bne August 2011

Inside this issue: Russia two decades on Spies like us in Hungary Turkey's not-so beautiful game Fast food on the steppe August 2011 www.businessneweurope.eu

Special Report: Frontier Markets

EMERGING EUROPE AND EUROZONITIS

bne August 2011 Editor-in-chief: Ben Aris (Moscow) editor@businessneweurope.eu

Contents

+7 9162903400

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Managing editor: Nicholas Watson (Prague) +42 0731582719 watson@businessneweurope.eu Eastern European editor: Tim Gosling (Moscow) +7 9031927966 gosling@businessneweurope.eu Eastern Europe: Graham Stack (Kyiv) stack@businessneweurope.eu

+7 9266052742

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26

CENTRAL EUROPE

COVER STORY 6

The Insiders

26

Spies like us in Hungary

8

Emerging Europe and Eurozonitis

28

Pohjola Bank's Baltic push a sign of deeper post-crisis shifts

30

A victory of sorts for CEZ in EU competition probe

31

Poles apart in IPOs

32

Has Piano found keys to internet publishing pot of gold?

33

Dancing with the Polish stars

34

airBaltic flies through storm clouds

36

Wizz Air succeeds where its rivals fail

11

CEE bonds with investors

14

Perspective

EASTERN EUROPE 16

20 years since fall of the Soviet Union – is life better?

17

Russia's thirst for power

19

RTS and Micex merger – the end of the beginning

21

Bring it on Kupikupon

22

Tatarstan attracts Islamic investment

24

Russia's billionaire car salesman

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Contents

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I5

55

Feeling at home in Central and Eastern Europe starts right here.

SOUTHEAST EUROPE 38

The not-so beautiful game

48

Malays deep in Central Asia

40

Privatisation proceeds in Turkey

49

Fast food on the steppe

50

Oil on troubled waters

52

Georgia's growing pains

53

Georgia sees spies behind the lens

41

42

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EURASIA

An energy exchange in Turkey Yugosphere and loathing in Toytown

44

Investors hardly Mol-ified

45

Romania returns to investment grade but problems persist

SPECIAL REPORT 55

Winners and losers in Eurasia's frontier markets

56

Still talking at least

59

Under-mined in Central Asia

60

Oxus and asset grab

61

Taking what's mine in Mongolia

63

Customs Union a mixed blessing for Kyrgyzstan

65

Rule of law eludes Central Asia

67

Moldova still labours under its past

68

Georgia's green power

69

CLASSIFIED

70

UPCOMING EVENTS

6

I The Insiders

bne August 2011

Hardcore cross-cultural negotiating

A

One of my own favourite diplomatic/business negotiation moments came in Warsaw a few years ago. I was British Ambassador to Poland, joining a private dinner with senior Polish and international business experts to explore a possible Polish telecommunications privatisation.

At one point, the clever assistant of the senior British commercial negotiator raised what he said was an important point, not hitherto covered in the discussion. His boss's arm made a dramatic sweeping gesture, as if to brush such trivial issues far away: "Detail!"

This example shows a key part of any negotiation: distinguishing What's Important from What Matters. Senior people are paid to focus on what matters, leaving what's important to clever members of their team to sort out. And the higher you go in any organisation, especially government, the more "what matters" becomes less about specific positions and more about strategic instincts: Is the other side basically trustworthy on this one, or not?

Which in good part explains why the Eurozone is in such a wobbly state now – too many senior European leaders allowed their strategic hopes and instincts to run away with them, and ignored crucial points of operational detail.

Cultured negotiations Many other negotiations, particularly those where cultural rivalries are at stake, are a lot less clear and rational. The Russian approach to diplomatic negotiations is far removed from the usual world-weary cost-benefit pragmatism of British diplomacy. Russia wants to project psychological ascendancy – Russia's very greatness – as an end in itself. The vocabulary of Russian diplomacy still has Soviet-era phrases conveying

Inat refers to a self-evidently counter-productive action done precisely because it is self-evidently counter-productive – a loud show of pride and defiance, intended to demonstrate an existential freedom from mundane considerations. This takes a negotiation on to a different psychological plane, again as an end in itself.

One of my own crashing encounters with inat came in 1996, when as UK Ambassador to Sarajevo I was trying to persuade the Bosnian Serb leadership to attend a major international conference hosted in London to support the new Bosnia and Herzegovina constitution. The Serb side refused to sit behind a nameplate on the table saying "Bosnia and Herzegovina".

Charles Crawford of ADRg Ambassadors

typical international business negotiation tends to be, well, businesslike. The two or more parties meet because they have interests in common, above all the prospect of future financial gain achieved by cooperating.

Outcomes usually can be measured in the one language all cultures understand: money. "If we agree to this, on a worst case scenario we can expect to earn and share X – on a bestcase scenario we'll get Y and do really well."

bne August 2011

brooding inexorable depersonalised doom: "Negative consequences for your interests cannot be excluded."

A nice example of Russian negotiating vocabulary came in June, when Russia and Belarus were having yet another spat over Russia's energy supplies. Russian Foreign Minister Sergei Lavrov sent a blunt message to Minsk: "It is in our interests that emotional outbursts be removed from the public sphere – I have repeatedly talked about this with my Belarusian counterpart." Translated into normal language this means: "OK, the game's up, Minsk. Time to pay your electricity bills – and public squawking won't help you this time round…"

Key to Russian negotiating technique is showing invincible

I went to meet the Bosnian Serb foreign minister, Aleksa Buha.

I told him that 60 foreign ministers would be attending this event – the leadership of the Bosnian Serb Republic (Republika Srpska) and even indicted war criminal Radovan Karadzic's own SDS party could at last emerge from isolation to present their case to the world. But there had to be one new Bosnia and Herzegovina delegation. Buha insisted that without the nameplate being changed, the Republika Srpska delegation would not go.

We wrangled for some three hours. Finally I forced the issue: "Look, do you agree that it is in your interests to go?" "Yes," he replied.

document, which gave that portfolio to the Serbs. The Bosniaks had hoped to gain an advantage with a trivial forgery!

I pressed Bildt to publicise this outlandish manoeuvre. "What's the point?" he replied. "Everyone on all sides would just laugh and say 'Nice try!'"

Time bandits One aspect of dealing with especially difficult negotiations – especially in those involving pronounced cultural differences or acutely difficult hostage negotiations – is thinking differently about managing time.

This is part of a wider philosophical question for all negotiators.

Is it better to create complexity for your opponent, to give pause for thought, to generate a sense of uncertainty as to what the best outcome is? Or rather, should you aim to create simplicity – "let's face it, it all boils down to this" – to strip away all that "detail" and instead try to focus both sides on what you think "really" matters? Quicker – but not necessarily wiser?

Sometimes it is wise to deliberately slow things down: to try to de-dramatise the situation and "reframe" the other side's demands in much less threatening terms, to try to engage with them on a different psychological level where some unexpected common ground might be found. The deal might take a lot longer to reach, but would be all the better for it.

"So are you going to go?"

"The Russian approach to diplomatic negotiations is far removed from the usual world-weary cost-benefit pragmatism of British diplomacy" strength by heading off would-be "pressure." Russian negotiators in effect insist that "we can withstand more pressure than you can possibly exert, or even imagine. Oh, and whatever you do to hurt us, we will do something far worse to hurt you."

All this can be countered, of course, by being tough in response. Some of it is bluff, and Russian diplomacy can be as inept as everyone else's. But the very fact that the Russians set about their business in this way helps frame issues and likely outcomes on their terms. It projects ruthlessness/determination. A handy way to start. And from the Russian point of view, a good way to finish, as BP and other major companies investing in Russia have learned the hard way.

Balkan bluster Things are different in the former Yugoslavia. There too psychological games are played, but often with a different underlying rationale. Namely inat.

"No." "In that case your position is stupid."

"Serbs are stupid."

One other local ploy has startled Western diplomatic negotiators in that part of the world. Whereas Russians typically argue tenaciously over every jot and title of a contract, but then insist on each word being implemented, in former Yugoslavia the signing of a contract can have much less significance. Western negotiators believe that signing a contract ends a negotiation.

Balkan negotiators can see a signing ceremony as merely one signal that negotiations are getting more serious, with most issues still "open."

Back in 1997, High Representative Carl Bildt saw one amazing example of Bosnian negotiating trickery. After weeks of haggling, a disposition of ministerial responsibilities was agreed among Bosnia's Bosniak, Croat and Serb leaders. The document recording which ethnic community got which jobs was duly signed. Bildt kept the top copy.

Months later a disagreement erupted over the Bosnian airspace portfolio. The Bosniak side produced a copy of the signed agreement showing that they had this job. Bildt felt that something was not quite right. He dug out the original

In real life people are impatient. Better a quick "good enough" outcome to get things moving. This sense of extreme time pressure propelled in late 1995 the Dayton Peace Accords aimed at ending the crisis in Bosnia. Years (and billions of dollars of assistance) later, Bosnia is still dysfunctional in key respects. Too many key issues were glossed over or fudged to "get the result" needed to help Bill Clinton get re-elected.

One way or the other, it does not follow that being bloodyminded or even threatening force will deliver a game-changer.

So much depends on context – on how far one's bloody-mindedness is credible to the other side, and how the other side balances its own ability to withstand pain with what it sees as your own willingness to deliver it.

Take Libya. Gaddafi's willingness to tolerate Nato bombing seems to exceed Nato's willingness to be ruthless enough to finish the job quickly. If, that is, Nato knows what finishing the job actually entails.

Moral: if you don't know what you really want from a negotiation, don't be surprised if you don't get it.

Charles Crawford CMG was British Ambassador in Sarajevo, Belgrade and Warsaw. In 2010 he was a founder member of ADRg Ambassadors, a new partnership of former senior diplomats offering corporate diplomacy consultancy, problem-solving and training.

8

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I

n a new take on the old maxim about Germany sneezing and Europe catching a cold, investors are asking whether the same can be said of the Eurozone and Emerging Europe.

In the lead up to the latest package of measures agreed by the leaders of the Eurozone on July 22, the markets of Central Europe and Southeast Europe – which have performed relatively well since coming out of the 2008 economic crisis – were wobbling. By mid-July, the New Europe Blue Chip Index was down almost 10% from the end of May as investors continued to pull money out. Global fund tracker EPFR reported that equity funds dedicated to Europe, Middle East and Africa saw their outflow streak hit 10 consecutive weeks in the second week of July – their worst performance since a 26-week run of losses ended in late January 2009.

The region's currencies were also suffering, with Bloomberg reporting that the Hungarian and Polish currencies both hit their weakest levels against the Swiss franc on July 18 since the newswire began tracking them more than 13 years ago. In a report released on July 14, Citigroup picked Hungary’s forint and Poland’s zloty (together with South Africa’s rand and Brazil’s real) as the emerging-market currencies most vulnerable to a new credit crisis like that sparked by Lehman Brothers' collapse in the autumn of 2008.

Emerging Europe and Eurozonitis Nicholas Watson in Prague

However, the deal hammered out by the Eurozone members, which will force private lenders to contribute to an aid package designed to give Greece decades more to repay its debts, offered some relief. Mildred Hager of Erste Group describes the deal as an important step towards a clarification of the debt situation, which "should calm down the markets for now."

However, she, like many others, warn: "Whether this will be the last word in the medium term remains uncertain."

Indeed, the chief economist of the European Bank for Reconstruction and Development (EBRD), Erik Berglof, was warning on July 21 that the risks to the bank's 2011 economic growth forecast

Cover Story I 9

bne August 2011

Channels of contagion Investors remain worried by three main channels through which the crisis could arrive on Emerging Europe's shores: public sector debt/financing, the banking sector and the real economy/trade.

Even so, Neil Shearing of Capital Economics argues it would be complacent to assume that these relatively sound fiscal positions will enable Emerging Europe to sail through the euro crisis unscathed. "While the solvency of the region’s governments is not in doubt, high external financing requirements mean the region is vulnerable to a fresh liquidity squeeze," Shearing says. "With the crisis in the Eurozone now threatening to engulf the likes of Spain and Italy, there is plenty of reason to be cautious on this front."

Looking at the debt/financing angle, Emerging Europe is not facing a solven-

The region is probably most vulnerable through the real economy/trade

of 4.8% for the 29 countries in which it invests are continuing to mount.

"An escalation of the Eurozone crisis would pose serious risks to growth and recovery across the region, especially in Southeastern Europe and the new EU members."

particularly Germany, rather than from any improvements in domestic demand.

"Most CEE countries have profited from strong export growth towards the Eurozone, while their domestic demand and investments are lagging behind and are not contributing much to GDP growth," says Wolfgang Ernst of Raiffeisen Bank International, a big lender in the region.

At particular risk are the smaller and more open economies of Slovakia, the Czech Republic and Hungary. In 2008, the share of exports in Slovakia's GDP stood at 74%, Hungary's at 72% and the Czech Republic's 66%. Poland, on the other hand, only had an export/GDP ratio of about 33% that year, and it was largely because of its large domestic market that it managed to be the only EU country to avoid recession during the recent crisis and is better placed to withstand a future one.

"With the crisis in the Eurozone now threatening to engulf the likes of Spain and Italy, there is plenty of reason to be cautious on this front"

cy crisis like many of those countries in the Eurozone; save for Hungary, debt is much lower than in the Eurozone.

According to Royal Bank of Scotland (RBS), the average ratio of public sector debt/GDP in Emerging Europe is only around 40% at present – half the average for the EU as a whole and significantly below the likes of Greece at 145%. "Hungary is perhaps the exception, with its ratio of public sector debt/GDP standing at around 78%, but nevertheless still just below the EU average," says Tim Ash of RBS. Regarding financing, RBS notes that many of the sovereigns in the region have substantial fiscal reserves and have already financed themselves for this year, while many also still have existing lending arrangements with multilateral lenders like the International Monetary Fund (IMF). What’s more, while Emerging Europe’s external financing requirement is large relative to its GDP, it is small in dollar terms and, if necessary, could be met with fresh help from the IMF.

Even so, while countries with a larger domestic demand base may be able to counter negative external effects more efficiently than the smaller and less diversified economies, the overall region will continue to depend on economic trends in the Eurozone, and especially Germany, given their strong reliance on exports. And while it's fiendishly difficult to figure out how

channel. The relatively strong recovery of the economies of Emerging Europe compared with their western peers has been almost entirely driven by the resurgence in exports to Western Europe,

OUR 'CONTAGION INDEX' HIGHLIGHTS VULNERABILITY IN CEE – FOR OBVIOUS REASONS – BUT NON-ASIAN EMs ALSO SEEM TO BE AT RISK Vulnerability to Eurozone 0.0

0.1

Hungary Czech Rep Poland Turkey South Africa Brazil Mexico Romania India Egypt Ukraine Colombia Philippines Malaysia Thailand Argentina Peru Indonesia Chile Korea China Russia Source: Citi Investment Research and Analysis

0.2

0.3

0.4

0.5

0.6

0.7

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exactly the Eurozone crisis is going to pan out (a debt restructuring, a breakup of the Eurozone, or its survival in present form through a move to fiscal federalism), analysts say one thing is clear: in the near term at least, under almost any scenario, European growth and recovery looks set to lag.

"The risk is that a messy ending to the euro crisis causes interbank markets in Western Europe to freeze in much the same way as they did post-Lehman" "For Emerging Europe, which has become increasingly integrated into the European economy, this has to be bad news, adding an additional brake to an already disappointing rate of recovery," says Ash. Shearing agrees that at the very least, strong trade ties should ensure that growth in the region slows over the next year as demand in the Eurozone softens.

However, he says the potential for the euro crisis to spread to the region’s banking sectors poses a far more dangerous channel of contagion, which could ultimately tip some economies in Emerging Europe back into recession and – in the extreme – require fresh bailouts from the IMF. The results of the most recent bank stress tests, designed to assess whether European banks have enough capital, that were released on July 15, aren't particularly encouraging.

Out of the 90 European banks participating in the 2011 stress tests, eight failed, of which five were Spanish, two Greek and one Austrian. Two other Greek banks, Piraeus and TT Hellenic Postbank, just scraped through. Greek banks have been major investors in Southeast Europe, particularly Bulgaria (where their share is over 25% of the market), Romania (over 15%) and Serbia (over 15%), and there is some evidence over recent months to suggest

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Cover story

that they have used regional subsidiaries to secure cheap financing for the parent. "While strict regulations should prevent parent banks from withdrawing capital from their subsidiaries in the east, the risk is that a messy ending to the euro crisis causes interbank markets in Western Europe to freeze in much the same way as they did post-Lehman," warns Shearing.

their currencies in order to lower their liabilities, so imposing on their creditors anyway a slow-burn 'soft default'," argues Liam Halligan, chief economist at Prosperity Capital Management.

Pot, kettle, black On July 23, Hungarian Prime Minister Viktor Orban, made a typically bombastic speech in which he predicted the sovereign debt crisis would turn the world on its head and "states thought to be strong earlier will weaken and countries seen as weak will turn out to be strong."

That is indeed what is happening as many emerging markets are finally being rewarded by global investors for their much sounder fiscal positions and stronger economic growth. However, if Citigroup's 'Contagion Index" is any guide, Hungary's PM is in danger of speaking too soon.

Citigroup's index tries to present a picture of the vulnerabilities that would emerge if the Eurozone starts to produce more contagion than we've witnessed so far. The index is made up of indicators of each type of contagion already mentioned: i) the ratio of liabilities to European banks as a share of reserves; ii) the debt/GDP ratio; and iii) the contribution of exports to the Eurozone to GDP growth. In addition, Citigroup adds two further indicators that would become relevant during a more general fall in risk appetite: i) the size of each country’s external financing requirement, and ii) the share of non-FDI capital flows as a percentage of GDP. Putting these variables together into a "Contagion Index", it appears that Hungary, then the Czech Republic, Poland and Turkey are at most risk if the Eurozone crisis worsens. Russia is notable by its place as least at risk.

I 11

CEE bonds with investors Ben Aris in Moscow

E

very cloud has a silver lining, but for sovereign bond issuers in Central and Eastern Europe the recent crisis has done more than drive down interest rates as investors snap up each new issue – it has promoted the entire region and turned it into an attractive asset class in its own right.

"The CEE market has enjoyed a re-rating that is for the first time based purely on their macroeconomic fundamentals," says Clemens Popp, head of sovereign bond issues at UniCredit Group. "CEE issuers have been a clear beneficiary of the crisis, as they now offer decent value and decent credit quality compared to many of their peers in Western Europe, and offer a real alternative to the more traditional issuers."

Not much has changed with the issuers. Most of the countries in the region are still sporting the same relatively healthy macroeconomic fundamentals they had pre-crisis and they continue to put in strong growth as the game of catch-up with the West matures.

What has changed is western investors are finally waking up to the realities of bond investing in the region and are basing investment decisions on a country's fundamental state of health.

But this is still a work in progress.

"Many global investors are still in denial, assessing that default risks in many of the big emerging markets

This change of heart strikes to the core of the problems that the Eurozone is currently facing. Prior to the crisis, interest rates across the Eurozone were rapidly converging as despite the fact that members of the euro skipped over the hard fiscal union that many believe is necessary to make the whole euro project work, investors widely assumed that if a country like Greece got into trouble, the other member states would bail it out; a hope that was largely proved correct when a new debt deal was thrashed out by EU leaders in Brussels on July 22. The upshot was Greece borrowed at the same rate as Germany – and they did so, in spades.

The post-crisis change is dramatic. Now Greece (and the other members of the so-called PIIGS) are being charged at a rate that reflects the health of their economies, not that of Germany, and the cost of borrowing has soared. On the other side of the fence in CEE, despite the robust fiscal health and GDP growth, they're still being charged a premium for simply being an emerging market. "Prior to the crisis, the convergence story was driving spreads, but investors seemed to have forgotten to look at the underlying fundamentals," says Marcus Svedberg, chief economist

"Investors are still in denial, assessing that default risks in many of the big emerging markets are much greater than in the West. At best this is nonsense, and at worst it is deluded prejudice"

are much greater than in the West. At best this is nonsense, and at worst it is deluded prejudice – particularly when you consider that the governments of the 'advanced' countries are tacitly reliant on debasing and depreciating

at East Capital. "The assumption was that if you were in the [EU] club, then your bonds were as creditworthy as those of Germany. People had forgotten about the underlying credit quality."

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CDS SPREADS HAVE REMAINED CONTAINED IN SPITE OF THE RISE IN EUROZONE SPREADS CDS spreads in CEEMEA vs Western Europe

330 SovX CEEMEA

310

SovX Western Europe 290 270 250 230 210 190 170 150 Jan 11

Feb 11

Mar 11

Apr 11

May 11

Jun 11

Jul 11

Source: Citi Investment Research and Analysis

The premium that CEE has had to pay was not entirely unfair. Debt rates are calculated as a function of a country's financial health, but like any borrower your credit history is also a factor and the newness of the CEE issuers on the international debt markets warranted a premium for investors. At least that was the theory until the crisis broke. Everyone's time horizon has telescoped down significantly. The question most investors are asking now is: "Can pay, will pay?" In Europe's periphery, the answer to this question is largely "no", while in CEE it is a big fat "yes." Popps says: "The

occupied with sorting out the mess on their books caused by the meltdown.

But as we emerge from the crisis, international investors are starting to look for places to put their money to work. The trouble is that CEE countries have been reluctant to tap international markets.

For example, Russia wrote in $17bn of international borrowing each year over the next three years, but after oil prices recovered it issued just one Eurobond for $5.5bn – its first in over a decade – and has since cancelled plans for more

"The crisis has proven to be a leveller. Portugal and Greece enjoyed tighter spreads before the crisis, but now even Italy is trading far above Slovenia" crisis has proven to be a leveller. Portugal and Greece enjoyed tighter spreads before the crisis, but now even Italy is trading far above Slovenia."

