bne:Magazine November 2013

Inside this issue: Tatarstan a magnet for Islamic world A phantom move to Latvia Fixing Serbia's economy

November 2013 www.bne.eu

Another landslide in Azerbaijan

A Tug-Of-War Over Ukraine

bne November 2013

Contents

Editor-in-chief: Ben Aris (Moscow)

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Managing editor: Nicholas Watson (Prague)

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News editor: Tim Gosling (Prague)

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

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

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COVER STORY 6 The Insiders

CENTRAL EUROPE 26 Czech dealmaker turns kingmaker

8 A tug-of-war over Ukraine +7 7073011495

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

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14 Perspective

27 Old attitudes die hard in Czech politics 29 EU's boost for eastern energy infrastructure

EASTERN EUROPE 30 Recovery gathers pace 16 Tatarstan – Russia's magnet for Islamic world

31 Hungary steps up fight with utilities

17 A smart city in the making +44 7738783240

Cover illustration: Illarion Gordon

33 A phantom move to Latvia 19 UniCredit looks for way out of Ukraine

34 Poland's politics get personal over pensions

21 Kremlin rhetoric worsens immigrants' plight

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23 Russia's brave bet on organic growth 25 Electrifying Russia's business climate

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bne November 2013

Contents

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SOUTHEAST EUROPE

EURASIA

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Fixing Serbia's economy

48

Another landslide in Azerbaijan

38

Kosovo elections – a known unknown

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Azerbaijan's initial initial offering

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Kazakhstan’s new business hub

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Kazakhstan replaces central bank governor

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Turkey's Pegasus flying high

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Erdogan the reformer returns

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MOLlifying Croatia

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Croatia hopes there will be oil

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Uzbekistan turns east as cotton boycott continues

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What's holding back Romania?

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Buy Uzbek

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Passing through Georgia

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Mongolia – a tale of two mines

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Ulaanbaatar's growing pains

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OPINION Four reasons to buy Russian equities now

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Follow us on twitter.com/bizneweurope

UPCOMING EVENTS

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Russia's WTO membership – a double-edged sword?

Vladimir Tchikine of Goltsblat BLP

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ussia recently celebrated its first anniversary as a full member of the World Trade Organisation (WTO).

Experts agree that membership will be beneficial for Russia in the long term, as it will improve competitiveness, demand and international investment, as well as driving innovation among manufacturers.

However, the first 12 months have not been easy. There is profound scepticism in the manufacturing sector about what membership means for Russia, particularly within the automotive industry, which is at the centre of the first formal WTO case filed against Russia: the EU and Japan have complained to the governing body about Russia’s recycling fees for imported vehicles.

But perhaps even more surprising than what has happened so far is what has not happened. As a member of the WTO family, Russia can now challenge anti-dumping measures and special duties imposed by other countries against Russian goods, but we have yet to see it file a complaint with the WTO authorities.

Is this about to change? Speaking at the Sochi Economic Forum in September, Russian Minister for Economic Development Alexei Ulyukayev said that Russia would use its WTO membership more “actively” to protect the interests of its exporters and manufacturers.

The sentiment was echoed by President Vladimir Putin, who said shortly afterwards at the VTB Capital annual investment forum in Moscow that Russia should learn to actively use WTO mechanisms and protect its domestic market.

So what does the future hold for Russia as a WTO member?

And how can it better maximise its membership to promote internal growth?

Recycling news The recycling fee dispute continues to make headlines, amid real concern within Russia that the country’s nascent automotive industry will be made to suffer. The alternative could see Russia become the first exception to the unspoken

rule that no action is taken against countries in the first year of membership. What action the WTO authorities could actually take against Russia is an interesting question, however.

The WTO may not impose direct penalties on a member country, so if Russia refuses to scrap the recycling charges for imported vehicles or makes domestic producers pay it too, the only alternative would be for the EU and Japan to impose additional duties for Russian goods.

But what goods would this apply to? Russia’s most important export to the EU by far is oil and gas. However, imposing

"The recycling fee dispute is likely to be resolved by applying the levy to all cars sold in Russia to level the playing field" additional duties on those would be a case of cutting off your nose to spite your face, as the EU relies on Russia to meet its energy needs.

The recycling fee dispute is likely to be resolved by applying the levy to all cars sold in Russia to level the playing field – and a bill to that effect was introduced to the Duma earlier this year, although parliamentary holidays began before it could be considered.

This leaves us with the question of which sectors are likely to be the next focus of WTO disputes? One highly contentious area is agricultural machinery.

Earlier this year, the Customs Union began considering the possibility slapping of protective tariffs on foreign-made grain harvesters, following a request from Russian agricultural machinery manufacturers Rostselmash.

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Rostselmash’s desire to protect itself is hardly surprising: it is the largest manufacturer of grain harvesters in Russia and competes directly with all imported brands; naturally it wants to protect itself against any competition.

However, the decision on protective duties for Russian grain harvesters has been met with scepticism in Kazakhstan. Thus the tariff implementation has been delayed pending a final decision by the Supreme Eurasian Economic Council of the Customs Union – in other words, the heads of state or the heads of governments for Russia, Belarus and Kazakhstan.

The Council decided at the end of September to introduce a minute quota for the import of harvesters and ordered the commission to amend its safeguard decision respectively.

Could another lawsuit against Russia be on its way to the WTO dispute resolution body as a result?

Steeled for action WTO membership is actually a double-edged sword for Russia.

It has already spelled short-term troubles for certain sectors, but it also means that Russia can use the WTO legal framework to protect its own interests on the global economic stage.

Currently there are over 100 restrictive measures in force against Russian exports globally. These are largely antidumping measures aimed at the steel and chemical industries, and in some cases there is evidence of anti-dumping rules being abused to disadvantage Russian producers internationally.

Prime Minister Dmitry Medvedev has publicly spoken about the importance of protecting the steel industry and the WTO can offer a good platform for constructive engagement on this internationally. In the next couple of years, we can expect to see Russia bringing its own court case through WTO channels to protect these critical industries.

Winning a case in the WTO will be a breakthrough for Russia’s standing on the international stage and have obvious economic benefits. However, bringing a case could have real benefits even if Russia were to lose. It will send out a clear signal to the international community that Russia is an equal player following the rules. Effective use of the WTO legal framework will be a powerful illustration of the fact that Russia can stand up for its producers, takes its obligations seriously and is committed to handling disputes in full accordance with international law.

The Russian economy is facing significant challenges in the wake of the global recession and competitive pressures on the world stage. Russia’s future lies in working constructively within the WTO framework – but we need to see Russia making full use of the advantages conferred by membership over the coming months.

Vladimir Tchikine is the Customs and International Trade Partner at Goltsblat BLP, the Russian practice of international law firm Berwin Leighton Paisner.

"Currently there are over 100 restrictive measures in force against Russian exports globally"

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A tug-of-war over Ukraine Mike Collier in Riga, Ben Aris in Moscow

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"This is not just the Vilnius summit, this is a summit in Vilnius, I am always saying. We share ownership and we will share success after that – it's not the end of the game," says Lithuanian foreign Minister Linas Linkevicius.

The second thread is political: former US secretary of state Hilary Rodham Clinton slapped the Kremlin in the face last December by saying that Russia was doing nothing more with the EEU than trying to rebuild the Soviet Union under a new name. “There is a move to re-Sovietise the region,” Clinton told a news conference in Dublin just hours before going into a meeting with her Russian counterpart, Sergei Lavrov.

“It’s not going to be called that. It’s going to be called a Customs Union, it will be called Eurasian Union and all of that,” she said, referring to the various iterations of Moscow's plan to deepen economic ties with its neighbours.

Such uncharacteristic restraint from the Lithuanian side should not be too surprising, given that Vilnius' recent form regarding major summits is not encouraging. At the last major summit in Vilnius, the Council of Baltic Sea States in 2010, the two headline acts, Russia's Vladimir Putin and Germany's Angela Merkel, both cancelled at the last moment, creating yet another international anti-climax and another flaccid joint declaration that even its authors have probably forgotten by now.

Whatever its final name and form, Russia has been very aggressive in trying to pressure the countries in its former backyard into joining the Customs Union.

Kazakhstan and Belarus are already members, while the impoverished Kyrgyzstan and Tajikistan have little choice but to apply for membership, as no one else is likely to lend them more money. So ahead of the EU summit, Russia has been badgering, cajoling and threatening the EU's Eastern Partnership countries also into joining its trade bloc.

This time promises to be different, as the Vilnius summit will be all about the "Eastern Partnership countries" – a grouping created by the EU four years ago to strengthen ties with six countries to the east of the EU: Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine. And Russia has been leaning heavily on those countries in the run-up to the summit in an attempt to derail their gravitation toward the bloc.

Armenia surprised everyone by announcing in September that it would give up its European ambitions – but that was after the Kremlin threatened to increase arms exports to its belligerent neighbour Azerbaijan. Plucky Moldova refused point blank to join the Customs Union – and immediately saw its wine barred from Russia, its biggest export market. It and Georgia are looking to finalise Association Agreements, including Deep and Comprehensive Free Trade Areas, in Vilnius. But all of these countries are a sideshow to the main event: Ukraine and the signing of its free trade and association pact with the EU.

he EU's summit in Vilnius on November 28-29 has been billed as a "game changer" for relations between the EU and the countries to its east, including Russia. The surprising thing is that for once it is not the Lithuanians themselves who are talking up the chances of a history-forging couple of days in their lovely baroque capital.

Eastern Partnership There are two threads to the summit.

The first is economic: the EU is worried about Russia's attempt to build the Eurasian Economic Union (EEU) as a counterpoint to the EU, which Russia is unlikely to join anytime soon – if ever. So Brussels' idea is to create a borderless space in the east to enable the free flow of goods, services and capital, which allows everyone to cash in on their comparative advantages and get that much richer than they could on their own.

Neither the political nor economic aspects of the Eurasian Economic Union make much sense without Ukraine, which is the fourth largest European country in terms of population after Germany, Russia and Poland. Russia has been wooing Kyiv with offers of cheap gas and threatening it with claims for a $7bn unpaid gas bill and a trade embargo,

which would cripple the already wobbly economy. On the other side of the fence the EU has promised to accelerate the association agreement benefits like open up its markets quickly to Ukrainian goods as well as promising hundreds of millions of dollars in short-term loans to see the country through the winter.

It has all become a bit unseemly and if the EU had any doubts about the cost of bringing a corrupt economic basket case into its fold, those have now been forgotten as both sides try to snatch Ukraine out of the hands of the other.

The summit has been transformed from a relatively routine, albeit high level, discussion of trade issues, into the venue for a geopolitical struggle and a clash of ideologies.

The edge Over the last few years Ukraine’s president, Viktor Yanukovych, has been doing the one thing he is really good at: playing one side off against the other.

However, about a month ago he had to finally choose and has publicly come down on the EU’s side – although knowing Yanukovych, he is bound to maintain his "will he, won't he?" approach to signing a full trade and association pact with the EU right up until the very last minute.

The indications are that Ukraine will indeed sign on the dotted line, but with such a devotee of brinkmanship as Yanukovych at the helm, there's always a chance there will be some last minute flim-flam.

Yet the simple fact is Kyiv has little to lose by signing other than a place on Vladimir Putin's Christmas card list, and plenty to potentially gain. The obstacle presented by having former prime minister Yulia Tymoshenko in prison on partially politically-motivated charges – her release had become a pre-condition to doing a deal in Vilnius – is shrinking by the moment as the unintended effect of Moscow's aggressive pursuit of Kyiv is to make the EU realise that springing Tymoshenko from jail might not be all that important as it once seemed.

As Steven Pifer of the Brookings Institution in Washington pointed out

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in an October op-ed for the US-Ukraine Business Council, Yanukovych is likely to be thinking rather more of his own job prospects than whether Ukrainian sausages will be labelled in accordance with EU regulations when the fateful fountain pen is placed in his hand.

"Integration is popular with average citizens, and 'I brought Ukraine into Europe' could prove a powerful theme for his expected re-election campaign [in 2015]," says Pifer.

Tymo time Far from being a boulder blocking the road to EU accession, the Tymoshenko case is, in the words of one Ukrainian ambassador who was speaking to bne, "the small stone in our shoe". In fact, by now it may even be a nice smooth bit of tarmac. With everyone talking about whether or not Tymoshenko will be sprung from jail, no one is bothering to ask much about Ukraine's kleptocratic government, its economy on the edge of the abyss and its stalled $15bn bailout with the International Monetary Fund (IMF), its corrupt court system, the vast amounts of dodgy cash being laundered

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European nationals should not depend on any single criminal case," Kozhara insists, adding that Tymoshenko might help her cause if she agreed to actually attend court occasionally.

The likeliest scenario is that Ukraine will sign its free trade and association pact in Vilnius while allowing Tymoshenko out of the country for medical treatment.

Then around the end of the year, some sort of presidential clemency will be declared so that Tymoshenko can emerge back onto civvy street while continuing to protest her innocence, and Yanukovych can look statesmanlike while saying it all shows how the legal system works and he didn't just buckle to an EU ultimatum. (Although she will probably remain a convicted felon, which in theory prevents her from running in the 2015 presidential race.)

Senior Party of the Regions MP and presidential advisor Hanna Herman has already signalled such an outcome as likely, saying on ICTV on October 1: "I believe that having signed the association agreement, and having

"Russia has been very aggressive in badgering the countries in its former backyard into joining the Customs Union"

by Ukrainian businesses (often with the help of Ukraine-connected banks based not a million miles away from Vilnius) and a range of other issues that should be of even more concern to EU citizens than whether the iconic Tymoshenko is eating too much porridge. "The Ukrainian leadership is specifically addressed to find a solution to that criminal case, but at the same time a positive resolution can be found only on the grounds of the Ukrainian constitution and Ukrainian law," Ukrainian Foreign Minister Leonid Kozhara tells bne.

"We understand the importance of the Mrs Tymoshenko case, but it is even more important that the relationship between 46m Ukrainian nationals and 500m

found our feet, the president of Ukraine, who is looking for ways out of this situation, will find a solution and ease the fate of his opponent.”

At that point the EU will congratulate itself on its wonderful diplomatic prowess and naive editorials will appear testifying to the importance of soft power – at least until everyone realises that despite signing up for the EU, Ukraine will carry on playing footsie with both the EU and the Customs Union. There is a big difference between signing an Association Agreement and the long, hard work of actually implementing it in any meaningful way, a fact that seems lost on Brussels in its eagerness to gazump Russia for Ukraine's betrothal.

There's also that stalled IMF bailout to consider. Ukraine needs some sort of deal and soon. With hard currency reserves dwindling at an alarming rate, economists say the economy will crash within a matter of months unless some new sources of financing are found. Borrowing on global markets has already become more expensive and analysts such as Capital Economics have pencilled in a 10% devaluation against the dollar by the end of 2014, with the chance of something far more dramatic in the wings.

That makes it far better for Ukraine to go cap in hand to the EU for cash than Russia. Not only will an EU Association Agreement help get the IMF back onside, but the EU doesn't have a habit of asking for control of major industrial and infrastructure assets in return for propping up someone else's economy, whereas Russia does (just ask Belarus).

And if the EU doesn't want to pick up the tab, Ukraine can always "do an Armenia" and start making apologetic noises while facing due north.

And all the others…

On which note, it should be remembered that the Vilnius Summit is supposed to be about five other Eastern Partnership countries as well as Ukraine. Of those, Armenia is already a test case for whether it is possible to be involved in both the Customs Union and European integration following its September 3 decision to sign up to the former – despite finishing negotiations over the shape of its own EU Association Agreement just two months earlier.

"We consider these processes not as mutually exclusive but complementary to each other," said Armenian PM Tigran Sargsyan ahead of that bombshell. If he can make that stick, it really would open up a new option for countries such as Belarus and even archenemy Azerbaijan, which have little appetite for core EU reforms but have no objection at all to being part of a free trade zone encompassing both the EU and CIS countries.

Much as Armenia's decision to sign up with Moscow was tut-tutted in Brussels,

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it should be remembered that not that long ago the EU itself was known as the European Economic Community (EEC), a group of countries with free trade as their main reason for clubbing together. All the talk about shared values and common identities was bolted on some time later.

In that context, the Customs Union may not be quite the Trojan horse that Russiabashers habitually assume it must be.

At the other end of the euro-spectrum from Armenia are Moldova and Georgia – two countries that have jumped through ten-times as many hoops as Ukraine in their efforts to join the EU, but which find themselves still trailing in its wake. At Vilnius they will be allowed only to initial their Accession Agreements when Ukraine gets to sign up properly. Understandably, they are started to feel decidedly miffed, like two polite and hardworking students who have been buying flowers and chocolates for months only to discover that the cheerleader they've been wooing has run off with the school's quarterback because he has big muscles.

Natalia Gherman's official job title in the Moldovan government is Minister of Foreign Affairs and European Integration, a clear indication of the primacy Moldova attaches to joining the EU. Initialing Moldova's own Accession Agreement will be "an important step" she tells bne, while admitting it would have been nice to sign in full in Vilnius.

She would like greater recognition of the way her country's entire government programme from visa reform to peacekeeping duties to tackling the frozen conflict with breakaway region Transdniester (without much help from Ukraine) is based on a "profound commitment" to doing exactly what is asked for by Brussels. "We have managed to integrate with the EU in a very advanced way. That makes us different to some of the other Eastern Partners because the commitment is taking a practical form now," she says.

According to Gherman, what is needed is clear "differentiation" between the Eastern Partners so that EU wannabes like Moldova and Georgia are no longer

Cover story

Customs Union popular, study finds

bne Substantial majorities in most of the potential Customs Union member states are in favour of joining the bloc, according to a study by the Eurasian Development Bank (EDB).

The EDB Integration Barometer, compiled by the EDB’s Centre for Integration Studies and the Eurasian Monitor research agency, finds that the highest level of support is in Central Asia. A full 77% of Uzbek respondents say they are in favour of joining the Customs Union and the Single Economic Space, the trade block Moscow is currently pushing so hard to fill with former Soviet states – especially those to the west that are flirting with the EU. In Tajikistan, 75% of respondents would be happy to join. In Kyrgyzstan, where the government has said it plans to sign up by 2015, 72% of respondents would like to see the deal sealed. The figures are even higher than in the existing member states, Belarus, Russia and Kazakhstan, where public support of the bloc stands at 65%, 67%, and 73% respectively.

Surprisingly, a majority of Georgians, 59%, are in favour of hooking up with the Russian-led bloc. The figure is twice as high as that recorded in the 2012 Integration Barometer. According to Eugeniy Vinokurov, director of the Centre for Integration Studies, the results demonstrate “a substantial change" in Georgian public opinion towards the Customs Union in general and Russia in particular. "We think that it creates a window of opportunity to normalise Russian-Georgian relations," he concludes.

Neighbouring Armenia is set to become the first state from the Caucasus region to become a Customs Union member after President Serzh Sargsyan surprisingly announced in early September that Armenia would join. Despite demonstrations in Yerevan against the decision – due to the fact that it will likely rule out closer association with the EU – 67% support the move, according to the survey, which was conducted in May, four months before the announcement.

By way of contrast, just 37% of Azeris would like to see their country join the Customs Union – the lowest level of support in any country of the Commonwealth of Independent States. Over half, 53%, regard the club negatively. Negative opinions have also increased in Moldova and Ukraine, reaching 24% and 28% respectively. However, 50% of Ukrainian respondents and 54% of those in Moldova said they supported Customs Union entry.

Meanwhile, the research shows that many countries in the post-Soviet space still consider countries outside the region to be the most attractive sources of foreign capital. In the fields of science and education, respondents also plumped for outside the region. Vinokurov points out that prominent education centres within the CIS, such as Moscow, Kyiv and St Petersburg, are becoming less attractive compared to the cachet of an education in the EU or US. Following the break-up of the Soviet Union, “the countries of the region experience difficulties building a new scientific and educational foundation,” he says.

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Putin’s dream of Greater Europe fades

bne Half a dozen counties from "new Europe" are due to hitch their wagons to the EU’s economic horse at the Vilnius summit in November, which looks like it could kill Russian President Vladimir Putin's dream of building a “Greater Europe.”

The Cold War is over, but relations between Russia and the West are still determined by the old animosities. And if anything, the relations between east and west have taken a nosedive just as Russia has started to get back on its feet. The fight to get Ukraine to join one club or the other epitomises the “them and us” mentality that still under pins much of pan-European politics.

Since he took office in 2000, Putin has been pushing to redefine the relationship between the former Soviet bloc and Western Europe, and lay the foundations on which to build a new reality. But to the Kremlin’s frustration it feels it has been ignored or rebuffed at every turn. “This concept [of a Greater Europe] has not emerged from a void: it is a continuation of ideas championed by Putin’s predecessors: Boris Yeltsin and Mikhail Gorbachev. It has re-emerged regularly as a general political slogan, and was conceptually developed only in 2010,” writes Marek Menkiszak, a political scientist at the Centre for Eastern Studies (OSW), in a recent paper.

Putin called Europe Russia’s “natural partners” in a famous speech in Munich in 2007 and warned that the region needed to meet Russia half way. Shortly after taking office in 2008, then president Dmitry Medvedev was in Europe and followed up with a call to draw up a new European Security Agreement during his first major foreign speech. Nothing happened.

It is clear why Russia would want to redefine relations. The old relations were set up specifically to contain a possible attack by the Soviet Union.

Today, Russia is severely weakened and unable to defend itself, which must be unsettling for the Kremlin.

