2 in every $3 lent coming from the European Bank of Reconstruction and Development (EBRD), Dutch Development Bank (FMO) and Millennium Challenge Corporation (MCC). General Electric will supply the materials and Newcom will manage the farm. "We have been measuring the Gobi's potential for three years now and we have some good wind down there," says Byambasaikhan. "Placing a turbine 25 metres to the right can make a big difference when catching the wind channels and we have mapped each turbine's location."

Going with the flow Wind energy's popularity has boomed over the last few years due to its cheap operational costs, quick construction times and minimal impact on the environment. One in every 40 lights around the world now turns on because of wind generators, up 27% on average for the last five years. China overtook the US in 2010 to become the world's leading wind energy supplier, with 4% of its energy demand coming from wind power, or a whopping 62 gigawatts (GW).

Now Mongolia is getting on board. "Power generated from coal costs 6-7 cents per kilowatt-hour, and can rise up to 10 cents/ kWh during peak hours," says Tumentsogt Tsevegmid, chief representative of General Electric in Mongolia. "Wind will cost 9.5 cents on this scale, and mines are now paying 40-50 cents on their power from diesel generators! We estimate it will take 13 years to break even on this project."

While sceptics watch coal sales rising faster in Mongolia than ever before, some attractive economic motives are gather-

Eurasia

ing behind wind energy over traditional forms of power generation. "Just do the math," says Byambasaikhan. "We're building 50-MW wind for $120m, and a 450-MW coal plant will cost $1.4bn in Mongolia." This makes wind around a third cheaper to build and a lot faster too.

Even with Mongolia's infrastructure limitations, the farm is expected to be completed by the end of summer this year, and construction has only just begun.

For Newcom, this project is just the beginning. The company recently signed an agreement with Softbank, a Japanese telecommunications conglomerate, to cooperate on forming an "Asian Super-grid", stretching from India to Japan and down to Indonesia. Mongolia's role will be to scale up its wind and solar farms to create a multi-GW system across the Gobi desert, ready for export. "We estimate there is 2.6 terawatts of potential wind and solar energy in Mongolia," says Byambasaikhan.

"Even 10% of that would be huge."

The future of Japan's nuclear industry is in doubt after the Fukushima disaster, and the government is scrambling to find alternative sources. Newcom and Softbank's agreement could provide that alternative down the road. "The off-taker for Newcom's 50-MW Salkhit project is the Mongolian state grid," says Tumentsogt, "but to be competitive we need international buyers."

As is often the case in Mongolia, infrastructure deficiencies are the biggest reality check for any dreams. Over the border in China where roads and railways can support much larger operations, a similar project is estimated to cost two-thirds of the price. Mongolia's government is behind on its railway expansion plans, on which many mining projects will rely.

"Infrastructure is costing me," says Byambasaikhan. "It's no easy feat to transport over 40-metre-long blades across a dirt track. We have already laid a 28-km high voltage line, but there is a lot more to do if we expand."

But for all the potential hiccups, Newcom's green vision is fuelling a wave of optimism that Mongolia can move beyond its reliance on coal. "We just have to make sure politics don't get in the way," says Byambasaikhan.

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"We have rich energy sources below ground, but also above the surface"

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cessful city. "The best way is still to build cities in an organic way… top-down planned cities can be a failure, as we saw in many cases in the 20th century," he says. "Usually, the government will put in the infrastructure and private developers will then build homes and sell them – this is why cities can be a business opportunity for them."

From conflict zone to tourist zone Molly Corso in Tbilisi

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eorgia is banking on two new developments on the Black Sea to bolster investment, and create a modern image for the conflict-ridden country. But a sluggish economy and lingering problems with property rights has cast doubt on the projects' durability.

Georgian President Mikheil Saakashvili is behind both ambitious initiatives: plans to rebuild the Black Sea village of Anaklia as a modern sea resort, and create Lazika, a completely new city next door.

Lazika is the star in Saakashvili's vision for the future. Slated for development in western Georgia, plans for the city were first announced late last year. On April 2, however, the cabinet met to discuss the city's "concept" – a plan that pins development on foreign investors rather than government-funded building.

But the scale and scope of international interest is far from the government's projections for the project and the neighbouring pasture land it plans to develop into a new city, Lazika. A promotional video, posted on YouTube

on March 28, depicts an ultramodern metropolis with skyscrapers, quiet suburbs, and modern planning – a city of the future. Yet during a recent trip to the region, just horses roamed in the vast marshland where Lazika is slated for development. Locals report some

But for Saakashvili the city is as good as built. With an eye to his image as the builder of modern Georgia, Saakashvili reminded the country during his annual address to parliament that his vision for the future is bright, and focused on new buildings, new cities, and new resorts. "When you ask what I plan – my plan is to build Lazika… I will definitely be in the built Lazika and I will take part in its construction… You wonder what my plans are – my plan is to live in a brightened Georgia, which no one will ever be able to darken and it will be achieved too in a few years," Saakashvili told parliament during the annual debates on February 28, noting the ruling party has a "modernisation" plan. "[W]e should make a leap from third world countries into the team of developed countries and Georgia now is in this process of making this leap."

Rebuilt, rebranded Factoring equally high in Saakashvili's

"The best way is still to build cities in an organic way – top-down planned cities can be a failure, as we saw in many cases in the 20th century"

basic work has started to clear the area for a new road, but no buildings have started yet.

Carlo Rotti, director of the Massachusetts Institute of Technology (MIT) SENSEable City Lab, tells bne that "organic" cities, which put the emphasis on investment, rather than "top-down" planning is a core part of building a suc-

plans for rebranding Georgia from conflict-ridden to tourism-driven is Anaklia, a sleepy seaside village roughly 30 kilometres from the Abkhaz conflict zone and immediately to the north of the Lazika project.

The tiny hamlet has been the site of intensive construction over the past two years. In 2010, there was no road and

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no cafes for tourists. Today, three new hotels grace the sandy beach, and the government built a "bridge of peace" to connect its new boulevard.

Keti Bochorishvili, head of the Georgian National Investment Agency (GNIA), says government investment is on track: the state is preparing infrastructure like new roads. Foreign investors, she notes, are also interested: WhiteWater West Industries, a Canadian-based water park developer, has announced plans to build the largest water park in the Caucasus in Anaklia. The park will open in August, according to the company's website.

For the current residents of the region, however, the developments are far from positive. Allegations of a massive government attempt to usurp land rights abound as the state prepares for the region's development. A report published on April 11 by four nongovernmental organisations in Tbilisi found property rights are regularly violated in the build-up to major government projects.

