June 2013

Inside this issue: Hollywoodski Unsure of shale in Poland Vanquished by Vucic Not-so priestly behaviour June 2013 www.bne.eu

Invest in Astana

SOUL MINING IN MONGOLIA What kind of country will Mongolians vote for in June?

How to invest in Eastern Europe and China

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

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

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

bne June 2013

Contents

Editor-in-chief: Ben Aris (Moscow)

+7 9162903400

Managing editor: Nicholas Watson (Prague)

+42 0731582719

News editor: Tim Gosling (Prague)

+42 0720180811

Eastern Europe: Graham Stack (Kyiv)

+38 50 0639722

Central Europe: Robert Smyth (Budapest) Jan Cienski (Warsaw) Mike Collier (Riga) Matthew Day (Warsaw) Tom Nicholson (Bratislava) Kester Eddy (Budapest) Steven Roman (Tallinn)

+36 19995200 +48 604994850 +37 129473192 +48 607291187 +42 1907732736 +36 308665550 +372 56665911

Southeast Europe: Justin Vela (Istanbul) David O'Byrne (Istanbul) Bernard Kennedy (Ankara) Ian Bancroft (Belgrade) Bogdan Preda (Bucharest) Branimir Kondov (Sofia) Guy Norton (Zagreb)

+90 5393614470 +90 5359210950 +90 535 7485120 +40 722580137 +38 513835929

Eurasia: Bureau Chief: Clare Nuttall (Almaty) +7 7073011495 Molly Corso (Tbilisi) Oliver Belfitt-Nash (Ulaanbaatar) +97688113149 Advertising & subscription: Elena Arbuzova +7 9160015510 Business Development Director Tatiana Alexeeva

+7 9168306850

Alec Egan Business Development Director (International)

+44 2030516548

Design: Olga Gusarova-Tchalenko

I3

19

34 COVER STORY

CENTRAL EUROPE

6 The Insiders

28 Unsure of shale in Poland

8 Soul mining in Mongolia

29 Czech miner NWR raked over the coals

12 Perspective 13 Chart of the month

EASTERN EUROPE

31 Drunk with power in the Czech Republic 33 Hungary's banks grow weary of the fight

14 Obuv Rossii puts shoe on right foot

34 Private equity now on cable in Poland

17 Accident is water under bridge for RusHydro

36 Czechs and Poles call truce in food fight

19 Hollywoodski

38 Latvia warned again over itinerant Russian cash

+44 7738783240

21 Is this the end for Russian NGOs? Please direct comments, letters, press releases and other editorial enquires to editor@bne.eu All rights reserved. No part of this publication may be reproduced, stored in or introduced to any retrival system, or transmitted, in any form, or by any means electronic, mechanical, photocopying, recording or other means of transmission, without express written permission of the publisher. The opinions or recommendations are not necessarily those of the publisher or contributing authors, including the submissions to bne by third parties.

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

22 Spies "R" US 24 SocGen on the ropes in Russia 26 Nightmare on Tooley Street 27 A pardon in Ukraine?

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

Many talk about Capital Market Transactions in Central and Eastern Europe.

We do them.

Raiffeisen Bank International has relationships in Austria and Central and Eastern Europe second to none. Close relationships, too, with major investors worldwide. Investors value our regional know-how and market access, giving issuers firm placement at the right price. www.rbinternational.com

bne June 2013

Contents

I5

51

42

64

SOUTHEAST EUROPE

EURASIA

40

Cobbling together a government in Bulgaria

48

Russia puts pressure on Kyrgyzstan, Tajikistan

42

Turkey-Japan nuclear deal lacks detail

51

Railroads to Afghanistan

53

Educating Giorgi

54

Not-so priestly behaviour

55

An age-old fight against pensions reforms

56

ENRC takeover proposal rejected

43

Turkey's financial dreams

44

South-eastern promise

46

Serbia bucks European downturn

47

Vanquished by Vucic 57

A Mongolian to soothe nationalist feelings

OPINION 58

EBRD sees no quick turnaround

SPECIAL REPORT 61

A capital economy

63

A New City in Astana

64

Countdown to Expo-2017

65

France leads high-tech investors into Kazakhstan

67

Kazakhstan to open up PPP market

70

UPCOMING EVENTS

6

I The Insiders

bne June 2013

The new avtoritet in town

Dr Mark Galeotti of the Center for Global Affairs at New York University

T

he term "post-Soviet organized crime" has an increasingly antiquated sound to it; the rather clumsy "Russian-speaking organized crime" is still used a lot; while "Eurasian organized crime" is favoured by others. But whatever you call it, it is a significant and growing problem in Europe in general, Central Europe in particular and the Czech Republic especially.

The initial influx of gangsters from the former Soviet Union into the new democracies like the Czech Republic in the 1990s created a predictable moral panic – and not without reason. This was the age of the bandits, of criminal gangs turbocharged by seemingly inexhaustible economic resources and a guaranteed haven at home. However, the most aggressive inroads were beaten back, sometimes quickly, and we saw a wide-reaching rollback of Russian and other Eurasian criminal power in Central Europe, Italy and the Baltic States.

But there is a new wave of outlaw rising in Russia as well as in other post-Soviet republics – essentially the criminal entrepreneur, the avtoritet gangster-businessman, who looks different and works in a new way. The growing problem of Russian organized crime in say, the Czech Republic, is now much more a criminal business – it's the world of the avtoritet rather than the bandits. Whereas they used to come as conquistadors, planning to conquer virgin territories, now these criminals come as merchant-adventurers, offering all kinds of opportunities – the heroin business, money laundering, cybercrime, contract killing – to local organized crime gangs.

The overt violence – indeed the overt gangsterism overall – is far, far less in evidence. Rather, this new breed of Eurasian criminals tends to be much less noticeable and obvious.

They are better educated and have a more market-oriented perspective on crime; they're not interested in the loyalty, respect and other community-based values of traditional vory v zakone, the older Russian criminal subculture – the name literally means "thieves within the law" – who were born in the Stalinist labour camps and adhered to a humble lifestyle. These criminal entrepreneurs and gangster

businessmen don't care about codes; they don't want to wear elaborate tattoos or anything else that makes them identifiable as criminals. They want to get invited to the ambassador's reception, send their kids to the best private schools, and travel freely so they can spend their money in London, New York and Paris.

Evidence of the emergence of a new Russian criminal elite is backed up by local law enforcement in the Czech Republic.

The most recent declassified report of the police Organized Crime Unit (UOOZ) notes strong links to "large supranational criminal structures," especially Russian-speaking entities.

"While there is no evidence yet of substantial direct flows of truly dirty money running through the Czech banking system, money that has been pre-laundered is almost certainly coming though Prague on its way to London or New York"

Of course, that doesn’t make these new criminals any less dangerous, but rather that their danger is measured as much as anything else through how they empower other gangs, as they are much more prone to be facilitators, suppliers and partners of local criminals.

The distinguishing factor for all these groups is, of course, their links to Russia and its still-thoroughly corrupted banking system. And it's the developed and conservative nature of the Czech financial infrastructure that forms one part of the attraction for the country.

bne June 2013

Home away from home With the European banking crisis rumbling on – about twothirds of the estimated €30bn of Russian money stashed in Cypriot banks that has been hit by the emergency tax was of dubious provenance – these criminals have been casting about for a new haven to put their money. The Czech Republic with its relatively dependable banking sector, stable political system, cultural links to Russia and relatively high level of corruption makes it an ideal destination. I'm not saying that these criminals are trying to take over the Czech Republic, but they regard the country as an increasingly interesting area of operation.

While there is no evidence yet of substantial direct flows of truly dirty money running through the Czech banking system, money that has been pre-laundered is almost certainly coming though Prague on its way to London or New York – the places where these criminals really want to get their assets. Thus the Czech Republic gives this money a certain level of provenance that it might not previously have had.

Then there's the Czech Republic's geographical location in the heart of Europe. A growing share of Afghan heroin is not going through the traditional routes like the Middle East and Turkey, but instead is being trafficked via the so-called northern route through Russia. The existing heroin markets in Europe are supplied through Russia and gangs are constantly looking for new European routes to take this heroin. The Czech Republic is attractive due to its central location, small size and thus relatively small law enforcement community. The large profits made from this trade money can then be siphoned through the country's developed financial infrastructure.

The Czech Republic's deepening problem of corruption within the state also opens up a useful avenue for this new breed of criminal to exploit. The recent report from Czech organized crime unit notes the transition from open violence to "more latent criminal activity" and an expansion of "strictly economically oriented criminal activity" that involves setting up puppet companies as well as infiltrating corporate and state entities. "One of the most significant factors supporting the development of organized crime is corruption within the public administration," the report says. "Highly placed civil servants do not only succumb to corrupt activity; surprisingly often, they themselves initiate it."

Finally, the Czech Republic is a place that in many ways doesn't resemble a criminal haven, making it attractive.

There is something specific about the Czech Republic – it is small enough to be vulnerable, but stable and established enough to be appealing. Though Russian-Czech relations are complicated by history, there is a large (and growing) settled Russian community. And it is located nearer to the home country than London, which is becoming a less-welcoming place for Russian criminals.

The Czech Republic represents a safe bolt-hole, an escape from Russia where for a variety of reasons tensions are rising. The odds of a mob war in Russia are about 50-50 at the moment, and we've seen a steady rise in the number of killings recently as gangs try to squeeze out others. Prague is a good place to buy a second home, send the wife and educate the kids at one of a growing number of international schools with good academic records.

Are the Czech authorities aware and concerned about these developments? From my contacts in the Czech law enforcement community, they are cognisant of the growing problem, but there appears understandably little appetite for a general, broad-based campaign. A key problem, after all, is that the modern avtoritet is a criminal-businessman and has legal as well as illicit interests – it is often difficult and controversial to distinguish him from his more legitimate counterparts.

Instead, the burden of dealing with Russian organized crime will as usual rest on the operational arms of the police and financial regulatory authorities. However, the limitations to this approach can be seen in the UK, which is far better resourced and experienced, yet has a bad track record in confronting the problem. These people don't make it easy to spot them; they excel at hiding the true source of their wealth; and they have learned how to get round the law and use the political system to their advantage. They are, in short, a thoroughly modern challenge to modern societies, and they are coming to the Czech Republic.

Dr Mark Galeotti is professor of global affairs at New York University’s Center for Global Affairs and an expert on Russian and transnational organized crime.

"There is a new wave of outlaw rising in Russia as well as in other postSoviet republics – essentially the criminal entrepreneur, who looks different and works in a new way"

8

I Cover story

Soul mining in Mongolia What kind of country will Mongolians vote for in June? Mongolia's June presidential election will do much to determine how this fledgling economy will fare over the next decade or so.

Terrence Edwards in Ulaanbaatar

bne June 2013

Cover Story I 9

bne June 2013

T

amir and Byamba are two men under the age of 30 who live two sides of the Mongolian story.

Tamir is a marketing professional working for an investment bank who was spending his Wednesday evening at the posh Sky Lounge on the 17th floor of Central Tower for a networking happy hour event. Byamba spent his afternoon the next day at a water pump, just two and a half kilometres from the prestigious Central Tower, to collect water for a household that lacks

is something western nations would die for, but for Mongolia that's 3.2 percentage points lower than earlier projections due to falling commodity prices, slowing growth from China and the passage of legislation unfavourable to foreign investors.

The latter has reared its ugly head because of rising complaints that foreign investors are pilfering Mongolians' land and natural resources, encouraging some elected officials to try to impress

"Our life is the same as it was 10 years ago"

plumbing and electricity. Neither is sure if Mongolia is on the right track for its future.

Though he may live on meagre means compared with Tamir, Byamba exuded only dignity as he hoisted his water container off the ground, careful not to spill water on his pressed, white collared shirt. "We still have not benefited yet from mineral resources," says Byamba. "Our life is the same as it was 10 years ago." Byamba said that he's seen change in the form of new roads and high-rise buildings, but not in his life or that of his family's.

Tamir, too, couldn't say for sure his country had the right policies, but rather that was because of the instability the government has been creating recently. "At the moment the government is acting unpredictably," says Tamir, "and that's not really good for me or the independent companies working here."

With data showing 27.4% of Mongolians were still living in poverty in 2012, voters who think like Byamba are impatient to see some benefits from the rapid economic growth of recent years from the mining boom; the World Bank predicts 13% GDP growth for 2013. But those in Tamir's camp are worry that the government might be spoiling everything; 13% growth

voters by creating new hurdles for foreign companies and proposing new taxes that mining companies say would make it impossible to operate in the country profitably.

That has set the stage for the June 26 presidential election, with the winner facing enormous expectations, challenges and difficult decisions over his (or her) term of office.

The race is on Though many investors have become increasingly disappointed with the turn Mongolia has been taking over

prepared to build extensive road and rail networks that are certain to spur even more growth from the resulting boom in trade with China. "Previous presidents never dealt with billiondollar projects before," says Otgonshar Nagi, vice president of Ulaanbaatar's Resource Investment Capital. "Mongolia is heading towards a development phase where it is seeing significant projects heading its way."

The main contest will be between the current president and favourite, Tsakhia Elbegdorj, and the opposition Mongolian People's Party's (MPP) celebrity wrestler candidate, Badmaanyambuu Bat-Erdene.

Elbegdorj is regarded as one of the founders of Mongolian democracy, someone who rallied the public to demand a new, democratic government in 1990. He is also one of Mongolia's educated elite, having worked as a journalist and political activist in his youth before entering politics, and claims Harvard University as his alma mater.

He is also likely to be the candidate that investors will be cheering on.

Elbegdorj's Democratic Party, which heads the current coalition government, in April managed to steer through parliament an amendment to the controversial foreign investment law of last year, which which it hopes will allow over 100 pending investment

"If this former wrestler wins, it'll be reason enough for investors to re-evaluate all their options" the past year or so, the country is still on track for the launch of commercial exports from Oyu Tolgoi, which is destined to be one of the world's largest producing copper mines. Investors are also still looking forward to the public offering of the state-owned mining unit operating Mongolia's enormous Tavan Tolgoi coking coal project. And using the funds from a $1.5bn bond offering sold last year, the country is

deals to now progress. The Strategic Entities Foreign Investment Law (SEFIL) was rushed through parliament in May 2012 as protests grew about the increasing foreign (read: Chinese) control over the country's vast mineral wealth. But the wide-ranging nature of the law caused investment to fall through the floor as international investors felt the law was designed to deter all foreign participation in

10

I Cover story

the economy. The amendment is a step in the right direction, though many investors argue the law is still too unclear to move forward with investment.

X factor Bat-Erdene, on the other hand, is known for his highly critical position toward foreign investment. BatErdene's celebrity factor is an important element to his campaign, as wrestling is an important facet of Mongolian culture and its champions are adored nationwide. So much does the nation prize its top athletes, the government bestows relatively large monthly cash allowances to winners of national and international athletic competitions.

Bat-Erdene's most notable political feat to date was his introduction of 2009's "Law To Limit and Prohibit Mineral Exploration and Mining Operations at the Headwaters of Rivers, Protected Zones of Water Reservoirs and Forested Areas" (cheekily dubbed by Mongolia's

bne June 2013

One other contender has stepped into the fray. Natsag Udval – who currently serves as health minister as a member of the Mongolian People's Revolutionary Party (MPRP), a junior member of the governing coalition – is particularly notable as the country's first female candidate to run for president. She is also regarded as the proxy vote for incarcerated former president Nambar Enkhbayar. In March 2012, Mongolia witnessed Enkhbayar's dramatic arrest on corruption charges, during which he was seen slinking outside a family member's apartment with his head down and barefoot.

The arrest, coming as it did before the 2012 parliamentary election, was inevitably labelled political by his supporters, who have taken up countless protests since. The most visible demonstration was during a meeting of the Community of Democracies in April, when Enkhbayar's sympathisers appeared before the delegates from around the

"If Elbegdorj doesn't make a mistake, he should win without problem" media as “The Long Name Law”). The law's name might be convoluted, but it quickly interfered with the operations of both domestic and foreign firms such as Toronto-listed Centerra Gold.

The gold miner, which also operates its Kumtor mine in Kyrgyzstan, was looking towards shutting down its current Boroo mine and replacing it with another in Mongolia, the Gatsuurt gold project, but Bat-Erdene's law has prevented it from getting permission to do so. "If this former wrestler wins, it'll be reason enough for investors to re-evaluate all their options," argues Nagi.

world, who were attending in support of emerging democracies, waving signs and shouting slogans that Mongolia's democracy was a lie.

Enkhbayar still remains the MPRP leader, and has been a vocal proponent of the nationalisation of Mongolia's mines. Given the former president's continued influence and the similarities in the rhetoric of the two parties – the MPRP is made up of politicians who broke away from the MPP – it's entirely conceivable that Enkhbayar's supporters will cast their votes for

Udval instead of Bat-Erdene. "Both parties share the same electorate, and there could be a part of the MPP voters who will vote for Ms Udval," says Luvsanvandan Sumati, director of the Sant Maral Foundation, which released a survey recently looking at Mongolians' political preferences.

There's little polling data available in Mongolia, so that report from the Sant Maral Foundation – released in April before Elbegdorj's opponents were announced – offers some clues as to how the election will go. The most relevant question asked was who would make the best president for Mongolia: 19.2% named Elbegdorj, while just 2.2% said Bat-Erdene. Although Bat-Erdene and Elbegdorj were not directly compared in the question (respondents were asked to fill in a name rather than choose from a list), Sumati still thinks the data gives strong indications about the electorate's intentions. "[Elbegdorj] has a much better chance than the two others," reckons Sumati. "If he doesn't make a mistake, he should win without problem."

A win in the first round would require 50% of the electorate plus one vote. In the event no candidate achieves that, a run-off vote will be scheduled.

Many Mongolians cheered as the government made the business climate more difficult for foreign investors, and some argue Mongolia is better off without them. However, Tamir, sipping a draught beer in the swanky bar, disagrees that foreign business has brought little in the way of benefits to Mongolia. "Right now there are a lot more international companies like Anglo American, Rio Tinto and PwC," he says. "They're creating jobs and improving the standards of how business is run. In those means, of course it is benefiting the Mongolian economy."

Cover story I 11 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

bne June 2013

What you need to know

bne’s veteran team of journalists have more than 100 years of collective experience of reporting on this dynamically growing region and can explain the “why” of “what” is going on.

Eastern Europe Russia Belarus Ukraine Central Europe Estonia Latvia Lithuania Poland Czech Slovakia Hungary Southeast Europe Slovenia Croatia Serbia Romania Bulgaria Turkey Moldova Albania Bosnia Croatia Macedonia Montenegro Kosovo Eurasia Kazakhstan Georgia Uzbekistan Kyrgyzstan Turkmenistan Tajikistan Azerbaijan Armenia Mongolia

Sign up today for a free month trial of all our services www.bne.eu

12

I Perspective

bne June 2013

Concerns over the future were sufficiently bad that Prime Minister Dmitry Medvedev had to tell Russians not to panic on May 20. "I am confident we will succeed in avoiding a crisis like that of 2008-2009. There is no need to stockpile canned meat, soap, matches and salt!" Medvedev said in an interview with Komsomolskaya Pravda newspaper.

Russia's economy – dustbin or dizzy heights?

Ben Aris in Moscow

C

onfusion reigns over what will happen to the Russian economy in due course: is it headed into the "dustbin of history", in Trotsky's immortal phrase, or will it be the fastest growing in Europe by the end of the year?

Compare the headlines following the release of the final first-quarter GDP figures. "Russia posts bleak growth," wrote the Wall St Journal after Russia's economy grew just 1.6% over the first three months of this year. "Russia's GDP growth beats expectations," declared Uralsib in a research note, pointing out the consensus expectation was for only 1.2% growth and the final figure was revised up from the initial 1.1% growth.

Of course, both points of view are right, but the situation is even more confusing if you start looking at the full-year forecasts. The European Bank for Reconstruction and Development (EBRD) slashed its 2013 expectation in half in May, forecasting only 1.8% growth this year, whereas Goldman Sachs downgraded its forecast – but not by much: at the start of the year the bank was predicting growth of 3.8% this year, now it believes it will grow by 3.1%. The government also cut its own forecast from 3.6% to 2.4% in April, which is in the middle of most estimates.

That's a big spread of guesses over a pretty short time horizon, and when this happens it usually means analysts are pretty clueless as what is really going on. The trouble is that large negative and positive forces are both in play at the moment.

There is talk of a looming recession and even of stagnation.

The more positive pundits argue the fears are overblown, as there is nothing fundamentally wrong with the Russian economy; much of the current slowdown is due to a statistical quirk. "Part of the current slowdown is due to the high base effects from last year, rather than any fundamental problem," says Grafe. "Inflation was high, there was a food price shock, and investment has been undermined by politics, which has increased the uncertainty for businessmen… The growth drivers in the second quarter will not change, but the growth will be better due to the base effects."

The slowdown over the start of this year was widely expected by economists, but what surprised was just how dramatic it was; the economy basically stalled in February, whereas most economists were predicting growth of around 2.2% between January and April.

The Kremlin has leapt into action. Several short-term measures to give the economy a shot in the arm have been introduced, including a "budget manoeuvre", which shifts spending from state-owned companies to teacher and doctor salaries. The amount to be invested in infrastructure has also been increased. And a game has been played with the exchange rate used in the budget that has effectively increased the crucial oil price assumption, which determines overall

"The more positive pundits argue the fears are overblown, as there is nothing fundamentally wrong with the economy" spending power of the government, from $91 to $103. "We expect the negative trend to break in the second quarter. The economic growth will exceed 3% in July-December," Economic Development Minister Andrei Belousov said in May. The Central Bank of Russia is even more confident and decided not to cut interest rates at the start of May against wide expectations of a cut of 0.25 percentage points or even 0.5 points. The CBR is still putting the fight against uncomfortably high levels of inflation above the need to stimulate growth. "We don't see an output gap," says Grafe, who believes the decision to leave rates on hold was the right one. "You should only cut rates if growth is falling – that causes the output gap to widen – or if inflation is falling, but neither of these things have happened."

Perspective I 13

bne June 2013

The lack of investment is the biggest drag on the economy.

Russia's factories are running at full capacity and with retail turnover growth running at around 6%, Russia's consumer market is in robust health. But despite operating in one of the few European economies growing above 1%, owners are not investing in new capacity.

There are several major changes underway at the moment that has put most business people on the back foot, the main one being the new rules that ban state officials from holding assets or bank accounts abroad. "For the first time since 1992, Russia has imposed restrictions on the flow of capital out of the country. People don't understand the motive or what the next steps will be," says Grafe. "The wealthy are worried this is all the start of something bigger. Putin has gone out of his way to say it won't happen, but we did have the conversation [about introducing capital controls] during the worst of the crisis."

Russia still has one of the most open currency regimes of any emerging market and the new rules currently only apply to politicians serving in government, high public officials or those at the top of state-owned companies.

But just broaching the subject of restrictions on sending

money abroad has put the willies up most oligarchs, who are worried that the rules may eventually be broadened to include them as well. It is these collywobbles that have been contributing to the disappointingly high levels of capital flight: the CBR was predicting that capital flight would fall to $10bn this year, but it had already reached some $12bn by the end of the first quarter, according to Goldman Sachs.