Not spoilt for choice Since Lehamn Brothers collapsed in September 2008, there has been little activity on the sovereign bond market in CEE, as most bond traders were fully

issues, instead ramping up domestic borrowing. All across the region, demand for new paper is running far ahead of supply. "Russia's economy is looking strong and its low level of debt means that if the Russian government were to go to the credit markets, it could collect as much money as it wants," reckons Popps.

The reason why investors are starting to talk about CEE as a new asset class in its own right (as opposed to a bolt-on to the generic emerging market story) is that most of the countries in the region are running much more prudent fiscal policies than their profligate peers in the west. Russia is working hard to bring its deficit down to zero and will probably get there by next year.

Bulgaria has written into the constitution that deficits can be no more than 2% of GDP and was upgraded by Fitch Ratings in the middle of July as this policy starts to bear fruit. And Poland has made a similar hardwired commitment to prudence. "Italy used to enjoy tight spreads that were converging to the Western European average, but 160% debt/GDP ratios are unhealthy full stop. In contrast, Poland has a constitutionally fixed maximum debt ratio of 55% of GDP – less than the Maastricht recommended level – and if debt breaches this level, then spending cuts automatically come into effect."

Moreover, Popps says that the low level of leverage has insulated the CEE region from any possible double-dip or second wave of the financial crisis.

"If Hungary issues $3bn of bonds and America gets into trouble, it can easily replace a dollar issue with another currency. Poland, Slovenia and other countries can also work in euros. CEE won't be a safe haven, but they are not as at risk as more developed economies."

Still, not everything is perfect in CEE. You can't compare Poland, which is the only country in Europe not to go into recession during the crisis, with the likes of say Albania. Size still matters, so Poland, Turkey and Russia still dominate the story. But turning the issue on its head, countries like Greece would be better off classed as emerging markets.

And the reality of this change can be seen on the trading desks in London; according to bne sources, in some banks Greek bond trading has been moved off the European bond desk and passed to the distressed debt desks that are used to dealing with emerging market issues, while CEE bond trading is making the migration in the other direction.

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14

I Perspective

Perspective I 15 itself for the EU's "Third Internal Energy Market Package", which member states are busy adopting into legislation and which is designed to, among other things, make the trading of energy across borders easier. During this period, "any restrictions in our [energy] investment should not be allowed," Meshkov blustered.

What he was alluding to was the vote by the Lithuanian parliament on June 30 to adopt legislation that, in line with this third energy market package, forces the "unbundling," or separation, of the gas supply business from the gas transportation business, if both are concentrated in the same hands. And indeed they are, with Gazprom the supplier of gas to Lietuvos Dujos as well as being a 37% shareholder in that Lithuanian utility (E.On Ruhrgas owns 39%, the Lithuanian state with 18% and minority shareholders the remainder).

EU-Russia relations – the usual suspects Nicholas Watson in Rome

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f Russia’s new EU friends, the Germans are the oldest: former chancellor Gerhard Schroeder threw himself into building ties with Vladimir Putin and for his troubles landed a plum job running the Nord Stream gas pipeline project. Italian Prime Minister Silvio Berlusconi has also long cosied up to Moscow – his kids holiday with Putin's daughters in Sardinia and the two alpha males like to hang out. France was later into the game, but before she got her new job as head of the International Monetary Fund, Christine Lagarde was a constant visitor to Moscow, attending almost all of the high-profile investment conferences over the last two years and overseeing France's rise up the Russian investment league to second spot after Germany.

In fact, the relationship between the EU and Russia has grown and deepened to such a degree it's now considered among most European capitals to be one of the most important – and that's set to continue whatever the outcome of the Russian presidential election in 2012. But energy and defence are the twin issues that continually cast a shadow over those relations.

Take the July 6 conference, "Relations between the EU and Russia after 2012," organised by the Italian Senate. Amid the fading glory of the 16th century rooms in the building of the Senato della Repubblica, speaker after speaker stepped up to heap praise on Putin's Russia and to express the hope the upcoming Duma and presidential elections would represent another step in the country's march toward becoming a liberal democracy.

"The democratic revolution started by Vladimir Putin brought the Russian people to participate in the economic and political modernisation of the Russian system," Senator Laura Bianconi told the assembled politicians, academics and press. "This system will not rely only on oil and gas, but on a modernisation programme which will connect the people to the other European countries."

Or here's Senator Rossana Boldi, who's also chair of the Political Commission of the EU: "Russia is one of the most important partners of the EU… It's inescapable that we need to find and develop new types of relationships."

Or Bernard Kouchner, former foreign minister of France: "Everyone forgets how swiftly Russia has developed – it was an empire and had communism until only a short time ago…

There is a will that impels relations between Europe and Russia, a true feeling of brotherhood in personal links."

"However," he adds, "there are specific political problems which don't make it possible for this understanding to always take shape."

And what might those specific problems be? Energy for one – and another dispute over gas looks ready to flare up.

A smell of gas Alexey Meshkov, Russian ambassador to Italy, hinted as much when he said that Russia must be given more time to prepare

What this means is that when the new law takes full effect in 2013, Gazprom will be stripped of its gas pipeline ownership rights, which it paid for when the Lithuanian government privatised the country's gas network in two steps during 2002 and 2004. Gazprom is, perhaps understandably, a bit miffed, and on the day of the Lithuanian parliament's vote, Gazprom CEO Alexey Miller warned that, "this will not go unnoticed."

Lithuania has asked the European Commission to investigate Gazprom's apparent abuse of its monopoly position in the country.

If previous experience is anything to go by, price discrimination and supply disruptions from the Russian side will follow, sending EU-Russian energy relations back to the dark days of 2009, when yet another dispute between Moscow and Kyiv caused gas supplies to Europe, which transit Ukraine, to be cut off. For this reason, Petar Dimitrov, a former minister of the economy and energy for Bulgaria, whose country is almost totally dependent on Russian gas and so suffered mightily during the last gas dispute, urged at the conference the EU to formulate a common energy policy and do away with bilateral talks with Moscow in favour of an EU-Russia approach, so that economically disruptive energy disputes will become a thing of the past. "In energy policy it's not acceptable for some member states to have different positions to others, it won't be a united Europe," he said.

Where Europe is more united is over defence, which largely falls under the Nato umbrella. Tensions between Nato and Putin's Russia have simmered since the US in 2002 unveiled plans for a missile defence shield in Central Europe, consisting of 10 missile interceptors in Poland and a radar facility in the Czech Republic. These tensions burst into the open in 2007 when the then-president Putin lambasted the West for reneging on promises made following the collapse of the Soviet Union, specifically that Nato would not put troops on Russia's borders.

Alexander Babakov, vice chairman of the State Duma, told bne on the sidelines of the Rome conference that better defence

ties between Russia and Europe were impossible without some permanent solution to the missile defence shield, which has evolved under President Barack Obama's watch to a more flexible arrangement of siting SM-3 ground-based interceptors in Poland by 2015 and in Romania by 2018. However, Michael Ancram (Lord Lothian), a former minister and chairman of the UK Conservative Party, sees an opportunity to improve ties if Nato is prepared to take a long hard look at itself, which he says many current and former members of the UK armed forces are now urging.

Ancram says Nato was conceived as a defence organisation, but through time mission creep has led to what he calls "aggressive" actions in Bosnia-Herzegovina, Kosovo and now Libya that conflict with Article 5, which states, "an armed attack against one or more of them in Europe or North America shall be considered an attack against them all." While Ancram says Bosnia and Kosovo could just about conceivably be justified on the grounds that they are in Europe, Libya is a step too far. "What I'm absolutely certain is that we're involving Nato in a way that Nato was not designed for," he said.

So what is Nato going to be? he asks. A defence organisation or the military arm of the UN? "If the members are willing to reconsider the purpose of Nato – and it is now in a situation where questions have to be asked about its purpose – I see a real opportunity to recast it in a way that is not going to create that sense of permanent tension with Russia," Ancram says.

Kouchner noted at the Rome conference that, "We have made some progress, but we need to work together to make more progress." Solving the twin issues of defence and energy – now that would be real progress.

"There is a will that impels relations between Europe and Russia"

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grains; 34.5 kg of pasta; 3.5 litres of vodka. And if you did not eat or drink for a month, you could save for 0.09 of a coat; 0.26 pairs of shoes; 0.12 of a suit; 0.11 of a pair of boots or 0.25 of a pair of women's slippers, says Vodyanova.

Russia's thirst for power

Tim Gosling in Moscow The caveat was that even if you had the money, the shops rarely had the goods.

Vodyanova relates a story of trying to buy toys from Detsky Mir (Children's World), the Soviet Union's notorious answer to London's Hamleys toy store. She arrived at the store in 1991 to find the queue next door to the KGB's headquarters in central Moscow encircling the huge building eight times. "It was the era of total shortages. Literally everything had to be obtained – not bought: from baby food to spools of thread," writes Vodyanova.

"When we finally got inside, alas there were virtually no goods left in the shop."

When Vladimir Putin was president, he summed up the problem neatly in one of his State of the Nation speeches: "Our country is rich, but our people are poor."

20 years since fall of the Soviet Union – is life better?

Ben Aris in Moscow

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n the months after the fall of the Soviet Union, western goods long banned by the Communist Party began to flood into the country. Street vendors stocked their kiosks with soft toilet paper, Levi's jeans, good shoes and foreign-made cigarettes. But what is the point of quality products if you can't afford them? The irony of the "free" market means that most things are too expensive.

The minimum monthly salary in 1991 was just 72 US dollars (at real rates of exchange after currency trading appeared) just after the fall of the Soviet Union, according to Yevgeny Gavrilenkov, chief economist at Troika Dialog. But this was enough to live a decent life, as the state provided so many of the things that Russians have

to pay for now: housing, education, heating, power, health and childcare, holidays, retirement homes. None of it was of particularly good quality, but it was universally available and free.

"Many people yearn for a bygone era, the symbols of which were vodka for RUB3.62, sausage for RUB2.20 and bread for 13 kopecks. You could even

has our existence worsened because of this? Have we really got poorer?" asked Margarita Vodyanova in a piece in the Russian paper Obshchaya Gazeta.

Money went a long way in Russia in 1991. The basic minimum salary, set at RUB71.83, could buy 74 loaves of bread, or your choice of: 6.2 kg of meat; 6.5 kg

"Many people yearn for a bygone era, the symbols of which were vodka for RUB3.62, sausage for RUB2.20 and bread for 13 kopecks" buy a box of matches or get a glass of fizzy water for a kopeck then. Today, you cannot get anything for a ruble. But

of sausage; 13.5 litres of vegetable oil; 163 litres of milk; 6 kg of cheese; 160 eggs; 28.7 kg of sugar; 33 kg of whole

Today, the problem has been turned upside down: now the goods are in the shops, but the people don't have enough money to buy them. However, that too is changing. In 1991, the average salary was RUB548, enough to buy just three bottles of whisky or 20 packs or imported cigarettes; in 2010, the average salary was the equivalent of $1,043, enough to buy 30 bottles of whisky or more than 700 packets of cigarettes.

Spending habits In May, a joint survey conducted by the Moscow Higher School of Economics and Russia's leading economy magazine Expert examined changes in the living standards of Russians and their material well-being between 1990 and 2009.

It found that per-capita consumption has risen on average by about half over the last two decades, though what people are spending their money on has changed dramatically.

Of course, a ruble today is worth a lot less than in 1990 – several thousand per cent less – but if you compare the purchasing power of money then and now,

The election cycle has thrown up deep uncertainty over Russia's utilities sector, but investors and analysts argue that it's no more than a temporary blip, and the prospects for the sector after March 2012 are bright.

Election years provoke populist policy around the world. In Russia inflation is nearly always top of the list, so Prime Minister Vladimir Putin's call for a 15% price cap on electricity tariffs in February inevitably hit investor sentiment on the sector. In the debate that followed, officials suggested tariff growth in 2012 could be capped as low as 5%, sending shares in the sector sliding further. In January, the RTS utilities index sat at its highest since July 2008; by May, it was at its lowest in 16 months.

However, although a final decision is not due until the middle of July, it appears that investors have begun to recall that the government has kept all of its promises to the private investors that came into the sector over the past 10 years. Comments from officials have hinted at a softer stance, suggesting the government will stand by promises made during the privatisation of UES in 2008. The break-up of the state’s rump electricity holding saw investors commit to build 36 gigawatts (GW) of new capacity whilst the government essentially promised to ensure returns.

Whilst the RTS index saw its traditional early summer sell off in June, utilities began to climb out of their hole. The revival accompanied improving inflation figures, as the growth of food prices slowed in June and allowed record lows in Russia's CPI. The Ministry of Economy promptly suggested tariffs should be allowed to swell by as much as 11%. "The market has over reacted to the government comments," insists Liam Halligan, chief economist at Prosperity Capital Management (PCM), a large minority shareholder in several generation companies (gencos). "The government has said that revenues foregone due to any limit of power tariffs would be shifted to future years, rather than lost completely. In addition, as the election season ends in early 2012, the negative rhetoric will subside."

Derek Weaving at Renaissance Capital points out that while officials have complained publicly that consumers simply can't afford higher electricity prices, this is clearly not the case. As he illustrates, Russian household electricity prices are the lowest in Europe, accounting for no more than 1% of household expenditures.

The majority of analysts support the idea that strict tariff caps are no more than playing to the gallery, and retain a bullish view on the sector given healthy demand forecasts. As Mikhail Rasstrigin at VTB Capital suggests: "The market is likely to start pricing in the possibility of there being a positive resolution to the tariff debate. Hence, risk takers might start buying at current depressed levels."

The crux of the issue for analysts and investors alike is that the government has little choice but to let tariffs off their leash once the elections for the Duma and presidency are past in March.

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Russia's latest supermarket: McDonald's Fast food retailer McDonald's has reportedly won a legal ruling that its outlets can now be classified as supermarkets rather than restaurants, which will save it huge tax costs.

The US company, which has been operating in Russia for 20 years and now has 276 "supermarkets" across the country, argued that it should change its classification for tax purposes because many of its products are pre-packaged and sold to customers in the style of a supermarket rather than a restaurant, reports The Daily Telegraph.

The move came as the Russian tax authorities were looking to double the company's tax bill, the report says, with supermarkets taxed at 10%, but restaurants at 18%.

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the survey found that per-capita income has increased by 45% between 1990 and 2009, while the volume of consumption per capita more than doubled according to GDP-based consumption figures.

A 45% increase in income is actually not very much over 20 years. Incomes plummeted for most of the first decade after the fall of the Iron Curtain and only began to rise after the 1998 financial crisis, taking off during the roaring eight-year boom that started in 2000.

Russia's default on its debt and devaluation on August 17, 1998 was not actually a crash; it marked the low point for incomes and the beginning of Russia's economic recovery. Today, somewhere between 40% and 80% of Russians enjoy higher incomes now than they did 20 years ago (depending on how you measure it), though one in five are still worse off than they were under communism; the Gini coefficient for Russia (a broader measure of wealth that includes things like property as well as savings) in the past 20 years has risen much faster than in any OECD country, and is on a par with Turkey and Mexico.

The main difference between the two eras is that things that Russians now

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Troika Dialog – which together control about 60% of the exchange’s equity.

have to pay for were things that used to be free. Compared to the Soviet era, a consumer could buy 70% more durable goods in 2008, 25% more food, and two to three times more cigarettes, vodka, cars and clothing. But at the same time, they can only buy a third as much services related to housing such as heating and electricity, the survey found.

Household spending on childcare and education has increased substantially, as has spending on private healthcare. The survey notes that World Health Organization (WHO) data shows Russian spending on private healthcare is now 40% of total healthcare spending – a level well above the EU average.

However, the survey also shows that the quality of life has improved hugely as measured in terms of possessions.

The ownership of consumer electronics devices and cars has soared. There are currently about 50 cars and 160 televisions per 100 households in Russia, the survey found. The average amount of living space per capita has also risen about 40% over the past two decades to a current level of about 22 square metres per capita, though that's still far behind a country like Finland where the figure in 2009 was 39 square meters per capita.

"Literally everything had to be obtained – not bought: from baby food to spools of thread"

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Under the terms of the merger, each of these banks can take 35% of their stake out as cash and will get shares in the combined entity at a ratio of three RTS shares to one merged Micex/RTS share for the rest. (The other smaller shareholders will be bought out over the rest of this year.) "All of the investors are going to take out some cash as the merger is a validation of their investment, but we still see a lot of upside in the coming years and will remain investors and involved in the exchanges," says Jelezko, who cut his teeth at Renaissance Capital.

RTS and Micex merger – the end of the beginning Ben Aris in Moscow

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Jelezko draws a parallel with Brazil.

"Brazil is comparable with Russia: it has the same level of technology, the same economic size and a similar economic profile. The Brazilian stock exchange is listed with a market capitalisation of between $15bn and $16bn. The combined Micex and RTS has a valuation of about $4.8bn, so we believe this will rise three-fold in the next five years or so."

The merger will be finalised in the autumn, as it still needs to be approved by the regulator and also the antimonopolies service (FAS). But given there are about 50 licensed exchanges in Russia (of which about six are functioning), participants don't see any problems with completing the paperwork.

leg Jelezko just made a packet from the biggest private equity deal in Russia to date. Da Vinci Capital Management, of which Jelezko is managing partner, can partly cash out of its 20% stake in Russia’s RTS after the exchange announced it would merge with its larger rival Micex on June 30.

launched as a crisis fund in October 2008 to capitalise on the rock bottom equity prices.

The merger is a significant step in the Kremlin’s much-vaunted plans to turn Moscow into an international financial centre (IFC) and build up the domestic capital market so it can better serve Russia’s growing investment needs. The Russian pension system is also in desperate need of reform – a quarter of the current state deficit goes toward topping up the state’s pension obligations – and a more efficient and better capitalised exchange is a first step in the pension reforms widely excepted next year.

"We still see a lot of upside in the coming years and will remain investors and involved in the exchanges"

Da Vinci was set up by a bunch of former Renaissance Capital employees in the wake of the 2008 crisis, and in a very ballsy move, as bne reported,

It was a big bet and it paid off handsomely. The fund has hit all its targets, initially raising $100m and then increasing this to the $300m of assets

under management it has now three years later.

Where things went off at a bit of a tangent was after the fund bought 2% of the RTS at the start of 2008. Da Vinci ended up as one of the five major shareholders in the RTS – along with leading Russian investment banks Renaissance Capital, Aton Capital, Alfa Bank and

Getting down to business The creation of a single stock exchange really only marks the beginnings of the IFC project. Despite the provocative moniker, the main point of the reforms is to create the financial infrastructure the market needs to integrate itself with the international capital markets, rather any attempt to somehow replace the

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likes of London and New York as the dominant global exchanges. "Really all we are doing it trying to make a giant plug that we can plug into the global markets," says Jelezko, who worked closely with the RTS a few years ago to create Russia’s derivatives market.

From a business perspective, the merger actually makes a lot of sense.

In the 1990s, the RTS was the favoured exchange for foreign investors that made most of the hay until the 1998 collapse, partly because all of the trades were settled and cleared offshore in places like Cyprus. However, as Russian investors got more involved in the stock market after 1998, Micex began to grow fast and really came into its own when it was given the exclusive right to trade

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the development of the RTS [as a business] as a secondary function.”

Like many owners of companies queuing up to list today, most of the RTS’ own shareholders were not particularly interested in developing the business further and wanted to cash out with an IPO that was due to happen this year.

But their plans were stymied when the government decided it would rather see a merger between Micex (which is majority controlled by the Central Bank of Russia) and the RTS – and so the exchanges were merged.

However, the IPO plans have resurfaced remarkably fast: the combined exchange plans to IPO by 2013 or earlier to raise at least $300m, Micex

"The combined exchange plans to IPO by 2013 or earlier to raise at least $300m"

Gazprom shares shortly before the socalled ring fence of protective regulators was nixed in 2006. Since then the volumes on Micex have soared.

The RTS has put up a good fight and came back by developing a specialism in derivatives and these sophisticated products came into their own following the 2008 crisis, which Micex was lacking. “After 2008, the RTS standard platform [for derivatives] was much better able to manage the risks for and of brokers than the brokers were able to do themselves,” says Jelezko.

And Jelezko and his team are the right people to be on the board of the exchange: the other shareholders see the RTS as a piece of infrastructure they use in their daily trading routing, for Da Vinci it is a business that needs to be nurtured. “The RTS was only fully dematerialised in 2007 and then became a commercial company,” says Jelezko. “But it lacked the commercial company mentality. Things like sales and marketing were missing and we tried to develop them. Most of the other board members were brokers and saw

President Ruben Aganbegyan told journalists at a press conference on Wednesday.

Eggs in a basket The next big challenge will be to create a central securities depository (CSD), something that has been under discussion for more than a decade. But that is likely to be as difficult as getting the two exchanges merged. Currently, there are two main depositories, DCC and NDC that worked with the RTS and Micex respectively. Neither of these depositories are keen to merge and the situation is made more complicated by the fact that much of Russian equity trading is cleared and settled through the company registrars, many of which are owned by oligarchs and used as a last line of defence to protect their companies from corporate raiders, who also don't want to see any more mergers.

However, the government is clearly committed to forcing through change in the sector. Jelezko is also a member of "Group #1", a task force dealing with financial infrastructure, headed

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by Alexander Voloshin, former chief of Boris Yeltsin's presidential staff and widely regarded as the éminence grise in the Kremlin in the 1990s. "The lack of a CSD is a key bottleneck for many foreign investors who can't buy local shares without it [thanks to rule 17f7 in the US securities code] and so are forced to buy ADRs [American Depository Receipts] instead," says Jelezko.