At the same time, Russia is hoping to mimic the economic benefits from a pan-regional trade club. The creation of the Customs Union on January 1, 2010 – comprising Russia, Belarus and Kazakhstan – was the first concrete step in creating a new Eurasian Economic Union that creates a borderless space with no restrictions on the free flow of capital, goods and services that should make all the members wealthier.

By extension a Greater Europe, which would comprise both Eastern and Western Europe, would create an even bigger market that easily eclipses the US by both cumulative wealth and population. However, the tug of war over Ukraine’s loyalties has only underlined how polarised Europe has become.

“We need to concentrate on building relations and not reach for the policies of exclusion on the basis of ideological differences as that path leads back to the Cold War," said Mevlu Tolshol, Turkey’s member of the Council of Europe at the Kazansummit in September, offering Russia some solace from another country that also has a prickly relationship with the EU.

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bracketed with geopolitical mercenaries like Belarus and Armenia willing to sell their loyalty to the highest bidder.

"There is no real differentiation between the partners at this point in time from the European Union. I therefore advocate that the EU treats all Eastern Partnership countries separately on the basis of clear distinctions and differentiation between the countries that want to integrate into the EU, are eligible and deserve it by virtue of their commitment to reforms, and the countries that clearly even today say they don't have this ambition to integrate," says Gherman. "One size fits all will not be possible after Vilnius. It takes a tailor-made approach and the principle of 'more for more' - the more you reform, the more support you receive.”

In any case, even the closest of ties with the EU give no guarantee of immunity from Russian influence. The Eastern Partnership countries could do worse than ask their hosts in Vilnius. An EU and Nato member since 2004, Lithuania in October saw Russia impose sanitary controls on its dairy products and increase border checks on Lithuanian truckers. The effect was immediate and sent milk prices plummeting across the Baltic states (Latvia and Estonia both send milk to be processed in Lithuania).

If you want access to Europe's fastestgrowing consumer market, it's best not to moan about its government too much.

By the time Riga plays host to its own summit during Latvia's presidency of the EU in 2015, the chances are there will be no such thing as the Eastern Partnership in its current form. Rather, there will be a series of eastern partnerships with individual countries: some wanting to join the EU, some not, some having enacted reforms to their political and legal systems, some not.

Russia will still be there and will still be the EU's largest provider of energy – so maybe getting the biggest, richest and most influential eastern neighbour of all into some sort of partnership should be the EU's real priority instead of building up a buffer zone of half-in, half-out countries between the two spheres of influence.

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• Takedown and deletion requests that bypass the courts and simply threaten legal action or other reprisals like losing one's job – an increasingly effective censorship tool used against bloggers and activists in numerous countries like Russia and Azerbaijan.

Then, of course, there's the tried-and-tested physical attacks and murder. "In 26 of the 60 countries assessed, at least one blogger or internet user was attacked, beaten, or tortured for something posted online. In five of those countries, at least one activist or citizen journalist was killed in retribution for information posted online, in most cases information that exposed human rights abuses," say the report's authors.

Less freedom to surf

Sorry state Of the 60 countries included in the study that are in Central and Eastern Europe/Commonwealth of Independent States (CEE/CIS), Estonia scored particularly well, ranked the second freest behind top-placed Iceland. Also in the "Free" category was Hungary in eighth place, ahead of even the UK in 10th, Georgia in 12th, Ukraine (surprisingly) in 16th and Armenia in 17th.

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ncreased surveillance, new laws controlling web content and growing arrests of social-media users have caused a worldwide decline in internet freedom in the past year, according to a new study released October 3 by the democracy watchdog Freedom House. Countries of the former Soviet Union scored particularly badly.

The survey, "Freedom on the Net 2013", identifies key trends in internet freedom in 60 countries, and evaluates each country based on obstacles to access, limits on content and violations of user rights. Among the 10 most commonly used types of internet control were: • Blocking and filtering of political and social content over the past year – especially common in China, Iran and Saudi Arabia, though Russia intensified such blocking in the past year; • Cyber-attacks against government critics, especially in the run-up to politically charged events like elections – in countries ranging from Belarus to Vietnam to Bahrain, opposition figures are routinely targeted with malicious software that is masked as important information about political developments or planned protests; • New laws that criminalize speech, either explicitly or through vague wording that can be interpreted in such a way – Turkey and Azerbaijan are among the countries that have, over the past year, significantly stepped up arrests of users for their online activism and posts; • Paid pro-government commentators to discredit the opposition – a method spearheaded by China and Russia, and increasingly common in countries like Belarus;

"Access to the internet in Armenia has significantly improved over the past few years, with the internet penetration rate increasing from approximately 6 percent in 2007 to 39 percent in 2012," Freedom House notes.

In the "Partly Free" category came Kyrgyzstan (23rd), Turkey (38th), Azerbaijan (39th), Russia (41st) and Kazakhstan (44th). In Azerbaijan, the report says the government there is practicing what has been termed “networked

"Of the countries in CEE/CIS that were included in the study, Estonia scored particularly well" authoritarianism” – a middle path between open access and censorship, where online content is relatively uncensored.

"Over the course of the last few years, Azerbaijan has acquired a vibrant and rapidly growing online community… [and] its limited, though growing, community of users has yet to see any major restrictions imposed on the technical level, given the country’s ongoing commitment and eagerness to promote itself as a leader of information and communication technology (ICT) innovation in the region," says the report.

In the "Not Free" category was Belarus (50th) and Uzbekistan (55th), which was just ahead of such luminaries as China (58th) and Iran in last place. Uzbekistan remains one of the most restrictive in Central Asia, the report notes. "The Uzbek

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authorities block access to a wide range of international news websites, human rights groups, and exile publications, while at educational and cultural institutions, access is strictly limited to the national intranet system, or ZiyoNet,"

"The only countries in the CEE/CIS region improved their score were Estonia, Belarus and Georgia"

it says. "A popular online news site, Olam.uz... was shut down in January 2013 due to the politically motivated

Freedom on the Net 2013 A global assessment of internet and digital media

Source: Freedom House

charges against its owner and editor-in-chief. Additionally, two journalists reporting for online media are serving long sentences on trumped-up charges."

Finally, the report notes that the only countries from the CEE/CIS region that improved their score from last year were Estonia, Belarus and Georgia; the rest had worsened.

However, the report was not all doom and gloom. It also found that activists are becoming more effective at raising awareness of emerging threats and, in several cases, have helped forestall new repressive measures. "While such positive initiatives are significantly less common than government attempts to control the online sphere, the expansion of this movement to protect internet freedom is one of the most important developments of the past year," it says.

Free

Partly Free

Not Free

Country Not Assessed In 2013

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Tatarstan – Russia's magnet for Islamic world Ben Aris in Kazan

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ussia’s relationship with the Arab world has been a focus of attention recently, but the reporting is mostly negative, with Syria in particular described as a Russian “client state.” However, at the start of October, high-level delegations from Qatar, the United Arab Emirates (UAE), Singapore, Malaysia and other countries of the Organization of Islamic Cooperation (OIC) gathered in Kazan, the capital of Tatarstan, to sign off on about $1bn worth of investment deals. Despite the hyperbole, Russia is building deep economic ties with the Muslim world and Kazan is leading the way.

Kazan is special in several ways.

First, it is the capital of the Tatarstan autonomous republic in the heart of Russia and as such enjoys a lot

of independence from the federal government. It even has its own president and parliament, and runs an investment policy pretty much independently from the Kremlin.

Second, it is a predominantly Muslim region, which adopted Islam just over

above the walls of an equally ancient Kremlin at the heart of the city. Investors from Islamic countries are likely to feel more comfortable investing in Kazan than in any other Russian city. “There are foreign investors and several projects already in Tatarstan and other regions of the Russian Federation,” said Linar

“The UAE has already invested some $8bn into the Russian Federation, which makes us one of the top ten biggest investors into Russia” 1,100 years ago. Like the rest of Russia, the local Muslims live cheek by jowl with their Orthodox brethren, symbolised by the minarets of the main mosques rising

Yakupov, chief executive of the Tatarstan Development Agency (TIDA). “But the time has come to move on and deepen those relations between our countries.”

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Link between east and west The Tatarstan government identified the notoriously cautious Arab investors as potential partners five years ago when the first "Kazansummit" was held at the instigation of the republic’s first president, Mintimer Shaimiev.

A smart city in the making

bne From a humble start in 2009 when only 50 delegates made the trip (including your correspondent), the summit has emerged as the main nexus for economic ties between Russia and the Islamic world. This year the numbers swelled into the hundreds, including 250 foreign delegates from 43 countries, many of whom were sporting the traditional thawb robe and headscarf of their home countries. “This is the fifth year of the 'Kazansummit' and our city is turning into a key link between east and west,” said Tatarstan's current president, Rustam Minnikhanov, in his keynote speech.

“Tatarstan adopted Islam in 922AD and today we are building a city to celebrate this heritage – a spiritual and cultural monument that is embodied in the Kazan Smart City,” the president said, referring to a new high-tech development that just broke ground a few miles to the south of the city centre, which will be a $10bn focal point for new investment.

To underline the region's openness to Sharia-compliant investment, an imam, who recited from the Koran, opened the main session. And the region has already made a lot of progress. It has two halal food-processing factories that were the first from Russia to be accredited for export to the UAE and the region has been working on setting up Islamic banking, which is still an uncomfortable fit with current Russian banking regulation.

This year saw ministerial delegations from Qatar, the UAE, Malaysia, Morocco, Sudan, Senegal, Saudi Arabia, Pakistan and Turkey in attendance. These countries are members of the OIC and the theme of the conference was building business and investment ties between the OIC

On October 1, the president of Tatarstan, Rustam Minnikhanov, broke ground on Kazan Smart City, the first high-tech city to be built in Russia.

“Our region is strong in petrochemical, automotive, oil and gas, and agriculture, but the idea of the Smart City is to promote new sectors – medical, education, high tech and tourism – to make Kazan a hub for innovation in Russia,” Bulat Gayanov, CEO of Tatarstan Development Corporation (TDC), said at the "Kazansummit 2013".

The site of the 650-hectare plot is to the southwest of the beautiful Kremlin and only a few kilometres from the international airport. The territory contains homes for 40,000 workers and their families, and has a high-speed rail link to Moscow that is being built for the 2018 World Cup. The first stage of building out the infrastructure and accommodation should be completed by 2015, and a total of $10bn will be invested by 2020 to complete the city, if everything goes according to plan.

There are three main areas: an education complex, a business complex at the heart of the city, and the high-tech park in the southern part of the city. And 16 plots have already been taken.

The biggest investor is Tatarstan Gulf Investment Company, which is investing $760m in commercial real estate development. Singapore’s Radiance Hospitality Group has already committed to building a university specialising in the hospitality industry in the education section, which will try to bolster Kazan’s efforts to promote local tourism. Radiance signed an agreement with the TDC in March making it the first investor in the Smart City. Initially, the Hospitality and Management University will have 500 students, rising to 5,000, mostly drawn from the region, who will graduate with a degree issued by the London School of Economics. Malaysia’s Advanced Tertiary College has also committed to build a University of Management and Tourism.

In the north is a business park that is also home to three hotels – a transit hotel that will also be built by Radiance, and a four- and a five-star hotel – where construction is due to start soon. “The idea of the city is to make use of advantages of high technology. It will have its own power station that is controlled by an intelligent system. Heat, telecoms, internet, parking, traffic – everything is integrated by the most up-to-date systems to create a city of the future,” says Gayanov.

Also 102 hectares of the city is a special economic zone (SEZ), where the corporate tax rate been slashed to 2% for the first five years of operation, rising to 7% for the next five years before reaching 15.5% after a decade.

Businesses registered on the remaining territory of Kazan Smart City enjoy a lower corporate tax rate of 15.5%.

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Yanukovych faces defeat in 2015 So Ukraine's Orange Revolution might have been worth it after all.

Viktor Yushchenko, who became president in 2005 after big street protests overturned a dubious election, proved to be a disappointing flop and was voted out of office in 2010. He was replaced by the man that had "won" that disputed election, Viktor Yanukovych.

President Yanukovych quickly reinstalled the oligarchic kleptocracy of Yushchenko's predecessor, Leonid Kuchma, and got down to the serious business of asset-stripping the country.

Ukraine’s economy has been so mismanaged it is now teetering on the brink of yet another financial crisis, even as the rest of the region shows signs of recovery.

But it turns out that the people’s efforts in 200405 might not have been in vain if the most recent polls are to be believed, because Yanukovych will be defeated at the next election in 2015 – a result that would show elections now mean something in Ukraine and simply being in control of the government doesn’t mean one controls the political process.

According to a poll by Ukraine’s Rating Sociological Group, in the first round of the 2015 election Yanukovych would win 24% of the vote. Jailed former PM and Batkivschyna Party leader Yulia Tymoshenko – if she weren't barred from running – would win 21%, while the new kid on the political block, world heavyweight boxing champion and UDAR Party leader Vitali Klitschko, would get 19%.

The same poll predicts that if the elections go to a second round – as they should with these numbers – either of the opposition candidates would comfortably beat Yanukovych.

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and Tatarstan. "In Russia, Kazan is a new site that can bring together Russia and the Islamic world," said Minnikhanov at a business breakfast that opened the first day of the event.

Moreover, this year the Russian Ministry of Foreign Affairs sent its ambassador-at-large, Konstantin Shuvalov. In the increasingly aggressive competition with the US to foster spheres of influence, Russia’s relations with the Muslim world have become more important, and the foreign ministry’s job has been made easier by the government of Tatarstan already breaking the ice. The "Kazansummit" is emerging as the key event in the calendar for promoting Russian-OIC relations.

“Developing cooperation with the Islamic world is a priority for the Russian Federation,” said Ambassador Shuvalov. “This is not just empty words; it is the result of building up long-term strategic interests. And it is important as we can see everywhere Islamic nations are going through a period of deep transformation – sometimes dramatic, sometimes tragic – but it is leading to a new economic reality. So it is important for us not to waste time, but to act now and build the economic foundation for a new partnership.”

The foreign trade turnover of Tatarstan with the countries of the OIC has soared in recent years. The main guest was OIC Secretary General Ekmeleddin Ihsanoglu, who said in his speech that

trade between OIC member countries and Russia has grown from $6bn in 2010 to $8bn today, again with the lion's share coming to Tatarstan. “Trade with the OIC countries has already tripled in recent years and we can participate in the building financial infrastructure and contribute to the economic development of Tatarstan and the Russian Federation as a whole,” Ihsanoglu said.

Trade with the UAE alone reached $2bn last year, or 9% of the region's total foreign turnover, and the UAE is now one of the ten biggest investors in Russia, much of which has been directed at Tatarstan. “The UAE has already invested some $8bn into the Russian Federation, which makes us one of the top ten biggest investors into Russia,” said Abdullah Al Saleh, undersecretary of the UAE’s Ministry of the Economy. “Our relations are built on mutual cooperation and will continue to flourish.”

However, it is Turkey where the most progress has been made. Turkey and Russia have been trading partners since Soviet times and the more secular Turks are already big players in Russia’s real estate sector, among other things. Trade with Turkey is also running at about $2bn a year, making it one of Russia’s and Kazan’s biggest trade partners.

“Tatarstan's contribution to building new ties has been very valuable in helping to build new economic ties with Islamic countries,” Ambassador Shuvalov said.

“Tatarstan is a pioneer and the initiator of this effort.”

It seems that Yanukovych is powerless to stop the democratic juggernaut, as any fix he attempts would have to be so blatant it will probably bring the people out onto the streets again.

“The UAE has already invested some $8bn into the Russian Federation, which makes us one of the top ten biggest investors into Russia”

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from a criminal investigation into theft of Ukrsotsbank property that was prompted by a complaint from the bank itself.

UniCredit looks for a way out of Ukraine Graham Stack in Kyiv

A

s if a looming financial crisis in Ukraine weren't enough to deal with, UniCredit Group is also having to deal with a dangerously escalating row between its Ukrainian subsidiary and a major debtor. The Italian bank is now ready to join other European banks that have left the country, licking their wounds – as soon as it can find a buyer.

Ukrsotsbank, Ukraine's sixth largest bank by assets, has accused the country's fraud squad of exceeding its powers during a raid on its Kyiv headquarters on September 20, which was carried out in connection with a court case brought by a major debtor of the bank. This is the first time a major European-owned bank has been raided by police in Ukraine and indicates that a wave of conflicts between international banks and debt welshers that have erupted since the economic crisis broke in 2008 shows few signs of abating.

“The bank expressed readiness to provide all documents and information regarding the request, but the officers launched an active inspection and ensuing removal of documents and computers from all premises of the

central bank offices, including those not on the court list,” Ukrsotsbank said in a statement September 23. “The bank regards such behaviour during a search as an abuse of power… such precedents fundamentally spoil not

In an apparent escalation of the conflict, on September 24, documents were leaked onto the internet pointing to a criminal case building against the bank. The leaked documents contain the protocol of a police interrogation of an official employed in the state registry of deeds, who alleges that he was forced under threat of physical violence to re-register disputed real estate assets built by Prime ISA to Ukrsotsbank, despite them having been frozen under court order at the time. This testimony could have served as the pretext for the police to search for documents believed hidden by the bank.

Ukrsotsbank CEO Graziano Cameli was called in for questioning by police following the raid. ISA Prime later put out a statement denying any connection to Ukrsotsbank's problems with the police, though the developer's CEO, Aleksandr Bashenko, does not deny the existence of the dispute. "The problem started not with us, but with the bank,"

"European-owned banks have been devastated by loans going sour in Ukraine" only the image of the bank but also the business climate for European investors.”

The root of the conflict is apparently a whopping $190m lent by Ukrsotsbank to ISA Prime Development and a string of related companies to build office towers in 2005-2007 – in fact, before UniCredit even purchased the bank in 2007. According to Ukrsotsbank, ISA Prime stopped servicing the debt after the crisis hit Ukraine in 2008, and it has since allegedly tried by hook or by crook to remove its properties that are under pledge to the bank. The court order backing the September 20 raid on Ukrsotsbank derives, ironically,

Bashenko claimed in a statement on September 24. "It stopped its funding and started to seize our properties instead of a constructive dialogue. We finished construction of the objects with our money, spending over $170m to do so."

Ukrsotsbank disputes this, saying the “talks had been going on for over two years, but the negotiations period was used by ISA Prime management to strip leased real estate objects from under pledge and not to settle the debt situation.” The bank believes ISA Prime's annual income from leasing the properties to have been around $25m.

As a result, the bank's press service tells bne, Ukrsotsbank had no choice but

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to file a complaint in order to open a criminal case for property theft.

The dispute turned nasty last year.

In April 2012, in what Ukrsotsbank representatives have suggested were attacks linked to the dispute, a yacht belonging to the bank's long-serving CEO Boris Timonkin went up in flames, and a number of cars owned by top managers followed suit. The parent bank UniCredit wrote a letter to Ukraine's president, Viktor Yanukovych, referring to physical threats made by ISA Prime against it, according to media reports. In a further twist, Timonkin, against whom most of Bashenko's wrath was targeted publicly, suddenly quit the bank in June of this year.

The big guys In a lengthy interview in Forbes Ukraine in January, Bashenko portrayed himself as a self-made man who had been undone

by Timonkin's overgenerous disbursal of credit pushed on his company during the pre-crisis lending boom.

Timonkin has acknowledged having had targets of 50% annual growth in the bank's credit book prior to 2008, but the huge volume of loans dispensed to ISA Prime Development between 2005 and 2007 – a volume even the Ukrainian state has difficulty attracting these days – points to weightier backers than Bashenko, whose only official position is deputy president of Ukraine's Federation of Cyclists.

Apparently, it was after two of Ukraine's richest families, chemicals oligarch Mykhailo Yankovsky and banking brothers Sergei and Oleksandr Buryak, became shareholders in ISA Prime in 2005 that loans from Ukrsotsbank really started to flow. According to the Spark Interfax database, there are two ISA Prime Developments – one private joint stock company (PrAT) where Bashenko is CEO and co-owner, and a limited liability company (TOV), which featured Bashenko as co-owner only until 2005. After that, Yankovsky and the Buryaks took parity stakes.

These men had not just financial but political clout: Yankovsky was

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a senior MP of the now governing Party of Regions, and Sergei Buryak is a founding member and MP in Yulia Tymoshenko's ByuT party, who also headed Ukraine's tax service from 2007 to 2010. He currently serves as first deputy chairman of the budget committee of Ukraine's Rada. Yankovsky could not be reached for comment, and Buryak was not answering his Rada office telephone.

According to the Interfax Spark database, the Buryak brothers sold out their stake in TOV ISA Prime to Donetskbased Yankovsky in August 2012. In July this year, the Buryaks then sold 80% of their Brokbiznes Bank, a top-20 bank, to dark-horse fuel-trader Sergei Kurchenko, for around €200m, according to Forbes Ukraine. Intriguingly, Ukrsotsbank CEO Timonkin left Ukrsotsbank in July to oversee Kurchenko's banking business, including Brokbiznesbank, where the Buryaks have kept the funds from the sale.

The bank is keeping mum over whether oligarch shareholders are implicated in the conflict. In previous public conflicts with alleged major debt welshers, such as with diner chain Puzata Khata, the bank has refrained from crossing swords directly with powerful shareholders of recalcitrant borrowers.

Mired in debt European-owned banks have been devastated by loans going sour in Ukraine. In a series of negative reports about the Ukrainian economy and its banking sector this week, Moody's Investors Service said it reckons problem loans at Ukrainian banks will amount to 35% of all loans by the end of 2013.