Omar Akubardia, a farmer in Anaklia with large land holdings, discovered 49.7 hectares of his land "disappeared" from the public registry in 2010. The public registry denied any wrongdoing; Akubardia submitted his case to the Strasbourg Court of Human Rights.

Development projects, notes Irina Lashkhi, a human rights and good governance programme coordinator at Open Society Georgia, should not come at the expense of human rights. "There are lots of other human rights violations where the ombudsman or the US State Department Human Rights report states the facts. But not the property rights violation," she says. "This is of crucial importance – not many people are talking about it."

Eurasia

Fast-food fight in the Caucasus

Molly Corso in Tbilisi A fast-food fight between US-based rivals Wendy's and McDonalds in the South Caucasus is on the cards as Wendy's plans to expand to Georgia and Azerbaijan in 2013. The deal could also bolster Georgia's efforts to attract US and European-based brands as local franchises.

Wendy's announced during a joint press conference with its Georgian partner, Wissol Group, in Tbilisi on April 5 that it has a 10-year plan to open 25 Wendy's in Georgia and Azerbaijan by 2023, making it a direct challenger to McDonalds, the reigning fast-food franchise in the South Caucasus. The announcement was attended by Prime Minister Nika Gilauri, Economy Minister Vera Kobalia and other members of the parliament, underscoring the government's focus on securing international brands for the Georgian market. Wendy's will be the fifth large American brand to enter the Georgian market, following large franchise deals with Coca-Cola, McDonalds, Texas Chicken and Donald Trump.

David Lee, president of the American Chamber of Commerce in Georgia, noted that the franchise deal is "good news" for the country and the investment climate. "Although the government of Georgia has been highly focused on improving the business climate, there are still not enough international brands on the high street," he tells bne. "Wendy's will therefore be a highly visible and welcome addition… this deal is good news for Georgia and its reputation as a good place to do business."

The franchise deal was the result of 18 months of negotiations, Samson Pkhakadze, chairman of the Wissol board of directors, told TV programme Business Courier during an interview with Georgian media on April 5.

"We are very proud to bring Wendy's to the Georgian market, where we will focus our development efforts over the next several years," he was quoted as saying during the presentation. "We are also excited that through Wendy's, The Wissol Group will bring additional jobs to our local economy.

After French oil giant Total and Italian API, we expect Wendy's to become one of the most important brands in our growing business portfolio."

The Wendy's deal is Wissol's first foray into the competitive world of fast food. The group, which includes gas stations, supermarkets, real estate, advertising and football, plans to open the first Wendy's in Georgia by 2013 in Tbilisi, not far from the country's oldest McDonalds restaurant.

The partnership dovetails with Wendy's expansion and brand redevelopment: currently the second largest fast food chain in terms of sales, it still trails McDonalds and Burger King in terms of outlets. The Wendy's fast food chain is expanding far past its Ohio roots, but with an estimated 6,650 restaurants in 26 countries, it is still considerably smaller than rival McDonalds (31,000 locations).

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CORPORATE STATEMENT:

Special focus: Azerbaijan

PASHA Bank – A commitment to quality

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Farid Akhundov, Chairman of the Executive Board

The first three-year strategy that the leading Azerbaijani financial institution has set for itself in 2009 was aimed at strengthening the institutional might of the bank. Now in 2012 that PASHA Bank has established itself as a reputable and transparent brand, both internally and externally, it has started the second phase of the strategy, which is built on a commitment to quality as the core concept.

The strategy will run 2012-2014, but PASHA Bank is already scoring well on the main quality indicators: it is number one in the country in terms of revenue per employee, it has the lowest cost/income ratio, and the real level of non-performing loans is one of the lowest in the sector thanks to its conservative credit policy. "We have very strict credit criteria, as we are a young bank and we want to build up a sustainable operation. That means being conservative, but it also means building strong foundations: 40% of our capital is from reinvested profits," says Farid Akhundov, chairman of the board of PASHA Bank, who in the early 2000s was one of HSBC's executives in Azerbaijan.

PASHA Bank has built its business on three pillars: private banking, corporate clients, and wholesale and treasury operations.

PASHA Bank's private banking offering "onshore services" is already well established in catering to the needs of Azerbaijan's leading businessmen. However, PASHA Bank is extending its "quality first" concept and researching partnership opportunities in Switzerland. "We already have a well-equipped team of bankers that had been trained at and certified by the Institut Supérieur de Formation Bancaire – a Swiss higher institute of banking training. Currently, we are researching Swiss domicile," says Akhundov. "The goal is to support our clients with access to the international capital markets, as well as to appeal to non-resident clients in Turkey, UAE, China, Russia and other countries."

Corporate clients will be also served by another new branch in Tbilisi, Georgia that is due to be operational by the end of this year. "The relationship between Georgia and Azerbaijan is developing rapidly, as these two Caucasus countries have many interests in common," says Akhundov. "The leading Azeri companies are very active in Georgia in food processing, real estate and energy. To

better serve our clients' needs, PASHA Bank is following our customers to Tbilisi."

Existing corporate clients remain key to PASHA Bank's operations, though under the new strategy the bank will also branch out and expand its business with small and mediumsized enterprises (SMEs), which are already a new growth engine of Azerbaijan's economy. PASHA Bank launched its SME operations in 2010 and the first deals came to fruition last year. But under the new strategy, SMEs will become a strategic direction, rooted in the growing economy and innate entrepreneurship of the Azeri people. "By the time the crisis hit in 2008, the share of the SME market amongst the local banks was fairly well established," says Akhundov.

"The crisis didn't have a huge impact on our economy, but the investment plans have slowed down a great deal. Now the economy has started to pick up again, thus igniting competition in the financial sector – the banks hope to increase the share of SME business in their portfolios. Azeri entrepreneurs are going to transform the economy and PASHA Bank strives to play a key role in financing their operations."

The last of the three pillars is wholesale and treasury operations and here too PASHA Bank continues to be a pioneer. In January, Bakcell, one of Azerbaijan’s leading mobile operators, issued one of the country's first corporate bonds on the local exchange. PASHA Bank acted as the underwriter and also provided most of the liquidity to make the offering a success. "The bond market is growing and there is a demand from local investors. We moved into the market at the right time," says Akhundov.

"Bakcell is a sophisticated company that has been in the market for almost 20 years. However, there are many other younger and less developed companies who have also started thinking about issuing bonds. It takes, however, two to tango and PASHA Bank as the relationship bank is the reliable partner for such clients."