"The registrars will resist, but this has to be countered at a high level as everyone recognises the need for a CSD. There are lots of interests involved which all have to be balanced if we are to build a centralised, streamlined infrastructure."

And the creation of the CSD is only the first of five key reforms that Jelezko says "Group #1" has identified as crucial to transforming Moscow into an IFC. Even more complicated will be integrating Russia’s nascent electronic trading system with that of the rest of the world.

“The RTS has been focused on e-trading for a year and now 13 international banks are connected to the Russian market, but it is not a seamless system and the traders still prefer to call to make trades,” says Jelezko. “We still need to do a lot in terms of operations, IT, and legal changes to make it seamless.”

It's worth making the effort, says Jelezko, because all of these initiatives will bring in more partners and open Russia further to new pools of liquidity that are currently barred.

The merger is a very positive sign that the political will is there to make the necessary changes and Jelezko can list several more (even more technical) improvements that have been put in place over the last two years – irrespective of the crisis winds blowing round the regulator's ears. Indeed, the meltdown of share prices on both the Micex and RTS during the crisis seems to have barely distracted the regulator from pushing ahead with the reform programme.

In the meantime Da Vinci is putting its money where its mouth is and hopes to follow through on the success of its first fund that invested in the RTS with a second one to launch this autumn targeting financial services in general.

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Mail.ru, bought a 5.13% stake in the American company for a reported $75m in the spring of the same year.

Mail.ru is a giant, servicing about eight out of every 10 emails sent in Russia, and the exclusive in-body email advertising that Groupon gets as part of this partnership has allowed the US company to streak ahead. However, this exclusive deal is due to expire this September, according to market rumours, which will throw the field wide open.

Bring it on Kupikupon Ben Aris in Moscow

"V

oodoo People" reads the sign taped on the door on a long corridor in the business centre near Paveltskkaya in Moscow. The building is so new that workmen are still putting windows in on the ground floor and bits of the elevator are lying about in their plastic wrapping.

"That's the room for the guys responsible for the content," says Djasur Djumaev, a young Uzbek who is one of the cofounders of Kupikupon.ru, Russia's answer to the discount retail site Groupon. Inside, a few guys are working behind the super large Mac screens putting the company's latest deals on the website. Today it is an 85% discount offer for a "non-invasive liposuction in the hips or abdomen" treatment in a Moscow clinic for RUB3,600 (€90), instead of the usual RUB24,000.

The bare room is more than half empty.

"Most of them don't turn up until near the end of the day. They like to work late. The office usually fills up at about 6pm and then someone is here until 2 or 3 in the morning," says Djumaev.

A bit further on, another door has "Miami Police" (legal department), "We make money" (deal team 1), "We make

the big money" (deal team 2). And then the playroom: a kitchen-cum-gym with Sony Playstations and table football.

At least that's what will be in these two rooms when everything is delivered.

Kupikupon only moved into these offices a few weeks ago, as it needed more space. The company's headcount has grown to over 200 in a little over a year as it mans up to fight its competitors.

Land grab A war has broken out in Russia's e-commerce space. Kupikupon was founded in May 2010 and saw revenues grow from nothing to $400,000 in its

Russia's e-commerce territory is currently a land grab. Like Russia's supermarket chains, the bulk of the market is virgin territory and retailers are opening hundreds of stores a year to capture as much territory as they can before the competition arrives – except things are moving a lot faster with online retail, which doesn't have to build physical shops. "We don't need new money to get growth, but simply to keep ahead of the competition," says Djumaev. "Currently, the three main players are all growing very fast, but we are eating into an untapped market. There is a ceiling on this non-competitive growth and there are about two years left until it is all gone. Then the only way to grow will be to eat into each other's market share and it will become really competitive."

Kupikupon has already raised $6m and is negotiating to raise another $10m, which it expects to receive by September, mainly from investors in the former Soviet Union. Then the company plans to go overseas to raise a further $50m at

"The three main players are all growing very fast, but we are eating into an untapped market"

first seven months of operation. This year, the company expects to turn over $30m, rising to $110m by the end of 2012. But the upstart only has a 20% market share and is doing battle with the incumbent, US giant Groupon, which entered the market after Russian businessman Yury Milner, who owns

the start of next year to pay for expansion to fill out the corners of the market.

All this business has been made possible by the explosion of broadband over the last two years. The number of Russians online is doubling every 18 months or so to well over 50m people – over a third of

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the Russian population is online – and the total penetration should reach 69% by 2015, according to Uralsib.

The regions and beyond Ruzaev and his partners have set up an impressive business. I met the young Uzbeks, who are all in their twenties, at the start of last year when they had flown to Moscow to raise money for an online investment and brokerage service based in the Uzbek capital of Tashkent that caters to international investors interested in Central Asia.

But while in Moscow they heard about Groupon's model and the same day I met them they raised their first $3m for Kupikupon. A month later they were back in Moscow and founded the company. It was an instant hit.

"At first we set up a simple website where customers could buy a simple coupon. The first merchants were

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things like beauty salons were you could get a facial or haircut at discount.

We had a deal every three-four days, then every day and now dozens a day," says Djumaev, who has struck deals with a choice selection of about 20 of Russia's leading retail chains.

From the very beginning the company began hiring staff in the regions and took aim at the wider market, not just the 15m-strong Muscovites, before quickly moving into other countries.

The company launched in Estonia in April and was the second largest company in the market with $400,000 a month turnover by July. Russia represents a 100m strong market and if you include the wider Russian speaking former republics, this goes up to 200m.

The company is now in 52 Russian cities as well as in Kazakhstan, Belarus, Ukraine and the Baltics. More recently, they launched in Finland and plan to

build up their business in Scandinavia over the rest of this year.

Getting new customers is cheap and thanks to the underdeveloped retail business in Russia, fairly easy to sell to. The hard part is finding them. In the West, online companies buy contacts from cost-per-action (CPA) networks, which are intermediates that buy lists of names from websites with well-defined users and so can give a potential advertiser a targeted list of emails. CPA networks are only just starting to appear in Russia and they are still very cheap to use. "We buy leads like confirmed emails for half the price we would buy them from social media sites," says Djumaev. "In the US, it costs about $7 per subscriber to your website and $15 per customer [who actually buy something], but in Russia the cost of a subscriber is about $2 and customers cost half what they do in America."

which has launched several projects in Russia's autonomous region. The ties with Malaysia are especially strong, as many local senior government members were educated in Malaysia, while the first Malaysian astronaut, Sheikh Muszaphar Shukor, went up in a Russian rocket in October 2007, so the Malaysians have especially warm feelings towards Russia.

Tatarstan attracts Islamic investment Ben Aris in Kazan

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here has been a lot of talk about money from the Islamic world coming to Russia, but little action – until now that is. Two Islamic-based funds have recently launched operations in the

Republic of Tatarstan, probably Russia's most progressive region.

The first is the Malaysian private equity outfit AmanahRaya Capital Group,

Tatarstan lies in the heart of the Volga region and 11 of the 13 Russian cities with more than 1m population are less than 1,000 kilometres away. In the 1990s, most foreign investors headed straight for Moscow. With a population of about 15m people, Moscow is the largest city in Europe and bigger than most of the Central European countries.

However, the game changed after 2000 and Russia's regions have become the new frontier; Kazan caters to the 80m Russians that live in the cities lining the Volga. "We bypassed Moscow and came to [the Tatarstan capital] of Kazan, as it offers the most attractive investment climate," says Dato Ahmad Rodzi Pawanteh, managing director of the fund, which is an Islamic finance vehicle.

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The fund's first project was the Kazan Halal hub, which imports halal meat and other products for the Muslims that make up the majority of the population in Tatarstan. Indeed, the local government have built a gleaming new mosque inside the traditional Kremlin walls that stand on a hill overlooking Kazan. Once established, the fund financed the construction of a halal meat processing plant in Baltash, 100 km from Kazan, where the local producers can also bring their meat to be processed according to Islamic rules, which is then distributed to the Muslim population in the rest of Russia.

The latest phase was to set up an Islamic fund management company in June that will invest in halal-related projects, as well as a save and thrift fund, and a pilgrimage fund to finance for local residents a Hajj, or trip to Mecca, that is every Muslim's duty. "We have been very successful with this sort of fund in Malaysia and it was an obvious product to bring to Tatarstan," says Pawanteh.

"But we are also working with the local government to raise funds on a private equity basis to bring in foreign investment to the region."

The local government has been very active in promoting foreign investment in the region and has taken a stake in these funds as a way of reassuring foreign investors that it is willing to share the risks with investors, notes Pawanteh.

Volga venture capital The second fund is from Foras Investment Company, which represents Saudi money and has launched a classic investment vehicle together with the newly established government-owned Tatarstan International Investment Company, or TIIC, that was launched at the recent Kazakh investment summit in Kazan in June.

The $50m fund will focus on the region's strengths in biotechnology, nanotechnology and IT, and counts among its founding investors the Islamic Development Bank (20%), the Republic of Tatarstan (20%), Foras International Investment Company (15%) and some smaller investors from Saudi Arabia, Malaysia and Yemen. Inaugurated

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in June, the founding investors have already contributed $10m and are in the process of raising the rest. "We are focused on the Volga region and the attractive investment climate the government has created here with tax breaks and incubators," says Amizan bin Mohd Nor, head of Foras International Investment. "One of the most attractive elements in this region is the high level of science and engineering, especially in things like civil aviation."

Indeed, Kazan was known in Soviet times as a centre of learning and its universities still churn out many of Russia's best engineers. It is also home to a flourishing aviation industry (Kazan Helicopter is a leader in the market and its order book is full for the next three years), as well as a burgeoning automo-

"One of the most attractive elements in this region is the high level of science and engineering, especially in things like civil aviation" tive sector (home to the Russian Kamaz heavy truck maker, as well as Ford and Chevrolet's Russian production). "We have 20 projects in the pipeline and 80% of them are brownfield that we will develop over the next three years," he says. "But probably the most prospective are in the technical aviation sector."

Amizan bin Mohd Nor says he can't reveal the details of the projects yet, as they are still in the set-up stage or in negotiation, but he is particularly excited by one project that will make aviation rescue vehicles and the region's parachutes are already the best in the world.

Likewise, he points to radiography as being another area where the companies in Tatarstan are especially strong.

"The companies here are advanced and the level of technology is as good as anything I have seen in Europe," he says.

"And the trouble with Europe is it is a highly saturated market and very expensive to do deals. In Russia, we can easily find companies where we can really increase the value, with willing buyers in the Middle East and beyond."

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The 1998 crisis was another blow, but hurt Rolf less than its competitors because Petrov had already built up several business lines. In addition to retailing cars, the company sold them wholesale to companies, serviced them and had established a second-hand sales unit. Competitors concentrating solely on importing were forced to slash costs, but Rolf could sustain itself on its other businesses to absorb the loses from devaluation.

Russia's billionaire car salesman INTERVIEW:

Ben Aris in Moscow

S

ergei Petrov cuts a diminutive and modest figure compared to the crowd in the lobby of the Ritz Carlton hotel in central Moscow.

That's somewhat surprising because the founder of Russia's biggest car dealership Rolf is probably the richest man in the room by far, and Russians are hardly known for understatement when it comes to displaying their wealth.

A taxi driver who built a car dealership empire, it's not only Petrov's clothes that buck the trend. He grew rich from selling cars, one of Russia's most corrupt businesses, but it appears that he's remained scrupulously honest while doing it, concentrating on quality of service rather than nefarious schemes. "We had to be strong and competitive, and we civilised this business," claims Petrov.

"In 1992, importing cars was little more than a smuggling operation, and people didn't know how to make real money.

But we always tried to do it legally; later other companies followed us."

Today, Rolf has 28 showrooms in Moscow and St Petersburg, Europe's biggest and second biggest cities respectively with a combined population larger than any of the Central European countries, bar Poland.

Business is flourishing. The 2008 crisis hurt Rolf along with everyone else, but the company's turnover was already back to well over $4bn in 2010, even if profits were halved. Petrov is a poster boy for the potential for real business founded on Russia's rapidly growing middle class.

"Is Russia better today?" he asks rhetori-

Sergei Petrov

cally. "Yes, things are better than when we set out on this path 20 years ago, but we hoped for much more."

Fleeting dreams Petrov had a fairly normal Soviet upbringing. He was born in the city of Orenburg in the Urals in 1954 and became a military pilot until he was forced to quit after the KGB accused his unit of "anticommunist activities" in 1982. He moved to Moscow and retrained at the Soviet trade university, graduating in trade relations in 1987.

Perestroika and the subsequent collapse of the Soviet Union threw everyone in Russia into reliance on their own resources, but also wiped the slate clean.

Petrov had been running the driver pool at the Moscow construction company Mosinzhstroy, but left in 1991 to set up his own company that provided drivers to many of the international companies that moved into Russia after the Iron Curtain fell. "We had a fleet of cars and the international companies needed reliable drivers. I drove one and helped the clients carry their cases," says Petrov.

Petrov obviously got on very well with his clients, so when he approached the head of Mitsubishi Russia for a soft loan to expand his fleet, he was instead given 40 new cars imported from Finland with no down payment and no collateral – a loan he was able to pay off almost immediately as the business flourished. A year later, the newly established Rolf won a tender to become the first official Mitsubishi car dealer in Russia.

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Despite the economic chaos and hyperinflation that wracked the country at the time, Rolf grew extremely fast.

Not everyone had been ruined by the collapse of the old system; Rolf's first customers were high-placed government officials and the newly minted "Russian mafia," mostly traders capitalising on the mismatch between Sovietera valuation on goods and assets and those in the international markets. "We earned enormous money [in the early 1990s]," Petrov remembers. "After [the late president Boris] Yeltsin introduced trade exemptions for charities as a way of funding their work, we were approached by one and imported the cars under this scheme without duties.

We had to pay a third of the duties and were making about $20,000 per sale. It was a lot for a small company like ours."

The first half of the 1990s operated on this huge arbitrage and made multimillionaires out of fast-moving businessmen literally overnight. Petrov tells a story of going to Japan to present to carmakers and explaining that the Russian market consisted of the top 5% of society who had money in spades, but below that was a retail desert. "Luxury goods was the only stable market then.

The fish were there – mainly high government officials, oligarchs and mafia," says Petrov. "The rest of society, about 80% of the population, had nothing."

However, as the economy began to pick up, the car market slowly expanded, and by the late 1990s Rolf had made Mitsubishi the best selling car in Russia outside the luxury segment.

Fear vs greed Over the first six months of 2008, Russia briefly became the biggest car market in Europe, selling 1.65m units to overtake former champion Germany. Then the latest crisis hit. However, despite the collapse that induced, sales of passenger cars and light commercial vehicles were up 30% in 2010, according to David Thomas, chairman of the Association of European Businesses (AEB). The uplift has continued this year, and Russia is set to take back the crown in 2015.

Already representing many of the world's leading brands – including the increasing number of domesticallyproduced foreign brands such as Ford, Toyota, and Volkswagen – Rolf will ride this wave. But building up the business hasn't been easy.

First, the company has always been forced to grow using retained earnings. "We've never gone to the banks for finances. The cost of money is so high that if you take loans, there is no profit," says Petrov. "The only financing we have ever taken was from Mitsubishi when we started importing more than 100,000 cars a year in 2007."

Second, there is the bureaucracy, especially in the import business. Petrov's solution to this snafu was to build his own car import terminal in St Petersburg, which takes all logistics out of the hands of the customs service, leaving them only to carry out inspections. This smoothes the supply of product to his dealership network.

Russia's lawlessness, though, has been the biggest obstacle. Organised crime was reported to control Russia's car

Eastern Europe

distribution networks throughout the 1990s, and imports arrived via schemes designed to avoid what were crippling import duties. However, Petrov declares that he stuck to his principles and insisted all his cars were brought in legally. "It was a battle of greed vs fear – and fear won. When we started selling Audis, my sales staff were demotivated," says Petrov. "Other dealers could offer a $2,000 discount on any car compared to our prices." However, when Vladimir Putin took over as president and threw oil magnate Mikhail Khodorkovsky into jail for tax evasion, Russian companies started to 'go white'.

The message was to business was clear: pay your taxes or else.

From oligarchs to taxpayers In late 2007, Petrov moved beyond the business world; he joined the political party Just Russia and was elected as a Member of Parliament for his home town of Orenburg. He also sits on the parliament's Budget and Taxes Committee, but he seems frustrated by the lack of action in parliament. "The Duma needs to take liberal actions, but we do just the opposite: there is pension fund spending as there are elections coming up and reforms are on hold," he complains.

The point is pertinent for the future of Rolf. The company is entirely dependent on the ongoing emergence of a Russian middle class, but this car salesman worries that the structure of the

I 25

way of thinking in which the main goal is to win privileges from the authorities.

Many of Russia's most powerful firms could not compete with the best of the international firms in an open market, he argues. "It corrupts you. My peers look at investments over a maximum of five years. They're prepared to invest in chickens, which produces money quickly, but not beef as it takes five years just to build up a herd."

Many Russians, particularly the younger ones, are getting frustrated and Petrov repeats an increasingly recurrent complaint that the country's brightest and most successful businessmen are choosing to leave the country, frustrated with the slow pace of reform. "The whole establishment is dedicated to Putin – they've all benefited from the last 12 years and naturally want to protect what they've built up because they can't compete in an open environment. They need protection," Petrov says. "People are asking 'what's the point of staying when our skills are deteriorating?'"

Still, the Rolf founder is staying put. In many ways, Russia is still at the start of the reform process, or at least at the start of the next phase: the basic problems have been solved and Russia Inc. is in profit, but now the more difficult task building a system that can deliver long-term growth starts. The alternative is stagnation, and then social unrest. "Russia is becoming normal, but

"Is Russia better today? Yes, things are better than when we set out on this path 20 years ago, but we hoped for much more" economy is so geared towards the state that rapid progress is unlikely. "Only 20-30% of the economy is really competitive," Petrov estimates. "The rest is state business and business connected to the state or the regional authorities."

A state-dominated economy has a fundamental effect on the attitude and plans of entrepreneurs, producing a

mainly because people are spending money, which is ultimately all coming from oil," says Petrov. "In the long run, I'm optimistic [about Russia's future], but in the short term we need to increase the number of people that think private business should be the main driver of the economy. We need to change people's mentality and change them from state dependents to regular taxpayers."

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they represented an immediate danger (Galambos has since been taken back into custody).

One opposition member of the committee told the news portal Hirszerzo: "The story we heard was extremely serious. If it is true, then all sorts of things over the

is interested in these almost entirely unknown security services leaders."

With Szilvasy seen as Gyurcsany's righthand man, it is tempting to link these latest arrests to that settling of accounts, especially since PM Orban promised at a recent party retreat that he would turn

"This is the latest in a string of cases that raise questions about the independence of prosecutors in Hungary from political influence" past few years will have to be seen in a different light." The MP added, however, that if the accusations were true, then it was hard to see why the three men had been released.

While the public could learn more if the affair ever comes to trial, there is a legal possibility of the trial itself being heard in camera, in which case the headscratching could continue for some time.

Spies like us in Hungary Thomas Escritt in Budapest

I

n July, two former heads of Hungary's intelligence service and a former security services minister were taken into custody for questioning on charges of committing crimes against the state, which appears to implicate these three people with close links to the previous government in spying for a foreign government. The move comes shortly after Viktor Orban, Hungary's prime minister, promised to make good on a campaign promise to bring to book those with ties to the previous government accused of political corruption. But it is also the latest in a string of cases that

raise questions about the independence of prosecutors in Hungary from political influence.

It is impossible to say what exactly Sandor Laborc, who ran Hungary's National Security Office until 2009, his predecessor Lajos Galambos, or Gyorgy Szilvasy, who was minister in charge of the security services until 2008, are accused of. A fourth man arrested in connection with the same charges has not been named. The parliamentary committee responsible for the security services was briefed on the accusations,

but the committee, in which the ruling populist-conservative Fidesz party has a majority, voted on July 4 to classify the minutes of the meeting for 80 years, meaning the press will be free to speculate on the nature of the accusations for some time to come.

At court hearings a few days later, two of the men were released from custody pending trial, against the wishes of prosecutors, while Galambos was placed under house arrest, suggesting that whatever the three men are accused of, the judge wasn't convinced

Old scores Since taking office in a landslide victory 18 months ago, Fidesz has promised a "settling of accounts" against those members of the Socialist-Liberal coalition that were in power between 2002 and 2010 who are accused of corruption.

There have been few successes. Gyula Budai, a Fidesz politician tasked with investigating the "corruption" of the previous government, has spent more than a year trying to stand up his claim that former Socialist prime minister Ferenc Gyurcsany ordered that land be sold on the cheap to a foreign investor in an ill-fated casino venture: in this case, prosecutors have requested that Gyurcsany's parliamentary immunity be lifted, though this hasn't yet happened.

In a July 19 blog post, Gyurcsany said the charges against the two spies and the politician were part of a campaign directed at him personally. "I'm waiting for the moment when they reach me in the political and moral horror that is known as the spying affair‌ Of course, I've no doubt that Fidesz's leadership

that employees of a private security company had attempted to place spyware on the agency's computers and had taken commissions from members of the then-opposition Fidesz party to track his movements. Recordings of telephone conversations were posted anonymously on YouTube that showed the company's directors discussing dirty tricks against a prominent opposition politician with Fidesz politicians as well as with Sandor Csanyi, chairman of Hungary's OTP Bank.

his attention to the matter after Hungary's presidency of the European Council ended in June. The government has nonetheless denied having any specific knowledge of the charges against the three men.