Still, there may be more clarity come July. The ban on foreign asset ownership is already on the books, but the all-important instructions that explain how the law is to be implemented have not been written yet. These will determine how strictly the new law is to be enforced and how much resources will be given to policing it. Business people are waiting anxiously for these details before deciding what to do next.

"The wealthy are worried this is all the start of something bigger"

Russian billionaires thriving, while trickle down remains limited

CHART:

T

he massive wealth being created in Russia continues to flow directly to the very top, with little trickling down, a new survey tracking the concentration of the rich and super-rich reveals.

WealthInsight, a consultancy which tracks high net worth individuals, found that New York City hosts the most billionaires out of the top 20 global cities for hosting the super rich, with the Russian capital now second, and followed by London and Hong Kong.

However, while Moscow is now home to the second highest population of billionaires in the world, it is bottom of the list for those that are struggling along on just a million or so. In terms of millionaires, Tokyo has more than any other city, with 460,700 individuals with net assets of $1m or more (excluding their primary residences). The Japanese capital is followed by New York, London and Paris. Moscow comes in 20th in the list.

At the same time, Russia's super-rich suck up a far greater portion of GDP than their emerging market peers. Whilst a stunning 23% of gross domestic product flows to Moscow's billionaires, at the other end of the scale Chinese billionaires account for no more than 3.5%.

Wealth of billionaires as percentage of GDP (year 2012)

25.0

20.0

15.0

10.0

5.0

0.0 India

China

China & Russia Hong Kong

Brazil

South Africa

Mexico

14

I Eastern Europe

bne June 2013

Anton Titov Chief Executive Officer of Obuv Rossii group of companies

Obuv Rossii puts shoe on right foot Ben Aris in Moscow

W

hen the Soviet Union fell in 1991 and the borders were thrown open to consumer goods, the first thing to arrive from the West, predictably enough, was cigarettes. The second was good shoes.

Shoes are important in Russia. The bad weather means you notice the quality of shoes very quickly, especially in the spring when the roads are awash in freezing slush. Everyone scrimped and saved in the midst of the economic chaos that followed the end of communism to buy at least one decent pair of shoes.

Anton Titov was still a kid when the Soviet empire collapsed, but his father was clearly an enterprising man. A retired soldier, Titov senior in 1993 started importing quality German shoes from Westphalia and opened a store in his native Novosibirsk in Siberia. The

shoes flew off the shelf and the company, called Westfalika, soon made enough money to buy a factory at the cost of $500,000 – an enormous sum in those days – to make its own quality shoes.

Titov junior, 16 at the time, helped out with the business as a sales manager, eventually going on to become the head of marketing. "It was a university," says the ebullient Titov, who is still only 34 today. "There was no brand awareness in those days, no real competition. The only real problem was getting hold of enough shoes and selling them fast, as we had over 100% inflation but we had to pay for the imports with Deutschmarks," says Titov, adding that the biggest sellers were high-heeled ladies' shoes and boots for winter.

Making money was not a problem, but holding cash was, due to the

hyperinflation. Business in Russia became a perpetual motion affair where the fleet-of-foot (excuse the pun) were the most successful.

Oddly enough, Russia's 1998 financial crisis was actually a boon for Westfalika, as the four-fold devaluation of the ruble reduced the cost of its locally produced shoes compared with the imported competition. "In 1998, the cost of shoes was half that of the cheapest Chinese imports," says Titov.

By this time, 70% of Westfalika's inputs were Russian, including the leather, soles and the insoles of its shoes. Prices stayed low for at least another year and the company couldn't make shoes fast enough to meet demand. Using the extra money, Westfalika expanded again. It opened dozens of new stores and even bought an Italian factory that had gone

Eastern Europe I 15

bne June 2013

bankrupt due to the effects on the rest of Europe of the Russian crash, as well another factory in Belgium and a sheep fleece factory in Russia that makes the warm lining for winter boots.

Rise of China Business continued to flourish until about 2003 when things began to change very fast, says Titov. China's meteoric rise was well underway and starting to impact the Russian market.

The Chinese had always sold cheap, poor-quality shoes to Russians, but as they began to assimilate western technology the quality of their shoes rose rapidly – but prices didn't. "The cost of production started to rise rapidly in Russia and soon was at the same level of the international producers. We needed to change strategy," says Titov. "We were like a Soviet factory, doing everything in the process ourselves. It was not effective any more as the market had changed."

Titov wanted to move production to China, but his father was not interested.

So Titov struck out on his own and set up the shoe retail chain Obuv Rossii, selling the Westfalika brand. "It was a small operation. In the first year we

stores that still trade under the name.

"We made lots of mistakes in the next few years as the price of experience is high, but we eventually found good partners in China," says Titov. "The key was to control the quality of the materials."

The Chinese don't argue about price, explains Titov, as if you push down the price, all they do is skimp on the quality.

And most of his competitors from Russia in China were pushing for the lowest prices they could find. Titov didn't haggle, but insisted on having his own quality inspectors visit the factory floors.

"Our priority was to control the quality of the materials in the factory and half the factory owners wouldn't agree to letting our inspectors in," says Titov.

Obuv Rossii's success is built on concentrating on the mid-range price group; the cheap end of the market is flooded with Chinese shoes and the top of the market is out of the reach of most Russians in the regions, even if Titov could technologically produce them.

And his insistence on quality has paid dividends. Typically, a contract with a shoe factory in Italy allows for a 3% return rate of the shoes; Obuv Rossii

"We were lucky that the crisis struck in the autumn, the shoe sellers' high season, as everyone is buying boots for the winter" opened five shops and sold 40% of the family's shoes and the rest were imports. The biggest problem we had was finding capital to grow. There were no bank credits then, but as I knew all the suppliers I could get materials and products on credit," says Titov.

In 2004 and 2005 Titov opened 10-15 stores a year, but by 2006 with 45 stores he had maxed out the credit available from suppliers. It was this year that he flew to Beijing to find producers and the same year his father closed down Westfalika as it was no longer profitable.

The young Titov took over many of its

had a return rate of just 0.8% over the last five years out of sales of 1.5m shoes a year.

With its new cheaper suppliers in China, the company grew fast in the boom years to reach over 200 shops in 60 cities of Russia by the time the 2008 economic crisis struck. The company is the largest player on the mid-price market in Russia and had sales over $110m in 2012 and $160m in 2013. According to Discovery Research Group, the total volume of the mid-price segment in 2012 was $10.5bn, accounting for 35% of the entire footwear market. "We have been growing at about 40-50% a year over the last three years," says Titov. "The shoe business has been growing extremely fast in general and is now the third largest retail segment in a market worth a total of $25bn."

Hard financial times The company's biggest problem remains financing its rapid expansion. For a mid-sized company based primarily in Russia's far-flung regions, it remains very hard to raise debt from banks. In 2007-2008, Titov broke new ground in Novosibirsk by issuing $23m worth of three- to six-month credit notes to fund buying stock for the shops that was entirely bought by 28 small regional banks. But when the 2008 crisis arrived this debt nearly killed the company off.

"We were lucky that the crisis struck in the autumn, the shoe sellers' high season, as everyone is buying boots for the winter," says Titov.

16

I Eastern Europe

As the economy went into meltdown, shoe sales remained exceptionally strong that year. Confusion reigned after Lehman Brothers collapsed in September, as the Kremlin remained in denial and the state television was reporting the crash as "America's problem". The government assumed that its $600bn in hard currency reserves was enough to protect Russia from the storm, so Russian businesses were getting mixed messages. It wasn't until about February the next year that the government realised the impact the crisis would have on Russia and started to withdraw its support, sending the economy into a tailspin. "Long before then, we were already closing stores, some of which we had opened only a few months earlier, cutting costs, renegotiating rents and pulling in all the cash we could," says Titov. "We decided we had to pay off our $23m credit notes by December."

By the start of 2009 when most other businesses were just starting to go into

bne June 2013

boots is not that much, but as mothers typically buy for the family, four sets of boots will eat up most of an average salary in one month. Obuv Rossii came to the rescue with a credit scheme that spreads the payments over the whole winter and was enormously popular.

In 2012, half of the sales were made on credit, or $50m, and the company is expecting this to rise to $85m in 2013.

The local banks were a bit non-plussed by this idea. "Why offer your customers credits when they can come to us and get a credit card?" the banks asked.

Titov explains that people still don't trust banks in Russia, as they have lost money with them too often. However, they do trust shoe shops, as the deal is clear: they want to buy shoes and we give credit to buy them. "No trickery involved," says Titov.

And the Russian retail borrower remains very reliable: Titov's nonperforming loan rate on these credits has been a mere 1.2% – better than

"In 1998, the cost of shoes was half that of the cheapest Chinese imports" crisis mode, Obuv Rossii was already through the worst. It started the spring season with dramatically lower costs and no debt at all. By the summer of 2009, on the back of strong sales – the population was largely unaffected by the crash and incomes have continued to rise throughout the current troubles – Obuv Rossii was opening new stores again and back into expansion mode, while the rest of the country's companies wallowed in misery. "In the autumn of 2009, going into high season the other companies had not bought enough shoes as they didn't know what was going to happen next, but we started our own credit scheme for customers to keep sales levels high," says Titov.

Shoes are not a big-ticket item, but because the winters are so cold people, and especially mothers, are willing to pay for a good pair of warm boots.

The cost of about $100-150 for decent

the 4-6% most banks have to deal with. "Besides, the banks don't like to lend less than RUB50,000 ($1,666), whereas we typically lend RUB5,000."

The Magnit of shoes Obuv Rossii is now hitting its stride.

The Russian economy may be slowing, but people will always need shoes and consumer spending is stable or growing.

The next stage is to expand the business

and open more shops and become the "Magnit of shoes", following in the footsteps of Russia's super successful supermarket chain.

In addition to Westfalika, a monobrand in the middle-price segment, the company is also developing the Peshekhod chain, a multi-brand footwear supermarket, and the fashion brand Emilia Estra, which offers inexpensive accessories. "We want to open 100-120 shops a year and get to 650 shops in the next five years, growing the revenues from $160m to $800m over the same period," says Titov.

Most of this will be done through organic growth. "Over the next five years, we will place an emphasis on the development of Westfalika in the shopping centre format. This will allow us to expand the consumer base of our brand by attracting the attention of younger and more active customers," says Titov.

He estimates he needs to invest $200m over the next few years. The company has already issued its first ruble bond on the Moscow Exchange worth RUB700m ($23m) in 2011, but plans to issue another RUB6bn in three tranches over the next five years with the first bond

offering of RUB1.5bn due this year.

There could be an eventual IPO too. "We may IPO eventually, but on the Russian exchanges," says Titov. "Some say that we should look at London's Alternative Investment Market (AIM), Warsaw or Hong Kong, but we are a Russian business with Russian customers and so the natural place to float our shares is where people understand our business and our market – in Russia."

bne June 2013

Eastern Europe

I 17

United Energy Systems is busy adding over 8GW of new capacity. That is almost three-times more than the 3GW of capacity Russia has added over the last decade.

Towards the end of the pre-crisis boom years, Russia was growing so fast that it was starting to run out of power.

Even the nation's capital Moscow was hit by blackouts as the state had failed to invest into new capacity. The 2008 crisis bought some breathing space as it knocked economy growth back by 8% in 2009 alone and reduced the demand for power, but RusHydro has not been sitting on its hands since.

Accident is water under bridge for RusHydro Ben Aris in Abakan

W

alking out from the main turbine hall of Sayano Shushenskaya, the biggest hydroelectric power station in Russia, there are four high-voltage lines that are literally crackling with power. The path leads down one side of the river that powers this plant, completed in 1978, and passes a small golden-roofed shrine to commemorate the 75 that died here in 2009 when one of the turbines broke loose and caused one of the worst industrial accidents in Russia's modern history. But the plant has now been largely repaired and its operator RusHydro is doing well, thanks in large part to the advent of a wholesale market for power in Russia.

The company's finances are in good shape – on April 30, RusHydro reported first-quarter results that showed a strong growth in profit margins thanks to high water flows and high spot prices for electricity in Siberia where Sayano Shushenskaya is located. RusHydro's cash flow (Ebitda) for the period rose 38% from the year before to RUB16.1bn ($537m) and net income jumped 49% to RUB11.2bn. The Ebitda margin was up 5.2 percentage points to 63.4%,

reports VTB Capital, thanks to an increase in hydropower production of more than a quarter as new production capacity built last year came online, which took RusHydro's total capacity of its operating power plants to 35.2 gigawatts (GW).

Sayano Shushenskaya's turbine room houses 10 turbine units that each have a capacity of 640 megawatts (MW) – enough to light a reasonably sized town. Five units are already working and another five are being upgraded to more modern designs and will come online this year. In all, the repair work will cost RUB40bn ($1bn), almost all of it coming out of the company's own pocket.

Russia's oil and gas reserves are well known, but it is also home to some of the world's best green-energy resources. The huge rivers that snake across Siberia between the low-lying mountains are ideal territory for hydropower dams (known by the Russian acronym GES) and the stateowned RusHydro that was formed to look after these plants after the breakup of state-owned holding company

Fatal accident For all their many faults, the Soviets were good at big engineering projects.

The concrete curtain wall that holds back the river Yenisei towers 242 metres over the turbine room at its base, making Sayano Shushenskaya the biggest plant in Russia and the fourth largest in the world in terms of height. It is also in the Guinness Book of Records as the word's strongest dam, holding back more than 30 kilometres of river that is used to turn the turbines.

The turbine room is huge. A glass covered hall, it is big enough to house a World Cup's worth of football pitches.

But on August 17, 2009, exactly a year after Russia's last big economic crisis, one of the turbines broke loose.

There has never been an official explanation for what exactly happened, but talking to the engineers at the plant they believe that because hydropower plants are used to regulate the power supply to the grid – unlike thermal power plants they can be turned on and off almost at will – the constant change of speed caused excessive vibrations in the turbines that gradually broke their restraining pins.

On that fateful day, turbine number two suddenly snapped away from its housing in the floor of the turbine room. Some 500 tonnes of spinning rotary leaped into the air and careened around the room wrecking everything in seconds.

The enormous space was flooded with

18

I Eastern Europe

water in less than 10 seconds. The people on the turbine room floor didn't stand a chance.

The automatic systems that are designed to shut off the water flow in the case of an accident simply didn't have time to react before the disaster was already over. Some of the workers who realised what was going on sprinted to the crest of the dam and closed the sluices manually, but not before 75 workers in the turbine room had been killed. "Since then, we have introduced many new safety elements," says Alexsander Goldin, RusHydro's head of investor relations. "But the most important one is the work on the overspill chute was accelerated. And now there is a new rule that there are no permanent posts at below flooding level in the plant."

Two tunnels lead from the river through hills at the side of the dam and can be opened at a moment's notice to siphon off excess water and take the pressure off the dam in an emergency.

Rebuilding and recovery The main hall is a hive of activity today. At its far end stand four round metal plates in the floor, the lids for the massive turbines that lie beneath.

The speed of their rotation can be felt through the feet as a constant quiet rumbling.

The other five turbine holes are open, full of workers. The turbines are in various states of repair; massive pins and wheels lie about on the shop floor like the toys of some absent gigantic baby. Just the nuts for the bolts that hold the assembly together are as big as a man's torso. "All the turbines were damaged in the accident," says Goldin, "but four of the 10 units were not damaged too badly and one of these

bne June 2013

was already out of operation for repairs and so was in the best shape."

Siberia, and especially the RusAl aluminium smelter a few miles away, which consumes about a quarter of the plant's power, was plunged into darkness on the day of the accident. But as a hydropower station typically works at 40% capacity, Sayano Shushenskaya only ever had four of its ten turbines running at any one time, so the station could be put back into operation in less than a year. The speed of the repairs was helped by RusHydro's management having already decided to upgrade the technology, so all the planning work was already done and some of the machinery already ordered. The upshot was that all the turbines were converted to more modern technology earlier than expected, supplied with equipment from Russian heavy engineering firm Power Machines based in St Petersburg.

New capacity, old tariffs Russia is in the midst of trying to upgrade its entire power sector and hydropower plays an important role.

RusHydro invested RUB116bn into its plants last year, of which 19% went to Sayano Shushenskaya, while another 19% was spent on building new capacity, mostly at sister plant Boguchanskaya under construction on the Angara River in the Krasnoyarsk region. However, the largest part of spending, some 22%, went on modernizing or rehabilitating existing power stations.

The company is in the "harvesting time," as Goldin puts it. Almost all the new 8GW of capacity will have come on line between 2012 and 2013, most of that from work done at Sayano Shushenskaya (total capacity 6.4GW) and Boguchanskaya (3GW). In 2014, about 1GW of capacity will be added

"The uncertainty over how profitable power generation in Russia will be has hurt the share prices of power companies"

in odds and sods elsewhere in Siberia and the Far East. Altogether, the new capacity should be enough to enable Russia's economy to grow strongly for many more years to come.

Still, there are still several challenges to overcome. The old bilateral relations between power stations and factories that used to set prices have given way to a wholesale market for power, but the reforms that will affect the price of power are in disarray.

Russia is split into three mega-zones when it comes to buying power on the spot market: European Russia (zone #1), Siberia (zone #2) and the Far East.

Factories can buy power from the spot market in both zones #1 and #2, but as most cities in the Far East are so isolated the price of this zone's power is still set by the government.

The so-called RAB scheme that was supposed to put the price of generating power on a commercial footing was abandoned last year as unworkable and a new version is meant to be ready by the middle of next year.

The uncertainty over how profitable power generation in Russia will be has hurt the share prices of power companies; RusHydro's shares – 40% of which are publicly traded – have lost more than half their value over the last few years.

Some resolution to the current uncertainties could be reached next year when the Russian government is due to put forward a new plan for calculating tariffs and regulating power prices that should guarantee investors decent, and more importantly predictable, returns, which are a pre-requisite to attracting the kind of huge amounts of investment the sector still needs.

bne June 2013

Eastern Europe

I 19

Bachurin is a child of the new Russia.

With his Malcolm McLaren haircut and pastel lily tattoos down at least one arm, he looks the part of a studio director – except at 34 he is on the young side by western standards. However, he is a rare example of a proven entity in Russia's young media business, having been a founding member of dance music radio station "Russia 2000" in the mid-1990, which was the first attempt to commercialise the explosion of clubs and raves that epitomised the wildness of Russia's first decade of independence.

State-of-the-art Glavkino takes advantage of Russia's backwardness, skipping over the incremental updating of facilities that has been forced on most western studios. It has gone straight for state-ofthe-art in everything.

Hollywoodski Ben Aris in Moscow

J

ust outside the MKAD, Moscow's outer ringroad, stands the Glavkino complex – a collection of brightly coloured buildings that are home to Europe's biggest and most modern film and television studios.

When movies depict film studios in action, usually the lot is full of actors in costume strolling between sound sets.

But at Glavkino you are more likely to see fork lift trucks and piles of bricks, as the studio has only just completed its first phase of construction. The administration buildings have yet to be built, but 12 sound sets are in operation and the studio is almost fully booked for the rest of the year.

Russia's TV business is booming, if its movie production is still struggling to re-establish itself. With a population of just under 150m people – almost twice the size of Germany – and a booming consumer sector, Russia has advertising revenues aplenty to fund shows like the hit singing special, "Battle of the Choirs" or "Bolshoi Tansy", a dancing competition – both of which were filmed at Glavkino. Demand has grown steadily in recent years, but professional space was in short supply: the last

dedicated film studio built in Russia was the world-famous Mosfilm that opened in 1937.

The idea of Glavkino was conceived five years ago by some heavyweights of the industry. Fyodor Bondarchuk, one of Russia's best and most successful directors, together with the young TV producer Ilya Bachurin, who cut his teeth in the youth music and TV world of the 1990s and is now Glavkino's

Work started in 2009 with the first phase of 22,000 square meters (sqm), and the studio was open for the last four months of last year. Bachurin says it will earn "multiples" of the $10m it took in during its first few months in 2013. The second phase of construction will add another 10,000sqm and should be ready in 2014.

The sound sets come in all different sizes, ranging from the enormous 3,100sqm main stage, the biggest in Europe, to a string of small sets. This compares with Mosfilm's biggest stage of 1,000sqm and 700sqm at Ostankino, the Soviet-era studios under the

"The largest part of the bookings are making TV shows, but in the long term we want to become part of the European film industry" CEO, founded the company in 2008.

Konstantin Ernst, the chairman of Russia's state-owned First Channel, the biggest broadcaster in the country, later joined them. Together, these three men own half of Glavkino, with the other half belonging to the financial investor Vitaly Golovachova, who helped organise a $100m credit from state-owned VTB bank to pay for the construction.

landmark TV tower and today home to many of the main TV stations. Moscow also has a handful of private studios set up by independent production companies like A Media, but they offer no more than converted factory space aimed at hosting TV production for the domestic market. "Even with the converted factory space that some production companies were offering,

20

I Eastern Europe

bne June 2013

there was not enough space to meet the demand, until we stepped in," says Bachurin, sitting in a black lacquer and chrome temporary office. "What we have built here is an international standard facility that we hope will become part of the international network of studios providing top-class facilities to film and TV producers."

Currently most of the bookings have come from domestic TV companies, including First Channel, which hosted its highly successful "Battle of the Choirs" on the main sound set. Choirs from round the country were invited to compete against each other and there was nowhere else in Moscow that could accommodate the several thousand people that participated.

The smaller sets are also constantly busy. Wandering through the building, we stumbled into a subterranean bar full of students drinking and dancing to music that was part of a soap being made for commercial broadcaster TMT. "We can make up to 20 programmes a month. Our facilities are nearly fully booked already. The largest part of the

"The TV business is totally different, as the economy there is healthy and the advertising revenue is more than enough to pay for new projects" bookings are making TV shows, but in the long-term we want to become part of the European film industry," says Bachurin.

Even under the Soviets, Russia was a powerhouse in the filmmaking world.

Mosfilm was home to "the Father of Montage" Sergei Eisenstein, who is best known for his classic feature "Battleship Potemkin" and several other masterpieces. But since the end of the Soviet Union, the industry has fallen on hard times and now lags far behind Hollywood. "Russian film values are not up to western standards.

About 15% of the films screened a year here are Russian, but most of the revenue goes to the international productions, especially the 3D movies," says Bachurin. "So the share of Russian revenue is small and even declining.

Between the end of the Soviet Union until about 2010, Russian cinema was losing investment and talent – it is going to be hard to turn it around."

For example, the latest Bruce Willis action picture, "A Good Day to Die Hard", the fifth (and final?) one in the "Die Hard" franchise, was nominally set in Moscow and included a few obligatory shots of some of the major landmarks, but the bulk of the movie was actually shot in Budapest simply because it was cheaper.

Nearly all the domestic Russian movies are in 2D, but these command a smaller share of the total box office revenue, which this year is expected to rise a little to RUB43.2bn ($1.4bn). Local industry experts say that Russian-made films will increase their share of the take, but by only 2%. Russians produce about 200 films a year, of which 60-70 actually get shown and only 10-15 of those go on to make a profit, says Bachurin. "The domestic industry is too small to support much development, so we are dependent on support from the government and it's surviving thanks to financial help," says Bachurin.

"The TV business is totally different, as the economy there is healthy and the advertising revenue is more than enough to pay for new projects."