The Azeri market remains buoyant and bankers are looking forward to faster growth. On the other hand, it is a young market, so the risks remain high. As one of the top five banks, PASHA Bank has committed itself to a conservative approach based on the highest standards of integrity to deal with these challenges. "We have a very simple and clear equation for success: focus on good corporate ethics and the highest quality of service, and this will surely generate profits," says Akhundov.

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opportunity. The competition is very timely, as tourism is one of the strategic sectors the government is trying to promote as part of its efforts to diversify the economy away from oil. Nine of the 11 climate zones can be found in the country, from snow-capped mountains in the north, to balmy beaches in the south, to the Naftalan oil spas in the west (famous in Soviet times as a treatment for rheumatism). And the state has targeted European as well as Middle Eastern tourists, who already regularly holiday in the republic during the Novruz spring festival, and is building upscale modern facilities up to the highest international standards, like Shakhdakh ski resort in the north, to accommodate them. Like California, Azerbaijan's climatic diversity means you can ski in the morning and spend the afternoon on the beach.

More than oil The small Caucasian republic of 9m people was a backwater during Soviet times, with the bulk of the population engaged in agriculture. Large oil and gas reserves began to be exploited after independence in 1991, but the country has been struggling to catch up.

The turning point came with the building of the BakuTbilisi-Ceyhan (BTC) oil pipeline, which bypassed Russian soil and connected the giant producing AzeriChirag-Guneshli oilfield in the Caspian Sea directly to western markets when it came online in 2005. Money began to pour into the country, propelling economic growth to a phenomenal 35% one year. Today, the issue is not financing. "We are mostly interested in the transfer of know-how and state-of-the-art technology," says Mammadov.

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A makeover based on oil, pomegranates and music Central Baku is in uproar due to the manic building works to give the city a facelift ahead of the 57th Eurovision song contest. "It's a nightmare," says one banker who works in central Baku, with good humour.

"It should be a 20-minute drive from home to the office, but every day they close off another street for repairs and it is all happening so fast no one ever gets round to working out where the diverted traffic should go before it changes again."

Yet few are losing their tempers over the traffic chaos, because they know it will end on May 26 when the final of the song contest will be held. Azerbaijan was the surprise winner in 2011 when Eldar and Nigar won with their performance of "Running Scared" – only the third time the country had every participated. This year Sabina Babayeva will defend the title with her song "When the Music Dies", and go head-to-head with the likes of Russia's six Buranovskiye Babushki – one of the more bizarre entries in this already pretty surreal

Ben Aris in Baku

competition. "You can't buy marketing like this," says Adil Mammadov gleefully, head of the state promotion agency Azpromo, which is charged with raising Azerbaijan's profile on the international stage.

On the ground, the airport is being fixed up, while the roads are being resurfaced. And the city is getting back some of its Nobel brothers-era glamour as the mansions are decked with lights. Compared with this correspondent's last visit two years ago, the city has been transformed into a gleaming vision of fin de siècle architecture and marble. On a more practical level, some 5,000 new hotel beds have been added and the shorefront Four Seasons Hotel should be open in time to accommodate the 30,000 visitors that are expected for the Eurovision.

Hosting the contest was an unexpected boon for the government, which has thrown itself into organising the best party it can as a once-in-a-lifetime marketing

"You can't buy marketing like this"

To its credit, the government, rather than squander the windfall, almost immediately launched a programme to diversify the economy away from oil. Half the population works in the agricultural sector and with average wages of $480 a month, the income gap between the urban well-to-do and rural workers remains large.

Azerbaijan's Soviet legacy means that manufacturing and industry are thin on the ground. However, the Sumgait city with its vast petrochemical infrastructure has been made the centre of an industrial park designed to attract more foreign investment. "We are new to the ideas of industrial parks, but we have

Gloves come off in Azeri bank sector With Unibank hiring market leader Bank of Baku's head of retail at the end of March, the gloves are coming off as Azerbaijan's banking sector gets more competitive.

Azerbaijan's banking sector was hurt by the 2008 crisis like everywhere else, but the effects have been relatively mild so far. "There was no major crisis in Azerbaijan.

There were no defaults, oil prices remained high and salaries were paid on time. We had no foreign debt and even the little foreign borrowing there is comes from [international financial institutions] that didn't call in their debts," says Elchin Gadimov, vice chairman of Rabitabank. "But the music did stop. Lots of banks realised there were things they should have been doing that they weren't."

The greatest damage was inflicted on the real estate sector, which remains both moribund and the source of the worst non-performing loans (NPL). One large bank in Azerbaijan was forced into the red by its Russian subsidiary's forays into the real estate market there. There are no official statistics, but experts estimate bad debt at Azerbaijan's banks is 20-35% of total loan portfolios. Still, now the sector is growing again, banks should be able to grow their way out of the hole. Corporate lending remains depressed, but the high-margin consumer segment is booming and rapidly becoming more competitive.

Consumer lending only appeared about two years ago, but Bank of Baku quickly built up a large market share and today earns some 90% of its profits from making small loans. Now Unibank, another top five bank, is getting in on the action.

The consumer segment is one of the few places banks, flush with cash, can go. Expanding small loans also makes sense in terms of matching assets with liabilities: interest rates are currently flat, but expected to become negative later this year, as deposits are rising faster than loans and banks are already starting to cut interest rates to slow the inflow of cash. "We are trying to avoid the mistakes of other countries like Kazakhstan [where aggressive expansion of consumer loans is one of the factors that brought the banking sector to its knees in 2010]. The central bank hopes that it will be able to manage the growth," says Gadimov.

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created a favourable investment environment here and plan to promote the full chain of production," says Mammadov.

Special focus: Azerbaijan

There is also a waste management plant on the outskirts of Baku, which has already significantly reduced the smog that used to hang over the capital, that has become the basis of another park, Balakhani technological park. Perhaps more significantly, the state recently signed a joint venture deal with Singapore to build the first Caspian-based shipyard. State oil and gas company Socar's large fleet of ships is aging and needs replacing. And the state will launch its first telecommunications satellite this year, as information technology is another target sector. The state-owned telecom company will use only about 20% of the satellite's capacity and the rest will be opened up to foreign investments.

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Food for export All these projects are making good progress, but the heart of the makeover to Azerbaijan's economy must be in agriculture, by far the largest employer in the country. Already famous in Soviet times for the quality of its fruit and veg, the challenge now has been to add all the bells and whistles of modern marketing, logistics and storage, and in doing so open up new markets.