The reasons cited why foreign banks have been particularly hard hit by bad loans is not just because they lent recklessly in the run-up to the crisis, but that – according to their debtors – they are not "flexible" enough when it comes to restructuring. Experts say they are also more vulnerable than Ukrainian-owned banks to skulduggery by borrowers hijacking state bodies and dodgy courts.

A leaked US diplomatic cable from 2009 entitled, “Extortion, bribes and threats: A Kyiv banker laments”, detailed the full extent of the misery – the fact that borrowers perfectly capable of paying on debts were using the crisis as an excuse to renege on their debts. The cable, quoting an extensive interview with a top executive from Austrian-owned Raiffeisen Aval, Ukraine's second largest bank, detailed how “secondtier oligarchs and members of the Ukrainian parliament are extorting from the country's banks and threatening bankers.”

“The powerful borrowers act with impunity, having paid off the court system to evade their debt obligations,” the banker complained, detailing physical threats to bank personnel similar to “Russia in the 1990s” and saying the bank was crippled in disputes with debtors by refusing to bribe judges despite “a court system that exudes corruption”. The current Ukrsotsbank conflict suggests nothing has changed.

Looking for an exit As a result of the disastrous legal situation and poor macroeconomic fundamentals, Ukraine's Europeanowned banks are rushing for the exit.

On October 3, UniCredit CEO Federico Ghizzoni acknowledged he was looking for a buyer for Ukrsotsbank.

Forbes Ukraine reported on October 14 that Austria's Raiffeisen Bank International (RBI) is also looking to sell Raiffeisen Bank Aval, its Ukrainian subsidiary bought with much fanfare in 2005 for a huge price of around $1bn.

RBI has since denied it is looking to sell up, but the bank's future in Ukraine does appear shaky after the departure of its emerging market champion Herbert Stepic as the result of a scandal in July. His replacement, Karl Sevalda, in August announced a change of strategy, saying the bank would focus in the future on Central Europe, Romania and Russia. Ukraine was notably absent from that list.

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Discrimination is widespread, institutional and casually accepted by most ethnic Slavs. Advertisements seeking rental property routinely point out that prospective clients should belong to a Slavic nationality. Parents try to avoid enrolling their child in a school with a strong non-Russian presence.

They claim it’s because a child would pick up habits of an alien ethos and learn Russian that is far from perfect.

Photo: ITAR-TASS

Kremlin rhetoric worsens immigrants' plight Julia Reed in Moscow

M

oscow police rounded up and arrested more than 1,000 migrant workers at a vegetable warehouse on October 14, the day after rioters staged the most violent nationalist unrest in the Russian capital in three years, with more than 3,000 going on the rampage, smashing up a market, overturning and burning cars, before clashing with police.

Racial tensions in the capital are on the rise once again, just as the Kremlin has been playing the nationalist card in response to the rise of an increasingly legitimate opposition movement. It is an effective and popular stance with the conservative Russian population.

Hidden behind the Iron Curtain in the 1960s, Russia missed out on the wave of liberalism that swept the western world and is only in the process now. Racism is endemic and deeply entrenched in Russia, and with the government fanning the flames for political ends, inevitably this has led to violence.

Riot police battled and arrested hundreds of Russian nationalists after they raided a warehouse in southern

Moscow that is used by migrants.

Police were searching of the man they blamed for the murder of a young ethnic Russian, Yegor Shcherbakov, who was killed on October 10. On October 15, police arrested a 30-year-old citizen of Azerbaijan, Orkhan Zeinalov, on suspicion of committing the crime.

Strangers in our midst There is hardly any other group of people less liked in Moscow than migrants, especially if they come from

The dislike of migrant workers is not a recent phenomenon. Moscow has historically enjoyed a much higher standard of living than the rest of Russia because it lived on federal money.

There is even a joke that the problem with Moscow is that it is surrounded by Russia on all sides.

In the Soviet times the capital’s residents frowned on those from the provinces. They were labelled limitchiki (workers who came on government quotas) and also blamed for taking more lucrative jobs and wanting to occupy valuable Moscow property, as well as for their lack of education and common manners.

By the 1990s, with the expansion of Moscow and rapid growth of economic and political migration from Russia and the former Soviet republics, core Muscovites became a minority. While a significant number of well-educated professional Muscovites left Russia, Moscow has continued to be the magnet for both rich and poor for Russia at large and the Commonwealth of

"I don’t like the way I’m being treated. I am a highly qualified engineer, but here people treat me like a slave” the Caucasus or Central Asia. Migrants, commonly referred to as gastarbeiteri by the Russian media, are usually disliked and avoided for their dark skin, unfamiliar language, sometimes different faith and a tendency to form diasporas and enclaves.

Independent States (CIS). Much like in the Soviet times, it has preserved its reputation of the mighty capital of the former Soviet empire. Whoever made it big elsewhere would flock to Moscow to enjoy their prosperity. And of course many more migrants moved to Moscow

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to avoid poverty, unemployment and political unrest at home.

The anti-immigrant sentiment is very strong across Russia and spans across all classes, backgrounds and ages. It's especially present in older people who remember the Soviet times when all ethnic groups lived in their respective regions and republics, and would only come to Moscow to receive higher education or on short, organised tourist visits.

The official rhetoric widely supports the general public opinion that immigration

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with my brother-in-law 10 years ago.

I have a university degree in electrical engineering but here I am a jack-of-all trades in a private house.”

It is the peoples from Russia’s southern belt with the dark skins that receive the worst treatment. However, conditions at home are usually far worse, so they stomach hard jobs to send money home to wives and children. “I work pretty much around the clock for three months, then go home for a month, then come back again. At home I have a wife and a son. I get paid RUB20,000 a month (about $666) by the housing cooperative,

"My business is a complete secret from anyone” should be tightened, with recently a provision being discussed that the CIS nationals must enter Russia only on their national passports and the reinstatement of the old Soviet practice of propiska – the right of residence granted only to those with an official registration. It is also widely recognized that the influx of migrants, both legal and illegal, has to do with corruption in the immigration system.

Yet all these ideas fade in the face of the reality that the economies of big cities like Moscow are completely dependent on migrant labour. The Uzbek yard cleaner has long replaced the more traditional Tatar from the Soviet Union.

Since every construction site in Moscow is unimaginable without Tajik workers, it’s not uncommon for all the signs to be in their native language. Many school populations consist of at least 50% migrant children.

While Muscovites almost openly dislike migrants and don’t make much contact with them, they routinely use their services simply because they cost half as much as employing a Slav. “My family is from Moldova. First my parents came to Moscow about 15 years ago. My mother works as a house cleaner, my father does odd jobs,” says Andrei Vieru, a 36-yearold migrant worker. “Then I came

plus I get to do private jobs in electrics, plumbing or wall painting from the house residents. They pay another RUB2,000 per visit on average ($66),” says Vieru. “I live in the basement of the same house with my brother-in-law. My pay isn’t enough to bring my family to Moscow and also at home they have a much higher standard of living with the money I bring, living in a house with a garden.

But I don’t like the way I’m being treated.

I am a highly qualified engineer, but here people treat me like a slave.”

And it is not just immigrants from the Caucasus that come; Russia is also significantly richer than other Slavic nations like Belarus and Ukraine, whose people also suffer discrimination and poor working conditions. “There was no work at home and I came to Moscow,” says Vera Kravchuk, a 55-year-old migrant from eastern Ukraine. “I rent a flat here together with my son and work as a nanny for a well-to-do Russian family who live in the country house. I get paid RUB40,000 ($1,333) a month and work six days a week. Eventually I will probably retire in Ukraine, but I still have to earn my pension money. I’m used to my life now and like my job, but I have no real future here.”

Papers! Passport!

Many of these workers either don’t

have work documents or in the case of the Ukrainians they have to cross the border every three months to renew their temporary status. Getting officially registered is beyond most because of the bribes involved. “I went through a fake marriage to get a Russian passport,” says Natasha Sedovchenko, another Ukrainian immigrant. “I got it after three years of ‘marriage’ and now I work legally. If I didn’t sort out my citizenship, I would not have had any prospects of finding legal employment”.

However, even these people have some hope of building some sort of permanent life in Russia if they can navigate the bureaucratic obstacle course. Other immigrants from nations friendly with Russia are simply living on borrowed time. “I am from Syria,” says Nur, who wouldn’t give his surname.

I came here 19 years ago to study medicine and never left since then.”

Nur speaks excellent Russian and is reasonably well dressed in glasses and smart casual clothes. He doesn’t look obviously Arab and so doesn’t stand out too much. But he lives a precarious life. “I lost my passport 10 years ago and never got a new one since I would have been jailed in Syria for avoiding military service. Now I own a small business making oriental sweets outside of Moscow. It’s just a few rooms on the grounds of a neglected factory.

My business is a complete secret from anyone,” says Nur, who has to sell his sweets to Russian shops through Russian intermediaries.

All of Nur’s staff are also from Syria, most of whom entered on tourist visas and simply stayed. Not speaking Russian and having no papers of any sort, they are all too scared to leave the factory’s territory. “The car I drive I bought in my Russian ex-girlfriend’s name. I have a fake driving licence. I am a careful driver, so I don’t get stopped much,” says Nur. “If I do, they will be looking at a foreign driving license with an Arabic name. Mine is even expired but they don’t notice it. I have no intention of going back to Syria, at least not for a long time”

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month decided yet again to leave them unchanged as inflation was still above target at 6.1% in September.

Another reason is that the government has rather perversely chosen now to implement its own version of austerity, imposing the first real budget cuts in a decade and reducing its oil price assumptions used in the budget. This bucks the global trend of austerity being abandoned and spending increased to pump-prime growth in flagging economies.

Russia's brave bet on organic growth Ben Aris in Moscow

R

ussia's growth over the first nine months of this year was 0%, Deputy Economic Development Minister Andrei Klepach said on October 15. While the rest of the world is fixated on trying to spur growth, the Kremlin is largely ignoring the problem of its stagnating economy, preferring to concentrate on the deeper problem of persistently high inflation. It is a brave bet that assumes Russia will be lifted out of its economic malaise by organic growth next year.

The first question that springs to mind is: will it work? The short answer is that despite the recent disappointing data, Russia has some really big fundamental advantages – and not just its massive $500bn-plus cash pile (although that helps a lot, of course).

Low unemployment, low debt levels and rising incomes all combine to put Russia in a totally different place to the rest of the world. On balance, there is a good chance that the bet will pay off – and if it does, then Russia will be much better placed to put in many years of strong growth.

Stalled But first the bad news. After almost a decade of 6-8% GDP growth, much has been made of the economy now effectively stagnating. Nominal GDP growth over the first six months of this year was a meagre 1.5%, but in real

Russian government spending has been rising by between 20% and 40% a year for most of the last decade, but this year spending was slashed by 5% in real terms and big expenditure programmes, like re-equipping the military, have been put off until at least 2014. At the same time, tariff hikes on things like power have been frozen for a year – they were supposed to be increased by some 15% this year – which is a throwback to the inflation-busting policies of the 1990s.

This starves utilities of investment capital.

And various ad hoc measures have been introduced. There is an unpopular change to the way state pension fund contributions are calculated to create extra cash for the budget, and the Kremlin says it will dip into the Reserve

"The government has rather perversely chosen now to implement its own version of austerity" terms there was no growth at all, said Trade and Economic Development Minister Alexei Ulyukayev in October.

Russia’s economy has stalled.

Part of the reason is that the Central Bank of Russia has kept interest rates high (8.25%), making borrowing unaffordable for many companies, while the rest of the world has cut rates to near zero to spur growth. Indeed, despite monthly predictions by economists it would cut interest rates, the CBR this

Funds to pay for infrastructure spending next year.

The reason for these measures is that the budget is about to go into deficit for the first time since the Yeltsin-era – as soon as the fourth quarter of this year – and deficits are anathema for this government. “The annual target for government expenditures this year is RUB13.4 trillion ($419bn) but the government will spend RUB4.4 trillion in the fourth quarter, implying

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a substantial increase in spending from the average quarterly tally over the first nine months of RUB3.0 trillion. So the budget will run a small deficit for the full year, which will be covered by borrowing,” Evgeny Gavrilenkov, chief economist with Sberbank CIB, said in a recent note.

Maybe the biggest concession to the slowdown has been the decision to borrow more. The budget includes $7bn of international borrowing a year and Russia got a Eurobond issue away in September for this amount. But from next year instead of issuing one bond, the state plans to hold bond investor meetings every three months or so and could increase the amounts offered. The Finance Ministry also just announced it will increase domestic borrowing to

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same time, capital flight is running unchecked, at about $12.9bn in the third quarter and $48.1bn over the first nine months – way ahead of the CBR’s forecasts at the start to this year of $10bn for the whole year.

So the Russian economy is going to hell in a hand basket, right? Well, not quite, as there is some good news too.

Focus where focus is needed Despite the economic slowdown, the CBR is probably right to focus on bringing down inflation over boosting growth.

One of the reasons that Europe has to do something about its lack of growth is so it can grow its way out of the debt hole in which it finds itself:

"Maybe the biggest concession to the slowdown has been the decision to borrow more" RUB800bn ($25bn) by 2016 – almost double the RUB440bn it is expected to borrow this year.

These measures are all a bodge to keep the show on the road – the economic equivalent of putting duct tape on a hole in the roof. In the meantime, things are continuing to get worse; the economic slowdown is now starting to affect incomes and shopping, which has replaced oil as Russia’s main economic engine. Retail trade decelerated in August by 4% on year on the back of a slowdown in growth of real incomes by 2.1%, reports Rosstat. A further drag on consumption comes from the CBR’s decision to crack down on the white-hot consumer lending by imposing much tougher conditions on retail-oriented banks this year.

And domestic companies are equally pessimistic, with growth in corporate borrowing in the red, which in turn meant that capital investment – usually another economic driver – also turned negative again in August. At the

between 80% of GDP and 130% for most countries on the Continent.

Even the US' debt burden is now over the unsustainable 100% of GDP. By comparison, Russia’s sovereign debt/ GDP external debt is only about 14%.

A second reason is that unemployment across Europe is running extremely high, with youth unemployment in countries like Spain at over 50% - a potentially explosive situation. In Russia unemployment is at 20-year record lows.

Third is that the standard of living in the West is falling, with per-capita incomes in the US, for example, falling by $1,000 a year for the last five years. In Russia average incomes continue to rise, although the rate of growth has slowed this year.

Thus, the average Russian hasn’t really been affected by the crisis or the subsequent slowdown. Anyone who wants a job has one. Their pay continues to rise. And the chance of

another crisis seems remote. However, having lived through almost a decade of hyperinflation, Russians have a deeply ingrained fear of inflation, which also eats into their savings; savings they rely on for their old age in lieu of a properly functioning pension system. High inflation is Russians' biggest concern, with 68% of respondents putting it as worry number one in a poll by the Levada centre earlier this year.

The government has a lot more time and space to deal with its economic problems than the rest of the world and has chosen to deal with the deep structural problem of inflation first, banking on a global recovery to provide the stimulus to spur growth, rather than trying to engineer it with rate cuts and stimulus programmes.

And that doesn’t seem like such a poor bet. The global economy seems to have passed through the nadir and economists are almost universal in predicting an upswing in 2014. Russian growth may only be 1.5% this year – the slowest since the 1990s – but the consensus is it will pick up to 3% next year.

Indeed, foreign investors seem a lot more optimistic about Russia’s future than the Russians themselves.

Domestic investment may be negative, but Chinese investment in Russia is up 40-fold in the last eight years to $4.9bn by the end of 2012. Likewise, Russia has seen a bum-rush of European retailers arrive in the last few years.

Russian President Vladimir Putin said in September that foreign direct investment into Russia has trebled in the first six months of this year alone to $55bn and this shows no sign of slowing down.

The irony here is that the Kremlin needs to do more to convince its own business people to invest in Russia if it wants the boom times to return. It is the return of flight capital that really fuels growth in Russia, not foreign investment.

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Electrifying Russia's business climate Artem Zagorodnov in Moscow

O

ne of Vladimir Putin's first acts on being inaugurated president on May 7, 2012 concerned launching a series of "road maps" to improve Russia's position in the World Bank's "Doing Business" survey from 118th place to 50th by 2015 and 20th by 2018, by slashing bureaucracy and red tape. With Russia's economy stagnating and investment scarce, one of the panels at this year's "VTB Russia Calling!" investment forum focused on the progress than has been made over the last year and looked toward the release of the next survey on October 21.

“This is the first time business and the Russian government have sat down together to develop solutions and monitor their implementation,” said Artem Avetisyan of the Agency for Strategic Initiatives. “Over 800 people have worked on the road maps, with another 14,000 involved via crowdsourcing. At this point the road maps are 49% complete.”

Last year Russia scored lowest in the Getting Electricity (184th place) category with a record 281 days required for a connection versus an average of 98 in Organisation for Economic Co-operation and Development (OECD) countries.

“The World Bank has already recognized us as leaders in reforming this sector,” said Sergei Belyakov, deputy economy minister.

Oleg Budargin, CEO of the Federal Grid Company, believes big progress has been made in the sector. He noted that in reliability (the number of outages) Russia had already surpassed many developed countries, and that outages in Russia last an average of 0.9 hour versus 1.7 hours in Europe and 3.3 hours globally.

“We've reduced the cost of an electricity connection by three-times from RUB9,500 in 2009 to around RUB3,000

today. This has led to a subsequent increase in applications from 200,000 then to 416,000 in 2012,” he said.

Knowledge economy Several business sectors are already benefiting from the improving business climate. “Retail has grown to 20% of the GDP and pays 10% of the nation's taxes,” said Ilya Yakubson, president of Dixie, one of Russia's largest and fastest-growing budget retail chains.

“There were 3,000 supermarkets opened last year. This is a good barometer – you can't experience 25-30% annual growth like we have in a poor business environment.”

Anatoly Karachinsky, co-founder and president of IBS Group, one of Russia's largest IT consulting and solutions companies (its subsidiary Luxoft listed on the New York Stock Exchange earlier this year), noted that Russia's other great competitive advantage apart from hydrocarbons is high-tech, which he ascribes to the country's superior education system. “Despite a lot of criticism, I've compared our public education system to those of other BRICS countries and we are ages ahead,” he said. “In the US and Europe, only 18 and 22% of college graduates respectively, majored in non-humanities a generation ago, because parents pushed their children away from engineering and into fields like business. Nobody knew that computer programming solutions would become so integral to the work of companies like JP Morgan, Boeing and Ford – all our clients. The latter we

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took from Microsoft recently. That's why Russia is now in a golden age of high-tech programming solutions; we have plenty of engineers."

The Agency for Strategic Initiatives' Avetisyan predicts Russia will come in at around 98th place overall in this year's 'Doing Business' ranking. “We're also in negotiations with the World Bank to have the data be collected not only in Moscow, but in three cities as of next year.”

Many fundamental problems, however, persist. “The number of people interested in opening their own business is catastrophically low – in the single digits,” said Belyakov. “More people want to enter the civil service because government still encourages rent-seeking behaviour.”

“It's easier nowadays to take someone else's wealth by becoming part of the system than to create your own. We need to increase competition by getting the state out of the economy and stimulating small business. We're spending a lot of money now on subsidies for big business and they are driving growth, but this model has exhausted itself,” he concluded.

At the opening panel at this year's event, Olga Dergunova, head of the Federal State Property Management Agency, lauded the government's work in privatizing over $7bn worth of assets over the last year. To most market watchers, however, the campaign to reduce the state's 50% share of the $3-trillion economy has been disappointing, with targets constantly scaled back because of “unfavourable market conditions.”

Without an equally focused effort on the part of officialdom to privatise more assets, it's unlikely there will be much more positive economic news at next year's forum – regardless of how far ahead Russia jumps in the World Bank's ranking.

“Despite a lot of criticism, I've compared our public education system to those of other BRICS countries and we are ages ahead”

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Czech dealmaker turns kingmaker bne

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he October 25-26 election in the Czech Republic ended as expected with a win for the main opposition centre-left Social Democrats (CSSD), though it failed to produce a clear winner, meaning the country's perpetual political instability looks set to continue.

With all the ballots counted, CSSD took the most votes though ended with a disappointing 20%. The polls had forecast the party led by Bohuslav Sobotka would receive anywhere up to 30% of the vote as voters expressed dissatisfaction with the centre-right parties, pilloried for harsh austerity and near-endless corruption scandals that caused the last elected government to implode in June.

That dissatisfaction led (like the previous election three years ago) to a rash of new parties, the most prominent of which was the big winner in this election. Led by Slovak-born billionaire Andrej Babis, Ano 2011 scooped up a better-than-expected 19% of the vote, meaning this political novice will act as the kingmaker for the next government – even though the larger parties all insisted early in the campaign they would not work with Ano 2011.

The Communists (KSCM) came in third with almost 15%, while TOP 09, a conservative group that featured in the previous centre-right government, came in fourth with 12%. The biggest loser was the country's once-powerful conservative Civic Democrats (ODS),

created in the 1990s by the former president Vaclav Klaus, which after being forced from power when their former leader and prime minister Petr Necas was caught up in a spying and corruption scandal had further humiliation heaped on them by winning only 8% of the vote.

The centrist Christian Democrats (KDUCSL) returned to parliament after a three-year absence with 7% of the vote, the same as another new party, Usvit (Dawn), led by the Czech-Japanese Tomio Okamura, a senator who calls for referendums as a way to empower voters.