Still, the studio is slowly building up its experience. Glavkino is doing the postproduction on Bondarchuk's war movie "Stalingrad" – a Hollywood treatment (in English) of one of the crucial battles of the World War II that has largely been ignored by western studios (even "Enemy at the Gates" starring Jude Law that covers the same ground was made by a French, not American, production team.) Glavkino has all the computers and 3D technology to produce what they hope will be an international smash hit. The film looks spectacular and will be out in September.

bne June 2013

Eastern Europe

I 21

and to the lack of public awareness of their existence.

Most were set up in the early 1990s and traditionally they have been funded with overseas grants. This had to do with the general poverty and instability of Russia at the time, as well as NGOs' nature of agents in the areas where the governments aren’t performing satisfactorily.

Is this the end for Russian NGOs? Julia Reed in Moscow

I

n an April 5 interview to the German channel ARD, Russian President Vladimir Putin declared that in the four months after the July law on nongovernment organisations (NGOs) that brands those that accept donations from abroad as "foreign agents" has been adopted, 654 Russian NGOs received about a $1bn in foreign funding.

This comment set off a storm of protest, as most NGOs receive money from overseas in the order of tens of thousands and the leading NGOs clubbed together to demand the president give some details of where this huge number comes from. Putin's press secretary Dmitri Peskov would say only that it is derived from "the intelligence sources."

Over the last few months, the authorities have been raiding Russia's leading NGOs – both domestic and foreign – to make sure they comply with the new law, but so far only one organisation has accepted the new moniker voluntarily, and another, Golos, an election watchdog, was branded the same as a result of checks.

The battle has been enjoined. On May

8, Russian activists said US Secretary of State John Kerry has assured them that Washington is talking with the Russian government on the Kremlin's crackdown on NGOs, which are refusing to accept the new classification (which labels them in effect spies). According to AGORA, a youth human rights movement, as of May 11, there are 21 NGOs on the black list with an additional 11 warnings to environmental organizations.

Unconfirmed rumours amongst the NGOs say that about 400 organizations have been approached so far.

Unsung heroes Most of these NGOs are little known to ordinary Russians. They don’t get many mentions on national TV, and society at large hardly uses their services, not because these services aren't needed, but mainly due to low numbers of NGOs

Russian individuals and companies mostly still have the Soviet notion that it is the responsibility of the government, not civil society, to care for the homeless, the elderly, the sickly and the environment. The culture of donating to charity never existed in Soviet Russia and has not established itself since (although recently some oligarchs have begun to organise themselves on these lines.)

The adoption of the Russian foreign agents law is commonly justified by comparing it to America’s Foreign Agents Registration Act (FARA) that was put on the books in 1938.

FARA states that persons acting as agents of foreign principals in a political or quasipolitical capacity should make periodic public disclosure of their relationship with the foreign principal, as well as activities, receipts and disbursements in support of those activities. FARA concerns foreign organisations acting on American soil and not the local organisations set up according to the local legislature, as is the case with the Russian foreign agents law.

"The prosecutors came to us with the justice department, tax police, sometimes department of internal affairs, emergency service, sanitary control, consumer control, fire department, but on the first day of the inspection they even arrived with a TV crew," smiles Irina Ostrovskaya of a

"Russians mostly still have the Soviet notion it is the responsibility of the government, not civil society, to care for the homeless, elderly, sick and the environment"

22

I Eastern Europe

Spies "R" US

bne Russia’s Federal Security Service (FSB) arrested US diplomat Ryan Fogle on May 14, who was allegedly caught red handed trying to recruit a Russian Interior Ministry official to spy for the CIA. The story is all a bit strange and smacks of either a put-up job by the Kremlin or amateurish incompetence on the part of Fogle. Either way, the Kremlin made sure the story made a splash and was well covered by the media, because irrespective of the truth of the charges, the arrest fits neatly with the line that President Vladimir Putin is increasingly pandering these days: Russia is surrounded by enemies.

The affair is a blessing for a government in the midst of a controversial current crackdown on non-governmental organisations. A new law demands that NGOs register as “foreign agents” if they have received money from foreign sources, with the implication that they are hives of spies trying to undermine the Russia’s sovereignty.

The FSB swooped on Fogle, the third political secretary at the US embassy in Moscow, as he tried met with a Russian intelligence official who dealt with the North Caucasus region.

So far so good, but then it starts to get weird. Fogle purportedly turned up to the meeting in a wig (and had a spare one in his bag) and carrying what could be described as a kiddy's version of an espionage kit, which also contained a map of Moscow, a telephone, about ¤100,000 in cash and a compass (can't the CIA afford smart phones with GPS?).

However, the strangest item said to have been found on his person was a "how-to-be-a-spy letter" that reads more like a phishing email from a “former assistant to deposed African president” that wants to send you $25m in cash. “We are ready to offer you $100,000 to discuss your experience, expertise and cooperation. The reward may be much greater if you are willing to answer specific questions in addition to that we can offer up to $1 million a year for long-term cooperation, with extra bonuses if we receive some helpful information,” reads the letter.

There are several problems with this letter. First, the letter offers $100,000 as payment for a conversation, whereas Fogle was carrying ¤100,000 ($129,000) in cash. Second, these terms seem to be extremely generous if compared with the money received in other spy cases.

All this casts doubt on aspects of the affair, even if Fogle was probably a CIA man. “It's very unlikely that an embassy official was recruiting spies for the CIA,” a diplomatic source tells bne. “We are all too closely watched.

We all assume that our apartments are bugged and that our phones are tapped and traced. If Fogle was carrying a mobile phone with a charged battery in it, then you have to assume that not only would the FSB know exactly where he was at all times, but they could use the phone to listen to him through it.

bne June 2013

Moscow branch of Memorial, a history and human rights society who collect a database of those repressed and killed in the Gulag, that was raided in April.

"How did TV know about it? On the same day a propaganda story about us came out, each department requested paperwork in their area. It’s not just a copy of our charter, minutes from all our meetings, all financial reports and reports from previous checks, all employees' contracts, but even our St Petersburg office staff measles immunisation journal and in our Zhenshini Dona (Women of the Don river) organization a confirmation of recently performed x-rays. It’s literally thousands of pages for each of our affiliates. In our office alone we prepared more than 7,000 pages. How is the prosecutor’s office going to check all this? Will there be any time left for any other activities, such as fighting corruption?" questions Ostrovskaya.

The Russian NGOs under investigation and subject to prosecutor warnings can only loosely be defined as those involved in political activities. The charters of most NGOs say that in order to achieve their mission statements, they aim to promote the right laws and shape the public opinion. This opens the door for any NGO to be classified as political. For example, on April 16 a Kostroma-based Committee of Mothers of Soldiers received an official warning from the Prosecutor’s Office that they must not be involved in political activities because the members of the NGO took part in monitoring the elections in December 2011 and March 2012. Another Kostroma-based NGO, Centre for Support of Social Initiatives, is now being sued because they conducted a panel discussion on Russian-American relations to which a representative from the US embassy was invited.

"The law is not meant to affect charities and socially-beneficial organizations but even groups trying to protect birds or healthcare organizations are vulnerable [to charges of engaging in politics]," says Veronika Marchenko, director of Pravo Materi (Mother’s right), an

bne June 2013

Eastern Europe

NGO giving free legal assistance to the families of soldiers who died or were killed in Russia during army service.

Some might ask what is so wrong with declaring yourself a "foreign agent?"

"We can’t do it because it’s not true. We do not act in anyone’s interests but in our own”, says Alexei Kozlov, director of the fund For Ecological and Social Justice.

"Our fund identifies cases of police cruelty and torture. We first brought these issues to public attention. It’s in the interests of our society, not foreign

The notion of foreign agents is all too familiar to Russians, as it recalls the 1930s under Stalin, who organised witch hunts for "saboteurs" and Jews that quickly filled the Gulag with inmates. The new laws on foreign agents and state treason (enacted in November 2013) are so broad the laws could be applied to anyone and anything, therefore re-creating the same vehicles of repression that Stalin used. "The foreign agents law clearly damages all NGOs, including charities which it isn’t aimed to concern. A major American fund who was willing to give us a grant

"A major American fund who was willing to give us a grant suddenly pulled out this year without an explanation as the law appeared" principals. Of course in the absence of any real political activity from political parties this can be seen as politics but we strive to improve our society."

suddenly pulled out this year without an explanation as the law appeared," says Veronika Marchenko. "They want to wait and see. Unless your charity deals

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

with children, it’s virtually impossible to raise money now."

The law has created a vacuum in funding for many NGOs. It's predicted that most of them will be forced to shut down both for fear of criminal prosecution (if they refuse to declare themselves foreign agents) and lack of funding. It is estimated by the economy ministry that in 2013 the losses of Russian NGOs from the fall in foreign aid could climb to RUB19bn ($630m).

Even in the very foreseeable but unlikely event that all NGOs dealing with environmental, election and human rights issues, now defined as dealing in politics, will close down, the societal need to have an alternative in these areas will remain.

Time has come for the Russian civil society to step up to the plate and start financing these NGOs themselves. If this happened, genuine reforms would come to Russia. Yet society is still not ready.

| Eastern Europe | Russia | Belarus | Ukraine | | Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

What you need to know

Sign up today for a free month trial of all our services

I 23

www.bne.eu

24

I Eastern Europe

bne June 2013

The arrest comes on the back of a very poor year for Rosbank, which lost $2.6m last year, but is expected to make a small profit this year, though that's far from the $150m a year of profit that analysts say it should be putting in to keep its investors happy.

Pre-crisis, the acquisition of Rosbank in 2006 looked like a good idea and the deal was hailed at the time as the biggest foreign acquisition in the market. But the crisis has changed all that. Russia's banking sector is growing half as fast as it was in the boom years, and the big state-owned banks are becoming increasingly more aggressive competitors.

SocGen on the ropes in Russia Ben Aris in Moscow

L

eading French bank Societe Generale (SocGen) had high hopes for Russia, but those dreams are rapidly unravelling. In the latest gust of a ground swell of bad news, the CEO of its Rosbank subsidiary was arrested on corruption charges on May 15, accused of accepting a RUB5m ($160,000) bribe and demanding another $1.5m.

"The bank's chief executive [Vladimir Golubkov] demanded $1.5m from a commercial organization representative to prolong a loan agreement and to sign an additional agreement with a lower interest rate and monthly payments. He asked the businessman to deliver the money to a senior vice president of the bank," the Interior Ministry said, reports Ria Novosti.

SocGen has yet to comment on Golubkov's arrest, but it must be worried that its $5.2bn bet on Russia is falling to pieces fast, and it needs to turn its crumbling operation around this

year or face mounting pressure from investors to cut its loses and pull out of Russia completely.

Golubkov has worked for Rosbank since 1999 and was made CEO in September 2008. Demanding backhanders in this way is a widespread practice in Russia’s banking system, but it's unusual to find at a foreign-owned bank, which

Indeed, all the foreign banks in Russia have been feeling the heat and several of the late arrivals have already pulled out, writing off heavy investments.

Barclays and HSBC have both shuttered their Russian universal banking operations. All in all, the non-resident share in Russian banks’ capital had slipped to 26.5% in the first quarter of this year. And this was despite a huge contribution to the sector capital made

by Chinese investors to open a unit of China Construction Bank, which has put China among the top-10 countries by investments in the Russian banking sector.

It wasn't meant to be It wasn’t supposed to turn out like this. Over the last decade, SocGen has built up a string of financial assets in Russia. It launched its own retail

"Golubkov demanded $1.5m from a commercial organization representative to prolong a loan agreement and to sign an additional agreement with a lower interest rate and monthly payments"

normally strive to stick to international best practices. The story highlights just how hard foreign banks are finding it to operate in Russia.

bank, Barings Societe General Vostok, which was merged into Rosbank in 2011. It also bought Rusfinance, which specialised in auto loans, and mortgage

bne June 2013

lender DeltaCredit. But the cherry on the cake was the 2006 acquisition of the 82% stake in Rosbank it bought from oligarch Valdimir Potanin. The deal lifted the French group into the top-ten biggest banks in the country,

Eastern Europe

Rosbank’s 2.5%. In general, the bank’s retail credit growth has been a third of the sector average – 1.1% versus 3.3% a month – since August 2011, according to Frank Research Group (FRG). These results are well off the bank’s own 2015

"The arrest comes on the back of a very poor year for Rosbank, which lost $2.6m last year"

with 600 offices in 340 cities and towns across Russia. SocGen has since been consolidating all these assets under the Rosbank brand and was vying to become the largest private bank in Russia.

In May, the bank dropped out of the topfive retail operations in Russia, giving up its place to the express credit king Russky Standard Bank, which increased its loan portfolio by 11.5% over the first three months of the year against

targets of a 25% growth in retail loans and 15% growth in corporate loans.

The bank says that it is following a more conservative lending strategy, eschewing the higher risk lending to small borrowers that Russky Standart prefers and concentrating more on things like mortgage loans. However, according to bne sources, another problem is that any loan bigger than $20m has to be approved by the head office in Paris, which can be such a slow

I 25

process that it often loses corporate business to its nimbler Russian competitors.

At the same time, an increasing number of loans are going bad, due to the current economic slowdown. In 2012, Rosbank tried to clear out the deadwood by selling off RUB8bn of overdue debt to the increasingly popular semi-legal debt collection agencies.

Retail lending has been booming and increased by just under 40% for the sector as a whole last year, but as the economy slows analysts are worried that a growing number of these loans are going bad. In the middle of May, Russia's central bank reported that 22% of Russian credit card holders had reneged on their debt.

Some investors are already calling on SocGen to bail out of the Russian market. But it would be an expensive call if acted on. JP Morgan estimates the current worth of the bank is €2.2bn using a one-times book value multiple, which is half what SocGen paid for its Rosbank stake.

26

I Eastern Europe

bne June 2013

crime background, and Ukraine's interior ministry and security service issued statements that there were no records of his involvement in any such criminal activities.

Ivanyuschenko, who does not have a press secretary, failed to respond to phone calls and emails from bne.

Nightmare on Tooley Street Graham Stack in Kyiv

I

t was billed in the Ukrainian media as the wedding of the decade to be celebrated on the uniquely romantic date of September 9, 2009 – 9/9/9. Ukraine's gossip columns were abuzz with details of the wedding, with international stars such as Eros Ramazotti being flown in to perform at estimated total fees of $1m. Donetsk grandees such as soon-to-be-president Viktor Yanuokvych and Ukraine's richest man Rinat Akhmetov were known to be attending. But the question that had journalists stumped: who was getting married?

Only the day after the opulent celebrations did the name of the bride become known and at first glance it was an anticlimax: Party of Regions MP Yury Ivanyuschenko had given away his daughter Yana to a resident of Monaco.

Journalists scratched their head at the name: Yury Ivanyuschenko had been listed as a Party of Regions MP since 2006, but no one remembered ever seeing him in parliament. Indeed, it transpired he had been based in Monaco for most of the last decade. Ukraine's company register did not list him as owner of any assets that could explain his apparent wealth, and Ivanyuschenko was also almost entirely absent from the media record – with two telling exceptions: donating money in 2001

towards construction of a church in his hometown, the small Donetsk mining town of Enakievo – also the hometown of the Yanukovych family itself – and an exposé of Donetsk organised crime published on the internet in 2007 and ignored at the time, that mentioned Ivanyuschenko as being the Enakievo strongman in the 1990s, and having run a gang of killers with 40 hits under their belt. The exposé was based on an alleged leaked Russian intelligence report.

A libel suit won by Ivanyuschenko in 2011 against the website produced testimony from the relevant Russian offices denying knowledge of any such document and a ruling that demanded the withdrawal of the article.

In February 2010, wedding guest, fellow townsman and longstanding friend of Ivanyuschenko, Viktor Yanukovych was elected president of Ukraine. By the end of 2011, Ukraine media rankings listed Ivanyuschenko as the second most powerful man in Ukraine, following Yanukovych himself, despite his holding no office besides that of MP. Media claimed that Ivanyushenko was tasked with taxing financial flows in Ukraine's massive shadow economy, and dubbed him the president's "left hand man" – "left" denoting shady in Russian.

Ivanyuschenko had won a libel action to quash media stories of an organised

Adding to the controversy surrounding Ivanyuschenko's sudden meteoric rise was his talent for acquiring assets and winning state tenders. First, Ivanyushenko outed himself as the senior partner of secretive Lugansk mining magnate, Ivan Abramov – and thus was part owner of a swathe of lucrative Donbass coal mines and processing plants, as well as Lugansk gas structures. Then in 2011, he acquired one of Europe's largest openair markets, the massive “7-Kilometer” market in Odesa, with annual rent revenue estimated around $29m. In 2011, he acquired a controlling stake in Azovmash, Ukraine's largest builder of the railcars crucial to the metal and mining and agricultural sectors, as well as Kyiv's Zhulyanii airport. In March 2012, he and Abramov detailed their assets in a list handed to journalists at Forbes Ukraine, which also included financial and agricultural assets. Forbes Ukraine estimated his assets as totaling $168m, making him only the 77th wealthiest person in Ukraine, but also calculated that structures linked to Ivanyuschenko had won around $300m worth of state tenders in 2012.

Address to depress While Ivanyuschenko jets between Enakievo, Kyiv and Monaco, both the list handed to Forbes as well as the company registers of Ukraine and UK show that he has opted to use the UK as the jurisdiction for holding his rapidly increasing Ukrainian assets – and one London address in particular, 122-126 Tooley Street.

Since his "coming out" at his daughter's wedding, he has set up an entire holding structure for his sprawling assets at this address: thus most of his assets are controlled via holding companies Pallace Limited and Rollexa Ltd registered at

bne June 2013

122-126 Tooley St, and their subsidiaries at the same address, such as Impool Ltd, Gazoil Corporation Ltd, Keenor Ltd, Keens Ltd and Goodlight Capital Ltd, which together own dozens of assets in Ukraine, according to the Interfax Spark database. The massive Odesa 7-Kilometer market is owned via Parrox Corporation Ltd, also registered at 122126 Tooley St. When in Kyiv, Ivanyuschenko occupies a magnificent office overlooking the Saint Sophia Cathedral, a Unesco world heritage site. By contrast, his UK address at Tooley St is a shabby ground floor office in a side street. And Ivanyushenko's companies share offices with numerous other East European businesses, some of whom have featured in bne reports: Thus, Espace Soft Trading, a Ukrainian-run company suspected by the UN of attempting to breach arms sanctions on Eritrea in 2012, is listed at the same address.

Diafall Ltd, which made up the numbers in an allegedly rigged Ukrainian state tender for a $400m drilling rig in 2011, is also a denizen of 122-126 Tooley St. Sergei Dadechko, former CEO of looted Ukrainian bank Rodovid, who narrowly survived an assassination attempt in Kyiv in March 2012, is director of three companies at this address.

In 2011, two Moldovan businessmen, Viorel and Victor Topa, accused companies registered at the Tooley St address of expropriating their stakes in Moldovan banks. Another company on the street, Liberton Associates, is claiming debts worth tens of millions of dollars from Ukraine's state-owned atomic power operator Energoatom, also derived from court decisions in Moldova.

The court case even led to a Moldovan arrest warrant issued for the head of Energoatom in Moldova in 2012. "The reason there are so many companies registered at this address is that we are a company formation agency," explains 73-year-old Brian Wadlow, manager for a number of company service providers at 122-126 Tooley St, as well as at number 88a. "And the reason that there are so many companies from Eastern Europe here is that we have someone – agents – in those countries."

Eastern Europe

A pardon in Ukraine?

bne Hanna Herman, an influential deputy of the ruling Party of Regions, who has long been close to Ukrainian President Viktor Yanukovych, told Radio Liberty that she firmly believes the former prime minister Yulia Tymoshenko will receive a presidential pardon once all judicial proceedings against her are concluded.

The continued jailing of Tymoshenko – currently serving seven years on charges that she abused her power when signing a gas contract with Russia in 2009 – has been named as the main obstacle to Kyiv cementing closer relations with the EU. A petition for a presidential pardon for Tymoshenko was rejected on April 27, with the Ukrainian presidential commission turning down the request saying it could not grant a pardon until all judicial processes against the former PM have been completed.

"I have repeatedly said that I believe in the president's mercy and I believe that the time will come when he will be able to use his right to grant pardon to Yulia Volodymirivna [Tymoshenko]," Herman said, according to Interfax.

Tymoshenko is reportedly suffering from severe health problems during her incarceration, and the former darling of the Orange Revolution has become a cause celebre in Brussels and Washington. However, she faces several investigations into her past in Ukraine's shady energy market.

A court is currently considering a case into financial irregularities at United Energy Systems, which was earlier led by Tymoshenko. Meanwhile, the Prosecutor General said in January that his office has completed an investigation into the 1996 killing of Yevhen Shcherban, which it says was motivated by a conflict of interests concerning the gas market. The prosecutor has said he believes Tymoshenko ordered the assassination, but has yet to bring charges against her.

More than 100 various petitions for pardoning Tymoshenko have been sent to the president since the ex-premier's imprisonment, which is widely seen as a political manoeuvre by Yanukovych to block the participation of his rival in the presidential elections next year. Tymoshenko is seen as the main leader of the opposition, although polls suggest she is more divisive than others such as the boxer Vitali Klitschko.

The European Court of Human Rights ruled in late April that Tymoshenko's 2011 detention was unlawful. The court held that "Tymoshenko's pre-trial detention had been arbitrary" and that "the lawfulness of her detention had not been properly reviewed." However, the EU court did not uphold Tymoshenko’s complaints of alleged physical mistreatment, and did not address the applicant’s main complaint that her arrest was politically motivated.

I 27

28

I Central Europe

bne June 2013

Unsure of shale in Poland bne

H

ave Poland's dreams of becoming an energy powerhouse by developing its reserves of shale gas been shattered, or is the nascent industry just going through growing pains?

What can be said for certain is that the process to develop the country's shale gas – the unconventional fuel that may be present in enormous quantities locked into rock formations deep underground, which Prime Minister Donald Tusk claimed two years ago were a godsend – is not going smoothly.

The latest setback came in May when Canada's Talisman Energy and the US' Marathon Oil sold their interests in exploration licences in Poland, following ExxonMobil's lead which pulled out of the country last year. All three had arrived in 2011 after the US

Energy Information Administration estimated that Poland could have the largest shale gas deposits in Europe – as much as 5.3 trillion cubic metres (cm).

"Thanks to shale gas, Poland has the chance of making itself energy independent," Janusz Steinhoff, a former

thirds of the 14bn cm of gas it uses every year, most of it from its historical foe Russia, which also supplies Poland with the overwhelming majority of its crude.

Furthermore, almost all of Poland's electricity is generated with coal, which may be plentiful, local and cheap, but which will become more and more

"The withdrawal from prospecting by the Americans has not helped the issue of Polish shale gas" economy minister, proclaimed at the time, thinking that was echoed elsewhere in political circles and the media. The prospect of energy security is enormously attractive for a country that imports two-

costly thanks to the EU's clampdown on greenhouse gas emissions.

However, things haven't turned out quite so well. As well as the poor

Central Europe I 29

bne June 2013

well tests and falling estimates of the volume of recoverable reserves, experts at a May economic conference held in the southern city of Katowice warned that the Polish government's attempts to monopolise future profits from shale gas production and planned taxes that are too high are also hurting the crucial foreign investment needed to develop the reserves.

