BNE February magazine

Inside this issue: Russia's civilised revolution A real mess for banks Croatia says "Da" Kazakhstan's veneer of democracye February 2012 www.businessneweurope.eu

Special Focus: Investment bank survey Special Report: Outlook 2012

The curtain comes down on Nabucco

The Russians, Turks and economic reality kill EU's gas pipe dream

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

Contents

+7 9162903400

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

+7 9266052742

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

31 COVER STORY 6

The Insiders

24

A real mess for banks

8

The curtain comes down on Nabucco

25

A Czech haven

27

Latvia's PM talks about life after loans

29

CEE can't break free of its historical bonds

31

Poland's bourse fights chill winds from Europe

12

Perspective

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EASTERN EUROPE 14

Russia's civilised revolution

15

The power of ruling parties

17

A law unto themselves

18

Overcoming the threshold

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

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Putting on the ritz in Eastern Europe

20

Russian warehouse party

21

Belarus faces brain drain

Advertising & subscription: Elena Arbuzova +7 9160015510 Business Development Director arbuzova@businessneweurope.eu

22

Russia buys into buybacks

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Alec Egan +44 2030516548 Business Development Director (International) egan@bne.eu Design: Olga Gusarova-Tchalenko +44 7738783240 o.gusarova@businessneweurope.eu

Please direct comments, letters, press releases and other editorial enquires to editor@bne.eu

CENTRAL EUROPE

Print issue: ¤68 / year Basic online package: ¤180 p/user, p/year Full subscription package: ¤500 p/user, p/year All rights reserved. No part of this publication may be reproduced, stored in or introduced to any retrival system, or transmitted, in any form, or by any means electronic, mechanical, photocopying, recording or other means of transmission, without express written permission of the publisher. The opinions or recommendations are not necessarily those of the publisher or contributing authors, including the submissions to bne by third parties. No liability can be attached to the publisher for these comments, nor for inaccuracies, errors or omissions. Investment decisions or related actions taken on the basis of views or opinions that appear herein are the responsibility of the reader and the publisher, contributors and related parties cannot be held liable for these actions. bne is the property of bne Media Ltd · Reg number: HE 185230 · Michalakopoulou 12, 4th floor, Suite 401, P.C 1075, Nicosia, Cyprus · Postal address: Schluterstrasse 19, Berlin 10625, Germany

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Contents

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

33

In defence of Turkey

35

Treasured islands

37

Turkey's Asian-style growth

38

Albanian PM plots path of greatest resistance

39

15 million customers have selected us as their bank of choice.

Raiffeisen Bank International represents more than 20 years of experience in Central and Eastern Europe, covering 17 markets in the region with subsidiary banks, leasing companies and other financial service providers. International companies, local businesses of all sizes and private individuals rely on our network of around 3,000 branches.

Over 100 international banking awards validate the group‘s service quality. www.rbinternational.com

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SOUTHEAST EUROPE

Flagging down ships in Albania

41

Croatia says "Da"

42

Political games undermine confidence in Slovenia

43

Romanians on the streets

45

Shale'acked in Bulgaria

EURASIA 47

A veneer of democracy in Kazakhstan

48

Eight Turkmen

49

Sharing the blame

51

Tipping the togrog

52

There's gold in them thar hills

54

I5

OUTLOOK 2012 57

Russia's uncertain smile

58

Ukraine's year of living dangerously

59

Blissful living in Central Europe

60

Fading Baltic bounce

62

Southeast Europe on shaky ground

SPECIAL FOCUS

64

A scrawnier Turkey

Investment bank survey 2012

65

Eurasia – a question of stability

68

CLASSIFIED

69

UPCOMING EVENTS

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I The Insiders

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Trading up in Europe

John Casey of HSBC

2

011 was, without question, a difficult year. The headlines continued to document the twists and turns in what is one of the most challenging periods in the Western world’s economic history. The picture for many countries in Europe remains extremely challenging, and as a result businesses are having to navigate choppy waters. But the first Global Trade Forecast from HSBC provides cause for optimism for the role that trade could play in driving growth in 2012 and beyond.

While trade has inevitably been impacted by the crisis, trade remains the backbone of global growth. This is borne out by the findings of the Global Trade Forecast, which we commissioned to help our customers shape their strategy. The Forecast tells us that over the next 15 years, world trade volumes will grow by 73% by 2025 and international trade activity will grow, on average, by just under $1 trillion a year between now and 2015.

Perhaps surprising given the current climate, the story is as positive, if not more so, for Europe, and especially its emerging markets. Europe's external trade to 2025 will grow at a rate that is faster than for the world as a whole. Our Forecast predicts that trade volumes for the EU27 will grow by 77%, versus the world average of 73% over the period. Secondly, it anticipates that to achieve this European businesses will increase their trade outside Europe by 4% a year to 2015 – double the growth expected for the rest of the world. In fact, Europe is predicted to perform better than North America, the Middle East and North Africa region in the short term. But what is driving this?

The European story over the next 15 years can be summarised into three key drivers; Europe's role in emerging market growth, the rise of the "global supply chain" and emerging growth corridors. Critically it is Emerging Europe that features throughout.

1. Europe's role in emerging market growth Emerging markets are building infrastructure at an incredibly fast pace. This is set to continue – and Europe is a fundamen-

tal part of that. As renowned producers of high end products in the engineering and construction industries, Europe is visibly and critically involved in exporting goods for major development projects, from railway construction to roads and buildings. Many businesses are already playing their part, but if growth is set to continue, then analysing where broader European products and expertise is required is key.

2. The rise of the "global supply chain" The second driver is perhaps the most significant part of the European story to 2025. Developed trading nations are adapting how they work to boost their competitive advantage and improve efficiency; this shift is creating a redistribution of supply chains from "local" to "global".

The change is twofold. Firstly, we will see European business powerhouses broaden their reach globally to spread their influence. And secondly we will see new and ambitious players in Emerging Europe take their own place in these chains, forming technical alliances, establishing new manufacturing hubs and becoming niche suppliers critical to the overall supply chain.

For example, Germany will remain a trading powerhouse, fuelled by its high-end innovation and technology sectors in automotives, manufacturing, chemicals and pharmaceuticals.

To improve their competitive advantage, German businesses are now using their European trade links, for example with Poland and the Czech Republic, to create strong and integrated European-based supply chains that can be competitive in global markets. Trade between Germany and emerging nations is forecast to grow by over 10% over the next 15 years.

In turn, we will see new and ambitious players in Emerging Europe taking their own place in these supply chains by forming technical alliances, establishing new manufacturing hubs and becoming niche suppliers in their own right. Poland is already in the top 10 emerging growth trade corridors of 28 of the 36 countries studied for our Global Trade Forecast, while the Czech Republic features in 18. This equates to an increasingly powerful and central role in world trade.

bne February 2012

In Poland, our economic forecasting model predicts trade volumes will grow by 125% to the end of 2025. Much of the growth will be in the export of motor vehicles and components, agri-business and data processing equipment; in other words high end products supplied to developed and emerging nations. Trade with Korea through imports of its photographic equipment is growing rapidly, which reflects Poland's focus on developing its role as a supply chain hub; it imports the equipment and then exports a new product out to its new trading partners. The country is also widening its trade into the Middle East, with countries like Egypt, the UAE, Qatar (although from very small numbers) and Saudi Arabia featuring strongly as trade partners in the coming years.

In the Czech Republic, our Forecast predicts trade volumes will grow by 100% to the end of 2025. Much of its growth will be in the export of manufactured goods such as cars and computers – sectors that rely heavily on the strong innovation base of the economy and its integration in the global supply chain. However, it’s an open economy and trade is very dependent on global demand – or more specifically, the demands of Germany as its major export partner. However, Singapore and other South East Asian markets are also increasing their trade with the Czech Republic. In Singapore’s case, it's forming a key part of its electronic equipment supply chain.

Critically, companies need to understand where there is a role for them in the global supply chain. Learning from peers can provide valuable insights. Considering new alliances is also useful; is there a potential partner also looking to forge links with new markets or companies? Where can businesses work in partnership with their bank or suppliers to mitigate the risks that working with a larger and more diverse supply chain can be associated? All of these are important considerations for a forward-thinking business.

3. Emerging growth corridors It will come as no surprise that Europe's external trade will increase via trade routes opening up with South America and Asia. India, Brazil, Thailand, Vietnam, Indonesia and Singapore are diverse but emerging trade corridors, which will be built on the back of integration with Europe's largest businesses and the trading of predominantly commodities like food products, iron and steel. For European businesses, understanding these emerging trade corridors and the markets driving them is important to help identify new partnerships and opportunities.

Despite the current climate, our Global Trade Forecast highlights that the next 15 years represent an exciting period for businesses in Europe if they take steps to capitalise on how the world is changing. Businesses need to trade their way back to health and companies wishing to take advantage of the opportunities that international markets offer must act now or risk being left behind.

John Casey is HSBC Head of Commercial Banking, Continental Europe

"Our Forecast predicts that trade volumes for the EU27 will grow by 77%, versus the world average of 73%"

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I Cover story

bne February 2012

The curtain comes down on Nabucco David O'Byrne and Nicholas Watson

A

t any other time over the past decade, a statement from a Turkish energy minister pledging Turkey's support for the Nabucco pipeline project designed to carry Caspian natural gas to Europe across Turkey would have been taken at face value. However, these are dark days for this heavily EU-backed project designed to reduce reliance on Russian energy supplies.

As an EU candidate state and a member of the consortium that will build

Nabucco, Turkey has every incentive to support the EU's long-held plan to open up a third gas corridor that would bring non-Russian gas into Europe and bypass Russian territory.

Slated to run the 3,300 kilometres from Turkey's eastern border with Georgia to Europe's main gas hub at Baumgarten in Austria, the 31bn cubic metre a year (cm/yr) Nabucco pipeline is not nearly big enough to replace Russia as a major supplier of gas to Europe. However, the

consortium building it – which comprises Botas (Turkey), BEH (Bulgaria), Transgaz (Romania), Mol (Hungary), OMV (Austria) and RWE (Germany) – argues it would offer at least a vital alternative to Europe's growing dependence on imports of gas from Russia, which already supplies over 50% of the gas imported into the bloc. This is a position that Turkey, which already imports around 60% of its gas from Russia, is in every position to understand.

Cover Story I 9

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Yet comments by Turkish Energy Minister Taner Yildiz at a conference in the Georgian capital Tbilisi on January 21 together with two other pipeline announcements over the previous month show that Turkey is at best ambivalent about Nabucco's prospects of being built. "[Nabucco] must be part of the solution for European supply security. We are one of the six consortium partners and our efforts to realise this project are continuing," he said.

Commentators seized on his use of the phrase "part of the solution" – after all, it is less than a month since Turkey was party to two announcements on rival pipeline projects that between them promise to take both the gas Nabucco that hopes to carry and the markets it hopes to serve.

The death knell, say many observers, is being sounded for this expensive and overly ambitious political energy project,

which changes in the energy markets and technology have combined to make increasingly redundant since it was first mooted in 2002.

Crossing pipelines Turkey and Azerbaijan chose Christmas Day to sign a memorandum for the creation of their jointly mooted TransAnatolian Pipeline (Tanap) – which will use mostly existing Turkish infrastructure to carry up to 16bn cm/y of gas from the second phase of development of Azerbaijan's Shah Deniz gasfield as far as Turkey's European borders, from where buyers can transit it to the various European markets.

Then just two days later, Turkey and Russia signed an agreement to allow the construction of Gazprom's planned South Stream gas pipeline, slated to carry 63bn cm/yr of Russian gas

through Turkey's sector of the Black Sea to Bulgaria and on via planned spurs to markets around Central and Eastern Europe. Construction of this pipeline, seen as Russia's counter to Nabucco, was then given a huge fillip by Gazprom's announcement in January that it has moved up the timetable to begin building this pipeline this year.

The rationale behind Tanap is simple enough – it is a straight alternative to Nabucco, carrying the same gas and following the same route across Turkey, albeit with little capacity for expansion and halting at Turkey's western borders.

Expected to cost far less than the €12bn15bn that Nabucco is expected to run to, Tanap does at least fulfil the EU's longheld aim of providing a vital alternative to Russian gas and, like Nabucco, would open up the EU's cherished South European Gas Corridor.

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I Cover story

South Stream on the other hand, with three-times the capacity of Nabucco, threatens to flood European markets with gas, lowering prices and making it difficult both for rival projects to sign up buyers in advance and to secure the financing needed for construction. And with much of the line running deep under the sea, it neatly avoids problems with transit countries such as Ukraine, with which Russia has long endured difficult relations due largely to Ukraine's insistence on Russia supplying cheap gas in return for transit to Europe. It's a strategy that Gazprom has already employed to good effect with the construction of its Nord Stream pipeline under the Baltic Sea, which began pumping 27.5bn cm/y of Russian gas in 2011.

Gazprom also appears to have managed to lure away from Nabucco Germany's RWE, which would've been one of the largest end-users of the gas from that pipeline. RWE CEO Jurgen Grossmann said in an interview with Dow Jones in January that his loss-making firm is considering scrapping its plans to participate in Nabucco. Says Andrew Neff of IHS Global Insight: "A potential withdrawal

by RWE from the Nabucco consortium would not necessarily be the end of the pipeline project, but it could trigger a rush for the door by other shareholders, as Nabucco appears more and more to be a sinking ship."

Neff says that barring Azerbaijan making a quick and definitive decision to

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supply its gas to Nabucco, "the pipeline now appears destined to be scrapped."

Yet such a decision from Azerbaijan is unlikely, given that its national oil company Socar has delayed again choosing its preferred gas export route for the gas from the second phase of Shah Deniz until at least the end of March, all the while it and Turkey's Botas are proceed-

some advantages that Nabucco doesn't," he says, pointing out that as well as guaranteeing to send 10bn cm/yr to Europe, the project allows for Turkey to take 6bn cm of Azeri gas, some of which will be used as feedstock by Turkey's only petrochemical plant, now owned

by Socar.

"Two rival pipeline projects between them promise to take both the gas Nabucco that hopes to carry and the markets it hopes to serve" ing full-speed ahead on Tanap. "[This] strongly suggests that Nabucco is virtually out of the running now in the southern corridor pipeline race," says Neff.

What is less obvious is how signing off on South Stream benefits Turkey, which hopes to cement its role as a major gas corridor into Europe with either Nabucco or its own Tanap project.

According to Turkish energy analyst and member of the World Energy Council Turkish National Committee, Necdet Pamir, Turkey's simultaneous support for the two projects doesn't reflect any grand strategy. "The details of Tanap haven't been announced yet, but it seems to offer Turkey and Azerbaijan

Turkey's support for South Stream, however, stems from a far different cause. Pamir points to one of Turkey's three existing gas import contracts with Russia, through which it takes 6bn cm/yr via the Trans-Balkan pipeline, most of which supplies gas consumers and power plants in Turkey's biggest city Istanbul. That contract expired on December 31, with Gazprom wanting Turkey to extend the existing agreement unchanged and Turkey preferring to instead transfer it to the private sector in line with plans to liberalise its gas market according to EU rules. "They knew Turkey was in a weak position, and squeezed," says Pamir, pointing out the risks of failing to reach an agreement with Gazprom during the coldest

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part of winter – namely similar to what happened in January 2009 when a gas dispute between Russia and Ukraine saw gas supplies cut off to much of Europe.

Ironically, these are precisely the same risks that the Nabucco pipeline project was supposed to have mitigated.

Turning on the TAP With the curtain coming down on Nabucco (named after the Verdi opera), the two pipelines that had been bidding against it to bring the Azeri gas to Europe have had new life breathed into them.

Nabucco was the only project providing transport of the Azeri gas all the way from Turkey's eastern border into the heart of Europe. The problem with the two competing pipelines – the Interconnector Turkey-Greece-Italy (ITGI) and the Trans-Adriatic Pipeline (TAP) – was that they both relied on the antiquated pipeline infrastructure of Turkey to get the Azeri gas to where their pipelines picked up the route. Turkey and Azerbaijan's Tanap pipeline solves that.

ITGI has approximately 1,700 km of the overall 2,500 km of pipeline already built. Missing is a 207-km offshore section - the Poseidon Pipeline – linking the Italian and Greek gas networks across the Ionian Sea, which is under development by Italy's Edison and Greece's Depa through the consortium IGI Poseidon.

Cover story

This will have a capacity of 8bn cm/y and cost around $1.5bn.

TAP, being built by a consortium of Statoil, E.On and EGL, will actually require the shortest pipeline to be built, just a 520-km long section with a 10bn cm/y capacity that will transport gas via Greece and Albania and across the Adriatic Sea to Italy’s southern Puglia region. The cost of the project is approximately $2bn.

TAP had been the only project out of the three that has one of the members of the Shah Deniz producing consortium in its shareholder structure, Statoil with a 42.5% stake. However, BP, which is the operator of the Shah Deniz consortium has entered the fray with its unveiling in September of the South East Europe Pipeline (Seep), which would run from eastern Turkey to the Baumgarten hub in Austria. "BP's Seep proposal has gone from dark horse to frontrunner in the past three and a half months since it was first mooted," says Neff.

Nabucco may be dead, but the pipeline battle goes on.

"Nabucco appears more and more to be a sinking ship"

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I Perspective

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Limited options The options for raising the necessary capital are limited, but shrinking the balance sheet is one route RBI will have to take, which will inevitably slow lending in CEE. "It's not our strategy to simply reduce riskier assets, but it is a component – we do not intend to grow as fast as we have been," Butler says, stressing that it's not a major withdrawal from the region's credit markets, which would be counterproductive.

A second option for the sector is to dispose of assets, but in the current climate it would be tough to attract buyers for subsidiaries in less promising economies, whilst few will want to offload those in high-growth markets such as Poland or Turkey. Butler insists this is not in RBI's strategy. "We made over €1bn profit before tax in the first three-quarters of 2011 – an awful lot of it in CEE. We'd be cutting off our nose to spite our face were we to divest."

Perspective I 13

He also suggests the measure is fundamentally flawed, a point apparently not lost on the international institutions currently attempting to build "Vienna 2.0" in a bid to protect and coordinate funding flows to and from CEE, just as the original "Vienna initiative" was set up to do in 2009. "I think it's important we measure everything with the same yardstick," opines Butler. "If the West expects CEE not to put up barriers to capital flows, then that should work both ways."

He claims that it would make little difference to RBI anyway.

"The bulk of funding in all our subsidiaries comes from the local market, so I don't envisage major problems for us in any market," Butler says, although he suggests the wider banking sector in certain markets could face challenges, expressing "some concerns for Hungary… and to a lesser extent Ukraine."

More positively, Butler suggests mid-January's improvement in market sentiment opens up a third option. "A week ago, I would have said that a lasting recovery in the equity markets

Shock therapy and banking in CEE Tim Gosling in Vienna

C

entral and Eastern Europe fears a sharp cut in lending as the sovereign debt crisis takes its toll on Western Europe's banks. One of the biggest lenders in the region, Raiffeisen Bank International (RBI), is indeed pulling back in response to the "shock therapy" of the EU's capital ratio demands, but it hopes to balance that against the greater growth opportunities the region offers.

The European Bank for Reconstruction and Development said January 24 that deleveraging by western banks appears to have been underway since the autumn, meaning that contagion from the Eurozone crisis to the region has already begun. That's no surprise given that January 20 was the deadline for 31 major European banks to submit plans to comply with the demand to raise Tier 1 capital ratios to 9%.

Patrick Butler, who sits on the board of RBI, insists his bank will meet the demand, but it's clearly a difficult ask. "We have

every intention of meeting the EU critieria by the deadline of June 30, but we are very unhappy that plans for a gradual increase in capital have been accelerated into an eight-month bracket. That's shock therapy, which is very negative for the economies of both Western Europe and CEE." This rush to recapitalise risks driving economies into a recession for two reasons. "Firstly, the equity market knows that there's potentially a lot of equity to be issued if the window opens. Secondly, the worry is that the banks will reduce asset growth or even assets."

That said, the banker doesn't expect many of RBI's peers to struggle to meet the deadline. "It's an issue for many," he agrees, "but I suspect only a very modest number, if any, will fail. There are banks that have had difficulties, and some of them have had business in CEE, so people are making a shortcut connection between those two points."

"We are very unhappy that plans for a gradual increase in capital have been accelerated into an eightmonth bracket – that's shock therapy" seemed unlikely, but sentiment has changed. The market senses that the European Central Bank's effective quantitative easing, plus budgetary measures in various countries, will buy time. I now think we will see an equity rally, and given the relief that [the €7.5bn capital increase from] UniCredit is out of the way, we may see some European banks able to raise new capital."

With every little bit counting in the European sector's fight to find the €115bn it needs by the summer, Butler suggests further options. "We intend to do a number of securitisation deals, whilst the other route is retained earnings. We have a machine that retains hundreds of millions per annum – which represents Tier 1 capital, of course."

Another point of optimism is Butler's take on November's so-called "anti-Vienna initiative," which was the Austrian regulator's attempt to limit the funding that its banks channel to subsidiaries in CEE. He says no one has called round to talk to RBI about it. "My latest understanding is that it was a statement of intent, but not a binding measure. Nobody is enforcing it, and it may not be enforceable under EU legislation anyway."

"I suspect only a very modest number of banks, if any, will fail"

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Eastern Europe I 15

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The power of ruling parties

bne With all this talk of revolution and vote rigging, bne thought it a would be good idea to compare Russia's election record with the other members of the Commonwealth of Independent States (CIS).

The chart below shows the shares won by the powersthat-be in the more recent presidential and parliamentary elections. In keeping with Prime Minister Vladimir Putin's "managed democracy" system, Russia falls somewhere in the middle on the "despot-o-meter" between democracy and dictator. You can roughly divide the rest of the CIS into two camps: those that have free elections and those that don't.

Russia's civilised revolution

Photo ITAR-TASS

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evgenia Chirikova, who sprang to prominence during the protests against the destruction of a forest in the Moscow region suburb of Khimki and successfully prevented the building of a highway, is an unlikely radical and caught the mood of December's protestors at a press conference.

"All the meetings of the protests, all the actions of the protests in Russia, are the most civilised protests amongst all those protests that are happening worldwide. There is no broken glass.

No overturned or burned cars. This is a civilised citizens' protest against a party of crooks and thieves, against them depriving us of free and fair elections," said Chirikova.

Contrast the 33-year-old former businesswoman, who has a taste for frumpy tank tops, with the freedom fighters in Libya or Syria (or even the hippies in New York's Zuccotti park). She is

emblematic of Russia's emerging protest movement – typically middle class in the western sense and, ironically, one of the real beneficiaries of Prime Minister Vladimir Putin's successful reforms that have lead to a 14-fold increase in income over the last 12 years.

widely reported election fraud still commanded about 60% of the real vote) and meekly accepted Dmitry Medvedev as their new president. But the global crisis that broke the same year has made bad government more obvious and the pain inflicted has goaded more into action.

Yet she is angry. The middle class were grateful enough (or at least complacent) in 2008 when they helped United

Even so, Russians remain relatively well off: unemployment is now at 6.1%, a post-Soviet low, inflation will end

Turkmenistan takes the golden biscuit for not even attempting to pretend it has a democracy. The ironically named "The Democratic Party of Turkmenistan" that supports the president won every seat on offer in the last elections in February 2010 and controls 100% of the legislature.