The results will make it hard to form a majority in the 200-seat lower house,

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meaning the country is in for another bout of instablity. The country has been without a proper administration since June and is currently being governed by a caretaker cabinet of technocrats (or cronies, argue some) appointed by President Milos Zeman, who has been angling to increase his power in this parliamentary democracy and will no doubt look to exploit the situation even though his centre-left Citizens' Rights Party-the Zemanites (SPOZ) failed to make the threshold to enter parliament.

CSSD will be the largest party with 50 seats, while Ano will have 47, the Communists 33, TOP 09 26, ODS 16, while the Christian Democrats and Usvit each have 14.

The obvious link-up is between CSSD and Ano in one form or another (either a coalition or CSSD minority government with support), with the Christian Democrats or even the Communists in the mix. A less likely scenario involves Ano plus the two centre-right parties of ODS and TOP 09.

Indeed, President Zeman will probably welcome as much horse-trading as possible. Sparking off the snap election when he exploited the fall of the last right-wing coalition to install his own "caretaker" government, the president has used the time to rebuild his influence within CSSD, the party that he used to lead. He fell out with his former party in 2005, but still has support amongst various factions.

Should the CSSD prove able to form a government, Zeman – who would formally appoint the prime minister – has made it clear that Sobotka could well find himself passed over in favour of Michal Hasek, the current governor of South Moravia. "The big question remains whether Zeman wants to exact his long-brewing revenge on Sobotka by not allowing him to become PM at all or by ushering him in now and then finding a way to run him out of office in a year or so. The other big question of these elections is how much Babiš is going to assist Zeman in this," notes Eric Best, a commentator on Czech politics.

Old attitudes die hard in Czech politics

Nicholas Watson in Prague The October 25-26 general election in the Czech Republic should see a radical shift in the country's political landscape, though sadly probably not in certain attitudes of politicians toward scrutiny and openness.

One prevalent attitude amongst Czech politicians of a certain age is that their past is not a subject for discussion – and definitely not by impertinent young journalists who appear more willing to do their job than supine predecessors.

Czech Labour and Social Affairs Minister Frantisek Konicek, who was appointed to President Milos Zeman's "cabinet of experts" that took over after the government of former prime minister Petr Necas collapsed in June over a bribery and spying scandal, took exception to a reporter of the online news site Aktualne.cz asking him about his previous involvement with murky offshore companies. "You are behaving like a moron. That is all. Goodbye," Konicek said before ending the interview, which was published on October 15.

Grungy-looking and self-assured, much about the female journalist in question, Eliska Bartova, might be expected to infuriate a man of Konicek's past and pedigree. Born in 1953 and one of the country's old guard of politicians, he has served in several governmental posts during the Czech Republic's tortuous and corruption-blighted post-communist years.

Yet the questions the reporter put were pertinent to the current election, in which Konicek is standing as an MP for the president's Party of Citizens' Rights – the Zemanites (SPOZ), and appropriate for the minister specifically.

On October 8, the Czech branch of anti-graft group Transparency International released a report that highlighted the links between offshore companies, public tenders, EU money and Czech politicians. Since 2008, it found that offshore companies, most of which have opaque ownership, won public tenders in the Czech Republic worth almost CZK200bn (¤7.8bn), as well as 277 of such companies receiving some CZK6bn from European funds, of which half has already been paid out. The Czech Republic is one of the last remaining European jurisdictions to allow bearer shares, which are anonymous and serve to hide the real ownership of companies.

"The level of non-transparency and opacity is beyond our imagination," David Ondracka, head of Transparency's Czech office, was quoted by Aktualne.cz as saying. "We realized that there are almost CZK200bn in public and government contracts over the last five or six years which went to companies that are offshore, which actually efficiently hide the real beneficiary owners.”

As part of its election campaign, Konicek's party SPOZ has promised to abolish bearer shares. Yet Konicek himself reportedly owns bearer shares of a company called Karlstejnska and has held senior positions at various companies, like Cyprus-based energy company Equity Brokers, whose true owners are hidden behind bearer shares.

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The Communists would also push Zeman's agenda should it enter a coalition, although it is likely to remain outside formal government due to sensitivity in the country over the past. Protest against the potential involvement of the Communists - and the Machiavellian scent issuing from the presidential office – took artistic form in the last week of the campaign. A giant purple sculpture of a raised middle finger aimed at Zeman's office in Prague Castle took up residence on a barge on the Vltava River, while dummies have been hung by the neck on lampposts around the capital.

Economic left turn While the intrigue surrounding the formation of an administration may well consume the Czech press for some time, what's clear is that the country will next be governed by a left-leaning cabinet.

Even in the most extreme situation that the CSSD fails to build a coalition, that would simply leave Zeman to install another administration of "experts," given the decimation of the right.

That collapse of support is widely due to the austerity run by the ODS/TOP 09 coalition since taking power in 2010.

While the spending cuts earned Prague some of the lowest bond yields in the EU, even analysts complained this year that the fiscal consolidation drive was also keeping the county bogged down in recession.

A left-leaning government will clearly loosen the purse strings somewhat, and taxes will rise, but in reality there's little room to manoevre in terms of state coffers, given that the previous coalition

abandoned the most extreme elements of austerity just before it fell. Analysts at Erste Bank suggest the country's economic policy is set for a "left turn" rather than an "about face".

"Irrespective of which government there will be after [the] October elections the fiscal policy won't be a drag on growth anymore," they write in a note. "This, together with expected continuing recovery of [the Eurozone], leads us to expect growth of around 1.5% in 2014 and over 2% in 2015."

The main danger, both to long term competitiveness and immediate market reaction, they note, is the level of influence the communist KSCM achieves. However, the CSSD is unlikely to allow it too much clout.

The "CSSD will want to keep KSCM in check, if for nothing else then because of [the] former's keener attitude towards [the] Eurozone," Erste continues. "For CSSD, complying with Maastricht criteria is of paramount importance as it wants to lead [the] Czech Republic into [the] Eurozone." The weakness of the right wing meanwhile means the next government will have no reason to implement extreme changes to the budget to bribe the population.

The CSSD has said it would plan to roll back the previous government's unpopular pensions and healthcare reforms, as well as trimming the lower level of VAT. It has also said it wants to raise income tax for top earners, and implement crisis corporate taxes on the financial and telecom sectors, amongst others.

"The big question remains whether Zeman wants to exact his long-brewing revenge on Sobotka by not allowing him to become PM"

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CEE. However, no project that carries Russian imports makes the grade, and only three gas pipeline import routes are offered support. They include a pipeline linking Algeria to Italy and a route connecting Cyprus to Greece.

The final project will form another link in the so-called "southern energy corridor" by connecting Turkmenistan to Azerbaijan.

EU's boost for eastern energy infrastructure Tim Gosling in Prague

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he European Commission released a list of priority energy infrastructure projects on October 14. The major thrust behind the list is the aim to relieve Central and Eastern European states of their dependence on Russian gas, and includes a nod towards a third guise of the ditched Nabucco gas pipeline.

The first EU list of projects of common interest includes a total of 248 schemes of regional importance. While many are set within a single country, they all serve to build up potential for interlinking EU states, which offers greater supply diversity. The publication of the list comes as Brussels is pushing against Russian pressure to prevent the likes of Ukraine and Moldova signing pacts with the EU next month. Moscow wields its dominance of gas supply to those countries as a major stick, and any disruption to flows could hit the wider CEE region.

EU common interest projects will see accelerated planning and permit procedures, with a strict three-and-ahalf-year term applied. They also qualify

to apply for funds from a special EU fund that should put â‚Ź5.85bn on the table over the next six years.

"In the gas sector, one priority is the security of supply," EU Commissioner for

That is a nod towards yet another bid to salvage what was once the grand EU-backed Nabucco pipeline scheme.

Originally planned to carry over 60bn cubic metres of gas from the Caspian into the EU, Nabucco failed to find supplies to fill it. Its scope was then repeatedly scaled back, but Nabucco West's hopes of routing 16bn cm of Azeri gas fell in the summer as a rival scheme (Trans Adriatic Pipeline) was given the nod by the consortium developing the Shah Deniz gasfield. However, Oettinger refuses to be denied, and said he is now looking at a stripped down version that would follow the Danube.

"Perhaps not under the name Nabucco West, perhaps with other investors, but the infrastructure alongside the Danube will remain an important project, particularly since we expect Romania to become not only a major

"After 2015 no energy islands should remain in the EU" Energy Gunther Oettinger told a press conference. "Our aim is that EU member states such as Lithuania and Poland, Romania and Bulgaria gain access to at least two alternative sources of gas supply. We seek the integration of these countries into the EU, and they should not be dependent on the gas supply exceptionally from Russia."

Liquid gold Among the projects on the list are 20 liquefied natural gas (LNG) terminals and gas transportation systems connecting EU countries, mainly in

gas market but also an exporter of gas with offshore gas and shale gas," he said. The commissioner added he also hopes to hold "binding discussions" with Turkmenistan in the near future.

Meanwhile, the list of projects also shone a spotlight on the Baltics, whose recent history as part of the Soviet Union has left Lithuania, Latvia and Estonia cut off from European energy networks.

At the same time, as current holder of the rotating EU presidency, Lithuania is on the frontline of the worsening trade stand-off with Russia.

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Recovery gathers pace in CE

bne Manufacturing PMI data for September suggests that the economic recovery in Central Europe is gathering pace, despite a slight drop in Eurozone activity. That saw the region starting to pull away from its CEE peers: although Turkey looks to have put its summer dip behind it, Russia's struggles continue.

In Poland, the latest purchasing managers index (PMI) released by Markit on October 1 jumped to 53.1 points, the highest level in more than two and a half years and the third month in a row that the number has been above the 50-point threshold separating expansion from contraction. "The Polish PMI now points towards industrial production growth of just under 10% year on year, and supports our view that the economic recovery here may be surprisingly rapid," said analysts at Capital Economics.

Despite a slight drop to 53.4 from August's two-year peak, the Czech Republic's PMI was in the black for the fifth straight month after contracting for the previous 13 months. "The data supports our view that the Czech economy has bottomed out and the recovery is underway," Royal Bank of Scotland said.

Hungary recorded a second month above the 50-point threshold at 54.5 points, although the data is not as strong a guide to industrial production as elsewhere. "Rising exports, new orders and employment sub-indices suggest that Hungarian industrial output will remain in expansion in the coming months," said Citigroup, "in line with our GDP forecast of 0.6% year on year."

All three Central European economies are reliant on exports to the Eurozone. While the single-currency region's manufacturing sector expanded for the third straight month, its performance dipped, edging down from August's 26-month high of 51.4 to 51.1.

Vital for Central Europe in particular, Germany remained in expansion territory at 51.1 points, though the figure also represents a two-month low. "We must not get too carried away," warns Chris Williamson, chief economist at Markit. "Although signalling the best performance for over two years in recent months, the PMI slipped slightly compared with August and remains only just above the 50 'no change' level, indicating that this is still early days in what looks like a fragile recovery."

Turkish manufacturing appears to be rebounding strongly. Turkey's PMI rose to a 30-month high of 54.0, up from 50.9 in August, showing the country's manufacturing sector has shrugged off the slowdown earlier in the year that culminated in the first contractionary reading in 12 months in July.

But at 49.4, the Russian PMI reading was the only one in the CEE region to remain in contraction in September. "This adds to a run of weak hard activity data to suggest that Russia's economy didn't recover in quarter three," Capital Economics notes, recalling that GDP growth dropped to just 1.2% year on year between April and June.

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That has done little to help it in ongoing talks over a new gas contract, with the current agreement set to end in 2015. Vilnius, which claims to pay the highest price for Russian gas in Europe, has been pushing over the past two years to develop projects such as an LNG terminal – set to launch late next year – in a bid to break its 100% dependence on imports from Gazprom. However, it's struggling to secure a better deal from Russia over its gas imports.

The EU list includes the six Baltic Energy Market Interconnection Plan (BEMIP) projects, which aim to finally plug the region's electricity and gas infrastructure into the wider continental systems. "The European Council agreed that the EU internal energy market must be created by 2014, and after 2015 no energy islands should remain in the EU," said Lithuanian Minister of Energy Jaroslav Neverovic at the same presentation. "The list‌ is a concrete step and the instrument for the elimination of energy isolation that conditions the EU energy islands (including Lithuania) as well as the creation of the EU internal energy market", stressed the Minister of Energy.

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energy companies as well as drafting legislation to ban dividend payments by utilities.

Hungary steps up fight with utilities Tim Gosling in Prague

B

ills are usually bad news.

However, those arriving to Hungarian households now offer a brighter message alongside the demand for cash; they tell the recipient how much money the government is saving them.

The lowering of household energy bills – the government said in 2012 it would force a 30% cut to household energy bills: a 10% cut was imposed in January, with a similar cut due in November – is a leading policy in Prime Minister Viktor Orban's campaign for the parliamentary elections to be held by next spring. His government is forcing energy companies to drop prices and sell assets to the state.

Meanwhile, the PM plays to the gallery, criticizing Brussels and the European energy groups operating in Hungary, and insisting the "colonisation" of the country is over.

Analysts at Standard Bank report that Hungarian utility bills now feature a big yellow box informing the customer of how much this strategy has saved the household over the previous 12

months. The government has reportedly set the wording, with large fines for those companies failing to comply.

"Now, imagine receiving four utility bills per month stating how PM Orban has saved you so much money," the analysts write. "Are you re-electing him, or what?"

That report came as a Hungarian government spokesman said in midOctober that Budapest had received a letter from the EU "attacking" its

Following calls from Orban for legislation to transform utilities into non-profit organisations, Development Ministry State Secretary Janos Fonagy said services that form a "natural monopoly" – like gas, electricity, water and others "serving important public interest" – should come mostly under central or local government ownership on a non-profit basis.

"The profit generated as a result of decent corporate activity could not be extracted as dividend, but rather it should be reinvested into the operation, maintenance and, very importantly, improvement of the service," he said.

The prime minister, who has handed out harsh treatment to other sectors dominated by foreign investors since coming to power in 2010, in September suggested Budapest will also seek to force price cuts for commercial customers, claiming such a move will help boost growth. Analysts point out that the energy price cuts are keeping inflation in line, allowing the government-influenced central bank to continue with its long monetary easing cycle.

The push to re-nationalise utilities started with legislation last year decreeing that all gas storage assets must be state owned. A deal to buy out E.ON's gas trade and storage units via state-owned MVM closed last month for

"If the consumer price fails to reflect the actual price, businesses will likely not enter this market because of the expected low profit" programme to cut regulated energy prices. In typically feisty fashion, Andras Giro-Szasz insisted Budapest would "pick up the gauntlet" and defend its actions, which include efforts to nationalise the country's

HUF281bn (€878m), which was above previous expectations. Budapest has now also agreed to buy a 51% stake in gas storage company MMBF from MOL, at an undeclared price. The opposition claims those deals need investigating.

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Slovakia's drug problem Countries in Emerging Europe are often looking to outdo each other, such as Slovakia being the largest per-capita car producer in the world.

However, the discovery that it is also home to one of the largest laboratories for the production of drugs in Central Europe ever discovered is probably not something the country wants to celebrate.

In October, police raided one of the biggest buildings in the local tourist area of ZemplĂ­nska Ĺ Ă­rava in the east of Slovakia and discovered an indoor laboratory for the production of marijuana. According to the SITA newswire, it took 80 officers 25 hours to document evidence and close the facility, with the drugs and equipment transported for expert assessment on three trucks.

In addition to dried marijuana, police also seized five assault rifles of various brands, laboratory equipment such as fans, air conditioning, special lighting and accessories, heaters, fertilizers and chemicals, along with other components.

No one has been charged yet in this case, though those convicted can expect prison terms of 10 to 15 years.

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With the E.ON assets in the bag, MVM plans to renegotiate the long-term gas import contract with Russia's Gazprom, which supplies most of import-reliant Hungary's gas needs. None of that is likely to impress the EU, which is pressing Russia to reduce gas prices across Central and Eastern Europe, as well as encouraging major customers to diversify their supplies and build up regional links to help reduce Gazprom's sway. Orban, however, has spent the past three years or so picking loud fights with Brussels in a bid to boost his popularity with an electorate struggling with the crisis and a moribund economy.

Fonagy claimed multinationals are behind the latest "attack" from the EU. That's perhaps not paranoia. The likes of E.ON, as well as RWE, EDF, GDF Suez and Eni all own substantial stakes in Hungarian utilities and clearly have the ear of senior officials in Brussels.

Reuters reports that none of the companies was willing to respond to news of the forthcoming legislation, but Budapest's advertisement of yet another letter from the European Commission questioning its moves suggests the strategy to plug into anti-EU sentiment among the Hungarian electorate continues.

According to an unnamed EU official quoted by portfolio.hu, it is Orban's earlier suggestion that regulation for commercial customers could be introduced that will be at the forefront

of EU objections. The source said the European Commission is likely to take a lenient approach to pricing reductions for households as it appreciates the social aspects, but will act more stringently when it comes to enforcing market regulations for businesses due to concern over single-market competition legislation. "We do not want to be those pointing a gun at some member state to eliminate the regulation of retail energy prices," the official said.

Reflecting that stance, European Commission energy spokeswoman Marlene Holzner said on October 8 that while Brussels is against price regulations and remains in favour of free market prices, central regulation of retail energy tariffs can be justified, although only for the short term and for a specified period. As she pointed out, the ongoing pressure on foreign investors in Hungary looks counterproductive in the longer term. "If the consumer price fails to reflect the actual price, businesses will likely not enter this market because of the expected low profit. There will be no investments or competition, and if there is no competition, the situation will be permanent and there will be nothing to push prices lower," Holzner said.

However, it seems apparent that Fidesz's concerns are short term right now, specifically the elections in the spring.

"We do not want to point a gun at some member state to eliminate regulation of retail energy prices"

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huge benefit. "Most of those who have obtained a Latvian residence permit come here with their families for at least one or two months of the year. We have already seen the economic effect in a developing real estate sector, the transport industry, trade, private jets, yachts, executive class cars, restaurants and much more," Lokomets says, arguing that the extra cash is used to broaden the financial base of the Latvian banking sector.

A phantom move to Latvia Mike Collier in Riga

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ries of "Thank God, the Russians are coming" are rarely heard in Latvia due to the Baltic state's turbulent history with its giant eastern neighbour. But that's the basic gist of supporters of a controversial Latvian immigration law that has seen thousands of Russians relocate – in theory at least – to the country.

On July 1, 2010, Latvia, a member of the EU since 2004 and soon-to-be member of the Eurozone from 2014, introduced a law allowing foreign citizens to apply for five-year residency permits provided they buy real estate worth at least LVL50,000 (€70,000) in the provinces or LVL100,000 in the capital Riga and its surrounding district, which includes the famous upscale Russian playground resort of Jurmala.

Other options are to place a substantial term deposit with a local bank or to give major financial backing to a local company, though it is the bargainpriced real estate option that has been attracting "investors" from not only Russia but also Ukraine, Belarus, Kazakhstan, and even China and India.

A report by the Latvian Interior Ministry presented to the government on September 17 suggests the scheme

has been a success, bringing €596m of foreign cash into the country at a time when it has been recovering from the world's deepest recession. According to a separate report by the accountancy

"I am sure that if the conditions are right the 'expatriate' business will grow.

However, drastic and ill-considered changes to the immigration law may discourage those who want to invest here and ruin this positive trend," he adds, alluding to growing opposition to the scheme.

Edgars Sins, chairman of the country's largest real estate agency, Latio agrees the scheme has been a success and also warns against tinkering with it.

"The popular opinion is that it has been supporting the real estate market, but I would argue this scheme has supported those families and businesses that are

"We have already seen the effect in real estate, the transport industry, trade, private jets, yachts, executive class cars, restaurants and much more"

Deloitte, by the time the scheme is five years old it could rake in more than €1bn.

Like the Russian travellers who have almost single-handedly revived Riga's tourist industry in the winter months, the eastern arrivals are also credited with propping up a real estate market that saw prices crash by around 80% in many cases when the bubble popped in 2008.

Rietumu Bank (Western Bank) has pioneered the influx of foreign investors, even advertising its ability to obtain an "EU Residence Permit" on the Russianlanguage section of its website. Board member Renats Lokomets says the cash that applicants bring has been of

heavily indebted. If they didn't have the opportunity to sell their real estate to foreign investors, their only alternative would be bankruptcy," Sins tells bne.

"The nationalist parties know it is enough to raise the issue to be elected to parliament. Unfortunately, we've got 5-10% of people who support almost fascistic ideas and unfortunately we have to live with that. The sad thing is, this news is read by potential investors and it could easily scare them away," says Sins.

Yet that opposition to the laws is growing, led by the right-wing National Alliance, one of three parties in the current ruling coalition.

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In the three years since the scheme was launched, 6,749 residence permits were issued to foreign investors and their families, with 71% of applications coming from Russia, 8% from Ukraine and 5% from Kazakhstan. Nearly 98% of applications made under the scheme were approved – a fact which on its own is enough to raise the eyebrows of Roberts Zile, a National Alliance member of the European parliament, who is calling for the law to be scrapped as soon as possible.

Because Latvia is a member of the borderless Schengen zone, a Latvian residence permit is effectively a five-year visa to the whole Schengen area. It is that fact that has really made the programme popular with people from countries of the Commonwealth of Independent States, says Zile. Once investors have their permit and some nominal property, they can concentrate on buying their real homes in France, Italy, Germany or Spain. "They are not buying houses, they are buying access to the Schengen area," he complains. "I'm trying to raise this issue with the Conservative group in the European parliament and I'd like to ask questions to the European Commission in the nearest future, because it's an issue

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that affects all Schengen area member states."