"The withdrawal from prospecting by the American companies [Marathon Oil and Talisman USA] has not helped the issue of Polish shale gas," admitted Piotr Wozniak, the chief government strategist on shale gas and deputy environment minister, at the conference. "The negative economic impact of the withdrawal is small, but I would prefer not to see such decisions."

Yet Wozniak was picked out by independent newspaper Rzeczpospolita as the one who appears most hostile to foreign investment in the shale gas sector and a confidential meeting of 130 businessmen called by him in Warsaw on March 8 left investors with a clear message that Poland has no intention of supporting foreign investment into the segment. One participant told the newspaper that Wozniak had singled out US and Canadian companies as problematic. "This was a declaration of war with North America," one of the meeting's participants was quoted as saying. "People responsible for energy issues are pushing forward the idea that the energy sector should remain in Polish hands…. Wozniak said that US equipment is not proper for gas prospecting in Poland."

Wozniak has not commented on the report by Rzeczpospolita, though attempts by the Polish government to keep foreign investors out of certain industries would be in keeping with past experience. Government officials fought tooth a nail to prevent a hostile takeover in its coal industry two years ago, while another participant of that March 8 meeting was quoted as saying: "The people in charge of the power sector are promoting the idea that it should be fully owned by the Polish government."

The issue of taxes, which was discussed

Czech miner NWR raked over the coals

Nicholas Watson in Prague When the new chairman of Czech coal miner New World Resources warned back in February that the first part of 2013 was going to be challenging, few probably envisaged it would be this bad. But on May 16, NWR revealed it made another record loss in the first quarter and said it would take a series of measures worth ¤100m in order to bolster its finances.

During the January-March period, NWR said its revenues fell 31% to ¤240m, which pushed the group into a worse-than-expected loss of ¤80.3m, compared with a year-earlier profit of ¤6.0m. The record first-quarter loss followed a then-record loss of ¤48.6m in the fourth quarter. "Our negative ebitda was almost entirely driven by price, because our costs are quite significantly down," explains Gareth Penny, who took over as chairman of NWR last October.

The average Australian spot price of hard coking coal, NWR's mainstay product which is used in foundries, has fallen more than 50% over the past two years as the global steel industry struggles in the face of drop in demand from the global economic slowdown. Steel production in the first quarter was down 2% from the same period in 2012, the company noted.

Negative ebitda indicates a business that has fundamental problems with its profitability, so NWR has been forced into taking a series of short-term measures while it carries out a thorough review of its entire business in order to ride out a longer period of what is calls "extremely difficult" trading conditions. "The general consensus is that thermal and coking coal prices are not going to improve significantly this year, so if we can't base a business on rising coal prices, we will have to take the necessary measures," Penny says.

On the cost side, the company said it will embark upon an across-the-board 10% cut in salaries, a reduction in contractor costs and capital expenditure, and sales of inventories of thermal coal – that used for heating – to onetime customers, all of which should realize around ¤100m through the rest of the year. Production for this year is forecast to be 9m-10m tonnes, down from a February estimate of 10-11m tonnes.

It is also planning to identify mines or parts of mines that could be idled or divested, and will look to sell its OKK Koksovny subsidiary that produces the coke used in foundries. The current economic climate and conditions under which NWR is looking to sell OKK are not ideal, but Penny says he believes a sale by August is feasible. "OKK enjoys right now lower coking coal prices… it continues to and is making money… and it has an important market position by controlling a third of the European foundry coke market."

The measures outlined were initially welcomed by investors, but after a rise the company's shares fell back, which analysts said could be put down to the realization that these measures might not prove to be enough.

30

I Central Europe

bne:infrastructure

The economic crisis has hurt all the economies of the world, but now governments across the Central and Eastern European region are planning to spend trillions of dollars on infrastructure investment as the most effective form of economic stimulus to put their economies back on a sustainable growth path.

This investment was badly needed even before the crisis hit 18 months ago. Decades of work lie ahead, which presents a unique opportunity for investors of all kinds.

Every two weeks, bne will publish an online a round-up of the main investment projects, analysis, commentary, regulatory changes, investment plans, and funding news in bne:infrastructure.

bne June 2013

at the March meeting in Warsaw, also remains a contentious issue.

Many experts have criticized a draft hydrocarbons law that proposes a tax of less than 40% of gross profits as insufficient, pointing out that Norway set its tax at a level of 70%. However, others say that investors will have to spend more money for drilling in Poland, where geological conditions are difficult.

"A tax of 40% is too high and it should be around 20% or less," Waldemar Pawlak, a former minister of economy, told the May conference. "We have not even started shale gas production yet and we are arguing about taxes."

Pawlak said that the latest withdrawals of foreign companies should not discourage other companies from drilling: "There is gas for sure." He noted that although forecasts for shale gas deposits of 5bn cubic metres were

"Companies involved in shale gas prospecting are waiting for the final shape of the law on hydrocarbons to accelerate their work," Izabela Albrycht, chairman of the board of the Kosciuszko Institute, told the conference. "The companies are encountering many bureaucratic obstacles and the climate around prospecting has deteriorated."

Piotr Truszkowski, CEO of Exalo Drilling, which is affiliated with Poland's largest gas distributor PGNiG, referred to the sometimes insurmountable bureaucracy that plagues investors. "A company which wants to start drilling needs to get about 30 permits of all kinds," he said.

"A company which wants to start drilling needs to get about 30 permits of all kinds" an overestimation by US experts, Poland still has one of the richest shale gas deposits in Europe. A recent report by the Polish Geological Institute says that about 340bn cm, enough for the country's needs for 60 years, are likely to be underground.

Marathon sold its 11 drilling licences to San Leon Poland for $10m, which makes the latter now the largest foreign prospector in Poland. "Our Polish acreage now spreads across three basins, targeting multiple conventional plays and two significant gas plays in the Baltic Basin," exploration director John Buggenhaggen said, adding that Poland is still attractive for San Leon.

Register and sign up for the list here: www.businessneweurope.eu/ users/register.php

to approve the draft by the end of June and the parliament may pass it by the end of 2013," he said.

Experts say that a two-year delay in enacting a stable law on hydrocarbons is also dampening interest among investors. Environment Minister Marcin Korolec told the conference that changes in the draft are being prepared. "The government is expected

But Bertrand Le Guern, CEO of Petrolinvest, called on the experts and investors not to panic following the withdrawals by the US companies. "The decision should not be interpreted as a collapse of shale gas expectations," he said. "We should not panic, nor surrender."

Yet there is a growing feeling that Warsaw's enthusiasm for the whole shale gas idea has waned. In particular, the sackings of Mikolaj Budzanowski from his post as treasury minister in April, closely followed by that of the CEO of national gas utility PGNiG, have raised significant questions, as both were leading proponents of the shale gas development. While it has not been confirmed, the speculation is that the government may have now changed tack, and that the casualties are a sign the ambitions for unconventional gas have now been scaled down, in particular, to halt the disruptions to the government's investment plans for the power sector.

bne June 2013

Central Europe

I 31

mouth were a call for the wobbling coalition to pack its bags.

That call was easily dismissed, but it was also a warning shot. In his first three months in office, the new president has launched a highly effective campaign to hack at the base of the government, with Prime Minister Petr Necas apparently helpless to respond. Speaking at a panel discussion on the new presidency hosted by Zaostreno and the Vaclav Havel Library, Jan Machacak, editor at Czech weekly Respekt, suggested: "Some people think Zeman is shifting us to a semipresidential system."

Drunk with power in the Czech Republic Tim Gosling in Prague

C

zech President Milos Zeman scored an internet hit in May when footage showed him swaying and stumbling his way through an official ceremony at Prague Castle.

Zeman's aides claimed he was the victim of a virus, his critics sneered he was drunk. More worrying, perhaps, is that other recent actions by the new president suggest he might actually be drunk with power.

The post-Velvet Revolution residents of Hradcany have a habit of going viral on YouTube. Vaclav Klaus, who occupied the president's seat for eight years before Zeman won the country's firstever direct election in January, was reportedly enraged in 2011 when the world chortled at a video showing him surreptitiously pocketing a pen during a state visit to Chile. Klaus – the old right-wing "enemy" of leftist populist Zeman – remains closely involved as his successor comes out of the gate

aggressively pushing to expand the power of the presidency.

Zeman's second-round victory over Foreign Minister Karel Schwarzenberg was largely driven by public discontent with the centre-right coalition government's harsh austerity policies.

It came as no surprise, therefore, when Zeman announced during the campaign that he intended to be heavily involved in the day-to-day running of the country. After securing the vote, practically the first words out of his

Ambassadors and academics At the core of the panel discussion was a long-drawn-out standoff between Zeman and Schwarzenberg over the appointment of an ambassador to neighbouring Slovakia. The president blocked the foreign minister's candidate, and then turned the tables to insist Livia Klausova – wife of his predecessor – be handed the job. The foreign minister dug in his heels.

If that sounds like petty point scoring in the wake of an election, then that's because it is to some extent. However, while there's little evidence the spat is damaging the country's reputation abroad, Lobos Dubrovsky, a former ambassador to Moscow and defence minister, warns there will be "more important ambassadorial appointments in the future" that could fall prey to this kind of squabble.

On May 17, Zeman's push moved outside the staid world of international diplomacy and into the stuffy offices of academia, when he blocked the appointment of a new professor at

"We're left with a picture of Zeman and Klaus, leaning over the balcony like a Czech version of Muppets Statler and Waldorf, as they direct a campaign which keeps them in the best seats in the house"

32

I Central Europe

Charles University. While gay rights campaigners complain that it is prejudice blocking the promotion of the homosexual historian Martin Putna, it's more likely the result of Putna's staunch criticism of Zeman.

Zeman has proved throughout his leading role in Czech politics since the fall of communism that he's always ready to use his power to stifle critics. His use of what is little more than a ceremonial custom to have the president sign off on professorships suggests he will look to even outdo Klaus, who littered his two terms in Prague Castle with the liberal use of the presidential veto to block government policy, most notably on EU business.

While Zeman is an enthusiastic Europhile, he has in many respects much in common with his old sparring

bne June 2013

As Klaus faced being shunted to the sidelines with the end of his presidency, he had his old mucker's back again during the 2012 election, in spite of the fact that the free-market ideology of Zeman's challenger, Schwarzenberg, is far closer to his own. Klaus' wife also took several digs at the foreign minister – in particular the fact that Schwarzenberg's wife is Austrian and hardly speaks Czech at all. Klausova's reward for doing this is apparently a recognition that Czech interests in Bratislava simply can't do without her supervision.

Double act Zeman's bid to boost the power of the presidency looks like nothing more than an attempt to extend the pair's tight control over the levers of power in the Czech Republic. Their success in this stems not so much

"The aim is to finally topple a government that's been on its last legs for the past two years" partner. Indeed, his push of the presidency into the micro-management of the country's government – and even into academia – is only an expansion of Klaus' antics.

The pair of them have been dancing like this for over 20 years, with the ideological split between the harddrinking leftist and free-market neoliberal seemingly irrelevant when it comes down to the brass tacks of running the country. With Zeman in the PM's chair as head of the Czech Social Democratic Party (CSSD) in the late 1990s – heading what was called the "Jan Becher cabinet", named after the producer of favourite Czech tipple Becherovka – the pair formed the much-maligned "opposition agreement," which saw Klaus' conservative Civic Democrats (ODS) given input on government policy in return for support of Zeman's minority administration.

from his "mandate" as the first directly elected president, but the inherent instability of Czech politics. Successive governments have continually teetered on the brink of collapse since Klaus and Zeman "retired" from the frontline of parliamentary politics in 2002.

Both these seemingly ever-lasting grandmasters of the political scene refuse to move aside, simply graduating from the PM's to the presidential chair. From there they insist on implementing their own vision, come what may. The fact that Zeman has been able to so swiftly produce a nationwide scandal is testament to the extreme weakness of the current coalition led by the ODS. "The [ambassadorial] dispute is a masterclass from Zeman," claims Jiri Caslavka from think-tank Glopolis. "It's designed to sow conflict in the ODS, where Klausova has many supporters.

It puts the PM in a tricky position,

and will likely only result in conflict between Necas and Schwarzenberg."

With the foreign minister one of the founders of TOP09 – the junior and last remaining partner in the ODS-led coalition – that suggests the aim is to finally topple a government that's been on its last legs for the past two years.

That leaves observers with a picture of Zeman and Klaus, leaning over the balcony like a Czech version of Muppets Statler and Waldorf, as they direct a campaign which keeps them in the best seats in the house. "This would not be happening if we didn’t have a government in disintegration," insists former foreign minister Cyril Svoboda.

Klaus is widely believed to have been behind a long – and ultimately unsuccessful – campaign by backbenchers last year to unseat Necas as head of the ODS and thus the premiership. Now in Prague Castle, Zeman is likely to try the same with the leadership of the opposition CSSD, with whom he fell out several years ago. That will be easier if the party is in government – as it's virtually guaranteed to be after the next election.

It's a familiar and depressing picture of the petty squabbling and grubby dealing that has haunted Czech politics since the fall of communism. On the one hand, history warns that the country's political culture is clearly yet to develop to the point at which it will be able to set aside such self-interest and plug the holes in a system cobbled together in the wake of revolution.

On the other, there's relatively little motivation to make the effort. No one takes much notice of the machinations, save the local press, certainly not investors. The numerous close scrapes with government collapse last year saw bond yields calmly continue setting record lows.

Meanwhile, younger guns are yet to fight their way through the duopoly to put down a serious marker. Then again, given the "bonuses" available to the political class under their hegemony, why change?

bne June 2013

Central Europe

I 33

followed by MKB Bank will further increase the bank's core value."

Csanyi is clearly happy to take advantage of the difficult situation for foreign banks in Hungary, saying he supports the call of Prime Minister Viktor Orban earlier this year for a higher ratio of Hungarian ownership in the sector, "because locally-owned banks are more deeply connected to the country and are not dependent on a foreign parent's decisions."

Hungary's banks grow weary of the fight bne

W

ith little evidence that the storm they've been weathering for the best part of three years is likely to end, the foreign banks that dominate the Hungarian market appear increasingly inclined to head for the door. Though this bodes ill for the economic recovery, the Hungarian government continues to heap more uncertainty on the sector.

The latest sign of a withdrawal came from Hungarian-owned OTP Bank, whose chief claimed on May 13 that the country's largest bank is discussing the acquisition of a pair of Hungarian banks from foreign owners who are looking to quit the country. "In one case we have already submitted a bid, not a binding one but a written bid, and in another case we are in the final stage of the talks," Sandor Csanyi told InfoRadio.

He added that the process could take three to four months, and that there is no certainty that OTP's bids would win because it has a conservative approach to pricing.

Speculation immediately centred on MKB Bank, which is owned by

Bayerische Landesbank. The German bank has to offload its Hungarian unit as part of a deal with the European Commission over a 造10bn bailout it received from the State of Bavaria in 2009, with the final deadline for the divestment 2016.

However, on May 17 the bank denied it was one of those in talks with OTP. "Given the strong brand name of MKB Bank and the recent successful restructuring efforts, there are a number of interested parties who have contacted BayernLB and expressed interest.

However, the Hungarian banker also criticized the government's harsh taxation of the banks and cautioned that Budapest must be careful not to drive away too many foreign-owned banks, as the country might then not be able to finance the economic recovery. "In the long term these taxes are clearly anti-growth and that should be changed, otherwise there will not be sustained growth and then the budget consolidation happened in vain and will not be sustainable," Csanyi said. "The Hungarian bank tax is 15-times the EU average... That cannot be sustained for long, or sooner or later banks who post losses will quit from Hungary."

"There are visible signs that some banks want to leave Hungary and these are not small banks," he said. "The question is who will buy these: another foreign bank which stays in Hungary or OTP or [the state-owned development bank] MFB?" Under pressure Dominated by Eurozone financial groups, Hungary's banking sector has been hit hard since the Fidesz

"Locally-owned banks are more deeply connected to the country and are not dependent on a foreign parent's decisions"

BayernLB has neither given exclusivity to any interested party, nor has it entered into advanced negotiations," the bank said. "The current strategic direction

government came to power in 2010.

High windfall taxes, one-off schemes to reduce foreign-currency debt amongst households and a new financial

34

I Central Europe

transaction tax drove the sector to its first loss in 13 years in 2011, and that continued last year.

Although they've pulled back heavily on investment and lending, the foreign banks have insisted throughout that they remain committed to the Hungarian market. However, that determination has started to crack as the pressure rises.

April saw the first exit of a foreign bank, when Italy's Banco Popolare agreed to sell its small subsidiary to Hungary's MagNet Bank for just ¤500,000. And the CEO of Italy's largest retail bank, Intesa Sanpaolo, said in March that it might cut its investment in Hungary after losses in the country pushed the group into the

bne June 2013

red in the last quarter. "Hungary as you know used to be very good for financial services, it has now turned into a sort of nightmare," Enrico Cucchiani told analysts in a conference call.

Despite this, the government continues to apply pressure on the sector. The banks spent the first quarter of the year fretting over speculation that Budapest would look to launch another scheme to try to reduce the huge foreign currency debt held by Hungarian households.

The last programme in late 2011 saw the banks forced to shoulder huge losses.

No sooner had officials ruled that out in comments in early May, than they started discussing a rise in both

the windfall tax and the financial transaction tax. Looking to make a lastminute escape from the EU's excessive deficit procedure in order to avoid losing around ¤500m in cohesion funding, the government has suggested it could raise the two taxes should the European Commission insist it needs to see more measures.

The suggestion gathered steam quickly through the month, as these types of threat tend to do amongst Fidesz officials, seemingly taking their cue from the centre. Designed to keep both Brussels and the banks on their toes, the danger is that more and more lenders will start to consider directing their feet toward the exit.

Janusz Kosinski, co-founder and president of INEA, says bringing in Warburg will allow it to complete its Next Generation Access (NGA) network in the Wielkopolska Region on as large a scale as possible, providing hundreds of thousands of Poles with what is known in the business as triple-play bundles (telephone, internet and television) through fibre-optic cables. "Since we engaged in the project to construct an NGA network, we have been looking for a partner who would allow us to complete this project," Kosinski says.

Private equity now on cable in Poland Nicholas Watson in Prague

H

as cable's time come in Poland?

That's the bet private equity group Warburg Pincus is making with its purchase of a stake in Polish cable operator INEA, and analysts believe more such deals will be struck over the next couple of years.

Though the terms of the investment were not disclosed on April 23, the transaction

between INEA and Warburg is believed to be the largest private equity investment in Poland this year – funds which will enable the cable company to expand and upgrade its network, as well as make acquisitions in the country's fragmented cable market. In return, Warburg will get a stake of under 50% in Poland's fourth largest cable operator, which operates in the western region of Wielkopolska.

INEA will also gain an experienced partner from the deal. Warburg has a lot of experience in the cable industry, including creating Dutch cable group Ziggo through the merger of three smaller firms, as well as in the Central and Eastern Europe region, having invested more than $1bn there since 1997. On May 10, Warburg announced it had finished raising another $11.2bn global fund, which will be invested in regions such as CEE and businesses such as telecoms.

"Warburg Pincus is of course one of the main operators and its experience in the Netherlands and other significant markets gives it rich experience, not only in knowing how to bundle services attractive to customers, but also in shifting skilled personnel to areas where

bne June 2013

skills are needed," says Paul Budde of BuddeComm, an independent research and consultancy company focused on the telecommunications market.

"This has been the recent hallmark of companies such as France Telecom and Vodafone which have their fingers in many pies and operate in several sectors within individual markets."

Laggard For a private equity outfit like Warburg, this deal ticks most of the boxes: there's stable cash flow, good growth prospects from regular business development as well as through M&A, and the company operates in a sector that usually offers owners a relatively simple exit via a sale or IPO. Poland has badly lagged other countries in the region in getting people hooked up to broadband internet, not least because as has often been the case in Poland it is hard to break the hold of entrenched interests. Former telecom incumbent Telekomunikacja Polska had a monopoly on the infrastructure side of the business as late as 2007. According to the consultancy IDC, broadband penetration among Polish households was 31% at year-end 2011, compared with 44% in Slovakia, 52% in Hungary, 53% in the Czech Republic and 61% in Lithuania.

That leaves a lot of growth potential for well-funded players like INEA. The regional nature of Poland's cable market also keeps the larger players like UPC at bay for now, allowing firms like INEA to grow and consolidate their patch. Currently, INEA has about 170,000 subscribers, the biggest among the 15 smaller cable companies operating in what is the third largest province of Poland. The largest broadband internet player in Poland is UPC, which at the end of last year had 854,700 subscribers. "Poland’s cable market is certainly competitive, with UPC, Vectra, Multimedia Polska and Aster all active, though they tend to concentrate in their own areas," notes Budde. "The market remains fragmented, with a number of smaller regional players, and is ripe for further consolidation. As a recent example of consolidation, last month Netia signed

Central Europe

an agreement with UPC to acquire infrastructure previously operated by Aster. This part of the network covers about 446,000 homes, apartments and businesses in Warsaw and Krakow and increased Netia’s coverage by 17% to 2.8m homes passed."

Budde also says the general economic backdrop makes Poland an attractive market for investors. Although the

I 35

connections of at least 30 Mbps by 2020 and have half of households able to access at least 100 Mbps.

The Commission has given Poland around €1.5bn to spend between 2007 and 2013 to help achieve the plan's aims. "The Wielkopolska Sieć Szerokopasmowa project… will be in part financed with support from the European Union, via a Polish development programme," says Paul

"The Polish cable market remains fragmented, with a number of smaller regional players, and is ripe for further consolidation" shine has come off the economy lately – Poland was the only EU country to avoid recession following the 2008 crisis – it's nevertheless expected to still grow about 1.2% this year, which is good by European standards. "The telecom market is also growing, albeit slowing, and this also bucks the trend for most of Europe. Just as thousands of Poles have returned home from the UK during the past two-three years (since the opportunities are now better domestically than in the UK), so too are investors attracted to Poland’s telecoms market as a growth area," Budde says.

Finally, there's government money on offer too, which is especially helpful during tough economic times.

Part of Warburg's investment will go into funding Wielkopolska Sieć Szerokopasmowa (WSS), a partnership with the local government which will construct a 4,000km fibre-optic network that puts 95% of Wielkopolskie households within a 4km radius from the closest distribution node. When completed, INEA says its network will be the most advanced in Poland, providing high-speed broadband access to over 500,000 homes across the entire Wielkopolska Region.

The WSS project could also qualify for EU money. The European Commission's "Digital Agenda for Europe" aims to give all European citizens broadband

Best, a Warburg managing director, adding that it's still subject to final approval from the EU. All this points to the probability that more foreign investment will find its way into Poland's cable sector. "We would expect to see further investor interest later this year and into 2014," Budde predicts.

Yet it's not a one-way bet. Growing faster than fixed broadband in Poland is mobile broadband, which is convincing many Polish households that they don't need a fixed connection at all, especially in the less-developed eastern part of the country where the infrastructure is lagging even further behind the western regions. "The mobile broadband market has been more vibrant and competitive than the fixed broadband market," IDC analyst Michal Wlasenko said in a report.