Still, Turkmenistan's president, Gurbanguly Berdymukhamedov, is a bit more modest than fellow dictators Uzbekistan's Islam Karimov and Kazakhstan's Nursultan Nazarbayev, in that he only arranged to win 89.2% of the vote in 2007, against Karimov's 90.7% and Nazarbayev's 95.5%, which made the Kazakh leader the most "popular" president in the CIS. Likewise, Azerbaijan produced 88.8% for the party of power in parliamentary elections and 87.3% for the incumbent president, which was on a par with Belarus (93.6% and 76.7%).

THE POWER OF THE RULING PARTIES

Happily, the second camp of open societies is growing, albeit slowly, with Mongolia (52.7%, 51.2%), Georgia (59.2%, 53.5%) and most recently Kyrgyzstan (n/a, 63.2%) holding real votes with real oppositions to produce real democracy.

Ukraine is nominally in the democratic camp, but is regressing fast. The ruling Party of Regions only won 34.4% in 2007 – the lowest rating of any ruling party in the CIS – and President Viktor Yanukovych only just beat Yulia Tymoshenko with 48.9% in 2010. Since then, Yanukovych has worked hard to undo all the progress Ukraine has made over the past seven years since the Orange Revolution. Tymoshenko was thrown in jail and the Rada passed in December a revision to the electoral law that is bound to see the Party of Regions "improve" its standing in the next general election.

Russia's parliamentary election result in December should put it in the democratic camp after United Russia only won 49.5%. But unlike the other members of this group, the process was clearly "managed," as there was no real opposition (other than the Communists) to vote for. The presidential elections in March should be interesting, as it looks like the Kremlin has been forced to offer the voters a little (just a little) more choice than in 2008 when Dmitry Medvedev won a whopping 70.3% of the vote. While no-one doubts Putin will win in 2012 (and in the first round too), if the trend holds up he will probably get closer to 50% of the votes than 70%.

RUSSIA

BELARUS

"Chirikova is emblematic of Russia's emerging protest movement – typically middle class and, ironically, one of the real beneficiaries of Putin's reforms" Russia sweep back into power (the ruling party officially won just over 66% of the seats, but even counting out the

UKRAINE KAZAKHSTAN MONGOLIA

UZBEKISTAN GEORGIA AZERBAIJAN ARMENIA

KYRGYZSTAN TURKMENISTAN

TAJIKISTAN

the year at about 7%, and after a brief reversal incomes continue to rise and have already surpassed their pre-crisis Source: bne

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levels. In other words, from a material point of view and relative to their western peers, Russians have little to complain about compared to where they were when Putin became president in 2000.

Russia's relative prosperity has muted the protest movement. The "Arab Spring" was sparked by the self-immolation of a

"Russia's relative prosperity has muted the protest movement" market trader in Tunisia, but it was rising food prices and high youth unemployment that provided the tinder.

And it is this very mildness that could make Russia's protest movement so powerful. Of all countries in the world, none are as familiar with sophisticated repression as Russia and Putin, a former KGB colonel, is explicitly schooled in the art.

However, he has caught himself on the horns of a dilemma created by his own "managed democracy," and may become victim to the Kremlin's own emphasis on developing the internet and allowing public discussion of corruption as part of Medvedev's own anti-graft campaign, among other things.

There is a lot of "manage" in this model, such as the state's complete control over the mainstream media and use of administrative resources to manipulate the vote. But there is also real "democracy" in there; Putin needs real votes to legitimise his programme and his own personal popularity (still amongst the highest in the world, albeit falling) is the bedrock on which his power rests on.

The vote in December 4's Duma poll may have been manipulated, but United Russia still only won 49% of the vote (estimates of the real result range from 25% to 35%), not the 90% typical of virtually all of Russia's neighbours to the east and southeast –home to real old-school dictatorships. The Kremlin is subtle enough to realise that it can't get away with that kind of ballot stuffing.

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So Putin is attempting a balancing act: giving a real voice to the voters, but using his hold on the levers of power to massage the result and maintain the control he clearly believes he needs to finish his 20-year transformation programme.

but many of his party colleagues did.

Their rationale is as follows: they had to choose between "bad" (the adopted law) and "even worse" (another draft pushed

by Yanukovych that envisaged the same changes but also contained a lot of procedural breaches).

What is less noted is the people appear willing to compromise. Unlike Egyptians and Belarusians, the majority don't necessarily want to topple the government; they just want to make it more accountable and representative. The most widely heard complaint is not a call for "change" but for "order", by which people mean an end of the unpredictability and cost that accompanies the endemic corruption (the way officials extract a bribe is to create an unforeseen problem). The Russian people want a quiet life where they can work and enjoy the fruits of the country's ongoing development. It is a quintessentially middle-class aspiration much closer to the occupy Wall Street Movement than the protestors on Cairo's Tahrir Square.

Shevchenko argues this law combines the worst features of proportional and majoritarian systems. "First, singleseat constituencies are usually sold to oligarchs who show up there once and then nobody sees them again," he says.

"The second problem is the closed party lists, so the party leaders, not voters, decide who is included and who is not."

If Russians continue to pursue Chirikova's "civilised" revolution, then ultimately the Kremlin will be powerless to stop it precisely because "managed democracy" requires a measure of civilised voting. The main danger is that the Kremlin reaches for the crackdown lever and then faces the prospect of radicalising the population and losing control. Putin's own stated goal is to raise two-thirds of the population into the middle class by 2020, but the middle class is by definition a political class, concerned with things like property and government services. What has caught Putin out is Russia's growing prosperity has increased so fast that the country is already at the point where the emerging middle class is demanding its say, some 10 years before Putin had expected.

The white ribbons that the protestors were sporting is an appropriate colour, as this revolution won't have the colour of the street battles in Minsk or Wall Street; it will be fought online and in speeches couched in the terms of moderation and insistence. But the ball is in the Kremlin's court now.

A law unto themselves Olesia Oleshko in Kyiv

U

kraine is set to hold general elections in the autumn, on which a new election law is expected to have a profound effect.

The new law, pushed through by the ruling Party of Regions in November, returns Ukraine to a mixed voting system where half of the deputies (225 out of 450) will be elected by proportional representation using closed party lists, while the other half will stand for single-seat constituencies. The mixed system was in effect in both the 1998 and 2002 parliamentary elections, and should enable the singleseat winners to build the necessary safety net for the ruling majority in the parliament in the October vote. Given the plummeting ratings of the pro-presidential Party of Regions, that would be a gift.

MPs also voted to increase the threshold for entry to parliament from 3% to 5% and forbade blocks of parties to run for elections, thus making it harder for smaller protest groups to win seats.

The corresponding law was passed by 366 deputies on November 17 and has already been signed into law by President Viktor Yanukovych.

Good, bad and ugly The ruling majority called the new law

a "personal contribution towards the democratisation of Ukraine." And Party of Regions' MP Oleksandr Kozub argues that the proportional system (with closed party lists) in place during the 2006 regular and 2007 pre-term elections ruined the connection between deputies and their voters, meaning the return of a majoritarian component was a necessary measure. "People do not trust politicians and we have to fix this problem somehow," Kozub tells bne. "So that's why

Shevchenko says that under the current political conditions a bunch of single-seat deputies would be "a gift to President Yanukovych," and recalled the situation surrounding the parliamentary elections in 2002 when the political party that supported the then president Leonid Kuchma lost the elections to the opposition led by Victor Yushchenko, but created a majority with the help of deputies elected in single-seat constituencies.

Dmytro Filipchuk, a member of one of the regional councils in the Kyiv region who wants to try his chances in a single-seat constituency in the October elections, explains how this mechanism actually works. "The ruling party will talk to the potential winners in all the

"People do not trust politicians and we have to fix this problem somehow" we want voters to elect people who will represent them in the parliament and who will be accountable to them."

The opposition takes a different line – or at least some of its members do. Andriy Shevchenko, an MP representing Bloc of Yulia Tymoshenko, the now-jailed former PM and opposition leader, says the new law was written with one purpose – to secure majority support for President Yanukovych. For this reason Shevchenko says he didn't vote for it,

constituencies," Filipchuk tells bne. "The rules are simple: either you cooperate with them or it will be very hard for you to win in the election."

Filipchuk thinks that the tradition of receiving a "blessing" from the regional governors (appointed by the president) will continue during the parliamentary campaign 2012.

Party of Regions MP Kozub totally refutes the idea that the candidates

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Overcoming the threshold

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in 1992 to partner with the ill-fated Paul Tatum, who set up the Radisson Slavyanskaya by the Kievsky station on the river Moskva. "The Radisson was the first foreign branded hotel in Russia and the only liveable hotel at the time," says Ritter, sitting in the library of the Hotel Ukraine, which he recently added to his pool of Radisson Hotels in Eastern Europe.

who run in single-seat constituencies will have to trade in their loyalty for an endorsement from the ruling party.

"This is just another election bugaboo," Kozub says. "A strong candidate will make his way no matter if he is backed by the ruling party or not."

bne Some political observers called the new 5% threshold "a conspiracy of big parties against small parties" that might have had a chance of being represented in the parliament had the previous 3% threshold been preserved.

Yet recent opinion polls show that some parties outside the top league could still secure several mandates for their members.

The results of the poll conducted by the reputable Democratic Initiatives Foundation, together with the Ukrainian Sociology Service, in November and December show that five political parties will be represented in the next parliament: Batkivshchyna (18.8%, +2.7 compared with March 2010 poll). The situation in the party is complicated by the imprisonment of its charismatic leader and ex-PM Yulia Tymoshenko. The party still has to decide who is going to be their number one on the ballot. Batkivshchyna promotes western standards, European integration and liberal conditions for business.

Party of Regions (17.8%, -5% compared with March 2010 poll). The ruling party has two formal leaders – President Viktor Yanukovych and PM Mykola Azarov, who is in charge of the party. The ratings of both dropped due to unsuccessful economic policies that impede development of business, poor social policy and attacks on their political opponents that have received strong criticism from the West. Officially declares parity in its relations with the EU and Russia, but has appeared to tilt toward the east.

Front zmin (11.4%, +6.1% compared with March 2010 poll). The biggest trump card of this party is its young and ambitious 37-year-old leader Arseniy Yatsenyuk, who can boast of having held several high ranking positions. The party officially criticizes policies of the current president and his team, yet it stays in the "constructive opposition" niche. Just like Batkivshchyna, it values western standards and cooperation with the West.

Communist Party of Ukraine (8.4%, +4.4% compared with March 2010 poll). The Communists, with a small faction in the parliament, have a chance to increase their presence. After numerous scandals within the party, Petro Symonenko is ready to monopolize the votes of the left-wing electorate as rivals – socialists and other minor parties – are too weak to compete. The Communists have always been faithful to their geopolitical agenda – closer ties with Russia and the CIS. Ukrainian Democratic Alliance for Reforms, or Udar (5.8%). Udar – the abbreviation also means "punch" – is a political creation of the current WBC world heavyweight champion Vitaliy Klitschko. He lost the Kyiv mayoral election in 2008, but his party was elected to the city council. Udar stands on a pro-western platform and could potentially form a coalition with Batkivshchyna and Front zmin.

Majority view Political experts struggle to predict the outcome of the October elections.

Many think the ruling Party of Regions together with its satellites from the Communist Party and single-seat winners will manage to form a majority. "I think that 90% of deputies who won elections in single-seat constituencies will gravitate towards the pro-presidential team", Oleksiy Koshel, political studies professor at the Kyiv Mohyla Academy, tells bne. "They have to protect their business interests and it's much easier to do so when you belong to the ruling team."

Oleskandr Chernenko, chairman of the election monitoring NGO the Committee of Voters of Ukraine, believes the Party of Regions is the more likely to create a majority but it won't be a solid one. "I am a political expert, not an astrologist, and it's hard to predict anything now as the situation keeps changing," Chernenko tells bne. "Look at Russia – the ruling party even with all its financial and administrative resources can't control the situation."

The opposition parties also have a chance to unite and form a majority, yet this possible tactical victory wouldn't serve their strategic goals. "By having supported the new law, the opposition de-facto surrendered the parliamentary elections in 2012," Koshel says.

He explains that the opposition parties want to get a decent result and mobilise their voters, but they don't want to form the majority and take political responsibility for further work of the parliament. "The opposition will play out the situation as 'we won the election, but that bad ruling party stole our victory'," Koshel says. "Thus they will just start building a 'launching pad' for the presidential election in 2015."

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Tatum was gunned down outside the hotel in 1996 in the midst of an ownership dispute over the hotel, but even Tatum's murder hasn't put Ritter off. The rest of the world may be on its knees, but the hotel business in Eastern Europe is booming. Rezidor now has 39 hotels in the region with a total of 10,500 rooms, and plans to add another 27 hotels that are currently being developed.

The crisis hurt Rezidor like everyone else, with rates falling by 40% in the worst days. But Moscow and St Petersburg rebounded swiftly, says Ritter, and are already more than half way back to their pre-crisis peaks. "Even this result is good, as the rates fell 40% from a very high peak," says Ritter.

Putting on the ritz in Eastern Europe

www.rezidor.com

"The performance of the hotels in Eastern Europe is still much better than in Western Europe. We have a luxury problem and most other business would be happy to have problems like these," he says, adding that margins are fat in Eastern Europe, typically running between 50% and 60% compared with the 35% to 40% of most Western European hotels.

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n the lobby of the Intourist hotel in Soviet Moscow, where foreigners had to stay in the old days, there was a sign in English that told tourists from the free world: "If this is your first trip to the Soviet Union, you are welcome to it!"

The concrete slab that was the Intourist is now gone, replaced by the Ritz Carlton, an icon of luxury where rooms cost $600 a night and upwards and which earned its developer over $1bn, according to bne sources. Hotel service in Eastern Europe used to be notoriously bad, but all that's starting to change as the sky-high room rates and fat margins

pull in a growing number of international operators.

Kurt Ritter, who heads the Rezidor hotel group, has been visiting Russia since the late 1970s, when he tried, but failed, to persuade the Soviet government to hand over the management of the Red Star hotel. But he was back again

Game of two halves Ukraine is enjoying a mini hospitality boom partly driven by the upcoming Euro 2012 football championships, which Ukraine is co-hosting with Poland in 2012.

In October, the ArtBuild Hotel Group, the official representative of the Best Western International hotel chain in

"If this is your first trip to the Soviet Union, you are welcome to it!"

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Russian warehouse party

Ben Aris in London Russia's property market has been recovering slowly from the 2008 crisis, but as Russians return to the shops and retail turnover levels pass their pre-crisis highs, a boom has taken off in the country's warehouse business.

“We just had our best year ever,” says Tim Millard, general director of Cushman & Wakefield’s (C&W) Moscow office. “The demand for new warehouses is at an all-time high.”

The real estate business in the West is in the doldrums as many mortgage holders remain under water. Likewise, the economic slowdown in the developed world has depressed the office market. The upshot is that attention has shifted to emerging markets. In its global investment atlas published in December, C&W praised Central and Eastern Europe as the fastest growing real estate market in the world, up 60% in terms of investment year on year.

“The traditional markets are all victims of the crisis, but the emerging markets are all growing," points out Millard. "Russia is particularly attractive, as it's large and right on the doorstep of the rest of Europe. It is the logical first step and the logistics of going into Russia are simple."

The economic growth outlook for Russia may now be significantly lower than in pre-crisis years, but it's still three-times above the average EU rate.

Building on the already strong trade ties that have developed in the last two decades, German and Italian firms are already well established, but the UK is lagging behind due to poor diplomatic relations. “In the UK the perception of Russia is different from the reality," says Millard. "Doing business in Russia is not as difficult as most assume, but the gap is closing slowly.

At a corporate level the crisis created some real winners and losers amongst the developers. PNK Group, a leading warehouse developer, did well, building state of the art warehousing for the likes of Mars and Adidas, while other companies like Sistema Hals are all but bankrupt.

“Today if you want to evaluate the potential of a Russian developer all you need do is look at what they did during the crisis,” says Oleg Mamaev, executive director of the PNK Group. “Those companies that survived the crisis have concentrated the business in their hands. As Russia comes out the other side they are already trying to create western standard quality objects that meet the requirements of international clients.”

Ironically, the current crisis in Europe should be a boon for Russia: with no growth on offer in the development markets for years to come, companies in the West have been forced to look to new markets if they want to expand.

In the first nine months of 2011, C&W saw $6.5bn worth of investment into real estate in Moscow, against the $5.8bn that was invested in all of 2008, the last boom year. Another $1bn-1.5bn of activity is set for the final quarter of this year.

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respondents (73.7%) said their financial position had worsened in the last three months and over half (52.7%) expected a worsening of the socio-economic situation in the country over the next few years.

Ukraine, said it will open up to five new hotels over the next five years, while Marriott International is close to sealing the deal for its first hotel in the country.

So far there is only Best Western in Ukraine, in Sevastopol, but Rose said the three-star, 79-room Best Western Conference Park Hotel would open in Kyiv in March 2012. "I think that total investment will be around $30m-35m in the next five years," ArtBuild Hotel's managing partner, Daron S. Rose, was quoted as saying by Interfax on October 26.

"We'll build four or five hotels ourselves, using our own funds, in cities with populations of over 1m: Dnipropetrovsk, Donetsk, Odesa and Kyiv. Design work is underway."

Marriott also has plans to have a hotel in Kyiv operating in time for Euro 2012.

"We're planning to announce a first hotel of the chain in Kyiv within one month.

Talks are coming to an end. It is to be a 150 to 200-room hotel in downtown Kyiv," Ivica Cacic, Marriott Hotels International Ltd. Regional Developer for Eastern Europe, told Interfax.

Cacic also said that Marriott is planning to open two or three hotels in Kyiv in coming three years, and one hotel each in Lviv, Dnipropetrovsk, Kharkiv, Donetsk and Odesa in the coming three to five years.

Ritter is also planning more hotels in Russia. But while Ukraine is still at the start of the process with the obvious big branded hotels arriving, Ritter is planning to diversify in Russia with a string of boutique hotels under the new luxury Missoni brand. So far there are only two, one in Edinburgh and another in Kuwait, but two more are planned in Brazil and Oman, with Moscow following shortly behind.

In most of Russia's regions there is still next to nothing in the way of quality hotels. While the development waves can be volatile, it is important to be first when opening new branded hotels, says Ritter. "But the whole region is growing. We want to ride the wave here and so we are putting a lot of effort into expanding."

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Many see escaping abroad to find work as the only solution. A 46-year-old construction worker Mikalay explains: "When your wife receives a salary that is just enough to buy only one pair of boots or food for several days, a man has to look for a way to make money – even in a foreign country and with uncertain prospects. But we are ready to come back to Belarus when we are sure that our skills are truly appreciated and needed at home.

Belarus faces brain drain as talent flees autocracy Vic Vapennik

"I

f we have another 10 years of these prices and wages, there will be no need for a census – a roll call will do."

This quote from a TV presenter on Belarusian state-controlled television went viral on Facebook and for a short while seized the headlines in the local independent media. State TV usually exudes optimism, but the pithy slip points to the serious consequences of the deepening political and economic crisis – the mass emigration of the skilled workforce.

The rule of President Alexander Lukashenko has been a boon for pensioners and the infirm, as his one great achievement has been to avoid the pain inflicted on the population by the collapse of the Soviet Union. However, the same tight control that had prevented the collapse of the economy also drastically restricted opportunities for the young, who have fled the country in droves in search of a better life.

When the economic crisis finally reached the country following the global meltdown in 2008, emigration accelerated.

The first wave of renewed emigration in early 2011 had purely political reasons: people were leaving out of fear and despair after the violent outcome of the December 2010 presidential elections, when riot police violently broke up popular protests. However, a year on and it's an economic crisis that is driving people out of the country. The National Statistical Committee said in November

Russia is regarded by Belarusians as one of the best places to migrate to due to the lack of complicated bureaucratic procedures and its high demand for labour, together with there being no language barrier and its cultural proximity.

1m to go Sociologists estimate more than 1m Belarusians left the country in 2011, or roughly one in 10. They speak about a serious risk this process presents for Belarus where the working-age population is just 5.8m, just a notch more than a half of the whole population of about 9.5m, of which 3m are pensioners.

According to a survey commissioned by the Belarusian Institute for Strategic Studies (BISS), two-thirds of those going abroad to work are qualified personnel.

"Even the Belarusian elite that are the main beneficiaries and defenders of the present regime now look for employment abroad" that inflation reached 103.4% over the first 10 months of 2011.

A public opinion poll conducted in September by independent sociologists from the Independent Institute of SocioEconomic and Political Studies (IISEPS) showed that almost three-quarters of

As a result Viktar, head of a big construction company, complains about the lack of skilled workers: "Just imagine, we couldn't find a single stonemason of the sixth grade – the highest – in Belarus, and those having the fifth are extremely scarce."

The economic malaise has also made it hard for qualified workers to find jobs

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that match their training inside the country. Engineers might work as construction workers, while teachers with a degree in pedagogical sciences are sometimes employed as babysitters.

Lyudmila, 40, is a teacher with extensive experience and a good reputation, but she abandoned her profession for a job in Russia: "I'm working at a toy assembling line there, in shifts. That means I live and work in Vyazma for two weeks, and then I spend two weeks at home. Well, it's difficult at my age, of course, but I have to pay for my daughter's education."

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Even the Belarusian elite that are the main beneficiaries and defenders of the present regime now look for employment abroad. Independent media uncovered the fact that a senior editorial staff member from the presidential newspaper had been applying for jobs with newspapers in Moscow. This person is notorious in Belarusian media circles for laudatory articles about the "Belarusian miracle."

Even the police force is fleeing: in one of the regional centres in the west of the country, there have been reports

of mass migration by police officers to jobs in Russia. In the course of a few weeks, five precinct police officers resigned and left for Russia where they got jobs as construction workers.

The well-known economist Leonid Zaika believes that 2012 will be even worse and the river of emigrants will become a flood of fleeing Belarusian specialists. "Instead of inflation, we get the problem of the loss of human capital. In this I see a serious challenge for our country."

R

ussian companies aren't famous for returning value to shareholders, but in the face of the prolonged crisis in Europe they have been doing just that with a raft of share buybacks. That window of opportunity looks to be closing, though.

Having accumulated large cash piles to battle against today's uncertainties, Russian companies have taken the opportunity of weak stock markets to buy back their shares on the cheap. Russians stocks have always been valued relatively lowly, but with the Micex plunging 17% in 2011 to give a price/ earnings ratio of 5.5x, Russian shares have rarely been so inexpensive and eight big name companies approved buyback programmes. "It took a bit more than a month for companies to deal with technical problems – to analyse the situation and to organise the board meetings," says Alemar analyst Sergei Zakharov. "Managers want to prevent a further decreasing of their capitalisation and to show their faith in companies' future."

Russia buys into buybacks Anna Krachenko in Moscow

First off was Russian agricultural holding Rusagro, whose board authorised a $10m buyback of global depositary receipts (GDRs) on August 25. The next day, oil services company Eurasia Drilling announced it would also buy $60m of its own GDRs over the period of a 180-day programme. Then in September mining giant Norilsk Nickel

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and Russian meat producer Cherkizovo also approved buyback programmes to repurchase 7.7% and 2.0% of their shares respectively. In October, the boards of industrial conglomerate Sistema, internet company Mail.ru Group, telecommunications holding Rostelecom and fertilizer produced Uralkali also initiated buybacks. The last two companies to join the club were coal miner Raspadskaya and estate developer Elaton Group.

Buyback battles The first to complete a programme successfully was Norilsk Nickel, but thanks to Russian legislation it came with a twist. As a buyback allows shareholders to increase their stakes in a company, the repurchasing of $4.5bn worth of the company's shares became a weapon in the long-running war between the company's major shareholders, Interros and Rusal, which put the whole programme in danger of being cancelled.