Soviet agriculture was seasonal and bucolic; the government's first task was to support private companies to build the infrastructure that would allow farmers to transport and store their produce to break the link with the seasons. "We have almost finished this process. We now have modern storage and logistical infrastructure in all the regions of the country," says Mammadov.

"In Azerbaijan, all our agricultural products are organic"

The small domestic population means that agriculture has always been an export-oriented sector, with Russia still the main market. However, the government is pushing to diversify export markets, with EU countries topping of the list. Further down the road, the state is helping farmers break into new markets. Azerbaijan recently started exporting pomegranate juice to the US. It sounds like an odd niche product to sell, but it is one of few products where Azerbaijan stands head and shoulders above the rest of the world (and Narsharab, a pomegranate sauce that accompanies kebabs, is both delicious and one of the undiscovered culinary treats of the former Soviet Union). Currently, Israel is responsible for a large share of pomegranate juice exports to the US, but Azerbaijan is ambitious about its prospects for this segment.

The plan is to open a window and then gradually increase the number of products passing through it.

"We went with lab tests done in the US to distributors to prove that our pomegranate juice really is 100% pomegranate juice," says Mammadov. "In the West, customers are keen on organic products, but in Azerbaijan all our agricultural products are organic – the trick is to get the certification."

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Opinion

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Putin III – what's in store?

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etre-deep piles of slush are lying about the streets of Moscow as the weather is having a gender crisis: it can't decide if it wants to remain winter or finally give in to nature and become spring. Politics are similarly confused – is a thaw coming or a crop-killing frost? I don't remember things being so confusing since Vladimir Putin took over in 2000.

Superficially, everything is going extremely well. The economy is practically booming (although there is no feel-good factor), so much so that VTB Capital's chief economist Alexey Moiseev warned at the end of March that the economy could be overheating.

All the indicators have jumped. Savings and Ural blend oil prices are at 20-year highs, and the current account surplus also hit a record $45bn in the first quarter. This has all fed through into rapidly accelerating consumption and retail sales.

Even the protest movement has died down, leaving a lowkey weekly gathering on Pushkin Square and the occasional gaggle of demonstrators on Red Square. But tap the barometer and the mercury is falling fast: a political storm is on its way to Moscow.

undermine Putin's authority – because that's what several of these measures will do – or whether he is playing liberal cop to Putin's authoritarian cop in concert with the president-to-be.

It's hard to tell. Russia has reverted to its Churchillian bulldogs fighting under the carpet.

However, several things are becoming clear. First, there are going to be sweeping personnel changes. One current rumour is that former Rosneft boss and Siloviki-in-chief (the Kremlin securities forces fraction) Igor Sechin has lost out in a clash with oil trader par excellence and uber-oligarch Gennady Timchenko. Sechin is out, say the little birds, and if true, then a big blow has been struck for the liberal camp. Energy Minister Sergei Shmatko is also expected to go. Together, all this suggests major changes are ahead for the energy sector.

On the other side of the fence, the liberals have ratcheted up their rhetoric and seem to be gaining traction. Minister of Economic Development Elvira Nabiullina issued a stark warning at the start of April that things have to change drastically or Russia faces stagnation. In a positive sign, Nabiullina is expected to be promoted to deputy prime minister in the reshuffle and young Turk, Arkady Dvorkovich, the presidential economic advisor, could replace her. To the liberals, it is patently obvious

Rumours are flying ahead of the inauguration of presidentelect Vladimir Putin at the start of May. It seems pretty clear that big changes are in the works.

President Dmitry Medvedev's appointment as prime minister is a done deal – for the time being anyway. But in his last weeks as president, Medvedev probably pushed through more laws than at any time during his entire four-year term. The direct election of governors has been re-introduced, various new graft measures passed and several more governors sacked. The interesting question is whether he is rebelling and shoving through changes before he leaves office that will

"Rumours are flying ahead of the inauguration of president-elect Vladimir Putin at the start of May. It seems pretty clear that big changes are in the works"

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that Russia needs a new economic model, but they are going to have a hard time convincing the Siloviki who are looking at the oil price and don't see a problem.

Which side Putin comes down on will be the key to resolving this tension, but just as in 2000 he is currently unreadable.

When he came to power, we wrote that there are two Putins: the economic one that pushed through a radical tax reform, and the political one that threw oligarchs in jail and fired the federation council deputies.

Massively increasing spending on the military and his disparaging remarks about condom-wearing protestors suggest the political Putin is in the ascendance. However, his crackdown on corruption in the utilities sector in December, (another) prospective radical reform of the tax code and the possible clipping of the Siloviki's wings (not to mention Medvedev's flurry of activity) all suggest the economic Putin is back. The reality is probably that, like before, we have both. I just wish someone would give him some potassium and he would make up his mind which he wants to be.

Maybe it makes more sense to see the changes in terms of economics, as after all Putin is at core a pragmatist and the Kremlin has started to hunt for more revenue. For most of the last decade Russia has been flush with cash. It didn't matter if everyone was stealing, as there was plenty to go round and still finance the state's pet projects. But now with pensions eating up a third of the budget and some $100bn being spent on both infrastructure and military reform a year, for the first time the government is feeling the pinch. The federal budget is in surplus for the moment – but that won't last for long.

During the recent presidential elections, Putin ignored the fact that he could have won some 53% of the vote without massaging the result, but he still added 10% to the tally using administrative resources. Why? Because his real constituency is still the elite. He needs to show the men in power he is still boss – especially if he plans to push through sweeping changes: an "Orange Revolution" of the elite. The protest movement is still only five months old after all and the people still sheep, although they did manage to reduce Putin's win from the 71% Medvedev won in 2008 to 63% this time round. Having said that, most of the Kremlin insiders are now talking about one more Putin term, not two.

Money matters Where is this new revenue going to come from? Taxing the voters is a non-starter politically. Cutting spending on state services is also a no-no. That leaves more growth, cutting down on corruption and taxing the raw materials sector. In this light, Putin's assault on the utilities sector has little to do with his dedication to rooting out graft and everything to keeping more state funds in the state's pockets.

A new draft tax plan is being circulated at the moment and according to bne sources it extends the tax-the-crap out of oil

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to the other big resources sectors, especially metals, which will be used to subsidise low taxes on the rest of the real economy.

