bne magazine August 2013 by Ben Aris

Inside this issue: Lukashenko linked to Belarusian fuel trader Corruption rises across Central Europe Food for thought as Croatia joins EU August 2013 www.bne.eu

Olympic test in the Caucasus Special Report: Invest in Azerbaijan

bne August 2013

Contents

Editor-in-chief: Ben Aris (Moscow)

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COVER STORY 6 The Insiders 8 Europe's west is doomed and its east might not make it

CENTRAL EUROPE 26 Corruption seen rising across Central Europe 27 CEE states the fattest in Europe

12 Perspective 13 Chart of the month

29 A Czech safe haven despite political crisis 31 Shocking cartel penalised in Latvia

EASTERN EUROPE 32 Concrete LNG support

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14 Lukashenko linked to Belarusian fuel trader

33 Hungary kicks off election campaign

17 Russia's privatisation programme sails into stormy waters

35 Poland rules enough consolidation of banks

18 Alfa's evolution from poacher to gamekeeper

36 Poland veers further from austerity

19 A towering business in Russia 21 Russia's WTO accession fails to bring benefits 22 Russia overtakes Germany to become 5th largest economy 23 Russian dirty money flows into CEE and Asia exposed

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bne August 2013

Contents

SOUTHEAST EUROPE

EURASIA

SPECIAL REPORT

A TAP on the shoulder

Xinjiang violence raises alarm bells in Central Asia

AZPROMO nurtures progress through diversity

Bulgaria's protests rumble on and flare

An Olympic challenge in the Caucasus

PASHA, Azerbaijani banks look to the future

Food for thought as Croatia joins EU

Tajikistan moves to reduce risk for lenders

Leasing grows in Azerbaijan

Croatia urged to keep up corruption fight

66 53

Tea for two hundred in Dushanbe

Private equity takes first small steps

Desperate measures in Turkey

67 54

Kazakhstan's car industry moves into the fast lane

IBA offers Islamic banking window into Azerbaijan

Serbian resolve to resist IMF demands stiffens

69 55

Kazakhstan blocks India's Kashagan deal in favour of Chinese

Azerbaijan to increase hydropower generation

Socar has big plans for gas production in the next decade

UPCOMING EVENTS

Mongolian investor heads for final frontier

OPINION 58

Navalny found guilty, but Kremlin got the wrong man

I The Insiders

bne August 2013

Russia's first year in the WTO – what business needs to know Saskia Seeger of White & Case

lmost a year ago, on August 22, 2012, Russia, the sixth largest economy in the world, became the 156th member of the World Trade Organisation (WTO). Those who believed that Russia as a newly acceded member would enjoy some sort of grace period to get used to the system and the rules were soon proved to be wrong. Only three months later, in a meeting of the WTO Council for Trade in Goods in November 2012, the European Union, Japan and the United States formally criticized Russia for maintaining trade barriers that appeared to be inconsistent with its WTO commitments. Similar concerns have been raised at the bilateral level and in other WTO meetings. After less than 11 months of membership, on July 9, the EU filed the first WTO case against Russia over a recycling fee for imported vehicles. Japan requested consultations on the same issue on July 24. The US is said to join the EU and Japan and to equally challenge Russia over this measure. By way of comparison, in China’s case, it took over two years before the US initiated the first WTO dispute against China. The recycling fee was introduced only nine days after Russia acceded to the WTO. The terms of accession obligated Russia to reduce import duties on cars. The fee subjects imported cars, trucks, buses and other motor vehicles to a fee which is determined on the basis of the year of production, weight and other physical characteristics that may affect the disposal costs. Domestic car manufacturers and companies that assemble cars in Russia are exempted from the fee if they commit to establish procedures in order to dispose of a vehicle at the end of its useful life. Exemptions also apply to cars imported from Kazakhstan and Belarus, which form a Customs Union with Russia. No such exemptions apply to cars imported from other countries. Whether the fee is necessary to protect the environment, as Russia claims, or whether it serves to protect the domestic auto industry from foreign competition, as Russia’s trading partners argue, is a question that will be decided by a WTO panel – unless the dispute will be settled through a mutually

agreed solution. Russia has also taken first steps to revise the relevant domestic legislation. If adopted, the recycling fee would be extended to three categories of vehicles currently excluded from its scope: vehicles assembled or manufactured by entities which undertake to safely dispose of them once they are no longer used, vehicles imported from member countries of the Customs Union, and certain vehicles that are placed under the legal regime of the Kaliningrad Special Economic Zone. The recycling fee is just one example of Russia’s trade measures that have been under close scrutiny in the WTO during the first 11 months of Russia’s membership. Russia’s compliance with its WTO obligations was discussed in different WTO committee meetings, including of the Council for Trade in Goods, the Committee on Sanitary

"Whether the fee is necessary to protect the environment, as Russia claims, or it serves to protect its auto industry, as Russia’s trading partners argue, is a question that will be decided by a WTO panel" and Phytosanitary Measures, the Committee on Technical Barriers to Trade, the Committee on Safeguards and the Council for Trade Related Intellectual Property Rights. The US Trade Representative recently published a Report on WTO Enforcement Actions: Russia, which lists the enforcement actions taken by the US in order to ensure Russia’s full compliance with its obligations as a WTO member. Among the measures that have repeatedly been criticized are the bans on imported meat that Russia imposes purportedly

bne August 2013

for reasons of food safety. According to some of its trading partners, these measures are lacking a science-based risk assessment, as required under WTO rules dealing with sanitary and phytosanitary measures, and operate as protectionist tools in violation of Russia’s WTO obligations. Concerns of non-compliance with WTO rules have also been raised with respect to certain technical regulations, such as the Draft Technical Regulation of the Customs Union on alcoholic products safety and certain rules regulating their storage. Over the past year, certain imports into Russia have become subject to trade remedies. Two of the more notable cases are anti-dumping (AD) duties against light commercial vehicles from Germany, Italy and Turkey, and safeguard measures against agricultural combine harvesters. These measures were imposed by the Eurasian Economic Commission (EEC), which is the main regulatory body of the Customs Union between Russia, Kazakhstan and Belarus. WTO rules permit the imposition of AD duties against dumped imports that cause material injury or threat of such injury to domestic procedures of the like product. A WTO member is also entitled to impose safeguard measures (eg. duties and/or quantitative restrictions) when increased imports cause serious injury or threat of serious injury. However, the relevant WTO agreements also impose substantive and procedural obligations on WTO members that seek to impose such measures. Some of Russia’s trading partners have already expressed concerns about the abovementioned trade remedy measures by the EEC. Although no complaint has been filed, trade remedy measures account for a significant portion of WTO disputes. Going forward, Russia may face increased attention to and challenge of any trade remedy proceedings.

according to the official site of the president of Russia, following a meeting with representatives from the industry, Vladimir Putin instructed the government and entrepreneurs’ associations to analyze the WTO consistency of trade barriers preventing access of Russian goods to foreign markets and to prepare suggestions how to overcome such restrictions. He also gave instructions to implement measures that will protect the domestic industry based on other WTO members’ experience. With respect to dispute settlement, Russia has not yet filed its own case, but it is a third party to a number of WTO cases. Among the trade measures that Russia is reportedly considering challenging through WTO dispute settlement are the EU’s alleged subsidies in the context of the EU-Mauritania Fisheries Partnership Agreement. As all these examples demonstrate, Russia, although it is still new to the WTO system, has been treated and acts like longstanding WTO members. From a business point of view, this underlines the need for companies that are engaged in trade with Russia and for Russian companies exporting to other WTO members to be aware of the many obligations and rights that apply to Russia as a WTO member.

Saskia Seeger is senior associate, White & Case LLP

Another area of concern when it comes to Russia’s compliance with WTO rules is trade-related intellectual property rights (IPR). Despite Russia’s continuing efforts to improve its IPR regime, the implementation and enforcement of IPRs has long been a concern of Russia’s trading partners. Consequently, some of Russia’s IPR laws have been subject to review at a meeting of the relevant council in April, at which some WTO members sought clarifications on these laws. Door swings both ways In the first year of WTO membership, Russia has not only been the focus of other members complaints, it has itself used the rights and possibilities under the WTO agreements to question other members’ trade actions. The times where Russia had to accept illegal, trade-restrictive measures in foreign countries, without a right to recourse or complain, are over. Most recently, Russia has formally announced that it would impose additional duties on imports of Ukrainian chocolate, glass products and coal fuel in response to safeguard duties imposed by Ukraine on imported vehicles. In May,

"Among the measures that have repeatedly been criticized are the bans on imported meat that Russia imposes purportedly for reasons of food safety"

I Cover story

bne August 2013

Ben Aris in Moscow

t's not going well. Governments around the world have had six years to make a dent in the huge debts they built up during the 2008 crisis, but in the first half of this year those debt levels have increased and the pace of that growth is accelerating. The West is doomed to default, devaluation or depression unless their leaders can grasp the nettle and do something about the millstone that's hanging around the neck of the world's leading economies. So far they are failing: at the latest G20 meeting held in Moscow at the end of July, the best they could manage was a protocol

calling for “more jobs” and “more stability” in the world. The trouble is they offered almost no details on how to achieve these goals. The outlook for the global economy is uncertain at best, but the emerging markets are the innocent bystanders and increasingly are being dragged into the mire. Two countries – Ukraine and Belarus – are already on the verge of collapse and the three mainstays of the regional economy – Turkey, Poland and Russia – are also in trouble. The best anyone has come up with is to throw money at the problem, which

doesn’t help: In this topsy-turvy world, traders now “buy on the bad news” assuming that poor macroeconomic results – and there have been plenty of those – mean more printing of money by governments, the so-called quantitative easing. The huge amounts of free money sloshing about have inflated a debt bubble on bond markets that was punctured in July when the chairman of the Federal Reserve, Ben Bernanke, said he would wind down the US' largesse, a process now widely expected to start in the autumn. That will force everyone to look at fundamentals again

Cover Story I 9

bne August 2013

and the picture is not pretty. “I am very concerned,” says Liam Halligan, chief economics columnist at the Daily Telegraph, who warned that the euro crisis is back in a recent editorial. “I am expecting things to get worse and volatility to increase over the summer.” The crux of this crisis is that countries around the world bailed out their almost-failing banking sectors by taking much of the commercial bad debt onto national balance sheets, sending debt/ GDP ratios soaring to well over the 60% of GDP maximum stipulated in the Maastricht treaty that governs the euro, and even over the 90% academics say kills growth (although this number is in dispute amongst scholars). The game since has been to reduce debt to “normal” levels, either by spending in the hope of growing your way out of the debt hole or cutting spending. Which model works best has become the centre of a crucial debate that was highlighted at the last International Monetary Fund (IMF) meeting in Tokyo, where an article by the IMF's chief economists, Olivier Blanchard and Daniel Leigh, argued that everyone is miscalculating the “fiscal multipliers.” What this means is that a very delicate balance needs to be struck between spending and austerity: too much spending and your debt rises faster than your ability to pay it back; too much austerity and your economy slows too much, depressing your tax revenues, and again your debt rises faster than your ability to pay it back. The fiscal multiplier is the number that defines this ratio and we are in unchartered waters here, as no one is sure what this number should be. Debt mushrooms At the moment it seems that governments have got the balance wrong. The size of the debt in the 17 countries that use the euro has risen. The debt of Eurozone countries hit 92.2% of their combined GDP at the end of March, up from 90.6% at the end of December, 89.9% at the end of September and 88.2% a year earlier, according to Eurostat. Things are

getting worse, not better: neither the spend-to-grow nor the austerity policies tried by most governments are working. Digging down into the individual country results and the picture becomes even bleaker. “The house of cards of the world economies continues to collapse. The problems of Greece and Cyprus are just the beginning of a global trend. Public debt may soon flatten everything in its path like a huge snowball,” the World Organization of Creditors (WOC) said in an alarming report released in July, which concludes that debt is piling up faster than ever. Out of a total of 27 EU member states, 21 registered an increase in their debt/ GDP ratio at the end of the first quarter of 2013 from the fourth quarter of 2012. The highest ratios of government debt were unsurprisingly found in those countries that started all these

in the economic doldrums. Having suffered the deepest slump since the Great Depression, we’re staging the slowest recovery in our recorded history. On top of that, and despite the 'austerity' rhetoric, our national debt has doubled since 2008 and, on official estimates, will have more than tripled over eight years by 2016,” says Halligan. Across the pond, the US is in similar trouble, although unlike Europe it went for the spend-to-grow model: the US has the largest absolute debt of all the developed markets at $16.7 trillion, well into the red zone at 103% of GDP as of the end of 2012. And despite the mild economic pick-up, the US' debt continues to grow, reaching 104.8% as of the end of March. It's expected to continue growing. The situation for the developed world is clearly unsustainable. The WOC

“I am expecting things to get worse and volatility to increase over the summer" problems: Greece had a debt/GDP ratio of more than twice the recommended level at 160.5%. Ireland saw the biggest increase in its debt in the period, up 7.7% to 125.1%. More worryingly, the debt of core European countries is also rising at an alarming rate. Spain is falling further into trouble with its debt rising 4% in the first quarter to 88.2%, Italy’s debt topped 130.3% and Portugal’s was up by 3.5% to 127.2%, the third highest in Europe. These countries are moving inexorably towards a credit crisis, unless there is a dramatic turnaround in the continent’s economy. Even the UK is floundering, despite the Conservative government's muchpublicised spending cuts: on the face of it, the UK’s 89% debt/GDP ratio is just on the edge of the red zone, but like Spain it saw debt levels jump by 10% over the last year as the economy sinks back into recession. “The UK remains

concludes that most developed markets are living in a “debt bubble” that will eventually burst. “The countries that are pressured by debt can’t find a way to pay their obligations and are being forced to borrow even more money to pay interest on their current loans. For both the majority of developed economies and countries where the debt/GDP ratio exceeds 60-70%, it looks like the point of no return has already been passed,” the WOC says in the report. "Sooner or later they will share the fate of Greece and Cyprus. But in this case, there will be no one to borrow the 'rescue' money from." Indeed, the only major developed market that seems to be coping with the crisis is Germany. The debt/GDP ratio is still high at 83%, but the country saw the growth in its debt slow last year and turned the corner this year, falling by 0.7% – the only major European country to actually reduce its debt in the last six months.

I Cover story

bne August 2013

125%

Emerging Turkey Russia Poland

100%

Advanced US UK

75%

50%

25% Expected debt % rate 0% 2006

2007

2008

2009

At the beginning of July, the IMF cut its latest updates for global growth again. The IMF said that “centrifugal forces” across the Eurozone remain serious and are pulling down growth everywhere with one or two exceptions. The IMF cut its global real GDP growth forecast from 3.3% to 3.1% and its outlook for next year from 4.0% to 3.8%. Europe will largely remain in recession this year, but on the face of it the US and the other Organisation for Economic Co-operation and Developmen (OECD) countries are doing better. However, a paper released by GK Research in June concluded: “This is case of GIGO analysis at its most blatant – as in: garbage in, garbage out... Most leading indicator indices are heavily weighted in components that have been manipulated by central banks,” Charles Gave, the founder of GK Research, argues. Stripping away the three dodgy indicators, the remaining indicators show that things are still getting worse in the OECD countries. “The Fed hopes that by manipulating asset prices, it will convince enough people that the economy has stabilized, thus igniting animal spirits. This is a psychological, mystical view of the economy. Of course, there is the possibility that the Fed is right. But if the economy does not do what the Fed expects, then eventually a lot of people are going to lose a lot of money,” Gave says. Better off but still at risk All these problems are pushing Emerging European countries into the corner. The 2008 crisis showed just how

2010

2011

2012

2013

the developed world’s problems can hurt the new world too. The problem for emerging markets is that their economies are a lot more fragile than those of the West. The stars of the region are the plucky little Baltic states. Estonia has the lowest debt/GDP with 10% and Latvia leads the Eurostat league table in terms of debt reduction: Latvia has a debt/GDP ratio of 40.7% at the end of 2012 and saw its debt fall faster in the first half of the year than anyone else, down by 1.5%. Indeed, most of the Emerging European countries have extremely low debt on the order of 30-40% of GDP. Another way to compare debt levels around the world is to think of the debt in per-capita terms. The outcome is that most developed countries owe the equivalent of a year’s average salary per worker, whereas the leading emerging markets owe only one month’s salary or less. Japan has the highest debt on a percapita basis in the world where the government owes $110,875 for each citizen or about four-times the average annual salary. Ireland has the highest per-capita debt of any country in Europe and its government owes $53,992 per person, or one year’s average income. This is slightly ahead of the US with $53,229, or slightly more than the $51,404 average annual salary, but that has been falling by $1,000 a year since the onset of the crisis. Despite the spend-for-growth policy, the average American is now some $4,000 worse off than he or she was before the crisis

2014

2015

2016

started. Compare this to Russia’s debt of a mere $1,570 per person, which is just twice the average monthly salary. The story is similar if you look at each country's currency reserves. In general, developed countries have leveraged themselves up to the hilt and keep little cash in reserve, whereas emerging markets tend to save heavily. Saudi Arabia is the richest country in the world in terms of the amount of cash it has versus its debt with $627bn in the bank, or 1,749% of its foreign debt. Likewise, China has 200% of its foreign debt in cash and Russia 252%, which are also the first and fourth richest countries in terms of absolute reserves. By contrast Japan, the second richest country in the world in terms of the absolute size of its $1.3 trillion of reserves, can only cover 10% of its debt with cash. Germany can cover 8%, Italy 7% and the US only 3%. Worst behind us? How will this end? Belarus and Ukraine are already teetering on the edge of the abyss. Ukraine has only two and half months of hard currency reserves left, while its budget deficit tripled over the first half of this year. It managed to raise some money with a Eurobond issue earlier this year, but since Bernanke’s announcement about tapering off the Fed's latest round of quantitative easing, yields on its bonds have jumped to over 10% – a price the government is not willing to pay. With a heavy debt repayment schedule coming up, it is

bne August 2013

hard to see how the government is going to manage. “Ukraine has financed itself over the past few years, despite weak fundamentals, because of liquid global markets, but it is unclear how much longer this can continue,” says Timothy Ash of Standard Bank. Ukraine could be Bernanke’s first victim. Belarus is in similarly dire straits. Exports to its main customers in Europe and Russia have collapsed, and the current account deficit jumped to 17% of GDP over the first six months from nothing last year, bleeding the country of reserves. The population is beginning to panic and the central bank was forced to hike money market rates to 40% at the end of July to head off a banking crisis. What has been President Alexander Lukashenko’s response? A massive hike in public wages and pensions to pump up the economy. It was a similar policy that causes the previous crisis in 201011, which led to a 60% devaluation of the Belarusian ruble. On the other hand, some pundits say the worst is passed and that growth will resume in the second half of this year (the IMF’s recent downgrade of global growth notwithstanding). The head of the IMF, Christine Lagarde, told Romanian bankers and journalists at a meeting in July: "Five years after the start of the crisis, the worst is most likely behind you, most countries have returned to positive growth. We expect only two countries of the region to be in recession in 2013 – Croatia and Slovenia – compared to eight last year." It could be that the Fed does successfully trick Americans into being more optimistic and igniting those "animal spirits," allowing the US to grow out of its quagmire. It could also be that after Angela Merkel is re-elected chancellor in September, and Germany steps in to bail out the southern periphery of the Eurozone. However, both these scenarios look unlikely, and in the meantime the forces for a crisis are building up as government debt continues to grow. If the politicians don’t act, eventually the market will.