Warburg's Best says there is room in the market for both fixed and mobile broadband, but fixed-line and particularly the fibre-based infrastructure operated by INEA and other cable operators currently offer dramatically faster speeds and bandwidth than mobile solutions.

"We believe that this technological advantage will be maintained for the foreseeable future," Best says.

36

I Central Europe

bne June 2013

he continued. "In the interest of both the consumers and the producers, we believe that today a new phase in communication between our countries should begin. We cannot really be happy with what the situation is like now."

Czechs and Poles call truce in food fight bne

I

n an attempt to defuse an increasingly ill-tempered spat over the quality of Polish food imports to the Czech Republic, the two countries' agriculture ministers agreed during a meeting in Prague on May 6 to boost cooperation, improve the exchange of information between their respective food inspection agencies, and reduce media speculation.

In what Radio Praha calls the possible first step to defusing the row, Czech Agriculture Minister Petr Bendl and his Polish counterpart Stanislaw Kalemba met to discuss moves to calm the situation. The food fight has been simmering since February 2012, when Polish products were contaminated by a criminal enterprise that saw road salt sold to bakeries and meat-processing plants.

While the Czechs banned imports of Polish salt and complained of a lack of information from Poland, Warsaw in turn accused Prague of using the situation to stifle free trade due to a fear of the growing clout of large Polish food producers. Since then several other cases have arisen, and

this year officials began sniping at one another across the border as Czech food inspectors reported Polish imports have been failing tests in increasing numbers.

"We would like to see much closer cooperation between our food inspection agencies," Bendl said following the meeting with Kalemba.

"Given the volume of Polish foodstuffs on the Czech market, we are certain that mutual communication should intensify. I have proposed an exchange

Leaks on leeks Kalemba meanwhile resorted to the favoured tactic in these types of circumstance of blaming the media – Czech presumably – for speculation over the results of food inspections on Polish produce. The two countries' media should only refer to those cases that have been proven beyond doubt, he says. "The media in both countries will be only informed of food inspection results after these results are ascertained by laboratory tests. The Polish and Czech sides have declared that this should clear doubts related to the quality and safety of food, namely in those cases that have been discussed in the media, and generally improve the situation on the market."

However, no details of how the cooperation should improve in this respect were released. While the issue no doubt appeared on the agenda during visits to Poland later in May of both the Czech president and prime minister, plugging such low level leaks from officials is unlikely to be easy to achieve, especially with the atmosphere so full of petty recrimination.

An unnamed official told Polish daily Gazeta Wyborcza in late March that

"Poland suspects the Slovak and Czech authorities of running a 'black PR campaign' against Polish food" of Czech and Polish food inspectors in order to better understand the system in each country, and to ensure that poor quality food is detected as early as possible."

"We are sure this will improve relations, and will also help sales of quality food,"

Poland suspects the Slovak and Czech authorities of running a "black PR campaign" against Polish food. That accusation was made more formal on April 8, when the Polish Embassy in Prague complained in an official statement handed to the media that criticism of the quality of Polish food

bne June 2013

Central Europe

products in the Czech Republic is driven by protectionism.

Around the same time, data from the Czech State Agriculture and Food Inspectorate revealed that products of Polish origin accounted for 24.1% of food that failed to pass quality tests in 2012, while just 14.5% of the total was of domestic origin. The percentage of Polish products failing the test was the highest of all countries importing food to the country, the inspection remarked.

Polish food imports constituted 16% of the Czech market overall in 2012, a trade worth â‚Ź870m. Polish officials though argue that Czech complaints about the quality of Polish foodstuffs are far more frequent than from other countries that receive far higher volumes of exports, such as Germany and the UK. Wider cooperation is clearly needed.

When Prague banned Polish salt imports in March 2012, it followed this

up by applying the ban to a range of other food products after it complained that Warsaw was not openly sharing information on the detail of the producers affected. That accusation was at least somewhat supported circumstantially when Polish food inspectors pointed out in reply that road salt is not harmful for humans at low levels of consumption.

Six months later the boot was on the other foot, as Czech alcohol was banned across the region due to dozens of deaths resulting from fake spirits tainted with methanol. Although Prague halted exports to Poland and Slovakia itself, Warsaw and Bratislava maintained their own bans well after the Czechs implemented a new system to control quality, in a move analysts suggested could be motivated more by opportunist protectionism than public health concerns.

The latest high-profile instance was during the European horsemeat

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

hullabaloo, with Poland furiously rejecting claims in the German press that it was a source of the unlabelled meat that cropped up across the continent. The Poles were clearly incensed when the Czech regulator announced that it had found horsemeat in beef burgers imported from Poland.

Then, in early April, the analgesic drug phenylbutazone was found in horsemeat sold in northern Moravia. The Czech food inspection agency said the meat had been imported from Poland.

At the same time, minor cases have also been multiplying. In January, traces of rat poison were detected in powdered milk used in wafers and other sweets produced by the Polish firm Magnolia.

In April, Czech food inspectors ordered crackers made of contaminated powdered eggs from Poland to be pulled off the market. Later the same month, Polish pickles and sauerkraut that were found to contain formic acid, banned under Czech food standards, were recalled.

| Eastern Europe | Russia | Belarus | Ukraine | | Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

What you need to know

Sign up today for a free month trial of all our services

I 37

www.bne.eu

38

I Central Europe

bne June 2013

Soviet Union and there's a large Russian population, and several boutique banks cater specifically to Russian businesses looking for a banking entrepot into the EU. Moody's said that in April the volume of Russian cash leaking out through the capital controls Cyprus imposed at the end of March is already increasing and putting pressure on Latvian banks.

According to data from the Central Bank of Cyprus, €6.4bn left at the end of 2012, but no one is clear how much has left since March.

Latvia warned again over itinerant Russian cash

The Latvian Financial and Capital Market Commission (FCMC) said in April that the volume of deposits made by non-residents increased by approximately €400m in the first quarter of the year and is rising. Nonresident deposits, which make up almost half the Baltic nation’s total, rose 32% in the last two years, while domestic savings fell 2%, Moody’s points out in its report. "We expect further deposit inflows into the Latvian system, which is stable by comparison [with Cyprus], although we recognize such flows are currently limited by the capital controls," Moody’s analysts Richard B. Foster and Simon Harris write.

Ben Aris in Moscow

W

hen the EU effectively closed down Cyprus' offshore banking system in April, some $20bn-plus of Russian money began looking for a new home. One of the more likely new havens for that cash is Latvia's banking sector and Moody's Investors Service warned on May 2 that Russian cash is already starting to arrive.

Russian deposits have gone from a boon to a liability. After Germany baulked at what would be perceived as using German money to bail out Russian gangsters and oligarchs who had deposited billions in Cyprus, experts say that storing large amounts of Russian cash now almost guarantees that you won’t get an EU-backed bailout if your financial sector gets into trouble.

The upshot is that no one in the EU wants to put out the welcome mat for the itinerant Russian cash. But Latvia is already heavily exposed, as so many Russian businesses already have

Stronger position For now at least, the Latvian banking sector is in a lot stronger position than that of Cyprus, despite its previous proclivity to offer banking services to Russians. Its financial sector is

"Deposits of non-residents create additional risks, because they complicate the banking system, which threatens the stability of the financial system" accounts there, making it hard to stop them depositing more money. Latvia has long been a destination for Russian cash. The country was once part of the

reassuringly small; the total nominal value of the economy was $22.2bn in 2012, according to the World Bank, with the banking sector accounting

bne June 2013

for a relatively modest 90% of GDP, way less than Cyprus’ 800%. Latvia’s banking sector is small enough for the government to deal with any problems on its own – in theory anyway.

Latvia's banks are not big borrowers on international capital markets, and they depend on deposits to fund their operations. Therefore, the question of where this money comes from is sensitive: Moody’s notes that foreign deposits are a lot less stable than domestic deposits, and 49% of the money on accounts in Latvia is foreign

Central Europe

Russian, it can be almost certain that the EU won’t step in to help if Riga does get into trouble.

Not surprisingly, the Latvian authorities have been quick to deny that the county is a haven for Russian cash.

"It is not true that Russian money from Cyprus is flooding into Latvia: extensive investigation by our office has confirmed that any changes in total non-resident accounts in 2013 are consistent with historical averages.

Latvia’s $10bn in total non-resident deposits is not remotely close in size to

"Russian deposits have gone from a boon to a liability"

– almost all of which is thought to be Russian. "Deposits of non-residents create additional risks, because they complicate the banking system, which threatens the stability of the financial system," the agency warned.

And that's the crux of the problem.

Taking in an extra €400m of Russian cash is not an issue, but if the country takes in all of the €20bn currently looking for a home, then that would double the size of the banking sector to about 200% of GDP, and boost the share of foreign money to around three-quarters of the total on account.

Put together, this makes Latvia susceptible to a very nasty banking crisis – and because the money is

the $75bn that flowed through Cyprus," Kristaps Zakulis, the Latvian financial regulator, said on April 24.

However, details on exactly what is going on remain sketchy. Moody’s said the inbound money is not equally divided among Latvian banks. While the agency thinks that part of the increase in deposits is simply due to the economic recovery that Latvia has recently enjoyed, at the same time deposits from the Commonwealth of Independent countries (CIS) have also played a "significant role" in Latvia’s banking system growth. The question now is how much more money will end up in Latvia.

I 39

Toadsquare The Czech Republic is famous for its security software industry, but with the Prague launch in May of Toadsquare (www.toadsquare.com) it's also looking to be part of the social media phenomenon.

Toadsquare is a new global online tool that looks to connect those working in the creative industries, providing them with a platform through which to showcase their work by hosting show reels and portfolios. The site is the brainchild of Jane Hrouda, a Prague-based Australian-Czech, who found having worked in the creative industries felt there lacked such a space, an online hub, that was specifically designed to help people in this space connect with each other. Some $1m and 10 years later, the result is Toadsquare. "I worked for quite a long time with people in the creative industries and it's really hard for them to find each other and connect," Hrouda says. "I have seen their problems in getting their work out – it's very hard for them to reach their audiences."

In its search for 20m users worldwide, Hrouda says Toadsquare is not targeting a specific part of the globe, though she says of course it's harder for those artists working in the emerging markets to connect than it is, say, for those in the West, where networks are more developed.

40

I Southeast Europe

bne June 2013

www.president.bg

Cobbling together a government in Bulgaria Sandy Gill in Sofia

I

t might be the start of a solution in Bulgaria, if it isn't the start of new problems. On May 23, Plamen Oresharski became the "technocrat" tasked with putting together a "programme government of experts" in the wake of Bulgaria's early elections held on May 12 – elections precipitated by mass street protests that proved inconclusive.

A former rightist politician who served as finance minister in a centre-left administration and has now been put forward by Bulgarian Socialist Party (BSP) leader Sergei Stanishev, Oresharski presumably has a welldeveloped sense of flexibility and paradox. And he'll need it. Not only in the next few days as he tries to rally support, or at least engineer acquiescence, for his cabinet. But also, if he succeeds, in the weeks and months to come, as that cabinet tries to please a

diverse and contradictory support base in extremely difficult circumstances.

impression: GERB was sleazy, and politicians generally aren't too nice.

Fitting finale, uneasy overture As widely predicted, May 12's elections produced complicated results.

Vituperative and scandal-ridden, dominated more by wire-tapping allegations against the formerly ruling GERB party and its leader Boiko Borisov than by policy issues, the campaign ended fittingly. On the day before the polls, a BSP-supplied tip-off prompted a police raid on a printing house in the town of Kostinbrod owned by a GERB local counsellor, revealing 350,000 surplus ballot papers. Whether these were sinister spares or legitimate "technological waste" has still to be determined. But much publicised in the media – and at rival party press conferences – the revelation will have reinforced many Bulgarians' general

The elections themselves went forward with relatively little incident, leaving international observers fairly pleased – though locals more sceptical. Turnout was hardly a triumph for democracy: at 51.3%, it was the lowest in a parliamentary or presidential election since communism fell, and was a curious and ominous contrast with the politicised atmosphere of February's demonstrations that forced out the GERB-led government.

And the credibility of the resultant parliament wasn't enhanced by the fact that, of those who had voted, over 24% aren't represented: the parties that these people voted for all fell foul of the 4% threshold required for entry to parliament. These included the

Southeast Europe I 41

bne June 2013

much-touted centre-right Bulgaria of its Citizens Movement (BCM) of former EU commissioner Meglena Kuneva; the seriously fragmented "conventional" anti-communist right, which failed to enter parliament for the first time since 1990; and, unexpectedly, the National Front for the Salvation of Bulgaria (NFSB), an extreme nationalist formation that, with 3.75% of the vote, wasn't so far from qualifying.

As to those parties that did enter parliament, they number just four, creating a parliamentary arithmetic that has been at once simpler and more intractable than some pundits expected. GERB has been reviled by just about everyone during the campaign and certainly suffered from it, polling massively lower than in the last elections in 2009. Even so, it (unprecedentedly in post-communist Bulgaria) retained its position as the largest political force, with 30.54% of the votes cast – ahead of its main tormentor the BSP (26.61%).

Next came the liberal and mainly ethnic Turkish Movement (MRF) with 11.31%, and finally, with 7.3%, the extreme nationalist Ataka. In Bulgaria's 240seat single-chamber parliament, that translated into 97 seats for GERB, 84 for the BSP, 36 for the MRF and 23 for Ataka.

With no party anywhere near a majority, the question of bedfellows became key.

Bedfellows Having the largest political contingent, GERB was entitled to first crack at forming a cabinet, but it very quickly emerged that no one would cooperate. Both BSP and MRF had treated GERB as anathema during the election campaign, making it clear on election night that nothing would change and that no deals were possible, and have continued to do so.

As to Ataka, its mercurial leader Volen Siderov was in characteristic form on election night. He denounced GERB and Borisov for treachery: cooperation early in the last parliament had led to nothing but the theft of his MPs, he pointed out – citing NSFB as proof – but he also furiously attacked GERB for complicity in what he described as the "colonialism" and "slavery" afflicting Bulgaria, exemplified by foreign

ownership of electricity distribution companies and foreign concessions on Bulgaria's gold mines. He promised to give support to "policies not parties" – and cited the withdrawal of Czech giant CEZ's electricity distribution licence as an example of a congenial policy.

very talkative, GERB became the first major political force in Bulgaria's post-communist history not to stage an election-night press conference. When GERB's senior officials broke cover a day or two later, a somewhat curious twintrack position emerged.

There have been obvious problems too with a BSP-mandated government.

Not as far as the MRF was concerned: despite differences – notably over the flat 10% income tax, which the BSP wants to replace while the MRF wants to keep it – it had been clear for months that the BSP and the MRF are eager to cooperate, with the common and declared aim of a "programme" rather than partisan government, and with Oresharski agreed as the prospective prime minister. With exactly half the number of MPs between them, a BSPMRF government – programmatic or not – would be in a precarious position.

On the one hand, GERB insisted that it had won the election and, once parliament convened, would take advantage of its prerogative of first try at forming a government – albeit a minority government. On the other – somewhat ironically in view of its opponents' charges that GERB would fix the polls – GERB announced its intention to contest the election's validity: party reactions to the Kostinbrod printing house affair, it argued, violated provisions for a "day of reflection" on the eve of election. And indeed, GERB has since submitted the relevant documents to the country's Constitutional Court, including for good measure the complaints of two other parties on voting irregularities among the sizable community of ethnic Turkish Bulgarian citizens in Turkey – complaints that, if supported, could reduce the MRF's parliamentary contingent significantly.

And collaboration with Ataka is, well, problematic. Not so much because socialists would sit uneasily with nationalists, but because Ataka and the mainly ethnic Turkish MRF are each other's bêtes noires. Each made it clear that it would not talk to the other – a matter of fundamental values not just politics, said MRF leader Lyutvi Mestan – though BSP diplomacy produced hints that it might be possible for them nevertheless to support the same

What the Constitutional Court decides remains to be seen. Meanwhile, however, parliament – ultimately valid or not – has convened, with President Rosen Plevneliev insisting, to the general agreement of political forces, that there

"Parties that did enter parliament numbered just four, creating a parliamentary arithmetic that has been at once simpler and more intractable than expected" cabinet. The BSP meanwhile – without evident success – sought to wean Ataka off some of its more extreme positions, for instance the idea of a BGN1,000 minimum wage by end-2013.

In the meantime, GERB's reactions to the elections have varied. The most immediate was stunned silence: though Borisov and his colleagues are normally

were urgent tasks to be tackled. Even at the ceremonial opening on May 21, however, the atmosphere was acerbic, with political groups accusing each other of procedural chicanery, Borisov delivering a tough speech reaffirming his determination to contest the election results, and the GERB MPs walking out in protest at the methods used to elect a BSP-aligned parliamentary chairman.

42

I Southeast Europe

bne June 2013

watts (GW), and that a sales agreement was reached guaranteeing purchase of the plant's output for 20 years at 11.8 US cents per kilowatt hour (KWh) or 10.8c/ KWh if Turkey provides uranium fuel for the plant.

Of the four companies named to date, only GDF-Suez has commented, confirming its interest in being a plant operator depends on a site feasibility study, and as a developer on full due diligence of the project. Hardly an unequivocal expression of intent, not to say one which fails to answer doubts over the project's viability.

Turkey-Japan nuclear deal lacks detail David O’Byrne in Istanbul

A

s the saying goes regarding any contract, "the devil is in the detail".

In the case of Turkey's newly signed nuclear agreement with Japan, the problem so far is the lack of detail.

ducted with four companies: Japanese companies Mitsubishi and Itocha, and French companies Areva and GDF-Suez – who are expected to operate the Sinop plant.

To begin with, contrary to the majority of media reports what was actually signed was not a "$22bn deal for the construction of Turkey's second nuclear plant". Rather, as was confirmed by Japanese Prime Minister Shenzo Abe in a sole press conference, it was an inter-governmental agreement between Turkey and Japan allowing for exclusive negotiations with a Japanese-led consortium for the development of the Sinop plant. In effect, little more than the talks agreed previously first with South Korea, and later with Japan – both of which foundered, the former over Turkey's refusal to grant the project treasury guarantees and the latter after Japanese operator Tepco felt unable to continue in the wake of the Fukushima disaster.

Together the four will take in the project a maximum 51% stake, with each company's share subject to negotiation between them, while the remaining 49%

What further details emerged regarding the current talks have come mainly from Turkey's energy ministry. Officials have confirmed that the talks are being con-

Feasible?

It seems safe to assume that Turkey is hoping that the purchase guarantee together with the 49% local stake will be enough to reassure investors in lieu of treasury guarantees. But will it?

It's only two years since GDF-Suez offered to submit its own bid for development of the plant. That bid was rebuffed by a Turkish government incensed by France's legislating to criminalize denial that killing of Ottoman Armenians during World War I was genocide and vocal opposition of France's then president Nicolas Sarkozy to Turkey's EU bid.

France may now have a new president and relations returned to normality, but President Hollande's control of the

"Almost the only aspect of the project not in doubt is that Turkey's power demand is expected to double over the next decade" will be given either in total to Turkey's state generator EUAS, or with EUAS taking 25-30% and the remainder going either as a block to another Turkish company, or to be sold by IPO. In addition, the two sides have confirmed that the plant will consist of four units of the Mitsubishi-Areva designed Aretema-1 reactor totalling 4.48 giga-

French legislature is far from assured, and his term will end in 2017, three years before the plant's first unit is expected to be commissioned. What will happen if France adopts more legislation that Turkey objects to is unclear, as is Ankara's possible response to another French President opposed to Turkey's EU accession – an important consideration given that the plant

bne June 2013

will be operating for 40 years after the guarantees end.

Both, though, will need to be considered

by GDF-Suez and its potential partners before committing themselves to the project and Ankara also, given that without an operator the project will again founder.

All this before both sides even consider the mooted partnership with EUAS and an unknown Turkish company, or how to run an IPO in a project for nuclear power plant given the post-Fukushima doubts over the future of the nuclear industry.

Almost the only aspect of the project not in doubt is that Turkey's power demand is expected to double over the next decade and to continue growing beyond that.

Clearly the Sinop plant will not be meeting demand that soon, although it will eventually be contributing to reducing Turkey's current account deficit, a large part of which is down to over-reliance on generating power from imported gas – primarily expensive gas from Russia and Iran.

But uranium fuel too has a cost and future supplies are neither secure nor their price guaranteed, while Turkey is surrounded by countries with gas which will become available over the next decade or so.

Israel has already signaled its interest in constructing a pipeline to export its gas to Turkey and on to Europe, a project which may yet convince Cyprus to shelve decades of enmity in favour of a guaranteed return on its own gas. Most likely to reach Turkey though is gas from Iraq, especially the Kurdish controlled north which has abundant supplies, an urgent need to monetise and no other route for export.

A pipeline to Turkey would be cheap to build and could be constructed in months. And depending on the sale price, the gas could serve to make Turkey's nuclear programme look like its older gas deals with Russia and Iran - an expensive mistake, which future generations have to pay for.

Southeast Europe

Turkey's financial dreams

bne For a country hell bent on turning its commercial centre into a global financial hub to rival London and Hong Kong, what better way for Turkey to press this home than have its stock market scale new heights.

Turkey's main stock closed above 90,000 points for the first time ever on May 8 as optimism grew over another sovereign credit upgrade by the ratings agencies to investment grade, further developments in the Kurdish peace process, progress in repairing relations with Israel, and the likelihood of another rate cut from the central bank.

Turkey's banks have been at the forefront of the rally, as they are on the frontline of beneficiaries of the falling bond yields; the two-year bond yield of Turkey's benchmark bonds fell below 5.00% in May, bringing it down more than 120 basis points since the end of March.

Bond yields could fall further if, as is hoped, Moody's Investors Service follows Fitch Ratings in upgrading the sovereign debt rating. Analysts spoke of a market swirling with "euphoria" late last year after the latter handed Turkey its first investment grade rating for close to 20 years.

The mood was lifted further when delegations from both Moody's and Standard & Poor's visited Turkey in early May, prompting Economy Minister Zafer Caglayanby to announce that he expects an upgrade soon. The criteria of many of the globe's largest investment funds demand investment grade from at least two of the major ratings agencies before they can invest in a country's debt.

Against this backdrop, the government is putting in place the pieces that it hopes will turn Istanbul into a global financial centre.

In May, the Turkish government said it's discussing a potential strategic partnership for the newly merged Borsa Istanbul with the London Stock Exchange and Nasdaq. Deputy Prime Minister Ali Babacan told reporters that up to 41% in Borsa Istanbul could be exchanged with a strategic partner or partners in return for some kind of tie-up. Once the stock exchange settles on a strategic partner, it would also seek opportunities for co-operation with other stock exchanges, such as cross-listings or joint indices, he added.

And an unnamed source cited by Reuters said there were plans for a stake of around 20-25% to be sold in an IPO while the rest could be sold in smaller stakes to other bourses, investment banks, a technology provider or hedge funds."

Speaking alongside Babacan on May 7, the chairman of Istanbul Borsa, Ibrahim Turhan, said talks with Deutsche Boerse are continuing, while CME Group – owner of the Chicago Mercantile Exchange – is also involved.

"Our aim is to finalise talks by July and progress to the level of signing a memorandum of understanding," he said.

I 43

44

I Southeast Europe

bne June 2013

state, signing more than 50 agreements with oil companies that allows them to prospect and commence production.