On September 28, the day when the buyback was announced, Norilsk Nickel's stock price reached RUB7048 per share and a 40% premium was on offer from the deal. Shareholders rushed to the company's registrar to tender their stock before the deadline. But the company's stock price started to fall over the subsequent trading sessions when it became clear that many private investors wouldn't be able to submit their offers in time. On November 3, Norilsk Nickel claimed the buyback successful: $120m worth of shares were tendered for $306 per share with a pro-rata coefficient of 10.95%.

The buyback of AFK Sistema shares went more smoothly. Between October 3 and November 4, the company spent $72m from a budgeted $100m to acquire Sistema and shares of its mobile phone subsidiary MTS. The company purchased 375,972 shares (at an average price of $16.61) and 8.745m (at an average price of RUB20.97) shares from markets in London and Moscow respectively.

The total value of the MTS buyback was $60m, or 4.311m ADRs at $13.92.

Sistema managed to buy the first batch

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of shares at a low price, but the market soon stabilised and the price started to rise again. Zakharov says the company wasn't quick enough and as the cost of the buyback started to increase, the process was halted.

Uralkali's one-year buyback programme started on October 7 with plans to spend up to $2.5bn on buying its own shares and GDRs. Uralkali had lost nearly a third of its value in the summer's sell-off from its peak and the board

"Managers want to prevent a further decreasing of their capitalisation and to show their faith in companies' future" claimed the company was undervalued.

According to market speculation, part of the motivation for the buyback was an effort to raise the company's share price, as the owners were under pressure from margin calls (demands for cash from creditors when shares used to collateralise a loan fall below an agreed level), but actually had no intention of buying any shares back at all. However, Aton Capital analyst Mikhail Pak argues the programme was driven by business reasons. "I don't think they would announce a buyback just to support major shareholders, the company went along with market trends."

The day Uralkali announced its buyback programme the company's stock price jumped by 11%, but no purchases were made until November 28, when the company bought 7,46m shares at an average price of $7.38 and 1.25m GDRs at an average price of $37.32, spending a total of $102m, or 4% of the total buyback programme.

Buying back stock when it's cheap is a classic defence in falling markets. But with the Russian stock market rallying from the end of December into January, the window for cheap buybacks appears to have closed.

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a very rocky road. The banks' previous inaction meant they could simply keep the valuations of the assets unchanged.

Enforcing the contracts would see those valuations plummet to current market rates. One Austrian banker who declined to be named suggested: "Every Austrian bank with significant exposure to CEE real estate is essentially insolvent – they just haven't reassessed the valuations on their balance sheets."

Claims the real estate industry player: "The banks are absolutely terrified of doing that exercise."

That's understandable if Deloitte is correct in its analysis. The consultant's Czech real estate practice estimates that the property sector in CEE faces a "huge refinance hurdle of €1.5 trillion," adding that the Austrian banks are set to cut their exposure. "[The] banks are in control of huge portfolios of 'underperforming' files," Deloitte's analysts say in a report.

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anks with big exposure to Central European real estate are essentially insolvent, but this is masked because they have not revalued the underlying assets, industry sources say.

However, with many loans issued in the boom years ahead of the crisis coming up for refinancing and a pullback in funding of regional subsidiaries, these banks could finally be forced to act.

While politicians across Central Europe talk up the stability of the banking sectors in their country, hoping to head off the risks to economic growth from lowered funding from the Western banks that dominate most markets, there's a potential time-bomb ticking away on the balance sheets of the local units – one that could total €1.5 trillion.

Much as anticipated, a distressed-asset feeding frenzy never materialised in the region's real estate sector during the first phase of the crisis, because the banks thought they could get through to the other side without having to take losses

on the over-leveraged sector. Now it looks like that was merely a postponement.

One real estate industry player says that in contrast to the trend seen in 2008, some banks in the region are becoming very aggressive in instructing borrow-

Rock and a hard place The banks in the region are caught on the horns of a dilemma. The same loans that were quietly left to their own devices during the first phase of the crisis in 2008 are now coming up for refinancing, so continued inaction is not

"Every Austrian bank with significant exposure to CEE real estate is essentially insolvent – they just haven't reassessed the valuations on their balance sheets"

ers to sell projects to catch up with their commitments. With much of the five- to seven-year debt issued in the boom years about to come up for refinancing, "the next 12 to 18 months will be very interesting," he suggests. "It's difficult to say how it will pan out."

an option. Yet the banks will struggle to approve new loans for the region's beleaguered developers.

However, the option of enforcing their claims on the assets underlying non-performing loans (NPLs) could lead down

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The credit ratings agencies are also concerned. On December 1, Moody's Investors Service changed its outlook on the Czech banking system from stable to negative, suggesting "the banks' operating environment will weaken, amidst a broader EU economic slowdown… over the next 12-18 months." Moody's took similar action on Polish banks in midNovember.

Of particular worry in the Czech Republic, on top of rising levels of NPLs, are "high levels of concentration in the loan books… including… continued asset concentrations in the corporate segment, especially in commercial real estate," Moody's says.

Figures from the Czech National Bank show that NPLs in the sector have steadily risen to 7.0% of total loans in the last six months. However, the share of commercial real estate loans in that total has risen dramatically. At 10.5% of NPLs, the sector's share hit double figures for the first time in the last decade in June 2010, a ratio which remained steady to May. However, in June they suddenly leapt to 12.4%, and have since climbed each month to leave

A Czech haven

Jacy Meyer in Prague In the midst of the current sovereign debt crisis, the Czech Republic is looking increasingly like one of the safer places for brave businesses to invest and expand into.

Ernst & Young included the country as one of their 25 rapid-growth markets, along with the likes of Brazil, Russia, India and China. One of only two CEE countries (besides Russia) named, along with Poland the Czech Republic is showing remarkable steadfastness in the face of terrible economic conditions.

According to Czech Trade, net foreign direct investment (FDI) into the Czech Republic fell by 4% on year to CZK63.4bn (¤2.5bn) in the first half of 2011.

That's down, but compare that with Hungary, whose economy ministry revealed on December 2 that it forecasts no more than ¤1bn in FDI for the whole of this year.

Petr Ocko, general director of the EU funds, research and development department at the Czech Ministry of Industry and Trade, says there's a number of simple factors that go into making the country attractive to foreign investors. "Our geographical position in the heart of Europe; our border with Germany but we are also a bridge to Eastern Europe. Connected with that is our tradition of being precise but flexible, our technical education and skilled people."

Ernst & Young says the rapid-growth markets are the "key drivers of global growth" and will account for 50% of global GDP by 2020 when measured at purchasing power parity. Their criteria – proven strong growth and future potential, size of the economy and population, and strategic importance for business – encompass what Ocko believes are the country's best assets.

"We have a stable, healthy economic and political situation, and our geographical position is an advantage," he says. "We see now lots of foreign investment in the technical area."

Historically, the Czech Republic's strongest industries have been in the high- and mid-tech industries, along with the automotive sector. Ocko's department is targeting hi-tech investments that officials believe can't go elsewhere. Ocko points to nanotechnology and biotechnology as new frontiers in the Czech investment world, and aviation as a traditional sector making a comeback. "For example, Elmarco in Liberec is the industry's first supplier of industrial scale nanofibre production equipment and in Kunovice, Evektor has recently manufactured the EV-55, a new utility turboprop plane," he says. "Quite a lot of innovation is happening here and many foreign investors can find partners or subcontractors to supply them."

While all this is positive, Ocko worries the Czech Republic might be tarred by the same brush as other countries in the region, which don’t share the same investor-friendly attributes. "Now foreign investors speak of CEE as a whole, but Hungary and the Czech Republic are very different, for example in their financial management, debt, etc." he says. "I don't want their situation to reflect on us."

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them standing at 13.6% of total NPLs in October.

Petr Bittner of Czech bank Ceska Sporitelna insists that while he "wouldn't dispute the claim of the Austrian banker," the danger, to the Czech sector at least, is not imminent. While the exposure of the country's banks to commercial real estate did bump up slightly in the boom of 2006, it has remained close to the current 11.9% of total loans – equivalent to around CZK270bn (€11bn). Meanwhile, he says, keen oversight from the Czech National Bank (CNB) has helped the sector into a position of resilience, with a capital ratio of 15%. "I don't see any significant

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rollover does grow, Czech banks still have (and will have) the resources to do that. The threat of liquidity squeeze from parent banks is possible, but the regulatory rules of the CNB are quite strict, and it's not so easy to transfer liquidity surplus across the board."

However, the constraints on crossborder funding from Western European parent banks are well documented. During the 2008 crisis, the region's banks had their funding flows from parents protected by the Vienna initiative; in November this year, Austria's banking regulator launched what is effectively the "anti-Vienna initiative," which will force local units owned by Austrian

"What if the local units are being told to cut their exposure to the sector in CEE, as is very likely?" threats resulting from exposure of the Czech banking sector to commercial real estate," he says, adding that he doesn't "expect any significant growth of loan volumes to be rolled over.

Meanwhile, Bittner says Czech banks have, give or take, CZK180bn of "capital surplus", and can face losses up to this level without the necessity of having to raise capital.

However, the banks are hardly in the same sort of rude health in every country in the region. For instance, the effect of the regulatory issues in Hungary are well known, and Raiffeisen Bank International worries that "some of the buffers that have served the CEE economies (especially in Southeast Europe) to withstand the global crisis, have been depleted."

Running out of options The preferred option of the local banks over the next year or two would clearly be to restructure or rollover the current debt and quietly wait it out once more, with the assets left on their balance sheets at what are now inflated valuations. Bittner says "even if the need for

banks to rely almost completely on their own funding to continue lending. For a regional banking sector that has one of "the highest dependencies on cross-border banking and on Western European banks in particular," as analysts at Raiffeisen put it, this arrangement will likely complicate the situation.

Even Marek Belka, governor of the National Bank of Poland, who led the objections to Moody's change to its outlook on the country's banking sector, admitted that this presents the region's banks with a major question. "Half of short-term financing to Polish subsidiaries from European parents matures in 2012," he pointed out. "Will they want to finance their unit on the same terms?”

Rolling over loans to real estate borrowers in particular could prove even more difficult, says one analyst. "What if the local units are being told to cut their exposure to the sector in CEE, as is very likely?" he asks.

At the same time, Raiffeisen analysts worry that high and persistent NPLs could turn into a drag on economic growth. "If NPLs are continuously rolled

over, capital is locked up in unprofitable activities," they note.

However, the second option – to pull the plug – looks even worse. In that case, seized assets would go to auction and the banks would receive cash sums that are a fraction of the valuations for the underlying assets on their balance sheets. Yet leave it too long, and they could be forced to accept far less still should borrowers go bankrupt.

This risk could see more lenders follow the example of Ireland's National Asset Management Agency (Nama), which was originally set up in 2009 to deal with the toxic assets of banks taken over by the state. In Central Europe, Nama – whose assets have already been written down – has become increasingly aggressive even on some of the better assets, claims the real estate source. "It seems to be coming to the crunch for the Irish developers in the region," he suggests.

"Anglo-Irish has been looking at enforcement options since the spring. This is going to force the Irish developers in the region to the wall."

Perhaps the best option for all involved would be the arrival of opportunist buyers and lenders – assuming they will be prepared to offer prices that will keep the wheels turning. That remains "a key block" according to Deloitte, but the region's large private financial groups – PPF Group, J&T Group, Penta Investments, and the recently ravenous Czech Property Investments – are said to be on the prowl for acquisitions.

At the same time, distressed debt funds are sniffing around the region. One group recently advised local service providers that it is interested in "buying discounted senior debt," suggesting "some of the portfolios coming from the…

Western European banks pulling out of CEE markets could be of interest."

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Latvia's PM talks about life after loans INTERVIEW:

Mike Collier in Riga Photo by Toms Norde, Valsts kanceleja

I

t would be enough to make most politicians lose their temper. Ever since Latvia brought to an end on December 22 its three-year, €7.5bn bailout loan from the International Monetary Fund that helped avert bankruptcy, Prime Minister Valdis Dombrovskis has been trying to get across how optimistic he is about the country's prospects. But all the foreign media want to talk about is a referendum that could make Russian the second official state language alongside Latvian.

With similar IMF bailout programmes in Hungary and Ukraine in turmoil, the 40-year-old Latvian leader was hoping to show the markets how disciplined and trustworthy Latvia is in comparison and maybe win the odd ratings upgrade. But the February 18 referendum that – in theory at least – could make Russian the second official state language alongside Latvian is hogging the headlines. "I think it is a waste of money," Dombrovskis tells bne. "It's very unfortunate that it's happening, but since it is happening, we are calling on all citizens to go and vote against this idea. We don't feel it will facilitate the cohesion of society. The Latvian language is the basis of integration while respecting minority rights and cultural diversity. We are not keen on this idea of challenging the constitutional basis of the state."

For all the coverage the referendum is getting, it is ultimately a pointless exercise. More than half the total electorate is required to back what would

be a major constitutional change, but with only a third of Latvia's population counting Russian as their mother tongue and the whole thing serving to provoke rather than mollify Latvian nationalist sentiment, there is no chance of Cyrillic script being seen on official documents anytime soon.

Nevertheless, the language issue does allow the leaders of the pro-Russian campaign – self-styled "National Bolshevik" Vladimir Linderman and Jevgenijs Osipovs, a scowling ultra-nationalist with a penchant for black polyester

the loan, but the bulk of repayments will be in 2014 and 2015," Dombrovskis says, noting that in the end only €4.4bn of the money supplied by the IMF and EU was actually used.

"The [growth] figures for 2012 will be more modest for two basic reasons: first, the Eurozone crisis will affect our exports. The other reason is that we are already above pre-crisis levels and our industrial production is reaching its capacity levels. It's easy to grow very quickly when you're coming out of deep recession with under-utilised capacity,

"The lesson we need to draw is that we need to strengthen bank supervision" uniforms – to fill column inches with the woes of Latvia's poor, oppressed Russians rather than the fact that Latvia does seem to have achieved what many said was impossible – a return to growth (of around 5% in 2011 and with 2.5% predicted for 2012) via a policy that Dombrovskis describes as an "internal devaluation".

"What is fundamentally important is to continue with this strong fiscal position and keep using it to reduce the deficit, because that will determine the refinancing rates on our international loan.

This year we have to repay some part of

but once you reach the potential level you can't expect 30% growth to continue each year," Dombrovskis says.

"It's important that we put a new emphasis on increasing competitiveness, attracting new investment and using EU funds to improve and expand productivity and capacity so we can grow in a sustainable way," he adds.

Bank bumps Not that reaching the end of the loan was without a few bumps along the way.

Towards the end of 2011, the collapse of Latvijas Krajbanka – a subsidiary of

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Busted in Latvia As anyone who has been through it will tell you, declaring a business insolvent is not pleasant. So imagine how much more upsetting it must be to have your successful multi-million-euro business declared insolvent from underneath you.

That's what has happened to Lithuanian retailer Palink, operator of the 34 IKI and 17 Cento supermarkets in neighbouring Latvia, which has invested more than ¤120m in the country since it entered the market in 2008 and where it employs around 1,200 people and recorded turnover of ¤73m in 2010.

On January 19, the owner of Palink, German giant REWE Group (annual turnover ¤53bn) submitted a complaint to the European Commission over Latvia's insolvency laws, which saw Palink declared insolvent in a Riga court on January 5 at the initiative of an individual named Sergei Gushkin, who is involved in a dispute with Palink over a construction project.

Gushkin says Palink owes ¤30,000 to his construction firm for a project that was put on hold when Palink scaled back its expansion plans as Latvia slid into the world's deepest recession in 2008-09.

Palink says the contract was terminated in a timely fashion and that it actually overpaid, but Gushkin took the option provided to him by the law to have Palink's entire Latvian operation declared insolvent.

At a press conference on January 12, Palink board member Oliver Ortiz was apoplectic. "It is shocking and painful to see today, in the 21st century, in independent Latvia, a full member of the European Union, how a judge of the Kurzeme district court in Riga is able to declare Palink insolvent based on ¤30,000. It is a scandal!" he thundered.

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Lithuania's Snoras Bank owned by Russian tycoon Vladimir Antonov – and a rumour-led run on Swedbank deposits a few weeks later showed that public faith in Latvia's crowded financial sector remains fragile, whatever the balance sheets say. "The lesson we need to draw there is that we need to strengthen bank supervision," Dombsovskis admits.

"When we talk about investment it is important to consider the quality of investment we are attracting. It is important that the [banking regulator] Financial and Capital Markets Commission scrutinises potential investors."

"We have the big retail banks and then boutique banks which are less of a concern in that they do not have such a broad deposit base. We are following the financial stability and capitalisation of the banking system and our banks already meet the increased capital adequacy requirements with Eurozone banks need to meet by mid-year."

Beneath his mild-mannered exterior, there is just a hint of annoyance that other EU members have been so reluctant to take the same bitter-tasting, but ultimately beneficial, medicine as the Baltic states. "Financial stability is a precondition for economic growth," he argues. "As soon as we restored financial stability we returned to economic growth, because it doesn't just mean the possibility to refinance state debt but also means the availability of credit to citizens and businesses, and investment flows both to and from the country.

Without financial stability you cannot return to economic growth; like it or not, that's what countries like Greece and Portugal will have to implement – they will have to restore financial stability one way or another. There is no easy solution to postpone austerity until things get

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I 29

better because things will not get better if you don't deal with the problem."

sionally and respectfully address this issue directly."

"You can stimulate your way out of recession only if the markets are willing to finance it – as is the case in the US or Japan. In Latvia, Greece, Portugal and other countries it's not the case.

The budget deficit in the US or UK is not much smaller than in Greece, yet somehow they are easily refinanced and Greece is in big trouble."

Yet nothing Fagan has done during a long career pursuing claims against governments and institutions could be termed quiet: he successfully sued Swiss banks for a reputed $1.25bn on behalf of Jewish survivors of the Holocaust; he has history with the Czech Republic after threatening legal action over its nuclear power plants; and he has been disbarred from practising law in New York and New Jersey for "misappropriating" clients' funds.

Energy The coming months should see progress made on Latvia's participation in Lithuania's much-delayed Visaginas nuclear power plant, notwithstanding Poland's decision to forget the whole thing.

Latvia is committed to a share of "15 to 20%" of the project, Dombrovskis says, and is also hoping that the European Commission will decide that Riga is the best location to build a liquefied natural gas (LNG) terminal to serve all three Baltic states when it takes into account its "obvious advantages."

In March, Dombrovskis will mark three years in power at the head of three different coalitions. That's good going by Latvian standards, and he says he still has plenty of energy and ambition to continue. But there's a danger that as the economic situation improves, the public may decide they are tired of mere technocratic competence and demand someone with a bit more pizazz.

To give him a shot at a sound bite, bne asks Dombrovskis for a catchy buzzword or two on Latvia's signature industrial sector for the future. "Exportoriented industrial production is our buzzword," he deadpans. Is he joking?

Probably not.

"The growth figures for 2012 will be more modest"

CEE can't break free of its historical bonds Nicholas Watson in Prague

H

istory hangs heavy over Central and Eastern Europe, a region termed the "Bloodlands" by Yale historian Timothy Snyder in his seminal work on the region in the 20th century. And with reparation lawyers like Edward Fagan about, sleeping dogs will never be allowed to lie.

Fagan, a US lawyer famous for courting controversy wherever he sticks his subpoena, and his partners have scooped up large numbers of pre-war bonds from across the region, and plan to file claims against Poland, Germany, the Czech Republic, Romania and Hungary for more than $2.3bn in interest and principal. In December, a claim was made to the Polish government over the bonds issued by the port city of Danzig (now called Gdansk) during the interwar period when it was a free city under the League of Nations' control. And in January claims were made to the Romanian government over Kingdom of Romania bonds and to Germany for Sudeten bonds and Protectorate of Bohemia and Moravia bonds.

In the Czech Republic, Fagan claims he's been given the run around by politicians and officials over the past few months as he tried to have validated some alleged outstanding dollar bonds issued by the

Czech spa town of Karlovy Vary in 1924 when it was known as Carlsbad. In letters sent to Czech President Vaclav Klaus, Prime Minister Petr Necas, government ministers, and other top officials at the Ministry of Finance in November, Fagan complains that Deputy Minister of Finance Jan Gregor, Karlovy Vary Mayor Petr Kulhanek and Czech National Bank Governor Miroslav Singer have unnecessarily blocked his attempts to have authenticated some 8%, 30-year City of Carlsbad municipal sinking fund gold dollar bonds currently in his possession.

By Fagan's estimates, the total outstanding debt including interest payments

Without a hint of irony, Fagan goes on to warn that, "This adversarial situation could further deteriorate to a point where what could have been addressed expeditiously and professionally, become [sic] a cause célèbre and a 'media circus'."

Of course, a media circus is exactly what's ensued, not least because, ironically, Prague is due to host a conference next year on the 2009 Terezin Declaration – a series of measures agreed by 46 countries to ensure the restitution of Jewish assets and property seized by the Nazis, amongst other things. But behind the headlines, does Fagan have a case?

Settled The Czech government argues the former Czechoslovak Socialist Republic [CSSR], which was dissolved following the end of communism in 1989 and has today become the Czech and Slovak

"The Czech government also argues the bonds expired decades ago" comes to around $506m. "I wanted to start the process and without a big to-do to find out whether the paper that I had was worth money or not," Fagan tells bne in a phone interview from Florida.

Fagan claims, perhaps somewhat disingenuously, that he has been "amazed" by the Czech government's "unbelievable" response to his efforts "to quietly, profes-

Republics, had offered to settle all outstanding claims against the bonds in the 1980s, as part of a deal to settle bond debts before the state was returned 22 tonnes of gold that had been seized by the allies after World War II. "This settlement was accepted by our US counterparty and sealed by an international agreement," the finance ministry said in a statement.

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However, Fagan argues some bondholders didn't get paid, a fact clearly in evidence in that the bonds he's currently holding haven't been cancelled. "When a bond is redeemed, the authorities don't give it back to you clean, they punch a hole in it. These bonds I have are pristine, meaning they were never cancelled and the final payments were never made," Fagan says.

The Czech government also argues the bonds expired decades ago, but Fagan says a US court has established that bonds expire at the later of two dates: either up to 30 years after the maturity, or seven years after the first attempt to validate the bonds. "The clock starts when you attempt to validate the bonds.

My clock on these Karlovy Vary bonds just started so I have plenty of time."

Furthermore, Fagan says under US law the clock can't start to run until a bondholder has the ability to make a claim and because the Czech Republic was a

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And he's also pursuing claims elsewhere.

In Poland, Fagan is hoping to get $56m in pre-war government bonds and $283m in bonds issued by Danzig (no called Gdansk). Poland is the only country in the region to have refused any general restitution of property confiscated by the communists. A plan to return a small percentage of the value of what was taken was shelved a few years ago following the first wave of the economic crisis and concerns about keep public debt from spiralling out of control.

Fagan's unwelcome return to the region will prolong a restitution process that the Czech state hopes to put to bed.

Most of the big cases were solved by the late 1990s in direct deals with individuals, but the sheer scale of the claims meant the government tightened up procedures and passed some dubious restitution laws that have since been challenged in European Court of Human Rights, meaning most of the remaining cases are now tied up in court. The

"I feel we're making progress to an extent, but the legal process here robs you of any belief in the judicial system" communist country, it is only since the 1989 revolution that a bondholder could realistically make a claim. This, he says, applies to other former Communist bloc countries where he also intends to make claims on unpaid bonds.