In parallel, the state is in effect going launch a Gref 2.0 liberal reform plan (following the original overseen by German Gref in 2000). The main elements of this are still emerging, but agriculture and the capital markets have already got a lot of attention and pensions are about to. At the same time, all this talk of business ombudsmen and transparency suggest the bureaucracy is going to be reformed as part of a systemic crackdown on corruption. The authors of the 2020 strategy have already shown their draft to First Deputy PM Igor Shuvalov (another one that might get sacked and sent to

"In his last weeks as president, Medvedev probably pushed through more laws than at anytime during his entire four-year term"

Siberia, according to reports) who sent it back for not being "radical enough," one source close to the debate told bne.

The state clearly intends to continue spending heavily, but a touch of realism is creeping in too. A deal to sell control of Avtovaz to French carmaker Renault is imminent, which would be the death knell for the Kremlin's aspiration to revive the Soviet-era automotive sector. The state will have to give up on other sectors too. It has already said it will allow foreign banks to open branches in Russia – something it has resisted vigorously for years – and the Superjet project is going very badly, as bne counts only six planes sold so far.

In typical Russian style, this plan will give ammo to both the "rah-rah Russia" crowd and Russia's detractors. One economist who has seen the tax plan warned the Ministry of Economic Development and Trade that it would drive investors away and hurt the equity market. The ministry attitude was: "They will come back. They always do."

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Special Report: Serbia votes

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the erstwhile Radical/now Progressive supporters that they had become pro-EU. "It wasn't as hard as we thought.

Really," says one young, fluent Englishspeaking party worker.

However, this EU label that the western press likes to employ as an easily identifiable way to typecast Serbia's various parties and candidates (read: pro-EU guy good, pro-Russia guy bad) is disregarded by most Serbs these days.

The idea that Serbia will be able to join a crisis-ridden, enlargement-fatigued bloc anytime before 2020 is dismissed by even many in Tadic's party as a fantasy.

"I'm not worried about an exact date," says Democratic Party Member of Parliament Konstantin Samofalov. "We're on an irreversible track to the EU – we're putting in place reforms to become compatible with EU systems and bring EU values to life in Serbia."

Serbian election to showcase the new normal Nicholas Watson in Novi Sad, Serbia

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nder a clear blue, spring sky in the main square of Novi Sad, around 3,000 people of all ages clap and sing along to a comfortingly respectable rock band, drinking beer and coffee from plastic cups as they wait for the party's big-hitters to arrive for a campaign rally ahead of Serbia's parliamentary and presidential elections on May 6.

What is surprising, however, is that they aren't waiting for the arrival of Boris Tadic, Serbia's polished, smooth, baby-kissing, pro-EU president for the past eight years; these people are here to cheer on Tomislav Nikolic, a man who until four years ago was the right-hand man of Vojislav Seselj, the head of the Serbian Radical Party currently mouldering in a cell in The Hague. Nikolic is now the leader of the splinter Serbian Progressive Party, which is in pole posi-

tion to win the parliamentary elections, and the presidential frontrunner.

The rally illustrates how much Serbia has changed and become, for lack of a better term, a "normal, democratic European country." Four years ago, this rally would have been a Radical one, held in a seedy hall in the countryside, the air thick with smoke and cheap whisky fumes, and heavies lending the whole affair an undercurrent of violence. Now it resembles more (but not quite) the chardonnay-quaffing rallies of Tadic's urban Democratic Party, complete with a sign-language interpreter at the side of stage, pollsters and campaign managers, some with experience of foreign elections.

"I do believe the electoral body has matured over the past years – we have had three democratic elections over the past decade or so, and the times in

which politicians got votes just by saying things that people wanted to hear are behind us," Dejan Soskic, governor of the National Bank of Serbia, tells bne.

New beginnings Nikolic's break with the Radicals, which was then the biggest party in Serbia's parliament though it never held power, has allowed him to attract the natural Tadic supporters – young, ambitious, many foreign-educated – who have been gradually turned off by the perceived cronyism and corruption that dogs the Democratic Party as it seeks to extend its time in government at the head of a proEuropean alliance.

A key plank for the Progressive Party was turning away from the strident Serbian nationalism espoused by the Radicals and sending out the bright-eyed new believers of the Progressive Party to tell

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It's the economy that is the pressing issue for most Serbs, not the issues that seem to concern the West, such as its pro-EU leanings or even its policy over the erstwhile province of Kosovo, whose independence was declared in 2008 after a brutal civil war ended by Nato intervention, but has never been accepted by virtually every Serb. "People are going hungry, we are now a desperately poor country," sighs one former politician and academic.

Indeed, economic growth in the final quarter of last year was a paltry 0.4% and is expected to be around that for the whole year, if not outright recession.

The local currency, the dinar, is at its weakest levels since the fall of the late dictator Slobodan Milosevic in 2000, while unemployment stands at 24%.

The country's finances are in even worse shape: budget deficit targets for 2012 of 4.25% of GDP that were agreed with the International Monetary Fund as part of a bailout loan look set to be breached.

And there's little in the way of investment expected from a European economy labouring under the sovereign debt crisis, while other global investors are scared off by the botched privatisations of the last 10 years that have meant 70% of them have been reversed and just 35% of more than 3,000 companies

privatised since 2001 are still producing anything today, implying many companies were bought by the politically connected because of the property owned, not because of their market potential.

"Industry used to make up 30% of Serbia's economy, now that figure is just 13% – we don’t produce anything," says one official of the Progressive Party.

Belgrade-based Faktor Plus had Nikolic – a stiffer, greyer figure than the flashier Tadic – pulling ahead with 36.1%, compared with 35.7% for Tadic. If Tadic loses an expected second round against Nikolic, perhaps his only way to remain near the apex of power is through a grand coalition between his Democratic Party and the Progressive Party.

The dire economic backdrop and related endemic corruption has hurt the Democratic Party, which is behind in the polls.

According to a poll of 1,400 respondents

by Partner Consulting conducted April 5-8, the Progressive Party had 29.7% support, while the Democratic Party garnered 25.1%. The Socialist Party of former dictator Slobodan Milosevic would get about 13%, while four other parties would pass the 5% threshold to enter parliament: the Turnabout Movement led

by Cedomir Jovanovic, the Radical Party of Seselj, the Democratic Party of Serbia (DSS) of former PM Vojislav Kostunica and the United Regions of Serbia led by former deputy PM Mladjan Dinkic.

Whiffs of corruption Though Tadic is a formidable opponent who has already beaten Nikolic twice, the latter's message of reinforcing the rule of law, judicial reform, and pressing on with the fight against corruption and organised crime is clearly hitting home.