Much of the speculation in the press has focused on the possibility that the three men may have been working for Russian state interests. Heti Valasz, a pro-government weekly, has claimed, for instance, that Laborc, a career spy who studied at the KGB's elite Moscow academy in the 1980s, commissioned a private company with Russian links to carry out polygraph tests on employees of Hungary's counterintelligence service as part of a campaign to stem leaks from the organisation. The test results could have fallen into Russian hands, the magazine claims. If these are indeed the charges, then it would be hard to justify the decision to keep them secret.

But this is not the first run-in between Laborc and the prosecutors. In 2008, Laborc resigned as head of the National Security Office saying that prosecutors had failed to fully investigate his claim

"The committee voted to classify the minutes of the meeting for 80 years, meaning the press will be free to speculate on the nature of the accusations for some time to come."

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And the process appears to be accelerating. In the first quarter of 2011 alone, the sector turned in €74m in profits, more than all of last year, the Bank of Estonia said.

Even with this level of recovery, however, Pohjola's plan, on the surface at least, seems bold given the dominance in Estonia of Swedbank and SEB. Small steps Pohjola's branch office in Tallinn will start by providing payment and liquidity management, working capital and investment financing, with more services to be added to the menu in coming months. The bank will open similar branches in Latvia and Lithuania by the end of 2012.

With such well-established, deeply entrenched giants roaming the Estonian banking landscape, not to mention other strong Nordic competitors such as Sampo and Nordea, one would wonder how Pohjola hopes to succeed.

Pohjola Bank's Baltic push a sign of deeper post-crisis shifts Steve Roman in Tallinn

W

hen Finnish lender Pohjola Bank announced in late June that it was opening a branch office to serve corporate customers in Estonia, international commentators quickly pointed to recovering Baltic markets as the reason for the move. But the real drivers were a banking sector shake-up and fundamental changes in the economy, insiders say.

There's no doubt that the economic recovery is genuinely lifting Estonia's banks out of the loan-loss doldrums that made so many headlines during the crisis. Local market leaders Swedbank and

Skandinaviska Enskilda Banken (SEB) both returned to profit last year after

Part of the answer is that Pohjola already has its own niche – it will start by serving its existing Finnish client base, mid-sized to large companies hoping to do more business in a nation many see as their own back yard. But more than that, the region's banking sector is ripe for expansion, according to Pohjola's senior executive vice president for banking, Reima Rytsaola. "It's not as saturated as you might expect," Rytsola tells bne. "Even though there are good, decent banks operating in the Baltic markets, it still seems that there are some kind of scars from the financial crisis so there is plenty of natural demand for new players."

"I suspect that Pohjola also scents the blood in the water" a harrowing 2009. In early July, Fitch Ratings bumped up Estonia's long-term credit ratings from 'A' to 'A+', citing signs of increased stabilisation in the banking sector, specifically declining risks and a net profit of €70.5m for 2010.

Blood in the water Those scars run deep, says James Oates, CEO of the investment company Cicero Capital and a veteran figure in Estonia's financial spheres.

bne August 2011

According to Oates, the recovery in the banking sector isn't simply a case of banks taking a hit and bouncing back to their pre-crisis positions. Rather, reaction to the crisis has actually altered the lay of the land. "Some would say that the impact of the crisis, where the leading players reduced or cut their credit lines to customers altogether, has seen many customers abandon their previous loyalties to the banks. The result has been a steady erosion of market share – notably of Swedbank," he says. "Meanwhile other relatively new players, Nordea, LHV etc., are gaining market share. I suspect that Pohjola also scents the blood in the water."

He said that the Swedish banks have not yet responded to this new competitive pressure because they themselves came under severe pressure from the Swedish central bank during the crisis to drastically reduce the operational independence of their Baltic operations.

"Without a more dynamic and proactive response, I think that their market share will continue to decline, and I would not be shocked to see even Swedbank lose its market leadership position," he says.

It's a situation that can only help Pohjola. Indeed, picking up a decent supply of local customers is a key part of the expansion plan. "You can't provide credible banking services on the Baltic market just to provide services to your Finnish-based customers. You need to have local customers as well to get the scale, and also to get the feel of a local market," Rytsola said.

Seismic shifts While the shake-up in the banking sector may have helped Pohjola decide when to leap, it was other, more fundamental changes in the market that convinced the bank's management that moving in was a good idea, according to Rytsola.

"The post-crisis market is one thing, but it definitely wasn't the key driver for our strategic decision to enter the Baltic markets," he says.

That driver was demand by Pohjola's Finnish customers, who are now drawn to the Baltics in a way that they never were in the pre-crisis boom years, the

Central Europe

health of the economies being their main motivator. "[At that time] when the economies were more or less overheating, and the economies weren't that cost efficient from a corporate point of view, Finnish corporations weren't that interested in entering or expanding Estonian operations or Baltic operations. But now it's shifting back again. It definitely seems more attractive," he says.

Other commentators have pointed to the post-crisis stability of the region as being much more positive than a simple return to business-as-usual would have been.

In fact, the change from the paper-tiger growth of recent years to one based on more solid foundations was noted by Fitch in its assessment of Estonia. The economic rebound, it said, was mainly bring driven by export and investment growth. "This marks a key difference from the pre-crisis growth model, which was fueled by inflows of foreign capital

"Finnish corporations weren't that interested in entering or expanding Estonian operations or Baltic operations. But now it's shifting back again" in the non-tradable sector," the credit rating agency stated.

Whether the more promising growth fundamentals, as well as new opportunities in the banking market, will bring in other hopefuls in the near future is hard to say. At least one other regional player – Eesti Krediidipank – has given the markets the thumbs-up, announcing in June that it will open branches in four new Latvian cities this year, as well as expand its loan portfolio threefold to reach €10m-12m.

That, coupled with Pohjola's optimism, are certainly signs that things are changing in this corner of Europe.

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central to the Commission's internal probe has been since moved to another department; that person declined the opportunity to discuss the matter with bne.

Formal probe While the Commission has decided not to formally open an investigation into those alleged abuses, it has opened a formal probe into CEZ over suspicions that the Czech Republic’s largest power utility illegally hampered rivals from entering the domestic wholesale electricity market.

www.cez.cz

VISEGRAD:

A victory of sorts for CEZ in EU competition probe

The Commission said it had concerns that CEZ may have hoarded capacity on the transmission network, abusing its dominant position and hindering rivals’ entry into the local market. The Commission stressed that the opening of formal proceedings does not imply that it has proof of illegal activities, but merely means it will investigate the case as a matter of priority, with no legal deadline to complete those inquiries. It also reserves the right to broaden its inquiry into other areas.

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EZ on Friday, July 15 was trumpeting being "fully cleared" of several serious accusations in an antitrust probe by the European Commission, giving investors hope the Czech utility is off the hook and will avoid a huge fine of about CZK18bn (€736m) and a possible break-up of its operations.

Sources at the Commission and the utility's legion of critics, however, say the matter is not quite so straightforward.

First off, the Commission did indeed choose not to open formal investigations into suspicions that CEZ had manipulated prices on the Czech electricity market, engaged in cartel activities and limited the trade in brown coal. However, sources say this is not quite the same as the firm's statement that, "CEZ has been fully cleared of several serious accusations. Clear evidence has been discovered that CEZ has not and could not have manipulated with electricity prices, has not engaged in a cartel with anyone, nor has it been involved in limiting the trade with brown coal."

Sources say the Commission has been hindered in its investigation from the outset when in November 2009 competition officials raided the Prague offices of CEZ and two other firms involved in the power market, Energeticky a prumyslovy holding (EPH) and J&T Investment Advisors, only to be met by a scrum of local press who had obviously been tipped off. The Commission subsequently brought formal charges against EPH and J&T in December 2010, alleging that they diverted incoming emails, failed to open encrypted emails and failed to block access to an email account. Typically, officials ask for email accounts belonging to key personnel to be blocked during dawn raids so that electronic documents cannot be destroyed. Those charges are still outstanding.

Who leaked the information of the raids officially remains a mystery, though sources say that it did not come from inside the Czech domestic competition authority, but rather from inside the Commission itself. A person who was

CEZ, which owns three-quarters of the country’s generating capacity, maintains its innocence, saying the investigation would prove that it has not committed any breach of competition laws. "CEZ believes that the continued investigation will prove that it has neither committed any breach of the applicable competition rules in this respect. The European Commission itself has stated that the initiation of its investigation procedure does not in any manner anticipate the outcome. Moreover, evidence has been found that numerous new operators have over recent years entered the Czech power generation market and many rival projects have been implemented using the Czech power transmission grid," a CEZ statement said.

The key charge is centred on the way CEZ reserved in advance transmission capacities on the electricity grid, operated by Czech state-owned company CEPS in Pocerady, North Bohemia, for its new natural gas-fuelled plant, which will replace the existing coal-fired blocks once they reach the end of their service

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life. But some analysts say this appears a fairly weak charge. “CEZ doesn’t own CEPS and it doesn’t sound like they’ve enjoyed any superior rights of access to the grid,” says Jan Tomanik of the Prague-based brokerage Wood & Co. “The likelihood of them being found in breach of any competition law is relatively low."

CEZ also insists the project is fully credible, arguing that the reserved capacity on the power grid was not in any way “speculative”, but directly connected to the construction of the new plant, which it has since begun.

However, critics of CEZ, including the Prague-based advisory firm Candole Partners, which counts amongst its clients the utility's competitors, said the Commission's move vindicates its own conclusions that the relevant wholesale market for assessing CEZ’s position is the Czech Republic. "The Commission's decision contradicts CEZ's long-held assertion that its relevant market is European. It explicitly refers to CEZ as the dominant market participant on the Czech wholesale market. If the relevant market was European, we would expect the Commission to dismiss the case on the grounds that other market participants are indifferent to where they build generation capacity," Candole says.

While CEZ could certainly take some comfort in the announcement, it was left in no doubt that this is not the end of the matter. Though some dismiss it as empty rhetoric, the Commission indulged in some sabre rattling at the end of its statement, saying it has brought to book some bigger energy firms than CEZ over the years. "This is not the first time that the Commission has had to deal with allegations of an abuse of dominant position in the energy sector. There have been many decisions in the gas and electricity sector in recent years, for example concerning E.On on the German electricity wholesale and balancing markets, EDF on the French retail market or the Swedish transmission system operator Svenska Kraftnät."

So, CEZ 2 – EC 1. Though it's a game of two halves and plenty to play for.

Central Europe

Poles apart in IPOs

bne The number of companies carrying out IPOs in Europe continued to increase in the second quarter of this year, with the Warsaw Stock Exchange leading in terms of the volume of IPOs, according to research by PwC. Though the London Stock Exchange dominated in terms of value – it tends to attract the largest IPOs and hosted four of the five largest IPOs during the period – the WSE had a large number of low-value transactions on its NewConnect market. The WSE had 55 IPOs in the April-June period with an average value of ¤11m; the LSE had 30 IPOs but with an average value of ¤344m. PwC argues the number of IPOs on the WSE would've been even higher were it not for the uncertainty over the euro crisis forcing some issuers to postpone.

Looking ahead, PwC Polska deputy head Jacek Socha says the WSE began the third quarter on a high note with the successful IPO of the coal mine of Jastrzebska Spolka Weglowa (JSW).

EUROPEAN IPOs IN Q2 IPOs

Average

Q2-2011

offering value (Єm)

Wiener Börse

1

366

Borsa Italiana

1

344

London Stock Exchange

30

344

Deutsche Börse

6

160

Oslo Børs & Oslo Axess

2

129

SIX Swiss Exchange

1

81

NASDAQ OMX

5

40

Luxembourg

6

34

Irish Stock Exchange

1

17

WSE

55

11

NYSE Euronext

5

7

BME (Spanish Exchanges)

1

5

Stock exchange

Source: PwC

"This is not the first time that the Commission has had to deal with allegations of an abuse of dominant position in the energy sector"

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amount. It's a similar concept to that of a cable-TV subscription.

And indeed, Piano found that, for the first month at least, this was true. From May 2 until June 2, revenues generated

by Piano's media subscription payment system of €2.90 per user netted over €40,000. Small beer perhaps (even so it's the most revenue ever earned through any publication subscription on the Slovak internet), but this was a trial service with many newspapers allowing only some of their content on the system and others opting to stay out altogether.

Has Piano found keys to internet publishing pot of gold?

Nicholas Watson in Prague

H

as a small start-up in Slovakia found the hidden grail of newspaper publishing: how to get more people to pay for content on the web?

In June, Bratislava-based Piano Media reported that revenues generated by its media subscription payment system, which groups different publishers under one roof, in its first month of operation had exceeded the monthly target in only a matter of days. The results were so positive that Piano is already in talks about expanding the system to other countries this year and next.

"We thought we'd have to wait until September to see if the system was working and whether we could launch in other countries, but we are already talking with publishers in other countries such as Scandinavia," Piano's chief executive, Tomas Bella, tells bne.

The concept behind Piano's media paywall is that the mental transaction costs of paying for content on the web – ie. finding a credit card, inputting the

However, several trends within the small total figure give cause for hope. For example, according to figures compiled by the Association of Internet Media, unique visitors on Piano publishers' websites, a key indicator of whether the public accepts paying for online content, actually increased, with the readership of more than half of the media that joined Piano rising after entering the payment system. "In fact, in May they were doing even better than a comparable group of publishers that stayed out of Piano," says Bella.

Bella also cites the example of the two publishers in the Piano system that were already charging for their content on an individual basis. Tyzden, a newsweekly, saw the number of its subscribers multiply by six in one month of joining Piano, while the daily Sme recorded 14

"The mental transaction costs of paying for content on the web are much greater than the monetary costs" details etc. – are much greater than the monetary costs of €2 to €3. Therefore, by grouping publishers together and allowing people to pay just once for all the content of those publishers in any country rather than paying for individual websites and having to keep track of passwords, payments, accounts etc., Piano believed that more of them would be willing to stump up the nominal

times more people paying for the same content on the Piano package than on an individual basis.

So what now?

Virtual dreams Publishers are clearly pleased with the results. "I am pleasantly surprised by the reader's interest in Piano. We are getting

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10 times more traffic than I thought we would [after Piano went live]," says Alexej Fulmek, CEO of Petit Press, owner of Sme. Bella admits that many of the publishers first approached had expected little from the venture, so had either opted to stay out or only offer a smattering of content. But with these positive results, he expects more will join up and existing ones to offer more content.

In the immediate term, Piano – which takes a commission of 30% in the first year and a lower rate thereafter, out of which it pays the fees of, for example, the mobile phone companies – needs to fine tune the system and is looking to add more payment options in the near future, such as a weekly Piano subscription via SMS. "Piano is the first system that handles payment transactions and content encryption on a majority of a country's news sites, so there were significant technical issues to solve before the launch," Bella says. "The implementation of Piano's system was largely trouble-free, even though there were a few bugs that could only be worked out after the system went live."

Over the medium term, the firm's eye is on expansion into countries where the content market is larger and potentially more lucrative, such as those in Scandinavia. "Even for much richer publishing countries than Slovakia, they look at the results very positively," says Bella. "We are hoping to open in a second country in the autumn or winter, and a few more countries next year."

Central Europe

Dancing with the Polish stars

Jan Cienski in Warsaw With a possible sale of TVN, Poland's largest private broadcaster, by its majority owner, the ITI Group, on the cards, foreign media firms are circling an opportunity to enter Central Europe's largest market.

ITI said on July 7 that it is "reviewing its strategic options" with regards to its controlling 56% stake in the broadcaster. TVN operates several entertainment channels, which broadcast popular fare such as Polish versions of "X Factor" and "Dancing with the Stars," as well as an all-news channel, a business channel and thematic channels devoted to fashion, sports and motoring.

The news came as a surprise, as TVN is doing well, but there have been reports of friction among the founding families of ITI following the 2009 death of one of the group's founders, Jan Wejchert. The other founder is Mariusz Walter. Together they opened TVN in 1997, and both men's families play an important role in managing ITI. "I think that the decision on a possible sale of TVN could result from the problems of the main shareholders," Marek Zuber, chief economist with Dexus Partners, a Warsaw financial advisory, told the Polish news agency. "It could be that the heirs have taken such a decision, or that the future of the whole ITI Group is unclear."

The final price for the TVN stake is likely to be 20-40% higher than its stock market valuation of $1.3bn, due to the premium paid for taking control of such a valuable media property. ITI also owns Multikino, a Polish cinema chain, which has also been subject to sales rumours, as well as Onet, the country's leading internet portal, and "n", a satellite broadcaster. But both TVN and ITI are also labouring under debt. TVN owes PLN2.5bn, part of "n"'s launch cost; ITI also holds ¤260m in debt that must be repaid by 2017.

Reports in the Polish press say that ITI has asked several companies, including Time Warner, Fox Entertainment Group (a subsidiary of News Corp), Vivendi, Discovery Communications, and Bertelsmann for initial expressions of interest in TVN. It is significant that the investors contacted

by ITI were those with a marginal presence in the Polish market except for Vivendi, which owns Canal+, one of Poland's leading satellite broadcasters. Polish competition authorities are unlikely to look with favour on more concentration on the Polish television market.

Analysts believe that a strong contender to buy TVN, if it does come up for sale, would be Time Warner, which has already invested in media properties in the region through Central European Media Enterprises, which has operations in the Czech Republic, Slovakia, Romania, Slovenia, Croatia and Bulgaria, but no presence in Poland, the region's largest market. Time Warner took a 31% stake in the regional broadcaster CME in 2009, increasing that to 34.4% earlier this year.

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Prime Minister Valdis Dombrovskis admitted the situation was bad and that the airline has "certain issues with transparency". "AirBaltic is exactly an example of how the state should not run a business," he said. "Listing the company on the stock exchange would have been an excellent idea... but unfortunately we cannot do so."

Grounded The reason a listing is unlikely anytime soon is because the airline's two main shareholders, the Latvian state with 52.6% and Baltic Aviation Systems (BAS) with 47.2%, are at each other's throats.

airBaltic flies through storm clouds Mike Collier in Riga

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atvian airline airBaltic is a strange sort of success story – its network of more than 70 destinations is unrivalled in the region, it was voted "Airline of the Year 2009-10" by the European Regional Airline Association and last year it transported 3m passengers. Its luminous green branding can be seen on everything from its planes to taxis and bicycle rental stations, and the passengers it carries pump millions into the Latvian economy. But that success looks increasingly imperilled with government ministers at war over whether it is on the verge of going bust, a chief executive who's scared to even enter the country from Germany and serious questions about the company's opaque ownership structure.

In short, the fate of airBaltic has become a test case for the whole of the Latvian business environment, a fact repeatedly stressed at a June 30 meeting of the American Chamber of Commerce in Latvia, which has long been pressing the government for investment opportunities and more transparency by listing publicly owned companies on the Riga stock exchange.

The latest round in a long-running saga of mutual antipathy took off on June 10 when Economy Minister Artis Kampars claimed in a radio interview that the company was haemorrhaging money at an alarming rate – LVL18m (€25m) in the first five months of the year – was close to insolvency, and that government money being pumped into it (LVL15m last year) was being "pumped out" to privately owned offshore companies.

That sparked a furious reaction from airBaltic CEO and BAS co-owner Bertolt Flick (the other BAS shareholder being Bahamas-registered Taurus Asset Management, thought to be linked to Russian billionaire Vladimir Antonov), who was perhaps understandably concerned that such reckless talk would cause flyers to stop making bookings. In response, he pulled his two representatives from the five-member governing council of the company. With four out of five votes needed to approve decisions, it effectively prevented the council from making any decisions at all. In Dombrovskis' words, "The majority shareholder cannot function."

"AirBaltic is exactly an example of how the state should not run a business"

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Wizz Air succeeds where its rivals fail

Kester Eddy in Budapest The website Wizzair Sucks does not beat about the bush. "Wizzair Sucks, aka No Wizzair, is an anti Wizzair site exposing the nightmare of flying 'the Wizzair way'," it baldly states, before listing a host of grievances likely to deter all but the most determined traveller. (This list includes allegations that the low-cost carrier intentionally keeps customers waiting on its phone enquiries while charging ¤1 per minute, and just gets worse.)

But the carrier that proclaims itself the largest low-cost airline in Central and Eastern Europe has at least one happy customer in Targu Mures, Romania.

S-P O'Mahony, chief executive of Opportunity Microcredit Romania, a microfinance company based in Targu Mures, says, "You'll only get positive from me about Wizz. I fly them regularly, on routes such as Tirgu Mures to London and Budapest, both launched this year. On the latter you can get incredibly low fares. They clearly want volume and that's what they get."

Such an endorsement must be music to the ears of Jozsef Varadi, Wizz Air's chief executive. The carrier, which set out to revolutionise affordable air travel opportunities in the region just over seven years ago, now operates from 15 bases in eight countries across the region, with at least one more, Macedonia, to be added later this year. Passenger numbers rose to nearly 10m in 2010, a jump of 23% on 2009, but Wizz Air declines to reveal profit or loss figures. "We are very satisfied with our results, with growth across all markets despite all the unfortunate circumstances like volcanic ash, flood and extreme snow conditions," Attila Dankovics, head of marketing, sales, and communication, tells bne.

The airline has added has added three more planes to its fleet in the first six months this year, bringing the total to 37; opened two new bases (Vilnius and Targu Mures); enhanced operations from Belgrade; and in May initiated new services to London's Luton from Skopje, Macedonia. Developments scheduled for later this year include new routes from Kyiv, Ukraine, and Brno, the Czech Republic. Growth to date might appear impressive, but the current fleet is but a fraction of the staggering total of aeroplanes on order; the carrier plans to have 132 Airbus A320s on its books by 2017 as it aims to expand further into the Balkans, Turkey and the former Soviet Union.