Fagan says that since the Czech government refuses to meet him and validate the bonds, it has essentially freed him to file a lawsuit in the US, where the bonds were sold. In the meantime, Fagan says he intends to take other measures against the Czech state, such as applying to international regulators to prevent the government from issuing more bonds on the grounds that it has failed to honour its previous debts, and looking to have the gold that was returned to the Czechoslovak state in the 1980s frozen since it hasn't abided by the agreement to honour all historical bond claims.

expense and time associated with lawsuits is gradually whittling these down.

"For those cases not solved by 1997, it became really difficult and many have given up because it's too complicated and expensive," says Stephan Temple, who successfully had returned his grandfather's villa in Prague that had housed the Algerian embassy during communism.

The two big outstanding cases concern the Catholic and other churches, and the Schwarzenberg family, whose principal heir, Karel Schwarzenberg, is the current foreign minister.

The case with the churches finally looks close to resolution as the government prepares to submit a bill this year to parliament on the restitution of property to churches. The draft bill provides for

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the state paying a total of CZK59bn in compensation to churches in the Czech Republic over a period of 30 years, and returning around 56% of confiscated property. The move is not popular, though; a poll conducted in December found most Czechs oppose the government’s plans to return property to churches.

Sobolewski has also been trolling for business in Israel, which already supplies some companies on the WSE like Cinema City International, a Netherlands-based operator of multiplex cinemas with Israeli roots. "We get interest from small funds and some technology firms," says Sobolewski. "I hear from them that Warsaw could be a good bridge to Europe, the same sort of thing that I hear in Ukraine and Belarus."

Karel Schwarzenberg is not actually the claimant in the other big cas – quite the opposite. Elisabeth Pezold, daughter of Prince Adolf Schwarzenberg, whose vast property holdings that included the chateaux of Hluboka and Cesky Krumlov were confiscated first by the Nazis and then the Czechoslovak state, claims her adopted brother Karel is blocking her attempts to inherit the property.

Pezold claims Karel, who was from a lesser line of the Schwarzenberg clan and adopted by Adolf because he had no male heir, has failed to meet the wishes of their father stipulated in his will that his successor should make every effort to get the property back as soon as possible. As such, he has forfeited his right to be the heir.

For Karel's part, he told Tyden magazine in May that he refused to sue the state when asked to by Pezold in 1989, considering such a move "an utterly counterproductive thing to do". Critics note, however, that he did his utmost to get the property from his side of the family back.

Pezold finally received some good news in February and March when the Supreme Administrative Court in Brno quashed the previous municipal court verdicts repeatedly rejecting over the last 20 years her claims to the former Schwarzenberg property. "I feel we're making progress to an extent," Elisabeth Pezold's son Adam tells bne, "but the legal process here robs you of any belief in the judicial system."

Now the courts will have to seriously consider Pezold's claims, meaning this restitution issue is set to run for some time yet.

I 31

Financial hub Sobolewski's sales pitch is part of a strategy aimed at making Warsaw Central Europe's leading financial hub. Originally, the WSE was aimed at playing a purely Polish role – something at which it has succeeded better than any other post-communist regional exchange.

Poland's bourse fights chill winds from Europe Jan Cienski in Warsaw

L

udwik Sobolewski is showing an entrepreneurial hustle as he takes the newly privatised Warsaw Stock Exchange on the road around Emerging Europe and as far away as Israel, in the hope of drumming up new listings. But with recent IPOs falling flat and a government less keen to sell off assets in these trying times for Europe's equity markets, the chief executive of the WSE faces an uphill task.

"We want to show that the WSE makes sense no matter what the conditions," says Sobolewski, sitting by a conference table in the exchange's modern Warsaw headquarters, just metres away from the old communist party central committee building that was the exchange's home when it started work in 1991. "Even if there is no concrete gain, we have to promote the idea that we are a regional market."

The result has been a steady stream of new listings on the WSE like Nova KBM, a Slovene bank, which first listed on the WSE in May.

Sobolewski has been particularly keen to lure listings from Ukraine. In May, the WSE attracted Ukraine's Industrial Milk Company, meaning it now has 10 Ukrainian companies and enough to create a separate national index for them.

Sobolewski says he constantly travels there, trying to sell the advantages of Warsaw, which include the stability of

As it grew, Warsaw first hoped to grow by buying other exchanges, but was stymied because it was 99% owned by the state treasury, which put off potential sellers. By the time the WSE was privatised last year, rivals like Vienna had already done deals with most of the significant bourses in the region – forcing Warsaw to try to attract listings directly.

With a current market capitalisation (which includes both local and foreign companies) of more than €155bn, it has passed putative rival Vienna – with a market capitalisation of €90bn – and has left Prague and Budapest far behind. Now Warsaw is aiming to pass

"I think it still makes sense to list – as long as you're prepared to accept lower prices" an EU regulatory environment while also providing decent analyst coverage at a listing cost that is much lower than for larger exchanges like Frankfurt or London. The scheme has been successful enough that one Ukrainian company, Kernel, an agri-business, has made it onto the exchange's blue chip WiG20 index, the only non-Polish company on the list.

such exchanges as Istanbul and Oslo, where the market capitalisation is more than €200bn.

Part of the WSE's strength has come from the steady supply of companies being privatised by the Polish Treasury – the latest large privatisation being the sale a third of JSW, a coal miner, in June for €1.4bn. However, investors

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"We want to show that the WSE makes sense no matter what the conditions"

were badly burned by that IPO, as the share price has fallen by 35% in the last five months, denting the government's and the WSE's plans to foster a broader investor culture in Poland. "It would be hard to find someone today pleased with the share price of JSW," admits Sobolewski.

With the WSE falling in tandem with most other European exchange – the WiG20 is down 15.6% so far this year – the Treasury is less keen to sell off companies in the current environment.

Plans to sell Lotos, the country's secondlargest refiner, are in trouble, and the earlier planned sale of as much as 15%

the gloomy economic situation makes Sobolewski's task of ensuring a steady flow of significant new foreign listings to the Warsaw bourse even more crucial.

"I think it still makes sense to list – as long as you're prepared to accept lower prices," he says.

of PKO BP, Poland's largest bank, have been put on hold until next year. "The unprecedented situation we observe in the Eurozone is influencing the high rate of turbulence on global financial markets," said a statement from the Treasury. "A consequence of that turbulence is a limiting of the ability to successfully carry out a secondary public offering for the shares of PKO BP – what would have been one of the largest transactions in the history of the WSE – in the current year."

Smaller Polish companies are still choosing to hold IPOs on the WSE – which has seen 36 new listings so far this year – but

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

However, there's been bad news recently, as Czech software firm AVG Technologies, which abandoned plans to float on the WSE in early 2011 in favour of a $235m loan due to market conditions, decided in January that it would revive its IPO plans – but on the New York Stock Exchange (NYSE). Recent reports say it's looking to raise $125m from the offering.

And at the end of 2011, Avast, another Czech-founded software firm, also announced it had filed a request to launch and IPO on the NYSE.

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Southeast Europe I 33

bne February 2012

In defence of Turkey Patrick Wrigley in Istanbul

K

urtkoy, on the Asian periphery of Istanbul, is a disjointed, unnerving suburb – a location that Istanbullus drive past but very rarely visit. A semi-rural building site, situated on barren hills sprouting brightlypainted residential tower blocks, it is the sort of place that would leave the uninitiated wondering whether this is a development newly deserted or one yet to be finished.

An overspill for Istanbul's rapid population growth, the area near Istanbul's second airport, Sabiha Gokcen, is the location for a new technology park centred on the defence industry, which the government hopes will create 30,000 jobs, generate $5bn in annual revenues and fill up these middle-income apartment blocks that currently sit halfempty.

Teknopark Istanbul, whose construction began with much fanfare earlier

in November, is being touted in the local press as the future "silicon valley of Turkey". While this is enough to set alarm bells ringing and to dismiss the project as another over-hyped headline in the hinterland of Istanbul, the project has the full force of the government and military establishment behind it.

Founded by the Undersecretariat for Defense (SSM), Istanbul Chamber of Commerce and Istanbul Commerce University, the tax-exempt zone could come to stand as a symbol of government attempts to place the defence industry at the heart of Turkey's economic growth over the next decade.

During the last election campaign in May and June of last year, Prime Minister Recep Tayyip Erdogan, whose Justice and Development Party (AKP) won a third term at the ballot box, made three high-profile speeches on the defence industry. Unusual in itself, Erdogan's claims that the country would have full self-sufficiency in defence technology by 2023 raised many eyebrows. As election campaigns are often seen as the silly season in Turkey, when politicians offer promises they know they can never fulfil, it was not hard to dismiss this as posturing, an attempt by Erdogan to shore up his nationalist and military credentials.

"Erdogan's claims that the country would have full self-sufficiency in defence technology by 2023 raised many eyebrows"

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However, many analysts believe that this is indeed an honest ambition. "I don't think it [defence] plays a large role in Turkish national politics – I don't think people care if Turkey builds its own drones or jet fighter," says Cenk Sidar, managing director of the consultancy and advisory firm Sidar Global Advisors and the former director of defence services at the American Turkish Council. "I think it is a smart move of developing coherent integrated industries from IT and software

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designed and produced Unmanned Aerial Vehicle (UAV), or drone, known as the Anka. The technology is considered key in the government's fight against the outlawed Kurdistan Workers' Party (PKK), which has been waging a war against the state in the south-east of the country since 1984.

Recent tensions with Israel have made this investment even more crucial, given that its former ally used to be Turkey's main supplier of the drone

"Recent trends do suggest that the defence industry is becoming an increasingly important component of Turkey's economy" to manufacturing. I think it's smart to put it at the centre of Turkish economic development to see how to benefit other sectors."

Recent trends do suggest that the defence industry is becoming an increasingly important component of Turkey's economy. Total revenues in the sector have been increasing continuously, jumping from $1.72bn in 2006 to $2.73bn in 2010, according to the Defense Industry Manufacturers Association. Exports have also been moving upwards with SSM expecting them to reach $1.5bn in 2011.

The focus on bolstering local production in the defence industry is certainly in keeping with the AKP's policy of championing local projects and national products. In the auto-manufacturing sector, for example, there are also plans to move from simple assembly to the production of Turkey's first locally designed and manufactured automobile, by the Bursa-based company Karsan.

The government has been pushing self-sufficiency in the defence industry for some time, and in 2004 the government-owned Turkish Aerospace Industries (TAI) signed an agreement with SSM to begin work on a domestically

technology. According to Sidar, "Israel was important for technology transfer.

It was very difficult to purchase specific technology from the US because of congressional approval and Israel was an easy solution for Turkey. The technologies Turkey wasn't able to get from the US were being dealt through Israel with US support."

The domestic drone programme will, therefore, be crucial in the longer term to bridge this shortfall.

Shooting for more money The most pressing question is how Turkey will achieve this eagerly soughtafter self-sufficiency, given the limitations of financing and home-grown capacity and expertise in the sector.

External aid for the defence industry has declined precipitously. For example, between 1982 and 1992, the US granted Turkey $3.3bn in military aid, in 2011 this figure is expected to be less than $6m.

For a country with the second largest army in Nato, the question of funding is going to remain crucial. While the government budget for defence increased by 7.6% in 2011 to $11.3bn, representing 1.4% of GDP and 5.4% of the total government budget, according to the Turkish defence ministry,

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Southeast Europe

His actual response was far more equivocal. "There are some possibilities for interconnection with Turkey with limited capacity – it has been discussed, but right now we're trying now to connect the islands to the Greek grid."

Yakup Evirgen, a retired army colonel and independent defence consultant, believes that there is increasing pressure on military and defence spending.

"During the AKP's rule, the national income of the country has increased so the total budget to the defence industry has increased, but the rate of increase compared to the other sectors has decreased," he says.

Hurriyet's report was an unfortunate misrepresentation and one that having been picked up by the Greek press, left Papakonstantinou, who had only recently been appointed to the post in Greece's post-bailout coalition government, dealing with a political firestorm.

Indeed, military spending in Turkey as a percentage of GDP has declined from a high of 5.4% in 1999, according to figures from the Stockholm International Peace Research Institute (SIPRI).

Questions of sovereignty over the islands remain a sensitive subject in Greece, which only took possession of the southernmost archipelago, the Dodecanese, in 1947. And to the right wing of Greek politics, any suggestion of allowing Turkish influence smacks of treason. In reality, though, despite an unresolved disagreement over three tiny islets, Turkey recognizes the islands unequivocally as Greek territory.

However, it is clear the government believes that it can bolster state-owned companies such as TAI and ASELSAN, a government-owned company specialising in electronics and communications, to meet the military's future requirements. According to Sidar: "The main companies are state companies owned by the military, so it is also a strategic move by the government. I'm sure they will be transferring funds to these companies for growth."

According to Evirgen, this is the only possible option. "The Turkish government has to support these projects because they won't be supported by the private sector, because investing in these projects is very costly requiring high capital input and delayed payments. They are not really feasible areas for investment," he says.

Treasured islands David O'Byrne in Istanbul

Government support to the sector will, therefore, be important, but it won't necessarily equate to success in meeting targets. "There are good steps towards self-sufficiency in areas such as artificial intelligence and software systems – more than just putting pieces together," says Sidar. "But I think self-sufficiency will be very difficult, not only for Turkey but for any developing country."

As such, while projects like Teknopark Istanbul could one day lie at the heart of a hi-tech Turkish defence industry, it is likely to be some time before Kurtkoy is talked about in the same breath as Palo Alto.

I 35

"B

eware of Greeks bearing gifts" – as the saying goes.

But who should the Greeks beware of? Well how about Turkish journalists looking for a quick scoop – at least that's what the recent experience of Greece's energy minister would suggest.

"Greece plans to connect islands to Turkish grids," blared a headline last month in the Turkish English-language daily Hurriyet Daily News, going on to quote Greek Environment, Energy and Climate Change Minister Giorgos Papakonstantinou as stating that the subject had been discussed with Turkish officials and was being "considered."

In fact, Papakonstantinou had said no such thing, but had merely responded to a question from this bne correspondent as to whether Greece had ever considered supplying its islands along the Turkish coast with power imported from the Turkish mainland.

Greek fears though, however misdirected, are perhaps understandable. The country is going through the biggest economic upheaval in its history and its most serious political crisis since democracy was restored in 1975. Two bailouts and four austerity packages later, and on December 14 the International Monetary Fund was still warning Greece that its economic reforms are behind schedule and need to be more aggressive in closing loss-making state enterprises and introducing market reforms.

Criticism of the state's controlling role in many areas of the Greek economy is nothing new. The country has been repeatedly criticised by the EU for its failure to introduce market reforms in the energy sector. The Greek state still holds 35% of Hellenic Petroleum, the

"The Greek islands would be a perfect market for us – the cost of generating power on the islands is high"

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bne February 2012

"There are some possibilities for interconnection with Turkey with limited capacity – it has been discussed, but right now we're trying now to connect the islands to the Greek grid"

country's main oil refiner and petroleum distributor with around 75% of the domestic market, while statecontrolled companies are responsible for all areas of the country's gas market from importation through transmission to distribution.

Complaints over PPC's stranglehold over the power sector are many, and range from criticism of its sloth in developing wind and solar power – of which the country has abundant resources – to direct accusations of "unfair competition" from Austria's Verbund, which pulled out of Greece earlier this year after only five years in the country.

With the Turkish state in the process of ending direct involvement in its power sector, any such initiative would be expected to come from the private sector, for which the Greek islands represent an attractive market. "The Greek islands would be a perfect market for us – the cost of generating power on the islands is high," says Mustafa Karahan, head of Turkey's Electricity Traders' Association (ETD), pointing out that their proximity to the Turkish coast makes the laying of transmission cables a simple procedure. More importantly, it would offer consumers on the islands the opportunity of guaranteed power at a lower price than current generating costs.

According to Turkey's energy ministry, it's an option that has not yet been examined. "We've never been asked, but if Greece is interested why not?" a ministry spokesman tells bne.

This is a scenario that many in Greece will find politically difficult to stomach, but which, depending on the country's ability to pull itself back from the brink of economic collapse, may yet be seen to make sound commercial sense.

I 37

In 2010, over 75% of Turkey's foreign direct investment came from the EU. In recent years, Turkey has been relatively successful in exporting to elsewhere in its region: to Russia, the Middle East and Central Asia. However, these countries have their own problems and the Middle East and Central Asia are hardly stable markets themselves.

One alternative, as suggested by Papakonstantinou, is the interconnection of the islands with the mainland Greek power grid. However given the distances involved it's an expensive option and one which Greece's currently parlous economic situation appears to rule out for the foreseeable future. A problem that makes the possibility of supplying them from the Turkish mainland all the more attractive – economically, if not politically.

And even then political opposition is not carved in stone. Greece already imports gas from Turkey, and has been exporting power to Turkey across its mainland border for several years.

Compared to other fossil fuels, fuel oil and diesel are both expensive and environmentally damaging, and with neither piped natural gas nor lique-

Southeast Europe

fied natural gas economically viable, and renewables such as wind and solar power unable to guarantee daily baseload, alternatives are limited.

And in power generation, the 12 gigawatts (GW) of power plant operated by state-owned Public Power Corporation (PPC) is 84% of the country's total installed capacity and supplies 78% of the country's power needs through the company's transmission and distribution grids. The company also holds an effective monopoly over coal mining in Greece and operates all of the country's renewable power plants.

More significantly, PPC is the sole supplier of power to the Greek islands, with 60 of its 97 power plants located on islands where they operate as standalone units unconnected to the mainland Greek grid. While the company does not publish detailed lists of its power plant portfolio, the islands close to the Turkish coast are believed to be powered by individual standalone plants burning fuel oil, or less commonly diesel, including a 206-megawatt (MW) fuel oil-fired plant on Rhodes.

bne February 2012

Turkey's Asian-style growth bne

O

n January 5, Turkish Deputy Prime Minister Ali Babacan forecasted that the country's economy expanded 7.5% in 2011 and will grow another 4% in 2012, in widely reported comments made to a business delegation in Ankara. Turkey did indeed power ahead in 2011 while other economies in the region stagnated and shrunk, though many see this as a last hurrah before the economy hits a wall later in the year.

In the third quarter of 2011, Turkey's economy grew a better-than-expected 8.2%, according to TurkStat. The market consensus for third-quarter growth had been only 6.7%. It was also announced that first-quarter growth had been revised up from a preliminary 11.6% to 12.0%, while second-quarter growth was 8.8%. This means that in the first nine months of the year, Turkey's real GDP growth was 9.6%.

The figures show a continuation of Turkey's impressive economic growth, though most analysts agree the country's economy will now slow. By how much is the big question.

Brick walls Speaking at a conference on January 12, Merrill Lynch economist Turker Hamzaoglu disputed Babacan's optimistic forecast, suggesting that the Turkish economy might experience no growth in 2012.

There is a consensus that growth will largely be dependent on events in the Eurozone. About half of Turkey's trade

Turkey's key economic tumbling block remains its massive current account deficit that is expected to come in at 10% of GDP for 2011, up from 6.7% in 2010, according to the International Monetary Fund. In November, the current account deficit actually shrank, bringing the 12-month cumulative deficit down to $77.8bn, its first such decline in about two years. Turkey's central bank predicts the country's year-end current account deficit will stand at around $73.6bn.

"More limited foreign financing would constrain the current account deficit to about 8% of gross domestic product and compress imports," suggests the IMF in reference to how a slowdown in the Eurozone might limit Turkey's ability to finance the current account deficit.

Another key vulnerability is Turkey's high rate of unemployment. In October, the unemployment rate was 9.1%, according to Turkstat. Yet Turkey has actually been more successful in combining rapid economic growth with job creation than Europe has. The International Labour Organisation's (ILO) cites Turkey as the top country in the region for combining

"We need many imports for our exports because the value added that Turkish industry appends to products is still very low" is with EU countries and its economy is closely linked to the health and prosperity of these states. Babacan has warned that Turkey must decrease its dependence on European markets, but the extend to which the country can successfully diversify its trade to other markets is open to question.

growth and job creation in its Global Employment Trends 2011 Report.

Murky middle ground For several months, economists interviewed by bne have suggested that Turkey will see about 2% growth in 2012, a similar figure in 2013, and then,

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ideally, return to a more sustainable 4-6% growth rate after that.

The IMF concurs with the expected 2% growth rate for 2012, and urges the government to adjust its fiscal policies to ensure a soft landing. Turkey's economy has changed from being seen as a star in an economic crisis to a liability for stable investment.

Experts argue the country must make serious structural reforms to its economy – and the expected slowdown gives the country the opportunity to do just that, analysts argue. "We need many imports for our exports because the value added that Turkish industry appends to products is still very low," businessmen Bulent Eczacibasi, chairman of Istanbulbased Eczacibasi Holding, told local newspaper the Sunday Zaman. "We have

bne February 2012

to produce and export products with more value added. This is not something you can fix overnight, but the country is on the right path."

The construction sector grew by 10.6% in the third quarter; wholesale trade grew by 9.6%; manufacturing by 8.9%; financial institutions 15.8%; transportation by 9.7%. In November, gold was one of the main financial investment tools in Turkey, according to TurkStat, implying people are starting to worry about inflation, which in November hit 9.48%, far higher that the central bank target for year-end of 5.5%.

Domestically, politicians and a supportive media are cheering the prospect of continued growth, and snide comments are being made comparing Turkey's stellar growth to Europe's looming

recession. Critics of the government's economic policies are blasted in the local media. On January 16, one newspaper close to the government bizarrely published a column linking a May 2011 attack on Prime Minister's Recep Tayyip Erdogan's campaign convoy (the PM had left the convoy) to critics of Turkey's economic policies, because it came not long after he had made a speech stating the government's goal was zero interest rates. The central bank's insistence on an ambiguous low-interest rate policy has long been a chief criticism, mainly of international observers.

The country is second only to China among the G20 in terms of growth. But the question now is, how will Turkey handle the slowdown?

INTERVIEW:

Albanian PM plots path of greatest resistance

Tim Gosling in Tirana Sali Berisha, photo by World Economic Forum

A

lbania was one of only two European countries not to fall into recession in 2009 and Prime Minister Sali Berisha claims the economy will withstand the second wave of the crisis thanks to the government's reform programme. However, to push through the most crucial reforms, analysts say the PM has to nurture the recent thaw in relations between the two main political parties.

Whilst debate rages over the EU project as it slides deeper into crisis, Berisha is unequivocal in asserting that "EU integra-

tion is the top priority of the country."

However, Brussels announced in November that for a second year running it would not recommend Albania as a candidate country to join the EU due to a two-year political logjam that has delayed important economic reforms – reforms that would help as the crisis in Europe grows.

Although some colleagues clearly exhibit anger over the EU's decision, Berisha appears to accept Tirana's responsibility. "I fully understand Brussel's right to insist that the reforms are voted through. EU integration is a pro-

cess based on a universe of reforms. My government takes it entirely and totally as a performance-based process. This is an issue for Albanians to solve."

After two years of stalemate, it would be easy to dismiss this as rhetoric, but the prime minister appears to have finally engineered a détente – temporarily at least.

Following disputed elections in 2009, the opposition Socialist Party under Edi Rama boycotted parliament, thereby blocking new legislation that requires a

bne February 2012

three-fifths majority to pass. However, Berisha offered a number of significant concessions to Rama – such as inviting him to consult on new election legislation – and the opposition reappeared in parliament late in 2011.