"Corruption is still blooming in Serbia and [the Progressive Party] needs to put an end to it," Nikolic tells bne. "If we want to live in a legal country with solid economy, we need to intensify and put all our effort in the determined fight against corruption and organised crime."

That would put the Socialist Party in a very strong position as a coalition partner, though the Progressive Party would probably prefer a deal with Kostunica's DSS. But the DSS policy of "political neutrality" – ie. not joining the EU to which Serbia was awarded candidate

Democratic Party MP Samofalov points out it's his party that has just reformed the judiciary to produce a batch of properly trained judges and exclude political influence from the courts. "The justice system was one of the weakest spots and it's this government that's reforming the justice system to EU standards," he says, pointing out that Serbia is now a regional leader in combating organised crime

"People are going hungry, we are now a desperately poor country" status in March, but also not selling out to the Russians – would appear to fly in the face of the Progressive Party's new EU-oriented credentials that it has spent the past few years convincing Brussels and Washington of. Bringing in Seselj's Radicals to bump up the numbers in a three-way coalition would send Brussels into conniptions. Some political insiders tell bne that a grand coalition of Tadic's Democratic Party and Nikolic's Progressive Party is a distinct possibility.

Such a coalition would depend on the outcome of the presidential race, which is on a tightrope: a mid-April poll by the

and it was Tadic who took on "some of the most dangerous people" and won.

Nevertheless, the whiff of corruption and cronyism that surrounds the Democratic Party – it is noticeable that its election posters rarely even mention the party, instead preferring to focus on the more popular and electable Tadic – is proving hard to disperse. "The people that have done well personally in the last 10 years are generally seen as those from the Democratic Party; any public jobs left go to people linked to the Democratic Party; and anyone arrested for corruption these days are those people

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"Corruption is still blooming in Serbia and the Progressive Party needs to put an end to it"

not affiliated with any of the ruling parties," says the former politician.

For all the politicking, it's noticeable that the two largest parties both advocate job creation through infrastructure projects, regional development, export-oriented growth by favouring industries such as agriculture and food processing, while at the same time looking to reform the pension and welfare systems and sign a new stand-by loan deal with the IMF. Kostunica's DSS, which could win between 5% and 10% of the vote, stands out here. The DSS can be

thought of as akin to the eurosceptic, radical free market wing of the UK Conservative Party – though with a pro-Russian bent. The DSS is pinning a lot of its hopes on an economic plan devised by Belgrade mayoral candidate Nenad Popovic, a Russian-educated (but English-speaking) former athlete with a penchant for wearing tracksuits.

Its economic platform emphasises negotiating a €10bn loan from the Serbs' favourite Slavic brothers, the Russians, and then using this money to rebuild industrial sectors such as construction, chemicals and textiles, which it argues will "seed" small business.

For a country that's heading toward bankruptcy, €10bn would undoubtedly be a useful sum. But critics point out the danger of giving such a large sum of money to politicians who until now have singularly failed to transparently and efficiently distribute similar amounts in the past. DSS officials counter to bne that establishing a development bank would solve this problem, though the recent draft law to establish the Development Bank of Serbia has been criticised and there are worries the Bank will lack transparency, be vulnerable to corruption and do little more than prop up lossmaking enterprises chosen on a criteria other than economic rationale.

Serbia may have changed much over the past five years, but building solid, transparent institutions are some of the things that will take much longer to complete."

Serbia's well-defined economic path INTERVIEW:

Nicholas Watson in Belgrade

I

f you wanted a living embodiment of the "new" Serbia, then Dejan Soskic, the governor of the National Bank of Serbia, is probably your man.

A graduate of the University of Belgrade's Faculty of Economics and a Fulbright scholar, he followed this with stints as a guest lecturer at a variety of US universities including Berkeley, before becoming a member of the Council of the National Bank of Serbia and then its chairman, finally assuming the governorship of the central bank in

Dejan Soskic, the governor of the National Bank of Serbia

July 2010. Polished, highly articulate in English, tall, impeccably dressed and suitably pro-European, he would certainly would not look out of place at the highest economic tables in Europe.

Seated at the long wooden conference table where the Bank's council meetings are held, surrounded by busts and paintings of governors past and occasionally interrupted by the chimes of an antique grandfather clock, Soskic (without a media relations aide present) talks candidly about Serbia's eco-

nomic shortcomings and the difficult issues the politicians on the stump need to raise with the electorate during this campaign.

He says the economic path that Serbia has to follow over the next decade is fairly well defined and apparent to all the major political players. "It's very important for the new government to be willing to commit itself to structural reforms, both to increase the income side of the budget, but also to decrease the spending as much as possible – and the structure

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of the spending to increase the portion that's not consumption but investments."

Serbia needs to export more, with particular emphasis on industrial and agricultural produce. "That may not be an easy path to take given the current economic conditions, but we need to go on further down this lane because the alternatives are not really there," he says Addressing this part of the economy that has been neglected for the past decade would go some way to sorting out the first major imbalance, the worryingly high current account deficit, which rose by a third in the period January through November 2011 to reach €2.5bn, amounting to around 8.5% of GDP. Improving this would hold down the cost of financing the other major worry, the rising levels of public debt, which look set to breach the constitutional limits of 45% of GDP, including state guarantees. "It's very important for all the political candidates in this period of time when they're very prominent in the media to be realistic about the options and to see that basically there is not much room for manoeuvre. There is this path that needs to be taken otherwise there will be a deterioration in the macroeconomic situation – something no one would like to see," Soskic says.

Indeed, Serbia is skating on thin ice as it is. For 2012, the government was targeting real GDP growth of around 1.5% for the full year, while the NBS recently revised its growth forecast for the year down to just 0.5%, following a disappointing 1.9% in 2011. First-quarter indications aren't good, and some worry that Serbia will actually be back in recession by the second quarter. And "without growth, the fiscal situation becomes more stressed."

Soskic points out that the previous Democratic Party government took some important steps in the right direction that weren't politically popular, such as holding down wage increases and freezing pensions, but stresses it's incumbent upon the new government, whatever its make-up, to enable a positive revision of the €1.1bn International Monetary Fund precautionary stand-

by arrangement agreed in September 2011, but which has since come off the rails, with failure to agree deficit targets for 2012, and also the levels of state guarantees the government is seeking to extend/include in the budget for 2012.

To get back on track, the way forward is "relatively easy to comprehend," Soskic says: the government needs to take steps to grow the economy and put an immediate stop to further increases in public debt through spending cuts.