The high acceptance rate is proof that the scheme is poorly policed with only token checks made of applicants' backgrounds, says Zile, pointing to the case of Anna Shalabayeva, wife of fugitive Kazakh banker Mukhtar Ablyazov.

Ablyazov is wanted in Kazakhstan in connection with a multi-billion-dollar bank fraud. On May 29, Italian police raided the couple's house in Rome and deported Shalabayeva and her six-yearold daughter to Kazakhstan – despite the fact that they were living in the EU on Latvian residency permits. "There is a serious reputational risk in this for Latvia," says Zile. "The people moving here have no interest in learning the Latvian language and over the last three years in places like Riga and Jurmala there is no doubt that the common language has almost become Russian."

Far from saving the property market, these phoney investors are keeping prices artificially high, in Zile's view.

"Young Latvians are emigrating because if you are 20 or 25 years old, you don't

have the opportunity to buy a home in a reasonable timeframe because this scheme is keeping prices artificially high. There are many properties which belong to the banks following the crisis, but they are not selling them. There are a lot of empty buildings but at the same time there is new construction going on of so-called 'Schengen apartments'," Zile says.

Proposals to raise the level of investment needed to qualify for the scheme would only make things worse, he points out.

But there is another implication of the residency permit scheme that is yet to be fully discussed. By being classed as residents, Russians and others with cash to place in Latvian banks are obviously no longer classed as holding non-resident deposits (NRDs), yet are arguably just as liable to participate in capital flight and similar sudden shocks as "proper" NRDs. That potentially makes comparisons of the relative levels of resident and NRD deposits meaningless – including both warnings from the International Monetary Fund about the size of Latvia's NRD sector and the assurances of the central bank and regulator that there is nothing to worry about.

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he accounting consequences of changes to a two-tier pension scheme do not sound like something that can get political pulses racing – but the Polish government’s plan to radically change the retirement system has set off a bitter fight, largely among people who would otherwise be backing the centre-right administration.

Poland's politics get personal over pensions Jan Cienski in Warsaw

Recent weeks have seen the finance minister Jacek Rostowski attacking Leszek Balcerowicz, the architect of Poland's post-communist economic reforms, while relations between Donald Tusk, the prime minister, and Jerzy Buzek, a former premier and now European MP, have soured.

The reason is that Tusk is planning on undoing some of the pension system reforms instituted in 1999. Under that scheme, part of workers' obligatory

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social security deductions were funnelled into funds managed by private firms – the so-called second pillar, or OFE. But starting from next year the funds will have to hand over their holdings of government bonds – just over half of the assets they manage.

Furthermore, workers will have a choice as to whether to keep part of the pensions with the funds or to switch

Central Europe

and Eastern Europe, told Reuters: “We are not taking a position whether this [OFE reform] is the right thing to do or not. But we certainly do not see a concern.”

Rolling back pension reforms has also caused Tusk little political grief at home, because Law and Justice, the leading opposition party, has never been particularly enamoured of the OFE funds.

"I've known him for so many years, but I never thought he'd be capable of that" completely to the state-run ZUS system.

The government insists that pensioners will not be harmed in the shift from having their assets in state bonds to relying on government promises to pay their pensions.

Jaroslaw Kaczynski, the party's leader, has called the OFE scheme “one great scam”.

Leszek Miller, leader of the ex-communist Democratic Left Alliance, several of whose members helped create the OFE system, now calls it a “devilish scheme”.

The result will see Poland's public debt drop by about 8 percentage points to about 47% of GDP – crucial as public debt was brushing against a legal threshold of 55% of GDP. The government also gains some muchneeded fiscal space that could see a boost in investments and subsequently faster growth.

That has left a group of commentators and economists, largely gathered around Balcerowicz, to take the lead in attacking the government for gutting the OFE system.

However, many analysts foresee the rump OFE funds shrivelling and dying over the next few years, and equity investors are upset because the Warsaw Stock Exchange will lose the so-called “pension premium” that had boosted stock prices on the WSE. Slavic shrug Outside of Poland, however, the general reaction has been a shrug. “Although these changes will hurt domestic capital market liquidity and increase the government’s pension-related contingent liabilities, government finances will benefit in the short-term,” notes Moody's Investors Service, the rating agency.

James Roaf, the International Monetary Fund's (IMF) representative for Central

Balcerowicz, never a man to shy away from a fight, has led the charge. He accuses Rostowski of “an attack on the savings of Poles. I've known him for so many years, but I never thought he'd be capable of that.” He has said that this

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1997-2001 term as prime minister. “The government's OFE proposal does not guarantee a long-term improvement in public finances nor the economic security of the insured. It is a proposal that is harmful to the Polish economy,” he wrote in a public appeal.

A nonplussed Tusk responded by saying that Buzek and Balcerowicz were being swayed by their emotional attachment to the OFE system as they were in part its creators. The tone went down from there.

Balcerowicz fired back that “Tusk avoids the truth” and denounced the patronising tone of the prime minister’s response, calling arguments in favour of changing the system “dishonest propaganda techniques”. Rostowski, who has revelled in a series of high-profile fights with Balcerowicz, his former mentor, in recent years, charged him of doing all he could to “torpedo rational, careful and well considered solutions”, and then accused him of being in cahoots with the funds managing the OFE system.

Buzek, a normally unruffled politician, tweeted that Rostowski's comments were “scandalous and below acceptable standards”.

Ties between Buzek and Tusk are now visibly strained, while Balcerowicz and other economists continue to accuse the government of dishonesty.

This fight is not helping Tusk as he tries to recover from a slump in the opinion

“Tusk avoids the truth” move is storing up long-term trouble for Poland's public finances, comparing Poland's prospects to those of Greece.

Balcerowicz has received support from an unexpected quarter. Buzek, a member of Tusk's own Civic Platform party as well as one of the country's most popular politicians, has denounced the changes to the OFE system, one of the signature achievements of his

polls that has seen Law and Justice overtake his Civic Platform party. And the personal nature of the bickering has also done little to elevate Polish politics. Few expect it to get any better until the next parliamentary election scheduled for 2015, though Tusk has said the next one could happen sooner if his government loses its majority in parliament, which is already super thin after several MPs defected.

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Fixing Serbia's economy Nicholas Watson in Prague

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he Serbian government on October 8 unveiled a series of painful reforms designed to fix the country's finances, which include raising taxes and the retirement age for women, cracking down on the grey economy, and cutting subsidies to stateowned companies.

The package of measures had been well trailed by the coalition government, with powerful Deputy Prime Minister Aleksandar Vucic particularly strident in his claim the country could face bankruptcy if urgent steps aren't taken to cut public spending. Such comment was widely dismissed as alarmist by analysts, who suggested they were rather a way of "softening up" the public ahead of painful cuts.

However, there are clearly stubborn and persistent problems in the Serbian economy that the measures target.

At an open cabinet session, Prime Minister Ivica Dacic strained against his visceral socialist leanings to announce fiscal consolidation measures that aim to improve the budget by €1.5bn over the next three years, and cut the deficit to 2-3% of GDP by 2017. That's no small ambition given the gap for the current year is likely to reach as high as 6.5%, according to government estimates.

Starting next year, the government plans to increase the lower VAT rate from 8% to 10%, while the retirement age for women will rise to 63 by 2020, from the current 60. Men will still leave

work at 65. Taxes on public servants making RSD60,000 (€525) or more a month will also rise, while a "solidarity tax" hike of 25% will be imposed on those earning more than RSD100,000.

With 179 state-owned enterprises (SOE) already set either to go on the block or close in 2014, they will also face an overhaul in a bid to save €300m-400m. Meanwhile, Belgrade hopes that a crackdown on the grey economy, including the black markets in tobacco and oil derivatives, should uncover another €150m a year. "Our commitment is vital also for the sake of creditors," Finance Minister Lazar Krstic said, according to Bloomberg. "We are talking about fiscal consolidation of around 4.5% to 5.0% of GDP through

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2017, which is more than €1.5bn in savings over the next four years."

Certainly, Serbia's finances are in a pickle, and need to be addressed sooner rather then later. At 65% of GDP, the country's debt levels are low by Western European standards, but they're headed in the wrong direction; four year ago

the domestic audience as he strives to limit resistance to forthcoming painful reforms," says Otilia Dhand, of Teneo Intelligence. "The government decided to tackle the budget deficit by cutting expenditures of Serbia's oversized bureaucracy and SOEs. This will likely mean across-the-board wage cuts as well as redundancies due to the restructuring

"Serbia's economic and fiscal policies over the past ten years have been irresponsible and lacked transparency" that figure stood around 40%. As of the end of July, the budget deficit was already equivalent to 3.5% of estimated full-year GDP, making the target of 4.7% for the year look challenging.

In May, the IMF warned that without additional budget consolidation measures, the 2013 gap could spike as high as 8.0%.

Serbia's economic and fiscal policies over the past ten years have been "irresponsible and lacked transparency," Krstic, a recent appointment to the cabinet, told the government session.

"The problem was not that Serbia's debt was growing, as all countries increase their debt in times of crisis," he noted, "but that the funds were used to cover current expenses, while there were not enough brave moves necessary for economic recovery."

Rhetoric Such trends prompted Deputy PM Vucic – whose Serbian Progressive Party is the largest in the coalition – to warn on October 7 that, "the state is almost bankrupt". Speaking to Serbian TV, Vucic said: "Measures for economic recovery will be difficult, not populist, and will affect between 300,000 and 500,000 people."

Many took issue with the rhetoric.

"While Serbia's finances are, indeed, in dire straits, Deputy Prime Minister Aleksandar Vucic's … statement on almost imminent bankruptcy is aimed at

of state owned enterprises. Widespread protests and systemic resistance present a risk to the implementation of the intended reforms, and Vucic's statement is to be understood as an attempt to mitigate it."

Indeed, Krstic affirmed that the government has enough cash – around $1.2bn – to finance itself through to the end of the year. Economists estimate Serbia has around $1.7bn of funding needs left for the year. Vucic said on October 7 that Serbia expects to receive a low-interest loan of $1bn from the United Arab Emirates (UAE), whose crown prince, Sheikh Mohammed bin

as equally injudicious remarks from Vucic about the possibility of rating downgrades in the near term. "Of all the comments from Vucic… this is the most inexplicable and damaging," says Tim Ash of Standard Bank. "With the sovereign set to come … to market over the next few weeks, it is difficult to understand why he would make such comments – unless the rating agencies had already given the nod."

Just back from a trip to Serbia, the analyst worries that the rhetoric risks becoming a self-fulfilling prophesy.

"We did not sense from our meetings last week in Belgrade that ratings downgrades were that imminent," Ash writes, "but if Vucic continues to talk in this fashion, they will be!"

However, the International Monetary Fund (IMF), with whom Serbia is trying to arrange a new stand-by loan, is doing its bit to help Belgrade out of the hole it's dug itself. Ahead of the government's announcement of the reforms, an official from the international institution told Reuters the IMF is "ready to support [the Serb government] in any way that suits." James Roaf, the IMF representative for Central and Eastern Europe, said: "If they want advice we can provide advice; if they want a financial arrangement we can work with them to do that."

"We did not sense from our meetings in Belgrade that ratings downgrades were that imminent, but if Vucic continues to talk in this fashion, they will be!"

Zayed Al Nahyan, the deputy PM has been assiduously courting. With further loans, Vucic said the total from the UAE could reach $2bn-3bn by the end of 2014.

Serbia said in September it is also looking to raise about $1bn from an international bond – a sale the finance ministry will find harder in the wake of the bankruptcy comments, as well

Serbia knows that securing a deal with the IMF is crucial to giving investors confidence in the country, which has huge potential but a dodgy past. The IMF froze the previous €1bn deal in 2012 because the previous Democratic Party government couldn't stick to commitments that the budget deficit in 2012 should not exceed 4.25% of GDP, and that public debt should remain below 45%.

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Kosovo elections – a known unknown Nicholas Watson in Prague

W

hile Serbia is full of talk about possible early parliamentary elections next year, the municipal elections in Kosovo on November 3 present a more immediate problem for Belgrade.

As part of the historic deal signed in April between Serbia and Kosovo to normalise relations that have been frozen since the erstwhile province declared independence in 2008, the four Serb-dominated northernmost municipalities are to be incorporated into Kosovo's legal system and so are required to take part in the local elections. As a reward for giving up its hold over the pockets of about 40,000 Serbs in the north of Kosovo, Belgrade will get to open talks with the EU about joining the bloc in the coming months.

According to the Central European Policy Institute (CEPI), the elections will provide a litmus test for the EU-brokered deal, dubbed the "Brussels Agreement" – whether it can be "a harbinger of a new era in the relationship between Belgrade and Pristina, as well as for their European transformation." Recent events suggest the jury is still out on that.

Fraught times The run-up to the local elections has been fraught with tensions between the two communities of Serbs and ethnic Albanians that have spilled over into violence, falling-outs between political leaders and heated rhetoric.

The most recent hiccup, a refusal

by Pristina to allow Serbia's prime minister to visit the municipalities for the duration of the campaign, was only resolved on October 7 after talks in Brussels between the two sides.

Ironically, Ivica Dacic only wanted to visit in order to encourage Serbs there to take part in the elections, which is seen as crucial to giving the polls legitimacy.

The mayors and most political representatives of the northern Kosovo Serbs have mounted a boycott against the elections and independent estimates put Serb participation at only 15-30%.

"We have agreed to establish a mechanism which would allow Serbian officials to visit Kosovo without problems," Dacic said after the talks with Kosovo Prime Minister Hashim Thaci. Following the talks, Thaci told Kosovo TV that, "Kosovo will respect the accord on the freedom of movement without discrimination."

There have been more esoteric arguments that threatened to derail the elections, some stemming from the necessity of leaving some questions unanswered or vague in order to get the "Brussels Agreement" signed in the first place. For example, Pristina regards the agreement as an important step towards full normalisation between

Voter registration has also been fraught with problems, given that many Serbs fled Kosovo when war erupted between the two sides in 1998 and the Nato bombing brought the conflict to an end in 1999. The Serbs say that so far the Central Electoral Commission in Kosovo has allowed for only 17% of the 39,000 voters from among refugees who have applied to participate in the elections, which they feel is too few.

The most worrying scenario is an upsurge in violence, which is never far from the surface in this volatile region.

On September 19, a Lithuanian officer of Eulex, the EU's police and civilian mission there, was shot and killed in Zvecan in northern Kosovo. And a week before that, the family of Oliver Ivanovic, the former Serbian secretary of state for Kosovo who is running for the post of mayor in Mitrovica, was attacked for his political stance that Serbs should participate in the local elections. According to UN data, between January and April, there were numerous serious incidents reported, including shootings, explosions and violent clashes. "A lot of things could go wrong," says Beáta Huszka of the Hungarian Institute of International Relations in Budapest, "among which an upsurge of violence is probably the greatest danger."

This violence could depress the voter turnout further – which is perhaps the point of it – making the whole election a farce and dealing a blow to

"A lot of things could go wrong"

the two countries and will eventually lead to Serbia’s recognition of Kosovo as an independent state; Serbia on the other hand sees the deal as statusneutral (it says it will never accept the independence of what it sees as the cradle of Serb civilisation), so was miffed at the appearance of “Republic of Kosova” on the ballot papers.

Serbia's hopes of starting a dialogue with Brussels about joining the EU. Worryingly, say observers, there appears to be no back-up plan by the EU in the case of the elections failing or to cope with any unintended outcomes in their aftermath.

The ramifications of failure would

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likely be immediately felt in Serbia in the form of early elections, ending a period of relative political stability and threatening economic reforms; CEPI notes that Dacic's "pompous reaction [to being refused entry to Kosovo] may

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mark the beginning of the electoral campaign for the next parliamentary elections in Serbia."

But even if the elections are carried off with some degree of success, analysts

stress that they are the beginning of the process, not the end. "Overseeing the elections will not be the last balancing act that the EU will need to undertake to see the process through to the end," says CEPI.

The optimistic scenario

The realistic scenario

• More than 30% of K/Serbs vote • Undisputed electoral process • The joint list must form coalitions with other K/Serb parties, also in the south • The Association of Serb Municipalities smoothly established • Interim Assembly fades into irrelevance • The EU sponsored Belgrade-Prishtina negotiations move into the next phase, tackling new issues

• The turnout hovers around 15-30% • The election process is disputed by limited violence but is not derailed • The joint list dominates the Association of Serb Municipalities • The new municipal structures maintain distance from Prishtina • K/Albanian majority increasingly nervous about state dysfunctionality • Belgrade-Prishtina negotiations continue at slower pace

The disastrous scenario

The pessimistic scenario

• Active boycott results in a turnout below 5% • Violent incidents lead to the withdrawal of OSCE staff from polling stations in northern Kosovo • Prishtina appoints provisional structures (with or without consent of Belgrade) • New barricades, KFOR use of force, new cycle of violence • Fall of Serbian government • Deadlock in Belgrade-Prishtina talks, stalemate in Serbia’s EU accession

• Security incidents, active boycott, turnout at 5%-15% • Prishtina rejects high by-mail turnout • K/Albanians acquire significant share in northern municipalities • Interim Assembly steps up resistance and grows in importance • Inter-ethnic tensions increase and Belgrade-Prishtina normalisation is in jeopardy

Less desired outcome

More likely

Less likely

More desired outcome

Source: The Central European Policy Institute (CEPI)

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Turkey's Pegasus flying high INTERVIEW:

David O’Byrne in Istanbul

W

ith arguably the most famous surname in the Turkish business world and a family business empire that guarantees a comfortable income, Ali Sabanci could be forgiven for taking life easy.

Instead, the past eight years has seen him propelled from the shadow of his better known relatives, to one of the most recognisable faces in Turkey after he succeeded in creating the fastest growing airline in Europe, in a country few believed had an appetite for air travel, let alone the no-frills budget variety.

"My goal in life is to play the best game I can with the hand I've been dealt," he grins, pointing out that in just eight years he has succeeded in growing the tiny Turkish charter carrier Pegasus that his family holding company Esas Holding bought for â‚Ź60m in 2005 into a major regional carrier straddling four continents with a market cap of $1.6bn.

Not bad for any business, but all the more remarkable for one operating in Turkey in a sector with a notoriously high level of failure. "There have been a lot of attempts at setting up airlines, but actually these were not really 'low cost' -there's a big difference in the two concepts," says Sabanci, pointing out that most of the 20 odd airlines started in Turkey in the 1990s and 2000s began as tour operators looking to increase margins by expanding vertically, but who failed to address the issue of how to fill planes in the off season.

"They didn't realise that it's a consumer business, you have to be in front of your customer all the time, and you have to sell," says Sabanci explaining that as air travel has become increasingly commoditised, the difference between running an airline, and a supermarket or hotel has narrowed.

travel was an unheard-of luxury. At the same time, it could answer the needs of the Turkish business community who need to travel economically to major trading partners, the Turkish diaspora in Europe who want cheap connections home, and not forgetting tourists looking for cheap flights into Turkey.

Sabanci points to the innovation of South West Airlines in the US from the 1970s onwards and subsequently in Europe by Ryanair and Easyjet as creating a model which Pegasus has adapted to Turkish market conditions.

He brought in former Ryanair group operations director Conor McCarthy and former Easyjet administrative manager Raymond Douglas Webster to sit on the Pegasus board.

Central to the model itself has been the standard "no frills" tactics of "dynamic pricing", which sees seats on flights offered at a hefty discount well ahead of time, getting steadily more expensive as bookings increase. In addition there's the "ancillary revenue" – selling things such as seat choice, check-in baggage and meals, which many airlines give as standard but which equally many passengers have no need of.

"There have been a lot of attempts at setting up airlines, but actually these were not really low cost" Key to success, explains Sabanci, has been adapting the existing "no frills" model to the more complex and less developed Turkish market, taking advantage of the aspirations of the country's rapidly expanding middle class to offer fast, cheap domestic flights to people who might otherwise have spent 20 hours travelling on a bus, while providing affordable flights to major international destinations to Turks for whom foreign

Dynamic pricing was not actually new to Turkey; entrenched national carrier Turkish Airlines adopted it for international flights before 2005 but which, due to lack of serious domestic competition, it had never used on domestic flights. Eight years on and Turkish Airlines' share of the domestic market has shrunk to just under 50% and Pegasus has grown to 27%, with four smaller competitors sharing the rest.

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Sabanci points to a number of factors helping Pegasus' remarkable growth.

These include an aggressive focus on efficiency, underpinned by a profitsharing scheme that sees 10% of operating profit shared between the company's 700 staff.

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Erdogan the reformer returns

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Indications are that it works – the 45 planes in the Pegasus fleet spend an average of 13 hours a day in flight, which is higher than Ryanair (at 8.5 hours) and Easyjet (at 11.5 hours).

The company's "cost per available seat kilometre" (CASK) at around €4.15 is second only to Ryanair in Europe and is the fourth lowest globally. No surprise then that Pegasus enjoys profit margins between 5% and 5.5% higher than Turkish Airlines.

Turkish Prime Minister Tayyip Erdogan modelled himself as a reformer and was rewarded by the electorate with three landslide elections. After a period in which that reformist label appeared to have all-but disappeared, on September 30 the PM unveiled a package of long-awaited political reforms, which include changes to the electoral system and increasing language rights.