Although Berisha points out that the government has had enough votes to implement reforms throughout – Jozefina Topalli, speaker of the parliament and deputy chair of the PM's Democratic

"We set up an economic system that resisted the 'bubble crisis' and is resisting the debt crisis"

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I 39

Flagging down ships in Albania

Tim Gosling in Tirana Albania is pushing to develop its tourism potential, with everyone from the prime minister down lauding the country's merits. While the government has been heavily investing in infrastructure to help visitors get to the unspoiled coast, one World Bank project hopes to attract the thousands already passing by on the large cruise ships sailing the Adriatic.

"In Dubrovnik I saw cruise ships carrying 4,000 passengers each lining up to dock. The port was crammed with buses waiting to take them on to sightseeing and shopping trips and to eat at restaurants. Can you imagine that in Albania?" exclaims Gazmend Haxhia, CEO of Albania Experience, the country's largest incoming tourist operator. Haxhia is hoping to tempt the largest cruise ships to start calling in on a country that he calls "the hole on the Adriatic coast" when it comes to the world's largest cruise companies.

Party, says the boycott has only derailed four draft reforms whilst she's "passed around 400 in the meantime" – blocked legislation includes central issues such as a much-needed Administrative Court.

If you believe the commentators on the tourist industry and Albania's government, major cruise ship operators are already said to have made land and are investigating the potential in Albania. They're attracted, says Haxhia, not only by the temptation of adding a new, and somewhat mysterious, destination, but also by services "around 20% cheaper than in the EU."

Replicating resilience Despite this, Berisha insists that his government has "set up an economic system that resisted the 'bubble crisis' and is resisting the debt crisis."

While the country is a port of call on the itineraries of the occasional smaller boat carrying 300 passengers or so (around 30 drop anchor for a short visit each year), the volume of tourists being fed, watered and entertained elsewhere in the Adriatic is far greater. Bringing in the world's biggest operators would change the game, reckons Haxhia.

Albania and Poland were the only countries in Europe to avoid recession in 2009, with Tirana reporting growth of 3%, following it up with 3.5% in 2010, according to the World Bank. However, the IMF worries that the momentum is slowing and that 2011 saw the economy expand by no more than 2.5%.

The World Bank also clearly sees the potential for "sustainable economic development" that the cruise ships offer, and is spending $4.7bn to help transform the southern port of Saranda into a dedicated ferryboat and passenger terminal. Tagged as the Saranda Gateway project, the plan includes the conversion of the existing cargo dock into a cruise liner berth and deepening of the port's sea channel to allow access to the bigger ships.

According to local media reports, Deputy Minister of Transportation Ernest Noka signed a construction contract with Greek company Ionois in September, and suggested that the project should be completed by late 2012.

That same pair expects no more than 2% growth in 2012, but Berisha brushes off the concerns over the 4.5% target on which his government based its 2012 budget. "We're ready to review the budget in June if we need to, but the objectives will remain the same," he retorts.

"We have space on spending," he claims, without expanding, whilst he points out that any privatization proceeds are not included in the plan, calling them "a reserve."

Still, the size of the challenge at a local level is daunting. "We're now looking at the most important part of the deal - to serve the passengers onshore with trips, events and local cuisine," says Haxhia. "Even for a medium-sized vessel carrying 2,000 we'll need to provide 40 buses, 40 guides and 2,000 lunches. That's a tough call in a small Albanian town."

However, it would be well worth the effort given the huge shot in the arm it would give the local economies. "Each passenger leaving the ship spends around ¤60," Haxhia says.

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"I'm confident that Albania will prove resilient once more thanks to the dynamism of the economy"

bne February 2012

"The debt crisis is affecting us," he admits, "but I'm confident that Albania will prove resilient once more thanks to the dynamism of the economy."

Whilst some suggest that the early development stage of the economy, alongside its small size, have helped significantly, Berisha naturally gives his own government the lion's share of the credit for introducing a host of free-market reforms, even if critics do suggest that the process is piecemeal and hampered by chronic corruption and administrative problems. "The only protection against crisis is to assist business," the PM says, outlining his ongoing campaign to cut red tape and simplify taxation and other fundamental systems. "The key in 2009 was small government, low taxes and a healthy business climate. It also helps that the banking system is small and strictly classical."

However, others worry that the reforms may have swung too far the other way.

The IMF has even sharply criticized the country's 10% flat tax rate, saying it should be raised to help reduce debt. Berisha is adamant the tax rate is appropriate, saying: "I'm a deep believer in low tax. I think you need to leave as much money as you can in private hands. They use it in a much better way."

Leaving that cash in private hands won't help much with the worrying level of state debt, however. Whilst in a Europewide context state debt is relatively low at 60% of GDP, in terms of Emerging Europe and the Western Balkans it's a high figure.

However, shrugging off recommendations from both the IMF and the central bank, the government plans to increase debt to as much as 63% of GDP by the end of the year, in no small part because it wants to continue funding its large road-building programme – another element that helped stave off recession in 2009, according to the PM, who points out that 70% of state debt is local currency and apart from €200m the rest is owed to the international institutions.

Needy neighbours Others are concerned that the govern-

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Southeast Europe

ment is overconfident in its ability to maintain the status quo. “Economic growth in the country has been financed in the last 20 years by raising debt … remittances and foreign direct investment,” then-governor of the central bank Ardian Fullani pointed out last year, expressing his concern that all of these funding sources look likely to dry up.

It's somewhat worrying then that Berisha appears surprised to be asked what plans the government has to make up for the inevitable loss of trade and investment stemming from Albania's two biggest partners: Greece and Italy.

The same pair also powers over 10% of Albania's GDP via remittances, with over 1m Albanians reported to work in Greece and around half that number in Italy. The volume of cash heading back to Albania has been diminishing over the past few years of crisis, according to the Bank of Albania.

A full 65% of Albania's exports go to those two struggling economies, and the PM admits "it's a concern," but suggests it's not an overwhelmingly serious one. "Exports grew 22% year on year in the first nine months of 2011, but our economic model is not so focused on growing exports."

Berisha clearly hopes that Albania will be able to find the investors to help FDI levels make up for the shortfalls, and outlines privatisation plans for oil and gas company Alpetrol, as well as four hydropower plants and an insurance company. He also has high hopes that Albania and its partners in the TransAdriatic Pipeline (TAP) gas pipeline project will succeed in bidding to carry 10bn cm a year from the giant Shah Deniz II field in Azerbaijan to European markets.

However, the question of investment brings the focus back full circle onto Albania's progress towards EU membership. If Berisha can steer the delicate détente with Rama onwards and secure the next step in the EU accession process, it could prove a real shot in the arm for Albanian FDI. No one is ready to discuss in public the consequences of a third refusal by the EU.

I 41

Enlargement Commissioner. "Croatia is a different country now," he tells bne, while acknowledging there is still "work to be done."

Some of the remaining work involves falling into line with EU competition policy by privatising shipyards, among other things. Other areas on Croatia's EU to-do list, Fule says, are in the areas of the judiciary and fundamental rights, and justice, freedom and security.

Croatia says "Da" Phil Cain in Graz, Austria

C

roatia as expected voted on January 22 in favour of joining the EU, though the poor turnout for the referendum was a clear indication of how the problems in the crisis-ridden bloc and the interminable accession process have combined to lessen the appeal of the bloc to many Croatians. Few entertain much hope that EU membership will resolve the country's more immediate problems – it was simply the only option available.

Croatia’s state referendum commission said that 68% of those who took part in the referendum, an apathetic 42%, answered "yes" to the question: "Do you support the membership of the Republic of Croatia in the European Union?"

About 31% were against, while the rest of the ballots were invalid.

The EU's current tumult makes membership, expected in July 2013, far from a thrilling prospect, but it's no worse than tackling Croatia's economic woes in isolation. Unemployment stands at 13% and over 30% among under 25s, while the economy is set to shrink by

1% this year, according to the World Bank. "This should be good news for the economy more generally, albeit the economy has other problems at the moment – low growth, deep structural problems, including a fundamental lack of competitiveness and inflexible labour markets, weak banking sector and lack

With the laws and institutional structures already in place, the challenge is one of implementation, a phase of reform for which Bulgaria and Romania have been widely criticised after entering the EU in 2007. Croatia will be different, Fule says, thanks to a new negotiating method that required Croatia to adopt a "systematic use of benchmarks for all areas."

But the Commission is not expecting to go on benchmarking Croatia after accession. "After accession, Croatia will be subject to the general EU mechanisms for ensuring the respect of EU law," says Fule. In any case the European Commission's experience shows that "transformation is an irreversible process."

Extreme opposition With all parliamentary parties backing EU entry, opposition came from the political fringes, mostly the far-right.

"This should be good news for the economy more generally, albeit the economy has other problems at the moment" of credit growth – which a weak EU cannot really help over night," says Tim Ash of RBS. "All hope is on the new centreleft government elected in December – that they can kick start growth through a far reaching reform agenda."

Despite the gloomy outlook, there has been real progress since the EU membership application was made in 2003, according to Stefan Fule, the European

The Party of Rights lost its place in parliament having campaigned against EU-membership in December's election.

Some from this extreme see the EU as guilty for the International Criminal Tribunal's April conviction of their hero General Ante Gotovina for war crimes during the break-up of the former Yugoslavia, while others see the EU as a sinister Jewish financial conspiracy.

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"Maybe the EU will soon be joined by Croatian 'Indignados' and instead of a stronger Europe, you will have a stronger protest movement" But there is some opposition to EU membership from the radical left too, including 26-year-old activist and author Srecko Horvat. For him, the referendum is an illustration of how the EU uses a democratic deficit to steamroll members into adopting neo-liberal policies. "You have a referendum after everything is already settled. You didn't have a referendum in 2003 when Croatia applied

for EU membership. You didn't have a referendum in 2005 when Croatia officially opened negotiations with the EU." There was no referendum either in 2010 when the constitution was changed to fit EU entry criteria. And now, he says, even the Social Democrat-led government, which took over in December's election, is pressing ahead with neo-liberal privatisation policies at the EU's behest.

The idea that joining the EU will clean up corruption is dubious, Horvat argues, pointing out that corruption allegations against Ivo Sanader, a former Croatian prime minister, involved EU companies – an Austrian bank and Hungarian oil company.

Given Croatia's high level of youth unemployment, "Maybe the EU will soon be joined by Croatian 'Indignados' and instead of a stronger Europe, you will have a stronger protest movement," he says hopefully.

Jankovic, whose Positive Slovenia party was the surprise winner of the snap election in December, failed to secure the necessary 46 votes in the 90-seat National Assembly to ensure that he could form a coalition government that would be able to address the country's growing catalogue of economic ills, which is likely to see the country lapse into recession this year.

Guy Norton in Zagreb

S

lovenia faces the unwelcome prospect of further credit rating downgrades and falling investor confidence as a result of the inability of the country's fractious politicians to agree on who should lead the country.

Hopes that Slovenia's December 4 general election would result in the rapid formation of a new government have been dashed, following the failure of prime minister-designate Zoran Jankovic on January 12 to secure sufficient

likely to include reforms in the labour market and pensions system, [and] to ensure growth that would maintain GDP per capita at the current level or higher."

Moody's Investor Services cut the country's sovereign rating to 'A2' from 'A1' on December 22; Fitch, the other major credit rating agency, said in January it would complete a review of its 'AA-' rating by the end of the month, with many observers expecting it to follow S&P and downgrade the country to 'A+'.

Under the terms of the Slovenian constitution, President Danilo Turk has two weeks in which to name a new candidate for the premiership. Turk told Slovenian press agency STA that he would soon start a new round of talks with party leaders before nominating a new candidate for the premiership.

support in the Slovenian parliament, the National Assembly, to form a new administration.

Political games undermine confidence in Slovenia

bne February 2012

That failure leaves Slovenia facing at least another month of political uncertainty at a time when there is growing concern over Slovenia's ability to cope with the prospect of declining creditworthiness and rising funding costs.

Downgrade Since November, yields on Slovenian government bonds have risen above the 7% level considered sustainable for members of the Eurozone, which the country joined in 2007. The rise in bond yields has been fuelled by a series of rating downgrades in recent months, the most recent on January 13 when Standard & Poor's cut its rating from 'AA-' to 'A+' and kept it on negative watch, meaning further downgrades "if the new government does not present, and begin to implement, a credible reform programme, one that is

Alternatively, a minimum of 10 members of parliament can submit their own proposal for a new prime minister. If none of the proposed candidates secures a parliamentary majority, then fresh elections must be called, which would necessarily further prolong the political impasse in the country since the previous government headed by Borut Pahor lost a confidence vote in September.

The closeness of the December elections means that there are a number of possible political combinations. Although Jankovic's centre-left Positive Slovenia won 28 seats, the right-wing Social Democratic Party (SDS) headed by Janez Jansa, who was premier from 2004-08, came in a close second with 26 seats.

Pahor's left-wing Social Democrats (SD) won 10 seats and the centrist Citizens' List of Gregor Virant, headed by a former minister in Jansa's government, secured eight seats. The conservative Slovenian People's Party (SLS) and the centrist Pensioners' Party (DeSUS) each have six seats, while the right-wing New Slovenia (NSi) party has four. Two seats are held by the Hungarian and Italian minorities in the country.

US Ambassador to Slovenia Joseph Mussomeli earlier in January earned a reprimand from President Turk following media reports that he had offered

Southeast Europe

Romanians on the streets

bne If ever one needed an illustration of the growing disconnect between the Romanian people and their feckless politicians, then the waves of protests rocking the nation's cities for the sixth day running are surely it.

What began as a series of small demonstrations against proposed reforms to the healthcare system, have quickly snowballed into violent protests against economic reforms in general and the entire political system.

"Newsstands, cars and a shop were set ablaze while riot police reportedly fired warning shots and used water cannons to disperse the crowd. Such violence may be discouraging other potential demonstrators to join the crowds, but an escalation of the protests remains likely," says Ana-Maria Morarescu, an economist with ING Bank Romania.

What initially brought people onto the streets were proposed changes to the dilapidated and cash-starved healthcare system that triggered the resignation of Under-Secretary of State for Health Raed Arafat, a popular and respected ethnic Palestinian doctor who created an efficient medical emergency system, but was critical of the draft bill which aims to privatise parts of the health system.

Small rallies in support of Arafat on January 13 quickly metastasized, descending into violence on January 14 and 15 as protestors clashed with police, leaving more than 70 people wounded. While politicians did their best to blame "football hooligans" from the "inept and violent slums", the government and President Traian Basescu – who helped spark the protests by accusing Arafat of leftist views on a TV show – clearly realised they misjudged the mood of the public and have tried to make amends.

Basescu has since announced the draft law be withdrawn and a new draft bill debated, and on January 17 Prime Minister Emil Boc reappointed Arafat. "He will resume his job as deputy health minister," Boc told the press, Reuters reported. "Mr Arafat remains the same expert and professional in his field... and will be part of the team working on the new healthcare bill."

However, given that the protests have moved beyond that narrow issue to one of wider dissatisfaction against the government's austerity measures and handling of the economy, few believe the protests will stop there. "The demands of Romania's protesters are political, and political demands need serious political responses," writes Cristian Cercel, a commentator for Observator, a Bucharest cultural weekly. "If Romanian authorities stubbornly continue to behave as if this were not the case, the 'inept and violent slums' might force Romanian politicians to be accountable to their electorate."

The problem for the government is that though the economy has perked up since the middle of last year after a deep recession for two years, it's been a jobless recovery. GDP growth turned positive in 2011 as activity expanded by an estimated 3%, aided by still strong external demand and a bumper harvest that probably made up a third of the growth figure.

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"The political vacuum in Slovenia means it will be mid-February at the earliest before ministers are in place to address the issue of strengthening the country's weak finances" himself as a mediator between various political parties and suggested that Slovenian politicians put aside their ideological differences for the sake of political stability and create a broad coalition containing both left- and right-wing factions. Turk labeled Mussomeli's supposed offer as "inappropriate". For his part, Mussomeli rejected claims of political meddling, telling STA that his meetings with Slovenian politicians were "nothing unusual" and claimed his talk of a broad coalition had been mis-

understood by Turk. "I think everyone from the president down agrees that to carry out the reforms it needs Slovenia ideally needs more than a slim majority in parliament... The broader the coalition, the more effective the government will be. Also this will resonate better with the Slovenian people, both left and right."

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Southeast Europe

fracking get into that. It's also Bulgaria's best farmland, so polluting it – also a risk, they say – would be criminal. Fracking uses a lot of water, and the forecast is that Bulgarian will have less and less of that in the coming decades. Moreover, the northeast is an earthquake-prone region, so it's not wise to play around with the seismically dubious high pressures used in shale gas fracking.

to address the thorny issue of strengthening the country's weakened finances.

According to the central bank governor, Marko Kranjec, Slovenia needs to cut public spending by at least €1bn this year if it is to conform with the Eurozone's anti-crisis plan and cut its budget deficit from 4.3% of GDP at present to 3% by 2014. Another concern is the heavily indebted banking sector, which has been saddled with growing bad loan losses and needs to attract at least €4bn of fresh capital to restart lending. "Bank losses will be even bigger this year as assets continue to decline, the fight for deposits intensifies and financing from abroad shrinks," Kranjec told business daily Finance.

The political vacuum in Slovenia means that it will be mid-February at the earliest before new ministers are in place

Shale'acked in Bulgaria Sandy Gill in Sofia

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www.bne.eu

I 45

W

ith shale gas a controversial topic in and beyond Europe, Bulgaria has made up its mind rather abruptly which side of the argument it's on – at least for now.

Events in January saw, in quick succession, reversal of a cabinet decision to award the US giant Chevron the right to explore in a shale-rich area of northeast Bulgaria and a parliamentary vote to ban the use of the controversial hydraulic fracturing (or "fracking") method in shale exploration and extraction.

The stakes could be high. In the leadup to the tender that Chevron won last June for the 4,400 square kilometre Novi Pazar field, contenders mentioned potential reserves of between 300bn cubic metres (cm) and 1 trillion cm of shale gas in the area. The amount won't be known till exploration has taken place, while commercially viable reserves are normally only a fraction of potential – the rule of thumb is 10% – but these are heady figures for a country that, at present, consumes between 3bn and 3.5bn cm of natural gas per year.

And a tempting prospect, given that said country is trying to move away from a worrying dependence (currently around 90%) on Russian gas.

But feelings have run high too, with environmentalists, concerned residents, leftist and nationalist politicians, and

A fracking mess The centre-right government of Prime Minister Boiko Borisov has been on the back foot since its decision in favour of Chevron. A contract was to have been signed within a month, but was repeatedly delayed. Borisov and his ministers gave reassurances that the government would allow nothing risky to happen, that this was only exploration, and that an environmental impact assessment (EIA) would be carried out before anything as radical as extraction took place. But opponents weren't reassured, especially when Chevron indicated – apparently to the government's surprise – that it proposed to use fracking in two wells it planned to drill at a late stage of exploration.

Things came to a head in January.

Thousands took part in anti-shale demonstrations in Sofia and 11 other Bulgarian towns from January 14.

Non-governmental parties competed in drafting laws and resolutions: the

"The PM's reasoning is: people are afraid and don't want this, so let's not do it; when they are convinced, we can reverse our decision" – supporters of shale gas would accuse – well-financed friends of Russia's Gazprom combining in an increasingly vocal alliance.

Shale gas development is risky, these critics say, and especially risky in northeastern Bulgaria. It's an area which is heavily reliant on underground water, opponents point out, and woe betide Bulgaria if the nasty chemicals used in

extreme nationalist Ataka has called for a 20-year moratorium on shale exploration and production, the former communist Bulgarian Socialist Party is for a permanent ban in the form of a law. The governing party GERB – that's the Bulgarian acronym for "Citizens for the European Development of Bulgaria" – opted for something a lot less radical: on January 16, its MPs voted in a moratorium until such time as

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appropriate legal amendments could be brought in, specifically requiring EIAs for exploratory drillings for shale, not just production as at present. Not much of a moratorium, said protestors: those amendments had passed first reading in December!

Then, a turnabout. Always rather sensitive to public opinion, Borisov excelled himself at a cabinet meeting on January 17, where he insisted on radical modification of the cabinet's June decision in favour of Chevron. Briefly summarised from the transcript posted on the cabinet's website, his reasoning was: people are afraid and don't want this, so let's not do it; when they are convinced, we can reverse our decision. Meanwhile, the cabinet decreed, Chevron can explore – but only for conventional oil and gas. And Borisov's hapless energy minister, Traicho Traikov, was instructed to lead the public debate on the subject that, the premier admitted, had been missing so far.

And, the same day, instructions went out to GERB's parliamentary group to throw their weight behind an outright ban, which was voted through parliament on January 18, complete with €50m penalties for companies infringing it by using fracking methods. Only a few MPs from the right-wing Blue Coalition opposed the motion: obedient as ever to their strongman leader, all GERB MPs present voted for it, barring one abstention.

Ill-advised? Certainly, a rather categorical decision was taken hastily, without formally consulting such expert organisations as the Bulgarian Academy of Sciences or the Geological and Mining Institute. Certainly, too, there's a lot of expert opinion that would contest the anti-shale arguments.

"Since Bulgaria shares its underground water with Romania, a Bulgarian ban would make sense only if Romania follows suit"

Overblown Bulgaria, experts point out, has used fracking in conventional oil and gas extraction since the 1960s (though admittedly not at such high pressure as would be used on shale). Shale is found at much greater depths than the water table (3,000-3,500 metres as against 1,000 metres), with solid rock in between, so there's little danger of pollution. Drilling through the water table is in itself no problem: that's already been done with 200 wells in the northeast, for conventional oil and gas.

The chemicals used in fracking are, for the most part, so harmless that they are also used in household detergents. Since Bulgaria shares its underground water with Romania, a Bulgarian ban would make sense only if Romania follows suit – of which there's no sign. And, say the friends of shale, fracking horror stories from the US are mostly explicable by poor drilling discipline and underregulation.

Well, perhaps. At a minimum, there's a lot of persuasion still to be done. But, if the jury's still out, it's fair to say that Borisov and his loyalists have rather rushed to judgement. Chevron wasn't proposing to drill its two wells (or do any fracking) until 2015 – its work till then would just have involved seismic tests.

By then, a good deal more will be known. There'll be experience from Poland, which is pushing ahead boldly with shale gas exploration. There'll be a decision on shale from the European Commission, due by end-2012. Further down the line there will be a definitive report from the US Environmental Protection Agency.

So why an outright ban now? Politics rather than statesmanship is probably the answer. Such decisions are not as easily reversible as Borisov imagines.

Nor, perhaps, will be the effect on Chevron. The US giant hasn't yet said much publicly except that it hopes to persuade Bulgarians of the virtues of shale. That's intelligible diplomacy short term. How patient it will be in the medium term remains to be seen.

Eurasia I 47

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A veneer of democracy in Kazakhstan Clare Nuttall In Alamty

T

wo smaller parties won seats in Kazakhstan's lower house of parliament alongside the ruling Nur Otan party in the January 15 parliamentary elections. The result has been hailed as the start of a multi-party system in Kazakhstan, but international observers say the election fell short of democratic standards.

Ak Zhol took 7.46% of the vote, while the Communist People's Party of Kazakhstan took 7.2%, lifting both parties past the 7% threshold required to take a seat in the parliament.

Allowing other parties to join the parliament, where previously all the seats allocated by public vote were occupied by Nur Otan deputies, was one of the government's aims in bringing the election forward from August to January. Changes to Kazakhstan's electoral code made during the last parliament guaranteed that at least one opposition party would take seats in the parliament even if it failed to pass the threshold. The move was intended by the authorities in Astana, who have been closely watching the unrest in the "Arab Spring" countries, to make Kazakhstan appear more democratic.