All very exciting and entrepreneurial, but can Wizz Air stay in the air given the challenges to the industry?

Eli Abeles of ABS Consultancy, a London-based air industry specialist, calls Wizz Air "the Ryanair of Eastern Europe." Financially, however, the situation "remains a little uncertain," he says. "They published results last year that showed an operating profit, but a significant overall loss after taking into account financing and development costs."

"Rising fuel costs remain a major problem for Wizz – fuel represents a higher proportion of their costs than for the legacy airlines, meaning that their fares will have to rise [disproportionately vis-à-vis their legacy rivals], and that may choke off passenger demand," Abeles cautions.

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Kampars' claims also sparked a row between himself (from Dombrovskis' Unity political bloc) and Transport Minister Uldis Augulis (from the oligarchinfluenced ZZS bloc), who is supposed to be responsible for the government's stake in the airline, adding a dose of political rivalry to an already confused situation. By Augulis' reckoning, the government should be ready to either keep pumping money into airBaltic or bring in new private investors.

Then on June 14 when Latvian journalists checked their inboxes, they found an unusual offer. airBaltic would fly anyone who cared to go to a press conference that Flick was holding the next day at a hotel – in Berlin. While the joke in media circles was that journalists would use the offer to get stories about Riga mayor Nils Usakovs (undergoing treatment at a Berlin hospital), those that did take a ticket heard Flick blasting the Latvian government's "aggression" – a reference to anti-corruption raids in late May that had included both airBaltic offices and Flick's private residence. Furthermore, Flick said he would not be returning to Latvia unless he receives a guarantee that he would not be arrested – a guarantee which has not been forthcoming.

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White knights Meanwhile, the names of potential investors and/or buyers for the company are doing the rounds. China's Hainan Airlines has been linked to an airBaltic buy-in for nearly a year as a way into the European aviation market. At a recent low-key meeting with Augulis, a senior Hainan figure offered to buy all airBaltic shares, according to the investigative TV show "Nothing Personal" on June 12. No price was quoted. Hainan is also reportedly in talks with Malev Hungarian Airlines.

British company Ocean Sky, which operates flight brokerage, aircraft charter, aircraft management, aircraft engineering and aircraft interior services, is the only company so far to have confirmed its interest. "I can confirm that we have sent a offer to participate in the coming capital increase of airBaltic," Ocean Sky's Jenna Prior tells bne. "It complements the services that our group provide."

Central Europe

But in such a confused situation, no-one is sure of the motivation for any sale or capital increase. Depending on whom you ask, it could be an exit strategy for Flick, an exit strategy for the government, a way for BAS to gain a majority stake, or – who knows – maybe a genuine commercial opportunity?

Speaking to the Dienas Bizness daily on July 9, Jay Sorensen of aviation industry consultancy Ideaworks pointed out that seen from outside, airBaltic remains an attractive proposition. "The European aviation industry is consolidating and airBaltic could be a winner in this pro-

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cess," he said. "The company's management has done great work in developing an important aviation base in a small country like Latvia... an offer to sell part of the company would make interesting reading."

The miracle is that throughout such a morass of misundertanding, airBaltic planes continue to fly their routes unhindered, and anyone who's flown into Riga on both Ryanair and airBaltic will hope that continues to be the case.

In the air and the boardroom, airBaltic always seems to provide an interesting ride.

"The European aviation industry is consolidating and airBaltic could be a winner in this process"

By June 28, an audit conducted by KPMG revealed that the airline had actually lost LVL13m (€18m) in the first five months of the year. Losses had reached as high as Kampars' claimed LVL18m in the first quarter, but profitability returned in April and May when the summer booking season had kicked in.

Since then, the Mexican stand-off between the major shareholders has continued, with the government preoccupied by looming elections in September (ironically, indirectly triggered by the very raids that caused Flick to flee the country) and Flick complaining the government has been changing its own council members so frequently it is making work (and approval of the 2010 accounts) nigh on impossible and warning that without fresh investment of about LVL100m in the medium term and much more in coming years to modernise its fleet, it cannot hope to stay competitive.

Photos: www.airbaltic.com

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Turkish Cup they won last year until the legal proceedings against some of their members are complete. Besiktas Chairman Yildirim Demiroren said in a statement that the club will reclaim its trophy after the legal process is complete and club officials are cleared of wrongdoing.

sentatives in next season's European competitions by the European governing body Uefa's deadline of July 15, and whether to allow clubs suspected of match fixing to continue to participate in Turkey's own leagues, ahead of any judgement issued by courts investigating any charges brought.

trading and some reports claiming the occurrence of unusual transactions by foreign buyers immediately prior to the first arrests. "There was some dealing of Fenerbahce shares, but neither the volumes nor the timing appear unusual," says an Istanbul broker on condition of anonymity.

Certainly grounds for suspicion exist. As recently as June 9, an internal investigation by the Turkish Football Federation (TFF) concluded that between 2008 and

With any club found guilty of match fixing likely to face automatic relegation and a cash fine, together with life bans for those responsible, the TFF needs to

"Purchases from overseas brokers are more likely to be for Turkish clients wanting to keep a low profile," he says, explaining that with US group AIG still locked in legal proceedings with Galatasaray over its exclusion from the club board in 2002 despite holding 21% of club stock, overseas interest in Turkish football clubs is not high.

"This is the first police investigation into match fixing and we hear they are looking at 19 games – so why has only one player been arrested?"

2010 no less than 17 top flight matches were rigged, and handed down life bans to 11 people, including former national team defender Fatih Akyel.

The not-so beautiful game David O'Byrne in Istanbul

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aving endured a bitterly fought general election on June 12, Turks could be forgiven for hoping that they were in for a quiet summer.

But far from it – following investigations into alleged fraud by a gang of retired footballers on the Istanbul Stock Exchange (IMKB), now Turkish football itself is being rocked by allegations of match fixing by the country's top clubs.

Operations begun by Istanbul Police on July 2 have resulted in arrests of close on 100 people, with around 26 of the game's top names including players, technical staff, owners and administrators remanded in custody pending the pressing of charges, and more arrests being announced daily

Those detained pending charges include Aziz Yildirim, chairman of last season's Turkish super league champions Fenerbahce, together with two club board members; Serdar Adali, vice president of Istanbul's Besiktas club, Besiktas club coach and former national team regular Tayfur Havutcu; as well as the club presidents of Sivasspor and Eskisehirspor, and Sivasspor goalkeeper Korcan Celikay, who conceded a controversial goal in the last match of the season, which gave Fenerbahce the title.

Indeed, central to the main investigation is the allegation that Fenerbahce and other clubs in Turkey's top league may have "fixed" the outcome of matches in their favour. Certainly, the

Istanbul club enjoyed a meteoric second half to last season, winning 16 of its last 17 games, rising from a distant third to pip second place Trabzonspor on goal difference alone. Fenerbahce's website proclaims that it was a "Well deserved title."

But reports in the Turkish media – not always the most reliable of sources – have claimed that police investigations are focusing on 19 matches that they think were "fixed", of which at least five involved the champions Fenerbahce.

Past form The investigations have already drawn blood. On July 14, Turkish Cup champions Besiktas said they forfeited the

And given the depth of those suspicions, many would like to see the investigations taken further. "This is the first police investigation into match fixing and we hear they are looking at 19 games – so why has only one player been arrested?" asks Bagis Erten, a football columnist on Turkish daily paper Radikal. "We need transparency in the game and the only way for that is through more investigation."

Even so, Erten and others believe questions also need to be asked about the timing of the announcement of the investigation. "Why now?" he asks, pointing to claims that the investigation was started over six months ago.

If true, that would raise the suspicion that the start of the arrests may have been postponed until after Turkey's general election on June 12. But while any such decision could be justified on grounds of the possible chaos it might have caused during the election, it has left the TFF with two seemingly insurmountable problems: namely, which clubs to put forward as Turkey's repre-

be sure of its ground before acting. "Any court case could take months to hear evidence and reach a decision," cautions Erten, suggesting that either Uefa or the TFF or both need to decide now on a course of action or face possible chaos half way through the season.

Playing the market With no clear indication of what will happen, chaos already reigns among Turkey's top clubs, with most calling a halt on player transfer moves pending a TFF decision.

Uncertainty has also clouded dealings in the shares of the four clubs with stock exchange listings including Fenerbahce and Besiktas, with limits imposed on

But amid all the swirling accusations and suspicions, and despite decades of close association between football and politics, the Turkish government of Tayyip Erdogan appears for once to be safely above the fray.

Such a position is a welcome surprise given Erdogan's most recent brush with top level football was being booed by supporters of Istanbul club Galatasaray, one of few top clubs not to have featured in the match fixing probe so far, at the inauguration of the club's new stadium earlier this year, the construction of which Erdogan's government helped fund. The more so given that Erdogan himself is a lifelong Fenerbahce supporter and kicked off his working life with a spell as a defender at Istanbul's Kasimpasaspor, who were this season relegated from Turkey's top league having won only five their 34 matches.

"Uncertainty has also clouded dealings in the shares of the four clubs with stock exchange listings"

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venture of Turkish businessmen Mehmet Emin Karamehmet and Mehmet Kazanci, offered the top bid of $1.2bn for an 80% stake, but Turkey’s privatisation authority (OIB) cancelled the deal in May after the firm failed to meet the payment deadline despite receiving two extensions and called for new bids in July.

Privatisation proceeds in Turkey Justin Vela in Istanbul

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ith a new tender for Turkish natural gas distributor Baskent Dogalgaz planned for July after the previous winner failed to meet the payment deadline in May, there appears to be no let up in Turkey's privatisation drive.

government gained $16.5bn in revenues from the sales of steel producer Erdemir, the petrochemical refiner Tupras and telecommunications giant Turk Telekom.

Last year, the country garnered about $3bn from privatisations, mostly from electricity distribution facilities.

This year, the Turkish government aims to collect $9.5bn in revenues from the privatisation of state-owned property

The next asset on the block will be the Ankara-based gas firm Baskent Dogalgaz, which as Turkey’s second largest

"We always privatise state-owned assets, but we will accelerate this because we have a very large current account deficit to finance"

and infrastructure. This figure is around 15% of the total from the privatisations carried out over the past 25 years, but the ballooning current account deficit and other economic weaknesses make it an imperative for the freshly elected Justice and Development Party (AKP).

Since 1988, Turkey has seen about 118 sell-offs. The largest privatisations occurred between 2005-2006 when the

gas distributor pumps about 2bn cubic metres of gas every year into 1.2m homes. In August 2010, MMEKA, a joint

The last completed privatisation was on June 16 when the Turkish consortium TASS Denizcilik became the owner of the Istanbul Fast Ferries (IDO), formerly a subsidiary of the Istanbul Metropolitan Municipality. TASS won the auction for 100% of IDO shares in April with an $861m offer. The Turkish daily Milliyet reported in April that the minimum value of IDO was set at $700m. The company's value is expected to increase to $1bn.

The six-month privatisation process saw 11 groups purchase tender specification documents, generating about $0.55m for the Istanbul Municipality. The money from the sell-off will go towards upgrading the city's transportation systems.

Along with IDO, the Turkish government has planned a series of other privatisations for this year to reach its goal of $9.5bn in revenues. These include, for example, the selling of its remaining 49% of Turkish Airlines; gas distributor IGDAS; ISPARK, a commercial enterprise established by the Istanbul Metropolitan Municipality that provides parking services; and state-owned Halkbank.

Several highways, including the EdirneIstanbul-Ankara Motorway and the Tarsus-Adana-Gaziantep Motorway in the south, will also be privatised, along with several bridges.

The way forward Altug Ozgur, chief economist at Istanbul's BGC Partners, a global brokerage house, says that with the June 12 parliamentary elections over with and the ruling AKP firmly in control, privatisations can be expected to increase through the

"The privatisations make sure the new entities are fully professionally and thus they become more beneficial to the Turkish economy"

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rest of 2011. "In the first six months of the year, except energy privatisation, probably we didn't do anything," Ozgur says. "We always privatise state-owned assets, but we will accelerate this because we have a very large current account deficit to finance. We need portfolio inflows as well, but other than portfolio inflows the healthiest way to finance the deficit is to increase foreign investment inflows."

Indeed, the ballooning current account deficit is Turkey's Achilles' heel. In May the current account deficit reached $7.75bn, a 163% increase over May 2010, with Turks heavily reliant on imported goods and energy.

State assets taken over by experienced and efficient private enterprises will be an important accelerator for the Turkish economy, experts believe. The country has strong economic growth, but needs to develop domestic production and infrastructure to create jobs and narrow the current account deficit. "The aim is to be able to use this money to boost Turkey's economy so that the economy can perform better in itself," says Can Buharali of Istanbul Economics. "[The privatisations] also make sure that the new entities are fully professionally and thus they become more beneficial to the Turkish economy."

Irfan Civcir, a business professor at Ankara University, says by privatisating assets, "the Turkish government is expecting to increase efficiency in the economy and to decrease the financial burden of state economic enterprises on the national budget."

Through privatisation, the Turkish government also obtains much needed funding to carry out infrastructure and development projects as it struggles to collect taxes in a country where the informal economy is still substantial.

"Please note that we are continuing our efforts while also decreasing [tax] rates, but please also know that the informal economy accounts for an estimated 40-45% of our national economy," Turkish Prime Minister Reccep Tayyip Erdogan told a group of businessmen in May.

Southeast Europe

An energy exchange in Turkey

David O'Byrne in Istanbul Less than a month after Turkey's power transmission grid was hooked up to the rest of Europe, the continent's market makers are backing the creation of a new regional energy exchange in Turkey's business capital, Istanbul. The potential trading volume could be significant, experts predict, and a liquid power market would enable utilities to raise the funds necessary to build new power plants and help meet Turkey's rapidly growing electricity demand.

Iris Weidinger, chief financial officer of the European Energy Exchange (EEX), and Jan van Aken, secretary-general of the European Federation of Energy Traders (EFET), were among a number of international guests who joined representatives of Turkish and European power companies at a series of seminars and workshops on June 28 aimed at setting out a roadmap for the creation of a regional energy exchange in Istanbul that would allow for the trading of both power and natural gas.

Speaking at a press conference after the meetings, Batu Aksoy, head of Turkey's Turcas Petrol, explained the workshops had resulted in the establishment of a number of working groups that would focus on what needed to be done to establish the exchange and to integrate its activities with those of the existing European Energy Exchange. "We expect the exchange to be established in the next six to 18 months," he said.

However, he added that the exact nature of the exchange was still unclear.

"It's up to the Turkish government to decide the type of organisation it will be," he said, explaining that it could be established as a limited company in line with current plans for transferring the state-owned Istanbul Stock Exchange to the private sector by transforming it into a company.

According to Radmacher, the exchange would have to be a Turkish legal entity, but that the European Energy Exchange could be a minority shareholder.

Commenting on the potential size of the market the exchange could be hosting, Radmacher pointed out that in Germany while the physical demand for power is around 550 terawatt hours (TWh), the actual traded market is between nine and 10 times that value. "Turkish power demand is currently around 210 TWh and will rise to 300 TWh in three or four years. Even with a low level of trade, the market could easily exceed 1,000 TWh a year," he said.

In order to meet Turkey's growing power demand, Radmacher said it was essential to create a liquid power market that enables power plant developers to raise the fund necessary to build new plants. "It takes around five years for a new plant to be developed," he said, explaining the need for developers to be able to know in advance that they would be able to sell the power produced and for there to be a secure mechanism for establishing the price of that power.

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after bloody conflicts, almost always tend to arrive at some sort of modus vivendi, whether it's based on economic self-interest or a genuine desire to heal the wounds – literal or metaphorical – that have led to war in the first place.

After all, what is the EU, which all the successor states of the former Yugoslavia are so keen to join, if not the ultimate example of reconciliation between former warring partners?

So what does the Yugosphere concept represent? A low rent version of the EU, based on a mutual desire to own your own house, drive a German car, wear an Italian suit, eat French cheese while drinking home-made rakija and listening to cajka –arguably the pan-regional choice of drink and music in the former Yugoslavia?

Yugosphere and loathing in Toytown BALKAN BLOG:

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od bless The Economist. An undoubted paragon of worthy western neo-liberalism, on occasions the UK politico-economic bible has an uncanny ability to get things both horribly right and horribly wrong at the same time.

Exhibit #1 in the case for the defence/ prosecution is the "Yugosphere" concept – dare one say ideology – propagated in the last couple of years by the magazine’s wannabe Fitzroy MacLean (the purported inspiration for James Bond),

Tim Judah. Truth be told, Judah’s Yugosphere idea, which is based on the reestablishment of the economic, political and social ties between the successor states of the former Yugoslavia, is a beguiling one at first sight. Who after all would relish a recurrence of the blood feud-type massacres that came to characterise the break-up of the second Yugoslav state?

On the other hand, it undoubtedly represents an exercise in stating the bleeding obvious – neighbouring countries, even

Central to the Yugosphere theme is the idea that former protagonists/ neighbours are increasingly willing to re-establish former trade links, with the 2010 takeover of Slovenian food company Droga Kolinska Group by its Croatian peer Altlantic Grupa cited by The Economist at least as the ultimate business example of its – god forbid, think many locally – Balkan "friends reunited" theme. Ironically, though, that takeover – at €324m the largest ever acquisition by a Croatian firm in Slovenia – has in turn led to an example of how things can go horribly wrong in terms of cross-border mergers between former Yugoslav states.

Droga Kolinska’s former chief executive, Slobodan Vucicevic, a Serbian businessman and a 5% shareholder in the Slovenian firm, has found himself in hot water after his NCA Investment Group brought a controlling 51% interest in Magma, a leading toy and clothing retailer in Croatia with his share of the proceeds from the Droga Kolinska sale. Having sealed a deal in February to take control of Magma’s operations in Croatia, BosniaHerzegovina and Serbia – which at a supposed total of €24.6m represented the biggest takeover of a Croatian firm by a Serbian entity – Vucicevic has since found himself at the heart of a business scandal in Croatia, whereby he has been cast the villain of the piece, representing

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a perfidious Serb businessman looking to swindle an apparently honest Croatian entrepreneur.

Precise details of the dispute, which are now the subject of legal action in both Croatia and Serbia, remain typically opaque in a region where the concept of client confidentiality is often used – for which read abused – to cover financial shenanigans. Ironically, what seems clear is that NCA has paid in full €18m for its share of Magma’s Croatian business, while having apparently reneged on its obligations to pony up over €6m for its share of the operations in Bosnia and Serbia. Meanwhile, the Croatian courts have slapped a ban on Vucicevic using several of the brand names he has paid for in Croatia, while he is seemingly free to use the brand names in Bosnia and Serbia he allegedly hasn’t paid for.

Confusing or what?

er, Goranko Fizulic, is a former economy minister in Croatia, who still wields a fair share of political clout at home, despite the fact that Magma almost went bankrupt as a result of the sharp economic downturn in Croatia, which has seen formerly spendthrift Croatian consumers slash their purchases.

Where we go from here remains a subject of fevered speculation. Magma is now hoping that a former suitor, Polish retailer EMPiK Media Fashion, will come to the rescue and buy out NCA, while Vucicevic, who is facing a €40,000 a day loss on his investment, is no doubt hoping against hope that the Croatian courts will side with his argument that he was sold a pup by Fizulic. Whatever the final outcome, however, the fact remains that the Yugosphere concept is as much a myth as a reality when it comes to doing business in the Balkans.

"The Yugosphere concept is as much a myth as a reality when it comes to doing business in the Balkans"

Events have been given a further twist by the fact that Magma’s one time sole own-

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but was thwarted due, in part, to public fears that Mol was trying to take more control. It is this, claims Mol, that is the basis for these unfounded attacks. "In the past weeks you could hear several unfounded attacks against Mol and its intentions in Croatia," Mol wrote. "Even bribery accusations fitting for a science fiction book took the stage."

Investors hardly Mol-ified

www.mol.hu

Kester Eddy in Budapest

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f you're suffering from a bad press, what better way to turn things round than use the press to get the "true story" out.

That's the strategy pursued by Hungarian oil and gas firm Mol, which on July 13 published an open letter in the Croatian press, entitled "The True Story," to defend its conduct in building up a 47% stake in Croatian peer Ina. The trouble began in June when reports surfaced in the Croatian media that the corruption scandal drowning former Croatian premier Ivo Sanader, who is sitting in an Austrian jail awaiting extradition, was lapping at the feet of Zsolt Hernadi, Mol's executive chairman.

The report claimed Hernadi had bribed Sanader with a €10m payment in order win management rights for Mol in Ina, in which it holds a 47% stake.

This was followed by more reports on July 5 that Croatian investigators had sought to extradite Hernadi over corruption allegations, which sent Mol's share tumbling over 6%. Although the Croa-

tian and Hungarian authorities, together with Mol, denied the report, investors remain jittery.

Saviour In the open letter, Mol claimed Ina would have likely gone bankrupt if it had not been for its support since it first bought a 25% plus one share stake in a

Mol said the problems began with the economic crisis in 2008. "When, due to the global recession and to the specific state of the company Ina ended up in 2008 in a dramatic, almost lethal situation, the Croatian government did the right thing when it made the decision to save Ina from bankruptcy," Mol wrote.

"In that dramatic liquidity situation, Mol was the sole supporter of Ina providing the necessary financial and operational support. To survive the crisis and to get further necessary loans for Ina, Mol needed to consolidate Ina into its books.

To do so, Mol needed to get the management rights, otherwise how can you take the responsibility? Would anybody among the critics of the decision made in 2009 seriously say that this was not the right path?