Are the Serbian people ready to hear such a frank message from their politicians? "I do believe the electoral body has matured over the past years. We have had three democratic elections over the past decade or so, and the times in which politicians got votes just by saying things that people wanted to hear are behind us," Soskic says. "The electorate want to know the truth – even if it’s a sour message."

Dinar is served A major worry for the electorate is the state of the dinar, which after losing more than 4% against the euro so far this year is trading at close to 112 to the euro, its lowest level in a decade. Soskic blames this partly on the country being in the political cycle, the inability of the government to resolve the issues with the IMF over the stand-by loan, and capital outflows related to US Steel's decision to quit its investment in the country.

The NBS has sold more than €500m in hard currency since the beginning of the year and made changes in banks' reserve requirements as part of short-term attempts to prop up the beleaguered currency. Raising interest rates would probably help choke off what meagre growth there is and so unsurprisingly on April 12 the council voted to keep rates unchanged at 9.5%. However, some argue that the traditional monetary policy tool of interest rates is a blunt instrument in an economy where more than 70% of all deposits and loans are done in euros – a remnant from the 1990s when the country suffered a nasty bout of hyperinflation and banking insolvency. This has fed through to a high level of forex mortgage loans, which has put some stress on, but not crippled the

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banking system, Soskic says.

To claw back some power for the NBS, therefore, Soskic has been pushing the "dinarisation" of the economy, signing in April a "Memorandum on Dinarisation Strategy", which aims to promote the use of the dinar. "The government, the financial industry, the corporate sector and the household sector – we all need to realise that using more local currency is going to decrease the [foreign exchange] risk pressure in the system," he says.

In current inflation terms, there's certainly some room for the NBS to cut interest rates further after slashing its main rate by 3 percentage points since last June. "Inflation is roughly around the target for this month in the year – we expect inflation to be around 4% for March," says Soskic.

However, given that interest rates influence aggregate demand with a certain time lag of around a year, then any effect from a cut would come through at the beginning of 2013 when Soskic sees inflationary pressures building from potential rises in regulated prices such as energy tariffs that have been kept steady due to the upcoming elections. "There are certain risks of accumulating inflationary pressures, especially with regulated prices, for the first couple of quarters in 2013 and this is making us relatively conservative at this point of time – I do not see at this point in time room for additional relaxation [of interest rates]," he says.

For all Serbia's economic difficulties, Soskic strikes a note of optimism about how the international investment community certainly views Serbia now in a different light to the dark days of the 1990s and early naughties. Proof of this was last year's debut $1bn Eurobond, which came with a 10-year maturity at a spread at a lower yield than some European peripheral countries. The Treasury expects to come to market again later in 2012 for Eurobond financing of around €1bn.

With April providing more evidence that the euro's problems are still far from over, Serbia's reputation as an improving long-term credit story is still very much alive.

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says designer Ana Ljubinkovic. "At a time when the Serbian national gallery and the Museum of Modern Arts were closed, we created an art district. We know we did something great, but BDD is not as popular as brand new shopping malls because we don't have money for big advertising, and that is sad."

With few customers in sight, many of the designers spend their days smoking and drinking coffee together. Others have an air of desperation as they offer to make alterations or run up a dress in a different fabric if none of their stock appeals. The pool of clients is small, mainly limited to Belgrade's artistic and media elite. As a result, many BDD designers are in a dire financial situation. "I am famous in Serbia but I don't earn enough to eat," Pavlov sighs.

Ana Ljubinkovic – Silent Spring @ Belgrade Fashion Week

Belgrade designers face uncertain future Clare Nuttall in Belgrade

T

ucked away down a heavily graffitied concrete passage behind a sportswear shop in central Belgrade, Choomich Belgrade Design District has housed the shops and ateliers of young Serbian designers since 2010.

But with consumer spending low and growing competition from international high street brands, the BDD's future is uncertain.

in political isolation. "Our country was almost hermetically sealed, we developed unique fashions, something a bit underground," says Pavlov. She and fellow designer Aleksandra Ziravac say the BDD is important for providing affordable retail space and the chance for consumer feedback. "We're not designing for Lady Gaga, but for ordinary people," Ziravac says.

Back in the 1990s, Choomich was the first high-end mall in Belgrade, stocking brands most people could only dream about buying. Two decades later, the mall was "practically dead", according to Tijana Pavlov, one of a group of young Serbian designers who approached the owners and asked for a deal on rent.

Unfortunately, since every shop in the mall has a different owner, the designers have never been able to renovate, or even replace the cracked, stained floor tiles. According to Pavlov, Belgrade city council has been unhelpful, never promoting the district or putting up signposts. And now the leases are due to expire in November 2012, casting doubt over the district's future. "We have a long way to go to keep the BDD alive,"

Belgrade's designers are a close-knit community, influenced by Serbia's years

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"Our country was almost hermetically sealed, we developed unique fashions, something a bit underground" designers and writers while also turning a profit. Already the owner of several successful restaurants, Slavko Markovic in November 2008 launched Concept Supermarket, a shop, restaurant and event space on Strahinjića Bana Street – dubbed "silicone valley" thanks to the many surgically enhanced fashionistas frequenting its outdoor cafes. "We launched just after the crisis started. It seemed like the worst period for starting something new, but Supermarket happened to suit the new age we were entering," he tells bne. "The crisis inspired a different way of thinking, that was less

about money and more about life, the environment and other people."

Markovic wanted to support new ideas and designers, selling local fashions alongside international brands. He believes that domestic products have gradually become more acceptable to consumers. "Previously, locally-made was a symbol for expensive and bad. We are slowly starting to see domestic products competing with goods from abroad."

One businessman has, however, managed to find a way to support local

supermarket – provided an alternate source of revenue. Even so, Markovic had to continue putting more money in to keep Supermarket afloat. Now, however, it has started to turn a profit, albeit a small one.

Given the small size and relative poverty of the Serbian market, the next step will be expansion abroad. A small version of Supermarket is going to open at Porto Montenegro, the largest marina on the Mediterranean currently being built in neighbouring Montenegro by a group of billionaires including Canadian gold miner Peter Munk and Oleg Deripaska. "After that, we want to open in Berlin and then spread to other major cities with a community of people who live for their art," Markovic says.

Running a restaurant in addition to the shop – all housed in a former food

Badly mall'd To an extent, this reflects the situation in the Serbian retail sector as a whole.

According to the Statistical Office of the Republic of Serbia, the sector declined steadily throughout 2011, with sales volume dropping 18.3% in September alone. A Cushman & Wakefield report describes market conditions as "challenging" and warns "a recovery in consumer sentiment is unlikely in 2012."