All this comes despite its larger domestic rival enjoying the benefits of bilateral government agreements restricting flights on many international routes to the two national carriers. "But like any business this never gets any less liberal," laughs Sabanci, pointing out that while Turkish Airlines may be pioneering new routes, once liberalised Pegasus will be able to take advantage of demand offering cheaper flights, continuing its remarkable growth. "It is slowing down, but we are still growing at just under 40% a year."

The move will be greeted warmly by parties representing minority groups.

The threshold is a major grievance of Turkey's Kurdish minority, who make up around a 20% the country's 76m population. The Kurdistan Workers' Party (PKK) fought a vicious insurgency starting in 1983, which has cost more than 40,000 lives. Erdogan and his Justice and Development Party (AKP) have made brokering peace a priority, since the drawn out conflict has hurt both Turkey's human rights record and the economy in the mainly Kurdish southeast of the country.

There is still plenty of scope to grow. The Turkish and regional markets have growth with the market penetration of low cost air travel at only 27% in Turkey and 13.5% in the surrounding regions, compared with 42% in continental Europe.

And it is to the region that Pegasus is looking for growth, Sabanci says, pointing to the huge potential of markets such as the Turkic republics, Saudi Arabia and Russia – with Pegasus having started flights to Moscow in October. That potential lies not just in those countries as destinations, but also in Turkey – specifically Istanbul as a transit hub between Europe, and all points south and east. "That's why the government is building one of the world's largest airports in Istanbul," he says, referring to Istanbul's recently announced third airport. "Turkey is sitting pretty."

In his first major policy speech since the country was wracked by violent street protests in May and June, Erdogan said a major part of the "democratization package" would be a debate in parliament about cutting or eliminating altogether the 10% threshold a political party needs to enter parliament. The limit is among the highest in the world and prevents Kurdish and other smaller parties from entering parliament.

A deal reached with the PKK in March this year for a ceasefire and a withdrawal from Turkey was hailed as the beginning of the end of the troubles. However, the Kurdish militant wing recently suspended its pull back due to a perceived failure by the government to make political concessions.

These new measures are seen as a move to restart that process. On top of the potential lowering of the parliamentary threshold, Erdogan said the teaching of Kurdish and other non-Turkish languages in private schools is to be allowed, that towns can officially take up their native-language names, that a nationalist oath recited by students at schools will be scrapped, and that an anti-discrimination commission will be strengthened.

However, the main Kurdish party - Peace and Democracy (BDP) - said the measures fail to go far enough to advance peace with the PKK. "The democratization package does not meet our expectations," co-chairwoman Gultan Kisanak told reporters. "The package does not have the capacity to overcome the blockages in the peace process."

Erdogan also vowed to change the laws regulating protests and gatherings, which came to the fore when the Turkish police cracked down on the Gezi Park protests that rocked Turkey in May and June, on grounds that the protests were "unauthorized" and thus "unlawful".

He also proposed reforms over the restriction on women wearing the Islamic headscarf, a ban that dates back to the inception of the Turkish Republic and has kept many women from joining the public work force.

Relatively low female employment in Turkey is regarded as one of the country's economic weaknesses.

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Opportunity knocks Certainly the timing is very convenient for Croatia, which is looking to regain control of a company it feels was let go for too low a price, and one whose prospects look increasingly bright.

MOLlifying Croatia bne

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roatia has only been a member of the EU since the summer, but already it's become embroiled in two ugly spats that both involve extradition.

found guilty of accepting a €10m bribe from MOL in return for awarding the company controlling rights in INA in 2011. Sanader is appealing, while MOL denies any wrongdoing.

On October 4, Croatia's parliament approved changes to legislation that had been voted into law just a day before the country formally became an EU member on July 1. The law included a retroactive prohibition on Croatian citizens being extradited, which goes against EU practice, and Brussels had threatened economic sanctions, such as suspending funds for Croatia's border controls, if it wasn't amended. Croatia backed down.

The Hungarian government smells a rat: the accusations and arrest warrants come as the two sides began negotiations over a new INA shareholder deal. “It is unacceptable for the Hungarian government that first the strategic partner is selected... which saves Croatia's most important company INA during

The other case appears less likely to be resolved so straightforwardly and could quite possibly get worse before it gets better.

Croatia sold 25% of INA to MOL in 2003 for $505m. In 2009, Zagreb allowed MOL to raise its stake to 49.1%, with Croatia holding 44.8%. But growing opposition in Croatia to Hungarian ownership meant MOL never gained full majority control of INA – hence the importance of that management control it was handed by Sanader's government.

Analysts too suspect Croatia's motives.

"Management talks at this level would typically involve the chief executive, but Hernadi could not attend any talks in Croatia and subsequently expect to leave the country without the detention order coming into effect," notes IHS Global Insight.

Both sides accuse each other of not living up to agreements. MOL claims the Croatian government was supposed to take back into public control INA’s lossmaking midstream gas business Prirodni Plin. Croatian daily Jutarnji List reported on September 12 that MOL was ready to

"MOL will defend itself by all legal means against the outrageous actions"

On October 7, a Budapest court rejected a European arrest warrant issued by Croatia for the head of Hungary's main oil company MOL, who is wanted for his alleged involvement in a bribery case.

the crisis, and then there are attempts to intimidate this strategic partner later... in order to regain control of INA without a buyout," the Hungarian government said in a statement on 2 October.

The request followed the nonappearance of MOL's chief executive, Zsolt Hernadi, for a hearing in a case brought by Croatia's anti-corruption bureau, the Croatian Office for the Suppression of Corruption and Organised Crime, over bribes paid to the now-jailed former prime minister Ivo Sanader. Sanader was jailed for 10 years in November last year after being

The company also responded: "Already in November 2012 MOL Group emphasised that no substantive evidence has been provided to the court in support of the specific charges as they relate to MOL… MOL will defend itself by all legal means against the outrageous actions... which appear to be influenced by interests seeking to intimidate both the company and its chairman."

sue Croatia for €262m in damages over Zagreb's failure to take over INA's lossmaking gas business, as agreed in 2009.

The Croatian government, however, argues MOL is not investing properly in INA's upstream potential. INA's exploration and production activities are focused on Angola and Egypt (Syrian operations have been suspended due to the civil war), though in the past it has been involved in E&P in 20 countries.

And there is growing interest in Croatia itself. According to KPMG, there is an estimated 18bn to 30bn cubic metres of unconventional gas in the Drava

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Southeast Europe

On September 29, the Sunday Times reported that the Croatian government is pinning huge hopes on a 13,500 squaremile subsea survey being conducted by Spectrum, a Norwegian seismic-imaging company, which has estimated that Croatia could have offshore reserves of 3bn barrels of oil, while the volume of gas has still to be analysed.

One solution would be for MOL to sell up. Indeed, Prime Minister Viktor Orban's government, the largest single shareholder in MOL with 24.6%, said on October 2 it would ask MOL's management to consider selling the stake in INA to the Croatian government or a third party. MOL has been playing hardball, threatening legal action against the Croatian government if talks fail to resolve the dispute over management rights. However, according to Croatian media, government officials say there's little chance Zagreb could raise the estimated €3bn it would cost to buy the almost-50% stake, especially given the current poor market conditions.

Thus the stakes are high, meaning few expect a quick resolution to the standoff. "The bribery case is setting the tone of the negotiations between MOL and Croatia over the INA shareholders' agreement… I doubt that any rapid solution can be found here and expect long drawn-out negotiations," says Tamas Pletser of Erste Bank.

Waiting in the wings are the Russians, which is ironic given that it was only two years ago that the Hungarian government managed to prise a 21.2% stake in MOL out of the hands of Surgutneftegaz, which bought the shares from OMV after the Austrian company’s hostile takeover bid for the Hungarian firm failed. INA's

Depression and INA believes there is more lying in deep shale formations.

"However, further exploration has to take place in order to gain more knowledge and understanding of potential source areas," KPMG said in a report last year.

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

refineries could be attractive to Russian companies, while its upstream business could benefit from Russian access to resources, capital and technology.

On September 6, Bloomberg reported that the Croatian government had approached Rosneft about acquiring MOL's stake in INA. Three days later this was denied by the office of Prime Minister Zoran Milanovic.

Yet while the Russians may have the cash, they would not be any better partners than the Hungarians as they would also pursue only their own interests, say observers. Indeed, Russian ownership would further weaken Croatia’s position in INA, as any company buying the stake would also obtain the management rights currently ascribed to them, in effect validating the transfer.

Keeping MOL in INA may prove the least bad of the limited options available, though that will require the smoothing of ruffled Hungarian feathers.

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Croatia hopes there will be oil Harriet Salem in Belgrade

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almy Mediterranean weather provides favourable climes for sun seekers and vineyards alike. Crystal clear waters surround more than 1,200 islands, sprinkled off stunning rocky shores that are littered with historical gems from Umag down to Dubrovnik. Croatia's Adriatic coastline is the jewel in the crown of the EU's newest member. Yet while it provides a lifeline for Croatia's faltering economy, which relies on tourism for nearly 10% of GDP, Zagreb is hopeful the coastal stretch is about to yield a new treasure trove: oil and gas.

In June, Norwegian company Spectrum signed a deal with Croatia's economy ministry to conduct a 2D seismic survey over more than 21,000 square kilometres of the Adriatic seabed.

Deploying technology that's analogous to ultrasound equipment used for imaging the human body, scientists will spend seven months creating a detailed picture of geological structures hidden below the earth's surface. If successful, the survey – scheduled for completion in April 2014 – will reveal the location of hidden oil and gas reserves, potentially worth hundreds of billions of dollars.

Yet while returns could be high, the gamble is big. More than $25m has already been invested by Spectrum, which is conducting the research at its own financial risk. Jan Schoolmeesters, chief operations officer at the Norwegian company, is confident the venture will pay off, noting the area shows "high promise" given known gasfields in the North Adriatic, as well as the Italian Adriatic's offshore oil reserves. As such, Schoolmeesters tells bne that Spectrum "expects sufficient interest from exploration companies, such that the sales of data licenses will turn this survey into a profitable project."

Investors appear convinced. Six months prior to completion, the survey's findings are already rumoured to be attracting substantial interest. According to a Zagreb insider, Vitol and Glencore have already expressed interest on the oil services side; Russian and US majors, Rosneft and ExxonMobil, are keen on the exploration side.

But knowledge of the potentially lucrative reserves is not new. Research into Croatia's offshore oil dates back to the Yugoslav era, and data gathered in 2009-10 indicated the presence of more than 2.8bn barrels – enough to meet the country's energy needs for more than a century. Why then, has it taken so long to explore this potential goldmine?

Regaining control Whilst technological advancements over the last decade have pushed forward the frontiers of oil and gas exploration worldwide, in Croatia's case a new hydrocarbon exploitation law, passed in July, has proved the real game changer.

"Previous legal provisions, or lack thereof, provided little protection to potential investors in the Croatian upstream oil industry and acted as a deterrent to international firms," says Luka Oreskovic, a Harvard University researcher specialising in Southeast Europe. "The current government have brought an end to this situation. From the state's perspective, competition is beneficial and this has now been formally recognised in law."

The new legislation is, in part, a response to the EU's demands on its newest member to open its markets and bring an to end monopolies. It also, however, gives the Croatian government significant leverage in its ongoing dispute to regain control over the former state oil and gas firm INA from Hungary's MOL Group.

MOL holds a 49% stake in INA, but the Croatian firm has been subordinate to the Hungarian firm since 2009, when a deal was struck by then-prime minister Ivo Sanader to hand over management rights allegedly in exchange for a €5m backhander. Following Sanader's conviction last November on multiple counts of corruption – which included a charge related to the INA deal – Zagreb is on a mission to nullify the original agreement. MOL have so far held firm, denying any wrongdoing and refusing to accede to Interpol and EU arrest warrants issued by Zagreb for its chief executive, Zsolt Hernádi, who is also implicated in the scandal.

However, Oreskovic argues that if INA is to participate "without handicap" in the lucrative public tenders for exploration rights in the Adriatic that will follow Spectrum's survey release – most likely in July next year – then the dispute with MOL needs to be resolved speedily, because the new legislation means much stronger competition than before.

"Whilst INA has local and proven expertise in operating on the Adriatic Coast, a degree of politics will surely play a role," Oreskovic explains.

As with all voyages into unchartered territory, there look to be several twists and turns in the plot ahead.

While Spectrum's data will provide a decent map for explorers, locating the exact "X" that marks the spot will take significantly more time, research and investment. "Since 2D seismic cross-sections are 5 to 10 km apart, the survey will provide a good indication, but cannot be used to accurately provide predictions of the oil and gas reserves in the subsurface," says Schoolmeesters. "For that, further 3D seismic investigations and ultimately drilling will be required."

And all that glitters is not gold. Much more precise information is needed before the exact value of any reserves can be established and, indeed, whether they will be accessible at all. "For oil and gas companies it is not so much about whether there is oil and gas, but where and in what quantity," explains Schoolmeesters.

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which have formed the Social Liberal Union coalition – to know exactly what to do from day one of their government.

And yet the much-needed foreign investments are mostly absent and the members of the governing coalition are far from having truly reached some sort of a consensus as to how to achieve an economic boost apart from introducing some new taxes.

What's holding back Romania?

Bogdan Preda in Bucharest

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here is, without doubt, something rotten and strange about Romania these days, even though by most accounts it has managed to achieve economic stability in a region that is still struggling from the effects of the 2008 crisis.

what’s left of public assets and money.

In a country that’s a member of the EU and is also still considerably richer in natural resources when compared with its neighbours, this situation, which is closer to Latin American models, is hard to fathom.

It has a better economic growth rate, a stronger fiscal position, an improving current account, and falling inflation.

However, Romania needs to grow much faster than current levels if its GDP per capita is to converge to the EU average. And even though it's more than nine months since the current coalition won a nearly 70% majority in parliament, the widest margin in more than a decade and a half, it has so far failed to make the kind of substantial structural reforms the country needs if the economy is to grow at its potential, estimated at around 4% a year.

With the exception of the period between its pre-accession and postaccession to the EU, which lasted from 2005 to 2008 and saw large amounts of money pouring into the country, Romanians have had to put up with

The poor performance of the new government presents Romanians with a lack of options, given that they have exhausted nearly all parties and alliances in the past 23 years since the country broke with Communism. It feels like no political force is truly capable of pulling together as soon as it comes to power and finds itself in control of

The only good news so far comes from a better-than expected harvest this year, which helped keep consumer prices in check. But such seasonal effects can be of help only in the short term in the absence of sounder policies that need to be implemented in the medium and long term.

Private sector pains The lack of planning and consensus within the government not only hurts what’s left of the state-owned economy, but also seriously affects business decisions in the private sector, which has started to become less competitive.

Hundreds of thousands of small enterprises either closed or applied for insolvency in the past years as a result of the crisis and increasing costs.

In fact, the new government has managed to scare off considerable investment from foreigners. It started by altering legislation that had previously attracted investors in the renewable energy industry by reducing the subsidy schemes, causing large banks to no

"The poor performance of the new government presents Romanians with a lack of options" slower progress because of their own politicians. Romanians are now generally voting for what they hope will be the lesser of evils rather than for instigators of genuine progress.

One would have expected the two experienced political parties that won the elections last year – the Social Democrats and the National Liberals,

longer finance such projects. Companies such as CEZ of the Czech Republic, which is a major player on the Romanian energy market, recently stated that it faces losing up to €40m from that change in the legislation, which has decreased or postponed the awarding of green certificates to investors.

The central bank warned at the end

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with being willing to use the companies as cash machines for electoral purposes.

of August that instead of looking at new financing opportunities on the local market, the local subsidiaries of foreign banks, which dominate Romania’s banking industry, have repatriated as much as €5bn over the past 18 months. Such a lack of interest for new financing opportunities in the local market is also reflected by the percentage of non-performing loans, which has now reached about 30% of total loans.

A growing number of Romanians are now becoming increasingly worried about what lies ahead, prompting thousands to take to the streets in several anti-government demonstrations this September – the largest number of protestors in the past decade. Among their gripes are corruption, lack of transparency and the feeling that greedy politicians have failed to fulfil

The absence of consistent incentives, mismanagement in the state sector, failure to absorb enough EU funds and the banks’ reluctance to resume lending, has meant that successive Romanian governments doubled the country’s foreign debt to €53.8bn in May, from €25.2bn at the end of 2008.

About half of the new loans ended up in government hands, which used them to pay pensions and restore previously reduced state wages, even though the slow pace of economic recovery didn’t justify such measures.

"The new government has managed to scare off considerable investment from foreigners"

Lack of Accountability The government, in another strange move in April, moved to change legislation that awards large national contracts via bidding procedures to offer them directly via a procedure called “competitive dialogue,” arguing that this would speed up investments. The move raised questions about whether the country is still preserving a healthy competition environment.

More recently, the leaders of the governing Social Liberal Union coalition have clumsily handled an argument over the Rosia Montana open gold mining project, which is being run by Canada's Gabriel Resources. National Liberal Party head Crin Antonescu unexpectedly spoke out against it, forcing Prime Minister Victor Ponta to postpone a parliamentary debate on the project.

The public spat showed cracks in the coalition, especially as it was followed by domestic accusations of corruption and even insider trading. Worse, it has resulted in threats of legal action from Gabriel and its billionaire backers to claim up to $4bn in damages if the project doesn’t move forward.

their electoral promises. Such protests mirror those in neighbouring Bulgaria, where daily demonstrations have been demanding the resignation of the government for almost two months.

Take for example one of the latest reports published by the Competition Council on August 28, in which it shows beyond any doubt that the cost to construct 1 kilometre of highway in Romania is on average three-times higher than in neighbouring Bulgaria, where corruption is also widespread.

Romania, the second-biggest new eastern member of the EU after Poland, has only 548km of highways, especially because of such high construction costs. The country’s National Highway and Roads Company in the past three years started tenders for 370km of new highways, but thus far only 42km have been completed, according to business daily Ziarul Financiar.

Escaping the state The government’s project to appoint private sector executives to manage its biggest state companies, as part of a publicized effort to stop losses now totalling hundreds of millions of euros and make them more efficient, also faces failure.

Some of the most prominent executives that embarked on such projects have either resigned, were forced to resign, or are about to resign, blaming political pressure and charging political parties

Gabriel Dumitrascu, head of privatisation at the Economy Ministry, was quoted by HotNews on September 19 as saying that politicians use anticorruption prosecutors to wield control over state-owned companies. “I’m coming from the private sector and don’t

find my position working for the state as convenient,” Dumitrascu said. “It’s not comfortable to see that any day one or another threatens you with the National Anti-Corruption Department or the Court of Accounts.”

There are many other recent cases of executives being put under pressure by politicians. Romanian national airline Tarom CEO Christian Heinzmann, who previously held executive positions in the airlines industries in Europe and Asia, was told to cut his term to one year from four years over differences with the company’s board. Heinrich Vystoupil, a former Austrian Airlines representative in Romania and Moldova, who was about to become Tarom’s general manager last year, refused to take up the job with the Romanian state airline a week after his appointment.

In April, Dimitris Sophocleous, a former Romtelecom and AD Pharma executive, left his position as general manager of passenger rail company CFR after the government rejected his plan to turn around the company. So did former banker Lucian Isar, who headed CFR’s board. In a similar move, former banker Mustafa Aysun, head of the board of freight rail company CFR Marfa resigned less than two months after taking the job and was replaced with Sorin Mindrutescu, former CEO of Oracle Romania. However, on September 18, Mindrutescu also resigned.

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Another landslide in Azerbaijan Clare Nuttall in Astana

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reliminary results from Azerbaijan's October 9 election show that incumbent Ilham Aliyev (pictured) has been returned to the presidency for a third term. His share of the vote appears only slightly reduced compared with the last victory, despite the decision of the main opposition parties to unite behind a single candidate.

The universally expected victory for Aliyev means business as usual in Azerbaijan, the Caucasus’ main oil and gas producer. Azerbaijan is becoming increasingly important as a supplier to European markets, with gas from the second phase of the giant offshore Shah Deniz field to be sent direct to European consumers through new pipelines from 2019.

Azerbaijan’s Central Election Commission (CEC) announced early on October 10 that Aliyev had taken 84.73% of votes counted, with the turnout at 72.31%.

That's a wider margin of victory than exit polls had forecast. A survey carried out

Still, the united opposition hardly made a dent. According to the preliminary results, Jamil Hasanli, the candidate for the National Coalition of Democratic Forces, managed to attract just 5.2% of the vote. The coalition’s original candidate,

"The high-tech nod to transparency released results showing a landslide for Aliyev – the day before the polls opened" by the NGO Cooperation Alliance gave Aliyev a majority of 83.89%, according to Azernews. However, it is slightly down on the 87% he took in the last presidential race in 2008.

Oscar-winning screenwriter Rustam Ibragimbekov, was barred by CEC after failing to meet residence rules, as he also holds a Russian passport. The other nine candidates all failed to make it past 3%.

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In a pre-recorded television address, Aliyev said the result was a "triumph for democracy", according to the BBC. "Azerbaijan will continue successfully to develop as a democratic country.

The fact that this election was free and transparent is another serious step towards democracy,” the returning president claimed. However, opposition leaders insist the vote was rigged.

Hasanli said on October 9 that his campaigners had observed several instances of ballot stuffing.

There was no expectation of an opposition victory, and that pessimism appeared confirmed thanks to the launch of a mobile app allowing users to follow the election process.