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highs of close to HUF26,000 were hit during April, ING's Pletser points to other factors that may be keeping investors on edge.

Pre-existing conditions Apart from macro factors – such as the lower oil price worldwide, which has reduced profits across the sector – he notes that the Hungarian government's purchase of a 21% stake in Mol from Russia's Surgutneftegaz, along with repeated statements of its intention to regain control of "strategic" companies in sectors such as energy, do little for investor sentiment.

Further, threats to Mol originate from well outside the immediate region, most notably (and somewhat ironically)

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due to Ina's rather successful efforts at exploration in Syria. "This very big project finished last year and is now on stream. This makes Syria responsible for something like one seventh of all Mol's [hydrocarbon] production," Pletser says.

Clearly, given the political upheavals now besetting Damascus, this promising development is at risk, though – perhaps surprisingly – not directly from any civilian protests. "Mol tells me that these

privatisation process in 2003. In October 2008, Mol then increased its stake to 47% with a minority shareholder buyout and consolidated Ina onto its books in the third quarter of 2009. The state holds a 45% stake, with the remaining 8% held by minority investors or in free float on the Zagreb Stock Exchange.

While Akos Herczenik, equity analyst with Raiffeisen Bank in Budapest, accepts that the reports from Croatia have unsettled investors, he argues these are primarily due to political posturing in Zagreb, prior to elections expected this autumn, and that the reaction is out of proportion to any realistic risk.

Late last year, Mol tried to buy out the minority shareholders in the company,

But noting that Mol's shares have lost more than a fifth of their value since

fields are a long way from the troubled areas and that Syria is sending payments for the gas it uses," Pletser says.

Rather, the concern stems from the possible international reaction to government repression in the country.

"I'm a bit afraid that if the European Union imposes sanctions, it will mean money transfers out, and asset transfers – I mean spare equipment – into Syria will be stopped," he says.

"Ina ended up in 2008 in a dramatic, almost lethal situation" On July 4, Fitch Ratings raised its assessment of Romania's credit worthiness to 'BBB-', the lowest investment grade rating, from 'BB+', the junk rating that the rating agency, together with another agency Standard & Poor's, dropped the country into at the height of a political crisis which put its International Monetary Fund (IMF) bailout deal temporarily on hold in late 2009.

The yield on Romanian sovereign bonds is now the highest for any country with the same Fitch rating. Moody's Investors Service, another rating agency, rates Romania's debt as 'Baa3', a similar rating to Fitch's now.

Analysts largely agree. With Mol at the helm, Ina "had its best ever first quarter" this year, while the loss of Hernadi, who has led Mol for more than a decade, would be "absolutely negative" news, says Tamas Pletser, oil and gas analyst with ING in Budapest.

"Even bribery accusations fitting for a science fiction book took the stage"

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Romania returns to investment grade but problems persist Phil Cain in Graz, Austria

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ucharest markets were buoyed in July by the first upgrade to Romania's credit rating for almost three years. Economists too are upbeat, though wary of the economy's

underlying problems and the temptation that cheaper credit could offer politicians in the run-up to elections next year.

The Bucharest BET stock index welcomed the news, rising 2% from the previous close of 5,491 to 5,605 at the end of trading on Wednesday. The leu, meanwhile, strengthened against the euro, trading at RON4.20896 to the euro midweek, compared with RON4.23950 immediately before Fitch announced its new rating.

The upgrade comes as a two-year recession apparently nears its end, export performance improves and the current account deficit narrows. GDP rose by 1.7% on year in the first quarter, boosted by 10% growth in the industrial sector where car manufacturing performed strongly. The current account

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deficit is now under 4%, having stood at over 14% before the economic crisis struck in 2008.

Muted applause Fitch's rating upgrade was given polite applause by economists. "Of course, this is good news," says Liviu Voinea of the Group of Applied Economics. "The previous grade was unfair."

However, he warns there are potential downsides to achieving a better reputation in the markets. "It will impact the exchange rate and potentially attract speculative investors, or hot money."

The government will also have to be more strong-willed to resist the temptation to borrow excessively, "Now that Romania can probably borrow cheaper – a likely result of the upgrade – we must be careful not to borrow too much," Voinea says.

Romania's economy ran into trouble at the same time as the global economic crisis hit, but was already in bad shape and is far from a picture of health now.

Ongoing problems include sluggish growth, the highest inflation rate in the EU and an ongoing fall in households' purchasing power. The official unemployment rate of just over 7% hides the fact that 2m Romanians, or around 10% of the population, work abroad. At

"Only time will tell whether politicians can resist the powerful incentive to indulge in a spending spree" 8.5%, inflation is the highest in the EU and still rising, with poorer households feeling the pinch most from a spike in food prices.

Fitch's improved assessment was also cautiously welcomed by other economists. "The upgrade was a pleasant surprise," says Dan Bucsa, chief economist at UniCredit Group, an Ital-based bank in the region. "Romanian banks were

expecting a return to investment grade in 2012, after two rounds of elections, local and national, which would probably have tested the deficit reduction."

The upgrade does not mean the Romanian economy is out of the woods, however. "Contagion worries from the EU periphery's debt troubles are likely to persist until a stable solution is found to current solvency problems," Bucsa says, though adds that Romania is not as exposed to Greek contagion as some might think, with exports to Greece making up just 1.5% of total exports.

There is more reassurance to be had.

The banking system in Romania is, Bucsa says, well capitalised, with an average solvency ratio of 14.75% and 15.7% in the case of Greek subsidiaries operating in Romania. The central bank's foreign exchange reserves cover the amounts lent by Greek banks to their Romanian subsidiaries by a factor of more than eight, he says.

Romania has received two IMF bailout programmes, one ending early this year and another ending in 2013. So far, these have "proven to be good anchors for improving public policies and cutting the budget deficit," according to Bucsa, who says 2011 deficit target of 4.4% of GDP is "well within reach."

Voinea says, however, the 25% public sector wages cuts and 15% cut in the state pension that delivered the improved ratios needed to satisfy the IMF do not constitute structural change and slowed the recovery.

Public debt is unlikely to exceed 40% of GDP in the medium term, according to Bucsa, "if no major spending slippages occur." But only time will tell whether politicians can resist the powerful incentive to indulge in a spending spree to secure the votes of a population weary of austerity.

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But Malaysia's ambitions in Central Asia go beyond the oil and gas sector.

Banking on the future Kazakhstan wants to throw off its legacy as a post-colonial producer of raw materials and become a diversified and sustainable economy. Malaysia has already been through this process, and today is one of seven Asian countries that within a generation have transformed themselves from developing nations in the 1950s into high-income developed economies today. According to a May 2011 report from the Asian Development Bank, "Asia 2050: Realising the Asian Century", Asia's growth over the next 40 years is set to be driven by the Asia-7 economies – China, India, Indonesia, Japan, South Korea, Thailand and Malaysia.

Malays deep in Central Asia Clare Nuttall in Almaty

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alaysian investors are targeting Central Asia in sectors ranging from oil and gas to Islamic finance. Although geographically distant, Malaysia shares with the Central Asian republics a religion and an economy based on natural resources.

The most recent Malaysian delegation to Central Asia, led by Prime Minister Najib bin Tun Haji Abdul Razak, was in mid-July, just a month after the Malaysian-organised World Islamic Economic Forum (WIEF) took place in the Kazakh capital Astana.

On July 11, Malaysian oil and gas company Petronas announced the signing of a gas purchase agreement with

Turkmenistan's state-owned Turkmengas and the Turkmen Agency for the Use and Management of Hydrocarbons. This agreement will allow Petronas to sell gas produced at Turkmen fields. The following day, Petronas opened its gas treatment plant at Kiyanly in west Turk-

projects with Prime Minister Karim Massimov.

Petronas is already active in the oil and gas sectors of Turkmenistan and Uzbekistan. Petronas is currently considering whether to build a $2.5bn synthetic liq-

"First the British made money, then we made money" menistan. Petronas head Dato Shamsul Azxarom Abbas also visited Astana to discuss cooperation in Kazakh energy

uid fuel production plant in Uzbekistan alongside together with Uzbekneftegas and South Africa's Sasol.

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In advance of the June WIEF, an annual event initiated in Kuala Lumpur in 2005, Malaysian Foreign Minister Datuk Seri Anifah Aman told journalists, that there is "enormous investment potential in Kazakhstan", citing sectors including Islamic finance and construction. "Kazakhstan's attractiveness has increased since its entry into the Customs Union, where it is a founder member alongside Belarus and Russia," Anifah said. "The combined population is 180m. Therefore, the opportunities that will arise are tremendous."

Meanwhile, Malaysia could help Kazakh companies to enter the markets of the Association of Southeast Asian Nations (Asean), he added.

The chairman of the WIEF, Tun Musa Hitam, said in an interview with bne there are a whole range of things we could do with Kazakhstan. "First, natural resources. Kazakhstan is a developing country and an exporter of natural resources, but to progress, it needs to go downstream," he said.

Tun Musa pointed out that like Kazakhstan, Malaysia is rich in natural resources, being one of the world's largest suppliers of tin and rubber the strategic commodities in the 1950s when the country gained its independence.

"First the British made money, then we

Fast food on the steppe

Clare Nuttall in Almaty Americana Group has brought several fast food franchises – KFC, Pizza Hut and most recently Hardee's – to the Kazakh market. But unlike Russia and the western part of the Commonwealth of Independent States, Kazakhstan has yet to see the arrival of McDonalds and its big rival Burger King.

CKE Restaurants, owner of the Hardee's brand, announced on July 7 that two Hardee's restaurants, the first burger quick service restaurant chain from the US to enter the country, had opened in Almaty. The firm said these were the first of 12 restaurants that will be opened in Kazakhstan over the next five years. "Kazakhstan is a market with tremendous growth potential and we wanted to take this opportunity to employ a 'first-mover' strategy in our segment," says Andrew Puzder, CEO of CKE. Kuwait-based Americana Group, which is operating the restaurants, already has 215 Hardee's restaurants in the Middle East and Africa. It now plans to expand to selected Central and West Asian countries.

As incomes have risen in Kazakhstan, the restaurant scene is evolving in a similar way to the rapidly developing retail sector. Average annual incomes have risen from just $700 per capita in 2004 to almost $10,000 in 2010, causing a leap in consumer spending, despite a slowdown during the recent crisis. BMI forecasts that per-capita spending on food will increase by 51.4% between 2010 and 2015, while soft drinks sales will increase 61.1% in the same period.

Kazakh fast food has until recently consisted of small-scale independent shashlik bars, ethnic Dungan cafes or kiosks selling samsi - triangular pastry parcels stuffed with meat or cheese. The international chains tend to be located in city centres or high-end malls, rather than bazaars and bus stations.

But as the market grows, two famous American brands are notable by their absence. Kazakhstan has never had a McDonald's, although the burger chain last year celebrated its 20th anniversary in Russia, having opened its first restaurant in Moscow back in 1990. Local rumour is undecided over whether the company backed away from Kazakhstan after coming face to face with official corruption, or simply realised that Kazakhs preferred their local varieties of fast food. Nor has Burger King set up in Kazakhstan, although it was expected in 2009, causing local ripoff King Burger to made a hasty name-change to "Kind Burger".

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made money. We diversified, moving downstream and identifying important subsidiary industries, especially those based around tin or rubber, such as tyre manufacturing," Tun Musa said. "We are seeing a similar process in Kazakhstan, which is rich in natural resources. I see a very genuine interest in foreign investment, and determination to fast-track the diversification process."

Speaking during the WIEF, CIMB chief executive Dato' Sri Nazir Razak commented on the parallels between the two countries. "Countries like Kazakhstan and Malaysia, have small populations of 28m and 16m respectively.

These markets are not like Indonesia, with its big domestic consumer base. To grow, we need to think beyond commodities," he said.

The WIEF saw the signing of a $50m Malaysian-Kazakh deal in the energy sector. CapAsia, the private equity unit of CIMB Group Holdings took at 12.9% stake in Kazakhstan's Central Asian Electric Power Corp (Capeco). CapAsia, which invested through its Islamic Infrastructure Fund, plans to invest into the upgrade of Capeco's power plants and distribution networks, increase efficiency and reduce emissions.

Malaysian firms are interested in Kazakhstan's financial sector, in particular the emerging Islamic finance sector. In June, Malaysian Amanah Raya signed an agreement with local Islamic finance company Fattah Finance and the Development Bank of Kazakhstan to set up Kazakhstan's second Islamic bank. Amanah Raya is also working with Fattah to establish a Haj fund for Kazakh pilgrims. Tun Musa told bne

that in adopting legislation on Islamic banking and finance, "Kazakhstan has the right priority since no projects can move without money."

However, Malaysian firms are also interested in other sectors beyond finance and energy. Before the WIEF, Anifah indicated that a Malaysian airline – possibly Malaysia Airlines or AirAsia – might start operating flights between the two countries. The AlmatyKuala Lumpur route is already served

by Kazakhstan's Air Astana. Meanwhile, Malaysian news agency Bernama reports that the Malaysian Cocoa Board recently identified Kazakhstan and Uzbekistan as two high-potential markets for its products.

By mid-July, some 1,200 workers at KazMunaiGas Exploration Production, the listed upstream arm of the stateowned Kazakh oil company KazMunaiGas, were on strike, protesting for higher wages and better working conditions. At the end of June, the company said production losses at the giant Uzen field in southwestern Kazakhstan would likely reach at least 600,000 tonnes of crude oil in 2011.

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lready suffering from a mounting worker's strike, Kazakhstan's oil industry could be in for further ructions if reports turn out to be true that the consortium developing the

Kashagan oilfield will have to ask the Kazakh government for an extension to the 2013 deadline for the first oil from the troubled project.

The company said it would replace striking workers with new employees in a bid to return to normal production levels, but criticism of the company's heavy-handed tactics against the strikers is growing both at home and abroad. And there are concerns that the industrial action could spread and even lead to some kind of popular uprising against the authoritarian regime of Nursultan Nazarbayev.

As if that weren't bad enough, reports emerged at the start of July that the giant Kashagan oil project could be delayed yet again, in what would be a humiliating move for the foreign partners developing the field that could have dire consequences for the future of the project.

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The 370,000 barrels a day (b/d) of oil from the first phase of the Caspian Sea offshore project, which has suffered repeated delays going back as far as 2005 even as costs have soared from an initial forecast of $57bn to $136bn, is vital to the Kazakh government's economic plans. As such, Kazakh Oil Minister Sauat Mynbayev has repeatedly threatened the North Caspian Operating Company (NCO) developing the field – which as well as Shell includes Eni, Total, ExxonMobil, ConocoPhillips, Inpex and KazMunaiGas – with heavy financial penalties if it misses the 2013 final deadline.

A last-ditch plan to meet the 2013 deadline involved pumping at least 50,000 b/d of oil directly onshore, bypassing an unfinished processing plant on an artificial island. However, The Daily Telegraph quoted an unnamed source at an oil services company in Atyrau, the Caspian Sea harbour city where the project is based, as saying that at an acrimonious meeting in June the partners rejected this option, leaving the consortium with no choice but to ask the oil ministry for an extension. "Our people went to a workshop 10 days ago, and were told that the partners had rejected the 'early oil' concept because it was not sufficiently worked out, and so they now had a brief to go back and ask for an extension to their 2013 deadline," the unnamed source told the newspaper.

A spokesman for the NCO said the consortium had not altered its plans to hit the 2013 target. "We are still working towards the target of the end of 2012 and a lot of effort is going into meeting that date," he told the paper.

Only in May, Eni CEO Paolo Scaroni was insisting that the Kashagan oilfield, which has recoverable reserves of over 10bn barrels, will pump its first oil by the end of 2012 or early 2013. "First oil is expected sometime in December 2012, or two to three months afterward," Scaroni said.

Heading for the exits The consequences of another delay in the project are uncertain, but are likely to further sour the mood of the foreign

Eurasia

partners, which have struggled with the technical complexities of the oilfield.

Its oil lies in high pressure reservoirs in shallow waters with a depth of less than 10 metres. Temperatures vary from 40°C in summer down to as low as -40°C in winter, meaning that during the winter the sea freezes over, putting oilrigs in danger from shifting ice packs, while summer storms can cause rapid fluctuations in the sea level.

"We are still working towards the target of the end of 2012 and a lot of effort is going into meeting that date"

A long drawn-out dispute over the lengthy project delays and cost overruns was resolved in late 2008 only when the foreign shareholders agreed to cede shares allowing state-owned KazMunaiGas to increase its holding to 16.81%, from 8.33%. The second phase of the project, for which Shell has been appointed operator and is intended to lift production to more than 1m b/d, has effectively been put on ice after the Kazakh government rejected the latest development proposal from the partners as too expensive. Shell then closed its office in Atyrau at the end of May on the orders of the NCO. "The second phase of the project of Kashagan is unfolding much as phase one did – marked by a series of disputes between the consortium and the government over project costs, resulting in delays to the timetable for oil production," says Andrew Neff of IHS Global Insight.

The partners are already balking at the price they are having to pay for their inclusion in a consortium they fought to be part of when the project began over 10 years ago. In June, ONGC, India’s state oil company, and GAIL, the Indian gas utility, said in June they were in talks jointly to buy part of ExxonMobil's 16.8% interest in Kashagan. ConocoPhillips has already signalled it's willing to exit the project as the US major looks to sell off assets to reduce its debt.

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financing the $4.5bn in commitments.

He said that over $2bn has already been paid, and the remaining $2bn is expected to be "processed" by the end of the year. "This means we still have some $2bn of readily available (committed yet undisbursed) donor assistance available for spending in the coming two to three years," he said.

INTERVIEW:

Georgia's growing pains

Molly Corso in Tbilisi Dimitri Gvindadze

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ith Georgia's economy crawling out of recession, newly appointed Finance Minister Dimitri Gvindadze is betting on the momentum of reforms and fresh financing to coax out more growth.

Gvindadze took the helm of the country's financial portfolio – including customs, tax and the Revenue Services – in June after former minister Kakha Baindurashvili stepped down. He comes to the job after successfully handling

Georgia's economy has steadily recovered since the double shocks of the 2008 war with Russia and then the financial crisis. After slumping into a 3.8% contraction in 2009, the economy grew 6.4% in 2010 and it's expected to grow 5.5% in 2011. The budget has increased $1bn since 2009, climbing to $5.955bn in 2011 from $4.916bn two years ago.

Foreign direct investment and exports were also hit hard during the crisis,

"The level of public debt has indeed gone up, yet we do not feel we are in any sort of a danger zone" the country's latest Eurobond offering – a sale that rolled over "the bulk" of Georgia's 2008 Eurobond debt.

"This transaction strategically extended Georgia's maturity profile and established a new liquid benchmark for Georgia's corporate and quasi-sovereign borrowers," he told bne an email interview in July. "Establishing a good track record as an international borrower is of key importance. The implications here go well beyond the immediate needs of the issuing government… This is probably the best confirmation of the soundness of fiscal and monetary policies that are being pursued by the government."

but the $4.5bn of financing pledged to Georgia during the 2008 donor's conference has helped the government fund investment projects and other, anti-crisis programmes. The cost of the government's strategy, however, has been higher debt levels.

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Rollover jackpot The Eurobond deal was a move to finance the $500m debt the government took on in 2008; the new $500m bond rolled over the payment, originally due 2013, to 2021, relieving the stress on the budget and the state coffers.

The ratio of public debt/GDP is 40% this year, Gvindadze said, lower than a high of 60% in 2003, but still considerably up from the approximately 25% registered in 2007. "The level of public debt has indeed gone up. Yet we do not feel we are in any sort of a danger zone," he said. "We mainly borrowed to finance infrastructure improvement measures and thus to lay down the groundwork for enhanced future productivity... With the current pronounced rebound in economic growth, this ratio will now start moving down again. We have weathered the impact of the global economic crisis quite well, and we have a rather robust public finance framework."

Gvindadze has a unique insight to the debt: following the war and the donor conference, he handled negotiations on

"We still have some $2bn of readily available donor assistance available for spending in the coming two to three years"

The final portion of donor financing provides a cushion for the government as it continues its anti-crisis programmes and prepares for the 2012 and 2013 election cycle. It also provides security for the economy, Gvindadze notes, as well for as the country's investors. "This will keep providing low-cost stimulus to the national economy. The bulk of these funds are for infrastructure improvement measures (energy, roads, municipal and urban infrastructure, agriculture)."

Investors and businesses play a big role in Gvindadze's forecast for the economy's growth.

Over the past seven years, the government has implemented scores of reforms focused on attracting investment and new business to Georgia. The Finance Ministry unveiled its own set of reforms to simplify and streamline the tax system – and increase dialogue and trust between the government and the business community. However, relations between the two sides became strained by allegations that the tax authorities, and the financial police, were being too aggressive with punitive audits against businesses. Over the past several months, though, reforms at the finance ministry have brought in a new head of Revenue Services – the body that oversees the financial police – and a new ombudsman for businesses.

Gvindadze also stressed the efforts the government is making to help promote private sector-driven growth. "The endbeneficiaries [of reforms], are people who do business in Georgia, people who invest into Georgia. One of the key functions of this ministry is promotion of the business-government dialogue and cooperation."

Eurasia

Georgia sees spies behind the lens

Molly Corso in Tbilisi On July 9, three Georgian photographers were detained and charged with spying for Russia in a potentially explosive case that threatens to increase international criticism of the Georgian government's treatment of human rights and the rule of law.

Inevitably, such a sensitive issue in this part of the world as arresting journalists has attracted opprobrium from some quarters, urgings of caution on the other. Journalists and media organisations have demanded the government release more information, and open the trial to the public (the trial is a closed proceeding because it allegedly involves state secrets).