And over the past few years it has been developing close relations with the country that offers the only realistic export route for the region's resources, namely Turkey.

www.bbm.gov.tr

South-eastern promise

David O'Byrne in Istanbul

I

f, as the old adage would have us believe, "It is better to travel hopefully than to arrive", then the visit in mid-May by Turkish Prime Minister Tayyip Erdogan and Energy Minister Taner Yildiz to Washington can be judged to have been a complete success.

High on Turkey's wish list was the hope that the US would approve Turkish plans to play a role in the development of oil and gas fields in the Kurdistan region of Northern Iraq, and the export of that region's oil and gas to Turkey for domestic use as well as to be transited on to global and regional markets. However, if the near silence on the results of the visit is anything to go by, those hopes were – if not exactly dashed – then certainly not met with the same degree of enthusiasm as Ankara has recently been displaying that it was hoping.

Departing Ahead of his departure to Washington on May 14, Erdogan finally confirmed reports that a Turkish state company had, with the blessing of the Kurdish Regional Government (KRG), formed

a joint venture with ExxonMobil to develop fields in Northern Iraq. That company is widely believed to be Turkey's TPIC, formerly the international arm of state upstream operator TPAO, which was earlier this year transferred to state gas company Botas.

Subsequently, Yildiz has gone further, suggesting that Turkey could this year sign more deals with US or Russian

Anglo-Turkish Genel Energy has already announced plans for the construction of a new crude oil line to the Turkish border from where it can connect with the existing Iraq-Turkey export line, which runs to Turkey's Mediterranean oil hub of Ceyhan. While at the same time, Turkish construction group Siyah Kalem has applied for a licence to start importing gas from the region to Turkey.

So with developers already in place, why not allow them to start exporting, allowing Turkey and Europe a valuable new source of natural gas and increasing the flow of oil to global markets, increasing supply security?

The benefits, Ankara has argued, are obvious to all. All, that is, except the Iraqi central government.

Regional tensions Baghdad, which has failed to pass a new petroleum law or reach an agreement which would resolve the dispute with its uppity Kurdish province, has stridently opposed granting any authority that could be construed as going beyond that granted

"The benefits, Ankara has argued, are obvious to all. All, that is, except the Iraqi central government"

companies to develop oil and gas reserves in Kurdistan.

Turkey's case is clear. Although still part of Iraq and under the control of the central government in Baghdad, the Kurdistan region has for the past two decades been a de-facto self-governing

by Iraq's federal constitution. To date, the only concession Baghdad has made is to allow the export of small volumes of Kurdish oil through the existing IraqTurkey oil line, in return for an agreed level of compensation paid to the KRG, which in turn pays the developers.

This is a significant concession that has

bne June 2013

Southeast Europe

allowed field development to continue, but on which Baghdad has frequently reneged, failing to make payments, which has most recently resulted in the KRG amending its own constitution allowing it to sell the region's oil and

this would drive Iraq closer to Iran.

US efforts to force Iran to abandon its nuclear programme have to date been unsuccessful, despite the imposition of wide ranging sanctions, including pressuring Turkey to reduce the volume

"Washington would also like Turkey to reduce the volume of gas it buys from Iran" gas itself, should Baghdad fail to make payments within 90 days.

For the US' part, it doesn't want the KRG to start gas exports to Turkey independent of Baghdad because they are afraid of a possible conflict between Baghdad and Erbil, and worried that

of crude its sole oil refiner Tupras has been buying from Iran at a discount on market prices and preventing Turkey from paying for the crude and gas it buys from Iran in gold bullion – a shortterm measure adopted in response to US sanctions which have enforced the isolation of the Iranian banking sector.

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

Washington would also like Turkey to reduce the volume of gas it buys from Iran, something Ankara has been unwilling to do both for fear of breaching its 10bn cubic metres a year take-or-pay contract and risking Iran arbitrarily cutting supplies, and because irrespective of whoever cuts supply from Iran, Turkey has no alternative sources of gas to fall back on. With Iranian gas currently meeting one-fifth of Turkish gas demand and with gas generating over 40% of Turkish power, losing gas would see Turkey facing crippling power cuts.

Hence the reason for Turkey's increasing interest in Kurdish gas. Not just with the aim of meeting growing demand, but also for fear that US policy on Iran may yet see Turkey lose its gas supplies from Iran. Turkey, it seems is between a rock and a hard place.

| Eastern Europe | Russia | Belarus | Ukraine | | Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

What you need to know

Sign up today for a free month trial of all our services

I 45

www.bne.eu

46

I Southeast Europe

bne June 2013

into the bank's 2.5-5.5% target band by the end of the year. "Weak aggregate demand, stable movements in the foreign-exchange market and a decline in the country’s risk premium, along with an expected full impact of policy measures taken to date" will all combine to bring inflation down, it predicts. With disinflationary trends seen likely to continue, this month’s cut could be only the first step in monetary easing.

Serbia bucks European downturn Nicholas Watson in Prague

I

t isn't often that Serbia outperforms the rest of Europe, but while the EU economy contracted by 0.1% in the first quarter, Serbia's economy was exiting from recession.

For the first time in a year, Serbian GDP expanded in the first quarter as a rise in industrial production of 5.2% contributed to moderate GDP growth of 1.9%, according to the country's statistical office. "The Serbian economy has thus formally emerged from a recession that lasted the whole of the previous year, when all four quarters saw a decline in GDP," the Ministry of Finance and Economy said.

The ministry said industrial output in the first quarter nearly tripled in the automotive industry due to increased production at the Fiat car plant – a joint venture between the Italian carmaker and the Serbian government – while decent growth was also recorded in the chemical, pharmaceutical, tobacco and textile industries. Exports grew by 22% from the same period last year. "This year, Serbia has finally begun to base its exports on finished products with a

high degree of added value, rather than on raw materials and semi-products of a low level of profitability," the ministry noted.

Even so, the National Bank of Serbia's (NBS) decision to cut rates in May for the first time in 17 months shows the

The central bank move is also more a reflection of the will of the government, which upon assuming the reins of power last year promptly forced out its conservative governor, and replaced him with the much more pliable Jorgovanka Tabakovic, a senior figure in the biggest political party in the coalition. At the time, the government said that Tabakovic had been appointed because of her support for its growthencouraging policies.

New debt Against this backdrop, Serbia's financial position has improved to the point that the government is expected to borrow as much as $1.5bn from the international debt markets over the next few months, which should be more than enough to cover this year's financing needs and would leave the government with a decent amount of fiscal reserves for 2014. "The debt sale

"The IMF seems to go along with the charade in Ukraine's case, but seems to be working on some different agenda when it comes to Serbia" central bank remains concerned about the sustainability of the growth, which is expected to be no more than 2% for the year. It cut its repo rate by 50 basis points to 11.25%, which brings Serbia into line with other central banks in Europe in cutting rates to stimulate growth in sluggish economies.

The NBS is helped by a benign outlook for inflation, which despite a recent on-off spike in April is expected to fall

should go well as long as we don't see a significant deterioration in market conditions… [and] should leave the government with about $1.7bn of fiscal reserves by year-end, providing a reasonable funding cushion as we head into 2014," says Abbas Ameli-Renani of the Royal Bank of Scotland, adding that the good market conditions means the debt issuance could come as early as June and not later than the end of the third quarter.

bne June 2013

While political risk – a perennial problem in Serbia given the volatile nature of its politics – has fallen recently with a stable government that has, against the odds, managed to push through a deal to normalise relations with its erstwhile province Kosovo, renewing a deal with the International Monetary Fund remains the biggest risk on the horizon.

In the first half of May the International Monetary Fund sent a mission to Serbia, though the Washington-based lender stressed that it was not intending to discuss a fresh loan deal with Belgrade, but described the visit as a "health check" of the Balkan country's economy.

The IMF's representative to Serbia, Bogdan Lissovolik, said the discussions "may offer a useful opportunity to reflect on the reform agenda and discuss what may be needed for a potential programme."

Serbia's government says it wants to secure a precautionary loan deal with the IMF to restore relations after the collapse of a previous €1bn arrangement last year under the previous government over missed fiscal targets and a row over the independence of the central bank when it sacked Dejan Soskic as governor and replaced him with Tabakovic Tim Ash of Standard Bank described the IMF's position as "disappointing". "I do find it difficult to figure out IMF management of relations in the region.

In Serbia, this is the third time by my reckoning the IMF has basically pre-announced that the mission is not going to be working on a new programme, prior to the mission's arrival. In Ukraine, however, the IMF has now been on two missions to negotiate new programmes, where it was pretty obvious that the government had no intention of signing up to a new programme, but was just playing for time. The IMF seems to go along with the charade in Ukraine's case, but seems to be working on some different agenda when it comes to Serbia," Ash says.

Southeast Europe

I 47

Vanquished by Vucic

bne So Aleksander Vucic, Serbia's powerful and pugnacious deputy prime minister, finally gets his man. On May 9, Serbian prosecutors announced that they had charged the country's richest businessman, Miroslav Miskovic, over a disputed privatisation deal.

Since the new government came to power last year, the largest party in that coalition, the Serbian Progressive Party, has spearheaded an anticorruption campaign aimed at rooting out the graft that has proliferated in this Balkan country since the 1990s. Vucic has been at the forefront of this campaign, with government sources saying Miskovic was top of his hit list.

By snaring Miskovic, Vucic believes it sends a message that no one is now beyond the government's reach. "Two things have been proven in Serbia - that nobody is protected and untouchable, and that the state is stronger than any individual," Vucic said December 12.

Miskovic is certainly a powerful figure. His Delta Holding has assets ranging from retail to construction, is the biggest private sector concern in Serbia, employs more than 7,000 people and had a turnover of ¤1.42bn in 2011. He, along with nine others including his son, have been detained since December 12 on suspicion of a variety of offences, including moneylaundering and tax evasion.

Miskovic and his fellow accused are charged with siphoning off a total of €25m from a privatised and now-bankrupt road repair company. "They illegally raised the value of shares of Preduzece za Puteve Nis... to sell them," prosecutor Miljko Radisavljevic told reporters. "They also evaded tax on capital revenues."

To many people, the extent of the charges appear rather like the US authorities putting Al Capone on trial for tax evasion. However, few doubt that more charges will follow, since Vucic has previously said the suspects were arrested in relation to 24 privatisation cases that the EU has flagged up as problematic.

Delta has repeatedly denied its boss broke any laws and says it will fully cooperate with the authorities. Already, its defence is growing apparent – the usual one in these circumstances of claiming that Miskovic is being persecuted for political reasons and is a proud patriot fighting for the common man.

But that's unlikely to be heard with much sympathy by a populace tired of its venal businessmen and political lackeys. Indeed, Vucic, a former hardline nationalist-turned-European liberal, is betting as much, as he looks toward cementing his party's position as the most popular in the country.

48

I Eurasia

bne June 2013

Photo ITAR-TASS / Mikhail Klimentyev

Russia puts pressure on Kyrgyzstan, Tajikistan Clare Nuttall in Astana

S

ince Russian President Vladimir Putin signed agreements with Kyrgyzstan and Tajikistan in the autumn of 2012, there has been a sharp divergence in the two countries' relations with Moscow. Kyrgyzstan has moved ever closer, in economic and political terms, with Russia rewarding this loyalty financially, while the Tajik government has delayed signing an agreement extending Russia's military presence in the country – though fears about new instability as the withdrawal of troops continues may force President Emomali Rakhmon back into line.

The deals agreed by Putin four months after he returned to the presidency were heralded as a new era in Russia's relations with the two republics on

the very edge of the post-Soviet space.

His visit to Bishkek in September yielded several agreements, including an extension on the lease of the Kant military base, with a commitment from the Kyrgyz government that the nearby US airbase at Manas international airport would finally shut down in 2014. In return for these concessions, around $500m of Kyrgyzstani debts to Russia are being written off and Russia is co-financing two major hydropower projects, Kambarata-1 and the Upper Naryn Cascade.

In the eight months since Putin's visit, the government-level agreements have been followed up by further Russian penetration into the Kyrgyz economy. Gazprom is close to acquiring

Kyrgyzstan's cash-strapped gas transmission and distribution company KyrgyzGaz. Negotiations dragged out longer than expected, but at an intergovernmental commission in April officials from both sides expressed the political will for the deal to go ahead, with Kyrgyz President Zhantoro Satybaldiyev saying that Gazprom's takeover would end Kyrgyzstan's gas shortages.

The takeover of Zalkar Bank – the successor to AsiaUniversalBank, which was Kyrgyzstan's largest bank until the April 2010 revolution – by Russia's Investment and Trade Business Holding was also agreed during the commission.

After nationalising AUB, Bishkek had planned a bailout package for the

Eurasia I 49

bne June 2013

bank, but this was put on hold after ethnic clashes broke out in the south of the country in June 2010, and the subsequent reconstruction drained the government's coffers. Instead, the Russian investor bought 90% of Zalkar for KGS193m ($4m) in a deal that closed on May 3.

Further cementing this close relationship is Kyrgyzstan's expected accession to the Customs Union in 2014, which currently includes Russia, Belarus and Kazakhstan. While touted as an economic rather than a political initiative, entry to the Customs Union will bring Kyrgyzstan even closer into the Russian sphere of influence. This will also reduce the influence of China – Kyrgyzstan's powerful neighbour and Russia's main rival for dominance in the region – within Kyrgyzstan; the experience of the three existing Customs Union members has shown that trade has increased within the bloc at the expense of other trading partners.

Holding out Although Putin's visit to Dushanbe in October 2012 appeared equally fruitful at the time, things have progressed much less smoothly since.

The main source of contention is Tajikistan's failure to ratify the agreement extending Russia's military presence in the country. Under an agreement, the Russian army's 201st base – which has operations in three Tajik cities, Dushanbe, Kulob and Qurgonteppa – will have its lease extended from 2014, when it is due to expire, until 2042, with the option for further extensions.

Ratifying the deal was expected to be a formality, but Dushanbe has since stalled as it holds out for additional concessions on top of those agreed in October 2012.

Dushanbe is understood to be hoping that Russia will guarantee planned investments in its hydropower sector and pay $200m to help modernise the Tajik army.

The different paths the two countries' relations have taken illustrate their

different relationships with the main regional superpower. "The political chaos in Kyrgyzstan in the last few years, especially the latest revolution in 2010, played into Russia's favour. The Kyrgyz government has been loyal and accommodating to Russian interests, whereas occasionally the Tajiks do things that are not to Moscow's liking," says Eugene Chausovsky, Eurasia analyst at Stratfor.

Russia has been instrumental in establishing and shoring up the regimes in both Kyrgyzstan and Tajikistan.

Discontent over former Kyrgyz president Kurmanbek Bakiyev's increasingly corrupt regime had been rumbling for some time, but the death knell for his rule came when he reneged on an agreement to throw the US out of Manas, an unofficial quid pro quo for the hundreds of millions of dollars in finance for hydropower projects he received from Moscow. Some of the leading Kyrgyz opposition figures are rumoured to have paid a visit to Moscow immediately before the revolution that ousted Bakiyev.

Back in the 1990s, Russian support was an important contributor to Rakhmon's victory over Tajikistan's Islamist opposition in the 1992-1997 civil war, and Russia's continuing military presence and financial support

demanding too much money to host the Russian military base and called for Tajik labour migrants to be sent home.

"What will the head of the republic, Rakhmon, do then? He knows well that it would be the end for him," Zhirinovsky told viewers. "And maybe the Taliban would trample on Tajikistan and they would hang [Rakhmon] in the centre of Dushanbe, like they did [former Afghan president] Najibullah," Zhirinovsky warned.

While Russia's foreign ministry distanced itself from Zhirinovsky's comments, Russian officials have also put pressure on Tajikistan over the base issue. On April 16, Deputy Prime Minister Dmitry Rogozin took part in an official inspection of a Tajik train on the Dushanbe-Moscow route. Rogozin commented during the inspection that the trains were "unfit for transporting people", and followed this up later in the day saying that such trains should "never be allowed into Russia," because they pose "a serious threat to the sanitary health of the whole nation."

While the threat to bar Tajik Railways trains from Russia, making Tajik passengers switch to Russian trains at the Russian-Kazakh border, has not been officially linked to Dushanbe's delay in ratifying the base deal, it is a familiar tactic from Russia. In 2011, a

"The political chaos in Kyrgyzstan in the last few years, especially the latest revolution in 2010, played into Russia's favour" have helped Rakhmon maintain control against the twin threats of domestic opposition and insurgency from neighbouring Afghanistan.

After the failure to ratify the base deal, Dushanbe's stance was thrown back in its face by Russian nationalist politician Vladimir Zhirinovsky. During a talk show on the Russia-1 television channel, Zhirinovsky said that Tajikistan was

Tajik court's sentencing of two ethnic Russian pilots for smuggling was swiftly followed by Russian threats to send home Tajik migrants. With remittance payments from migrant workers, mainly in Russia, making up around half of Tajikistan's GDP, Dushanbe swiftly caved in and released the pilots. There have been hints of similar tactics recently, with Russian officials proposing stricter passport requirements for migrants.

50

I Eurasia

bne June 2013

Tensions ease However, in recent weeks, the tensions seem to be easing. Although the base deal has not yet been ratified by the Tajik parliament, both countries have ratified a deal under which Russia will resume exports of duty free oil products to Tajikistan. After angry comments from Tajik officials accusing Russia of

Tajikistan's presidential elections, which are due to take place in November 2013.

"The internal issue is definitely a big worry for Rakhmon," Chausovsky tells bne. "There have been signs he is really concerned over the opposition, especially the IRP [Islamic Revival Party], being a big challenge. That would play into Tajikistan relying more on Russia, or at

"The internal issue is definitely a big worry for Rakhmon" trying to grab the lucrative DushanbeMoscow rail route, a dialogue on the trains issue has also begun.

least making sure relations with Russia are stable so that Russia is not a factor in providing instability to Tajikistan."

One of the factors pushing Tajikistan back into the Russian fold is the potential for further instability as a result of both the US withdrawal from Afghanistan and

Tajikistan sees periodic militant uprisings, with the remnants of the United Tajik Opposition holding sway in parts of the country nearly two

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

decades after their defeat in the civil war. On the long, porous border with Afghanistan, Tajik and Russian forces struggle to block both militants and drug traffickers. The government is also gearing up for a tussle with the opposition in November. Membership of the IRP, the only Islamist party represented in any parliament in the Commonwealth of Independent States, has increased rapidly, especially in Gorno-Badakhshan Autonomous Oblast – a region of Tajikistan on the Afghan border where there were clashes between militants and government forces in July-August 2012.

Because of this, and the lack of alternative protectors, Tajikistan already seems to be ending its brief show of defiance, at least for now.

And the Russian agreements signed in autumn 2012 are likely to be followed by further penetration of both countries, not just militarily but in the economic sphere as well.

| Eastern Europe | Russia | Belarus | Ukraine | | Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

What you need to know

Sign up today for a free month trial of all our services

www.bne.eu

bne June 2013

Eurasia

I 51

announced, Uzbekistan's state railways operator Uzbekiston Temir Yullari (UTY) said it was considering an extension to the existing line.

UTY has already started feasibility studies. The 230 kilometre extension is expected to cost around $450m, with the Central Asia Regional Economic Co-operation (CAREC) Programme expected to provide funding.

Railroads to Afghanistan Clare Nuttall in Astana

C

entral Asian states are stepping up efforts to engage with post-war Afghanistan economically as fears grow about the security implications that the US military withdrawal could have on the region as a whole.

Several of the Central Asian republics are pursuing plans for new railways to Afghanistan. Ashgabat has been the main driving force behind plans to build the Turkmenistan-AfghanistanTajikistan railway since the three countries sighed an agreement in March 2013. The Turkmen government wants construction of the 400-kilometre line to start as early as July. Feasibility studies are already underway, and President Gurbanguly Berdymukhamedov has told officials to organise a groundbreaking ceremony as soon as possible.

Several routes are still under discussion, but the line is expected to run from the Turkmen town of Atamyrat in the southeastern corner of the country into Afghanistan, to Akina-Andhoi, 650km from Kabul. From Akina-Andhoi, it will run east to Pyandzh in Tajikistan. The

Asian Development Bank has said it may finance the line.

As well as helping to connect Afghanistan to the two Central Asian states, it will also provide a direct rail link between Tajikistan and Turkmenistan, which are separated by Uzbekistan's Surhondarya region – a

As the withdrawal of international troops – expected to be completed by the end of 2014 – gets underway, the Central Asian republics, three of which border Afghanistan, and other international actors, in particular the US, are looking at the potential for economic integration to contribute to regional security.

Kazakhstan, which has no shared border but is the region's economic leader, has been actively promoting ties.

For several years, for example, Afghan students have been given scholarships to Kazakhstani universities. Astana has also been working to increase cooperation with Afghanistan in the economic sphere, with joint analysis and forecasting centres due to be opened in Almaty, Astana and Kabul.

In March 2013, Forbes.kz reported that Afghanistan's Ghazanfar Bank is planning to open a subsidiary in Kazakhstan to facilitate transactions between the two countries. Most importantly, Kazakhstan has already

"Most Central Asian governments have become more realistic about not only the threats, but also the opportunities"

major benefit to Tajikistan, which has poor relations with Uzbekistan.

Meanwhile Uzbekistan, Afghanistan's top trading partner in Central Asia, finished building the Hairatan to Mazar-i-Sharif in 2011. Just days after plans for the TurkmenistanAfghanistan-Tajikistan line was

seen Afghanistan become one of its top wheat importers, alongside its Central Asian neighbours, Turkey and Iran.

At a briefing in Astana on April 23, the US Assistant Secretary of State for South and Central Asian Affairs Robert Blake said "great progress" had been made towards integration. Citing examples

52

I Eurasia

bne June 2013

of new railways and the planned Turkmenistan-Afghanistan-PakistanIndia (TAPI) gas pipeline, Blake said, "I think all of these show that the region is committed to regional integration.

However, despite factors such as the large Tajik and Uzbek minorities within Afghanistan, the Central Asian republics are far from keen to embrace too tightly their southern neighbour, and concern for their own security is still the top factor for regional governments. Only Tajikistan, which has the strongest cultural similarities, wants a relationship that goes deeper than the security and economic dimensions.

According to Jos Boonstra, senior researcher at think tank FRIDE, Central Asian governments have tended to exaggerate the twin threats of terrorism and drug trafficking in connection to Afghanistan, both to ensure continued engagement from the US and Europe, and to distract from security issues at home. Recently, however, "most Central Asian governments have become more realistic about not only the threats, but also the opportunities. Perhaps the most notable example is Turkmenistan, which has become more active in its discussions with its partners - the EU, US, Russia - but also in its relations with Afghanistan, with trade, electricity and gas exports and so on," Boonstra says .

Boonstra points out that rather than a Central Asian Afghanistan policy, each of the five republics have individual agendas. "There are grand plans for fostering regional cooperation and trade, but basically these countries each have their own interest. For Tajikistan

and Uzbekistan, for example, this is especially linked to transport routes and electricity."

Power plays In addition to the scramble to take part in the reverse supply chain along the Northern Distribution Network (NDN), the Central Asian republics are also aware of opportunities to supply the Afghan market with electricity.