The high-tech nod to transparency backfired, though, with results released showing a landslide for Aliyev – the day before the polls had even opened.

The data was quickly removed, but not before reporters at opposition television channel Meydan TV had posted a screenshot of the premature "result". CEC later blamed the incident on a "technical glitch" that it "deeply regrets".

A report from the Organisation for Security and Cooperation in Europe/ Office for Democratic Institutions and Human Rights (OSCE/ODIHR) described the vote as neither free nor fair, saying it "fell short of international standards” and was undermined by “serious shortcomings". This met with bluster from Azeri authorities: "[It is] an insult to the will of Azeri voters,” said a spokesman for the CEC. International observers have also voiced concerns about the series of arrests of opposition activists and independent journalists in the weeks before the election. While mass protests are unlikely, there is still the possibility of unrest in Azerbaijan if the election is not seen as free and fair.

Along with Azerbaijan’s increased prosperity in recent years, the country’s opposition activists have become more willing to take to the streets – a change partly attributed to the example of the Arab Spring in several nearby Middle

Azerbaijan's initial initial offering

Clare Nuttall in Astana Online payments company Goldenpay intends to sell up to 10% of its shares in the first ever Azerbaijani IPO. The long-awaited debut floatation on the Baku Stock Exchange (BSE) is slated to happen by the end of this year, and is expected to pave the way for more Azerbaijani companies to list on the exchange.

The shares will be sold to local retail investors on the BSE. Goldenpay says it is in the process of conducting market research to estimate the size of the potential demand, with the preliminary price of one share ranging all the way from AZN10 to AZN50 ($7.80- $39). The issue is being organised by Azerbaijan’s leading investment bank Pasha Bank.

A source close to the process told bne that preparations were still underway and the IPO was expected to take place by the end of 2013, though it could be pushed back into the first quarter of 2014.

Goldenpay was Azerbaijan’s first online payment service provider when it launched in December 2008. It owns the Hesab.az website, which is the largest online payment site in the country. Clients include Azerbaijani utility companies and mobile operators, as well as online retailers, internet providers and other companies. According to the company’s website, Goldenpay “played a major role in the introduction of ecommerce in Azerbaijan.”

As well as raising funds for Goldenpay, the IPO is also a significant milestone in the development of Azerbaijan’s securities market. Speaking to journalists in Baku, Rufat Aslanli, chairman of the State Committee for Securities of Azerbaijan, said that government research suggests demand for the issue will considerably outstrip supply.

Goldenpay has also launched an online survey, via its Facebook page, to find out the level of retail interest in its IPO, asking users if they would buy shares in the company if they were for sale on the BSE. The results of the survey have not yet been announced.

The forthcoming IPO is just one of several expected to take place on the BSE in the near future. "Potentially two to three companies may hold an IPO in 2013 on the BSE,” Aslanli told journalists. Long and short lists of IPO candidates have already been drawn up, with 10-15 companies included on the shortlist.

Holding Azerbaijan’s first IPO is likely to stimulate activity on the BSE, which is relatively low given the size of the Azerbaijani economy. Turnover on the exchange peaked at AZN9.519bn in 2008 during the frontier markets boom immediately before the crisis hit. In the last two years, there has been a strong recovery, with turnover reaching AZN9.001bn in 2012, and the BSE recording turnover of AZN4.559bn in the first eight months of 2013.

Adoption of a new law on securities is also expected to help the exchange grow and increase the range of investments. The chairman of the BSE’s board, Emin Muradov, said adoption of the law would encourage the participation of private companies in the stock market and increase turnover.

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Eastern and North African countries.

Since early 2011, there have been more demonstrations, though most have been small, numbering just tens of participants, and swiftly shut down by police.

Aliyev first came to power in 2003, following the death of his father, former president Haidar Aliyev, and was re-elected in 2008. His time in office

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from $850 to $7,850 – while poverty has fallen.

Despite the progress however, concern lingers over corruption and income inequality. Baku has also been working to offset a decline in production at the country’s main oilfield Azeri– Chirag–Guneshli by diversifying the economy and supporting sectors such as manufacturing, agriculture and IT.

"The united opposition hardly made a dent" has seen a period of fast economic growth, driven by Azerbaijan's oil and gas sector. Over the last decade, GDP per capita has risen almost ten-times –

European governments are looking to Azerbaijan as an alternative energy source as they seek to reduce reliance on Russia. The opening of the Baku-

Tbilisi-Ceyhan pipeline back in 2006 allowed Azerbaijan to transport oil directly to Turkey’s Mediterranean coast, bypassing Russian territory for the first time.

New gas pipeline infrastructure is in the works. In July, the consortium developing the offshore Shah Deniz field selected the Trans-Adriatic Pipeline consortium to transport gas from the field from the Turkish border to Central Europe, picking it over the more ambitious EU-backed Nabucco pipeline project. From 2019, Turkey will receive 6bn cubic metres (cm) of gas from the field each year, with 10bn cm going to European customers.

Azerbaijan is also seen as a potential transit state to bring oil and gas from Central Asia to European markets.

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CORPORATE STATEMENT:

Kazakhstan’s new business hub With a steadily improving business environment and a booming private sector, Astana is emerging as a new manufacturing, transport and logistics hub for Kazakhstan.

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broad range of incentives is being offered to investors to ensure the economy continues to grow and diversify in Kazakhstan’s dynamic new capital city.

In a country best known internationally for its oil and gas sector, in recent years Astana has become the location of a growing manufacturing base as companies set up production there, drawn in by the preferences offered to investors at the Astana-New City special economic zone (SEZ).

The Astana-New City SEZ is one of ten such zones spread across Kazakhstan. Set up in 2001, four years after Astana became Kazakhstan’s new capital, the SEZ spans both the administrative and business centre on the left bank of the Esil river, and a 598-hectare industrial park. A second industrial park, with an area of 433 hectares, has been added due to high demand.

Investors at the SEZ benefit from a variety of tax and customers preferences, including exemptions from profit tax, land tax, various customs duties and VAT on building materials. A “single window” centre has also been set up to provide support and information for investors.

Currently 49 investment projects with a total value of KZT180bn ($1.17bn) have been launched in the industrial zone, with a total of over KZT1.2 trillion invested in the SEZ as a whole. International investors include Alstom, Eurocopter, GE Transportation and Talgo.

In addition to these large-scale investments, Astana has also seen a boom in entrepreneurship, with approximately one in five of the city’s residents having launched their own business.

In the sphere of electronic communications, Smart Astana, a wide-reaching programme to transform Astana into a "smart city", is underway. New technologies are being applied to improve service provision in areas from medicine to transport.

Plans for investment into transport, communications and other areas are being accelerated following the selection of Astana to host the EXPO-2017 world fair. The event will have the theme "Energy of the Future" and provide an impetus to develop and

showcase cutting-edge technologies in the spheres of renewable energy and energy efficiency. Despite its abundant reserves of fossil fuels, Kazakhstan – and in particular the city of Astana – is pushing for greater use of alternative energy technologies.

Kazakhstan as a whole has seen steady GDP growth for more than a decade, while foreign direct investment (FDI) continued to increase, reaching record levels during the recent global financial crisis. As of 2012, Kazakhstan had attracted a total of over $170bn in FDI since the country gained its independence, including a record $22.5bn in 2012. This is the highest level of FDI per capita across the CIS region, and second only to Russia in terms of the total volume.

The Kazakhstani government is working to stimulate investment and support entrepreneurs through a range of policies that have resulted in Kazakhstan’s rapid rise on the World Bank’s "Doing Business" survey. In the 2013 index, Kazakhstan was one of the top 10 risers, advancing seven places to 49th place. This was mainly thanks to improvements in two categories – registration of businesses and getting credit. Kazakhstan remained in 10th place out of 185 countries worldwide for protecting investors.

New legislation on public-private partnerships (PPP) adopted in 2013 will increase the use of PPP in Kazakhstan, allowing a wider range of PPP types and creating new opportunities for private sector involvement in infrastructure, transport and social projects. Eight new PPP projects, including the first to be launched in Astana, are already in the pipeline.

Astana’s location at the heart of the Eurasian landmass is another factor in the city's establishment as a business hub.

Spread across two continents, Kazakhstan is on the crossroads between China, Europe, Russia, south Asia and the Middle East.

By 2020, the volume of trade between countries bordering Kazakhstan is expected to increase by 50% to pass the $1 trillion mark. As a result, transit trade through Kazakhstan is expected to double to at least 50 million tonnes. The continuing growth in international trade flows puts Kazakhstan and its capital Astana at the heart of a new Silk Road, as crosscontinental land routes are revived in the 21st century.

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severe financial crisis. His first act on taking over was to devalue the tenge by 18%. This was followed just days afterwards by the nationalisation of two of Kazakhstan's largest banks, BTA Bank and Alliance Bank. Since then, Kazakhstan's economy has returned to steady growth, and the stability of the tenge has been maintained.

Marchenko has pushed to expand the NBK's powers during his second term.

After presidential elections in April 2011, the financial regulator (AFN) and the Agency for Regional Financial Centre of the City of Almaty were both abolished by presidential decree, and all functions and powers transferred to the central bank.

Kazakhstan replaces central bank governor Clare Nuttall in Astana

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rigory Marchenko has suddenly been replaced by former deputy prime minister Kairat Kelimbetov (pictured) as governor of the National Bank of Kazakhstan (NBK).

The unexplained move, announced on October 1, comes four years into the second term of the respected Marchenko, and just ahead of the central bank's takeover of the country's pension assets.

A statement from the presidential press office said Marchenko has been relieved of his post at the bank for "family reasons". No further explanations were offered for the dismissal of Marchenko, who returned to the post for a second time in 2009 during the depths of the recent financial crisis.

"He has worked in this capacity for many years, including through the difficult years," President Nursultan Nazarbayev said in a statement published on the Akorda.kz website.

"He has made a great contribution to the development of the financial system of our country, to the work of the

National Bank and management of the National Fund, for which I am grateful to him."

The bank's policy "will not change" as a result of the handover to Kelimbetov, the statement added.

Marchenko first headed the central bank between 1999 and 2004. He was

The departed governor has also continually called for full independence for the central bank. "Ideally, the National Bank of Kazakhstan should be independent, and there are no 'ifs'," he stated in March.

Indeed, in June parliament approved plans to give the bank more independence in certain areas, including giving it priority rights to buy gold bullion.

Marchenko was respected within Kazakhstan and popular among foreign investors, especially in the immediate neighbourhood. Two years ago - with Russia leading a push to expand the influence of the BRIC economies in international institutions - he was nominated as the CIS candidate to

"The president offered little detail on why Kelimbetov has been appointed" later moved to become deputy PM, then left to join the private sector where he was CEO of Halyk Bank, currently Kazakhstan's largest bank by assets.

However, he was brought back to lead the central bank again in early 2009 when Kazakhstan faced a

head the International Monetary Fund following the resignation of Dominique Strass-Kahn.

Critical time His replacement Kelimbetov has held several high-level government positions including minister of economy and budget planning, and deputy chairman

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of Kazakhstan's sovereign wealth fund Samruk-Kazyna. He has clashed more than once with Marchenko over Kazakhstan's reform agenda in recent years.

The president offered little detail on why Kelimbetov has been appointed.

"I consider that his knowledge of Kazakhstan's economy and financial situation will have a positive impact on the work of the National Bank," Nazarbayev's statement said curtly.

The change of leadership comes at a critical time for the NBK, which is in the process of taking over Kazakhstan's pensions system. Under plans pushed

by Marchenko and announced at the beginning of 2013, the country's ten private pension funds will be merged with the state fund. The resulting "GNPF Accumulation Pension Fund" will add

wealth does not make it far out of the major cities.

$23bn to the NBK's overall assets of $120bn – equivalent to 60% of GDP, Marchenko said in an interview with Reuters last month.

As in many CEE states struggling through years of economic hardship and fiscal difficulties, the government in Kazakhstan has shown enthusiasm for getting its hands on those private pension funds. Nazarbayev says collecting pension assets into a single, state-run fund will allow the government to mobilise billions of dollars for large projects to help sustain growth.

The president is pushing huge investment in infrastructure, both to help the economy and stem growing disillusionment amongst the population with the system. The biggest gripe is that the country's growing oil and gas

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

Analysts suggest that despite the pledge policy will not change under Kelimbetov, the GNPF is likely to raise its investment in infrastructure projects.

Marchenko had said he planned to raise the ratio of pension assets invested abroad, and warned that any large-scale state projects must be subject to strict expertise and be profitable.

Nazarbayev has set a deadline for the pension fund merger of January 1, 2014. However, Marchenko told Reuters in September that it is not certain the process will be completed by the end of the year. In June, Nazarbayev criticized the NBK for its role in a plan to make the retirement age equal for men and women, calling its work "unsatisfactory."

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Uzbekistan turns east as cotton boycott continues Clare Nuttall in Astana

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zbekistan has agreed a new deal to export 300,000 tonnes of cotton fibre to China as it seeks new markets to offset a boycott imposed by western firms over the use of forced and child labour during the cotton harvest. While Uzbekistan, the world’s sixth largest cotton producer, has for the first time allowed monitoring of its harvest by the International Labour Organisation (ILO), there have still been reports of forced labour this year.

In addition to the deal with China, Central Asia’s largest cotton producer has also reached agreement with Bangladesh to export 200,000 tonnes of fibre in August. The two Asian manufacturing hubs will together account for around five-sixths of Uzbekistan's total cotton fibre exports, which are expected to total around 600,000 tonnes this year.

and WalMart have joined a boycott of Uzbek cotton in an attempt to force Tashkent to stop exploiting children in its cotton harvests. As of October 14, 136 companies with a combined market capitalisation estimated at over $1bn had joined the boycott, according to the Responsible Sourcing Network.

In 2013, for the first time, the Uzbek government agreed to allow limited monitoring by observers from the ILO. The ILO said in a statement emailed to bne that it has been “involved in the monitoring of the cotton harvest in

statement issued at the start of the harvest on September 9 that: “We remain concerned that the ILO monitors will be accompanied by representatives of the Government of Uzbekistan and the official state union and employers’ organizations, whose presence will have a chilling effect on Uzbek citizens’ willingness to speak openly with the ILO monitors.”

The statement describes cotton production in Uzbekistan as “a state orchestrated forced-labour system”, with more than 1m people including children forced to the fields each year. Those who refuse are expelled from school, fired from their jobs, and denied public benefits or worse.” the statement adds.

Despite the presence of ILO monitors, there are allegations of ill-treatment of children and adults in the cotton fields during the 2013 harvest. Fergana

“It is much bigger than just agricultural land, the implications are much bigger”

Uzbek officials are expected to finalise the agreement with China at a cotton industry fair in October, according to RIA Novosti. The new deal will boost China's share of the harvest from around 15% to 50%, making it the single largest buyer of Uzbek cotton. At the same time, the Uzbek government is keen to increase domestic processing of locally produced cotton to 50%.

At present only 26-28% of the crop is processed domestically, according to the US Department of Agriculture.

Uzbekistan this autumn with the aim of preventing the use of child labour...

Monitoring activities will continue throughout the harvest period. The monitoring takes place in line with the principles and practices of child labour monitoring applied by the ILO's child labour programme (IPEC) in several countries. They are adapted to the specific circumstances of Uzbekistan.” A total of eight teams, each including an ILO-IPEC coordinator, are carrying out spot checks and other visits during the harvest, and meeting with Uzbek officials.

Boycott Previously, Uzbekistan sold its crop to a wide range of buyers. However, the country has come under increasing pressure from western buyers to abandon the use of child and forced labour during the cotton harvest, with many western firms now looking to other suppliers. International clothing manufacturers and retailers including Gap, Levi Strauss, Marks & Spencer

However, Uzbek opposition activists and international campaigners have voiced concerns that since Uzbek government officials have been allowed to accompany the monitors, the monitors won't gain an accurate picture of the situation. Independent news site Uznews reports that use of forced labour, including students aged under 18, has continued this year.

The Cotton Campaign said in a

News reports that a six-year-old boy suffocated under a heap of raw cotton on September 15 after going to the fields to help his mother.

While children have still been sent to the cotton fields in recent years, according to the Responsible Sourcing Network in 2012, ”the youngest children (aged 7-11) were not mobilized in mass quantities” – though there are reports of both children and adults forced to prepare the fields for cotton sowing this spring. The authorities have also continued to force more students, civil servants, doctors and other adults to harvest cotton.

Despite the encouraging sign that ILO observers are being allowed to monitor the harvest, now that almost all of the harvest is being sent to China and Bangladesh, the growing boycott by western producers may mean less pressure on Tashkent to continue the reforms.

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I 55

introduced earlier this year, the increased support for domestic production, especially of electronic consumer goods, appears to be part of a two-pronged approach to encourage import substitution and keep the trade deficit in check.

Buy Uzbek Clare Nuttall in Astana

T

he Uzbek government has continued to introduce new currency and import restrictions in the months since its shock announcement that it was banning the sale of foreign currency to Uzbekistani citizens. Importers have struggled to adapt to the new rules, while the government has stepped up its import substitution drive, offering more incentives to foreign manufacturers to start production within the country.

Most recently, the government announced additional support for local software developers, who will be exempt from all taxes and other mandatory payments until January 2017. Designers who manage to export at least 50% of their products will have the exemption extended for another two years, according to the September 20 government resolution.

Tashkent is also keen to attract more international companies to its free economic zones, which offer tax breaks and other incentives to foreign investors.

The largest, the Navoi Free Industrial Economic Zone, was set up back in 2008, but more zones have recently been set up in the Angren and Jizzak regions.

Several international high-tech companies have set up production in

the zones this year under joint venture agreements with local companies. The first “Uzbek iPads” – tablet computers produced by Indian-Uzbek joint venture OliveTelecom – are due to be launched on the domestic market by the end of this year. The company, a joint venture between state-owned Uzbektelecom and India’s Olive Telecommunications, already produces modems and other electronic equipment at the Navoi FIZ. Meanwhile, Pengzhong Xingsheng, a Chinese-Uzbek joint venture, has started producing ZTE smartphones for the Uzbek market. Its factory in the Syrdarya region has the capacity to produce 100,000

While the arrival of foreign manufacturers indicates some success, Lilit Gevorgyan, analyst at IHS Global Insight, points out it could lead to higher prices, a less competitive environment for local producers and an expansion of the black market.

“Considering that Uzbek producers have yet to develop reliable alternatives for these imports, it is Uzbek consumers who will carry the brunt of these changes. At the same time, the overwhelming red tape is likely to give yet another incentive to importers to avoid the customs services altogether by resorting to bribery,” Gevorgyan tells bne.

The new currency and import restrictions began when the government announced that from February 1 selling foreign currency to Uzbek citizens would become a criminal offence. The move was apparently intended to stop fluctuations in global markets from affecting the Uzbek economy and to halt the drain on forex reserves.

Uzbekistan has a long history of currency restrictions. The European Bank for Reconstruction and Development said in its 2012 "Transition Report" that there

"It is Uzbek consumers who will carry the brunt of these changes" handsets a year. And the local company Artel, launched in 2011, is now producing domestic appliances under partnership agreements with Samsung and electronics companies from China, Italy and Turkey.

Import substitution Combined with the import restrictions

had been “no progress” in eliminating distortions in the forex market – one of the main obstacles cited by foreign investors to investing in the country. The initial ban was followed up by further measures including a requirement for banks to report currency transactions to the tax authorities.

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“Clearly banning currency trading is geared towards weeding out foreign currency from domestic retail sales and services, including car dealerships,” says Gevorgyan. “But it is also designed to tap into the foreign exchange in the country considering that the country’s international reserves have been eroded recently due to a slump in foreign exchange revenues as a result of low external demand and the decline in world energy, metals and cotton prices, the main Uzbek exports.”

New rules on imports of consumer goods have also been introduced. In April, Tashkent increased the amount of documentation required from

bne November 2013

importers. From July 1, all imports of food and other consumer products approved for import have to carry labels in the Uzbek language and stamped by the manufacturer. While these were presented as anti-smuggling measures, there is a clear link to the drive to halt the decline in forex reserves.

produced item while a stuck-on label that has not been professionally printed signals an import. The general preference for foreign goods meant that importers were “in no hurry to make arrangements for the new labels”, leading to a scramble before the July deadline, Uznews says.

It is not yet clear whether these measures will result in a better level of local production or simply push up prices and feed the black market.

Independent news site Uznews pointed out that many importers were slow to switch to Uzbek-language labels, knowing that consumers assume an Uzbek label denotes a locally

With a population of 30m, despite lower incomes than in neighbouring Kazakhstan, Uzbekistan is potentially Central Asia’s largest consumer market. The appetite for electronics and other consumer goods is high, but Tashkent has not been able to shake the perception that imports are higher quality than locally produced goods.

transportation and logistics is still a main priority for the government and recently the Co-Investment Fund was established in Georgia… one of the key directions is logistics, what is really important for this country,” Marsagishvili says. “This means that the government realises that logistics is the key to success, economic development for the country. Also it is vitally important to spend money and invest in this sphere.”

Passing through Georgia Molly Corso in Tbilisi

A

s the recovery in emerging market trade continues, plans for a new port and investments by Georgia's recently launched $6bn Co-Investment Fund could help the country realise its potential as a regional transit hub.

A small country straddling European, Asian and Middle Eastern trade routes, Georgia has been pushing for a place in the international transit sector as China and Central Asian countries revive the ancient Silk Road for trade. Vakhtang Marsagishvili, a transport and logistics specialist with the US government’s

Economic Prosperity Initiative in Georgia, says that government support and investment are key to improving Georgia’s competitiveness and capacity as a transit hub.