As such, the Internal Affairs Ministry briefed the media on some of the findings in the case, pending the trial. Irakli Gedenidze, one of President Mikheil Saakashvili's personal photographers, and Ministry of Foreign Affairs' photographer Giorgi Abdaladze are charged with supplying Zurab Kurtsikidze of the European Pressphoto Agency (EPA) with photographs of classified material, namely the floor plans for the presidential administration, details of the president's movements and information about the staff at the administration.

Kurtsikidze is charged with passing the information on to Russian foreign agents. He is tied to the case by confessions from Gedenidze and his wife – also a photographer – who was also initially detained with her husband. On July 9, the authorities aired on television and posted on the Internet a videotaped confession of Gedenidze claiming that Kurtsikidze had at first solicited and purchased from Gedenidze official photographs of presidential activities, presumably for the use of EPA’s Moscow bureau.

After a certain period, however, Kurtsikidze requested materials relating to President Saakashvili’s residence and logistics, according to Gedenidze.

He refused initially, but was threatened with disclosure of the payments already received, he said. Further, according to Gedenidze, he realized at that point he was dealing with an agent of a foreign intelligence service, but felt "blackmailed" into continuing to cooperate.

However, Kurtsikidze's editors at EPA claim the conversations are innocuous: the agency regularly purchases images from photographers and needs bank account data for wire transfers.

The government claims to be in procession of classified documents stolen by the men and passed to Moscow. In a statement to the press on July 9, Ministry of Internal Affairs officials maintained evidence against the photographers is strong and ties them to officers with the Main Intelligence Division of the Russian Ministry of Defence.

While allegations of espionage have become more frequent since the 2008 war between Russia and Georgia, these arrests mark the first time the government has moved against journalists – a development some observers believe is another blow to the country's tarnished reputation with the media. In May, Freedom House reported that Georgian media is only "partly free."

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Frontier markets

Winners and losers in Eurasia's frontier markets Clare Nuttall in Almaty

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ongolia's mineral wealth and open economy has established it as a rising star among the world's frontier markets, though the post-Soviet republics of Central Asia and the Caucasus, while also rich in resources, have never quite captured investor interest to the same extent. As well as the specific challenges of investing in the region, the current uncertainty that's rife among global investors has made it even more difficult for these countries to attract the long-term commitments they need to develop.

Kazakhstan set itself apart from the rest of Central Asia with several billion-dollar

listings on the London Stock Exchange.

Mongolia has since burst onto the international scene, with the $650m Mongolia Mining Company IPO on the Hong Kong Stock Exchange in October 2010.

At the other end of the spectrum, the four resource rich but under-developed markets of south Central Asia are characterised by high political risk and low

transparency. Opportunities for exposure via public markets are rare.

The three Caucasian republics fall somewhere between these extremes. Oil-rich Azerbaijan is gradually diversifying and political reforms are in progress.

Armenia's economy made a remarkable recovery from its contraction during the recent crisis. Georgia has a developed

"The mistake made by some investors from outside is to think of the region as homogenous"

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"The mistake made by some investors from outside is to think of the region as homogenous. Each republic is different and some of the differences are quite significant," says Talgat Kukenov, managing partner of Aureos Central Asia Fund.

relatively open economy. "Mongolia is an open country to investors, especially compared to some of the Central Asian republics," says Alisher Ali, chairman of investment bank Eurasia Capital, pointing to the country's "rave reviews" from institutions including the European Bank for Reconstruction and Development, the International Monetary Fund (IMF) and the World Bank. "True democracy is a big plus, but this alone is not enough. Mongolia's mineral wealth has really driven the interest of international investors."

Milena Ivanova-Venturini, deputy head of equity research at Renaissance Capital, bemoans the lack of investment opportunities in public markets outside of Russia and Kazakhstan. "Mongolia is the only other place with publicly listed equities of meaningful size," she says.

"There has been talk about potential listings out of this part of the world, but nothing has so far come out."

Plans to exploit the country's resources are progressing fast. Rio Tinto and Ivanhoe Mines' $6bn development of Oyu Tolgoi, the world's largest untapped copper-gold deposit, is ahead of schedule. Production is expected to start in late 2012. According to Ali, this will be a "transformative event" for Mongolia, generating billions of dollars for the state.

Renaissance Capital's Rencasia index, which tracks listed equities across the region (though it is dominated by Kazakh equities), shows that "Central Asian indices are among the worst performers at present not only in [emerging markets], but in a global context as well," says Ivanova-Venturini.

Another milestone for Mongolia will be the much-anticipated IPO of Erdenes Tavan Tolgoi, owner of the Tavan Tolgoi coal deposit, with estimated reserves of around 6bn tonnes of coal. The IPO, which is likely to be in the range of $5bn-5.5bn, is expected to take place late this year or early 2012. Spurred on by these and other smaller projects, Mongolia is expected to be one of the fastest growing economies this year, with the IMF forecasting growth of 9.8% in 2011.

local capital market with a number of liquid stocks, and President Mikheil Saakashvili's efforts to eradicate corruption have boosted Georgia from 130th place in 2006 to 68th place in 2010 on Transparency International's Corruption Perceptions Index.

Clare Nuttall in Almaty The first face-to-face meeting between the presidents of Armenia and Azerbaijan in June 2008 raised the hope that progress was at last being made toward a resolution of the Nagorno-Karabakh conflict. But after a series of futile meetings between Armenia's Serzh Sargysyan and Azerbaijan's Ilham Aliyev, this hope is fading.

At a meeting in Kazan hosted by Russian President Dmitry Medvedev on June 24, the two presidents once again failed to take concrete steps towards a settlement of the conflict that has remained unresolved since the 1994 ceasefire. Since then, Medvedev has put forward new proposals that are now being considered in Baku and Yerevan.

Nagorno-Karabakh, which under international law is still part of Azerbaijan, has been effectively independent and closely linked to Armenia since the late 1980s. War broke out in 1988 when Baku tried to regain control of the majority ethnic Armenian territory. Around 30,000 people were killed and many more displaced in the war, during which Armenian and Karabakhi forces held on to the enclave and annexed additional Azerbaijani lands. Although a ceasefire was declared, a peace settlement has never been signed.

Sargysyan and Aliyev have met several times together with Medvedev, but little has come out of these meetings. "The two presidents seem to have a decent personal rapport at least on camera, but nothing concrete has happened that we know of," says Lawrence Sheets, Caucasus project director of the Crisis Group.

The talks in Kazan are understood to have stalled when the Azeri delegation asked for 10 new amendments to be added to the basic principles for settlement of the conflict. Armenian Foreign Minister Edward Nalbandyan said later that agreement would only be possible if Azerbaijan gives up some of the amendments, RIA Novosti reported.

However, Medvedev has not given up on the hope of reaching a negotiated settlement. Shortly after the Kazan summit, Russian Foreign Minister Sergey Lavrov visited both Baku and Yerevan to deliver letters from Medvedev proposing ways to move forward. On July 18, Azerbaijani Foreign Minister Russia Mammadyarov said he thought there was progress in negotiations, but "we have to wait for Armenia's response on the same proposals."

The Armenian government has indicated it will respond soon.

The long-standing issue is setting back both countries' efforts to develop their economies and attract international investors, who are deterred by the high level of political risk. "Nagorno-Karabakh is an enormous and completely unresolved problem," says Clemente Cappello, chief investment officer of Sturgeon Capital, which invests in Azerbaijan along with other Central Asian and Caucasian countries. "The situation continues to be of great concern."

Despite the challenges, the handful of investors focused on the region remain confident in its long-term potential.

"Overall, we are quite bullish about the whole region. The main risk is if China slows down substantially," says Clemente Cappello, chief investment officer at Sturgeon Capital. "The economies are doing well and pricing is attractive, although there is still substantial political risk. In the current environment, everyone is uncertain, which does not encourage long-term investments in the region.

When everyone is scared about what will happen in the next hour, they are less willing to commit to a frontier market."

Steppe up Mongolia has become an exception to this rule thanks to its vast and mostly untapped natural resources, its strategic location between China and Russia, and – unusual in this part of the world – its

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small by international standards, with a market capitalisation of just $1.6bn, the exchange was the world's best performer in 2010. This is expected to continue, with a wave of IPOs expected on the local stock exchange, predicts Ali. Back to Baku Azerbaijan is also known for its natural resources, particularly oil and gas. In 1994, Baku signed the deal dubbed the "Sale of the Century" with a consortium of international oil companies led by BP to develop the Azeri–Chirag–Guneshli oilfield. Until recently, the economy has been unhealthily dependent on hydrocarbons and distinguished by its high corruption level. But the process of change that started with the infrastructure investments during the economic crisis has been accelerated by recent government reforms.

This spring saw a series of hastily suppressed protests inspired by the "Arab Spring". It was no coincidence that in January, the Azeri government announced new anti-corruption measures. Observers on the ground say that concrete changes have been made, with investigations leading to dozens of dismissals among state employees. This was

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– state oil and gas company Socar has already indicated that it will. Cappello forecasts Socar will issue a Eurobond in the near future. "Once one large stateowned enterprise sets a benchmark, other companies will follow," he says, adding, however, that private equity is still needed to access most investment opportunities in Azerbaijan.

Also possessing large endowments of oil and gas and minerals, Central Asia's second-largest economy Uzbekistan has the potential to become a dynamic frontier market, but it needs even bigger reforms than Azerbaijan. Tashkent's recent record is ambivalent: Islam Karimov's November 2010 speech outlined wide-reaching reforms to the business environment and some steps towards liberalisation were made, but they have been accompanied by a clampdown on foreign investors.

Lawyers acting for Oxus Gold say the company is being forced out of the Amantayau Goldfields joint venture by its state-owned partners, while investors from Germany, South Korea and Turkey have also experienced difficulties. This is a pity because Uzbekistan has the largest gold reserves in Central Asia, as well as

"When everyone is scared about what will happen in the next hour, they are less willing to commit to a frontier market"

The Mongolian government, however, is struggling to expand road and rail infrastructure to keep pace with the development of the country's natural resources.

As Ivanova-Venturini points out, "monetizing on a lot of the resources is going to be a long-term prospect, with execution risk and raising the necessary investments for infrastructure being the main tension points."

accompanied by a gradual diversification of the economy. "In Azerbaijan, revenues from oil and gas are trickling through society. The interesting sectors are those that give exposure to the emerging middle class," says Cappello, citing sectors such as financial services and retail.

Not only has Mongolia tapped international markets with the Mongolia Mining Company, but the domestic stock exchange is becoming increasingly active and has signed a three-year development programme with the London Stock Exchange. Although still

Until recently, investment in Azerbaijan was further complicated by the lack of a local capital market, but the government is also making a concerted effort to develop the stock exchange.

Azeri companies may also decide to tap international markets in the near future

substantial deposits of uranium, copper, zinc and other metals, in addition to oil and gas. "If there is to be another internationally listed major mining company from Central Asia, on the scale of Kazakhmys or ENRC, it will come out of Uzbekistan," reckons Askar Yelemessov, chairman of Troika Dialog Kazakhstan.

"Not only does Uzbekistan have more gold than Kazakhstan, it also has some large mines and a very substantial mining complex that it inherited from the Soviet Union," Yelemessov tells bne.

"Unfortunately, the large companies such

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as Navoi Mining and Metallurgical Combinat that are exploiting its resources are not listed, and Uzbekistan does not yet have an international rating. For Uzbekistan to list companies internationally would be a major departure from the existing model of building the economy based heavily on their own resources."

Until then, investors are looking for alternative targets in the smaller, but more open, republics of Kyrgyzstan and Tajikistan.

Niche markets Small mountainous republics, with populations of 5.3m and 6.9m respectively, Kyrgyzstan and Tajikistan have substantial mineral reserves that are largely untapped, and have attracted a handful of investments despite the problems of poverty, instability and corruption.

But a high level of political risk remains.

Kyrgyzstan has seen two revolutions in

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six years and the threat of a resurgence of the deadly ethnic clashes seen in June 2010 remains. As recently as July, several hundred police were deployed to end a standoff between Kyrgyz and Uzbeks in the southern town of Aravan. Meanwhile, President Emomali Rakhmon of Tajikistan, the former Soviet Union's poorest republic, has maintained a precarious stability since the end of the civil war in 1997, but there is a constant threat of insurgency from neighbouring Afghanistan.

Although there are similarities between the two, Kyrgyzstan is considerably ahead of Tajikistan. It has close economic ties to Kazakhstan, is a member of the World Trade Oragnization and is set to join the Customs Union (with Russia and Kazakhtsan) possibly as soon as next year. "We are confident in Kyrgyzstan, despite the political turmoil, and to some extent in Tajikistan, even though this is the poorest Central Asian repub-

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local mining giants such as ENRC and Kazakhmys. Soviet geologists searched Kazakhstan and other satellite republics for hydrocarbons and mineral deposits. However, in the 20 years since the break-up of the Soviet Union, advanced exploration techniques have been developed, while other minerals such as rare earth metals are now more highly sought after, since they are used in new devices such as hybrid cars, mobile phones and digital cameras. "Extensive work was carried out in Kazakhstan, but in Soviet times geologists were only looking for particular minerals," said Kazakh Deputy Minister of Industry and New Technologies Nurlan Sauranbayev.

lic," says Aureos' Kukenov, who backed Kyrgyz cable company Ala TV in 2008.

"This is mainly because the private sector in these countries is much less controlled by the government than in Turkmenistan or Uzbekistan, where it is very difficult to do private equity deals."

However, both markets still have a long way to go. Tajikistan does not have a stock market, while in Kyrgyzstan the main domestic market, the Kyrgyzstan Stock Exchange, merged with its rival in March in the hope of boosting turnover.

This fell from a high of $130m in 2008, to just $10m in 2010 due to a combination of the international economic crisis and the local political turmoil. Further growth of these potentially attractive markets will depend on political stability and progress in building infrastructure and fighting corruption.

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Under-mined in Central Asia

Copyright Š 2010 Rio Tinto

Clare Nuttall in Almaty

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entral Asia's mineral resources remain under-developed given the region's potential. And outside of Kazakhstan and Mongolia, international investment into exploration is minimal.

Even in Kazakhstan, the most developed country in the region, exploration investment has been low by global standards given the size and range of its raw material base, which famously comprises all the elements of the periodic table. In 2010, Kazakhstan received just $76m of investment in exploration, of which $65m was directed at gold deposits; Chile, which has a comparable mining industry and resources, attracted $390m.

This is despite Central Asia being "probably the most prospective copper belt in the world," according to Rio Tinto's general manager exploration, Central Asia, Chris Welton. "There has been very little investment during the last 20 years,

and we are convinced that there are tier 1 discoveries still to be made here," Welton told the Central Asia Mining Congress (CAMC) in Almaty on June 21.

The small amount invested in exploration in Kazakhstan, the region's largest economy, confirms the significant under-funding in Central Asia as a whole, which enhances the potential of the belt in my eyes, Welton added.

Kazakhstan's mineral base was first developed during the Soviet era, when

Changes, initiated in Astana, are now in progress. A new exploration-dedicated company, Kazgeologia, is being set up within state holding company SamrukKazyna. "We are now turning over a new page, and would like to carry out more in-depth studies," Sauranbayev told the CAMC conference. "This will allow investors to see new structures and deposits that might be of interest."

Rio Tinto is already working with Ivanhoe Mining on the Oyu Tolgoi copper deposit in Mongolia and has recently moved into Kazakhstan and Uzbekistan.

It is now close to signing an agreement with Samruk-Kazyna subsidiary Tau-Ken Samruk to set up a 50-50 joint venture in Kazakhstan. "We look forward to signing soon and getting started on spending exploration dollars in Kazakhstan," Welton said.

Investor relations As Central Asia's largest economy, Kazakhstan has attracted billions of dollars in foreign investment to the mining sector since independence. However,

"From a geological standpoint, Central Asia is a very attractive region. The problem is politics" large-scale mining and processing facilities were established, some of which later formed the basis for today's

investors say more could still be done to improve the business environment.

According to David Neuberger, vice

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Oxus and asset grab

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president international mining at Cameco, which operates the Inkai joint venture with Kazatomprom, investors would benefit from greater clarity in regulation, and clear and predictable tax legislation. "Infrastructure development is still a challenge," he added.

Clare Nuttall in Almaty Oxus Gold, one of the longest-standing foreign investors in Uzbekistan, has accused the Uzbek government of trying to seize its assets and orchestrating a smear campaign to force it out of the market. A statement from the firm's legal counsel, Amsterdam & Peroff, alleges that Oxus has been subjected to "expropriatory, unlawful, unfair and discriminatory treatment," resulting in losses of at least $400m.

Oxus has effectively been unable to take part in managing the Amantayau Goldfields joint venture, in which it holds a 50% stake alongside Goskomgeology and Navoi Mining & Metallurgical Combinat, both of which are owned by the Uzbek state, since a punitive tax audit was launched earlier this year and employees of the venture have been forced under threat of arrest to sign secrecy agreements that bar them from contact with Oxus, the firm's lawyers claim.

Then on June 28, Goskomgeology accused Oxus of failing to meeting technology and environmental standards, and putting lives at risk at the venture.

Rebuffed Oxus has urged the Uzbek government to take part in good faith settlement discussions under the international treaty between Uzbekistan and the UK. In February, it also offered to sell its stake in Amantayau, but received no response from the government. "Instead, Goskomgeology and the NMMC have focused inexorably on involuntary liquidation for AGF," Oxus wrote in a formal letter to the government dated July 6.

The company is also seeking the release of its former chief technologist Said Ashurov, who is being tried in a closed military court on espionage charges. Ashurov, a Tajik national, is suffering from hepatitis and has been denied medical treatment. "Mr Ashurov faces the most serious charges," says Amsterdam & Peroff founding partner Robert Amsterdam.

AIM-listed Oxus has been present in Uzbekistan since the late 1990s. It remains the only publicly listed gold mining company with operations in Uzbekistan.

Amantayau is located in the Kyzlykum region, 40 kilometres from Muruntau, the world's largest open pit gold mine. According to Amsterdam, "Oxus has faced a series of expropriatory acts in the years it has been in Uzbekistan, but nothing as severe as this. The present situation is as bad as one can imagine."

Oxus is not the only international investor to come under pressure recently.

"This is anything but isolated," Amsterdam tells bne. "There have been recent actions against German, Korean and Turkish companies. I think of Uzbekistan as the Ponzi scheme of foreign investment – the government courts countries, people are encouraged to invest, then later they have to pull out."

In addition to working in the framework of the international treaty between Uzbekistan and the UK, Oxus plans to take action at a political level. The company plans to lobby the governments of Germany and other countries that are trying to develop relations with Uzbekistan, both to try and recover the company's assets in Uzbekistan and to secure Ashurov's release.

Despite these issues, Kazakhstan has by far the most investor friendly and highly developed mining sector in Central Asia, with a combination of local giants, major international companies and smaller frontier mining companies exploiting its resources. Mongolia is going down a similar path. In addition to the worldclass Oyu Tolgoi and Tavan Tolgoi projects, numerous smaller deposits are also on investors' radar screens.

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"Any other country with this much potential would have 50 or 100 companies exploring"

country with this much potential would have 50 or 100 companies exploring," says Arne. "Realistically, the only game in town in Kazakhstan. There are some issues, but they seem to be capable of making a deal and upholding it."

erty rights. Although the October 2010 elections took place peacefully, an arson attack on a remote mining compound in the Talas region in March caused up to $1m worth of damage, further rattling investors.

Kyrgyzstan's April 2010 revolution – its second in six years – was followed by nationalisations of some key assets and illegal squatting, both of which raised concerns over the protection of prop-

The new Kyrgyz government introduced a moratorium on issuing new mining licences in early 2011. While the aims were sound – the government wanted to ensure licences were only

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issued to genuine developers – the blanket approach meant that international mining companies have been unable to progress with their operations.

But there are some signs of progress.

Despite the problems faced by Oxus and other companies, Rio Tinto has opened an office in Tashkent. Meanwhile, in Tajikistan legislation is being reviewed, and a new subsoil use law and government programme for exploration are being drawn up. Tajikistan could also see the first large international company enter the mining sector to develop the Kalon Koninskai silver deposit. BHP Billiton and Kazakhstan's Kazzinc are understood to be competing in a tender process due to end in September.

It's a different story in the other Central Asian republics, however, whose mineral wealth has not been matched by investor friendliness.

Not politic Uzbekistan has substantial reserves of gold, uranium and other minerals, and in Soviet times was the largest economy in Central Asia. Since then, it has been decisively overtaken by Kazakhstan, while the investment climate has deteriorated. Oxus Mining, which has been active in Uzbekistan since the late 1990s and is one of the few remaining investors, says it has been the victim of an attempted asset grab by its partners in the Amantaytau Goldfields joint venture (see accompanying story). Investment is also low in Kyrgyzstan and Tajikistan.

"From a geological standpoint, Central Asia is a very attractive region. The problem is politics. Many of the people in government positions have a very fearful approach to foreign investors, and their aim is to take as much money and control as possible," Kenneth Arne, a consultant with Behre Dolbear, tells bne.

Arne points out that with legislation full of references to state control and management, Tajikistan has been "uniquely unsuccessful" in attracting investment. In Kyrgyzstan, there are less than 10 international investors in the mining sector, even though there are more than 29,000 gold discoveries and outcrops in the country. "Any other

Taking what's mine in Mongolia Oliver Belfitt-Nash in Ulaanbaatar

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n July 11 and 12, Mongolia's national festival of "Nadaam" consumed the nation and the capital's stadium overflowed with people who came to watch the three Mongolian national sports – wrestling, archery and horse racing. This year

there was a distinctly corporate feel to festivities, with the traditional dancers and Ghengis Khan-like warriors jostling for space with the banners of sponsors – banks and businesses that have helped drive the Mongolian economy to new heights over the past few years.