Cover story

I 11

Selected rating of countries by size of public debt Place in 2012

Place in 2011

Country

Public debt,bn US dollars, 2012

Public debt,bn US dollars, 2011

Change

Debt-to-GDP ratio 2012

USA

16,730.5

15,536.3

107%

Japan

14,148.9

13,476.9

237%

Germany

2,888.7

2,881.5

0.3%

83%

Italy

2,611.2

2,640.7

-1%

126%

France

2,440.0

2,387.9

90%

Great Britain

2,175.1

1,977.4

10%

89%

China

1,770.9

1,886.1

-6%

22%

Canada

1,579.3

1,483.8

88%

Brazil

1,569.7

1,619.0

-3%

64%

Spain

1,267.7

1,032.3

23%

91%

India

1,202.6

1,123.0

68%

Netherlands

547.0

547.6

-0.1%

68%

Mexico

520.3

506.3

43%

Belgium

492.0

502.1

-2%

99%

Greece

462.9

501.3

-8%

171%

Russia

222.9

221.3

11%

… 26

Selected rating of countries by size of international reserves, 2012 Place

Country

Size of international reserves,bn US dollars

Reserve coverage of public debt

China

3,549

200%

Japan

1,351

10%

Saudi Arabia

626.8

1749%

Russia

561.1

252%

USA

537.267

Taiwan

391

195%

Brazil

371.1

24%

Switzerland

330.585

114%

Republic of Korea

319.2

82%

Hong Kong

299.6

348%

India

287.2

24%

Singapore

253.3

88%

Germany

234.104

Algeria

190.5

1078%

Italy

173.3

Source: World Organization of Creditors, IMF, CIA

“The Fed hopes that by manipulating asset prices, it will convince people the economy has stabilized – this is a psychological, mystical view of the economy"

I Perspective

Emerging markets take lead in FDI Ben Aris in Moscow

or the first time, emerging markets took in more foreign direct investment (FDI) than developed markets in 2012, according to a new report from the United Nations Conference on Trade and Development, or UNCTAD. “Global FDI declined in 2012, mainly due to continued macroeconomic fragility and policy uncertainty for investors, and it is forecast to rise only moderately over the next two years,” Ban Ki-moon, secretary-general of the UN, said in the preamble of the World Investment Report. “In 2012 – for the first time ever – developing economies absorbed more FDI than developed countries," he noted. FDI is the holy grail of investment, as it brings not just cash but skills, best practices and technology that can be far more valuable to an up-and-coming economy. And emerging markets are starting to take over. The UN head noted that, "four developing economies ranked among the five largest recipients in the world. Developing countries also generated almost one third of global FDI outflows, continuing an upward trend that looks set to continue.” Obviously last year was a bad one everywhere for investment. A "phantom" crisis in Europe – nothing actually happened, but governments and companies reacted as if the Eurozone had collapsed – killed confidence and led most to put investment plans on hold. Global FDI fell by 18% to $1.35 trillion, dropping to a level last seen in 2009, says UNCTAD. The hope is that the trough has been passed and recovery will take hold in the second half of this year. “UNCTAD forecasts FDI in 2013 to remain close to the 2012 level, with an upper range of $1.45 trillion. As investors regain confidence in the medium term, flows are expected to reach levels of $1.6 trillion in 2014 and $1.8 trillion in 2015. However, significant risks to this growth scenario remain,” the report says. Still, the situation is not as bad in the fast growing emerging markets, which accounted for just over half of all FDI inflows, compared with the 42% taken in by developed markets. Overall, FDI inflows to developing markets were only slightly down in 2012 from the year before, while some markets, like Africa and labour-intensive economies in Asia like Vietnam, bucked the trend and saw increases. Meanwhile, investment into developed economies plummeted 32% to $561bn – a level last seen almost 10 years ago.

bne August 2013

Moreover, the developing markets are themselves taking on a greater role. As their best companies start to move out into the rest of the world, the first true emerging market multinationals are starting to appear. “The BRICS countries (Brazil, the Russian Federation, India, China and South Africa) continued to be the leading sources of FDI among emerging investor countries. Flows from these five economies rose from $7bn in 2000 to $145bn in 2012, accounting for 10% of the world total. Their transnational companies are becoming increasingly active, including in Africa. In the ranks of top investors, China moved up from the sixth to the third largest investor in 2012, after the United States and Japan,” the report notes. Big three In the region of the former Soviet Union, the big three of Russia, Ukraine and Kazakhstan accounted for 84% of all FDI inflows. The fate and health of these countries are increasingly determining that of the entire region. As a "transitional" country between emerging and developed – last week the World Bank upgraded it to a “high-income” country – Russia took in $51bn from a total of $87bn invested into that category, according to UNCTAD – 9% down from the year before. However, the numbers are confusing, as much Russian "FDI" is “round tripping” and should be counted as domestic investment. A recent report from the Eurasian Development Bank found that in 2012 the volume of “loans” to Cypriot companies from Russian companies exactly equalled the volume of FDI by Cypriot companies into Russian companies. That only increases the chasm between the volume of FDI into Russia and that going into Asia. Although Asian FDI dropped 7% in 2012, it still hit over $407bn. Investors are missing out. Russia may be one of the least popular investment destinations in the world, but it remains one of the world’s most profitable destinations. Between 20062011 the global average return on FDI was 7% for emerging markets (and 5% for developed markets). Last year the average rate of return in Russia was 13%. The only markets from the former Soviet bloc to do better were the Czech Republic (13%), Kazakhstan (26%) and Kyrgyzstan (41%). Kazakhstan had a good year: FDI inflows rose by 1% to reach $14bn – the second highest level ever recorded – thanks to its vast natural resources and high economic growth. In addition to the extractive industries, which accounted for almost one-fifth of inflows, financial services attracted a further 12%. Surprisingly, despite the rapidly failing health of the economy and the turbulent politics, Ukraine also managed to attract a record $8bn in FDI in 2012, although almost all of it came from Cyprus. Like Russia, it seems regional investors have a lot more faith in the country's long-term development than foreigners.

Perspective I 13

bne August 2013

CEE most vulnerable to global EM funding drop

CHART:

foreign reserves, the more vulnerable it is to a change in the extraordinarily loose monetary conditions currently prevailing worldwide."

ith the stall in the emerging market bond and currency rallies, it's those countries with the highest economic imbalances that are most at risk. That puts Central and Eastern European states on the frontline, according to a report from Standard & Poor's. As international capital flows into emerging markets become less plentiful and in some instances reverse â&#x20AC;&#x201C; at least intermittently â&#x20AC;&#x201C; on the back of suggestions from the US Federal Reserve and others that the huge volumes of liquidity will soon be wound in, it is clearly those countries that are struggling most with funding gaps. As the rating agency puts it: "the larger an economy's dependence on external funding is compared to its own stock of and capacity to generate

As this month's charts show, CEE sovereigns dominate the top 10 in terms of high debt levels and high current account deficits. The capacity of their reserves to act as a backstop to those twin peaks of imbalance is therefore under question. The two that stand out are Ukraine and Turkey. Should the rise in US Treasuries yields spark a real reversal of available funding, they look most at risk. That means extra pressure on Kyiv to finally agree a deal with either Moscow or the International Monetary Fund (IMF).

Emerging Market Sovereigns Ranking By Gross External Financing Needs/Current Account Receipts + Usable Foreign Exchange Reserves (Average Over 2012-2013e) Ranking

Sovereign

Foreign currency rating*

Ratio (%)

Ukraine

B/Negative/B

140

Turkey

BB+/Stable/B

133

Belarus

B-/Positive/B

124

Georgia

BB-/Stable/B

122

Bulgaria

BBB/Stable/A-2

118

Macedonia

BB-/Stable/B

118

Ghana

B/Stable/B

112

Croatia

BB+/Stable/B

109

Tunisia

BB-/Negative/B

109

South Africa

BBB/Negative/A-2

109

Emerging Market Sovereigns Ranking By External Short-Term Debt By Remaining Maturity/Usable Foreign Exchange Reserves (For 2012) Ranking

Change in position*

Sovereign

Ratio (%)

(2)

Belarus

272

Ukraine

261

(3)

Macedonia

185

(1)

Bulgaria

173

Georgia

154

Turkey

143

(4)

Hungary

119

Croatia

119

(9)

Kazakhstan

110

(2)

Chile

*Compared with table 1. A positive number indicates a higher ranking (lower vulnerability), a negative number indicates a lower ranking (higher vulnerability).

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bne August 2013

Lukashenko linked to Belarusian fuel trader Graham Stack in Minsk

leaked database of British Virgin Islands (BVI) companies links President Alexander Lukashenko to one of the largest private fortunes in Belarus, that of the shadowy oil trader Nikolai Vorobei. Belarus' state-dominated economy is not "offshore" like Russia and Ukraine â&#x20AC;&#x201C; because it remains mostly stateowned. Thus the database, which was leaked to the International Consortium of Investigative Journalists amidst no little publicity, contains only 19 with Belarus addresses. Further, only one comes with a director's name attached, but those scant details suffice to link Lukashenko to Vorobei.

The telltale BVI offshore is Interforest Corp, registered in 1998 under director Alexander Metla at a Minsk address. bne spoke to residents at V.Horyzhej 16, who confirmed that the man in question is Alexander Mikhailovich Metla, the well-known head of the Pamyat' Afgana charity for Afghan veterans. bne contacted Metla directly, who acknowledged that the company had been registered under his address. Metla said however that he knew nothing about the firm and that his name and address had obviously been used by a third party without his knowledge.

Good neighbours However, Metla apparently fronted for Belarus officials in one prominent case shortly after the BVI company was established. In 1998, when Interforest Corp was set up, no one had heard of Metla, but he made his public debut just a year later in a court case pitting the country's top policeman against an investigative journalist: a libel suit brought by Viktor Sheiman â&#x20AC;&#x201C; the feared interior minister and secretary of the national security council â&#x20AC;&#x201C; against journalist Sergei Anisko. Anisko had written an article describing what he said was a country residence being built by Sheiman at his parents' dacha in Podlipki, west of Minsk.

Eastern Europe I 15

bne August 2013

In the hearings, Metla testified that the sprawling new property under construction adjacent to Sheiman's parents' dacha belonged to him. As a result the judge awarded crippling damages against Anisko and the newspaper that published his piece. During the proceedings, however, it transpired that Metla had served sideby-side with Sheiman in Soviet Army operations in Afghanistan in the 1980s, and the pair were close friends. Sheiman was head of the Belarus police, Metla a humble deputy director of a no-name firm. The huge new property was next door to Sheiman's parents' house but on paper Metla indeed owned the mansion. “Metla was and is Sheiman's man, not an independent player,” Anisko claims to bne. Metla did not comment on the case. Metla's subsequent career points to the same. Working in Sheiman's shadow, he has achieved prominence as director of Pamyat Afghana. Founded 2002, the charity boasts Sheiman as a member of the supervisory board. It is also personally patronised by Lukashenko and enjoys generous tax benefits. Ironically for the director of a BVI company – and unusually, even in proudly pro-Soviet Belarus – Metla is an openly avid fan of Stalin. He even founded "The Stalin Line" theme park, which recreates a World War II battleground in Belarus. However, the links between Stalinist military glory and offshore practices may not be so incongruous in reality as they appear. Afghan veterans and Belarusian importexport operations were closely linked in the 1990s, when the state supported veterans' associations with excise tax exemptions, making them an important commercial channel, according to Anisko. Joining the dots Metla's apparent fronting for Sheiman highlights the relationship between the Lukashenko regime and Belarus' shadowy, but lucrative, private sector. Interforest Corp is linked to a prominent timber firm: Joint Venture Interforest, based in Novopolotsk in the north of Belarus, and founded in 1999, according

to the Belaspravka online register. Under Belarusian legislation, as a joint venture, it must have a foreign shareholder. The company told bne that it has an investor from “Western Europe”, but declined to name either the investor or the country of origin. Metla's Interforest Corp was founded just one year before the Belarusian Interforest JV, suggesting the BVI offshore may have played the role of "foreign investor". The leaked BVI data are valid up to 2010. Metla denied any connection to the Belarus JV 'Interforest'. Belarus does not have a publicly accessible register of company ownership, but according to the Orbis Business intelligence database, the Belarus shareholder in JV Interforest is OOO Avtoimport, also based in Novopolotsk. The database does not contain information on the foreign shareholders. OOO Avtoimport is a car importer established in the 1990s by powerful Novopolotsk businessman Nikolai Vorobei, one of Belarus' richest men. Vorobei's core business since the 1990s is oil and fuel trading via OOO Interservis. His home town is situated on the crucial Druzhba oil pipeline – the mainline carrying Russian crude into Europe. Novopolotsk also hosts the flagship

state-owned refinery has fuelled much speculation over the years. Vorobei, of whom no photos exist and who has never given an interview, did not respond to attempts to contact him. He is clearly connected to the very upper echelons of power however. In 2012, Interservis business practices even prompted a bust-up with Russia. Within the remit of forming the Customs Union – which now groups Belarus, Russia and Kazakhstan under free trade rules – starting in 2010, Belarus was granted the right to import Russian crude for its refineries free of export duties. However, should the resulting oil products be subsequently exported outside the Customs Union, the traders are required to stump up the bypassed levies to the Russian budget. Belarusian exports of oil-based solvents and diluents – which do not trigger the export duty payments – promptly soared tenfold or so in 2011-2012 – with Interservis the main exporter, according to media reports. Russia is crying foul, alleging false classification of exports. “We suspect that this product is a fraud: I cannot rule out that oil products are being exported under the cover of diluents,” Russia's tax tsar Sergei Shatalov said last year. In April, Russia's

"Metla's apparent fronting for Sheiman highlights the relationship between the Lukashenko regime and Belarus' shadowy, but lucrative, private sector" state-owned Polymir refinery, part of the giant state-owned Belneftekhim petrochemicals holding. Interservis has been one of Belarus' two largest private fuel traders since for a large part of the last two decades, according to media reports. The relationship between the company's private oil product trading and the

ambassador in Belarus said that the scheme had finally been wound up, with losses to the Russian budget estimated at around $1.5bn. Despite Russia's huge leverage over Belarus, Moscow's protests over its practices have done little to stem the rapid expansion of Interservis. In 2012, the company privatised Belarus'

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bne August 2013

largest bitumen producer, launched construction of a new $270m oil refinery in Novopolotsk, and in January this year bought a controlling stake in Amkodor, Belarus' leading producer of road-building equipment. Such frenzied M&A makes Interservis the “fastest

– appointed head of the President's Property Administration (in other words in control of all state assets) earlier this year – in turn is Lukashenko's trusted henchman of twenty years' standing. The BVI connection to Vorobei's business in the 1990s - during Sheiman's five year stint as

"Such frenzied M&A makes Interservis the fastest expanding holding in Belarus” expanding holding in Belarus”, claims Yaroslav Romanchuk, head of the Mises research center and an opposition presidential candidate in 2010. He estimates Vorobei to be the country's fifth richest man with assets worth over $2.5bn. All the president's men The pyramid climbs higher then. While Metla is Sheiman's sidekick, Sheiman

interior minister – suggests Sheiman acted as "krysha" (directly translated as "roof", but meaning a protector from the law and other predators) to Belarus' shadowy but lucrative private export-import business. Sheiman's loyalty to Lukashenko suggests that he in turn may have been acting in the name of the president.

entourage. Opposition activists allege he was responsible for the disappearance – presumed murder – of a number of leading opposition politicians in 1999, mostly notably former interior minister Yury Zakarenko. Leaked US diplomatic dispatches – calling Sheiman an "odious" figure, and also linking him to the disappearances in 1999 – quote sources that put his personal wealth at $397m in 2006. Sheiman, like many top Lukashenko officials is banned from travelling to the EU or USA. The Metla-Sheiman-Lukashenko link could for the first time offer a glimpse of documentation of the Lukashenko regime's involvement in Belarus' shadowy private sector. “Lukashenko has always been very careful never to leave any paper trail regarding property and money flows,” says Romanchuk, “it has never been possible to prove anything.”

Sheiman is generally regarded as the "enforcer" among Lukashenko's

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What you need to know

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bne August 2013

Eastern Europe

I 17

The stake is currently valued at around RUB10bn ($300m), according to a recent Economic Development Ministry assessment. Which way is up? The about turn from the order to list in Moscow is confusing, but there are several reasons why Sovkomflot, a company with global reach and one of the better state assets under the privatisation gavel, might have decided to head to New York.

Russia's privatisation programme sails into stormy waters Ben Aris in Moscow

ussia's privatisation programme fell into further disarray on July 9 as shipping giant Sovcomflot announced it plans to float a 25% stake on the New York Stock Exchange later this year. The decision to launch its IPO in the US comes just months after President Vladimir Putin ordered that all of Russia’s privatisations would now be held on the domestic Moscow Exchange. VTB Bank dutifully raised $3.3bn in April with the sale of a 10% stake, but few have joined it. The announcement on the Sovcomflot is just the latest setback for the privatisation programme. The state partially admitted defeat earlier this month by officially scaling back this year’s revenue target. However, most of the programme targets announced since it was re-launched in 2009 have been little more than pie in the sky. Sovcomflot’s decision to head to the US followed an agreement between

management and IPO organizer, Deutsche Bank. It has already been approved by First Deputy Prime Minister Igor Shuvalov and the Federal Property Management Agency, an

The VTB SPO in Moscow was successful – but only just, with sovereign wealth funds from Qatar, Norway and Azerbaijan buying the bulk of the offer. In an interview with bne, CFO Herbert Moos called the sale of such a large amount of shares to foreign investors a bureaucratic minefield adding that several legislative changes had been necessary to allow it to happen. VTB comes with its own in-house investment banking division, which can take care of a lot of the paperwork itself; perhaps the obstacles to listing in Russia were just too daunting for Sovkomflot. The second issue is the shallowness of the domestic market - there are simply not enough potential buyers. That's

"Most shipping companies' stocks are traded in New York, where the demand for such securities is the highest" unnamed source close to Sovcomflot's management told Russian daily Vedomosti. "Most shipping companies' stocks are traded in New York [Stock Exchange], where the demand for such securities is the highest," the source told the paper. However, in an attempt to save face, the source added that the decision is “not final” and that there is a “good chance” that the IPO will at least partially be held on the Moscow Exchange as well.

why VTB did not concentrate on selling its shares to domestic institutional investors, or Russians planning for their old age, but instead launched the bulk via what was essentially a private placement to three very large investors. Not every privatisation can line up this sort of investor, but Russian retail and institutional investors simply don’t exist in sufficient numbers. Experts have been dubious from the start over Putin’s plan to keep the