Tajikistan, Turkmenistan and Uzbekistan already export electricity to Afghanistan. Uzbekistan started exporting power in 2009 and has helped maintain a 24-hour supply in Kabul. Tajikistan and Turkmenistan are also exporters, and Tajikistan is hoping that major new hydropower projects and the planned CASA-1000 (Central Asia-South Asia) electricity transmission project will give a boost to exports. CASA-1000, a high-capacity power line that will export Tajik and Kyrgyz electricity south to Afghanistan and Pakistan, will allow Tajikistan to rival Uzbekistan as the main supplier to the Afghan market.

Meanwhile, there are also hopes for a peaceful Afghanistan in future, which would make it possible to open up southern import and export routes for the landlocked Central Asian states which are currently oriented mostly north and east. The most ambitious project is the TAPI pipeline, which will deliver Turkmen natural gas to south Asia. The four participating countries are trying to find investors and attract international oil companies, with the aim of building the pipeline by 2018.

"Concern for their own security is still the top factor for regional governments"

bne June 2013

Eurasia

I 53

reputation as an administrator and lacks the political experience of possible UNM candidates like former parliamentary speaker Davit Bakradze or former defense minister Giorgi Baramidze.

Educating Giorgi

Currently, however, the UNM does not present a major concern for the Georgian Dream. Saakashvili cannot run for another term, and his party is still struggling to find its base and solidify support after its defeat in the October 2012 parliamentary elections.

The UNM is in a weak position to win the presidential race, with just 10% support, compared with the Georgian Dream's 60%, according to ratings based on the findings of a National Democratic Institute March nationwide survey of 3,103 respondents.

Molly Corso in Tbilisi

W

ith just six months before the Georgian presidential election, solid popularity ratings for the governing Georgian Dream coalition indicate it's poised for victory in October.

Prime Minister Bidzina Ivanishvili's choice for the coalition's presidential candidate, however, has prompted questions about his own political motives.

While a move to a parliamentary system means that Georgia's new president will have a shadow of the powers currently enjoyed by President Mikheil Saakashvili, the Georgian Dream's decision in May to go with an academic – with little known political ambitions and no affiliation to any one political party – appears to add to perceptions that Ivanishvili is focused more on eliminating competition in the coalition than fostering a new leader to follow him.

Ivanishvili's choice, Education Minister Giorgi Margvelashvili, did not come as a total surprise. Margvelashvili, a former university rector and a wellrespected political analyst, has long been seen as an Ivanishvili favourite.

Over the past eight months in power, the prime minister has referred to him as one of the strongest members of the cabinet. Ivanishvili has also stood by Margvelashvili, tapping him to take over Defense Minister Irakli

Alasania's post as deputy prime minister after a falling out with Alasania, and defending Margvelashvili's criticism of the coalition's vision for Georgia's new labour code.

After months of scandal, arrests and unfulfilled promises, Margvelashvili is also one of the few ministers to make an impact over the past eight months since

Indeed, the prime minister had named other members of the coalition as possible presidential candidates in the months after taking power following the October 2012 parliamentary elections.

Vakhtang Khmaladze, a specialist on the Georgian Constitution and a member of the Republican Party – part of the Georgian Dream coalition – had been mentioned several times early in Ivanishvili's term. Other names,

"Whenever I come across difficulties I always call Giorgi and ask him for advice" the Georgian Dream coalition came to power: he took on – with mixed results – tycoon Kakha Bendukidze over his purchase of the Agriculture University and has announced plans to provide free textbooks to all children in public schools.

including former foreign minister Salome Zourabishvili and former footballer-turned-energy minister, Kakha Kaladze, were also floated by the media in the run-up to the coalition's official announcement.

Confident of victory In the ongoing battle against President Saakashvili and his United National Movement (UNM) party, the Margvelashvili nomination stands out, however, for its apparent confidence in victory. Because without the pull of Georgian Dream behind him, Margvelashvili looks on paper a weak candidate. He is popular as a political commentator, but he has a mixed

But on May 11, Ivanishvili said Margvelashvili was the "ideal option."

Stressing that the education minister is "creative," "unique," and a "team player," Ivanishvili said Margvelashvili is perfect presidential material, and one of the prime minister's few confidants.

But public reaction to Margvelashvili's nomination has been mixed. Some see him as a welcome change from

54

I Eurasia

Not-so priestly behaviour

Molly Corso in Tbilisi A peaceful protest against intolerance turned violent in Tbilisi on May 17 when a mob led by Georgian Orthodox priests and their followers swept past police barricades and tried to attack a group of human rights activists attempting to celebrate the annual International Day Against Homophobia.

Television reports have focused on the sheer size of the mob, which numbered thousands as it marched down Tbilisi’s central avenue and overtook police officers who were attempting to divert them away from the anti-homophobia event planned to take place in the city’s Freedom Square. The event, which had been announced several days in advance, was cancelled as police evacuated the activists in buses and patrol cars before the crowd broke through the barricades.

While police managed to keep injuries and clashes to a minimum, critics claim law enforcement did not do enough to protect the anti-homophobia activists or their right to protest. Human rights advocates and civil rights groups, as well as members of the opposition, have accused the police of failing to stop the Georgian Orthodox priests and their followers.

Indeed, the clash was widely anticipated by most. Last year, fights broke out at a similar event when priests and their followers tried to stop activists from marching down Tbilisi’s main avenue. Patriarch Ilia the Second - the head of the Georgian Orthodox Church and widely considered the country’s most influential figure – had called on the government to ban the anti-homophobic protest the day before the event, referring to it as propaganda for gay and lesbian lifestyles. “That would be similar to liking the actions of a drug addict and making a public display of drug addiction. Our people have different aspirations and for that reason it is understandable their sharp protest against this and similar rallies," he added, before generously noting that “sexual minorities” are free to live “their private life without restrictions.”

Homosexuality is still widely condemned in Georgia, a country where the conservative Georgian Orthodox Church wields considerable influence. Much like the rest of the former Soviet Union, Georgians tend to take pride in their traditional society. Unlike post-sexual revolution generations in Europe and the US, sexual minorities and unconventional partnerships are seen as largely taboo, and prejudices against gay and lesbian Georgians appears to run across the generational divide. As many as 32% of lesbian, gay, bisexual or transgender (LGBT) Georgians have been physically attacked over the past two years – and 87% feel they have to deceive their father or brother about their sexual orientation, according to a report by feradi.info, a Georgian visual data site.

In Georgia, while popular support for LGBT rights may be low, politicians have also tried to maintain a more measured tone. During a press conference on May 14, Prime Minister Bidzina Ivanishvili told journalists that Georgian society just needs time to accept sexual minorities as equals.

“I have said multiple times previously that sexual minorities are the same citizens as we are,” he said. “Society will gradually get used to it.”

bne June 2013

the larger-than-life personalities and political virtuosos who have forged modern Georgian politics. Others, however, are questioning if Ivanishvili's choice was dictated by an agenda to control power instead of risking the presidential portfolio on a possible political challenger.

Other options, like Alasania or Zourabishvili – if as a dual citizen she were to be allowed to run – could have given them and their respective political parties the political strength to become a competitor to Ivanishvili's Georgian Dream party in the 2014 local elections.

Alasania, the head of the Free Democrats, made no secret of his presidential ambitions prior to the October 2012 election. As minister of defense with his own political party and a network of supporters in the West, Alasania was poised to be a threat to any other presidential candidate in the race. As a presidential candidate, he would have also sent a clear message of Georgia's orientation toward Europe and the US. He opted out of running, however, after a fall out with Ivanishvili in February, stating that he prefers to concentrate on defense reforms and Georgia's bid for membership in Nato.

Zourabishvili would have had difficulty running since she is a dual French and Georgian citizen and has not lived in Georgia for the past two years, both of which make her ineligible to run under the current law. She returned to Tbilisi, however, this year and has been increasing her public profile, a move that seemed to indicate she is ready to return to politics. While her popularity declined along with other Georgian opposition groups after a series of unsuccessful protests at the height of Saakashvili's power, Zourabishvili has enjoyed strong political support in the past as the foreign minister who was responsible for negotiating the 2005 deal with Moscow that led to Russian bases on Georgian territory being closed.

Ivanishvili, however, appears to prefer a political confidant in the post of president, not a potential kingmaker.

bne June 2013

Eurasia

I 55

heart of Astana's government district, were being watched closely by a group of police officers.

An age-old fight against pension reforms Clare Nuttall in Astana

A

campaign against plans by the Kazakh government to overhaul the pension system is gathering pace, in a rare instance of mass public discontent in this autocratic Central Asian state.

The campaign began after Labour and Social Protection Minister Serik Abdenov became a figure of fun in Kazakhstan after unsuccessfully trying to defend plans to increase the retirement age for women from 58 to 63 at a public meeting in the industrial town of Temirtau in April. Asked why the retirement age was being raised, the very boyish-looking 36-year-old Abdenov replied: "You have to work and work... because, esteemed fellow countrymen, because, because..." A video from the meeting has since gone viral on YouTube and opponents of the pension plans have launched an online campaign, with women posting photos of themselves carrying signs that say, "I must work and work until 63 years... Pa-ta-mu-chto, Pa-ta-mu-chto", a misspelling of "because, because" in Russian which sounds mocking.

Abdenov said later that his words had been taken out of context, and that he had been trying to lighten the mood.

He has continued a series of meetings around the country to explain the reforms. But his position has been further undermined as campaigners point out that in September 2012 he said there was no need to raise the retirement age.

Women in several Kazakhstani cities have been collecting signatures on a petition calling for a public hearing on the reforms that will see the retirement

Aliya said that they had gathered around 60 signatures in Astana, but that several thousand had been gathered in other parts of the country, with strong support for the movement in industrial cities such as Ust-Kamenogorsk. As of May 8, the "Patamuchto, patamuchto" Facebook page had 5,249 likes, with members using it as a forum to compare Kazakh pensions with those in other countries, and criticise spending on the Expo-2017 world fair due to take place in Astana, as well as posting cartoons mocking Adbenov.

In a more direct attack, Abdenov was pelted with eggs at a press conference in Almaty on April 26. Abdenov was heckled by a man who introduced himself as Andrey Tsukanov, a communist from the industrial city of Karaganda. Tsukanov was arrested and sentenced to seven days in prison.

Pension reforms The Kazakh government says that the retirement age for women needs to be brought into line with that for men, as the country will not be able to continue supporting pensioners from an early age. Similar moves to raise the retirement age have been initiated in several European countries, where governments are concerned about a

"Many women already die before they reach retirement age" age gradually raised by six months a year between 2014 and 2024. "Life expectancy is not so high in Kazakhstan, our standard of living is not so good. Many women already die before they reach retirement age," Aliya, one of a small group of women gathering signatures in Astana on April 28, told bne.

"A woman is not a horse," added one of her fellow activists. The group, which was standing just a few hundred metres from Kazakhstan's parliament in the

demographic time bomb due to ageing populations and low birth rates.

In Kazakhstan, as of 2012 average life expectancy at birth was 66.5 years – 72.6 years for women and 60.7 for men – according to the World Bank. This is well below most Western European countries. As of 2012, the country had a birth rate of 25 births per 1,000 people, up 3.1% from 2011, which is significantly higher then the 12.27 births per 1,000 people in the UK and

56

I Eurasia

ENRC takeover proposal rejected

Clare Nuttall in Astana Eurasian Natural Resources Corporation's (ENRC) agony continued in May. And the spate of negative stories over transparency and corruption at the London-listed Kazakh miner is also starting to have a damaging effect on investor confidence in Kazakhstan.

On May 17, the committee of independent directors at ENRC rejected a takeover proposal from the company's founders – alongside the Kazakh state – despite a deepening corporate governance crisis and a string of accusations of corruption. Those began with the UK's Serious Fraud Office announcing in April it was carrying out a formal investigation into contracts worth $100m awarded to a company linked to ENRC's chief financial officer, Zaure Zaurbekova. The company's activities in both Kazakhstan and Africa have also come under scrutiny. Several senior management figures have now left, and Deutsche Bank and Morgan Stanley quit as advisers to the company in early May. The statement from the Independent Committee of the Board of ENRC said that the $2.3bn proposal from the company's three founders – alongside the Kazakh government and sovereign wealth fund Samruk-Kazyna – for the 46% stake they do not own, "materially undervalues ENRC". The buyout consortium has been given until June 3 to make alternative proposals by the UK’s Panel on Takeovers and Mergers, which oversees the company due to its listing on the London Stock Exchange (LSE).

Kazakh billionaires Alexander Machkevitch, Alijan Ibragimov and Pathokh Chodiev announced on April 18 they were considering buying out other shareholders, in a move that could result in ENRC being delisted from the LSE. The Kazakh government owns an 11.65% stake through the State Property & Privatisation Committee of the Ministry of Finance of Kazakhstan. Another Kazakh miner Kazakhmys owns 26%, while ENRC holds a mirror stake in the rival mining giant. Kazakhmys said on May 20 that it might support a bid for ENRC. The consortium's initial proposal includes 175 pence per share in cash, plus 0.231 of a share in Kazakhmys. Overall, the offer amounts to slightly over 253p per ENRC share, below the May 17 closing price of 272p. "We believe the current proposal materially undervalues ENRC, and we will use the extension to seek an improved and formal proposal," the chairman of the independent committee, Dr Mohsen Khalil, said in a statement.

"The Independent Committee is committed to serving the best interests of minority shareholders through a professional, transparent and rigorous process, which incorporates the highest standards and principles of independence and integrity."

Analysts say the continued pressure on the share price from the swirl of corruption allegations creates an incentive for the deal to go ahead. "One can never say it’s a done deal in Kazakhstan, but I would say that most likely the takeover will go ahead," believes Visor Capital's head of research, JeanChristophe Lermusiaux.

bne June 2013

just 8.33 births per 1,000 people in Germany. However, Kazakhstan's state statistics agency forecasts that the birth rate will start to decline from 2015.

The pensions reforms have also caused concern among Kazakhstan's investor community due to plans to merge the country's 11 pensions funds – ten of which are private – into a single fund under the control of the central bank by July this year. Tight restrictions on the assets that pension funds can invest into have already forced many Almaty-based brokers to shut down or lay people off.

Rare show of dissent Unlike neighbouring Kyrgyzstan which has been shaken by two revolutions in the last decade, Kazakhstan has little history of mass political activism, making the backlash against the pensions reforms and the growing campaign online and in the streets a rare occurrence.

Both government and population were shocked by the Zhanaozen tragedy in December 2011, when at least 14 people were killed in clashes between rioters and police on the country's 20th anniversary of independence. The riots followed a seven-month strike by oil workers, the longest and most acrimonious in postSoviet Kazakhstan's history.

Forced to reassess its social policy in the aftermath of Zhanaozen, the government took a carrot-and-stick approach. On the one hand, the violent crushing of the riot was followed up with a clampdown on opposition parties and media. At the same time, funding was announced for projects to raise living standards and create more economic opportunities in the regions, especially in remote mono-industry towns like Zhanaozen.

Almaty-based think-tank the Institute of Political Solutions (IPS) forecasts that Kazakhstan will see an increasing number of grassroots protests based on specific issues, with the campaign against pensions reform a prime example of this. The IPS writes that efforts by the authorities to promote unpopular social initiatives "leave much to be desired."

bne June 2013

Eurasia

I 57

operating officer at local investment firm BDSec, in a note to investors about the order. "Minister of Mining Gankhuyag was specifically instructed to 'speed-up the land, foreign labor force, customs documentation permits and take actions on solving water, environmental, power plant, third-party laboratory, and infrastructure issues'." © Copyright 2013 Oyu Tolgoi LLC

Rio Tinto appoints Mongolian to soothe nationalist feelings Terrence Edwards in Ulaanbaatar

W

hen the Mongol conqueror Genghis Khan was expanding his empire in the 13th century, he made it a habit to take wives from the conquered people to help fortify their new bonds. Rio Tinto might have taken a page from Genghis' strategy book with the high-level appointment of a prominent Mongolian businessman as it looks to engineer a smooth launch of commercial exports from the $6.2bn Oyu Tolgoi copper-gold mine.

Rio Tinto's bride-to-be is Bold Baatar, a native Mongolian who has served as an advisor to the Anglo-Australian diversified miner for the past three years. He will act as president of international operations of Rio Tinto's copper group from London, effective June 3. This addresses a key complaint of the Mongolian government that it is not well represented in the management of the project.

The Mongolian government has been at loggerheads with Rio Tinto, which is leading operations at Oyu Tolgoi with a 66% stake in the project through its subsidiary Turquoise Hill Resources, claiming that the mining company has put the strategic project off budget by some $2bn and is behind on paying its taxes.

The coveted Oyu Tolgoi copper-gold project is central to the country's explosive economic growth, forecast at 13% for this year by the World Bank, as well as being the focus of a growing resource nationalism movement among the Mongolian people and politicians. Members of parliament have twice attempted to amend the 2009 investment agreement for Oyu Tolgoi to increase the state's stake in the project from 34% to 51%. Such moves are popular; according to an April survey from the pollster Sant Maral Foundation, 24.7% of Mongolians polled nationwide said they would prefer that all mining projects have 100% Mongolian ownership, while 59.6% said more than 51% ownership was necessary.

Yet there are signs that Mongolia and Rio Tinto may be finding common ground. In April, an order came down from the Office of the Prime Minister to expedite any remaining permissions needed to ensure that the project remains on target for a June launch of exports to China. "This is a significant about-face, as we had been told by several contacts on the ground not to expect a resolution until after [the presidential] election, [scheduled for June 26]," said Nick Cousyn, chief

The appointment of Bold Baatar, who will report directly to Rio Tinto's chief executive of copper, Jean-Sebastian Jacques, will go some way to satisfying one of the government's main complaints at a stakeholders' meeting held in February, which was for more local representation in management, as well as provide a fillip to the national pride of this callow, emergent country.

"It is a momentous event demonstrating global recognition of the value of Mongolian intelligence and skill," local magazine Mongolian Economy, which is published in both Mongolian and English languages, declared in response to the appointment. “Baatar Bold has opened the door to make this dream of Mongolia come true.”

Bold is well known in Mongolia as an active figure in Mongolia's private sector, participating on the board of the Business Council of Mongolia as well as being chairman of the Mongolian National Mining Association and former chairman of the Mongolian Stock Exchange. "As a respected business and civic leader, his advice often is sought by government, industry and civil society organisations as they work to balance a business-friendly investment environment with protecting Mongolia’s interests," says Cameron McRae, Oyu Tolgoi's chief executive officer and president, in a statement.

Though the appointment may appear political, Bold is a field-tested manager with big experience in the mining sector. Bold has been lauded for his role as CEO in the transformation of mining firm Altan Dornod Mongol from one owing the government millions in back taxes, to The Mongolian National Chamber of Commerce and Industry's 19th most admired company in its "Top 150 Enterprises" list for 2012.

58

Opinion

bne June 2013

EBRD sees no quick turnaround Ben Aris in Istanbul

"T

he news is not good: there is no quick turnaround in sight." That was the conclusion of the European Bank for Reconstruction and Development's chief economist, Eric Berglof, at the multilateral lender's annual conference being held this year in Istanbul on May 10-11.

The EBRD has downgraded its economic outlooks for almost all the countries in which it operates in Central and Eastern Europe/Commonwealth of Independent States (CEE/CIS) due to the ongoing crisis in Europe. Berglof highlighted the fates of Turkey, Poland and Russia as key to the future of the region; collectively they account for two-thirds of the GDP of the entire region and have become the engines of growth. If they do badly, everyone does badly. And they are doing badly.

Russia is the sickest of the three. Growth was expected to slow going into 2012, but as the year wore on it became clear the Russian economy has not just slowed, it stalled completely in February. Russian President Vladimir Putin has been rushing about, calling meetings and issuing strict orders to all and sundry to pull their finger out and fix the machinery. Few believe that all this noise will make much difference in the short term and the Kremlin has always talked about reform, but failed to do much. The optimists can only point to the fact that the tone is a lot shriller than normal and without the necessary oil revenues as the oil price falls, the Kremlin actually has to produce change this time or face stagnation. To drive the point home, the EBRD issued a press release as its annual meeting got underway that almost halved its Russia growth outlook for 2013 from 3.5% to 1.8%, the biggest downgrade of all the countries in its patch.

Poland too is being affected by the pall hanging over the continent. Famously the only country in the EU to avoid recession in 2009, government debt has been climbing in the intervening years and is approaching the constitutionally fixed 55% of GDP ceiling. That means Poland is fast running out of wiggle room to boost the ailing economy. "The Polish government is running out of room and can't stimulate the economy any more, so growth is slowing," Berglof said.

The country has reported a string of bad figures that are giving rise to concern in the last months, most recently lackadaisical

retail figures that show consumption and demand are both falling with little prospect for a turnaround in the short term.

Turkey, host of this year’s jamboree, is the one bright spot, but even its economy has been slowing too. However, Berglof said one has to see this in the context of the credit-fuelled consumer boom of last year, so the cooling pace of growth is actually a positive. "This was an economy that was overheating and now they are coming in for a soft landing, which is a good thing," said Berglof.

The turnaround is clearest in Turkey’s trade figures: it was running a huge trade deficit until the second quarter of 2011, but as credit was wound down, the flow of goods reversed, putting

"Rising levels of non-performing loans are very worrying as they are already decaying"

the country in a much more healthy position. Turkey was one of the only countries in the region where the EBRD expects growth this year to be higher than last year.

Still, the slowdown is squeezing everyone and one place that the problems are already manifest is in the decay of credit quality, said Berglof, hinting that this is the thing that concerns his bank most. Bank loans are starting to go bad and this will eventually lead to a crisis unless the governments of the big three can put their houses in order. Slovenia is already in trouble and on May 9 unveiled a new package of taxes and reforms designed to raise more money that can be used to bail out its crippled bank sector. Happily for Ljubljana, international bond investors are hungry for highyielding bonds at the moment, so the country has had access to cash. But like everyone else the pressure is on to make

bne June 2013

Opinion

effective reforms and put them in place fast. "Rising levels of non-performing loans are very worrying as they are already decaying," said Berglof.

More generally, lending by banks to companies across the region remains weak and is stymieing the recovery. Crediting has been especially weak in CEE, but grew faster in the east and Turkey in particular.

What next?

As traditional methods to stimulating economies are nearly exhausted, governments are turning to increasingly unorthodox measures in the hope of kick starting their economies, such as off-budget investment funds and directly crediting small and medium-sized enterprises (SMEs).

Russia probably faces the biggest challenges, as both consumption and investment are falling. The country began 2012 with just under 5% growth thanks to a boom in consumer crediting, but this failed to spur production nor did it lead to a pick-up in investment, and by the end of last year retail turnover began to fall again.

The country is also facing constraints on the supply side, as the very low investment means factories are running at close to full tilt, which is also reflected in the record levels of unemployment. The state plans to increase spending, especially in infrastructure, but this still doesn’t address the fundamental issue of how to encourage private enterprises to borrow and build more capacity. But hope dies last and surveys from across the region show that businessmen are increasingly optimistic about the future. "The rising business confidence suggests that we have passed bottom," said Berglof.

In particular, exports over the last six months have increased from almost all of CEE/CIS, with the notable exceptions of Belarus, Mongolia and Croatia.

Another positive development is that capital flows are back.