Speaking after the vote at the Nur Otan headquarters in Astana, Kazakh President Nursultan Nazarbayev described the election as "a great day of joy".

"Just now we have heard the exit poll results – our party won with convincing results," Nazarbayev told party members, Kazinform reported. "It demonstrates that our programme, our work were supported by the people. They understand us, they are with us, and they continue to trust us."

tion parties had been unable to stand, while other popular candidates were de-registered close to election day. "The authorities did not provide the necessary conditions for the conduct of genuinely pluralistic elections. Several political parties were blocked from standing and a number of candidates were deregistered without due process," said a statement from the OSCE/ODIHR.

However, according to observers with the Organisation for Security and Cooperation in Europe/Office for Democratic Institutions and Human Rights (OSCE/ODIHR), the elections "still did not meet fundamental principles of democratic elections."

Cosmetic changes Although two parties are likely to have passed the 7% mark, broadening representation in the parliament, this is not expected to result in real changes. Ak Zhol at least has become increasingly close to Nur Otan, while opposition parties that have provided genuine criticism of the regime have been forced out.

At a press conference in Astana this afternoon, OSCE/ODIHR officials highlighted the fact that several opposi-

Alga! DVK has been for the last decade trying unsuccessfully to register with the authorities, while the Communist

"The authorities did not provide the necessary conditions for the conduct of genuinely pluralistic elections"

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I Eurasia

Party of Kazakhstan received a sixmonth ban in October because of its leader Gaziz Aldamzharov's support for striking oil workers in the town of Zhanaozen. Kazakhstan's green party, Rukhaniyat, was disqualified from fielding candidates on dubious grounds after its leaders criticised the government's handling of the strike. Several individual candidates for other opposition parties were prevented from standing. "If Kazakhstan is serious about their stated goals of increasing the number of parties in parliament, then the country should have allowed more genuine opposition parties to participate in this election," João Soares, head of the short-term OSCE observer mission and the delegation of the OSCE Parliamentary Assembly, told journalists in Astana.

While there were fewer reports of electoral violations in this election than in Kazakhstan's April 2011 presidential election, some cases of fraud and other violations were noted. "This election took place in a tightly controlled environment, with serious restrictions on

bne February 2012

citizens' electoral rights," said Miklós Haraszti, head of the ODIHR's election observation mission. "Genuine pluralism does not need the orchestration we have seen – respect for fundamental freedoms will bring it about by itself."

According to the Central Elections Commission, turnout across the country was 75%, down from the 89% in the 2011 presidential election, suggesting that less pressure was put on people to vote.

The level of interest in the election has been low, and although a small demonstration (numbering around 30 people) was organised in Almaty, mass public protests are not expected.

Voting took place in a tense atmosphere in Zhanaozen, where just one month ago on December 16 at least 16 people were shot dead by security forces when police tried to evict striking oil workers from the town square. Zhanaozen is still under a state of emergency and there was a heavy military presence in and around polling stations.

The lowest turnout was in Almaty city,

Eight Turkmen

In fact, the Organisation for Security and Cooperation in Europe/Office for Democratic Institutions and Human Rights (OSCE/ODIHR) has already said it doesn't plan to send any observers to the election. ODIHR officials visited Turkmenistan in December, later releasing a statement saying: "[it] does not consider that the deployment of an election observation mission, even of a limited nature, would add value at this point in time."

The sacrificial lambs include two serving government ministers – Water Resources Minister Annageldy Yazmyradov and Energy and Industry Minister Yarmuhammet Orazgulyev – and Recep Bazarov, the deputy governor for agriculture in Dashoguz region.

Eurasia

where just 41.38% of registered voters participated in the election. Almaty is Kazakhstan's former capital and the business and cultural centre of the country. Sophisticated Almaty residents tend to be sceptical and cynical about Kazakh politics and the election process. Turnout was also relatively low at 53.3% in Astana. However, in Almaty oblast, turnout reached 92.6% and in several other regions it was over 80%.

Kazakh television showed voters queuing at polling stations in the western Atyrau region.

Speaking to Nur Otan members, Nazarbayev indicated that the government would push ahead with its existing programmes, as well as working to tackle the expected onset of a second wave of the international economic crisis. "The results of the elections, for we know the preliminary ones, speak for the fact that Kazakhstan continues and will continue its course for the country's development, economic and political modernization, welfare gain of Kazakhstanis, and the most important thing, unity, welfare, mutual understanding and tolerance in the multiethnic society," Nazarbayev told party members.

The biggest question in the coming days will be the composition of the new government, since the current government must resign with the election of a new parliament. Nazarbayev aide Yermukhamed Yertysbayev indicated in December that Karim Massimov, independent Kazakhstan's longest-standing prime minister could be replaced

by Deputy Prime Minister Umirzak Shukeyev, or Timur Kulibayev, head of Kazakhstan's sovereign wealth fund Samruk-Kazyna and Nazarbayev's sonin-law. Since Kulibayev has been sacked over Samruk-Kazyna's handling of the Zhanaozen strike, this leaves Shukeyev as the most likely candidate.

I 49

Although the Prosecutor General’s report says that police had to use weapons in subduing the riot, it also singles out several officials at the regional Department of Internal Affairs (DIA) and within the security forces. Five officials face criminal trials for their role in the violence. "In the given conditions, the police squad, after several warning shots, had to use weapons against activists of the insurgency," says the report.

"As a result of the clashes, 64 persons received gunshot wounds, 14 persons died. The death of other two persons is not related to the mass disorders on the streets."

Given that Nur Otan will hold a substantial majority of seats in the new parliament, significant changes in Kazakhstan's political direction are not expected.

bne Eight candidates are registered to take part in Turkmenistan's February 12 presidential elections, the Turkmen State News Service reported. But despite the appearance of a choice, there is absolutely no chance any of the other seven candidates will beat incumbent President Gurbanguly Berdymukhamedov.

bne February 2012

Sharing the blame

Six people identified as organisers of the riot have been arrested and charged. Thirty four others that the Prosecutor General says were involved in mass disorder, looting and arson have also been arrested. The report also claims that those arrested "stated that they were preparing for the insurgencies in advance, involving a group of young people who prepared bottles of Molotov cocktail and armed themselves with improvised weapons."

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A

s part of efforts to mend its recently battered international image, Kazakhstan's investigation into the violence that erupted in December in the town of Zhanaozen is pointing toward toward putting individuals from among both the rioters and the authorities on trial.

Police "had" to use weapons against striking oilworkers in the west Kazakhstan town of Zhanaozen, but in some cases the use of force by security forces was excessive, according to a statement from Kazakhstan’s Prosecutor General at the end of January.

Sixteen people died in Zhanaozen when fighting broke out between the oil workers and security forces in the town’s central square on December 16.

This followed a seven-month long strike at the nearby Uzen oifield, which had become increasingly acrimonious after over 1,000 striking workers were fired in August 2011. The riot represents the largest single loss of life in any conflict

between police and citizens in independent Kazakhstan's history, shattering the country's carefully nurtured reputation for stability and internal harmony.

Enough to go around After the shootings, which took place on the 20th anniversary of Kazakhstan’s independence, President Nursul-

However, several officials are also being brought to trial. These include the deputy head of the Mangystau region who was in charge of the police squad; the head of the DIA's anti-extremist division; the deputy head of the Zhanaozen Office of Internal Affairs Bakytkaliuly; and one police inspector. The report concludes that in most cases police officers acted in accordance with law, but

"In the given conditions, the police squad, after several warning shots, had to use weapons against activists of the insurgency" tan Nazarbayev ordered a full investigation. Nazarbayev has already put part of the blame onto state-controlled oil and gas company KazMunaiGas and its parent company, sovereign wealth fund Samruk-Kazyna, for their handling of the strike.

adds: “Nevertheless, in some cases use of weapons and special devices by the police was of disproportional character, reaction to the acts of the attackers was unequal to the threat thus leading to the death and injures of people.”

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"The events in Zhanaozen have been used as a pretext to clamp down on opposition activity"

bne February 2012

An investigation is also being carried out into the death of Bazarbay Kenzhebaev, who according to his relatives died of injures sustained while in police custody. The head of the temporary detention facility in Zhanaozen will be brought to trial, the report says.

The shootings happened after several months of strike action, in an increasingly nasty fight between strikers and regional officials and oil company executives. Journalists covering the strike were attacked and there have also been several unexplained deaths, including that of the 18-year-old daughter of one of the strike leaders. For their part, KazMunaiGas officials claim the strike was being funded by outside forces (former BTA Bank boss Mukhtar Ablyazov is one of those named) who want to destabilise Kazakhstan.

Since December 16, there has been a concerted effort from Nazarbayev to

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

Eurasia

However, the events in Zhanaozen have also been used as a pretext to clamp down on opposition activity. This week has seen a series of arrests of opposition activists in Almaty, including Alga! DVK party leader Vladimir Kozlov on his return from meetings with EU officials to discuss the tragedy. Kozlov and other activists may be charged with inciting social discord, a vaguely defined offence that carries a prison term of up to 10 years.

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I 51

deficit is nothing new, we have to import everything," says Jargalsaikhan Dambadarjaa, CEO of XacLeasing and host of Mongolia's "De Facto" TV talk show. "But now it's suddenly on a much larger scale.

We have very high foreign direct investment for the mining sector, but these funds go right back out again to bring in materials for projects like Oyu Tolgoi."

heal the wounds, and to prevent future conflicts by showing that he has not forgotten those who have been left behind

by Kazakhstan's growing prosperity.

The Prosecutor General's report, which puts blame onto both rioters and police, is one step towards this. On December 26, Nazarbayev sacked his billionaire son-in-law Timur Kulibayev from his position as head of Samruk-Kazyna - a message to the population that no one is above the law.

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bne February 2012

Hard to control These heavy flows are proving a struggle to control for the Bank of Mongolia, which boldly promises a stable togrog and single-digit inflation past 2012.

Unfortunately, its aims have already been undermined as consumer prices rose 10.2% in 2011 and the currency begins its sharp trend reversal.

Tipping the togrog

Oliver Belfitt-Nash in Ulaanbaatar

I

n 2010 Mongolia had the best performing currency in the world, but in 2011 it had one of the world's worst, with the togrog falling 11% against the dollar. When the large-scale resource exports begin, few doubt the currency will resume its rise.

It was a combination of huge imports, high inflation and the global recession that dragged the togrog down last year, even though the economy put in an astonishing 17.3% real GDP growth rate. Frontier Securities predicts GDP growth of between 15.1% and 16.6% for 2012 – a level of growth that should continue and even rise in subsequent years as the country's giant resource projects come on stream.

Mongolia's biggest story is the development of the gigantic Oyu Tolgoi copper-gold mine, which alone requires $6bn investment before the metals can

be dug up and sold. As the country produces little itself, almost all this cash is being used to import machinery and materials to develop the site and house employees, practically creating a new town in the Gobi desert from scratch.

The rising inflation has caught the eye of the World Bank and International Monetary Fund, which has warned of an "overheating" economy. Even so, the Mongolian government continues to dole out cash to citizens. Some MNT21,000 (around $15) is given out every month to each person as part of a promise made in 2008 to win votes in an election, and is likely to continue at least until the polling stations open again this June. "This money should be spent productively on infrastructure and skills development," says Jargalsaikhan, "but instead it's funding the vodka producers. This careless spending will only increase in the first half of 2012 leading up to elections."

But the politicians aren't the only ones to blame. A surge of "hot money" in 2010

"This money should be spent productively on infrastructure and skills development; instead it's funding the vodka producers" Largely because of this single project, Mongolia's imports outweighed exports by $1.75bn, or around 23% of the country's GDP in 2011. This trade deficit rose six times from the previous year, and is extremely high compared with the world's average of 9.3% of GDP. "A trade

bubbled up through Mongolian stocks only to be sucked out again in 2011 on signs of slowing global growth. In the second half of 2011, the European debt crisis spooked investors worldwide, causing risky positions to be closed and money ploughed into the safe haven of the

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bne February 2012

"A trade deficit is nothing new, we have to import everything"

dollar. The sudden rush created a vacuum under commodity prices and Chinese imports from Mongolia seemed at risk.

The country suffered a crash in its flagship stocks like Ivanhoe Mines and the togrog was sold from deposits as banks tightened their lending. "We say the Mongolian togrog is pegged to the US dollar, but it would be more correct to say it is pegged to commodity prices," says Jargalsaikhan.

Indeed, coking coal exports boomed 155% in 2011 to account for almost

half of everything exported from Mongolia, thanks to companies like Mongolian Mining, dubbed the private sector's "national champion". It's not surprising that since 2010, togrog movements have tracked global coal indices.

Yet the impressive volume of coal exports will soon give way to Oyu Tolgoi's copper and gold, due for shipment in the second half of 2012. The colossal mine is predicted to produce $3.5bn worth of metal exports per year by 2015

and dwarf any previous operation in Mongolia. Thus trade deficits may be a thing of the past when exports begin to soar, putting pressure on the togrog to appreciate as dollars flood into the market. Even if the government makes more election spending promises, tax revenues and its 30% stake in the mine will be a big earner for state coffers.

If the world avoids recession or it's at least a mild one, Mongolia will feel investor confidence return as quickly as it felt the fear. The togrog has already begun to show signs of strengthening since the first week of January. "Global capital is ready to move," says Jargalsaikhan – and Mongolia will move with it.

While reformed legislation has helped bolster the mining industry in nearby Armenia, pushing gold production up 30% to 1,266 kilograms of gold in 2011, issues with the Georgian law have already nearly cost the country one investor, the mining exploration company Lydian International.

There's gold in them thar hills Molly Corso in Tbilisi

L

ong before it was famous for roses, revolution and reform, Georgia was known for its gold. But today the country's antiquated laws could be pushing potential investors away – to Armenia.

Tbilisi maintains its efforts have been focused on modernising the mining legislation, although industry specialists say the country could be wasting its chance to prosper from riches laying just beneath the surface.

Lydian discovered a large gold mine in Armenia five years ago and started to investigate Georgia's potential after determining that an "arc" of volcanic ash led from Turkey straight through Georgia and Armenia and into Iran – a find that signalled there could be gold, according to Tim Coughlin, president and CEO of Lydian.

While the company moved into Armenia in 2005 – discovering Amulsar Gold Mine just one year later – development in Georgia has taken a lot longer.

With a more modern legislation for exploration mining, Coughlin says Armenia has become an easier sell for companies searching for gold. Lydian first sent an exploratory team, just specialists "in boots on the ground" to Georgia in 2010, but it was a full year before they could obtain a license to explore the site they discovered in the

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southern region of Adjara. "I've spent my career in just about every country in South America, worked in Eastern Europe, Turkey, Russia, Armenia, Africa – now in Georgia. The Georgian mining law has got to be pretty close to the bottom of the list," Coughlin tells bne in a phone interview from London.

The biggest issue, Coughlin notes, is that the Georgian law couples exploration and development – two different parts of mining. While the Armenian law looks at the two processes separately, the Georgian legislation considers them part of the same license agreement.

Another major obstacle is that once a team discovers something, the Georgian law does not give them any priority when it issues mining rights. In practice, that makes it too expensive to explore for new gold deposit sites, notes Professor Alexander Tvalchrelidze, the deputy general director of Georgian Minerals. "If you want a dramatic increase in investors, you should design a new mining code," he says. "It is the hugest obstacle because… no one will invest in exploration if he or she has no guarantee that he or she will ultimately acquire the license. That is why only little dots are licensed now and nobody is performing huge, country wide exploration."

Other issues with the law include a formula that allows the government to reassess the cost of a mining license if a serious fine is discovered. "So the hugest difficulty comes from the business risk," Tvalchrelidze says. "You have no guarantee that you will discover something.

You have the right to [look geologically] without a license, but if you find something, you have no guarantees you will receive a license."

Work to be done Coughlin believes that many investors have been frustrated by the shortcomings in the Georgian law. "There are plenty of people who have looked at Georgia," he says. "In Turkey there are copper ore deposits and they extend right into Georgia… [but] the mining law just doesn't work for exploration.

That has closed the door for a lot of people."

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I 53

Giorgi Tatishvili, deputy head of the Agency of Natural Resources at the Ministry of Energy and National Resources in Georgia, maintains that the sector is gaining interest from investors even as the government works on reforms. He notes that, in addition to the Lydian investment, the government sold two other gold mining licenses in 2011 – including one for GEL93m (€43.5m).

However, Paul-Henri Forestier, director of the European Bank of Reconstruction and Development (EBRD) in the Caucasus, Moldova and Belarus,

"I've worked in Eastern Europe, Turkey, Russia, Armenia, Africa – now in Georgia. The Georgian mining law has got to be pretty close to the bottom of the list"

says the "inadequacies" in the law are definitely stifling development for the sector in Georgia. EBRD, an investor in Lydian's exploration project, has been working with the company and the government on the licensing issue.

"What is extremely important to induce exploration investments is that if and when you find something, you must know exactly the conditions that will apply to the development phase. If the odds of hitting a commercially viable deposit are one in 10, then you want to make sure that your investment to achieve this is commensurate with the expected find," he says.

The EBRD is working with the Ministry of Energy and National Resources in Georgia to reform the law, he notes.

"There is nothing wrong and dubious [with the Georgian law] – it is just inadequacy. But in the case of the Georgian government that is looking for foreign direct investment in such a potentially promising sector, inadequacy must be urgently dealt with."

bne February 2012

Special focus: Investment bank survey 2011

second largest Ukrainian IPO ever and the biggest IPO since the financial crisis erupted.

The award for "bne 2011 Best Local Investment Bank Kazakhstan" goes to Visor Capital, which occupies a similar space in Central Asia to Dragon in Ukraine.

And like Ukraine, Kazakhstan is still struggling in the aftermath of the crisis. Even so, Visor was able to close one M&A deal in 2011, the sale of a 50% stake in local pharmaceutical company Khimpharmn to the Polish group Polpharm for an undisclosed amount. And there are hopes for a huge boost in business this year as it looks as though the National Bank of Kazakhstan will opt to give local banks, not international investment banks, the business to manage the individual listings of the so-called "People’s IPOs" – a programme to sell shares in some of Kazakhstan's largest state-owned companies to the population at a discount.

A holding year bne

54

Welcome to bne's "Investment Bank Survey 2011", our second annual survey for Central and Eastern Europe compiled from interviews and using data from Dealogic.

Despite the nervous pall that hangs over the capital markets, our 2011 survey shows that investment banks in the region managed to hold their own against the deteriorating crisis conditions. However, it's an open question whether 2012 promises to be a further step back towards the nadir hit in 2009 or the base from which a recovery in business can be built.

2011's total M&A transaction volume in CEE was $158.2bn, which was down from $192.0bn worth of M&A deals in 2010, but well up from the $99.5bn recorded during the depths of the crisis in 2009. This pattern was repeated in the debt and equity capital market categories: the top 20 investment banks managed $100.9bn of debt deals in 2011, which was down from the $116.4bn worth of deals in 2010, but up from $92.2bn in 2009; and the banks managed equity capital market deals worth $19.5bn in 2011, which was down from $23.3bn in 2010, but up from $9.6bn in 2009, reports Dealogic.

The winner of the "bne 2011 Best Investment Bank for M&A" was Deutsche Bank, which advised on 19 transactions worth $22.5bn. VTB Capital was the most successful of the regional banks, coming in fifth place with 23 deals worth $15.1bn, but this was significantly down on the $20.6bn worth of deals that it advised on in 2010, reflecting the hostile business environment in Russia in the second half of last year.

However, VTB Capital won both the "bne 2011 Best Investment Bank for Equity Capital Markets" and the "bne 2011 Best Investment Bank for Debt Capital Markets". VTB has been on a roll since it was set up in 2008 and is today the largest regional investment bank.

Following on VTB Capital's heels are peers Sberbank and Gazprombank in the debt capital markets, and

Renaissance Capital in the equity capital markets – all of which were active in Russia and the wider Commonwealth of Independent States region.

Local banks Due to the disparity in the size of the various markets in CEE/CIS, there are the "bne 2011 Best Local Investment Bank" awards for the crop of banks operating in the local economies. The investment banking business in the smaller economies of the region is mixed, as it remains in its infancy and very underdeveloped in many of the countries, so we have tried to choose the most interesting.

Dragon Capital remains the top bank in Ukraine and is the clear winner of the "bne 2011 Best Local Investment Bank Ukraine". Founded almost a decade ago, Dragon has been a pioneer in the Ukrainian capital markets, and today accounts for about a third of the turnover on the Ukraine Exchange, and the lion's share of bond underwriting and M&A advisory. However, the Ukrainian capital markets have been walloped by

"It's an open question whether 2012 promises to be a further step back towards the nadir hit in 2009 or the base from which a recovery in business can be built" the crisis and the ongoing political uncertainty has depressed both trading volumes and the amount of inbound investment to such an extent that Georgia's BG Capital, one of Dragon's main competitors, closed its offices there in November. Still, Dragon completed the IPO of Coal Energy on the Warsaw Stock Exchange, the

Finally, there is a special mention for Mongolia's leading investment banks: Frontier Securities, MICC and Monet Capital. The Mongolian capital markets are right at the very beginning of their development and there are few deals to write home about. However, 2011 saw US investment manager Firebird Management buy up 40% of the free float on the Mongolian Stock Exchange in a matter of days, sending the index soaring from 6,164 to a peak of 32,955 in March. It has since fallen back to about 20,000, but that still made Mongolia yet again the best performing stock market in the world in 2011.

CEE ECM Bookrunner Rankings 2011*

Rank

Bookrunner

Deal Value ($m)

CEE M&A Advisor Rankings 2011*

Rank

All Advisor Parent

Deal Value at

No.

%share

Announcement ($m) 1

Deutsche Bank

22,563

19

14.3

2

Rothschild

18,556

26

11.7

3

Goldman Sachs

17,896

12

11.3

4

JPMorgan

16,229

36

10.3

5

VTB Capital

15,113

23

9.6

6

Credit Suisse

14,233

19

9.0

7

Bank of America Merrill Lynch

14,029

17

8.9

8

Credit Agricole CIB

12,244

5

7.7

9

Barclays Capital

10,364

9

6.6

10

Citi

9,809

9

6.2

11

UniCredit

9,378

12

5.9

12

ING

9,074

10

5.7

13

Nomura

9,023

9

5.7

14

Morgan Stanley

7,870

22

5.0

15

Troika Dialog

6,945

25

4.4

16

Gazprombank

6,776

12

4.3

17

UBS

6,694

11

4.2

18

SG Corporate & Investment Banking 6,652

10

4.2

19

Renaissance Capital

6,338

10

4.0

20

Trigon Dom Maklerski SA

6,168

1

3.9

Total

158,254

4,558

100.0

*CEE Countries are based on Dealogic Criteria and include Target, Acquiror or Divestor involvement.

55

CEE DCM Bookrunner Rankings 2011*

No.

%share

Rank

Bookrunner Parents

Deal Value $

No.