I Eastern Europe

Alfa's evolution from poacher to gamekeeper

bne The M&A arm of Russia's Alfa Group won a landmark victory on July 17, after a court in Kazan decided that a state-of-the-art logistics park in the autonomous republic of Tatarstan owed $60m to its former owner, thus effectively returning control of the asset to the Irish government. It is the first time that a Russian entity has acted on the behalf of a foreign government to recover assets in Russia. A1 is the special situations vehicle of Alfa Group (formerly known as Alfa Ekho) that specialises in recovering distressed assets. In April, A1 went into a joint venture with the Irish Bank Resolution Corporation (IBRC), which has been trying, so far unsuccessfully, to recover 12 assets that used to belong to Ireland’s now-defunct Quinn Group. Sean Quinn, the founder of the group, defaulted on loans worth ¤2.8bn from the Anglo Irish Bank, which went bust and its assets were taken over by the state-owned IBRC, which has been trying to convert them back into cash. However, parties believed to be associated with Quinn transferred the ownership of the assets to various shell companies, putting them out of the reach of IBRC, which turned to Alfa Group for help. The court in Kazan ruled that Q-Park, a state-of-the-art logistics park that was set up by Quinn in Kazan, owes its former owner Demesne (and a subsidiary called Logistika) $60m in debt from its construction and other funds. The ruling means that A1 can now appoint its own receiver over the park and start the process of preparing it for sale. Most importantly, A1 will get effective control over the park’s cash flows even while the appeals – if any – are held, the crucial point in any Russian dispute over assets. A1 said in a statement: “It later turned out that on May 11, 2011 the shares of ZAO "Logistica" have been sold to Sean Quinn, Jr.; on June 3, 2011 shares were resold to ZAO "Vneshkonsalt" and in fall of 2011 – sold to two Panama companies – Forvar Overseas S.A. and Lockerbie Investments S.A. These acts were allegedly committed in order to eliminate the [IBRC] from the corporate control of ZAO "Logistica" and foreclosure on the assets of ZAO "Logistica".” Two shell companies – Vneshkonsalt and another creditor to many of the disputed assets, Stroitelnie Tekhnologii — are names that have come up again and again according to A1, as the owners of almost all of the disputed assets, including Q-Park. All in all, IBRC and A1 are trying to recover 12 assets in Eastern Europe (11 in Russia and the Ukraina shopping mall in Kyiv) collectively worth some $500m.

bne August 2013

listings in Russia, despite the progress made in reforming the domestic capital markets. The government now seems to be waking up to that reality. Moscow started the year with a plan to raise RUB300bn ($10bn) from privatisation, but upped the ante on April 3 when it added another RUB800bn worth of names to the list. However, the size of the challenge became rapidly clear. By April 30, Economic Development Minister Andrei Belousov was saying he expected no more than RUB320bn. Yet even going back to that original target looked ambitious. By June, the State Property Agency had slashed its forecast to just RUB60bn. Its targets for the coming years were also pared severely. For 2014, the target is now just RUB180bn ($5.5bn), down from RUB350bn, with similar cuts for 2015 and 2016. The fact that in just three months the plan has gone from selling RUB300bn to RUB1.1 trillion to RUB60bn (and even that is in question) on top of the abandonment of Putin's plan to push all the listings onto the domestic market make the privatisation programme look like it is in total disarray.

bne August 2013

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I 19

A towering business in Russia INTERVIEW:

bne

ussian mobile phone operators just launched their first 4G networks and the biggest cities should be covered by the end of this year. The change-up to better technology has opened a new world of opportunity for Russia Towers, the country’s first, and to date only, independent company leasing out mobile phone base stations to what are now the biggest operators in Europe. Peter Owen Edmunds is one of the pioneers of Russian telecommunications. After leaving the British Army’s Welsh Guards he moved to St Petersburg, where he was one of the founding partners in PeterStar, the first commercial fixed overlay network operator set up in 1992 , which blazed the trail for foreign investors into the new Russian market.

by sharing towers than it does to add new networks where one already exists. Putting up telecom towers is capital intensive with a long-term pay back – a difficult proposition in Russia, which is plagued by crises and the lack of long-term money. Before Russia Towers could go into operation, the two men had to first get the mobile phone operators to agree to lease them and at the same time get investors to promise the millions it would take to build the towers. “It was all a bit crazy, as the operators didn’t want to sign off on the leasing contracts until the money

Leading Russian fund UFG Asset Managers was the driving force behind raising the $40m in the first round of financing and helped persuade institutional investors like the European Bank for Reconstruction and Development (EBRD) and some private individuals to commit to the project. Russia Towers has grown fast and has since signed up all the dominant players – Megafon, Vimpelcom and MTS – on the Russian mobile phone market. It had a second round of fund raising in 2012 where Macquarie, ADM Capital out of Hong Kong and Japan’s Sumitomo, as

“People here are starting to understand that they don’t need their own towers”

Those were the days of wildcat banking and “breakfast bombs”, but PeterStar was a success and eventually sold to Russian major mobile phone operator MegaFon in 2002. Owen even got to know Russian President Vladimir Putin well, who was the deputy mayor of St Petersburg at the time.

was in place, but the investors weren’t keen to promise the money until leasing agreements were in place,” says Owen Edmunds, whose bearing still betrays his military background.

At a loose end, Owen dreamed up the idea of Russia Towers with his partner of many years, US entrepreneur Garth Self, and set the company up in 2009. Mobile phone companies need base stations to send out their signals. But once the competing networks all cover the same ground, the rationale for owning these towers changes: it makes more sense for rival firms to cut costs

Swedish telecom operator Tele2, which was recently bought by VTB, broke the ice and agreed to a deal for 55 towers that released investment. On its way to becoming Russia’s fourth big mobile phone operator, Tele2 also had the least developed tower network and the company was keen to defray its operating costs by leasing towers rather than building them itself.

well as UFG and EBRD again, put in another $100m. “We are not reinventing the wheel here,” says Owen, referring to the fact that most developed markets have seen tower operators appear after the initial networks have been put in place. “People here are starting to understand that they don’t need their own towers,” says Owen. “Today the mobile phone companies are no longer competing in terms of coverage as they were in the early days, but in terms of services and data. Russia is already as covered [by mobile phone networks] as it needs to be.”

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bne August 2013

Leasing towers helps mobile operators' balance sheets, as the cost of building and maintaining towers is transformed from a capital expenditure item that needs to be financed to an operating cost that can be paid out of revenues, which is attractive for publicly listed companies. Russia Towers offers a deal that effectively finances the towers over 15 years, so that instead of paying RUB6m ($194,000) to put up a tower, the customer can choose to lease a tower for RUB48,000 ($1548) per month instead.

on trains. And as Russia has begun to invest heavily in building high-speed rail links between a dozen major cities ahead of hosting the World Cup in 2018, demand for mobile coverage along rail routes has increased. “We can get the land, access to electricity, install our monitoring system and manage these sites better than the mobile phone companies,” says Owen. “Russian Railways likes it too as they only have to deal with one customer which makes the process of organising the towers simpler.”

Still, it is early days for the business. By the end of this year, Owen Edmunds says Russia Towers will have some 800 towers up and running, against the 24,000 that the mobile operators own and run for themselves. At some point it will make sense for Russian Towers to buy all these towers, and Owen says that just how far this process goes varies from country to country. “Owning

Currently, Russia Towers has concentrated on building out-of-town stand-alone towers, as Russia’s big three operators did most of the inner city roof-top deals in the first stage of development. However, Russia is just starting to issue its first 4G licences, which means even the inner city mobile networks will have to be completely rebuilt. “The 4G technology needs new base stations that are much more densely packed in a city. But they don’t need to be as high, so you can make use of things like street furniture like lampposts,” says Owen.

“Owning towers used to be seen a strategic asset in Russia" towers used to be seen as strategic asset in Russia and usually the operators were reluctant to give up control over all their towers. It depends on where you are. However, at the moment all the operators are thinking about it,“ says Owen Edmunds. Building and maintaining towers is a chore that doesn’t sit well with mobile phone operators as they transform themselves into pure service companies. It involves buying thousands of tiny plots of land in the countryside or renting rooftop space with the owners of buildings in a city – both of which are tedious and laborious tasks in Russia. One of Russia Towers' competitive advantages is its tie-up with Russian Railways that gives it access to land right across the country, and mobile phone services along rail tracks is in high demand, because there are lots of people that want to use their phones

Under the terms of the licences all three of the big operators, as well as fixed-line operator Rostelecom, met the deadline to launch 4G networks by June 1. Both MTS and Vimpelcom, which operates under the Beeline brand, launched their first 4G networks in the centre of Moscow, while MegaFon launched its network in Yekaterinburg and Rostelecom in Sochi. Vimpelcom’s Vice President Igor Parfyonov said at the end of May it would cover all districts in Moscow by the end of the year and will also launch 4G in six other Russian regions highlighting the central role Russia’s regions play for the mobile operators. The remaining issue to be resolved is making more of the 800 MHz frequency available, currently used by the military, to allow for full rollout of 4G in Russia, but the changeover has already created a new opportunity for a company like Russia Towers to expand rapidly and move into all of Russia’s main cities.

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Down on the farm The one area where the WTO accession is regarded as having a significant impact is in the agricultural sector â&#x20AC;&#x201C; and that was extremely negative. Russia is phasing in the compliance to the WTO rules over eight years, with the most vulnerable sectors, like automotive, required to meet the new rules last. But with agriculture all the restrictions were dropped from day one.

Russia's WTO accession fails to bring benefits bne

"WTO entry has to some degree exposed a lack of price competiveness and a dependence on state support. The pork industry in particular has felt the impact of a reduction in in-quota tariffs to zero by some Russian companies," says Global Counsel. These problems are already causing a backlash in the Duma where companies are lobbying for some more protection, or at least compensation.

t took Russia 18 years to get into the World Trade Organization, but as the one-year anniversary approaches most Russian businesses are asking why the government bothered. None of them report any economic benefits, while several important sectors are actually a lot worse off. And if anything, the simpler trade rules have actually made Russia's relations with the rest of the world worse, not better.

after three to five years, but the full impact could take much of this decade to emerge."

That is the conclusion of several surveys and reports issued ahead of the anniversary of Russia's accession to the global trade club on August 22. At the time, Russia's membership was hailed as a real step forward in modernising the Russian economy and a badly needed goad that would force the Kremlin to press on with reforming and diversifying the economy. However, it seems that the benefits, if any, will arrive much further down the road.

"The majority of Russian businesses have felt little or no change following Russian accession to the WTO in 2012"

"The majority of Russian businesses have felt little or no change following Russian accession to the WTO in 2012," Global Counsel, a consultancy belonging to Peter Mandelson, a former British politician and EU commissioner for trade, said in a report released at the St Petersburg International Economic Forum on June 20-22. "The Russian authorities expect that the impact of new competition will begin to be felt

In the spring, the Strategy Partners Group (part of state-owned banking giant Sberbank) surveyed 2,000 owners and top managers of Russian companies with annual turnover of more than $100m. More than half of them said

they had expected a positive impact of WTO accession on the Russian economy immediately following accession, but now more than 50% think that there has been no impact at all, with 32% thinking that the impact was negative. These findings were mirrored in a separate survey conducted by the Association of European Business, although with the caveat that these foreign businessmen, as opposed to their Russian peers, remain optimistic about the benefits from the club's membership in the medium term: two-thirds of the AEB's members report no change in their business from the WTO accession.

Opposition lawmakers from the Just Russia party (that voted against WTO accession) claimed at a panel discussion held on June 20, which was attended by groups lobbying on behalf of engineering, agriculture and clothing industries, that Russia has lost "billions of dollars" due the cut in import tariffs and lost business for domestic companies.

"The WTO is bringing us into an [economic] depression," Konstantin Babkin, head of harvester producer Rostselmash, was quoted by the Moscow Times as saying during an emotional speech, adding that his industry is amongst the hardest hit by the lower tariffs which have opened Russia up to cheaper imports; milk imports alone have grown 17% in the last year, making Russia the biggest fresh milk market in Europe. Babkin has threatened to challenge the accession in the constitutional court on the grounds that Russia still doesn't have a representative office at the WTO headquarters. However, the

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bne August 2013

Russia overtakes Germany to become world’s fifth largest economy

bne Russia passed an important milestone on July 15 overtaking Germany to become the biggest economy in Europe in terms of purchasing power parity and the fifth biggest in the world. This achievement comes on top of the World Bank’s decision a week earlier to upgrade Russia from a ‘middle-income’ to a ‘high income’ country after gross national income per capita passed the $12,616 threshold. Russia is now the only one of the five BRICS nations – Brazil, Russia, India, China, South Africa – that is a high-income country and definitively no longer an emerging market. Indeed, Russia has not been an emerging market for several years already according to the UN Development Programme (UNDP) rankings. The World Bank's new GDP rating published in July ranks the United States as the world's largest economy by purchasing power parity last year with $15.7 trillion, followed by China with $12.5 trillion, India with $4.8 trillion, and Japan with $4.5 trillion. Russia overtook Germany last year to rank fifth with $3.4 trillion, versus Germany's $3.3 trillion. In 2011, Russia's GDP based on purchasing power parity totalled $3.203 trillion, compared with Germany's $3.227 trillion. While most commentators focus on China’s astronomical GDP growth rates where Russia does poorly in comparison – Russia’s economy grew by a mere 1.6% over the first quarter of this year whereas China’s economy expanded by over 7% – this ignores the differences between the two leading emerging markets: while Russia is a high income country, China has only recently moved into the middle-income bracket.

Kremlin have ignored their complaints and is very unlikely to reverse the WTO accession, which was personally championed by Russian President Vladimir Putin.

On the other side of the coin, Russian producers have not taken advantage of the opportunities that they now enjoy from the nominally freer trade with the rest of the world.

Even so, the Kremlin itself is in hot water with the EU by imposing administrative barriers on the more sensitive sectors. The EU has threatened to sue Russia after it imposed an auto recycling fee on foreign, but not domestic, car makers in an effort to protect its domestic manufacturers.

Moreover, several commentators say there is a serious lack of Russian lawyers that are au fait with WTO rules and Russia has not brought a single case in the WTO to protect the interests of its own manufacturers in other markets. "Many Russian businesses do not fully understand the

implications and potential benefits of WTO membership in terms of a more level global competitive playing field. This has often encouraged a defensive position in which WTO entry is seen as something for which industry must be compensated with domestic protection or subsidy. In some cases, the Russian government seems to see the problem the same way," says Global Counsel. "Both in government and in the private sector, the first year of Russian WTO membership has highlighted a clear shortage of qualified experts on WTO law and procedures." Wider problems The WTO accession has been a disappointment, but some analysts say that the problems are symptomatic of a more general reduction in Russia's competitiveness in the global market place, which has caused the economy to slow even more dramatically than was expected at the start of this year. "The WTO accession has done little good to the economy so far. Instead, Russia has to spend more resources protecting the uncompetitive sectors of the domestic economy than it benefits from through its exporters having access to international ones. Coupled with the cooling off of the commodity markets these factors suggest that no breakthrough can be expected over the next year, at least," say analysts at Russian investment bank Uralsib. Still, the majority of commentators still believe that the WTO accession was an important step for Russia and that over the longer term the increased competition will benefit the country and its economy. The point of increasing the competition is that domestic firms will have to work harder and more efficiently to stay in front, but for this to work they actually have to make the effort. At the moment most companies and several elements in government are still hiding behind protective barriers, looking backwards at the loss of their easy life, rather than looking forward to the benefits that easier access to bigger markets will bring.

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concentration of efforts by law enforcement agencies, I think it is possible to find these people." Later, addressing the State Duma, Ignatiev detailed the workings of this platform, which he said accounted for $25bn of the total illegal capital export last year. The cash was transferred to foreign bank accounts as payment on bogus imports from Belarus ($15bn) and Kazakhstan ($10bn), fellow members of the Customs Union - the funds likely the fruits of tax evasion, drugs and bribery. In June, there were reports of a criminal investigation into All-Russian Regional Development Bank for illegal transfers of nearly $1bn in 2011-12, the payments apparently made for fictive imports from Belarus. Intriguingly, the bank is controlled by state-owned oil giant Rosneft.

Russian dirty money flows into CEE and Asia exposed Graham Stack in Kyiv

he head of Russia's central bank said earlier this year that billions left the country illegally in 2012. However, bne can reveal that the National Bank of Belarus is claiming huge amounts of dirty money have been flowing out of Russia to be laundered in banks across Asia and CEE in a scheme existing since 2009. Sergei Ignatiev, the former governor of the Central Bank of Russia (CBR) revealed in February â&#x20AC;&#x201C; towards the end of his 12-year tenure â&#x20AC;&#x201C; that $50bn had been illegally moved out of Russia in 2012. Shell companies, he said, routed the money as payment for bogus import contracts.

Indeed, half of this sum, the CBR chief said, was the work of one interconnected "platform" of companies, apparently set up by a single group of money launderers. "You get the impression that they

According to the letter circulated by National Bank of Belarus (NBR) and seen by bne, the scam actually started as early as 2009 â&#x20AC;&#x201C; a year before the Customs Union between Russia, Belarus and Kazakhstan was launched. The first countermeasures were attempted in 2010, according to the NBR, and letters issued by the Russian Central Bank in 2010 and 2011 on procedures for verifying Belarus exporters confirm concern on the Russian side at the time. However, Ignatiev's comments suggest Russian law-enforcement took little or no actual action to halt the illegal capital export, which points to the scheme being protected from somewhere on high. Unsurprisingly, the NBR letter insists that the scheme in no way actually

"You get the impression that they are all controlled by one well organized group of people" are all controlled by one well organized group of people," Ignatiev said, in an interview with business daily Vedomosti. "With a serious

involved Belarus. Rather, it says, the money launderers set up Belarusian shell companies solely for the purpose of issuing waybills for goods purportedly

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shipped to Russia. They then present these papers on behalf of Russian shell companies to Russian banks in order to wire funds in payment. Crucially, the Belarus firms have bank accounts not in Belarus but in jurisdictions from where the money can percolate into the international financial system. According to the NBR letter, real Belarus firms in fact require special individual permission from the NBR to open foreign bank accounts, and thus Belarus cannot be blamed for the scheme. Hence, according to the NBR's argument, it is a purely Russian affair, and none of the funds actually passed through Belarus. Usual suspects According to the NBR letter, the foreign banks through which the illegal funds

"Hong Kong and Turkey have no Soviet links and may point to new channels being developed" flowed out of Russia were located in Cyprus, Latvia, Estonia, Kyrgyzstan, Hong Kong and Turkey. That again appears to confirm the central role of Cyprus for laundering Russian money, an issue flagged by Brussels this year by its controversial bailout terms for the island's secretive and swollen banking sector. That resulted in a severe haircut for all depositors with over â&#x201A;Ź100,000 in their accounts. According to a leaked May 2013 audit of 390 customers at the six Cypriot banks by Deloitte and the European Council's anti-money laundering watchdog MONEYVAL, "systematic deficiencies in the implementation of preventive measures" and a "cumulative level of inherent risk beyond a level that is capable of being effectively mitigated" was found. While the banks had reported a mere handful of suspicious

transactions between 2008 and 2012, Deloitte identified 29 in just the previous 12 months. Meanwhile, 10% of customers were "politically-exposed persons" who had not been identified as such. Suspicion has also long hovered over Latvia's banks for much the same reasons, and it has only raised since the Cypriot meltdown in August, as fleeing cash seeks a new home. A chunk of the $480bn fraudulent tax rebate funds flagged up by deceased whistleblower Sergei Magnitsky moved through Latvia, according to an investigation by lawyers Brown Rudnick. Kyrgyz banks entered the money-laundering market around 2008, in close cahoots with their Latvian peers, according to a Global Witness investigation. However, since the 2010 revolution ousted thenpresident Kurmanbek Bakiyev, and led to nationalisation of the notorious Asia Universal bank, it seems to have lost its role. Estonia is apparently the new kid on the money-laundering block, meaning there's little indication of the volume of funds moving through the Eurozone member. The most prominent case of dirty funds moving through the smallest of the Baltics was the case of an Ilyushin jet intercepted at Bangkok Airport in December 2009. The plane was found stuffed with weapons en route from North Korea to Iran, and was leased by a New Zealand shell company with an account at Estonia's Sampo Bank, according to an International Peace Information Service investigation. In contrast to the other jurisdictions through which the dirty Russian funds have been moving, Hong Kong and Turkey have no Soviet links and may point to new channels being developed. With the problems experienced by Cyprus resulting in heightened attention in the Eurozone to the risks from member states laundering Russian money, that's not too surprising.