Recent years have seen some international brands enter the market, though Serbia lags behind other Emerging European countries because of low spending power, lack of modern retail space and continuing perceptions of political instability. "Per-capita shopping centre provision is very low by European standards, although provision across Serbia should increase in the next few years," says the C&W report. Zara was one of the first entrants to the Serbian market. Delta Sport, the Zara distributor for Serbia and Montenegro, opened the first store in 2006, and others have followed. They provide stiff competition for local designers, and with the economy expected to remain sluggish – the IMF forecasts 0.5% growth 2012 – there is not a lot of spending power to go around.

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Amidst the challenges of post-socialist and post-war transition, several municipalities throughout Serbia – particularly Valjevo, Stara Pazova, Sremska Mitrovica, Ruma, Nis, Cacak and Zajecar – have been working hard to create more business-friendly conditions.

It's not been easy: Violeta Jovanovic, executive director of the National Alliance for Local Economic Development (NALED), tells bne that attracting investment requires that Serbian municipalities offer "competitive conditions… [including] simple procedures, efficient administration, well-equipped land and financial incentives, as well as advanced marketing tools for promoting their investment potential."

Local heroes Ian Bancroft in Belgrade

W

ith rising unemployment, particularly amongst young people, local economic development is a key issue in the upcoming elections – particularly after the Serbian

Association of Small and Medium-Sized Enterprises and Entrepreneurs (APPS) publicly criticized the current government and announced its support for the opposition Serbian Progressive Party.

In order to improve economic competitiveness, Jovanovic stresses that more attention needs to be paid to regional cooperation to harmonise business standards in Southeast Europe. With this in mind, NALED has implemented a business-friendly certification programme – whose evaluation criteria pertain to strategic planning in partnership with businesses, efficient systems for securing construction permits,

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transparent local taxation and financial incentive policies, and investments in local workforce development – as a means of introducing "common standards of business environment quality."

Despite the challenging economic conditions, several municipalities have begun to see the fruits of their labours. As Branislav Nedimovic, mayor of Sremska Mitrovica, a municipality some 60 kilometres due west of Belgrade, explains: "the difficult period we live in cannot at any time be an excuse for not working to create a better Mitrovica."

He says the past few years have seen the completion of 242 different infrastructure projects, worth almost RSD2.4bn [about €22m]. And these improvements – which include the development of industrial zones and the establishment of an Office for Local Economic Development – has helped create some 3,000 new jobs since 2007.

"Infrastructure is only a prerequisite for dealing with the biggest problem in the country – unemployment," he says. "We need to continue the path of foreign investments, as they bring us the jobs we all need."

Other municipalities have also enacted reforms worthy of replication elsewhere in the country. Zrenjanin for instance – the second largest municipality in terms of area, roughly 76 km north of Belgrade – has, in partnership with Slovenia's Kolpa, established six duty free zones and plans to recon-

bne May 2012

struct Ecka Airport and build a pier on the Begej River. Valjevo – one of only three cities with its own credit rating ('B1') – has attracted investment from Austrotherm (a manufacturer of insulation products), Interrex, Gorenje (which produces domestic appliances) and Golden Lady (one of the world's largest producers of hosiery), amongst others.

Velimir Stanojevic, mayor of Cacak in central Serbia, tells bne that a large number of steps have been taken in his patch, including the adoption of strategic documents and the foundation of a Science and Technology Park. "We invest a lot in education…[and] our efforts in the future will be focused on becoming a university town," Stanojevic says, adding how such work was only the "foundation stones" on which the future of the town would be constructed; "nourishing tradition, yet also following modern trends."

Red tape In spite of such valiant efforts at the local level, many structural obstacles to stimulating inward investment remain.

Aside from the general economic downturn, excessive bureaucracy and lack of affordable credit remains one of the key impediments for many small businesses.

The recent draft Law on Development Bank of Serbia has been criticised not only because of the lack of public consultation, particularly with busi-

"Fears abound that the Development Bank will lack transparency, be vulnerable to corruption and do little more than prop up loss-making enterprises"

ness, but because it doesn't provide for oversight by the National Bank of Serbia and possesses extremely low start-up capital (€400m). Fears abound that the Development Bank will lack transparency, be vulnerable to corruption and do little more than prop up loss-making enterprises chosen on a criteria other than economic rationale – similar criticisms to those levelled at Serbia's Development Fund. There are also question marks as to whether a new Development Bank would provide more favourable funding rates than those currently offered by the Development Fund.

The example of business friendly-certified municipalities provides a source of considerable optimism amidst a largely bleak economic picture. Indeed, in a country as centralised as Serbia – with its largely Belgrade-dominated institutions and outlook – such municipalities are key drivers of economic reform; advocating for legislative and institutional changes necessary to improve the business climate of Serbia as a whole.

In the absence of wholesale reforms necessary to create a more favourable climate for local economic development and the flowering of small businesses, Serbia's unemployment will continue to place an intolerable socio-economic strain on the country's creaking public finances and services.

Only local economic development can provide a way out of the downward economic spiral.

bne May 2012

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Upcoming events 2012

Russian Real Estate Summit (30 May - 1 June) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

The 5th Annual Central Asia Mining Congress 2012 (18 - 21 June) Terrapinn Rixos Hotel, Almaty, Kazakhstan www.terrapinn.com

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Private Banking (19 - 20 June) EBCG +421 2 3220 2200 Prague, Czech Republic agnes.pajorova@ebcg.biz www.ebcg.biz

Emerging Market Investments Summit 2012 (5 - 6 June) IB Centre Moscow, Russia www.ibcentre.org/

LTE Forum 2012 (5 - 6 June) HanseCom Media & Communication Istanbul, TURKEY www.lteforum2012.com

Russian Securities Forum (6 - 7 June) ICBI Baltchug Kempinski, Moscow, Russia www.informaglobalevents.com

Emerging Europe Deal Forum (12 - 13 June) C5 Vienna www.c5-online.com

Emerging Market Investments Summit 2012 (19 - 20 June) Marcus Evans Summits +357 22849 308 Radisson Blu Alcron Hotel, Prague, Czech Republic Summits-emea@marcusevans.com http://bit.ly

SuperReturn Emerging Markets 2012 (25 - 28 June) ICBI Intercontinental Hotel, Geneva, Switzerland www.informaglobalevents.com

The World Banking and Finance Summit (26 - 27 June) Lafferty Group London, UK www.lafferty.com