%share

(Proceeds) (m) 1

VTB Capital

2,556

10

13.1

1

VTB Capital

11,403

68

11.3

2

Deutsche Bank

2,349

6

12.0

2

Deutsche Bank

8,434

30

8.4

3

Morgan Stanley

1,708

9

8.7

3

Citi

7,128

26

7.1

4

Goldman Sachs

1,618

8

8.3

4

JPMorgan

6,749

23

6.7

5

Bank of America Merrill Lynch

1,549

3

7.9

5

BNP Paribas

6,690

21

6.6

6

JPMorgan

1,111

5

5.7

6

Barclays Capital

4,342

17

4.3

7

Credit Suisse

1,071

7

5.5

7

HSBC

3,907

14

3.9

8

UniCredit

830

6

4.3

8

SG Corporate & Investment Banking 3,746

21

3.7

9

ING

782

6

4.0

9

Erste Group Bank AG

3,604

18

3.6

10

Renaissance Capital

726

5

3.7

10

Sberbank

3,553

26

3.5

11

Citi

665

5

3.4

11

Gazprombank

3,540

26

3.5

12

PKO Bank Polski SA

625

5

3.2

12

RBS

3,337

14

3.3

13

Ipopema Securities SA

321

3

1.6

13

Goldman Sachs

3,331

14

3.3

14

SG Corporate & Investment Banking 275

1

1.4

14

ING

3,200

14

3.2

15

Troika Dialog

260

2

1.3

15

Troika Dialog

2,925

30

2.9

16

Credit Agricole CIB

242

1

1.2

16

UniCredit

2,676

10

2.7

17

ISM Capital LLP

200

1

1.0

17

Raiffeisen Bank International AG

2,534

23

2.5

18

HSBC

197

1

1.0

18

Vnesheconombank

2,331

22

2.3

19

Santander

182

7

0.9

19

Credit Suisse

1,780

13

1.8

20

Oyak Menkul Degerler AS

159

2

0.8

20

Morgan Stanley

1,612

5

1.6

Total

19,528

217

100.0

Total

100,975

251

100.0

*CEE Countries are based on Dealogic Criteria. ECM includes IPOs, follow ons and convertible bonds.

Special focus: Investment bank survey 2011

bne February 2012

*CEE Countries are based on Dealogic Criteria. Excludes ABS, MBS and Supranational issuance

Outlook

bne February 2012

I 57

Russia's uncertain smile

Ben Aris in Moscow

I

n the five years that bne has been writing a Russia outlook report for the coming year, never have the prospects been so uncertain. The complications are multifarious, but can be split neatly into external and internal problems.

OUTLOOK 2012 Russia Ukraine Central Europe Southeast Europe Eurasia

The most obvious obstacle is the ongoing sovereign debt crisis in Europe, which is stymieing growth by depressing exports and investment flows. The prospect of a meltdown in the EU would have serious consequences for the Russian economy, although that said, its economy is in a much better position to withstand the shock than it was in 2008.

At home, despite a deceptively strong economic performance in 2011 and rapid recovery, the economy is more vulnerable to fluctuations in oil prices than it has ever been. On top of that, political risk returned to Russia on December 11 after a 30,000-strong street protest – the largest since the fall of the Soviet Union – which has spooked investors used to the placid millpond of Prime Minister Vladimir Putin’s political stability. Political uncertainty will reign until the presidential elections slated for March 4 (and now expected to go to a second round in the summer) have passed.

Most analysts assume Europe will "muddle through" its debt crisis without a meltdown and that as the fears of collapse recede, Russia will enjoy a strong second half of the year as confidence returns.

Citigroup’s Kingsmill Bond summed up the consensus view on politics well in his outlook note: • The return of political risk: We believe that the market is only now starting to price in the return of top-level political risk for the first time in 12 years, and that developments in Russia will lead to more short-term downside.

• The protests are likely to continue: Russia is unusually well-educated and wealthy to endure a system characterized by so much corruption. Now that the spark has caught the tinder of discontent, we expect more protests.

• The government reaction is likely to be populist: We believe that the government is likely to indulge in populism

to attract votes rather than reform to improve the long-term situation. We anticipate more friction with the West, more government spending, and a postponement of liberal policies. There is also the risk of attacks on unpopular oligarchs and higher taxes on rentier companies.

• The threat to the reset: It is standard policy for regimes under pressure to seek out a foreign enemy. We believe that the conflict of words between Prime Minister Putin and US Secretary of State Clinton may escalate further.

• The ruble is likely to weaken: We expect more ruble weakness as a result of the political uncertainty and the relatively significant role played by foreigners in providing long-term capital to Russia.

• The metals and mining sector is most at risk: We see risk to companies that are beneficiaries of the current rentier system or controlled by oligarchs.

• Regulated companies are also at risk: The government may elect to postpone again electricity price rises and to force oil companies to lower their domestic prices.

• Potential beneficiaries: Retailers are the most obvious potential beneficiaries of higher government spending.

GDP forecasts * Official Troika Danske Uralsib Citi IMF TCB Capital Moody's UBS Morgan Stanley bne CONSENSUS

3.7% 4% 4.5% 2.8% 3.5% 4.1% 3.5% 2.8% 3.3% 5% 3.72%

* these forecasts are all assuming there is no meltdown in Europe and oil prices stay in the order of $95-$100 per barrel

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I Outlook

New model for growth The presidential elections will dominate the domestic part of the story in the first half of the year, but there is an air of expectation that Putin could take Russia in a new direction in the second half of the year. It has become clear to all that Russia needs a new economic model if it's to return to the 7% GDP growth it enjoyed pre-crisis.

The priority for the new model should be boosting investment: Russia's investment levels reached a peak of about 25% growth year on year, but have dropped back since 2008.

There is talk in Moscow of a radical plan that will appear in the middle of 2012 to run to 2024, which is not out of the question. If Putin follows through, then the economy would quickly take off. "If Russia were to succeed in unleashing forceful structural reforms, we believe GDP growth rates of 5% to 6% would easily be possible over the longer term," says Reinhard Cluse of UBS. "The marginal productivity of investment in a market-friendly environment would be very

bne February 2012

high, delivering a big boost to economic activity, and this would surely get foreign investors excited as well. So in this sense, while we remain cautious on reforms, we hope to be surprised positively by Mr Putin and his team after the presidential elections are out of the way in March 2012."

By the middle of January, the first green shoots of optimism were appearing amongst analysts as Russia entered what Citigroup has dubbed the "hope stage", when equity prices start rising on the expectation of a recovery, even though corporate earnings have yet to grow significantly.

Russia’s equities ended 2011 losing 22% on the year – its third worst result ever – with half the losses coming in December alone. January got off to a better start with stocks rising 10% over the first three weeks of the year.

Confusion reigns over predictions for the stock market in 2012.

Many Russian brokerages believe that the RTS Index will keep

Ukraine's year of living dangerously

Dragon, traditionally one of the Ukrainian bulls, cut its GDP growth forecast in 2012 to 2.2% from 4.0%. Chief economist Olena Bilan said at a press conference that revised assumptions about Ukraine's all-important steel production had prompted the decision.

This followed the World Bank, which shortly before Christmas dropped their 2012 forecast from 5.0% to 2.5%. The downside risks to the World Bank forecast are unusually high, warned its economist Ruslan Piontkovsky in January. Moody's Investors Service also warned that Ukraine was in danger of a multi-notch downgrade if the crisis deepened internationally.

One of the issues to watch for this year will be whether Ukrainian government's can please the IMF and so engineer the release of the next tranche of its standby agreement. The need for an IMF bailout could be avoided if the government can successfully negotiate a reduction in the price it pays for Russian gas: Ukraine paid the most of any of Gazprom's customers in 2011 at about $400 per

"If Russia were to unleash forceful structural reforms, we believe growth rates of 5-6% would be possible" within the current range of 1,400-1,500 points until the end of 2012 due to the economic slowdown in Europe externally and political turbulence from the presidential election internally.

But by mid-January, a few banks were becoming more bullish. Russia’s biggest investment bank Troika Dialog surprised Russia-watchers by revising its end of year target up to 2,200, which would mean a whopping 60% over the year. Clearly much depends on how well the rest of Europe deals with its problems. "If we get that crisis-rebuild scenario in Europe and elsewhere, then the case for Russian market out-performance in second half of 2012 and into 2013 will be boosted by the fact that the next government [that will take office in the summer of 2012] is expected to take a more proactive and pragmatic route to improve investment in the economy, and the reform agenda should proceed at a steady, albeit modest, pace," says Chris Weafer, head of strategy at Troika Dialog.

The bond market should also be a strong performer. In January, the government said it would return to the Eurobond

Ben Aris in Moscow Ukraine's expected 5% growth in 2011 is a distant memory as Ukraine's leading brokerage Dragon Capital on January 12 became the latest to slash Ukraine's GDP growth forecast for 2012 and warn the country will face considerable risks this year.

bne February 2012

1,000 cubic metres, but is holding out for a reduction to some $250. The two sides seem to be inching towards a deal that will involve Ukraine giving up at least partial control over its gas pipeline system, but this will be an extraordinarily difficult deal to pull off. Without either of these things happening, the government is going to have a hard year: the planned budget deficit of 2.5% of GDP in 2012 is based on extremely optimistic forecasts at a time when its access to external funding is very restricted.

Another wild card in the pack is the general election slated for October, for which President Viktor Yanukovych clearly intends to consolidate his control over the political process in the face of his plummeting popularity. It is highly unlikely he will push through the reforms the IMF is demanding – especially a 50% hike to household gas tariffs hikes – before spring when gas use plunges. After flirting with true democracy, the October elections are expected to be dirty and, depending on how egregious the fix is, there is even the possibility of social unrest.

The two bright spots in the economy are consumption and agriculture. Wages remain high and people are spending, fuelling domestic demand. And Ukraine harvested a bumper 56.7m tonnes of grain, up 44% on 2010, which is an important source of foreign exchange earnings. The prospects for this year's harvest are also good.

Outlook

I 59

market with a sovereign issue, although neither the timing nor size was specified. However, in 2011 the government switched to the domestic market as its main source of funds, and it plans to issue RUB1.6 trillion of bonds on the domestic market in 2012.

The new Central Securities Depository (CSD) also came into being in January, which makes it possible for foreign investors to participate directly on the domestic bond market by setting up the newly sanctioned nominee accounts, thus opening up a new pool of capital for issuers. It remains to be seen how much difference this will make, but the capital market reforms are chugging along nicely and will have a cumulative effect going forward. "In general, 2012 promises to be very interesting in terms of government borrowing policy, as the Finance Ministry increasingly depends on the bond market functioning, which means that the ministry will be increasingly willing to accommodate investors in terms of pricing," say analysts at UralSib. All in all, Russia’s fundamentals remain as strong as ever. The core sectors of consumption, real estate and investment were all recovering nicely as the year began. Likewise, the banking sector has emerged from the woods and lending and assets are growing by about 20%. This is not a stellar pace of growth and companies across the board are feeling the pinch as competition begins to bite – and will bite harder after Russia finally acceded to the WTO in December. But that is a good thing, as too much easy money makes you lazy.

Blissful living in Central Europe Tim Gosling in Prague

I

gnorance is bliss, so they say. That should make Central Europe the happiest place on the planet in 2012, because as governments try to gauge the impact of the building crisis in the Eurozone, it's clear that no-one knows anything.

Apart from the Hungarians of course, who know that everyone's out to get them.

EU officials may feel the same way as they struggle to assemble the bazooka that the markets have been urging

them to aim at the sovereign debt crisis. Irked by the continued delay – never get between a banker and another round of quantative easing – the financial markets have punished heavily indebted states, and even Germany has seen its cost of borrowing rise.

Heavily dependent on export demand in the Eurozone, the Central European members go into 2012 balanced on a knife edge, with the crisis not only weighing on their currencies

60

I Outlook

and pushing borrowing costs higher, but also threatening to severely undermine economic growth.

East Capital points out how fundamental the connection is for Central Europe, suggesting "the starting point for any judgment on growth perspectives… is the rapid and marked slowdown in economic activity in the whole of Western Europe. The cooling down became apparent in late spring/ early summer when economic indicators turned into a negative slope. Forecasters started revising their outlooks, first cautiously, later in huge leaps."

bne February 2012

Still, as analysts point out, whilst many of the older members of the EU are facing recessionary scenarios, the Central European economies are likely to do much better. However, if the Eurozone goes into a deep recession, then Central European countries, with Hungary by far the most vulnerable, could go with it.

While none of the countries has actually forecast a contraction, the hopeful predictions of 3-4% that reigned before the summer are long forgotten in the face of predictions from the likes of the European Commission that forecast in November EU growth will remain at a near standstill throughout 2012.

Juggling the numbers It's no wonder then that the second half of 2011 saw Central European government officials juggling with more scenarios than you can shake a stick at, with GDP growth forecasts tumbling across the board as draft budgets were prepared.

"The protracted sovereign-debt crisis has taken its toll on confidence affecting investment and consumption," the Commission wrote in its Autumn Economic Forecast. "The first signs of improvements for GDP are projected for the second half of 2012, however, with very limited impact on job creation."

Whilst Hungary, Slovakia and the Baltics have responded to the uncertainty by simply lowering the bar as confidence sank – it felt like it was almost on a weekly basis at points in the late autumn - the Czech Republic and Poland considered differing scenarios. However, the Czechs dispensed with these as a base for the budget, allowing them to even scout out a "catastrophe" model in which the euro collapses. Warsaw, meanwhile, eventually plumped for the middle course, which envisages "some slowdown" in the EU.

Fading Baltic bounce

Mike Collier in Tallinn One year ago, Anti Poolamets – leader of a “Save the Estonian Kroon” campaign – was seen as a party pooper when he told Estonia that by joining the Eurozone it had bought "the last ticket on the Titanic." 12 months on and even though the northernmost of the Baltics boasts the EU's fastest-growing economy – 8% is expected in 2011 Poolamets' warning looks prophetic.

Clearly, Estonia's economic prospects in 2012 are inextricably linked to the fate of the Eurozone, with many analysts worrying over the impact of the slowdown, and the likelihood the Baltic bounce could hit a brick wall. On December 14, the Estonian central bank sounded a stark warning, forecasting “economic growth will decelerate sharply in 2012," and that should “the external situation deteriorate even more, a recession cannot be ruled out.”

That would be a tough sell to a population sick of listening to Greeks moan about austerity measures that are paltry compared to the ones they've undergone. Even Finance Minister Jurgen Ligi, despite pushing through a 2012 budget that includes the country's first targeted deficit in three years at 2.1% of GDP, is not immune. "Europe tends to think a 3% [budget] deficit is good and we can live in deficit all the time," he told the Baltic Economic Forum in Riga on November 24. "They are forgetting... you will never have growth."

That's also the growing feeling in Latvia, which was supposed to have a dull 2011 as it plodded slowly out of the world's deepest recession (a cumulative contraction of 24% of GDP in 2009-10, according to the IMF).

However, the country is clearly rattled as it heads into 2012 following a series of political shenanigans and the collapse of Krajbanka in November, which stirred

bne February 2012

memories of the disastrous failure of Parex bank in 2008, and prompted a run on Swedbank on nothing more than Twitter rumours in December.

Suspicion remains hanging over the banking sector then, despite the claims of Finance Minister Andris Vilks to bne that "there is no more bad news" in the banking sector. "I think the markets and the international lenders now trust us," he says, anticipating that Latvia will go to the markets for up to ¤1bn – or the dollar equivalent – in 2012.

Since the country completed its ¤7.5bn IMF programme in December, it hopes to receive a ratings upgrade soon.

Having steamed ahead during the first three quarters of 2011, Lithuania would like to forget the last three months.

That bodes ill for 2012, and the country looks like it faces another tough year, particularly with elections due.

The collapse of Snoras Bank saw the state forced to find ¤1bn it hadn't bargained on and has sparked suggestions it may have to turn to the IMF. While official policy in Vilnius is to beat its own path, that spectre is likely to hover in the background should market conditions deteriorate.

In December, the official growth forecast was slashed from 4.7% to 2.5%.

Lisa Ermolenko at Capital Economics expects to see another 0.5% shaved off, withEstonia remaining regional leader with 2.5% and Latvia lagging on 1.8%.

Like the similar small, export-led economies in Central Europe, the bounce that the Baltics put back in their step in the first half of 2011 is already fading. "The Baltic States are in a better shape now than they were in 2008/09," admits Ermolenko,"[but] growth will still slow."

Outlook

Private borrowers are unlikely to find it much easier or cheaper to get hold of credit given the dominance of Western European banks in their markets. The need of Europe's banks to raise capital is dampening funding for Central European subsidiaries to lend out, which will add another drag on macro growth whilst also boding ill for investment.

Commerzbank analysts estimate that although it has narrowed since 2008, the potential external funding gap for Central and Eastern Europe in 2012 is likely to come in at $10bn or so.

Meanwhile, the final outlier for the individual Central European economies is the swift contagion still seen across the region. For instance, the Czechs can run as conservative a fiscal policy as they like, or the Poles can enjoy robust domestic demand, but their currencies and bond yields are still hit when Hungary earns itself a downgrade.

Both countries ended up with a forecast of 2.5% GDP growth.

While analysts broadly agree with Poland's prediction, the Czechs essentially admitted their number is a fallacy, but pointed out that without a crystal ball, who cares? "Nobody is able to estimate now how the Eurozone will deal with the crisis and what its impact will be on the Czech economy," said Czech Finance Minister Miroslav Kalousek after budget was passed on December 14.

As third-quarter manufacturing data for the region came in, it became more obvious that the problems in the EU were already hitting the Central European economies where it hurts: exports.

The region's exposure to export demand in the 27-member bloc has been a boon which now threatens a bust, with domestic demand in Central Europe's small open economies in no state to take up the strain. The one exception is possibly the far-larger Polish economy, but even there the eventual 2012 budget saw its GDP growth forecast cut from an original estimate of 4%, with a tough set of austerity measures promised on top.

Falling risk appetite and reduced financial flows are also likely to continue to effect the cost of borrowing for sovereigns, and in one case, Hungary, could even risk closing access to debt markets altogether should the situation take a bad turn and the government continues to play the maverick.

That leaves governments across the region facing a conundrum, especially should they all sign up to the EU fiscal compact, handing Brussels greater powers to oversee their national budgets. Tasked with commitments to lower deficits, and debt in the case of Hungary and Poland, they're left with little room to stimulate the economy, particularly via interest rates. However, without growth, it will be difficult to reduce debt and deficits sufficiently.

I 61

"If the Eurozone goes into a deep recession, then Central European countries, with Hungary the most vulnerable, could go with it"

62

I Outlook

bne February 2012

Southeast Europe on shaky ground

leading to weaker profitability," it says. "In addition to the probable negative effects on [Central and Southeast European] subsidiaries' franchises, this regulation may alter their business models. In particular, several subsidiaries of the larger Austrian banks currently have loan/deposit ratios that exceed 110%, and primarily rely on parental funding for their foreign-currency loan portfolios."

Raiffeisen Research says the upshot is that with the possible exception of Albania, double-digit loan and asset growth rates are unlikely in nearly all banking sectors in Southeast Europe for the foreseeable future (to 2015). "The Romanian banking market is set to be the most attractive Southeast Europe market, reflecting its position as the largest banking market in Southeast Europe and the decent expansion that looks sustainable," Raiffeisen says. "In contrast, the outlook for the Croatian banking market – the second largest in Southeast Europe – as well as the Bulgarian banking sector remains challenging."

Nicholas Watson in Prague

T

he big question for investors in Southeast Europe in 2012 is the same as that for anyone invested in the wider region: what will be the fallout from the mess in the Eurozone?

There is only one country in Southeast Europe that is actually a member of the Eurozone – Slovenia. But with strong trade, funding, investment and banking ties, every country in the region will feel the pinch as Western Europe's economies, particularly those of Greece, Germany and Italy, continue to struggle.

"There is a high but uneven degree of economic dependency between [Emerging] Europe and the Eurozone in general and Germany in particular. There are four main transmission mechanisms between East and West: (i) trade, (ii) investments, (iii) credits, and (iv) sentiment," says Marcus Svedberg, economist for the CEE-focused fund manager East Capital.

Indeed, the banking route that could carry the dreaded contagion from Western Europe is already looking wide open.

Western European banks, which account for around 90% of all cross-border banking claims on CEE, are being squeezed on one side by demands for more capital, and on the other by downgrades of their sovereign debt holdings. These factors are working particularly against banks from Austria and Greece, which are unfortunately also heavy investors in the banking sectors of Southeast Europe. Greek banks, for example, are particularly exposed to Bulgaria (where their share is over 25% of the market), Romania (over 15%) and Serbia (over 15%). "A sovereign default in case of Greece could have a severe impact on the Southeast Europe region," note analysts at Raiffeisen Research.

East Capital says: "The banking sectors in Croatia, Romania, Czech Republic and Slovakia are almost completely dominated by foreign banks whereas the ratio is above 80% in Hungary, Lithuania, Serbia, Estonia, Poland and Bulgaria.

Comparatively, it is below 40%, 30% and 20% in Ukraine, Turkey and Russia respectively."

bne February 2012

In 2009, during the first wave of financial crisis, a "Vienna Initiative" involving the European Commission and the parent banks' domestic regulators, worked to ensure that funds did not flow back to parents from regional subsidiaries.

Today, people are fretting about an "anti-Vienna initiative" due to proposed restrictions by the Austrian regulator on the amount that Austrian banks' Emerging European subsidiaries can lend, a move that prompted angry reactions from regional politicians like Romanian President Traian Basescu, who threatened unspecified "counter-measures" against the Austrians. "You [Austrian bankers] have made huge profits and if you are now getting ready to leave Romania unfinanced during the crisis, we will think it is an act lacking fair play towards Romania," he said, addressing a conference in Bucharest on November 24. "I don't want to believe we will be left to pay the bills of banks' greed."

Under the Austrian financial regulator's proposals unveiled on November 21, Austrian banks will have to reduce lending to below a fixed percentage of local deposits. The preliminary regulation stipulates that the ratio of new loans to local funding (which includes local deposits plus funding in local capital markets and funding from supranational institutions) is not to exceed 110%, though the numbers will be fleshed out at a later date. The regulator's move is part of an effort to shore up Austria's credit rating after Fitch Ratings said earlier in the month that its 'AAA' was "at risk". A downgrade would increase the cost of servicing Austria's debt, which stands at around 68% of GDP, a relatively modest sum by current European standards.

Moody's Investors Service notes that given the top Austrian banks – Raiffeisen Bank International, and Erste Bank alongside the struggling Italian UniCredit Group are among the major players in many of the banking systems of Emerging Europe, the loan growth limitations will have a number of credit negative implications for the region's banks. "The instruction effectively limits the Austrian banks' subsidiaries' ability to enhance their position within the [Central and Southeast European] countries and will constrain their contribution to economic growth in the region, likely

On December 14, Fitch Ratings issued a report saying that the combined outlook for banks in CEE remains stable, but that downside risks are increasing against a backdrop of weakening GDP growth, worsening asset quality and potential funding constraints. "Adverse trends have continued for banks in Bulgaria, Romania and Croatia, although they retain some flexibility to absorb shocks, warranting stable outlooks. The balance of risks remains negative in Slovenia and Hungary," it said.

What worries people like Moody's is that the Austrian regulator's move could set off a round of similar moves by other countries whose banks have invested in the CEE region. In particular, Moody's notes that this risk exists in Italy, Germany,

"Banks from Austria and Greece are unfortunately also heavy investors in the banking sectors of Southeast Europe" France, Belgium or Greece, all of which have significant operations in the region. "We believe that there is an increasing risk of regulators elsewhere introducing similar measures to preserve stability of their own banking systems. If such a scenario occurred, there would be a limitation on lending growth and profitability across the region, which will constrain economic growth and prove to be a significant credit negative for [Central and Southeast Europe] banks," Moody's says.