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Corruption seen rising across Central Europe Kester Eddy in Budapest

ransparency International (TI) released its "Global Corruption Barometer 2013" on July 8. It reveals that perceptions of graft continue to grow across Central and Eastern Europe. Membership of the EU is no guarantee of progress. TI's analysis on Hungary reveals that 61% of respondents think that corruption has increased in the past two years, while 82% believe that the government’s actions are "somewhat or heavily" influenced by a few groups of firms. The report, however, indicates that Hungarians are not ready to stand up against the trend. "Seventy percent of Hungarians would not report

corruption if they encounter it: this is an exceptionally high percentage in Europe and in the region," Jozsef Peter Martin, executive director of TI

Equally telling are the reasons Magyars give for keeping quiet. Four in ten said reporting corruption would not lead to any action, while two in ten said

"While Hungary's behind the likes of Estonia, Slovenia and Poland, it's comfortably ahead of the Czech Republic and Slovakia" in Hungary, told a press conference. By way of comparison, 50% of Slovaks and a full 84% of Slovenes – the region's most zealous opponents of graft – said they would report incidents.

they "feared the consequences" should they do so. For the Fidesz government, which campaigned vehemently against corruption when in opposition, the

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results are hardly reassuring. No more than 15% of respondents judge the current administration's much publicised anti-graft efforts as effective. "According to citizens' perceptions, corruption is unfortunately very widespread in Hungary. This is related to the fact that public trust is alarmingly low and institutions do not work efficiently," Martin added. Harsh, but fair? Budapest is hardly alone in failing to get to grips with graft. Even by TI's own global rankings, Hungary comes in level with Brunei in 46th place out of a total of 174 countries. While that's behind the likes of Estonia, Slovenia and Poland, it's comfortably ahead of the Czech Republic down in 54th place, and Slovakia, which is a further eight spots behind. In the Czech Republic, 71% of people think civil servants are affected by corruption, and 73% feel political parties are also tainted. In Slovakia these figures – at 64% and 66% respectively – come out better, but 69% of Slovaks also view the judiciary in a poor light. In the Czech Republic, 52% are suspicious of the courts, while Hungary's judiciary looks relatively clean to all but 33%. Indeed, Hungary outperforms the Central European regional average in a number of areas – notably corruption associated with police, education, health care and public administration. The latter is somewhat surprising, given that 85% of Hungarians report that personal relationships "have a fundamental role in solving administrative issues," according to TI. Still, the TI analysis clearly paints a pretty grim picture, requiring a decent dollop of lip service from the government at the very least. "Any indication of the presence of corruption is alarming," government spokesperson Ferenc Kumin told bne, "therefore the latest TI report is worth studying". Perception vs reality However, Kumin stresses that the majority of the most alarming figures

CEE states the fattest in Europe

bne Obesity has been identified in recent years as an epidemic of the western world, but it's the states of Central and Eastern Europe that top the European continent when it comes to the prevalence of obesity among adults. Their role as the biggest beer drinkers in the world probably doesn't help the Czechs, who weigh in at the heaviest in Europe, according to a new report from the UN. As many as 28.7% of Czechs are obese, according to the "State of Food and Agriculture 2013" report by the Food and Agricultural Organization of the United Nations – or at least were in 2008, when the survey was taken. On more recent lists on obesity, Croatia has ranked particularly high. Other notable entries in the UN report's upper echelons include Slovenia (in second spot with 27.0%), Russia (4th/24.9%) and Hungary (6th/24.8%). Lithuania and Slovakia also make it into the top ten. The Czechs have some way to go to challenge the global heavyweights however. On a global basis, the Micronesian island of Nauru is top at 71.1%, Kuwait at 42.8% and Egypt at 34.6%. In the developed world, Mexico is top with 32.8%, followed by the US with 31.8%. In Europe, France and Switzerland rate as the least obese nations, with 15.6% and 14.9%, respectively, and Western European states occupy the top seven places in those terms. Romania, with 17.7%, performs best out of CEE states. The additional health threat in CEE only serves to suggest another drag on those countries' efforts to catch up in terms of economic development, and extra costs in terms of health care. As the UN report notes, obesity imposes "economic costs on society directly through increased health care spending and indirectly through reduced economic productivity." "Although no global estimates of the economic costs of overweight and obesity exist, the cumulative cost of all non-communicable diseases, for which overweight and obesity are leading risk factors, were estimated to be about $1.4 trillion in 2010," it points out. That was around 2% of global GDP that year.

Country

Prevalence of obesity among adults, %

Czech Republic Slovenia Malta Russian Federation United Kingdom Hungary Lithuania Slovakia Ireland Andorra

28.7 27 26.6 24.9 24.9 24.8 24.7 24.6 24.5 24.2

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– such as the 82% who believe the government is in collusion with a coterie of favoured businesses – refer to perceptions. These figures "don’t necessarily equal the actual level of corruption in a country," he says. While he admits the negative perception of corruption "matters", he says it could be just as much based on the media narrative as on real life experiences. At the same time, the opposition insists that there is an overwhelming government influence in the Hungarian media, this might be difficult to justify. However, it is nonetheless a clear trait of the TI report. Understandably, given the figures, Kumin argues that "the most objective indicator" of the actual corruption level in Hungary is the response to the question: "Have you paid a bribe in the last 12 months?" "The global average here according to the TI report is 27%," he notes, "while the Hungarian figure is 12%. Most of our neighbouring countries like Slovakia, Romania, Serbia, Ukraine – which come out to 21%, 17%, 26%, and 37% respectively – are worse in this respect." However, he also insists it doesn’t mean that the Hungarian government is satisfied with the general corruption environment. "Numerous provisions and programmes," are being undertaken with the "aim to improve the situation," he says.

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HAVE YOU PAID A BRIBE?

More than 1 in 4 people around the world report having paid a bribe

% OF RESPONDENTS WHO REPORT HAVING PAID BRIBES IN THE PAST YEAR TO ANY ONE OF EIGHT SERVICES BY COUNTRY/TERRITORY < 5% Australia, Belgium, Canada, Croatia, Denmark, Finland, Georgia, Japan, Korea (South), Malaysia, Maldives, New Zealand, Norway, Portugal, Spain, Uruguay

20–29.9% Bosnia And Herzegovina, ColombIa, Greece, Iraq, Lithuania, Madagascar, Moldova, Papua New Guinea, Paraguay, Peru, Serbia, Slovakia, Turkey, Venezuela

5–9.9% Bulgaria, Estonia, Italy, Slovenia, Switzerland, United Kingdom, United States

30–39.9% Bangladesh, Bolivia, Egypt, Indonesia, Jordan, Kazakhstan, Mexico, Nepal, Pakistan, Solomon Islands, South Sudan, Taiwan, Ukraine, Vietnam

10–14.9% Argentina, Chile, El Salvador, Hungary, Israel, Jamaica, Palestine, Philippines, Rwanda, Vanuatu 15–19.9% Armenia, Cyprus, Czech Republic, Kosovo, Latvia, Macedonia (Fyr), Romania, Sri Lanka, Sudan, Thailand, Tunisia

Source: Transparency International

40–49.9% Afghanistan, Algeria, Democratic Republic Of Congo, Ethiopia, Kyrgyzstan, Mongolia, Morocco, Nigeria, South Africa 50–74.9% Cambodia, Cameroon, Ghana, India, Kenya, Libya, Mozambique, Senegal, Tanzania, Uganda, Yemen, Zimbabwe 75% Liberia, Sierra Leone

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above where they stood on June 12, the night before police raids hit multiple government buildings to carry out searches and arrest the closest aide of then-PM Petr Necas. Constitutional meltdown – so what? That illustrates investors are maintaining their traditional stance toward the country, ignoring the petty squabbles within the Czech political scene – perhaps even to the extreme. Throughout 2012, the coalition government flirted with collapse, but bond yields continued setting new record lows.

A Czech safe haven despite political crisis Tim Gosling in Prague

he Czech Republic is facing a drawn-out constitutional crisis after a bid to oust the president's newly-appointed cabinet failed to whip up the required support in parliament in a vote on July 17. Meanwhile, investors maintain their aloof stance, with the Czech sovereign promoted into the top 10 of the world's least risky issuers by Standard & Poor's. A proposal to dissolve parliament from the Social Democratic Party (CSSD) – a step needed to call early elections – mustered only 96 votes in the 200-seat lower house. A three-fifths majority of 120 votes was needed to carry the motion, which was sparked by President Milos Zeman's decision to push past the objections of political parties of all stripes to appoint a "government of experts" on July 10. Headed by Zeman's economic advisor Jiri Rusnok – and stuffed with the president's allies – the new administration must face a vote of confidence in parliament by August 8. Even though it's unlikely to win the 50%+ it needs, Zeman could yet keep his pet cabinet in office for the next

10 months. The political parties have pledged to block its policymaking, threatening gridlock in governance. The first priority is to build a 2014 budget. Despite all this, S&P Capital IQ's Global Sovereign Debt data report for the last quarter – released the same day as the parliamentary vote in Prague – saw the Czech Republic enter in the global top

While emerging market currencies have been hard hit by the recent sell-off on the back of comments from the US Federal Reserve, the Czech koruna remains barely affected, leaving the Czech National Bank to continue to try verbal intervention in a bid to stimulate exports. The economy remains in its longest ever recession. Now, not only does the country face the likelihood of political gridlock, but it also stands on the edge of potential constitutional meltdown. Zeman, who has been pushing at the boundaries of the presidency ever since he took office in March, appears determined to continue his grip on the levers of power by maintaining his "interim" government.

"The Czech Republic is officially a parliamentary democracy, but Zeman is widely accused of trying to push it towards a 'semi' presidential system" ten for safest sovereign debt. While the country benefited from the widening of credit default swap (CDS) spreads – the cost of insuring debt against default – in Australia and New Zealand, it also sits just 38 basis points (bp) above the UK in ninth spot.

Both the centre-right coalition of ODS/ Top09, which fell in June with the resignation of Necas, and the leftleaning CSSD object furiously to the administration. However, they fatally destined to pull in different directions in their strategies to overturn it.

Yields on 10-year treasuries sat at 2.11% as parliament went to the historic vote, reports Bloomberg. That's just 5bp

The coalition insists it has majority support in the lower house and should be allowed to establish a new

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A wild boar chase Wild boar goulash is a speciality in the Czech Republic, though some tourists came a little too close to the main ingredient on July 14 when a wild boar stormed the Hilton Hotel in Prague. The boar was first spotted swimming across the Vltava River in the direction of the Hilton. After smashing a display window at the hotel, it then fled toward the Old Town with police in hot pursuit, before reversing course through the residential areas east of the centre of the capital, according to local news. After a two-hour chase that ended more than three kilometres away in somebody's garden, police managed to subdue the animal with tranquilizer darts, but not before it had nearly knocked over a mother with a pram, sent workers scurrying up scaffolding, and attacked one officer three times before he was able to wrestle it to the ground. Police then turned the animal over to the company in charge of Prague's forests, where wild boars have been reintroduced over the past decade, perhaps a little too successfully. There have been sightings of boars roaming the streets and squares of smaller towns near the capital, damaging gardens and terrorising inhabitants.

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government to see out its term, which finishes in May 2014. The CSSD – a shoo-in to win the next election whenever it should fall – claims an early vote is the rightful solution. However, with ODS and Top09 facing annihilation at the polls due to years of harsh austerity, the CSSD's proposal to dissolve parliament and hold a vote in September is doomed to failure. That leaves Zeman the opportunity to leverage the vaguely-worded constitution, stretching its spirit further in order to keep his cabinet in situ until the next scheduled elections. Should he follow that route, it risks a legal fight over the constitution and the entire basis of the political system.

The Czech Republic is officially a parliamentary democracy, but Zeman is widely accused of trying to push it towards a "semi" presidential system. More immediately, two of the three possible routes – Zeman's cabinet or a CSSD government – promises to see fiscal policy relaxed. It was the hawkish stance of the coalition over the past three years that helped push Czech yields to outperform the likes of neighbouring Poland through the emerging market bond rally of the last few quarters. Yet the market continues to push all this to one side, with analysts insisting that it matters little who governs the country – there's little room for fiscal manoeuvre anyway.

Top 10 Most Risky Sovereign Credits Position Q1

Country

5 year CPD (%)

1 2 3 4 5 6 7 8 9 10

Argentina Cyprus Venezuela Greece Egypt Pakistan Ukraine Portugal Lebanon Iraq

81.62% 65.51% 51.36% 48.56% 46.39% 45.79% 44.25% 30.32% 29.55% 27.93%

5 year CDS MID (BPS) 3155.45 1245.06 1010.57 986.1 881.1 843.3 812.82 391.7 478.6 470.9

Previous Ranking 1 – No change 2 – No change 4 – Down 1 New entry 5 – No Change 3 – Up 3 6 – Up 1 7 – Up 1 9 – No change New entry

Note: CPD is a function of the recovery level which varies according to several factors and distance to default, e.g. emerging markets assume 25%

Top 10 Least Risky Sovereign Credits Position Q1

Country

5 year CPD (%)

1 2 3 4 5 6 7 8 9 10

Norway Sweden Finland USA Switzerland Denmark Germany Austria UK Czech Rep.

81.62% 65.51% 51.36% 48.56% 46.39% 45.79% 44.25% 30.32% 29.55% 27.93%

Source: S&P Capital IQ CDS

5 year CDS MID (BPS) 3155.45 1245.06 1010.57 986.1 881.1 843.3 812.82 391.7 478.6 470.9

Previous Ranking 1 – No change 2 – No change 4 – Down 1 New entry 5 – No Change 3 – Up 3 6 – Up 1 7 – Up 1 9 – No change New entry

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The cartel appears to have operated in classic manner, with the pre-decided winner telling the other "bidders" exactly what was in its tender. The form of kickbacks handed out to those "losers" was not revealed. Due to the depth and duration of the price-fixing racket, companies will be fined a percentage of their 2012 turnover, ranging from 7.5% to 1.5% depending on how involved in the scam they were. Coughing up the lion's share of the cash will be construction firms Vidzemes Energoceltnieks (LVL471,000), Latvijas Energoceltnieks (LVL309,000), the Latvian subsidiary of Finland's Empower (LVL303,000), Rio (LVL194,000) and Aiviekstes Energobuvnieks (LVL118,000).

Shocking cartel penalised in Latvia Mike Collier in Riga

atvia's business watchdog announced at the end of June that it is imposing fines totalling more than LVL2m (€2.8m) on 26 companies carrying out energy infrastructure construction works. The companies are accused of operating a huge cartel with the implicit support of state-controlled utility Latvenergo. The action – which includes some of the stiffest fines ever handed out by the Competition Council (KP) – provides a reminder of the huge influence wielded by Latvia's biggest construction firms. A select few seem to win every major contract, raising suspicion that they prefer a bit of backscratching to genuine competition. In its ruling, KP said more than 300 contracts, dating as far back as 2006, handed out by Latvenergo, distribution subsidiary Sadales Tikls, Latvian Railways and oil-transit firm LatRosTrans (the largest Russian joint

venture in the Baltic states) show evidence of being decidedly dodgy. Typically the works involved the installation or replacement of power lines, cable laying and similar tasks.

Repeat offenders KP also criticised Latvenergo for playing a "significant role" by turning a blind eye to "obviously illogical and mismatched tenders from bidders". In addition, Latvenergo representatives were "in close contact with individual bidders," it noted. Anti-corruption bureau KNAB is following up with its own investigation. This is by no means the first time Latvenergo and its sub-contractors have been linked to corruption. In 2010, Chairman Karlis Mikelsons – one of the highest profile businessmen in the

"The companies are accused of operating a huge cartel with the implicit support of state-controlled utility Latvenergo" Contracts involved amounts "from a few thousand lats to around LVL150,000," KP said in its summary: "The offending electrical construction companies... agreed to participate in a particular procurement [method], thereby eliminating competition and denying the customer the opportunity to receive a lower, normal market price."

Baltics – was led away in handcuffs to be charged with similar offences involving bribery and rigged procurement contracts. His trial is ongoing, largely as a result of Latvia's inept court system, which virtually ensures any major case will drag on for years. In May, investigative news show "Nothing Personal" had already blown

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Concrete LNG support

bne Making concrete Brussels' support for the efforts of Lithuania to break its dependence on Russian gas, the European Investment Bank (EIB) on July 9 signed off on a deal to provide the "backbone" financing for Lithuania's project to build a liquefied natural gas (LNG) terminal. The completion of the agreement on the ¤87m, 20-year loan from the EU development bank comes just over a month after the funding to statecontrolled Klaipedos Nafta was initially approved. It offers Lithuania 50% of the financing for the lease of a floating LNG platform, which is planned to launch operations in late 2014. According to newswires, Klaipedos Nafta has already signed off on the lease contract, as well as agreements for construction of the port and pipeline infrastructure that will directly surround the platform, and says it expects to wrap up talks on LNG import contracts in the third quarter. However, the company failed to attract the necessary funding from commercial banks in March. It had been seeking ¤73m in loans and $50m in guarantees. However, after a plan to force gas distributors to buy at least 25% of supplies from the terminal was scrapped under EU legislation, lenders became concerned that Russian gas export monopoly Gazprom could cut the price of its exports to Lithuania in a bid to scupper the LNG terminal. Lithuanian Minister of Energy Jaroslav Neverovic called the EIB loan "vitally important" to the project, while Klaipedos Nafta CEO Rokas Masiulis said it "will be the backbone of the LNG terminal's project financing and will ensure that the project will be completed in a timely fashion." Lithuania - with strong support from the EU – has proved adept at fighting Gazprom's machinations to prevent it developing alternative sources of gas. The unbundling of national gas utility Lietvos dujos, which was completed in June despite the Russian company holding a significant stake, was a real coup. It was also key to gaining control of the country's pipelines in order to make the LNG terminal work. A price cut from Russia is the whole point for Vilnius. Cut off from European energy grids like its Baltic cousins Latvia and Estonia by its Soviet past, Lithuania imported all 3bn cubic metres or so of gas consumed last year from Russia. Neverovic said the country paid $500 per 1,000 cm of Russian gas, calling it "one of the highest, if not the highest in the EU". The LNG terminal will be a "game changer" he told EurActiv in an interview published on July 8.

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the whistle on Latvijas Energoceltnieks in connection with allegedly rigged contracts in the central Gulbene region. Its owner is Guntis Ravis, one of the country's richest men, and owner of a portfolio of 40 construction companies that are involved in most of the country's highest-profile construction works. Many of those contracts end up costing a lot more than expected. The most notorious example is a run-ofthe-mill road bridge across the River Daugava that cost significantly more per-metre than the spectacular Millau viaduct in France. The Latvian span is now known locally as the "golden bridge" – not because of its colour, but because it must presumably be built out of the yellow metal. Questions are also unanswered on the hulking new national library – which even the mayor of Riga has likened to a supermarket – and more modestly a row of flower stalls next to the cabinet office that cost a remarkable €1m. The KP ruling completed a poor week for Ravis. On the night of June 20, Riga castle, the official seat of the president, spectacularly caught fire, and the historic building suffered severe damage. The construction magnate was swift to try to deflect criticism against his company Skonto Buve, which happened to be carrying out renovation works at the time. The exact cause of the blaze is yet to be established, but on June 25 state TV channel LTV said cigarette butts and two empty fire extinguishers had been found in an area under renovation near where the fire is believed to have begun. If anyone is ultimately found guilty of negligence for burning down Latvia's number one landmark, the fines handed out by KP will look like pocket change.