With yields close to zero in most developed markets, investors have been hunting for returns and snapping up emerging market bonds willy nilly.

As the star performer of last year, Turkey still remains a magnet for investors and has received large, if volatile, inflows.

Most of CEE is also in black. Russia has seen a pick-up in the amount of FDI coming into the country, mainly from retailers, but is still experiencing a net outflow of capital.

However, most countries are being thrown back on their own resources and increasingly turning to unorthodox measures.

Poland will dodge its constitutional borrowing cap by launching off-budget investment funds. Hungary has introduced a central bank lending programme and several governments have given more firepower to their development banks. "But there is no shortcut to growth. All the governments need to continue to push ahead with their reform and privatisation plans," said Berglof.

"Rising levels of non-performing loans are very worrying as they are already decaying"

59

60

I Special report

bne June 2013

bne:Invest in Astana

This is an abridged version of the new monthly "bne:Invest in Astana" monthly newsletter. You can sign up for free to the newsletter by going to www.bne.eu and registering.

Special report I 61

bne June 2013

A capital economy

Kanat Sultanbekov, Astana's deputy mayor

Clare Nuttall in Astana

A

stana's economy has grown rapidly since it became the capital of Kazakhstan in 1997, with a focus on trade, services and, increasingly, high-tech manufacturing. The growing population has helped create a vibrant local economy with many small and medium-sized enterprises (SMEs).

The selection of the city to host the Expo-2017 world fair will create further impetus for development in the coming four years.

The economies of many Kazakhstani towns are determined by the local raw materials, giving rise to the oil and gas towns in the west and the mining and metallurgical centres such as Temirtau and Ust-Kamenogorsk. Astana, however, has become Kazakhstan's centre for high-tech manufacturing, in particular

for the railway industry, and the location of booming trade and services sectors.

Trade and services accounted for the lion's share of Astana's gross regional product in 2012, 75.2%, which was up from 60% in 2011.

Since 1997, Astana has been transformed from a small provincial town to

Kazakhstan's total GDP. In 2012, the city attracted investments worth KZT615.5bn ($4bn).

To help the capital to develop, the Astana New City special economic zone (SEZ) was set up to manage both Astana's business and administrative district on the left bank of the Esil river, and

"Astana has become Kazakhstan's centre for high-tech manufacturing" a high-rise modern capital. Investment into Astana's economy has steadily increased, as has the city's share of

a dedicated industrial zone. The project has been so successful, bringing in both domestic and international investors, an

62

I Special report

bne June 2013

"The city will become a showcase of environmental protection"

extension to the industrial zone is now being built.

Astana also has a thriving SME sector.

"Small and medium-sized businesses in the capital are developing very actively," says Astana's deputy akim (mayor), Kanat Sultanbekov.

Many companies have grown up around the larger enterprises now established in Astana. Kazakhstan's national railways operator Kazakhstan Temir Zholy (KTZ) has, for example, set up joint ventures with several major international companies to produce locomotives and rolling stock in the Kazakh capital. In turn, these have created opportunities for smaller local suppliers. "This is a prime example of small businesses around large enterprises, such as KTZ and its subsidiaries," says Sultanbekov. Other growing areas include food production, furniture and textiles manufacturing, mechanical engineering, and printing.

For more than two years, the Kazakhstani government has been supporting SMEs through the "Roadmap 2020" programme, which has already resulted in a 47% increase in lending to small businesses. "The Astana city authorities have been actively supporting businesses through the programme, approving 118 investment projects in 2012, which is 9-times higher than in 2010 when the pilot was launched and 3.5-times higher than in 2011," Sultanbekov says.

The selection of Astana as the host for the Expo-2017 world fair is set to be

a huge boost, not just for the capital's international reputation, but also for businesses active in the city. This will further stimulate the services sector, and many new hotels, restaurants and other facilities are expected to open in the run-up to the event. There are also numerous opportunities in the renewable energy and energy efficient technology spheres, since the theme of the Expo is "Energy of the Future", and the expo city will run entirely on renewable energy. "Expo 2017 provides a real chance to put Astana on track to create a green economy and a city corresponding to global standards of quality of life. The city will become a showcase of environmental protection.

The transition to environmentally sustainable development is the only way to advance the economy and the country as a whole," Sultanbekov says. "This will give an impetus to the development of science, new green industries and job creation, and an economy based on new standards."

Astana is already investing in modern infrastructure to serve its growing population. This includes the expansion of utilities and road networks to new districts of the city, and the modernisation of public transport systems. A light railway, running across the city from the airport to the railway station, is due to be completed by 2017. Reducing greenhouse gas emissions and air pollution by switching public transport to gas – and in future biofuel and electric power – is another priority for the city.

Special report

bne June 2013

I 63

profit tax, land tax and VAT on building materials.

A "single window" centre was set up to provide support and information services for investors, according to Meder Masselov, head of the Astana akimat (city authorities) department for administration of the SEZ. As of late 2012, there were 41 projects in development in the industrial zone, with total investments of over KZT150m. Total investments to date in the SEZ, including real estate and infrastructure as well as the industrial zone, amount to over KZT1 trillion (€5.14bn).

Meder Masselov, head of the Astana akimat (city authorities) department for administration of the SEZ

A New City in Astana Clare Nuttall in Astana

W

hile Astana started out as Kazakhstan's administrative capital, the government and city authorities have been working to establish the city as an industrial hub for northern Kazakhstan. The Astana New City special economic zone (SEZ) has had an important role in managing the growth of both the newly built “Left Bank” district of the city, and its industrial zone.

The SEZ was set up in 2011 by presidential decree, with a mandate to manage investment into new housing, offices, retail and trade centres, industrial space and the infrastructure underpinning construction of the city.

The volume of investment into Astana has steadily increased in recent years. To encourage businesses and construction companies to set up in Astana, investors at the SEZ receive a variety of tax and customs preferences, including exemptions from corporate

Several of the industrial investors are in the rail sector, where Kazakhstan's national rail operator Kazakhstan Temir Zholy is carrying out a multibillion-dollar investment programme, but more have followed in several other sectors. "Under the plan for further development of the Astana New City SEZ, we have a new set of priorities for the industrial park, including production of machines, electronics and instruments, chemicals and pharmaceuticals, and in the energy and information, communications and technology spheres," says Masselov.

"We will be actively working to attract international companies to these areas."

The industrial park is now being expanded, and a new innovation park added. In total, the SEZ is being expanded from 7,093 hectares to 7,562. This will require extending infrastructure for roads and utilities to new areas as Astana – whose population has more than doubled from around 300,000 in 1997 to 775,000 in June 2012 – expands out onto the steppe.

"The volume of investment into Astana has steadily increased in recent years"

64

I Special report

bne June 2013

An international competition to design the exhibition city has been launched, with the BIE due to choose a winner in October 2013, paving the way for construction to start in early 2014.

Countdown to Expo-2017 Ben Aris in Astana

L

ess than 20 years after becoming Kazakhstan’s capital, Astana will be the first city in the CIS region to host a world fair in the event’s 162year long history. Astana’s bid, themed “Energy of the Future” was backed by an overwhelming majority of the Bureau International des Expositions’ (BIE) selection committee. With the clock already ticking, Astana has started preparations to host millions of visitors at Expo-2017.

Kazakhstan’s bid to hold the 2017 world fair in Astana gained support from 103 BIE member countries, compared with just 44 for its main rival, the Belgian city of Liege. Speaking after the decision was made in November 26, 2012, BIE secretary general Victor Gonzales Loscertalies said the results of the vote were “simply impressive”.

“I think this is a well deserved victory because your country’s candidacy turned out to be the most popular and important for the global community. I am confident that Kazakhstan will make sure it makes worthy preparations to host Expo-2017,” Loscertalies said.

Kazakhstan’s President Nursultan Nazarbayev, who has taken a personal interest in the plans for Astana, both before and after the decision,

commented that the victory was “not mere chance”. “Now we have the task of hosting Expo-2017 at a high level.

It is not just a test for our country, it will also reveal our creative potential,” Nazarbayev said. “The Astana Expo will encourage the innovative development of our republic.”

Since becoming Kazakhstan’s capital in 1997, Astana has hosted several major international events, notably the OSCE summit in 2010 and the 2011 Asian winter games, which were co-hosted with Almaty. However, with around 5m people expected to visit the fair over a three month period, this will be the first time Kazakhstan’s capital has hosted an event on this scale.

Organising such a huge event has already proved to be a challenge. On April 22, Nazarbayev announced plans to simplify management of the Expo2017 preparations, placing responsibility with the dedicated Astana Expo-2017 National Company. The company is directly under the control of the government, with the Astana akimat (city authorities) also involved in areas such as transport planning.

Since the very first world fair in London’s newly built Crystal Palace in 1851, the world fairs have left a legacy in the architecture of their host cities – the most famous being the Eiffel Tower built for the 1889 Paris world fair. The iconic structure was originally planned as a temporary entrance arch for the fair.

Additions to Astana’s exotic architecture are expected.

Another legacy left by the world fairs has been to raise the profile of the host cities and countries internationally. While Kazakhstan’s faces a hefty bill to host Expo-2017 – it is expected to cost at least $1.5bn – successful world fairs typically attract many times more in investments than the host country spends.

Despite its huge reserves of oil and gas, Kazakhstan is looking to Expo2017 as an opportunity for Kazakhstan and other BIE members to showcase

"A legacy left by the world fairs has been to raise the profile of the host cities and countries internationally" Preparations are already underway.

A plot of land in southeast Astana has been allocated for the exhibition area.

This will host the pavilions as well as a brand new satellite town and innovative cluster, all of which will be equipped with state of the art energy technology.

innovative alternative energy and energy efficiency technologies. The Kazakh government is promoting the use of wind, solar and other forms of renewable energy to ensure future energy security and reduce the impact on the environment.

Special report

bne June 2013

I 65

and the new space satellite assembly plant being built under an agreement with France’s EADS. “Astana is already established as a manufacturing base.

The city has engineering capacity and, with the opening of the Nazarbayev University, the educational basis as well,” Karmanov says.

France leads high-tech investors into Kazakhstan Clare Nuttall in Astana

F

France entered the top 10 investors rance has shot upo into top in Kthat e and Structure f the FDI azakhstan into Kazakhstan,” Karmanov says. In three investors in Kazakhstan, as

France’s Alstom is one of several international companies to have set up railway-related manufacturing within the Astana New City special economic zone. Alstom, Russia’s Transmashholding and Kazakhstan’s national railways operator Kazakhstan Temir Zholy (KTZ) opened an electric locomotive production plant in Astana in December 2012. This followed the opening of a diesel locomotive assembly plant by GE Transportation and KTZ in 2009. Together with KTZ and TransMashDiesel, GE now is setting up a diesel engine plant in Astana that is due to open in 2013, and will serve the CIS market. Spain’s Talgo has also opened a plant to build passenger carriages in a joint venture with KTZ.

the first nine months of 2012, France Outside the railway manufacturing was ranked third among countries directly investing into Kazakhstan, after sector, France’s EADS Astrium is the Netherlands and the US, overtaking working with state owned Kazakhstan 20.8 Gharysh Sapary to build a space China, the UK and Russia.

“More Along with companies from east Asia, 19.8 19.0 19.0 18.5 satellite assembly plant in Astana, as French companies are leading a growing companies from South Korea, Malaysia 17.0 bill. seeks USD to create its own Kazakhstan and Taiwan have come to Kazakhstan trend of investment into the high-tech and are 10.6 investing mainly outside the oil space programme. manufacturing sector, with many

8.3 and gas sectors,” Karmanov adds. of these investments located in the 6.6 4.6 Helicopter manufacturer Eurocopter, capital Astana, because 4.6 of the4.1 existing 2.8 2.1 1.9 1.7 bill. U

1.2 1.0 a subsidiary ofSD EADS, has also set Most of the high-tech investments are manufacturing base in the city and in Astana, the location of railway sector up a joint venture with Kazakhstan government incentives.

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 investments 2005 2006 by 2007 2009 2011 9 Engineering m to assemble helicopters.

GE, 2008 Alstom and2010 Talgo, 2012 Eurocopter Kazakhstan Engineering Eurocopter’s helicopter assembly plant, Kazakhstan has seen a sharp upturn in foreign direct investment (FDI) recently.

Almost 50% of the $165bn worth of Top investors into Kazakhstan FDI2the FDI by country (2009-9m. 2012) 2009-­‐9m.

012country has received since 2009-­‐9m. 2012 independence in 1991 was made in the last three years, since the launch of Netherlands 27.1 the state industrialisation programme.

16.4 USA 6.4 21.0 For the first time, Kazakhstan is France 5.3 attracting FDI to high-tech industries China 4.5 such as pharmaceuticals, computer manufacturing, electronics and optical UK 3.4 8.3 products, Kairat Karmanov, deputy Virgin Isles (UK) 2.8 chairman of Kazakhstan’s export and 2.6 Russian Fed. investment agency KazNex Invest, Canada 2.5 tells bne. the profile of investment into the country evolves away from the extractive industries into high-tech manufacturing.

FDI inflows in RK, bill. USD

165.5

46%

75.9

By industry

d oil

By country

Japan

30.2

“Geographically, the biggest change is Manufacturing

,SploraUon

Other

Other countries

2.2

19.1

66

I Special report

bne June 2013

plant serves the entire CIS market from its plant in Astana. In March 2013, the company announced that Kazakhstan will become one of the first countries in the world where Eurocopter’s newly developed EC 645 T2s are assembled.

While Astana is at the centre of the new wave of high-tech manufacturing investments in Kazakhstan, it is not the only destination. The northern city of Kostanai, 570 kilometres from Astana, has emerged as a new hub for automanufacturing.

France's PSA Peugeot Citroën plans to start assembling cars in Kostanai from June 2013, as demand for new cars grows in the increasingly affluent

which in February said it would start assembling SUVs in Kazakhstan.

Speaking after the joint venture plans were announced, Peugeot’s managing director for Russia, Ukraine and CIS, Bernd Schantz, said the project was an “important milestone” in the company’s business development in the CIS region which is “one of the priority zones for our group”.

Kazakhstan’s attractiveness as an investment destination, from where manufacturing companies can supply the Eurasian region, has increased with the founding of the Customs Union and Kazakhstan’s steady rise on the World Bank’s doing business index. According to

"Kazakhstan’s attractiveness as an investment destination has increased with the founding of the Customs Union" Kazakh market. Peugeot signed an agreement with Kazakhstan's Agromash Holding on the assembly and distribution of Peugeot passenger cars and LCVs during the FranceKazakhstan joint committee meeting in Paris on March 7. The French automaker follows Japan's Toyota,

Karmanov, Kazakhstan has the most stable economy in the former Soviet Union, and a steadily improving investment climate.

Kazakhstan has been one of the top 10 reformers on the World Bank’s Doing Business Index for the last two years, and now stands in 49th place on the index, after rising more than 30 places.

“Since Kazakhstan co-founded the Customs Union, any investor can export to Russia duty free and has access to 170 million possible customers.

Kazakhstan also has a more attractive tax regime than Russia, with a corporate tax rate of 20% compared to 30% in Russia, and a 12% VAT rate, compared to Russia’s 18%,” Karmanov says.

KazNex is continuing to work with investors with the aim of persuading more companies to choose Kazakhstan as a manufacturing site rather than simply a source of raw materials.

Karmanov hopes that companies from long-term investors such as the US and UK, which until now have been focused on the oil and gas sector, may start to enter other sectors of the Kazakhstani economy.

He also hopes that domestic high tech manufacturing, as well as operations set up foreign investors, will become a possibility. In December 2012, a delegation from KazNex visited Silicon Valley to talk to companies, venture capitalists, scientists and professors at Harvard and Stanford. “Ultimately we want to have strong national champions in Kazakhstan, in addition to bringing in foreign investment,” Karmanov says.

“Ten – or even five – years ago, this isn’t something we would have thought of.”

The Volume and Structure of FDI in Kazakhstan FDI flows into Kazakhstan ($bn)

FDI inflows in RK, bill. USD

25.0 18.5

20.0 15.0 8.3

10.0 5.0 0.0

1.3 1993

0.7

1.0

1.7

2.1

1.2

1.9

1994

1995

1996

1997

1998

1999

By industry 2009-­‐9m. 2012

2.8 2000

4.6

4.1

4.6

2001

2002

2003

19.8 19.0 19.0 20.8

17.0

165.5 bill. USD

46%

10.6

75.9

6.6

bill. USD 2004

2005

2006

2007

2008

2009

2010

2011

9 m 2012

By country 2009-­‐9m. 2012

Special report

bne June 2013

I 67

has its preferred forms. For example structures with availability payments are mostly used for toll roads, capacity payments for power generation, revenue sharing for airports, and so on,” says Jannat Salimova-Tekay, head of project finance and infrastructure, Central Asia and Caucasus, at Ernst & Young.

Kazakhstan to open up PPP market Tim Gosling in Astana

K

azakhstan is close to adopting legislation that will open up a wide range of sectors from road construction to healthcare to public private partnerships (PPP). Several international companies including France’s Bouygues and Spain’s Isolux are among those now lining up to look at infrastructure projects once the new law comes into force.

By opening up new sectors to PPP and allowing a wider range of contact types to be used, the government hopes to encourage private investment into the infrastructure and social sectors. So far, progress has been low; in the seven years since Kazakhstan’s law on concessions was adopted, there have been just six PPP projects.

The new law, which was approved

by Kazakhstan’s lower house of parliament, the Majilis, in February 2013, amends the concessions law, and other legislation relating to PPP. A key change will be to allow the use of several forms of PPP including buildown-operate (BOO), build–operate– transfer (BOT) and design-build-

finance-operate (DBFO). “Previously only BTO [build-transfer-operate] contracts were possible in Kazakhstan, but if the law is adopted in its current form, concessionaires will no longer

The need for availability payments, periodic payments to concession holders, became evident since the adoption of Kazakhstan’s 2006 concessions law. While availability payments are routinely used for social facilities such as hospitals, Kazakhstan’s large size and distances between cities means that they are also needed for infrastructure projects, since road charging schemes used in densely populated European countries are not feasible.

“The government has realised that many PPP projects are impossible without state funding and certain forms of state guarantees, and the draft law introduces changes including lifting some restrictions on when and how compensation can be paid, and introducing a mechanism for availability payments,” says Aigoul Kenjebayeva, managing partner of law firm Dentons’

"By opening up new sectors to PPP, the government hopes to encourage private investment into the infrastructure and social sectors" be limited to the one type of contract,” says Galymbek Mamrayev, deputy chairman of the executive board at the Kazakhstan Public-Private Partnership Centre, a government initiative to promote PPP. Allowing different contract types is important, as Astana is interested in using PPP in transport infrastructure, municipal infrastructure and social facilities such as hospitals and kindergartens. “Customarily each sector

Almaty office. Other changes include introducing long-term off-take contracts to increase the financial viability and bankability of projects.

PPP projects launched in Kazakhstan so far include the renovation of Aktau international airport, construction of a power transmission line, and the Shar to Ust-Kamenogorsk railway. However several did less well than expected because of the crisis that hit the country just a year after the concessions law

68

I Special report

bne June 2013

was adopted. The railway, for example, has seen lower than expected freight volumes, and several of the enterprises expected to use the power line were out of action or operating below full capacity.

Now, however, Kazakhstani officials are enthusiastically preparing lists of projects to be financed using PPP when the new law is adopted, most likely by mid 2013, to meet the country’s many infrastructure needs. “With the law due to come into effect soon, ministries and public sector officials are already drawing up lists of projects. We expect a stable flow of projects in areas such as healthcare, transportation and utilities,” says Mamrayev.

In the transport sector, there are plans for a comprehensive modernisation of freight and passenger rail transport, and a pressing need to reconstruct roads in many parts of the country. Many

announced plans to build light railways, and are planning to use PPP. According to Mamrayev, several international companies are already interested. “There has been strong international interest, with companies including France’s Bouygues, Vinci and Veolia, and Spain’s Isolux and Aqualia looking at Kazakhstan. This is not a full list as there are a lot of consultants, engineers and investors from around the world all looking for pilot projects,” he says.

Kazakhstan is expected to start relatively small, with pilot projects in new sectors, and expand them to other cities and regions if they are successful. However, there is still a note of caution to be sounded, with Dentons’ Kenjebayeva warning that the draft law fails to tackle all the necessary issues.

“Overall, the new law is an important breakthrough that resolves many issues

"Kazakhstan is expected to start small, with pilot projects in new sectors, and expand them to other cities and regions if successful" regional airports need their runways and terminals rebuilt in line with international standards. The ministry of transport and communications plans to start the revamp of five airports in 2013, with others to be targeted in the next two years. Currently, this project is state funded, but the ministry says it hopes to use PPP in future.

At a city level, water supply networks and other municipal infrastructure is equally in need of attention. The mayors of both Astana and Almaty have

seen as obstacles to implementing PPP projects,” she says. “However, problems remain, including that it is almost impossible to use international arbitration to resolve disputes.”

Mamrayev also points to the dangers in over-using PPP to finance infrastructure projects, citing the example of Portugal, one of the world’s largest users of PPP. Because of this, Kazakhstan is not expected to use PPP for more than 10-15% of infrastructure projects.

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

What you need to know

bne’s veteran team of journalists have more than 100 years of collective experience of reporting on this dynamically growing region and can explain the “why” of “what” is going on.

Eastern Europe Russia Belarus Ukraine Central Europe Estonia Latvia Lithuania Poland Czech Slovakia Hungary Southeast Europe Slovenia Croatia Serbia Romania Bulgaria Turkey Moldova Albania Bosnia Croatia Macedonia Montenegro Kosovo Eurasia Kazakhstan Georgia Uzbekistan Kyrgyzstan Turkmenistan Tajikistan Azerbaijan Armenia Mongolia

Sign up today for a free month trial of all our services www.bne.eu

70

I Events

bne June 2013

Upcoming events 2013

London Stock Exchange and CIS conference (5 - 6 June) +44 207 797 4386 Moscow, Russia anechaeva@londonstockexchange.com london-ipo.com/2013

3rd Edition Turkey Private Equity & Venture Capital Summit (21 June) EEL Events +44 (0) 207 275 8063 Turkey ersin.kara@eelevents.co.uk www.eelevents.co.uk

5th International Conference The Russian Bond Market 2013 (27 - 28 June) URALSIB Capital +7 (495) 788-0888, ext. 3826 zenkinaoi@uralsib.ru www.bondcongress.uralsibcap.ru

Saint - Petersburg International Banking Conference (10 - 13 July) Promsvyasbank +7 495 745 79 20 http://spbconf.com

Nvest Mongolia 7th Annual Investment Conference (1- 4 September) Frontier Conference Ulaanbaatar, Mongolia www.frontier-conference.com

KAZANSUMMIT 2013: V International Summit on Economic Cooperation of the Russian Federation and OIC countries (2 October) KAZANSUMMIT Organizing Committee +7 (843) 567-60-60 info@linova.ru www.kazansummit.com

bne June 2013

Events

July 10–13 2013 Corinthia Hotel St.Petersburg St.Petersburg, Nevsky Prospect, 57 tel.: +7 (495) 745-79-20 spbconf@psbank.ru http://www.spbconf.com Organizers

General Partner

Official Partner

Media Partner

Official Transport Partner

I 71

72

I Events

bne June 2013