Business and money is never far from the minds of Mongolians these days.

The first half of 2011 will be remembered in Mongolia for the battle among foreign investors to develop the Tavan Tolgoi coal mine, a perhaps connected

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fuel crisis, and the increasing politicisation of mining.

In the week before Nadaam, it was announced that the US' Peabody Energy, China's Shenhua and a Russian-Mongolian consortium had been selected to develop the western part of the giant Tavan Tolgoi coal mine, which the gov-

"The Mongolian government needs to play its cards right. The decisions it makes now will have heavy consequences for many years to come" ernment estimates could hold reserves of as much as 7.5bn tonnes. It is unsurprising that the country's two powerful neighbours were selected, and Peabody has been in the picture for years, but there remains confusion about whether those three constitute the final list and what happened to the other short-listed companies, who are complaining the process was unclear and unfair. The identities of the Russian-Mongolian consortium are still unclear and confusion arose after some Japanese and South Korean firms that were part of the Russian-led group said they weren't told of the outcome, while China's Shenhua teamed up with Japan's Mitsui but the Japanese firm's name was dropped without explanation.

Government officials told Reuters in July that talks were continuing with all parties and the final proposal has not yet been approved by the National Security Council nor has it been submitted to the parliament.

Uncertainty surrounding major decisions is not unusual for Mongolia. Many have been waiting for this lengthy decisionmaking process to end to allow the development of Tavan Tolgoi to begin.

The schedule declared by the government adds some serious pressure to get these players on the ground and digging out the coal. Citizens are waiting for their share of the profits and are becoming impatient. "Mongolian citizens now own

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shares in Tavan Tolgoi – we are opening thousands of new brokerage accounts," says Batbold Ariyasuren, general-director of Monet Capital Investment Bank. "Many are still sceptical, but most are eagerly waiting to cash in their shares."

not yet ready" to join the Customs Union, rowing back from Prime Minister Almazbek Atambayev's hasty April declaration to join from January 2012.

Atambayev argues that preferential access to the 170m consumer market would open up a huge market for Kyrgyz industry and agriculture, which will create jobs and attract investment. "It will strengthen the Republic's borders and improve the living and working conditions of about half a million Kyrgyz nationals working in Russia and Kazakhstan today," said Atambayev, referring to incentives including quotas for Kyrgyz labour migrants, military and technical assistance, and a $106.7m loan from the EurAsEC anti-crisis fund.

Fuelling a crisis Undermining confidence among the people was a recent fuel crisis. Mongolia relies 100% on imports for its petroleum and diesel, and over 90% of this comes from Russia. Despite all the natural resources being discovered, there is precious little progress in discovering a domestic supply of oil.

On May 1, Russia cut its oil exports ostensibly due to a lack of supply at home, and Mongolia suffered immediately. All businesses from farming to mining rely on this flow of diesel to fuel their operations, and a wave of fear swept the nation. Petrol stations ran dry, and at one point only those with loyalty vouchers from specific petrol companies could fill up their cars – and even then at a shockingly inflated price.

The crisis highlighted Mongolia's reliance on its powerful neighbours, and how delicately it must tread when making decisions that concern China and Russia. In an already high-pressurised political debate over the future of the mining sector, this shock was seen by some as a reminder of Russia's influence. While investors and exporters alike see China as the natural partner for business development in Mongolia, Russia remains an ever-present player.

Some believe that Russia's move was a case of it flexing its muscles to remind Mongolia who really pulls the strings.

So while China, Russia and the US have all been selected to manage Tavan Tolgoi, there is little doubt that these political tensions will continue in Mongolia as long as there are assets to sell. Letting the three superpowers fight it out for much longer would've been more trouble than it's worth, argue some. "The Mongolian government needs to play its cards right," says Fiezullah Saidov, head of Investment Banking for Monet Capital. "The decisions it makes now will have heavy consequences for many years to come."

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Customs Union a mixed blessing for Kyrgyzstan Izabella Mier-Jędrzejowicz in Osh

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he Kyrgyz government plans to rush into the Eurasian Customs Union regardless of the crippling effect this could have on its economy.

This act of loyalty is not only a reflection of the recent strength of Russia's influence in the region, but also of Russia's economic struggle with China.

The Customs Union of Belarus, Kazakhstan and Russia was launched in 2010 partly in response to the EU's Eastern Partnership programme that aimed to draw Ukraine, Georgia and Belarus closer to the EU; partly because Moscow, recovering from the global economic crisis, wants to protect its

domestic market by regaining influence over the Commonwealth of Independent States. Inviting Kyrgyzstan and Tajikistan into the Customs Union is necessary, it believes, to control and seal the porous borders with China.

On July 16, Kyrgyz President Roza Otunbayeva declared her country "willing but

Uchkunbek Tashbaev, minister of economic regulation, warns that staying out of the Customs Union could mean that Kyrgyzstan loses its Most Favoured Nation status. This would cut duty-free supplies of oil and raw-materials from Russia and Kazakhstan, on which the state heavily relies, and limit exports to the Customs Union states, which today account for 44.9% of Kyrgyzstan's foreign trade, according to official statistics.

Closing the markets borders would cut emigration considerably, increasing unemployment and instability.

In the long run, government officials argue that accession makes a lot of sense for a country in desperate need of support and stability. And after recent political upheaval, these arguments appeal to many Kyrgyz citizens nostalgic for fondly-remembered Soviet comforts. “The common conviction is that the Russians will know how to make things better," says Anar Musubayeva, expert of the Institute for Public Policy.

But the rushed and unprepared accession suggested by Atambayev carries its own dangers.

"The Customs Union states don't belong to the WTO and have imposed high tariffs, mostly dictated by Russia"

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“The common conviction is that the Russians will know how to make things better"

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Re-export According to the Asian Development Bank (ADB), the European Bank for Reconstruction and Development, and United States Agency for International Development, joining the Customs Union means elimination of the reexport trade, which would have a major effect on the state budget by decreasing revenues from customs duty. Imposing high tariffs with World Trade Organization states (a change from the average 5.1% in Kyrgyzstan to the Customs Union average 10.6%) would also cause consumer prices to rise sharply, especially on medicine and technology.

There will be membership costs too (around 58 million soms) with comparably low withdrawal benefits (3% of Customs Union revenues.)

Today, Kyrgyzstan is a leader in reexports to other countries of Central Asia and Russia. The World Bank estimates 75% of Chinese goods entering Kyrgyzstan are re-exported, creating livelihoods for 350,000 people and amounting to 33% of Kyrgyzstan's GDP. The Customs Union would eliminate profits on this trade.

"It's already a lot worse than it was," says Ulan who works at the Dordoi bazar, the largest market in Central Asia.

Since July 2010 when Customs Union tariffs were introduced, re-export activity has slowed. "There are a lot fewer traders than two year ago, many haven't made a profit, but there are just as many goods," says Ulan, who sells wholesale from his transport container stacked high with clothes marked Hugo Moss, Kate Boss and Golden Hores – all Made in China.

"Trade with China is the basis of Kyrgyzstan's economy, our country is a trade hub of goods from China. What's more, tariffs on goods from China aren't paid on the actual goods, but on the weight of the transport, regardless of its value," says Roman Mogilevskii, director of the Centre for Social and Economic Research.

These simplified trade procedures mean foreign trade is at least four times

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higher than official government statistics and Chinese goods make up 70% of imports. "Everything comes from China, we don't manufacture anything.

The prime minister argues the Customs Union will increase domestic production, but in reality it will just make us dependent on Russian products, which our small and medium entrepreneurs can't compete with," says Mogilevskii.

lack of transparency in their governance systems. Already 20 years since the collapse of the Soviet Union, Central Asia has had particular difficulty in establishing the rule of law.

Findings from the 2011 edition of "Nations in Transit", Freedom House's annual assessment of democratic development in the former Soviet Union and Central and Eastern Europe, put the challenge into perspective. On key indicators, the five Central Asian republics perform at woefully poor levels.

In consequence Kyrgyzstan would become a source for cheap raw materials and agriculture, processed in the other Customs Union states then imported back into the country. Adjusting prices to the common market will bring inflation, halting the development of domestic business. This would cripple the economy of this already frail state, rapidly raising unemployment, discontent and political instability. "The Customs Union protects the Russian and Kazakh market from China," says Mogilevskii, "the Customs Union states don't belong to the WTO and have imposed high tariffs, mostly dictated by Russia."

For example, on judicial independence, the average rating of the Central Asian republics is 6.55 on a scale of 1 to 7, with 7 representing a total absence of meaningful redress mechanisms. This level of performance reflects environments in which judges routinely face interference and coercion from the executive branch of government and other powerful actors, and where there is little expectation of dispassionate resolution of disputes. This is especially true concerning politically sensitive cases and those involving strategic economic interests. The average corruption rating for the Central Asian republics is 6.5, the same as Russia's.

According to the ADB, the Customs Union inherited 92% of Russia's external tariffs which for Kazakhstan, with its undiversified economy based on oil exports, has meant a sharp rise in consumer prices, while Kazakh producers complain of the difficulties in obtaining Russian licences that would allow, for example, Kazakh alcohol to be sold in Russia, reports centrasia.ru.

"Whatever the cons, not entering the Customs Union would be the worst thing to do," argues Atambayev, stressing that Kyrgyzstan's economy needs the help and support of its neighbours.

But many argue that Kyrgyzstan should postpone accession for at least six or seven years, by which time the Chinese re-export market will have naturally shrunk. A few more years could also see the Customs Union of Russia, Kazakhstan and Belarus enter the WTO, eliminating the dilemma Kyrgyzstan now faces: should it leave the WTO or pay compensatory adjustment to all other WTO states to ensure the situation is no less favourable to trade.

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Rule of law eludes Central Asia

COMMENT:

Christopher Walker and Sylvana Habdank-Kolaczkowska of Freedom House

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he absence of rule of law is a glaring feature of virtually all of the countries of the non-Baltic former Soviet Union. To one degree or another, these systems still struggle with the legacy of hyper-presidential systems, monopolised politics and

entrenched corruption. A subset of the region's authoritarian states, including Kazakhstan and Russia, have ambitions for economic modernisation, but they are ill-equipped to achieve meaningful institutional reform, given the absence of genuine political competition and

Shades of grey Kazakhstan, the wealthiest and most advanced of the Central Asian states, continues to confront major corruptionrelated challenges. Corruption fuelled by enormous oil, gas and mineral wealth is deeply embedded among ruling elites, who use their official positions to appropriate and distribute key resources for personal gain. Under the leadership of President Nursultan Nazarbayev, anti-corruption efforts are applied selectively and capriciously. The most recent "Nations in Transit" report on Kazakhstan points out that, "charges of corruption and abuse of office tend to be levelled against government officials or political figures only after they enter into a personal or political rivalry with more powerful elites or challenge President Nazarbayev's authority." The main bodies charged with tackling corrupt practices - the Ministry of Internal Affairs, the National Security Committee (KNB), and the tax and financial

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police - have become instruments for senior officials to accrue power, intimidate rivals and extort bribes.

In Russia, the size of the grey economy is estimated at anywhere between 20-50% of the country's economic

"The distinction between 'emerging' and 'frontier' markets in the region says little about these countries' performance on indicators of democratic governance" output, and capital flight in 2010 was estimated at $38.5bn. Although President Dmitry Medvedev has made cleaning up corruption a top priority of his government, the 2011 "Nations in Transit" report on Russia finds that anti-corruption rhetoric has not translated into meaningful action to get corruption under control. After nearly a full Medvedev term, it appears as though the corruption genie is entirely out of the bottle.

Freedom House's Russia report details a long and growing list of problems that include, "civil service appoint-

representatives and enforced by impartial courts, but on the state of their relations with the leadership. Loyalists are rewarded and enemies are punished.

While these two countries have made headway in terms of macroeconomic growth, much of this is a result of rising commodity prices. To date, neither state has been able diversify its economy from reliance on hydrocarbons, which among other things speaks to the absence of serious policy debate and alternatives in these systems. Serious questions remain as to whether these countries can turn the corner and establish publicly accountable and transparent institutions capable of consistently protecting property, enforcing contracts and combating graft. The trajectory in Freedom House findings

In general, the extent to which citizens can exercise their rights depends not on the law as established by freely elected

suggest that without a major democratic opening, they are unlikely to do so.

Christopher Walker is director of studies and Sylvana Habdank-Kolaczkowska is managing editor of "Nations in Transit", an annual assessment of democratic institutions in the former Soviet Union and Central and Eastern Europe at Freedom House.

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alliance of Alliance for European Integration took over from the Communists in September 2009, it's a quite different country. There is no more authoritarian regime, we have a separation of powers, and the political institutions are now much more accountable to the public.

And there are no more 'hostile takeovers' [such as Peter's] with the help of administrative resources," he says.

These realities must be considered carefully by potential investors in key parts of the former Soviet Union. The distinction between "emerging" and "frontier" markets in the region says little about these countries' performance on indicators of democratic governance, which can be strikingly similar. Russia and Kazakhstan are both designated as consolidated authoritarian regimes in "Nations in Transit" and both are heading in the wrong direction on the assessment's indicators.

"Already 20 years since the collapse of the Soviet Union, Central Asia has had particular difficulty in establishing the rule of law" ments in exchange for bribes or on the basis of personal connections, business activities conducted by public officials, the influence of billionaire business magnates on state decisions, demands for informal payments from businesses, and widespread graft problems in the health and education spheres."

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Moldova still labours under its past Kester Eddy in Chisinau

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peaking to a group of visiting journalists in 2008, the mayor of Chisinau, the capital of Moldova, told the story of a successful local entrepreneur – let's call him Peter – who, having spotted how effectively pizza restaurants operated in the US, decided to replicate the idea back home. His first outlet being an instant success, he quickly set about opening a second, and a third, and so it went on till he had a dozen or so pizza parlours in the city.

Then one day two man called by. They told Peter that they represented someone very close to the highest echelons of Moldovan political power, and if he wanted to stay healthy, Peter would sell his chain of eateries for a nominal sum to their boss. Peter prevaricated for a while, but after a short, if violent reminder, a deal was struck. Alas, this tale of political lawlessness was not an isolated incident.

Given such a business environment, along with limited natural resources, it's little wonder that Moldova, a former Soviet Republic, was – and remains – "the poorest country in Europe," as Iurie Leanca, Moldova's minister of for-

Not that Leanca, who speaks English like a man in a hurry, with one idea rapidly following another, pretends that either political or business life has become perfect overnight. There remain numerous "vested interest" groups, often nominally state owned, run as management fiefdoms; corruption is commonplace; the judiciary barely functions; and the governing coalition contains politicians desperate to block any reforms that would touch their economic interests. Further, the political and economic misery of the noughties led to widespread despair among the general population, with hundreds of thousands – some estimates say a million – leaving for a better life abroad, including many of the well educated.

And the new government had and still has to deal with Moldova's unique situation inherited from the dissolution of the Soviet Union – the breakaway sliver in the east of the country run as an unrecognised state with the tacit support of Russian forces, the so-called Transnistria, or "Left Bank of the Dniestre", as it is officially known in Moldova. "The Alliance

"There are no more 'hostile takeovers' with the help of administrative resources" eign affairs and European integration, told bne in a recent interview.

Poor it may be – the World Bank put GDP per capita at a mere $1,516 in 2009 (neighbouring Romania was $7,500 the same year) – but at least the country is "no longer living in fear," Leanca insists. "Since the [governing]

could not produce miracles," says Leanca.

"We inherited many, many challenges. We are still learning what the word 'co-habitation' means, to live together."

Unblocking the bottlenecks Yet Leanca insists the economic changes seen over the past 22 months have been very significant. "When we came to

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I Special report

Georgia's green power

David O'Byrne in Istanbul With Turkey's latest power consumption figures showing demand rising a staggering 9.7% over the first six months of this year and with repeated warnings that the development of new power plants inside the country isn't keeping pace with this, it's little surprise that Turkish energy companies have started looking abroad for sources of power.

What is surprising, though, is that instead of looking to take advantage of Turkey's recent interconnection with the pan-European ENTSO-E electricity grid, many Turkish companies are instead looking to Turkey's northeastern neighbour Georgia, both as a source of power and as a destination for investment in new hydroelectric power plants. "Georgia is a perfect fit for Turkey – long in the winter and short in the summer," says Mustafa Karahan, head of Turkey's Electricity Traders Association (ETD), explaining that Georgia has a big demand for power during its cold winters and a low demand for power in summer when the mountainous country's many rivers are in full flow – and when Turkish demand is highest.

In short, Georgia is the ideal location for hydropower projects that can supply the local Georgian market in winter and export excess power to Turkey in the summer.

Currently, Georgia and Turkey are interconnected by a 28-kilometre, 220-kilovolt line, which has allowed limited seasonal power trading.

However, the two governments have agreed to construct a new 400-kV line between Akhalshike in Georgia and Borcka in north-eastern Turkey at an estimated cost of $312m, which will allow for far higher levels of exports and is expected to encourage the development of more hydropower projects, both in Georgia and in neighbouring Azerbaijan, which also has spare capacity.

Some 40 hydropower plants totalling 2,485 megawatts (MW) are currently already under development in Georgia, of which 782 MW is being developed

by Turkish companies, with several other Turkish groups in negotiations with Georgia over other as-yet unfinalized projects.

While relations between Turkey and Georgia have become increasingly close over the past two decades, Turkish companies have been helped in their efforts to develop Georgia's hydropower potential by former Turkish bureaucrat Yusuf Guney, who, since the end of his term as head of Turkey's energy regulator, has been working as an advisor for the Georgian Energy Ministry.

Largest of those hydropower plants already under development is the Namakhvani cascade, which is being developed by a consortium of Turkey's Nurol Group and SK International of South Korea, and once complete will consist of three dams totalling 450 MW.

bne August 2011

power, the budget deficit was heading for 16.5% of GDP. We had to undertake extremely unpopular measures. Vested interests, related very closely to the former leadership, limited many parts of the economy, with quasi-monopoly situations," he says.

With the help of an International Monetary Fund programme worth $574m in early 2010, the government began a programme of reforms, slashing state spending and attempting to remove the economic blockages, particularly in the key agricultural sector. As a result, in 2010 the budget deficit was reduced to 2.5% of GDP, and economic growth hit 6.9% last year, with 8.4% in the first quarter this year.

Lucian Angheli, chief economist of BCR, Erste Bank's Romanian operation, confirms the liberal policies of the Alliance. "The government has a pro-European way of doing business.

Before everything in business needed a licence – they have reduced the number of licences by 70%. And they have introduced competitive tenders for infrastructure projects," he says.

Moldova also began negotiations for an association agreement with the EU. "We started one year and some months ago, three years later than Ukraine, and by now almost finalised all the chapters; 90% of it has been agreed. What remains is to do with economic policy, sanitary standards, financial and competition law. We hope that in one and a half years we should finalise these negotiations," says Leanca.

And, partly as a result of closer links with Germany, there is even some hint of movement on the thorny issue of Transnistria. "Chancellor Merkel understands the situation there very well," he says.

Meanwhile, perhaps the biggest change in terms of daily life for ordinary citizens has been the transformation of the media. "People have much better access to various sources of information. There is no more kind of brainwashing that happened during the previous eight years of rule by the Communist Party," he says.

bne August 2011

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Upcoming events 2011

Russian Stock And Financial Markets: Future Trends (22 - 25 August) FINEXPO +7-495-646-14-15 Sochi, Russia info@finexpo.org www.ff.finexpo.ru/english/

Eurasia Mega Build fair (8 - 11 September) CNR Expo Istanbul, Turkey www.cnrmegabuild.com

5th Annual Private Banking in CEE, SEE & CIS (13 - 14 September) Fleming Europe Prague http://finance.flemingeurope.com

II Cbonds Russia & CIS Fixed Income Conference (15 - 16 September) CbondS London, UK www.cbonds-congress.com/events/75/?l=2

Eastern Europe Summit (14 - 16 September) East Capital Istanbul

Private Equity in CEE 2011 (20 - 22 September) Informa The Bloomsbury Hotel, London, UK www.informaglobalevents.com/FKW52228BNEWB VIP Code: FKW52228BNEW

Gas Infrastructure World Caspian 2011 (21 - 22 September) Terrapinn Hyatt Regency Baku, Azerbaijan www.terrapinn.com/2011/gas-infrastructure-caspian/

CCS 2011 (22 - 23 September) EEL Events +44 (0) 207 275 8020 London, UK delegate@eelevents.co.uk www.eelevents.co.uk/ccs-2011/

2011 Annual Meetings (23 - 25 September) The World Bank Group and the International Monetary Fund Washington, D.C. www.imf.org/external/am/2011/index.htm

JetFin RUSSIA 2011 (29 September) JetFin +41 22 839 8080 Grand Hotel Kempinski, Geneva, Switzerland sophie.lavaud@jetfin.com www.jetfin.com/russia2011-geneva/program_en.php

Syndicated Lending in Russia - 2011 (29 September) CbondS Moscow, Russia http://cbonds-congress.com/events/73/

IPO and SPO in Russia and CIS (3 - 5 October) C5 London, UK www.c5-online.com/2012/640/ipo-and-spo-in-russia-and-cis

KazStimOil 2011 (4 October) Caspian Eents Palace of Peace and Reconciliation, Astana, Kazakhstan

4th CFO Summit Emerging Europe & CIS 2011 (11 - 12 October) FINANCIAL GATES +49(0)60 31-73 86-17 06 Vienna, Austria info@cfo-summit-ee.com www.cfo-summit-ee.com/

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