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At the same time, the PM boasted of his government's success in fiscal management, and predicted a spectacular growth figure will be recorded in the fourth quarter, reports portfolio.hu. "Orban is keeping to the prudence in public finance mantra, given that elections are due by April 2014. He seems to view prudence in public finance (low deficit, declining public debt) as a selling point with the electorate," suggests Tim Ash at Standard Bank, in an emailed note.

Hungary kicks off election campaign bne

he Hungarian government has launched campaigning for the 2014 elections with antiEU rhetoric and a move to eject the International Monetary Fund (IMF). Another huge hit for the country's banks could be next on the list. Following up a demand from the previous day that the IMF, which led a â&#x201A;Ź20bn bailout of Hungary's economy in 2008, pack its bags, Prime Minister Viktor Orban on July 16 pledged Budapest will fight for space to decide its own economic policy and reject dictates by "European Union bureaucrats" for non-euro members. The apparent start of campaigning by the ruling Fidesz party is likely to put investors on alert. None more so than the battered banks; a deputy PM duly obliged, separately suggesting the government is mulling the introduction of legislation to modify foreigncurrency loan terms.

Speaking to Hungarian ambassadors in Budapest, the PM admitted that the success of the Eurozone is in Hungary's interests due to country's huge dependence on export demand out of the single currency bloc. However, he

Bad loans Meanwhile, Deputy Prime Minister Tibor Navracsics said the government is mulling implementing wholesale changes to the conditions of retail forex loans via legislation. That move comes after Hungary's highest court ruled in favour of the country's biggest bank OTP â&#x20AC;&#x201C; in what was seen by the market as a test case of the banks' ability to maintain the conditions on the billions of euros' worth of loans handed out during the boom. Navracsics claimed on private channel HirTV that pressure is now mounting on the government to find a solution. "We are now looking at possibilities within the constitutional framework whether there is a way to modify the conditions of foreign currency loans with a general effect, with a law or

"The PM boasted of his government's success in fiscal management, and predicted spectacular growth in the fourth quarter" also warned that Hungary must take into account that the Eurozone is going to be rapidly and decisively integrating institutions and economic policy. Like the move to see off the IMF that was announced on July 15, Orban's latest comments are clearly meant for domestic consumption ahead of the 2014 parliamentary elections.

legislation in the autumn session (of parliament)," he said, according to Reuters. "This could happen if some circumstance that were valid at the time the contract was signed has changed fundamentally in a way that could not be foreseen, and therefore the borrower cannot be blamed for

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not being able to fulfill it," the official added. He also made clear that the legislation would apply to existing loan contracts as well as future ones. His words will send shivers down the spines of the banks, who have already been hit for huge losses on forex loans by the Fidesz government in 2011. However, the high levels of forex loans

"The Hungarian political spectrum has moved significantly to the right in recent years and EU-bashing goes down rather well with the centre-right constituency" (Swiss franc in particular) are one of the last brakes on its "unorthodox" policymaking. With the likes of the EU and international institutions such as the IMF relegated to virtual bystanders by Budapest's approach, that leaves the markets as one of the few palpable international forces in Hungary. A sharp drop in the local currency, the forint, would cast thousands of forex borrowers into even more difficulty paying their loans than currently. That would hardly play well at the polls, whereas a reduction in mortgage payments and hit to the banks would offer a huge potential boost to the government's short-term popularity, given the mood towards the financial industry right now. A step to the right The forthcoming election, at which Fidesz needs to defend its parliamentary majority from both the main opposition Socialist Party and the far-right Jobbik, is now presenting renewed risk to Hungary's battered investors. "The Hungarian political spectrum has moved significantly to the

right in recent years," Ash notes, "and EU-bashing goes down rather well with the centre-right constituency." The mainly foreign-owned banking, telecommunications and energy sectors have already suffered at the hands of the populist conservative administration, and so will remain wary of fresh action. The first direct victims of the 2014 campaign were the utilities, which have been forced to swallow lowered tariffs and forced sales to the government. "It's a great wheeze," says Ash, "as it slows inflation, and allows the [central bank] to further trim policy rates. Long term it may well impact on the efficiency of utilities, as investment will likely stall, but this is a short term ploy by the government to win the 2014 elections." Unsurprisingly, the tactic to lower energy costs for the population â&#x20AC;&#x201C; cuts totaling 30% ahead of next year's vote were promised at the start of 2013, with 10% implemented thus far â&#x20AC;&#x201C; seems to be working well if recent opinion poll ratings are anything to go by. With the forint and yields holding up well currently, despite the emerging market pullback, the government may reckon on pushing more populist moves past the market while it thinks it can get away with it. However, the long-term consequences are also palpable. The banks were furious in late 2011 when Orban forced them into a scheme allowing forex borrowers to pay off loans early at exchange rates well below the market. Alongside high sector taxes, that programme saw the banks pull in their heads and practically cease lending. With three years of Fidesz under their belts, and five years of crisis, the strain is starting to tell. Foreign banks have started to leave, and Raiffeisen Bank International announced "massive" cutbacks in Hungary and Slovenia on July 16.

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with the crisis having caught up squarely with the Polish economy and continuing to batter business across the Eurozone, the PKO acquisition – alongside the BZWBK/Kredyt merger – has increased competition amongst the country's top banks. The CEO of BZWBK, Mateusz Morawiecki, claimed on June 19 that Pekao is now under pressure and possibly mulling a merger.

Poland rules enough consolidation of banks bne

s speculation grows over another wave of consolidation in Poland's banking industry, the country's financial markets watchdog KNF suggested at the end of June that there is little interest from foreign players in the country's banks, and that it stands ready to block any further concentration in the sector. "We don't have any signals from foreign banks that they are interested in taking over entities in Poland," KNF head Andrzej Jakubiak told reporters on June 20. That flies in the face of suggestions that the country's biggest banks are under pressure to grab market share, and that the foreign owners of the country's second- and third-largest lenders are looking for targets. In the wake of an announcement on June 12 by the country's biggest bank – state-controlled PKO BP – that it has agreed to buy the Polish assets of Scandinavian bank Nordea, speculation has grown that it will spark another round of consolidation in the banking

sector, to follow the series of deals seen between early 2011 and 2012. Those acquisitions in a market that appeared to be immune to the crisis came about because of some forced sales by certain Eurozone banks struggling to meet new capital

On the other side of the equation, speculation persists that Portugal's Millennium bcp will soon be forced to put its Polish unit up for grabs. Rabobank is also said to looking to unload agricultural lender BGZ, despite the Dutch bank having only bought out the remaining 40% stake from the state – at a huge price – less than a year ago. Growing retail player Alior pushed through an IPO in Warsaw last year, but is reported to need to find a strategic investor by the end of the year. "Taking into account the level of concentration... I believe there will be another consolidation wave," Morawiecki insisted in June, suggesting such a trend is unavoidable. Close to optimum However, the KNF is likely to block any further major moves, Jakubiak said on June 25. "The takeover of Nordea by PKO is not disturbing the competition on the banking market yet. We have a big bank in a good situation and

"We don't want to allow Poland's three biggest banks control some 70% of the market as that leads to limiting competition" adequacy rules. The purchases were bookended by Santander's acquisition of Bank Zachodni WBK and Kredyt from Allied Irish and KBC respectively. The Spanish giant completed a merger of the two lenders in early 2013 to create Poland's third largest bank, following UniCredit-owned Pekao and PKO. Following a break of just over a year,

a relatively small bank being taken over. But we think that we are close to optimum as far as Polish banking sector concentration is concerned." "In the case of the largest banks – meaning the top ten, perhaps 15 – we expect that changes in the shareholder structure will take place by seeking a new investor and not through

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Poland veers further from austerity

bne Completing the slow arc of its focus from tough austerity to growth measures, the Polish government announced on July 16 that it will expand the budget deficit and suspend automatic stabilizers on to state debt. Due to slower-than-forecast revenue to the tune of PLN24bn (¤5.6bn), Prime Minister Donald Tusk told reporters that the government is set to widen the gap in the budget in a bid to avoid adding pressure on consumption and investments. In order to fuel that increased deficit, the 50% of GDP limit on state debt will be suspended for this year and next. Finance Minister Jacek Rostowski claimed the increase for the deficit would release money to the equivalent of 1% of GDP into the economy. Tusk started out his second consecutive term in 2011 with promises of stiff fiscal consolidation for state debt already on the edge of its constitutional limits. However, that was far easier a line to follow at the time, with the Polish economy looking like repeating its 2008 trick of dodging the slowdown plaguing the rest of Europe. However, the crisis caught up with a vengeance last year, and by October – 12 months after he returned to office – the PM was stepping into line with the wider EU trends to talk of measuring austerity alongside stimulus. The expansion of the deficit, and especially the suspension of the lower debt ceiling, is a significant step in that arc. However, with state debt already over the 50% threshold which would freeze the budget, Warsaw has little choice. It has been searching for a way to circumvent the limit for some time – messing about with accounting practices for instance – as it complained of missing out on making the most of the emerging market bond rally. While the backstops on state debt at 55% and 60% of GDP will remain in place, the government also wants to suspend other stabilizers tying budget spending to inflation, according to Dow Jones. Economic growth in Poland slowed to 0.5% annually in the first quarter of 2013, from 3.5% across the first three months of last year. The government's forecast of finishing 2013 with 1.5% growth is seen as optimistic. Tim Ash at Standard Bank says the budget deficit will now rise to 4.5% of GDP, from the 3.5% contained in the government's European Commission Convergence Programme from April. This is also likely to stall plans for Poland to exit the Commission's excessive deficit procedure in 2014 as had been planned. The analyst also notes that the move could stir up political problems for the PM. "The backdrop here is that the ruling Civic Platform government is struggling a bit in the polls… Signs of fiscal easing will be grist to the mill of those on the right of the party… this same wing has been mounting a leadership challenge."

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consolidation," Jakubiak added in comments to the Polish Press Agency. "In particular, we don't want to allow Poland's three biggest banks control some 70% of the market as that leads to limiting competition." As the crisis has worn on, KNF has led concern expressed in Warsaw that the level of foreign ownership in the Polish banking sector – although below that seen in regional peers – makes it vulnerable to funding cuts or even outflows to struggling Western European parents. To that end, the watchdog has strictly patrolled M&A activity and dividend policy, insisting on a 25% listing on the Warsaw Stock Exchange and limit on payouts. Nordea group CEO Christian Clausen said earlier this month that the requirement for a 25% free float was a major factors behind the sale of its Polish assets. It remains to be seen however how strict KNF will be with state-controlled PKO, which has been chasing assets across CEE for some time, with only the PLN2.8bn purchase of the Scandinavian bank to show for it thus far.

Central Europe I 37 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

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What you need to know

bne’s veteran team of journalists have more than 100 years of collective experience of reporting on this dynamically growing region and can explain the “why” of “what” is going on. Eastern Europe Russia Belarus Ukraine Central Europe Estonia Latvia Lithuania Poland Czech Slovakia Hungary Southeast Europe Slovenia Croatia Serbia Romania Bulgaria Turkey Moldova Albania Bosnia Croatia Macedonia Montenegro Kosovo Eurasia Kazakhstan Georgia Uzbekistan Kyrgyzstan Turkmenistan Tajikistan Azerbaijan Armenia Mongolia

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bne August 2013

A TAP on the shoulder Nicholas Watson and Tim Gosling

he consortium developing the giant Azeri gasfield Shah Deniz on June 28 announced it had picked the planned Trans Adriatic Pipeline (TAP) to carry its gas exports from the Turkish border into Europe, finally bringing the curtain down on the increasingly unloved EU-backed Nabucco project. TAP and Nabucco West had been battling for the right to collect 10bn cubic metres a year (cm/y) of Azeri gas at the end of the planned TransAnatolian Pipeline (TANAP) at the Turkish border to transit it to EU markets. Both projects were part of Brussels' wider "southern corridor" strategy to take gas directly from the Caspian Sea and Central Asian region while avoiding Russian territory. For its part, Moscow is pressing on with its

giant South Stream pipeline, which will deliver as much as 63bn cm/y to Europe via the Balkans. "For over two years now we have been working closely with and evaluated a number of pipeline projects to select the best option that will become part of the planned southern corridor," said Gordon Birell of BP – the consortium leader in the Shah Deniz project, which also includes Azeri state energy company Socar and Norway's state-owned Statoil. "I'm privileged to announce on behalf of the consortium that Azerbaijan's first gas to Europe will go via the Trans Adriatic Pipeline." Nabucco has had a long but troubled history. The Nabucco West project that lost out to TAP is the rump of an overly ambitious – and ultimately doomed –

EU plan developed over a decade ago to bring gas about 4,000 kilometres from Azerbaijan – and perhaps later Turkmenistan – to Austria. Nabucco had huge political backing given it would help diversify Europe's gas supplies, but it simply wasn't economically or practically feasible. It planned to bring 31bn cm/y of gas a year, but found few suppliers other than Shah Deniz II's 10bn cm/y (16bn cm/y will be made available from the field, but Turkey will take 6bn cm/y for its own use). The shorter and smaller version, the renamed Nabucco West, that emerged in May 2012 was only 1,300km long with a capacity of 10bn-23bn cm/y and was designed to pick up from the planned TANAP that's currently being built by Azerbaijan and Turkey. Construction of TANAP, estimated to

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cost $7bn, is scheduled to start in 2014 and will be completed by 2018. However, TAP prevailed because the 10bn-20bn cm/y pipeline offers a shorter route from the Turkish-Greek border across Greece and Albania and onward under the Adriatic Sea

market prices," blighted the Nabucco's chances. "We saw a difference between the two pipelines measuring in billions of dollars." Aleksandra Jarosiewicz of the Centre for Eastern Studies (OSW) believes that Shah Deniz's decision was based on the

"We saw a difference between the two pipelines measuring in billions of dollars"

to southern Italy, with fewer transit countries and fewer partners to complicate matters. TAP also had the huge advantage that one of its shareholders, Norway's Statoil, is at the same time a lead member of the Shah Deniz consortium. TAP's current shareholder structure includes Axpo of Switzerland (42.5%), Norway’s Statoil (42.5%), and Germany’s E.ON Ruhrgas (15%). On June 17, the European gas infrastructure group Fluxys said it would consider taking a shareholding in the TAP project if it was chosen by Shah Deniz; analysts say other companies may also now jockey to join the project. For many, the writing on the wall for Nabucco West came with the June 21 announcement that Socar had reached an agreement with Greece to acquire a 66% stake in the country's gas transmission system operator, DESFA, as a way to increase its gas sales in Greece and neighbouring Bulgaria. Wasting little time, Greek Deputy Energy Minister Assimakis Papageorgiou said on June 28 that DEPA, Greece's domestic gas supplier, had made an initial offer to buy 1bn cm/y from TAP. The same day, a Socar official announced the state company is set to build Albania's first gas infrastructure. Al Cook, BP Azerbaijan's president for Shah Deniz, told newswires that "commercial factors, including the cost to get the gas to the market and the

greater options available for deliveries to individual markets connected to the TAP route; the pipeline will offer the Azeri producer access to markets such as Montenegro, Bosnia-Herzegovina via the planned Ionian Pipeline, as well as Western Europe thanks to the network of Italian pipelines it will link into. "This is key considering the changes taking place on the EU market (a fall in demand, shale gas)," she says. "Furthermore, due to the connector under construction from Greece to Bulgaria... there will be the possibility to deliver gas to the Bulgarian market and from there

Azerbaijan attempted to offer some consolation. "We clearly see the Nabucco pipeline corridor as the natural market for our future volumes of gas," Rovnag Abdullayev, president of Socar, told a news conference. "We expect that the ability of the southern corridor to bring new sources of supply to European markets will extend beyond the immediate areas transmitted by TAP," he said. Socar officials suggested earlier this year that Nabucco West and TAP were "definitely not mutually exclusive." Attempting to put aside the disappointment, EU Energy Commissioner Gunther Oettinger played up the fact that Europe will at least have a link to Caspian gas that does not cross Russia, which was the whole point of Nabucco. "We have a definite commitment from Azerbaijan that gas will be directly delivered to Europe through a new dedicated gas pipeline system," he said in a statement. "Whether the system consists of two gas pipelines – TANAP and TAP – or one single pipeline as earlier projects had foreseen does not make any difference in terms of energy security. We now have a new partner for gas, and I am confident that we will receive more gas in the future."

"Nabucco's proposed route through Bulgaria, Romania and Hungary would also have improved energy security for these countries" onwards to Romania and Hungary along connectors currently existing or under construction." Not over until the fat lady sings So what now for Nabucco, which was named after the Verdi opera? Gerhard Roiss, chief executive of Austria's OMV, which was the lead partner in Nabucco, mournfully told reporters that "the Nabucco project is over for us."

For some, though, TAP's effect on spot markets will be minimal and its ability to diversify the EU's gas sources limited. "The pipeline will terminate in Italy, which is already well supplied with natural gas from sources including Russia, Algeria and Libya," says Fitch Ratings. "Nabucco's proposed route through Bulgaria, Romania and Hungary would also have improved energy security for these countries, which are highly dependent on Russian gas."

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Nikolay Staykov, a coordinator for the recently established Antigovernment Information Service (www.noresharski. com), squarely blamed official incompetence. Timing parliamentary committee sessions to coincide with the evening protests wasn’t clever, he tells bne. Police actions also needlessly inflamed the situation: "Trying to make a way through several thousand people forcefully is completely inadequate,” he said. “You can remove a live chain or a few people lying on the pavement. But not when they are thousands."

Bulgaria's protests rumble on and flare Sandy Gill in Sofia

ll’s peaceful in Sofia. On the evening of July 24, the dogged Bulgarians who have been protesting for seven weeks against the Socialistled government of Plamen Oresharski staged a well-attended and conspicuously peaceful demonstration, following violent clashes outside parliament over the previous night. By international standards these clashes had been fairly tame stuff. Hospital reports suggest that 18 people – including five police as well as protesters – were admitted for treatment as a result of the clashes in the late hours of July 23, with only two of them actually hospitalised. But for peaceful Bulgaria just about any violence is a shock, especially as the preceding 40 straight days of demonstration had been almost entirely without violence. Politicians are debating, pointing fingers and standing their ground. But it looks as if the outbreak might be a turning point. Predictably, the blame game is underway. The violence started at around 10:00pm as police tried to bus MPs, ministers, trade unionists and journalists, present for the committee stage of a controversial budget bill, out of a

parliament that had been surrounded by protesters – the first successful full blockade since the police-controlled zone around parliament had been enlarged a month ago. Police and demonstrators clashed, as the former tried to move the latter out of the way. Stones were thrown at parliament and the bus, which turned back. Physical barricades began to be built from paving stones and trash-cans. Evacuation under escort – and without benefit of a bus – took place only after 3:00am. There’s criticism. While Interior Minister Tsvetlin Yonchev says that police acted quite properly, anti-government sources insist that they used quite serious force. Situation management has been questioned too. Was it wise to provoke by attempting evacuation in what chief prosecutor Sotir Tsatsarov pointedly described as a “big white bus”? Some are pointing to the conspicuous absence of “anti-conflict” police in the crowd: helped by peaceful protestors, these have been effective in recent weeks in identifying and isolating violent and provocative elements. Then there’s police morale: officers have been working long hours for weeks to cover the demonstrations, and the strain is beginning to show.