A good sign, he notes, is that Prime Minister Bidzina Ivanishvili’s Co-Investment Fund – a private equity fund launched on September 30 with major backing from the Middle East, China, Kazakhstan, Turkey and Azerbaijan – has listed the trade and transit sector as a priority for investment. “What is important is that

The fund's management has already revealed plans to build a new port in Anaklia, a Black Sea village near the Abkhaz conflict zone, which would be the deepest port in the country. The Anaklia port project was initially floated as part of Georgian President Mikheil Saakashvili’s Lasika development.

Reviving the transit sector was a priority for the Saakashvili administration following the 2003 Rose Revolution, and it began by reforming the country’s corrupt customs, dilapidated railways and crumbling road infrastructure.

The previous government’s efforts paid off: Georgia has consistently improved in the World Bank’s "Doing Business" annual survey, and is currently ranked the 4th easiest economy for transit in the Eastern Europe-Central Asia region, above Russia and Turkey, its main competitors among regional trade routes, which are in 19th and 8th place, respectively.

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New investment While the reforms underscored Georgia’s potential as a transit hub, high costs and out-dated logistics terminals have hurt the country’s competitiveness and hampered the ability of Georgia to exploit its strategic location, according to a 2012 report published by Deloitte Consulting as part of the USAID Economic Prosperity Initiative in Georgia.

Observers say a new €10.5m logistics centre built by Austrian Gebrüder Weiss and Georgian Tegeta Motors is a good first step from the private sector to rectify this.

Alexander Kharlamov, the centre’s general manager, says it's the first warehouse and modern logistics centre of its kind postSoviet space. And Chaim H. Huijsman, head of corporate sales at Gebrüder Weiss, says the investment is part of the group’s eastward expansion. “From a strategic point of view, our growth is eastwards,” he says. “One still fantasizes about the Silk Road… For the past few years we have a team working on this area of the world.”

The thinking is that the transit route through Georgia offers a good alternative to the northern route through Russia,

Eurasia

And these costs through Azerbaijan and further east, especially over the Caspian Sea, undermine the attractiveness of the route. According to the World Bank's "Doing Business" survey, it takes nearly four-times as long – and costs twice as much – to export a container from Azerbaijan as it does from Georgia.

Intergovernmental initiatives between Turkey, Georgia, Azerbaijan and the Central Asian countries could help ease some of the issues that are slowing the transit cargo. The Baku-Tbilisi-Kars (BTK) railway, for example, a sevenyear project to create a unified rail line from Turkey to the Caspian Sea, has been promoted as an important link to increase capacity and speed for transiting cargo. Once opened in 2014, the new railway could move up to 30m tonnes of cargo through the region every year.

Observers are optimistic about the future, especially given the recovery in trade in the region and beyond.

Emerging market export growth accelerated to 4.7% on year in value terms in August, following a 3.7%

"Enough people are using the internet for online businesses to be viable" because it is less corrupt and quicker.

But despite the relatively short transit distance from the Black Sea to Central Asia, high costs along the route have hurt the country’s competitiveness as a regional transit hub.

The Economic Prosperity Initiative's Marsagishvili points out a cargo that originates in Central Asia needs to pass through Central Asian countries like Uzbekistan, Turkmenistan, then across the Caspian Sea, then though Azerbaijan before it reaches Georgia.

“When we are talking about transit routes, the transit route is not only Georgia," says Marsagishvili. "We have several players and all of them have their costs and issues.”

expansion in July, with the recovery in shipments from Emerging Europe, and the Middle East and Africa, which started in the first half of the year, gathering pace.

As evidence of this optimism, Kharlamov says Gebrüder Weiss might consider expanding its 10,000-square-metre logistics centre. “There are no such warehouses in the former Soviet Union and when the economy grows, and business is growing, that is the first step for a business – to have such an A-class warehouse in the country,” he says.

“There are difficulties, but somehow we handle this,” he adds.

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understanding of costs related to the project.

Mongolia – a tale of two mines Terrence Edwards in Ulaanbaatar

I

t is not the best of times for Mongolia's two largest mines. Both are falling well short of their moneymaking potential and, ever mindful of this, the government is in talks with its partners in each project to open a new chapter in the Mongolian investment story.

major spillovers globally and especially in the region. Spillover risks will particularly affect the more vulnerable emerging market economies. In light of this, Mongolia needs to change course to avoid becoming highly exposed to these external shocks and risks of crisis.”

Expectations were high for the Oyu Tolgoi copper mine and Tavan Tolgoi coking coal mine; both projects ride on their enormous reserves of 2.7m tonnes of recoverable copper and 1.84bn tonnes of coal, which are in big demand in next-door China. "Mongolia is an extended China resource play,” says Howard Lambert, chief representative of ING Bank in Mongolia. “If you believe in China's demand for commodities, Mongolia should be on your radar as a producer of low-cost minerals."

The problem for Mongolia is that too much hope has been invested in these two mines. For example, the investment agreement signed in 2009 governing Oyu Tolgoi, which is destined to be one of the world's largest producing copper mines, set the stage for the investment boom in Mongolia and it acts as an investment bellwether for the economy as a whole.

However, the gloss has come off the projects after a series of disputes between the government and the projects' partners, as well as slowing growth in China. The International Monetary Fund (IMF) warned in its World Economic Outlook report in October that a slowing Chinese economy has caused it to cut Mongolia's projected GDP growth for 2015 from 7.6% to 5.8% and for 2016 from 9.6% to 3.6%. “China’s economy is expected to rebalance away from a mostly investment-based growth model toward a more consumption-based growth model,” Geert Almekinders, who led a recent IMF mission to Mongolia, said on October 7.

“Both these factors are bound to have

Then there's the problem at the stateowned coal miner Erdenes Tavan Tolgoi, or Erdenes TT as locals call it, since it signed an off-take agreement with Aluminum Corporation of China (Chalco) that left it with $350m in debt to be repaid in coal exports. Erdenes TT now regrets signing the contract because it set below-market prices for coal in an already depressed market. The Mongolian government has since attempted to cancel the contract by paying a cash penalty and even suggested it would try to secure a better deal from another Chinese stateowned miner, Shenhua. That didn't pan out, however, and Mongolia has since been stuck with the original deal.

Public pay-off An attempt to deliver immediate benefits from the mining boom to a population where some 30% still live in poverty has also created problems for both projects. Oyu Tolgoi and Tavan Tolgoi were required to contribute $250m and $350m respectively to the Human Development Fund (HDF), whose ambitious goal is to bring Mongolia’s human development status to the same level as that of the developed countries by 2020. Although the programme was sold as a way to turn mining profits into societal

"Mongolia is an extended China resource play" However, the Mongolian government has found itself continually at loggerheads with Rio Tinto, which is leading operations at Oyu Tolgoi with a 66% stake in the project through its subsidiary Turquoise Hill Resources. The development of an underground mine there, where the company says 80% of the mine's value lies, is on hold after a government official notified Rio that parliamentary approval was necessary for a $4bn project financing package.

Rio says the financing package is the only option to move forward, but the government is hesitant to permit the financing package until it has a better

benefits, in practice redistributing those loans to the country's 2.9m citizens in cash has been more effective in driving up inflation, which until March had been in double digits for the previous two years, hitting 14% in December 2012. Erdenes TT was financially crippled by the HDF obligation, while Rio expected its debt to the fund to be treated as a pre-paid tax credit for 2012, but the government refused to allow it, creating another bone of contention.

Despite the stumbling blocks, Lambert at ING, which was the first foreign bank to open a representative office here in 2008 and has seen at first hand the ups

bne November 2013

and downs at both projects, says the problems with the two mines need to be put into context. "In terms of mineral production, Mongolia has come a long way in a relatively short period of time," he argues. "OT [Oyu Tolgoi] is producing from phase one, which is a milestone achievement. [Erdenes] TT is also producing and has been for some time – the question now is in relation to the timing of the buildout of the necessary infrastructure, power, wash plant and rail."

One optimistic sign is politicians' apparent mellowing over the issue of ownership at Oyu Tolgoi, which given its importance has always put it at the centre of a bitter debate over resource nationalism. A number of populistleaning politicians criticised the 2009 investment agreement because it leaves Mongolia with a minority share of 34%.

But now even the mining minister, a long-time critic of the original agreement, has softened his stance. “It is true, I used to criticize the Oyu Tolgoi agreement,” said Mining Minister Davaajav Gankhuyag at a September 26 press conference. “Now the government of Mongolia is not against the OT agreement… The OT agreement was made already, so we’ll fulfil the agreement and everything shall be handled according to the agreement.”

The two sides are back at the negotiating table. Government officials met with Rio management in London in late September and another meeting is widely expected to be held in Ulaanbaatar soon.

Since then, Mongolian officials have spoken more amicably about Oyu Tolgoi and the need to find consensus with the Anglo-Australian mining group. Prime Minister Norov Altankhuayg is also set to visit China on October 22, where many expect him to discuss outstanding issues with China about Erdenes Tavan Tolgoi's agreement with Chalco. He may also try and work out a customs issue that has prevented some 38,000 tonnes of copper concentrate that travelled over the border to China from reaching Chinese smelters.

An end to the mines' problems, and a new beginning for Mongolian investment, could be in sight.

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Ulaanbaatar's growing pains

Terrence Edwards in Ulaanbaatar Rapid urban development is never straightforward – and can be dangerous when shortcuts are taken to keep up with a furious pace. Mongolia's capital Ulaanbaatar is a prime example, where former officials are now under investigation as the current authorities grapple with heat and power shortages, and problems associated with traffic congestion.

Ulaanbaatar has been at the centre of Mongolia's mining boom, serving as the base of operations for the biggest foreign and domestic players in mining, banking and finance. “UB, not only being the capital, is also the place for half the population. It has become a cluster spot for businesses to convene in Mongolia,” says Saijrakh Narantuguldur, director for Khan Investment Management.

But this has brought its own challenges, with the October 3 collapse of scaffolding into the street at the central Twin Towers site a vivid reminder of why Ulaanbaatar Mayor Erdene Bat-Uul felt forced to suspend a number of construction projects last year.

In July, the State Specialized Inspection Agency (SSIA) reported that nine construction site accidents had occurred so far this year, claiming the lives of four workers. This was sharply down from the 36 construction site accidents that occurred in the first half of 2012, resulting in 18 fatalities – a high number attributed to the lax conditions that were pervasive under the administration of Bat-Uul's predecessor, Gombosuren Munkhbayar.

Authorities announced in October that the former mayor was under investigation along with two other members of his administration for allegedly profiting on the sale of state-owned property.

After a young person died from falling debris at a construction site under development by Eco Construction last year, Bat-Uul suspended all realestate development to allow city authorities time to review permits and shutdown the ones that did not go through official channels. The SSIA said in July it had discovered 36 construction sites operating without permits.

As well as building accidents, the city 's population faces growing health risks from the pollution caused by coal burning during the winter – the World Health Organisation named Ulaanbaatar as the second-most polluted city in the world in 2011 – worsening traffic problems, and an expected energy and heat crunch as the myriad of new building projects attempt to link up to the grid.

Heat is essential in Ulaanbaatar, the world's coldest capital, as temperatures often fall below minus 30° Celsius in December and January. "Everyone agrees that there will be a shortage of heat in Ulaanbaatar until the new power plant is built,” says Harris Kupperman, chief executive officer of commercial properties-focused Mongolia Growth Group.

Yet progress on a new coal-fired plant has been fitful as officials repeatedly scrapped plans and changed locations. In August, GDF Suez led a group selected to build a $1.2bn power plant 15km east of Ulaanbaatar, which is planned to start operating in 2017.

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Four reasons to buy Russian equities now bne

O

ver the last few months, stock pickers and financial market commentators have started wondering if now is a good time to buy Russian stocks.

Russia’s economy has fallen into something of a slump, but it is still growing. The World Bank reduced its outlook for growth last month to just 1.8% (the same as the official prediction), but the consensus view for 2014 and 2015 is on the order of 3%.

Here are four reasons why now might be a good time.

1. Russian stocks are super-cheap “Buy low and sell high,” goes the old investment saw. Russian stocks have always been cheap compared with their peers – and today they have never been cheaper. Russian stocks are priced with a deep discount to their already deep Russia-risk discount.

“According to Bloomberg, Russian equities have the cheapest valuations among 21 emerging markets at 3.8x 12-month estimated earnings, compared with a multiple of 10.5x for the MSCI EM Index,” Prosperity Capital Management said in its most recent newsletter.

2. This is not a crisis year “Investing into Russia is easy. The only thing you need to decide is if this is a crisis year or not. If not, then the market always returns a handsome profit for investors,” Roland Nash, chief strategic office at Verno Capital once famously said in the boom years.

This pearl of wisdom is still true, but it has been tempered somewhat by the crisis. Between 1996 and 2008, the RTS index returned between 8.3% and 197% each year (and the 8.3% in 2004 was an aberration because all the other years were over 30%), except in 1998 when the market lost 85% of its value, 2000 when it dropped 18% and 2008 when it fell 72%, according to Bloomberg. Since 2008, the RTS returned 128% in 2009, 22% in 2010, 10% in 2012, but lost 22% in 2011.

As Prosperity Capital Management pointed out in their September newsletter, the actual growth number is pretty irrelevant for the stock market as long is it is not a big movement either up or down. The trick is not how fast the economy is growing, but to invest into quality companies. “Economists are often focused on indicators which are rather meaningless for investors. One of them is obviously changes in real GDP. It does matter when it’s a significant negative number or a significant positive number, but if it’s 2% or 4% it hardly makes any difference to the stock market,” Prosperity said in its investors’ newsletter.

With Russia’s robust macroeconomic fundamentals today – almost unique in Europe – a crisis this year seems highly unlikely.

Going on Russia’s track record, this would suggest Russian equity should return at least 8% this year – and probably a lot more.

3. Russians stocks always rally over the end of a year “Sell in May and go away,” is another worn investment saw, but in Russia’s case it works remarkably well.

Aton Capital found in a study at the start of this year that if investors had followed this advice, then in all but three of the last 18 years their investments would have returned at least 20%.

In other words, over the last 18 years Roland’s Rule, as it should be dubbed, worked in every year except in 2000 and 2011 – two years that weren't "crisis" ones, but the market fell anyway.

The reasons why it works are varied. Obviously trading volumes (and price-impacting news) fall during the long Russian summer holidays. Funds also tend to allocate fresh money, dividends, pension plan contributions and capital gains contributions at around the end of the third quarter, which means there is simply more cash in play chasing the same stocks at the start of the last quarter.

While obviously predicting when a crisis is going to hit is a mug’s game, by the same token saying when one is not going to hit is a little easier.

And there are budget funds around, as much of the federal spending is rushed through in the last few months of the year and any superfluous funds left over in the budget are spent in

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the first quarter of the following year, or lost when the next budget is drawn up around Easter. Aton found that March was the strongest month of RTS returns over the last 12 years, which traditionally marks the end of the "Santa Claus" rallies.

May usually sees a sell-off, because funds need to report and tend to lock in profits at this time of year. Also once dividend payments have been made at around this time of the year, the appeal of shares drops. And then you are into the slow summer months again. “What if an investor committed $1,000 at the beginning of December and sold by the end of April and then stayed in cash in May-November? For 2001-12, this strategy would have returned 1,193%, beating the 1,000% return of the RTS Index for the full period,” Aton said in its report.

On this basis, it seems that Russia is already starting to enjoy something of the “Santa Claus rally”. For most of the last three years, the RTS Index has traded in a band between about 1250 and 1350, but in September it broke out and was trading at 1430 at the time of writing.

The classic rule of thumb for guessing where the RTS "should be" is to multiply current oil prices by 20, as Russians stocks and the economy in general are heavily dependent oil. On the whole this has worked well in the past. Indeed, the RTS broke above 2000 in May 2008 ahead of the crisis when oil was about $100. This would imply that the index should be again at about 2000, but in the current global economic malaise Russia’s leading investment banks are predicting the RTS will finish this year at somewhere between 1400 and 1750.

behind all this noise there are a handful of world-class companies getting on with the business of building a new economy.

No company exemplifies this better than the regional supermarket chain Magnit. When the company IPO’d in 2006, it had outlets in 500 small cities and town, with plans to open 400 more a year. Now it is achieving scale and opening 1,000 stores a year. It is already in 1,700 towns and cities and will open another 900 over the next five years as it concurrently begins to branch out into new business lines like cosmetics.

Overall, its organic sales growth has been running at 37% a year to reach $15bn by the end of 2012 and could top $20bn by the end of this year. This story would be remarkable in any country – but doubly so as it has happened in Russia. And the company’s stock reflects this astronomical growth; the company's shares trade on a multiple closer to 30 than 3 as a result.

Magnit is not alone; there is a range of companies with similar stories in obvious sectors like telecommunications, and less obvious ones like clothing, footwear and apparel, furniture, or e-commerce. However, most of their names are unknown to investors and the massive gains have remained the preserve of Russia’s specialist investors like East Capital, Verno Capital or Barings Vostok Capital Partners.

At some point the rest of the world is likely to wake up to what is going on and the whole market will rerate. But no one is expecting this to happen any time soon.

Historical returns (%), USD terms

4. Upbeat earnings forecasts The cheapness of Russian stocks on a price/earnings basis is one of the huge red herrings of stock picking in Russia.

Russians stocks have always been cheap on a P/E basis – in the boom years as well as the bad years. It is beyond the Kremlin’s ability (or desire) to address the Cold War fears that kept the specific Russia-risk discount in place.

The way to pick Russian stocks is to look at a company’s earnings, not its P/E multiple. And thanks to more than a decade of oil money-fuelled growth and rising incomes, the increase in earnings have driven a steady growth in share prices.

The autumn reporting season is coming to an end and Russian companies on the whole have done pretty well for themselves.

“60% of Russia’s companies managed to exceed consensus expectations [for earnings]. 36% missed to the downside on revenue and 26% on EBITDA,” VTB Capital said in a recent note.

Stock pickers should be looking through these winners for the best companies and here one in ten managed to beat expectations by more than 5%. Even the ones that missed their targets only missed by 2-3%, says VTB, and none missed the target by more than 5%.

The coverage of Russia is swamped by negative political news, but

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Year

RTS

EMBI+ RU

MICEX Corp Bonds

Cash, RUB

Cash, USD

1996

141.8

114.3

n/a

n/a

5.6

1997

97.9

2.8

n/a

n/a

5.8

1998

(85.2)

(82.6)

n/a

n/a

5.7

1999

197.4

165.7

n/a

n/a

5.4

2000

(18.2)

54.9

n/a

9.0

6.6

2001

81.5

55.8

n/a

4.7

4.2

2002

38.1

35.9

n/a

9.8

1.8

2003

58.0

22.4

18.1

17.1

1.2

2004

8.3

11.5

6.5

10.2

1.5

2005

83.3

13.3

7.1

1.1

3.4

2006

70.7

5.5

9.0

14.4

5.2

2007

19.2

7.3

6.5

13.2

5.4

2008

(72.4)

(16.8)

(11.7)

(9.2)

2.9

2009

128.6

37.1

23.7

11.5

0.3

2010

22.5

8.6

12.0

2.5

0.3

2011

(21.9)

6.1

0.9

(0.6)

0.2

2012

10.5

17.1

14.1

12.3

0.2

2013 YTD

(6.8)

(5.8)

0.8

(1.0)

0.1

Aug 2013

10.2

1.9

3.5

3.3

0.0

SELECTED PERIODS' RETURNS, ANNUALISED since 2000

15.7

16.6

n/a

6.5

2.4

since 2003

12.7

8.9

8.0

6.1

1.9

6.4

3.7

0.2

(3.3) (7.1) last 12mo Source: Bloomberg, VTB Capital Research

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Upcoming events 2013 II International Investfunds Forum Russia (8 - 9 November) Istanbul, Turkey http://cbonds-congress.com

German Equity Forum (11 - 13 November) Frankfurt am Main, Germany www.eigenkapitalforum.com

Deepening and Widening The Eurasian Integration (12 - 13 November) Eurasian Development Bank +7 (495) 258 2760 Moscow, Russia info@eabr.org www.eabr.org

V Economic Forum of Big Business (23 November) Astana, Kazakhstan www.raexpert.kz/events/e200kz-2013/

4th AIFM Directive 2013 Conference (28 November) Private Equity Forum +44 (0)845 463 7621 London, United Kingdom register@privateequityforum.co.uk www.aifmdirective.co.uk

XI Russian Bond Congress

December 5—6, 2013, Saint-Petersburg

CONGRESS R U S S I A N

B O N D

SAINT-PETERSBURG 2013

Adam Smith Conference’ 20th Anniversary Russian Banking Forum (3 - 5 December) Adam Smith Conferences +44 20 7017 7444 London, United Kingdom events@adamsmithconferences.com www.adamsmithconferences.com

The congress was first held in 2003, and currently is Russia’s largest debt market conference and one of the biggest events in financial markets.

Hosted by:

Lead sponsors:

Official partners:

Sponsor of gala dinner:

Sponsors:

Sponsor of dinner at Paulaner: With contribution from:

Agenda, sponsorship: Yury Pavlov e-mail: pavlov@cbonds.info Phone: +7 (812) 336-97-21 *121

Participation: Elena Mokritskaya e-mail: elena@cbonds.info Phone: +7 (812) 336-97-21 *104

www.cbonds-congress.com

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