And growth is exactly what Southeast Europe needs right now. Recently released data from Eurostat show that for all the talk of how Emerging Europe is catching up with Western Europe and the crisis is turning the world on its head, GDP per capita data from 2010 show that Southeast Europe in particular has a long, long way to go.

Outlook

I 63

At the bottom of the EU pile are the two latest additions to the bloc, Romania and Bulgaria, whose GDP per capita stands at just 46% and 44% of the EU average – pretty much unchanged from the year before. Slovenia is the highest ranked of the new member states at 85% of the EU average. Croatia, which has just been accepted into the EU and will formally join in the summer of 2013, is relatively well placed in terms of GDP per capita at 61% of the EU average. The other aspiring members still have much further to go. Turkey's figure is more than 50% below the EU average, while Serbia, Bosnia-Herzegovina and Macedonia have a gap of 60% - 70%. Albania is stuck right at the bottom with a GDP per capita level just 28% of the average. Moldova, whose GDP per capita level is possibly even lower than that of Albania, was not listed.

Yet growth in the region looks set to be anaemic in 2012.

Citigroup Global Markets predicts emerging economies will likely grow by just over 5% next year, a mild softening after 6% growth in 2011. But Citi says much of this relatively strong performance will be down to China, while CEE (and the Middle East) are where "the biggest vulnerabilities lie," because of the risk of Western European banks deleveraging and accompanying constraints that countries may find in trying to meet their external financing needs. Gross repayments of bonds and loans for the CEE region as a whole are set to rise to an historic peak of $217bn next year, forecasts Citi.

According to the European Commission's autumn economic forecasts, EU growth will remain at a near standstill during 2012 and return to slow growth in 2013, which will hinder the more robust recovery that Southeast Europe had been expecting before the euro crisis began building. The 2012 forecasts range from Bulgaria's 2.3% GDP growth down to 0.8% for Croatia.

Economists too have been busy revising down their forecasts for growth as data from the real economy (such as exports and manufacturing) and sentiment indicators show the pace of economic recovery in the region has already started to lose steam as Western Europe stagnates.

East Capital's Svedberg notes that for the Czech Republic, Hungary, Slovakia and Slovenia, exports to the Eurozone make up around one-third of GDP. For others, like Poland and Romania, the export sector is of far less importance, while for Latvia and Croatia the Eurozone is of little importance.

The investment pattern looks pretty similar to the trade structure, and there is ample evidence that flows of foreign direct investment to the region are weakening significantly (though Svedberg stresses the worsening outlook for FDI is not only due to the outlook in Western Europe, but is also related to the fact that the prospects for green-field investment in the region are smaller as most of the large-scale privatisation projects are already implemented). The Balkans saw a fivefold increase in direct foreign investments between 2003 and 2008, rising from $30bn to $155bn, according to PwC. FDI plunged 50% in 2009 as the crisis took hold, with only a modest recovery from 2010 onward. This year Bulgaria, for example, saw its FDI drop

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I Outlook

by 40% in January-October versus the year before.

All this will, of course, have an adverse impact on the region's financial markets as risk appetite worsens and portfolio flows reverse. According to fund-tracker EPFR, year to date, all emerging market equity funds tracked have seen net outflows of about $36bn. "Emerging equities and currencies have both suffered in recent months as investor risk appetite soured," says Capital Economics. "The pattern of underperformance in the bad times and outperformance in the good is longstanding, so… the troubled global backdrop inclines us to believe that emerging currencies and equities will underperform in 2012."

However, it adds: "Further ahead though, as investors focus on the emerging world's stronger fundamentals and its resilience to turmoil in the Eurozone, we expect a significant rebound in 2013.

bne February 2012

They go on to add a warning however that this prediction, as the economic growth forecasts doing the rounds, is based on a muddling-through scenario in the Eurozone. If the Eurozone goes into a deep recession, triggered by financial breakdown and a disintegration of the euro, no part of Southeast Europe will be spared the shock. "The biggest risk to our view is that Eurozone break-up is much messier than we now expect, triggering a financial crisis which spreads to Eastern Europe – Hungary, Ukraine, and the Balkan countries look most exposed," says Capital Economics.

If Europe's politicians don't take decisive action to solve the problems plaguing the euro, the ground beneath the Southeast European economies looks very shaky.

In December at the World Policy Conference in Vienna, Turkish President Abdullah Gul also took up a theme that has become increasingly common among ruling Justice and Development Party (AKP) ministers. "At a time when euro member states are not able to abide by the criteria that they put for themselves, we are at the stage where we can meet those criteria," he said, tapping into the public mood of schadenfreude at the EU's woes and confidence in the stability and durability of the local economy.

While much of this is politics, reminding the electorate of the AKP's achievements and grandstanding in front of a population that has become increasingly disenchanted with the EU, such comments are not completely without foundation. Turkey's economy is expected to grow by 8% in 2011, according to the central bank, well above the estimated EU rate of 1.6% and, in all likelihood, second globally only to China. Furthermore, as Gul suggested, Turkey's fiscal housekeeping puts many within the Eurozone to shame. Turkey's budget deficit is currently at 2.5% of GDP, according to Gul, within the EU benchmark of 3% and significantly below countries such as Greece (10%) and Portugal. The AKP's nine-year stewardship of the Turkish economy has also brought public debt/GDP down from 74% in 2002 to 42% in 2010, significantly below EU countries such as Greece (143%), Italy (119%) and Portugal (93%).

Yet despite such achievements, the current indulgence in hubris could yet come back to haunt the government.

Turkey's stellar growth has come at the cost of significant

Clare Nuttall in Almaty

T

Patrick Wrigley in Istanbul pressure on the country's balance of payments, with the current account deficit growing from 2.28% of GDP at the end of 2009 to an expected level of approximately 10% (approximately $79bn) at the end of 2011. This has been fuelled by rising energy imports, consumer spending and a dependence on intermediate imports to fuel production.

The widening current account deficit and an overheating economy has also had a significant impact on the lira (which lost nearly 20% of its value against the dollar in the first 11 months of last year) and seen inflation threaten to move back into double digits, with the expectation that it will end 2011 at 10%. There is, thus, growing concern for the coming year.

While Murat Ucer, a former advisor to the governor of the central bank and currently advisor for GlobalSource Partners, is largely behind the IMF prediction of 2% growth this year, he doesn't rule out a bleaker scenario. "We're going to continue looking good as long as revenues keep flowing, but we're going to look like the emperor with no clothes if revenues stop because primary expenditures are still growing, reasonably in line with nominal GDP… There is a distinct possibility of recession."

The 'R' word is not something the government has been contemplating. While it is far from a certainty, the confidence displayed by the likes of Gul and Babacan seems to be somewhat out of kilter with the prospects for 2012.

Whether Turkey sinks into recession or not, 2012 is likely to be a much more sombre year and the ruling AKP could face a rare test of its economic management credentials.

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Eurasia – a question of stability

he bad news in 2011 was that Kazakhstan’s carefully guarded reputation as an oasis of stability in Central Asia has been tarnished by a series of terrorist attacks and civil strife in some cities. There are worries that this year will be even more turbulent one for Kazakhstan and indeed the rest of the region.

A scrawnier Turkey

Outlook

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The most serious terrorist attack so far was in the southern city of Taraz on November 12, when a lone gunman killed seven people before blowing himself up. So far the attacks have mainly targeted the security services, rather than the general population or business interests.

Kazakhstan's independence day in December was marred when at least 16 people were killed in clashes between striking oil workers and police in the western oil town of Zhanaozen. For Kazakhs, the shootings were reminiscent of the Zheltoksan uprising in December 1986, one of the first mass protests against Soviet rule, which was violently put down. Bloodshed on the scale of the Zhanaozen tragedy is unprecedented in independent Kazakhstan, and the country is still coming to terms with what happened.

Despite the uncertainties ahead in 2012, Kazakhstan is set for strong growth in the medium-term as several major natural resources projects are due to start production. “2012 depends on the global context more than on growth projects, but we expect to see significantly higher production of Kazakhstan's main commodities in the next three to five years,” says Lermusiaux.

These include the offshore Kashagan oilfield, where commercial production is due to start in 2013. Kazakhmys is developing major new deposits. Kazatomprom has the ability to ramp up uranium output when necessary. The Kazakh government is also close to a deal with the international consortium operating the Karachaganak gas condensate field, which would see state-owned NC KazMunaiGas take a 10% stake in the project. Once this is signed, planning for Karachaganak’s third phase of development can go ahead. “Most of the large projects, especially those in the mining sector, are already

funded,” Lermusiaux points out. “However, some quasigovernment companies do need money or there could be a bottleneck. NC KazMunaiGas, for example, needs around $20bn to fund its plans over the next four years.”

On the back of the expected increase in oil, gas and metals production, Kazakhstan’s government hopes to see GDP per capita reach $15,000 by 2015, which would put Kazakhstan among the world’s high-income countries.

Kazakhstan is set to maintain steady economic growth of around 6% in 2012. The country is well prepared to weather a global economic slowdown, although its performance will depend on the impact of global events on commodity prices.

Oil prices in particular will determine the pace of growth in 2012. China accounts for an increasingly large proportion of Kazakhstan’s hydrocarbon and metals exports, insulating the country to an extent against the growing difficulties in the Eurozone and Russia. But a strong global slowdown would affect the Chinese economy, thus curbing growth in Kazakhstan.

Investment banks Visor Capital and Troika Dialog forecast 6% growth in 2012. Visor forecasts a fall in inflation from around 11% in 2011 to 8% in 2012, and provided oil prices stay above $70 sees no reason for any depreciation in the tenge. Troika forecasts that the Kazakhstan economy will do well if oil prices remain at $80 or above. “This will depend on events in the Eurozone and elsewhere in the world since Kazakhstan is a small open economy that lives to a large extent off export revenues,” says Askar Yelemessov, chairman of the board of directors at Troika Kazakhstan. “A deepening of the crisis in the Eurozone could cause a fall in demand for energy resources.”

Even in the case of an international slowdown, Kazakhstan is much better able to weather a crisis than it was at the start of the previous crisis. “Kazakhstan is in much better shape than it was in 2008, when the country was doubly hit by the implosion of the real estate bubble and the sharp fall in commodity prices,” says Jean-Christophe Lermusiaux, managing

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director and head of research at Visor. “Today, reserves are at a record high, amounting to around $70bn cash net of debt, and M3 coverage is 110%. Kazakhstan is not immune to stress, but is definitely in a healthier position.”

Armenia is on track to achieve growth of 4.3% in 2011, according to the International Monetary Fund (IMF). Growth has been driven by mining and manufacturing, but agriculture and other sectors also showed a strong post-crisis recovery. However, the country is vulnerable to both the Eurozone crisis and a possible slowdown in Russia, which is both Armenia’s main export market and the primary source of both foreign direct investment (FDI) and remittances. In November, Moody’s Investors Service changed the outlook for Armenia’s sovereign rating from stable to negative.

According to the ratings agency, Armenia is in worse financial shape than it was at the start of the previous crisis, and therefore less able to resist turmoil in the global economy.

Armenia is also preparing to hold parliamentary elections in May 2012. These will be the first national elections since the 2008 presidential elections, which were followed by mass riots and the deaths of at least 10 people.

In Azerbaijan there is a growing realisation that the country’s oil and gas reserves won't last forever. Unless major new discoveries are made, production is set to peak in 2020, bringing Azerbaijan’s oil boom to an end. 2011 saw a fall in hydrocarbon production for technical reasons, resulting in low forecast growth of just 0.2%, the IMF says. While production is set to revive in 2012, Baku has focused recently on building up the non-resource sectors of the economy with some success. Economic growth outside the hydrocarbons sector is expected to come in at nearly 9% in 2011, up from 7.5% in 2010. Measures are being taken to encourage the development of Azerbaijan’s stock exchange to expand the funding options for local companies. The government also hopes that continued economic prosperity will stave off political discontent. Early 2011 saw several, admittedly small-scale, protests organised via social networking sites and apparently inspired by the Arab Spring.

2011 was a good year for the Georgian economy, which is expected to grow by 5.5% according to the IMF, slowing slightly to 5.2% in 2012. With the exceptions of agriculture and construction, production in most sectors of the economy is now above pre-crisis levels. The government is targeting further growth in the energy, tourism and agricultural sectors, and has opened negotiations with the EU with the aim of increasing agricultural exports to Europe. Inflation, a concern earlier in 2011, has been brought under control.

Inflation fell to just 2.3% year on year in October, allowing the National Bank of Georgia to cut the main refinancing rate from 7.25% to 7.00%. FDI, which was severely hit by the August 2008 war against Russia, revived in 2011. The latest figures from Geostat show that FDI was up 66% year on year in the third quarter of 2011. Georgia attracted a total of $643m in January-September.

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With two revolutions in just six years, Kyrgyzstan has had a turbulent time recently. After Almazbek Atambaev was sworn in as president in December, there are hopes that stability will be restored and the economy given a chance to grow. The April 2010 revolution and ethnic violence in June 2010 caused a 1.4% contraction in the economy that year, but in 2011 there has been a strong recovery, with GDP up 5.5% in the first half of 2011, according to the European

“A deepening of the crisis in the Eurozone could cause a fall in demand for energy resources” Bank for Reconstruction and Development (EBRD). Bishkek hopes to attract much-needed investment, especially to the mining, tourism and agriculture sectors. This may be helped by the country’s accession to the Russia-Belarus-Kazakhstan Customs Union, which is expected soon. However, there are some concerns for 2012. Kyrgyzstan’s ruling coalition collapsed immediately after Atambaev’s inauguration and as of mid-December a new government had not been formed.

The financial sector has largely recovered from the events of 2010, but some problem banks remain, the EBRD says.

Kyrgyzstan’s transport and energy infrastructure is also in urgent need of repair and modernisation.

On the back of its mining boom, Mongolia is set to be one of the world’s fastest growing economies in 2011, with growth of 11.5% rising to 11.8% in 2012, according to the IMF. FDI, most of it going into the mining sector, reached 26% of GDP in 2010, and similar levels continued in 2011. In addition to the massive Oyu Tolgoi copper-gold deposit and the Tavan Tolgoi coal deposit, Mongolia has numerous smaller deposits. Ulaanbataar is seeking to avoid over-reliance on a single sector, and through the creation of the Mongolian Development Bank will invest into other areas of the economy.

However, there are growing concerns the economy could be overheating. The IMF has warned that the government’s expansionary policies have created inflationary pressures and made the economy more vulnerable to economic shocks.

“Additional spending would further overheat the economy, hurt the poor by driving up inflation, increase the vulnerability to a global commodity shock, and undermine credibility in fiscal policy and the fiscal responsibility law,” the IMF warned in November.

The poorest of the post-Soviet republics, Tajikistan’s economy rebounded in 2010 and the country is expected to achieve a respectable 6% growth rate in both 2011 and 2012, IMF forecasts say. Tajikistan is the world’s most remittancereliant country, with remittances from migrant workers mainly in Russia accounting for at least 31% of GDP, according to the World Bank. It is therefore vulnerable to problems

Outlook

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in the Russian economy. China is also playing an increasingly large role in Tajikistan, where investments into new roads and other infrastructure are mainly being funded by Beijing. Tajikistan has continued investing into the hydropower sector. The CASA-1000 project will see surplus electricity from Kyrgyzstan and Tajikistan exported to Afghanistan and Pakistan. However, construction of the massive Roghun dam, which is hotly opposed by Uzbekistan, has not yet started.

Turkmenistan continues to grow strongly based on expansion of the oil and gas sector. According to the EBRD, growth was more than 14% on year in the first half of 2011, making it the region’s fastest growing economy. Gas production was up 40% in January-June, and exports have increased following the construction of new pipelines to China and Iran. Ashgabat is still weighing the options for future exports.

President Gurbanguly Berdymukhamedov said in November that exports to Europe were a priority, but later that month Turkmenistan signed an agreement with Pakistan on the TAPI (Turkmenistan-Afghanistan-Pakistan-India) pipeline project.

The EBRD thinks that GDP growth prospects are good, but that Turkmenistan faces downside risks “related to the global slowdown, over-reliance on gas production and exports, excessive state intervention, and slow progress with marketoriented reforms.”

Uzbekistan was relatively unaffected by the recent crisis, maintaining growth due to its isolation from the international economy and a state stimulus package. The economy has continued to expand since then, with GDP set to grow by over 8% in 2011, according to the IMF. “Strong growth was registered in services, transport and communication, trade, and agriculture and was driven by buoyant domestic consumption supported by large wage and pension increases,” says an IMF report issued in November. Several major investment projects are moving forward including Lukoil’s investments into the Aral region, and plans for a $3.2bn gas-to-liquids (GTL) plant that Uzbekneftegas hopes to build in partnership with Malaysia’s Petronas and South Africa’s Sasol. However, there are a number of concerns about the Uzbek economy, including the perennial problem of currency convertibility.

Directed lending has increased in the banking sector, where there are signs that asset quality is deteriorating.

"There are growing concerns the Mongolian economy could be overheating"

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I Classified

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13 March 2012 The Brewery London

PPP In CEE

Business Information In A Global Context

21–22 March 2012 Crowne Plaza London, St. James

Join up to 100 leading stakeholders in a dynamic networking and learning environment about the future of PPP in CEE.

Events

Upcoming events 2012

S E R I E S

2nd Annual

SECONDARIES

Financing future projects in Central and Eastern Europe

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Ltd nts Eve

Easy ways to register: Online: www.eelevents.co.uk Email: delegate@eelevents.co.uk Fax: + 44 (0) 207 681 2889

Part of the C5:

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Secondaries are on a fast track for a record year. LP sellers, driven away by wide bid-ask spreads during the past couple of years and now pressured by an unprecedented level of regulation, are returning to the market in droves. Shored up by a very strong interest from both opportunistic and strategic buyers, secondaries have moved up the agenda of many institutional investors. It is against this strikingly positive backdrop that the movers and shakers of the secondary private equity industry are meeting for their Second Annual Conference on Private Equity Secondaries. Join this comprehensive and dedicated event, thoroughly tailored to the imminent needs and challenges of the secondary players and get the most up-to-date and unbiased information on: • How to nd immediate liquidity; generate cash and eliminate balance sheet liabilities associated with unfunded capital commitments.

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Ukrainian Energy Forum (28 February - 1 March) Adam Smith Conferences +44 20 7017 7444 Kiev, Ukraine events@adamsmithconferences.com www.adamsmithconferences.com

Agribusiness in Ukraine (13 - 15 March) Adam Smith Conferences +44 20 7017 7444 Kiyv, Ukraine events@adamsmithconferences.com www.adamsmithconferences.com/ru7bneb

Funds Russia Forum (29 February - 1 March) Adam Smith Conferences +44 20 7017 7444 Grand Marriott Hotel, Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

Russian Automotive Forum (20 - 22 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

7th Caspian International Conference and Showcase BANKING & FINANCE (1 - 2 March) Iteca Caspian LLC +994 12 447 47 74 Baku, Azerbaijan banking@iteca.az www.banking.iteca.az

2nd Annual Private Equity Secondaries (21 - 22 March) C5 +44 20 7878 6888 Crowne Plaza London, St. James, London marketing@c5-online.com www.C5-Online.com/SEC

Corporate Banking Forum 2012 (1 - 2 March) Global Leading Conferences Budapest, Hungary gabi.zoren@glceurope.com www.glceurope.com

Russian Retail Forum (26 - 29 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

www.glceurope.com globalleading leading conferences global conferences

corporate banking forum 2012 start date: 2012. 03. 01 end date: 2012. 03. 02 time: 9:00 am - 5:00 pm

Visit: www.glceurope.com location: budapest industry: financial services

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corporate banking forum 1st - 2nd March 2012, budapest, Hungary

Attend the event and take the opportunity to network and benchmark with leaders involved in day to day corporate and transaction banking issues, and acquire the latest information, which can help you when developing similar strategies.

Turkey Acquisition Finance & Private Equity Forum

2nd Annual

Key speakers

Senior Vice President, Nordea, Finland Head of Trade Finance and Cash Management, Deutsche Bank, Germany Global Head of Regulatory and Market Strategy, Citigroup, UK Deputy Global Head of Cash Management, BNP Paribas, France Expert Advisor, European Central Bank, Germany Head of Global Transaction Banking, Unicredit Group, Italy Head of Corporate Clients, ING, Austria Managing Director, PKO, Poland COO Raiffeisen, Hungary Senior EU Business Project Manager, SEPA, HSBC, France

reasons to attend

• Meet leading corporate banking representatives • Learn about Corporate Banking future and trends 2012 • Discuss most effective cash management, supply chain management risk and liquidity management strategies • Understand the current economic situation and the impact of SEPA on European payment market • Gain valuable information about Multichannel Management and Electronic Bank Account Management (eBAM) • Extend your knowledge on corporate banking technology investment and explore top investment priorities, where to invest and what is the outcome • Benefit from interactive discussions with your peers to benchmark your experience

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7th & 8th February 2012 – Mövenpick Hotel, Istanbul

The primary event in the Turkish acquisition finance and private equity market REGISTER BEFORE 16th December 2011 and SAVE €100

For further information on the agenda or to register: Call: +44 (0) 20 7779 8999 Email: tbarnes@euromoneyplc.com Visit: www.euromoneyseminars.com/TAFPE

Institutional Investors' Congress (5 - 6 March) Opal Events London, UK www.opalgroup.net

PPP in CEE (13 March) E.E.L Events London, UK www.eelevents.co.uk

HSE in OIL and GAS. Russia and CIS (13 - 15 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

2nd Annual World Islamic Finance Conference 2012 (27 - 28 March) Fleming Gulf London, UK www.fleminggulf.com

Airport Development Russia & CIS (27 - 29 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

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Russian Wood and Timber (27 - 29 March) Adam Smith Conferences +44 20 7017 7444 Grand Marriott Hotel, Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

Cash, Treasury and Risk Management in Turkey (17 - 18 April) EuroFinance Istanbul, Turkey www.eurofinance.com

Wealth Management & Private Banking: Russia & CIS (17 - 19 April) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

25th BACEE Country and Bank Conference (19 - 20 April) BACEE Budapest www.bacee.hu

CASPIAN TELECOMS 2012 - 11th International Caspian and Black Sea, CIS countries Telecommunication and IT Conference & Showcase (19 - 20 April) ITE Moscow LLC +7 495 935 7350 Hilton Hotel, Istanbul, Turkey Kochergina@ite-expo.ru www.caspiantelecoms.com

The 3d International Forum Of The Association Of Industrial Parks "Investrussia 2012: New Opportunities" (19 - 20 April) Industrial parks of Russian regions MOSCOW, THE PRESIDENT HOTEL investrussia-2012.com/en

KAZANSUMMIT 2012 (21 - 22 May) IBFD Kazan, Russia www.kazansummit.com

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9th Annual Retail banking conference (22 - 23 May) Fleming Europe London, UK http://finance.flemingeurope.com

KITEL 2012 (29 - 31 May) ITE Moscow LLC +7 495 935 7350 Almaty, Kazakhstan Kochergina@ite-expo.ru www.kitel.kz/en

Treasury and Risk Management in Russia (June) EuroFinance Moscow, Russia www.eurofinance.com

Emerging Market Investments Summit 2012 (June) Marcus Evans +357 22 849380 Fairmont Le Montreux Palace, Montreux, Switzerland summits@marcusevanscy.com www.emisummit.com

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

Transport in EE (3 - 4 July) E.E.L Events

5th CFO Summit Emerging Europe & CIS (16 - 17 October) Financial Gates Vienna www.finance-events.de

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