Were there “provocateurs” or “extremist elements” among the protestors? “Some, definitely: but the majority of the protesters have been and continue to be non-party aligned citizens with no criminal record and no violent intentions. Part of the art of managing such protests is to avoid situations where normal crowd escalates to violence.” The authorities have been peddling the line that “the protestors are only a few hundred people, we are in charge, and police is working perfectly,” says Staykov, who thinks they fell for their own propaganda. Peaceful The preceding weeks had seen daily demonstrations remarkable for their persistence and their good nature – almost festive occasions. Originally provoked by the appointment of the controversial media tycoon Delyan Peevski to head Bulgaria’s State Agency for National Security (DANS), the protests survived his embarrassed withdrawal and broadened to demand the resignation of the recently appointed and allegedly oligarch-dominated Oresharski government. Evening demonstrations each day at 6:30pm – responding to the Twitter invitation “DANS with me” – were soon supplemented by a morning rendezvous for free coffee in front of parliament. Protestors often had children in tow; imaginative events kept interest up – most recently a group of protestors has taken to dressing up as particularly disliked politicians; those “anti-conflict police” worked well; protestors regularly applauded police lines as they passed

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them; and the only real violence involved the eccentric and extreme nationalist leader Volen Siderov, defending his HQ against supposed threats from demonstrators and rival nationalists. All this in the context of a strange and hardly sustainably political situation. With the former government of Boiko Borisov’s GERB party driven from power by demonstrations in February triggered by high electricity bills, a bitter campaign had yielded a surprisingly low turnout in elections on May 12. Lambasted for authoritarianism, corruption and phone-tapping, GERB had nevertheless emerged as the largest party with 97 out of 240 seats – but with no one prepared to cooperate with it. The former communist Bulgarian Socialist Party (BSP) and the mainly ethnic Turkish Movement for Rights and Freedoms (MRF) had 120 seats between them, and formed Oresharski’s government on the basis of a quorum ensured by the MRF’s arch enemy Siderov, leader of Ataka, the fourth party that had made parliament. This recipe for instability was further seasoned by the fact that almost a quarter of the votes cast had gone to parties that hadn’t cleared the 4% hurdle needed to enter parliament. Moreover, disputing the legitimacy of the election – the subject of an appeal since overturned – and displeased at the distribution of parliamentary committee chairmanships, Borisov has boycotted all parliamentary business except that to do with electoral reform and, in the last few days, the budget. All in all, it’s a most dysfunctional parliament. The Peevski gaffe has been followed by others; for instance, Siderov’s election to head parliament’s anti-corruption and parliamentary ethics committee and, more recently, the appointment of a regional governor with alleged connections to one of the 1990s’ biggest organised crime groups. But the protestors have also been fuelled by the young intelligentia’s general distrust of the BSP – one of the most frequent chants is “red trash” – and suspicions that the interests behind the government have hidden agendas. The Corporate Commercial Bank (widely believed to be connected

Southeast Europe

with Peevski) is cited. So is a rather untransparent visit of Gazprom’s Alexei Miller in early July. So is the proposed acquisition of the Doverie Pension Fund by Russian-connected offshore companies. And proposals for an – allegedly unnecessary – BGN1bn loan (€510m) for the state is giving opponents ammunition: it will benefit the “energy mafia”, they say, and is redolent of the financially catastrophic premiership of the BSP’s Zhan Videnov in 1996-97. The demonstrators’ persistence also derives from a sense of empowerment. Listen to Sofia-based political scientist Vladimir Shopov. “It’s premature to talk of the ‘development of civil society,” he says. “But there’s been a gradual process of cultivating civic intuitions over some years.” And it’s been a “bottom-up” process rather than a matter of heroic individuals. “People have been getting together on micro-issues – mothers whose kids suffer from a particular disease, for instance. Then the grievance-based groups have got together with similar groups. And green NGOs have grown in legal and organisational

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times higher – as high as 30,000 on some occasions. Again, the protests might be argued to be a bit narrowly based. As the international media, in “compare and contrast” mode, have been quick to point out, they’re to a large extent “middleclass”. And, also in contrast to February’s protests, they’ve mostly been confined to Sofia. But, says Shopov, they involve those elements of the population that are “the most active and competent in terms of constructing public influence and knowing how to advocate change.” The protests would also probably have been a lot larger if it weren’t for fear that they might let Borisov back in, he argues: “Several of my friends have given precisely that reason for not taking part.” It looks as if quite a large proportion of the population sympathise. An opinion poll in early July by the National Centre for the Study of Public Opinion (NCSPO) – a parliamentary-affiliated agency not noted for its subversive tendencies – suggested that 58% of Bulgarians supported the protests and that 60% thought the government should resign (37% “immediately”). It also credited the govern-

“You can remove a live chain or a few people lying on the pavement. But not when they are thousands" capacity, partly through contact with the EU.” But politically aware people weren’t confident in their ability to act as one social group, until the protests started: “They saw their activity as virtual and suddenly it was transformed into activity as a physical group. That’s the source of a lot of energy,” says Shopov. Numbers have been uncertain, but impressive. Headline figures issued by the Interior Ministry have generally been around 3,000, but that’s admitted to refer to numbers on Independence Square, the initial rallying point for evening demonstrations. Counting those who join subsequently, it’s clear from TV footage that total numbers are several

ment with a 59% disapproval rating, the highest initial figure for any government on record. There’s been encouragement from other sources. In early July, the respected President Rosen Plevneliev suggested publicly that early elections were the only way out of the political mess. Not long after, the German and French ambassadors spoke up in favour of the protests, urging the government to abandon an “oligarchic model” of government (which earned the French a Delacroix tableau, complete with a top model playing a bare-breasted Liberty, from the protestors on Bastille Day). And European Commission vice-president

I Southeast Europe

Viviane Reding spoke enthusiastically of “those who are protesting on the streets against corruption” when she visited Sofia earlier this week and, while emphasising that Brussels couldn’t change national governments, pointedly wished Bulgarians “success in forming a government that you trust." Stonewalling To date, however, there’s been stonewalling from the dominant forces in parliament. Siderov – ignored by all and sundry – has been complaining of the dangers to himself, sporting a gun and a truncheon on one occasion, and calling for miscellaneous officials, including the Sofia mayor as well as the interior minister, to keep the streets clear. As to the government, the response has been consistent: the government can’t cease to govern just because a few thousand people choose to protest; there’s urgent work on welfare to do; there’s need for dialogue rather than categorical demands for resignation; and resignation would simply destabilise the country. On the surface, that seems still to be the case after the July 23 violence. With Oresharski notably silent – though rumoured to have suggested to BSP leader Sergei Stanishev that his presence as PM might not be desirable – Stanishev and Interior Minister Yovchev have done most of the talking, referring to “violent provocations” and, in Stanishev’s case, hinting that Borisov might be behind them. A plenary session of the party’s ruling council on July 24 repeated the “no resignation” line, and insisted the protests were Sofia-based and represented a small minority. However, it called for “broad political consultations” and, interestingly, said that the government’s programme should be

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implemented by “spring 2014”. Though it explicitly denied any electoral intent, May 2014 is when EU elections are due in Bulgaria and the possibility of double elections has been widely mooted. Meanwhile, two senior BSP politicians have hinted at early elections: Yanaki Stoilov has said they are possible but “not now”, while former presidential candidate Ivailo Kalfin has said that they are needed because the legislature is unable to function “for a number of reasons”. What elections soon, or next May, would yield is an interesting question. Pollsters – not universally trusted in Bulgaria, it must be said – have been hinting at a parliament as narrow or even narrower than the present one, were elections to be held soon. For instance, that NCSPO survey concluded that immediate elections would return only three parties to parliament – GERB, with 22-23% of respondents, BSP with 19-20%, and MRF with 6-7%. BBSS Gallup International – having polled between June 27 and July 4 – names the same three, but in a different order (BSP 21.6%, GERB 17.8%, and MRF 6.4%). Given Siderov’s effective backing of a government of “communists and Turks” – and given his subsequent antics – it’s not implausible that Ataka would be excluded from the next parliament (though it might well be replaced by the somewhat more moderate and considerably less erratically led National Front for the Salvation of Bulgaria). But the situation is fluid and, supposing the polls accurately reflected the situation in early July, they may not do so even now. For a start, the right may finally be getting its act together, repenting of the disunity that put all its formations under

"Politically aware people weren’t confident in their ability to act as one social group, until the protests started"

the 4% barrier in May. A Reformist Block has been formed by five parties including Democrats for a Strong Bulgaria and former European Commissioner Meglena Kuneva’s Bulgaria for Citizens Movement – with the significant Union of Democratic Forces (UDF) on the point of joining. “It’s difficult to imagine these turning into a coherent block,” thinks Shopov. “But probably the impetus given by the current situation will make their leaders behave sensibly in the next year or so.” If so, it’s electorally significant, says Shopov: “A lot of people – perhaps as many as one-third of GERB’s peak support – have voted for GERB in the past simply because there was no credible right-of-centre alternative. Some of these voted for Kuneva in May, but more just abstained. Mobilise these, and you have quite a lot of votes.” Then there’s the question of a “protest party”. That’s more delicate, says Shopov. “The protestors are very sensitive to old ways of doing politics: the classic pattern is that a figurehead politician founds a party and is quickly revealed to have powerful sponsor. So there would be a strong reaction to anyone trying to found a party at this stage. An aspiring party-builder would need to be patient and produce a political organisation that clearly isn’t sponsor-controlled.” One long-term hopeful, perhaps, is Sasha Bezuhanova, who stepped down from a very senior job at Hewlett Packard in mid-July to found a “civil project” entitled “Bulgaria Can”. She might have the right approach, thinks Shopov: “It’s a platform for ideas rather than something explicitly political; it includes a lot of people who aren’t centre-right; and it’s shying away from anyone obviously ambitious.” But it’s a long game.

Southeast Europe I 43 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

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What you need to know

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Food for thought as Croatia joins EU Harriet Salem in Sarajevo

haring over 1,000 kilometres of border, it's not surprising that Croatia and Bosnia-Herzegovina have historically enjoyed strong trade ties. However, since Croatia joined the EU on July 1, those relations have once again been disrupted.

analysts are predicting Croatia’s economy will suffer in the short term. Joining the bloc will see the Croatian market open up to other EU member states, but close its membership in CEFTA – and the adjustment will likely be painful.

Although disturbed by the brutal wars of the 1990s, the trade ties between the pair were reaffirmed in 2006. That's when Bosnia, alongside the other countries of former Yugoslavia, followed Croatia into the Central European Free Trade Agreement (CEFTA) – a commonmarket free trade agreement between the non-EU countries of Southeast Europe.

The reduced cost of market-ready imports from EU states will increase competition for Croatian food producers on the internal market. At the same time, while they are looking to develop their new capacity to export freely into the bloc, goods they send to CEFTA states are already subject to a 15% import tax. That local market accounted for 45% of Croatia’s food exports last year.

"Traditionally our markets are very much connected, Croatian consumers are used to Bosnian products and vice versa," explains Vesna Malenica, a policy analyst at Sarajevo-based think-tank Populari. "Of course, before [the war] we were one country and one market." Croatia’s accession to the EU has meant the eradication of many tariffs and other trade barriers. However, despite increased access to the EU’s vast market, with over 500m consumers in comparison to CEFTA’s 27m, economic

So far, Zagreb's attempts to negotiate with individual CEFTA members for preferential trade agreements have been unsuccessful. That's largely because Croatia’s exit creates a vacuum in the trade club that neighbouring countries are keen to fill. In practical terms, this means most Croatian food goods will be priced out of CEFTA markets – a situation the Croatian Employers Association warn could create up to 3,000 job losses and cost the economy €250m a year.

Foot dragging However, farmers and food producers in neighbouring Bosnia stand to fare far worse. Whilst Croatia’s exit from CEFTA does not preclude continuation of Bosnian exports to the country, food products must now meet stringent EU standards. Despite having over five years to prepare, the Bosnian government’s administrative complexity and entrenched political rivalries – based on ethnic divisions – means necessary legislative and structural changes have simply not happened. Consequently, since July 1 no animal products from Bosnia, bar honey, fish, hides and skins, have been allowed across the border into Croatia. "The system here is too fragmented between state level and the other two entities [the Bosnian Federation and Bosnian Serb Republic]," explains Andy McGuffie, spokesperson for the Delegation of the EU to Bosnia. "The EU’s system of control is based on the principle of traceability, or farm to fork. This requires a single point of entry, an interlocutor, behind this needs to be a system behind which stands legislation." It's unclear how long it will take for Bosnia's authorities to reach the standards required for export to the EU. The last few months saw a flurry of action as the deadline approached, including the introduction of a Hygiene Package laying out standards for foodstuffs for export to the EU, as well as attempts to sew together existing pieces of legislation and regulation. However, even should the government manage to fulfil the necessary obligations, the EU's Food and Veterinary Office must still approve the results – a process that could take up to six months. The loss of Croatia, as the largest single importer of goods from Bosnia, accounting for over 60% of the country’s milk exports alone, to the EU will cost Bosnian farmers and food producers more than €22m annually. That's a potential disaster in a country with an unemployment rate already above 40%. State failure "It is going to be very difficult. This is a clear failure of state," says Malenica.

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"Many producers, especially big ones, have already taken required steps to align with EU standards," though adds that they are at the mercy of the foot dragging legislators. Milkos, one of Bosnia's largest dairies is one example. Over 50%, or €2.7m of the company’s annual exports, were previously sold in Croatia. According to General Manager Adin Fakic, the dairy has already fulfilled all business level obligations required for issuance of an EU export number; now it is waiting for the authorities to catch up. "This is irresponsible," he says. "We are in a global market, we need the same rights both in the region and in European trade." The situation means that instead being a growth opportunity, Croatia’s CEFTA exit leaves farmers and food producers trying to compensate for losses. "We have invested substantial effort and money in finding new markets in CEFTA," Fakic points out to bne. However, McGuffie warns conditions will be tough. "Croatia's exit is not just to the benefit of Bosnia. Other countries in the region such as Serbia, the Former Yugoslav Republic of Macedonia and even Turkey will also seek to expand business." Some interest groups are now calling for the EU to intervene; under the 1995 Dayton Agreement that ended the Balkan wars in the 1990s, the Office of High Representative has the power to issue the final word on contentious issues. But that's unlikely to happen. McGuffie insists Bosnia needs to start taking its own steps towards EU integration. "If we are running the country for them, then that's not helping. In a functioning democracy, politicians need to be accountable to citizens, and citizens need to make their voice heard." However, the EU spokesman also sounds a more optimistic note. "I think this is beginning to happen," he suggests, referencing the recent wave of public protest. "People need to ask, 'if we are in a situation where we can’t export our milk to Croatia, then are the politicians serving the people?' because it would appear not."

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Croatia urged to keep up corruption fight

Andrew MacDowall in Split As Croatia sealed EU membership on July 1, anti-corruption analysts were urging the country to maintain the fight against graft. Transparency International (TI) said in a June report it is concerned that having achieved its goal of joining the EU, Zagreb's efforts to stamp out graft risk coming to a standstill and slammed the failure to really get to grips with political corruption. The international watchdog focused on Croatia’s opaque system of campaign financing as a particular weakness. “Croatia should make political party financing more transparent to strengthen its democracy as it prepares to join the European Union (EU),” TI said in a statement. The report ranks Croatia third from bottom in the region in terms of “the reliability of political parties’ financial reporting”, beating only Serbia and Macedonia. “According to the report, independent experts in Croatia estimate that official reports on campaign financing only cover up to 50-60% of the actual revenue in campaign budgets,” TI said. A common issue across the whole region is that structures and legislation are in place, but implementation is patchy, and this is apparently the case in Croatia’s efforts to increase transparency. Luka Oreskovic, a Croatian researcher at Harvard University, tells bne that the issue of election campaign finance in Croatia is closely tied to the broader challenge of corruption, and that efforts to tackle graft have necessarily to encompass those to enhance transparency in political funding. However, he concedes that reforms in recent years have substantially reduced the flow of suspect money. Previously, an unholy alliance between parties and PR and marketing companies led to the recycling of cash from the advertising spend of stateowned enterprises (SOE) back to the ruling party. Oreskovic says that this channel has now been “completely eradicated," noting that state-owned companies (of which Croatia still has a number as its privatisation efforts have slowed) are now banned from using PR agencies. That makes it "highly unlikely that services of PR and marketing companies will be used by SOE's in exchange for later favourable campaign financing and advertisements for the party in power," Oreskovic suggests. However, TI’s report suggests “there is evidence to suggest that the media and advertising companies sell advertising space to parties and candidates at different prices”, despite legislation intended to stamp out these practices. As the watchdog notes, Croatia has gone further down the path of tackling high-level corruption than most of its neighbours. The jailing last year of former prime minister Ivo Sanander for graft and war profiteering, for instance, has few precedents. Oreskovic cites it as an example of the country’s seriousness in the struggle.

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Desperate measures in Turkey bne

aving hinted a week before that it would hike interest rates at its next meeting on July 23, it came as little surprise when Turkey's central bank kept to its word and raised the overnight lending rate by 75 basis points (bp). Whether that will do enough to help the wobbling economy is another question. Economists had been predicting a rate rise of between 50bp and 100bp, so the rise was in the middle of that range. The benchmark one-week repo was left unchanged at 4.5%, though this is of little import right now because the Central Bank of the Republic of Turkey (CBRT) allows market rates to move in a corridor between that lower rate and the higher overnight lending rate (now 7.25%), and market rates have already moved to the upper ceiling of the corridor over the past month. The accompanying statement from the central bank made clear that monetary policy would be tightened further “if needed”. However, for some who worry about the imbalances in the economy, this wasn't enough. "Disappointing… and I think an opportunity missed," says Timothy Ash of Standard Bank. "The reality is that the current account [deficit] and external financing requirements are way too large and the one message from the [US Federal Reserve] tapering scare for EM [emerging markets] over the past month is that the CBRT needed to work harder to force rebalancing and close the external financing equation sooner rather than later." Turkey's high current account deficit is the economy's chronic Achilles' heel, leaving it reliant on hot-money flows to fund a large part it. In April the 12-month trailing current account deficit widened to $51.3bn, which

is equivalent to about 6.0% of GDP, and it's expected to come in at around $59bn for 2013. "If you take the $59bn current account deficit forecast from the latest CBRT survey, and then add in the $163bn in short-term debt falling due over the next 12 months, this is the total external financing requirement which needs to be covered," says Ash. "At $222bn, this is a huge number relative to the size of the economy (about 28% of GDP). Indeed, this external financing requirement is probably equal to that of the rest of Emerging Europe combined, plus some change." Turkey has only been able to cover such a large external financing requirement because global markets have remained liquid, especially due to western central banks' quantitative easing flooding the global system with cash. The Turkish economy has received over $50bn in net portfolio inflows over the past year alone. The government has become addicted to these flows, yet a weak lira will do much to limit them. Given this, the CBRT has been defending the lira through liquidity controls and massive direct interventions in the currency market, because its whole "unorthodox" policy strategy has been centred on keeping interest rates low while trying to cap domestic demand to keep the current account deficit down. Through midJune, the country had sold $6.3bn to defend the currency. However, its foreign exchange reserves are running low; they dropped by 4.4% in nominal dollar terms over the course of May alone and are likely to have tumbled by nearly 10% during June, estimate analysts.

Risky business At times of market turbulence when money flows out of riskier economies and brings down the exchange rate, such countries like Turkey need high interest rates to keep and attract the amounts of capital required to fund the large current account deficit. And the lira has lost about 8% of its value against the dollar since May, when anti-government protests and Prime Minister Recep Tayyip Erdogan's heavy-handed response to them, together with the deterioration in the previously strong economy, began unnerving investors. Following the July 23 announcement by the bank, the lira strengthened to 1.9081 against the dollar from 1.9153 beforehand, while the 10-year bond yield fell to 8.49% from 8.69%, according to Reuters. However, Turkey faces a long, hot summer of protests and a year of crucial elections, so few think this latest hike in rates by the bank will be enough. "Turkey’s current account deficit leaves it vulnerable to a fresh deterioration in investor sentiment. We think the currency is likely to weaken further over the next six months, meaning further rate hikes are likely. We’ve pencilled in another 50bps increase in the by the end of the year. But another sharp sell-off in EM assets could still result in a much sharper rise in rates," says Neil Shearing, chief emerging markets economist for Capital Economics. Yet the CBRT is in a bind, because while raising rates would be the obvious thing to do to hold up the value of the lira, the PM and his ruling Justice and Development Party (AKP) have made a point of blaming the mysterious "interest rate lobby" as well as various other suspect groups like the international media for being behind the protests to destabilise the country. But the lira will remain under pressure throughout the summer. In the long run, to get that current account deficit down from the unsustainable 7% of GDP, Turkey needs to trade higher growth for tighter monetary policy – something Erdogan and the PM will be loath to do.

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The stance has already had an effect. At the same time as the government meeting, Belgrade raised RSD3.3bn ($38m) of two-year debt, which was just 33.7% of the RSD10bn offered. Serbia was forced to sell the issue at a yield of 10.48% - significantly above the 9.89% it achieved at a previous auction of two-year bills in May, the finance ministry's debt agency said in a statement. On July 11, the Serbian central bank also decided to keep borrowing costs unchanged after cutting the benchmark rate for two consecutive months.

Serbian resolve to resist IMF demands stiffens bne

ith a start date for EU accession in the bag, and global debt markets regaining a little of their recently lost confidence, the Serbian government insisted in July that failure to secure a new agreement with the International Monetary Fund (IMF) would not be "a tragedy". Following a government meeting on July 2, First Deputy Prime Minister Aleksandar Vucic cast fresh doubt on Belgrade's willingness to push to meet the demands of the IMF to secure a new loan, as investors have been hoping. Insisting the revised 2013 budget will be planned for Serb citizens, the powerful head of the largest party in the governing coalition insisted it would "not be a tragedy" should a fresh bailout not be agreed. Prime Minister Ivica Dacic echoed his stance. "We are not here because of others, but because of our citizens,"

the PM said. "The state did not go bankrupt even when it was at war, and it certainly will not go bankrupt now." Vucic said the IMF's demands would be very difficult to meet, and as Tim Ash at Standard Bank notes, Vucic is the power behind the ruling coalition in Serbia, heading the nationalist Serbian Progressive Party (SNS), which is currently riding high in the polls. "So one has to assume that what Vucic says, goes."

"Unfavorable movements in international financial markets have led to higher investor risk aversion, which has sparked an increase in risk premiums and depreciation pressures almost throughout the region,” the Narodna Banka Srbije said as it left its one-week repurchase rate at 11%. Policymakers are balancing the need to shore up Serbia’s struggling economy, against fighting inflation and shielding the weak dinar from recent market turmoil. Strategists say keeping rates unchanged is needed to maintain the carry trade appeal of the Serbian currency and ease pressures on the dinar from the past month, which forced the central bank to intervene 15 times between May 30 and mid-July to prop up the currency, selling €325m. In a note, Petr Grishin, economist at VTB Capital in Moscow, said keeping the pressure off the dinar “was the only reason to leave rates unchanged.”

"The state did not go bankrupt even when it was at war, and it certainly will not go bankrupt now"

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Xinjiang violence raises alarm bells in Central Asia Clare Nuttall in Astana

housands of kilometres from China’s booming east coast, the Xinjiang region has become Beijing’s gateway to Central Asia. But as the former backwater’s economy grows, rising social tensions have erupted repeatedly into deadly violence, most recently in June. Should the situation in this ethnically divided region worsen, it could have negative consequences – both political and economic – for Central Asia. Sharing borders with Kazakhstan, Kyrgyzstan and Tajikistan, the Xinjiang Uyghur Autonomous Region is the point of entry for China’s trade with the resource-rich region. Back in the early 1990s, this was mainly small-scale trade in consumer goods; Xinjiang’s capital Urumqi and the former silk road city of Kashgar are both within a

1,200km radius of Almaty and Bishkek, where two of Central Asia’s main wholesale bazaars are located. Two decades later, not only has trade grown 100 times, increasing from $460m in 1992 to almost $46bn in 2012, it also flows in the opposite direction with oil, gas and minerals entering China via Xinjiang. China is now the largest trading partner for both Kazakhstan and Turkmenistan, and among the top three partners of Kyrgyzstan, Tajikistan and Uzbekistan, China’s Deputy Commerce Minister Jiang Yaoping announced on May 28, Kazinform reported. As of 2010, while Central Asia accounted for just 1% of Chinese exports, the region absorbed no less than 83% of the Xinjiang region’s exports, with 52% going to Kazakhstan.

Kazakhstan’s trade with China saw a steady increase during Karim Massimov’s term as prime minister from 2007 to 2012. An ethnic Uighur educated in China, Massimov is widely credited with further opening up trade with China. With China’s growing demand for raw materials, there have been heavy investments into infrastructure to export Central Asian oil, gas and minerals. The Central Asia-China gas pipeline exports gas from the Turkmen Caspian basin to Xinjiang, via Uzbekistan and Kazakhstan, with Uzbekistan starting exports through the pipeline in mid-2012. Kazakhstan also has a direct oil pipeline link to China, and exports are expected to increase after the launch of production at the offshore Kashagan oilfield, where

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China National Petroleum Corp (CNPC) will soon become a shareholder. There are also plans to build new road and rail infrastructure connecting Central Asia and Xinjiang. Minority report However, Xinjiang has become increasingly restive in the last two decades as millions of Han Chinese settled in the region, turning the Uighurs, who now make up just 48% of the population, into a minority. Growing social inequality is another factor. This has raised concerns in the Chinese government both about internal security and the possible consequences for trade with Central Asia. The most serious outbreak of violence was in 2009, when at least 200 people were killed in days of rioting in Urumqi. The trigger was a demonstration over the “Shaoguan incident”, the deaths of two Uighurs in a fight in China’s Guangdong province, but it escalated into attacks on local Han Chinese and large-scale inter-ethnic fighting. The violence also had an impact on Kazakhstan and other Central Asian countries, which temporarily banned travel to Xinjiang. The move was intended to protect their own citizens and seal the borders against any potential spillover effects, but caused a temporary slump in trade. Violence broke out again in June, leaving at least 35 people dead, with unofficial sources saying the death toll was considerably higher. The first incident was in the Turpan region, where a group armed with knives launched an early morning attack on a police station and local government offices, torching police cars and killing nine police officers and eight civilians before security forces opened fire. Just days later, there was a second outbreak of violence in Hotan, in the south of the region. The Chinese press quotes foreign ministry spokesman, Hua Chunying, describing the Turpan riot as a “violent terrorist attack”, the usual line taken on incidents in the region. However, there

appears to be some acknowledgement of the social and economic pressures behind the attacks. “The economic modernisation programme in Xinjiang has had less benefit for the ethnic minorities, especially the Uighurs, resulting in economic stratification between rural and urban areas, and different ethnic groups,” says Dr Michael Clarke, research fellow at Griffith University and author of "Xinjiang and China's Rise in Central Asia". "Both Turpan and Hotan have experienced rapid urbanisation in the last 10 to 15 years, so there is a direct correlation between the central government’s modernisation programme in Xinjiang and growing ethnic resentment." Heading off trouble Ironically, since the breakup of the Soviet Union the Chinese government had been pushing to develop Xinjiang, and promote trade with Central Asia, in an attempt to ensure the region’s future stability. This includes safeguarding China against any spillover of instability from Central Asia or Afghanistan, says a report from the International Crisis Group. “China’s strategy seems to be the creation of close ties with Central Asia to reinforce economic development and stability, which it believes will insulate itself, including its Xinjiang

Central Asia and Xinjiang share a common history and religion, and the Uighur language is similar to the Turkic Central Asian languages. There is a substantial Uighur minority in Kazakhstan of up to 200,000 people, while Kazakhs are the second-largest national minority in Xinjiang. During the Soviet era, Uighurs in the Soviet Union were allowed a higher degree of cultural expression, probably in an attempt to unnerve the Chinese authorities. This continued immediately after independence, with a conference on the creation of an independent “Uighuristan” held in the former Kazakhstani capital Almaty in 1992. This raised alarms in Beijing that the newly independent Central Asian states – especially Kazakhstan – could inspire the Uighur minority to push for independence. However, with the two revolutions in Kyrgyzstan and Kazakhstan’s own 2011 Zhanaozen tragedy, internal security has been made a higher priority in Central Asia. While there has not yet been any political fallout in Central Asia from the 2009 and 2013 violence in Xinjiang, there are concerns on both sides of the border about the spread of unrest in either direction. “The potential for spillover is always there, given Kazakhstan’s large Uighur population and the number of Uighur political

"Despite being divided by the Chinese and Russian spheres of influence, Central Asia and Xinjiang share a common history and religion" Uighur Autonomous Region, as well as its neighbours from any negative consequences of Nato's 2014 withdrawal from Afghanistan,” writes the Crisis Group’s Central Asia project director, Deirdre Tynan. Despite being divided by the Chinese and Russian spheres of influence,

organisations active in Kazakhstan. However, in terms of the recent violence, spillover to Kazakhstan in particular seems unlikely, give the security cooperation developed between the Kazakh and Chinese authorities,” says Clarke, citing the Shanghai Cooperation Organisation (SCO) as an example.

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terrorist attacks in Russia including those on the Moscow metro in 2010 and Moscow's Domodedovo airport in 2011, reportedly lost a bodyguard in a gunfire exchange with the Russian Antiterrorism Committee on July 13, according to media reports.

Olympic test in Caucasus Molly Corso in Tbilisi

n the face of threats of terrorism against the Sochi 2014 Olympic Winter Games, Georgia has put its full support behind Russia's Olympic endeavour. But analysts warn it's unlikely this will provide any real improvement to Tbilisi-Moscow relations or resolution to the problem of its breakaway regions of Abkhazia and South Ossetia. Doku Umarov, a Chechen Islamist military leader, called on his followers to thwart Sochi 2014 in a video message released on July 3. This new strategy marks the end of a ceasefire Umarov started last year when Russians started protesting against President Vladimir Putin and his government. In his message, Umarov called on Mujahedeen to use “maximum force” to stop the Games. “They plan to hold the Olympics on the bones of our ancestors, on the bones of many, many dead Muslims buried on our land by the Black Sea. We as Mujahedeen are required not to allow that, using any methods that Allah allows us,” he said in the video, which is believed to have been filmed in June.

Coming nearly a month after a series of YouTube videos that outlined jihadist threats to target Georgia in retribution for its support of the Nato mission in Afghanistan, the video message raised concern in Georgia. While the timing of Umarov’s message was disturbing, regional security specialists, as well as the Georgian government, have

Blame game Working to stop the terrorist groups is in Georgia’s interests, according to regional specialists. McGregor, who also serves as a senior editor at the Jamestown Foundation Global Terrorism Analysis Program in Washington DC, tells bne that any terrorist attack at the Sochi Games could indirectly hurt Georgia if Moscow decides to blame it as part of the ongoing propaganda battle raging between the two countries. “I think they [Georgia] are doing all they can do. They are trying to distance themselves from the [Mujahedeen] and they are giving some basic support for the Sochi Games,” he said. “I don’t think any kind of attack at the Sochi Games could benefit Georgia.” While tense relations with Georgia over the conflict territories have captivated Russia’s attention in the past, Moscow has bigger concerns as the country prepares to host the Games, McGregor said. Islamic groups, already angry with Moscow over its policy in the North

"Russia has a long history of blaming Georgia for harbouring terrorists" downplayed concerns that supporting the Games could make Georgia a target. “I don’t think the North Caucasus Mujahedeen views Georgia as a special enemy,” says Dr Andrew McGregor, director of Aberfoyle International Security in Toronto, Canada. While the threat of terrorist attacks is unlikely to extend to Georgia, Russians are already trying to counter the possibility of an uptick in violence in the region. Umarov, who has taken credit for some of the most horrific

Caucasus, are fuming at Russia’s support of Syria, he said, which makes them a much bigger threat than Tbilisi in the run-up to the Sochi Games. Fears that security problems at the Games could be used against Tbilisi have long been a concern, however. Russia has a long history of blaming Georgia for harbouring terrorists; in 2001, Moscow used the pretence of Islamic fighters allegedly hiding in Georgia’s Pankisi Gorge to bomb the area. Last year, Georgian Special

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Forces were involved in a controversial shootout with its own citizens, allegedly Islamic fighters attempting to use Georgia’s border with Dagestan and Chechnya to travel. Over the past month, however, Georgian Prime Minister Bidzina Ivanishvili and Defense Minister Irakli Alasania have both pledged to work with the Russians to ensure security at the Games. Ivanishvili told reporters in May that his government is ready to “provide maximum assistance” to Moscow to insure security at the Games. Russian President Vladimir Putin has tentatively agreed to take Georgia up on its offer, although there has not been any public discussion on how the two countries would work together. The topic is a tricky one for both Tbilisi and Moscow. In addition to the

fact the two countries have not had official diplomatic relations since the August 2008 war, the Sochi Games are scheduled to be held about 4 kilometres outside of Abkhazia, one of Georgia’s

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border that separates the breakaway territory from Georgia proper. On July 15, during a press conference, however, Alasania told reporters Georgia

"We want peace during the Olympic Games"

two conflict territories. Abkhazia and South Ossetia have been recognized as independent states by Russia. An unknown number of Russian troops are stationed in both territories, and in South Ossetia Russia has taken the added precaution of building a fence around the de-facto administrative

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

has “repeatedly” voiced its readiness to help prevent terrorist attacks at the Sochi Games. "The Georgian government and myself have repeatedly spoken about our willingness to cooperate with regional countries, including Russia, in assuring the security of the Sochi Olympics. We want peace during the Olympic Games,” he said.

What you need to know

www.bne.eu

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depends heavily on the availability of effective information systems which streamline credit risk management and consequently support the financial needs of businesses and consumers." The Tajik project was CRIF's first step into the Central Asian market, which "with few existing credit bureaus but growing economies... represents for us also an interesting business case for long-term growth."

Tajikistan moves to reduce risk for lenders Clare Nuttall in Astana

wo recent developments – the launch of the country's first credit bureau and the adoption of new legislation on money laundering – are set to create a better environment for banks and other lenders in Tajikistan. Tajikistan's first – and only – credit bureau, the Credit Information Bureau of Tajikistan, has been "very active" since its launch on June 12, according to one of its founders, international credit information systems developer CRIF. The bureau was set up by several of Tajikistan's largest banks together with CRIF and the International Finance Corporation (IFC), part of the World Bank Group. Its aim is to help banks and other financial institutions to assess risks, thereby reducing borrowing costs and increasing the availability of credit – one of the main obstacles faced by businesses in Tajikistan. The National Bank of Tajikistan issued a licence for the bureau in December,

and for the last six months it has been collecting information to build up a database of more than 200,000 records. The bureau has already signed contracts with nine banks and microfinance institutions representing over 80% of the Tajik market, and

The IFC said in a statement that launching the bureau will help improve access to finance for small businesses, entrepreneurs and consumers. "The credit bureau will play a critical role in increasing access to finance and promoting financial stability in Tajikistan by enabling responsible access to finance and expanding access to credit," says the IFC's principal operations officer, Fabrizio Fraboni. At risk Also in June, Tajikistan adopted new legislation setting criminal penalties for money laundering, shortly after the release of a report naming the country as one of the world's most at risk for illegal money flows and terrorist financing. Several new laws aimed at protecting the local currency, the somoni,

"The credit bureau will play a pivotal role in credit risk management and in the promotion of a more mature credit culture in Tajikistan" is now in the process of testing and loading data from these institutions, a CRIF spokesperson told bne. "The credit bureau will play a pivotal role in credit risk management and in the promotion of a more mature credit culture in Tajikistan," says Enrico Lodi, general manager of credit bureau services at CRIF. "As CRIF has already experienced in many other countries, the evolution of the financial sector

and preventing money laundering were passed by the upper house of parliament on June 12, and signed by President Emomali Rakhmon the following day. The legislation amends the existing penal code to criminalise money laundering and terrorism financing, central bank Chairman Abdujabbor Shirinov told the upper house of parliament, according to CA-News.

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The new legislation follows the release of the 2013 Basel Anti-Money Laundering (AML) Index by the Basel Institute on Governance. The survey ranks Tajikistan fourth from the bottom in the world. Only Afghanistan, Iran and Cambodia performed worse on the index of 149 countries. The index ranks countries on their vulnerability to money laundering and terrorism financing, looking at indicators including AML and CounterTerrorist Financing (CTF) frameworks as well as rule of law, financial standards and public transparency. Criminalising money laundering was one of the key tasks set for Dushanbe by the Financial Action Task Force (FATF). At a parliament session in May, Shirinov said the legislation had been drawn up following that international assessment delivered in 2007. The report criticised the situation in Tajikistan, and the country was placed under a monitoring regime by the G7 initiative, but Dushanbe has been slow to move. In February, the FATF criticised Tajikistan for its lack of progress. "Despite Tajikistan's high-level political commitment to work with the FATF and EAG [Eurasian Group] to address its strategic AML/CFT [Anti-Money Laundering and Countering Financing of Terrorism] deficiencies, the FATF is not yet satisfied that Tajikistan has made sufficient progress in implementing its action plan, and certain strategic AML/CFT deficiencies remain," the report said.

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Tea for two hundred in Tajikistan

Clare Nuttall in Astana Tajikistan is about to get a new entry in the Guinness Book of Records when it opens the world’s largest tea house in time for Independence Day on September 9. While more than a third of the country’s population still live below the poverty line, a staggering $60m is being spent on the teahouse in Dushanbe. Situated on the shores of Lake Komsomol, not far from central Dushanbe, the many domed teahouse – known as a choikhana in Tajikistan – will have a billiard hall, ballroom and presidential dining room, according to Eurasianet. At $60m, the cost is around 1% of Tajikistan’s annual GDP. It is just one of a growing number of prestige projects in the Tajik capital, many of them built by local business owners keen to impress President Emomali Rakhmon. Tajikistan has already taken the record for the world’s tallest flagpole and the world’s longest flag. In the two decades since independence, other Central Asian states have also sought to make their mark through exotic architecture – the cities of Ashgabat and Astana being particular examples. Turkmenistan holds the record for the world’s largest enclosed Ferris wheel, and Ashgabat has the highest density of white marble buildings. But unlike the Turkmen and Kazakh capitals, Dushanbe doesn’t have constant flows of petrodollars to finance vanity projects, which include Central Asia’s largest national library and mosque, in addition to the new tea house. In 2012, the national library opened in Dushanbe, with 25 reading rooms over nine floors and room for 10m books. However, the $40m allocated to the library from the national budget was not enough to fill the shelves, and the library opened with just 2.5m books – despite a national campaign spearheaded by the ministry of education asking Tajiks to donate “unwanted” books. Still under construction is the region’s largest mosque, which will have capacity for 115,000 worshippers. Qatar is providing 70% of the $100m construction costs, with the remaining $30m coming from the Tajik government. It is not clear how much benefit these investments have for the Tajik population. According to Eurasianet, around half the 400 workers at the tea house are Chinese, despite chronic under-employment in what is the poorest state in the former Soviet Union.

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Karaganda and Kostanai – which together make up half Kazakhstan's car market, in 2013, and expand mainly in the south of the country in 2014.

Kazakhstan's car industry moves into the fast lane Clare Nuttall in Astana

azakhstan has seen a sharp increase in purchases of new cars in the last year, with sales breaking pre-crisis records. Rising incomes, Kazakhstan's entry to the Customs Union and legislation restricting imports of used cars have all contributed to the increase, encouraging firms such as France's Peugeot Citroen to set up production in the country and existing manufacturers to expand their operations. Peugeot has announced plans to launch production in the northern industrial city of Kostanai in July, with the first locally assembled cars due to reach dealers in September. Expanding into Kazakhstan is part of the French company's strategy to diversify away from its base in Europe, where demand is still sluggish. Speaking to journalists in Astana in June, Peugeot general director for operations in Russia, Ukraine and the Commonwealth of Independent States (CIS), Bernd Schantz, said that the crisis in the European auto market has prompted the automaker to develop other regions with the aim of increasing the share of its business outside Europe to 50% of the total by 2015.

Kazakhstan was selected because of the rapid growth of its car market. "Kazakhstan has benefitted from political and economic development and a good investment climate," Schantz told journalists. The market has

Peugeot is not the only company to aim to take advantage of growing demand and spending power in Kazakhstan. Several manufacturers in the two industrial centres of Kostanai and Ust-Kamenogorsk have launched 50 new models in the last three years. Kazakhstan's largest auto-manufacturer, Azia Avto, announced in May 2013 that it had dispatched the first consignments from its Ust-Kamenogorsk plant to the Russian market. However, domestic manufacturers still account for only around 20% of new cars purchased within Kazakhstan. Petrol heads The market as a whole saw a dramatic upturn in 2012, when around $2bn worth of new cars were purchased, beating sales in the pre-crisis consumer boom. According to the Association of Kazakhstani Auto Business (AKAB), 98,000 cars and light vehicles were purchased in 2012 – more than double the 45,300 purchased in 2011. This trend has continued into 2013, with 13,290 new vehicles sold in May, 29%

"Kazakhstan has seen a steady increase in income per capita and disposable income, but still has relatively few cars on the road" the potential to triple in size to 300,000 cars a year, Kazakhstan's Minister of Industry and New Technologies Asset Isekeshev predicted in February. Initially, four Peugeot models will be produced at Kostanai-based AgroMash Holding with production to start at 4,000 vehicles a year. Production may increase to 10,000 vehicles in future. Peugeot, which will work with distributor AllurAuto, the parent company of AgroMash Holding, plans to target four cities – Almaty, Astana,

higher than the 8,369 sold in May 2012. Total sales since the start of 2013 were up 72% on year to 54,342, and the AKAB forecasts that new vehicles sales for the whole of 2013 will be at least 155,000. The association attributes this to "accumulated deferred demand, recovery of purchasing power and market lending, as well as government support for the domestic auto retail sector." Kazakhstan has seen a steady increase

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in income per capita and disposable income, but still has relatively few cars on the roads, with just 214 cars per 1,000 people, compared with 523 in France and 643 in the US. "Sales are still low by international standards... in Russia 158 cars are sold per 100,000 people and in Germany the figure is 428 new cars per month; we have barely reached 83. Thus the growth potential of the Kazakhstani market remains high," says the AKAB. Meanwhile, the average age of cars in Kazakhstan is between 13.5 and 19 years, varying strongly between regions, compared with the European average of just seven years. Along with the other Central Asian countries, Kazakhstan has long been the final destination for

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ageing vehicles from Europe and the Far East. While demand for new cars soared in 2012, there was a corresponding 75% fall in purchases of used cars. The sale of more economy model cars, and restrictions on imports of used cars, are responsible for the fall in used car purchases, many of which still take place in the shadow economy. The launch of the Customs Union, which removed customs barriers with Russia and Belarus, is another factor driving the market by reducing the cost of Russian made cars to Kazakhstani consumers. Kazakhstan is also set to join the World Trade Organisation (WTO) in 2013, which will result in substantially lower customs duties on cars from WTO member states.

Mynbayev’s announcement came a day after the then chairman of KMG, Lyazzat Kiinov, said on July 1 that Conoco Phillips’s stake will be sold to China National Petroleum Corporation (CNPC) via back-to-back deals with KMG. He did not offer a deadline for the deal's completion but said he hoped it would close quickly.

Kazakhstan blocks India's Kashagan deal in favour of Chinese Clare Nuttall in Astana

s the long-awaited launch of production at Kazakhstan’s offshore Kashagan oilfield approaches, the Kazakh government confirmed in early July that it is using its preemptive right to block the sale of Conoco Phillips' stake in the field to India's ONGC Videsh Ltd. The stake is instead set to be sold to China National Petroleum Corp (CNPC), reinforcing

China’s growing role in Kazakhstan’s energy sector. Shortly before being moved to head of state oil and gas company KazMunaiGas (KMG), Oil and Gas Minister Sauat Mynbayev said the government would buy US major Conoco Phillip’s 8.4% stake through KMG, which is one of Kashagan's largest shareholders.

Speculation had already spiked that Chinese state-owned CNPC would get its hands on the stake, despite an agreement struck by the US company in November 2012 to sell it to India's ONGC Videsh Limited (OVL). The price the Chinese company has reportedly agreed is slightly above the $5bn that the Indian state-controlled company had agreed. Having invoked legislation allowing it the final say on "strategic" investments in the country to delay that deal, the Kazakh government was expected to make a decision on the sale of the stake to OVL by May 25. However, those negotiations have dragged on, with Chinese officials understood to have been lobbying hard for the asset. China has been steadily increasing its investment in Kazakhstan's oil and gas sector, as it seeks to secure steady supplies of hydrocarbons to meet

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growing domestic demand. Around 25% of Kazakhstan's oil output is now produced by Chinese companies. The purchase of Conoco Phillips' stake would finally give Beijing an interest in the massive offshore field a decade after members of the North Caspian Operating Consortium (NCOC), which is developing the field, blocked an attempt by CNOOC and Sinopec to buy BG Group's holding. With a similar thirst for energy, India has also invested in oil and gas assets in the Caspian region, buying into Kazakhstan's Satpaev field as well as investing into Azeri assets. However,

by October at the latest, according to Kazinform. However, an oil and gas industry source tells bne that there is still the possibility that production may again be postponed until early 2014. In recent weeks, the start date has edged closer. In June, the Bolashak Processing Facility, which will process crude from Kashagan, was formally opened. NCOC has since announced that it had started introduction of sweet gas into the offshore facilities on the artificial D Island on July 17, following the lighting of the flare on 14 July – another milestone bringing the project “a step closer to the start of production

"The price the Chinese company has reportedly agreed is slightly above the $5bn that the Indian state-controlled company had agreed" there is no infrastructure linking the region to India, despite a proposal from New Delhi to build a pipeline. Almost there The news comes as the existing consortium approaches the start of commercial production at the field after years of delays – mainly due to technical difficulties – that have frustrated Kazakhstani officialdom. The much-postponed launch of production at Kashagan is believed to have been the reason behind the decision to sack Mynbayev after six years as oil and gas minister, demoting him to head KMG on July 3. The consortium, which includes Shell, ExxonMobil, Total and Inpex as well as KMG, faces heavy financial penalties if production does not begin by October 1, but the launch date is still not clear despite pressure by the Kazakh government to start by July 6 – the Capital Day holiday and President Nursultan Nazarbayev’s birthday. New Oil and Gas Minister Uzakbai Karabalin then announced during a visit to Atyrau on July 18 that preparations were 98% completed, and production would start

later this year,” the consortium said in a statement. Workers are also being laid off at several Kashagan-related sites as construction work is completed, triggering a three-day strike at D Island in early July. Kashagan is the world’s largest oilfield discovery in the last three decades, with an estimated 35bn barrels of oil, and the government is eager to start receiving revenues from increased oil exports. The NCOC plans to produce 180,000 barrels per day in the first phase of operations, increasing output to 370,000 b/d in the second phase. When the field reaches peak production it will launch Kazakhstan among the world’s top oil exporters. In the shorter term, the production launch will revive Kazakhstan’s slowing economic growth, which has taken a hit from the slowdown in China and other trading partners. The International Monetary Fund (IMF), which forecasts 5.5% GDP growth in 2013, cites possibility of delays in the start of production at Kashagan as one of the main downside risks for this year.

bne August 2013

Eurasia

Mongolian investor heads for final frontier Terrence Edwards in Ulaanbaatar

small yet bold Mongolian firm is preparing to launch a new oil enterprise in North Korea. It’s an unlikely pairing, but the firm is betting it has the key ingredients to make such an unlikely gamble pay. As Mongolia sputters away from frontiereconomy status into the territory of middle-developed, Mongolian Stock Exchange-listed HBOil has hopes to tap into one of the world's last remaining true frontier markets. The company is counting on Mongolia’s close relations with the neighbouring hermit kingdom to help serve as a base to launch the country’s first home-grown multi-national. “It's a big opportunity, especially having ownership in a foreign company,” said Ulziisaikhan Khudree, HBOil's chief executive. Valued at just $2m, HBOil is chiefly involved in oil-waste recycling, but it has thus far found its digs at home less than fulfilling; Mongolia sports just one producing oil well and no refineries. North Korea may mirror the potential Mongolia has in natural resources – with 24 times the reserves of South Korea and 360 varieties, according to the Korea Energy Economics Institute. A 2012 report by the Asia-Pacific-focused think tank Nautilus Institute suggests the best indicator of potential onshore production is reports from 2006 of up to 300,000 tons of crude oil a year, while Pyongyang is said to be eyeing the West Sea (the Korean name for the Yellow Sea), which is said to hold 12bn barrels of oil. The deal will open onshore exploration, development, and production rights for HBOil via the full acquisition of Malaysian company Ninox Hydrocarbons (L) Berhad. Ninox will

offer HBOil 20% in KOEC International – a joint venture with the state-owned Korea Oil Exploration Corp – as well as the option to acquire 51% of an entity with oil exploration and production rights in the Korean East Sea (internationally known as the Sea of Japan). The value of the deal has not been released, but a capital raising of $5-15m will cover the costs and also determine the acquisition of the offshore interest, according to Ninox. Breaking the chains of energy dependence Dependence on foreign fuel has built a strong desire in Mongolia to develop the country's own production capabilities. Petrol and diesel shortages are the norm during the summer months, when Russia typically cuts its supply, while in January 2012 Mongolia was pushed to the verge of crisis when oil prices spiked 16% overnight. Lacking in its own industries, Mongolia relies on imports

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refurbishment currently, HBOil hopes it will eventually win the right to deliver all of Sungri's output to Mongolia. “From our perspective the refinery is a strategic value proposition… from HBOil's perspective, they were looking at expanding their domestic recycling business by taking it overseas and potentially looking at refineries,” says Joseph Naemi, CEO of Singapore-based seller Ninox Energy. With rail already linking Rason and Mongolia, the deal also hints at future access to North Korean ports, which would offer Mongolia’s growing minerals output reach to new international markets. Currently China consumes more than 90% of the country's mineral exports, but with the giant's growth slowing, access to Japan, South Korea and India would hedge Mongolia's risks. Such a move was advised in a report published by Japan’s Economic Research Institute for Northeast Asia (ERINA) last January. “Mongolia's securing of sea access to the Pacific via DPRK ports is highly strategic and could reduce its dependence on Chinese and Russian transit ports," it forecast. Fool’s errand or final frontier? North Korea is absent from the lists of most investors due to perceptions of a regime gone rogue, the veil of mystery surrounding the governing structure,

“Mongolia's securing of sea access to the Pacific via North Korea ports is highly strategic and could reduce its dependence on Chinese and Russian transit ports" to meet demand for numerous goods, including most groceries. Hikes in fuel prices therefore directly impact prices as transport costs are hit. A key point in the deal for HBOil then is the interest it offers in the Sungri Oil Refinery at the Rason Special Economic Zone on the northeast tip of North Korea. Although the facility is under

and its concerning nuclear agenda. The Eurasia Group counted North Korea as one of its top risks for 2013 for these reasons, but HBOil and Ninox say they have seen enough change to validate the move. “There's lots of foreign investment in the DPRK,” says Naemi, adding industries such as tourism and telecoms to mining, where foreign investors had already made their mark.

Opinion

bne August 2013

Navalny found guilty, but Kremlin got the wrong man bne

court in the regional city of Kirov found anti-corruption blogger Alexei Navalny guilty of corruption on the morning of July 18 in a closely watched case. Navalny has been sentenced to five years in jail for theft and embezzlement, with Judge Sergei Blinov ruling the anticorruption campaigner had defrauded a timber firm. The verdict in theory bans Navalny from public office for life. According to the law on the main guarantees of suffrage in Russia, those Russian citizens who “are imprisoned some time ago for grave and heinous crimes, except for the cases, when under a new criminal law these offences are not found grave or heinous crimes,” do not have the right to run in elections. Navalny has already declared his intention to run for president in the next election in 2018. He is also trying to run in the Moscow mayoral election this September, for which he was accepted as a candidate earlier in July. On July 20, Navalny arrived in Moscow after being released on bail while he appeals his conviction on embezzlement charges, declaring to a crowd that he intends to win the mayoral election. According to reports, a higher court decision is now needed to decide the issue. The case has become a cause célèbre and taken as an example of the misuse of the judiciary by the Kremlin to further its political aims. According to Navalny’s camp, the charges were trumped up and nonsensical, but the outcome of the trial was never really in doubt: the presiding judge has never acquitted a defendant in his career, according to press reports. However, the Kremlin has convicted the wrong man. If the point of the trial was to neuter a political rival, then Navalny is not that man. While he serves a useful job as an anti-corruption blogger – three senior Duma deputies have been forced

to quit this year on the basis of evidence of dodgy dealing provided by Navalny – he remains a political non-entity amongst the Russian voting population. Journalist Irina Galushko tweeted from Kirov just before the trial opened a comment by a local passerby: “#Navalny's trial again? so f***** sick of it, when will they finally put him away!” – a sentiment that sums up a widespread attitude to the case by most Russians.

"If the point of the trial was to neuter a political rival, then Navalny is not that man"

Take the Moscow mayoral election: incumbent Mayor Sergei Sobyanin has a massive lead in the race with some 46% of the vote, according to the most recent opinion poll. Navalny has around 3% of the vote – he won't even be an “also ran” unless something dramatic happens. And this is in Moscow where opposition to the regime of President Vladimir Putin is at its very strongest. The problem is Navalny is not the Nelson Mandela figure that most international press reports make him out to be. He has not founded a party (he refused to join a political party set up by his own followers.) He has come up with no alternative programme. And he doesn’t even have grassroots support. Indeed, the entire opposition movement is losing its relevancy with the Russian people, as it has failed to offer any ideas other than “not Putin,” which is not a political platform.

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Opinion

Navalny’s name has been climbing up the recognition stakes, which in other countries would mean he would have a shot at a political career. But in Russia, as Navalny becomes more famous, his popularity with Russians is actually falling – perhaps because he has not put forward any concrete reasons for people to support him. The irony here is another poll found that most Russians think Navalny’s trial was politically motivated, but at the same time most Russians could give a monkey’s if he is convicted or not. Other polls found what Russians really care about is inflation and unemployment – both scoring over 60% in another poll, whereas freedom of speech and rule of law comes way down near the bottom of the list, says Levada Centre research. The appeal of Putin is that he offers stability and prosperity, whereas Navalny offers change and uncertainty; what most commentators miss is that Russians are making their political decisions in the context of the 1991 collapse of the Soviet Union and the chaos that followed. In this context, uncertainty is very unappealing so most prefer (and polls show increasingly reluctantly) to take the stability over more freedoms. That will change, but it is going to be a long, slow process – perhaps even a generational one. In the meantime, Navalny’s campaign so far consists almost exclusively of playing to the international media that have been following him about in a swarm; almost the entire international press corps made the trip to Kirov to report on the trial to the point where the court posted a list of “first come, first served” correspondent names on the door of the court the day before the trial, as the room couldn’t hold everyone who wanted to watch. This is not to say Navalny or his campaign is irrelevant, or that the international press should ignore the case. Navalny is important because he is the personification of the lack of rule of law, the atrophied state of civil society, an illustration of the impunity with which the elite can rob the country of its riches, and, most scary of all, the 1930-esque intolerance in the Kremlin has shown for any sort of organised opposition to its rule. But if the Kremlin was worried about opposition politics then it would have done better to ignore Navalny because he is not building an effective opposition alternative to the powers-that-be. All the Kremlin has done is give itself (yet another) huge PR black eye, and if anything bolstered Navalny’s very thin credentials as a politician, as opposed to his real credentials as an effective civil society activist. But there is the rub: other than Navalny, there is no one else in the opposition that can don the mantle of “leader.” Hence the furore over this case.

"Navalny’s campaign so far consists almost exclusively of playing to the international media, who have been following him about in a swarm"

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bne:Invest in Azerbaijan

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

Multilateral strategic partner Azərbaycanda İxracın və İnvestisiyaların Təşviqi Fondu

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bne August 2013

AZPROMO is the main partner of the bne:Invest in Azerbaijan newsletter.

www.azpromo.az

AZPROMO nurtures progress through diversity bne

zerbaijan is a rich country. Home to some of the biggest hydrocarbon reserves outside of Russia and the Middle East, it has been the second fastest growing economy in the world over the last decade after China, says The Economist. But the government has launched a major campaign to make use of its oil wealth to diversify away from its dependence on raw materials and so ensure the long-term prosperity of the Caucasus republic. This strategy has met with some success. While hydrocarbons still play an important role in the stateâ&#x20AC;&#x2122;s finances, the private and non-oil sectors have already taken over as the main motors for growth, says Rufat Mammadov, head of Azerbaijan Export and Investment Promotion Foundation

(AZPROMO), a joint public-private initiative established by the Ministry of Economic Development of Azerbaijan in 2003 with the aim of attracting foreign investments in the non-oil sectors of economy and stimulating the country's exports of non-oil goods to overseas markets. Azerbaijan first came to the attention of international investors in mid-1990s when the first large-scale contract with a number of leading global oil companies was signed. Foreign investors received an even stronger message after the economy exploded in 2006 and 2007, putting in annual growth of 35% and 25% respectively in those years after the countryâ&#x20AC;&#x2122;s oil exports were hooked up to the rest of the world via new pipelines running out of the region.

The pace of growth has come off those heady highs more recently, but Azerbaijan was still the fastest growing country in the world in 2009, and even the 5% the economy recorded over the first six months of this year, the latest available statistics, still makes it one of the fastest growing states in the world. It is noteworthy that the economy is among the most stable ones in the world. So, according to the World Economic Forum, Azerbaijan boasts a stable macroeconomic environment and is placed 18th among 144 countries in this pillar of the latest Global Competitiveness Report. And oil is contributing progressively less and less to the bottom line expansion. Last year, oil and gas did not contribute to the overall growth, declining by 5%, while the non-oil sector came to 9.7% growth in the same year. Thus, the 2.2%

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GDP growth was driven by the non-oil economy. The same is happening this year, with the non-oil sector expanding by 11% over the first six months of the year. The reason for this change is the state has been pouring money into other sectors of the economy. The most profitable investments are increasingly found in the private sector and are connected with the growing middle class as per-capita incomes continue to balloon. Today, more than half (52.7%)

the rest of the economy: the share of FDI in oil and gas has fallen in favour of non-oil FDI, while the overall volume of investment has been rising steadily. Encouraging results were achieved in 2012, when volume of inward foreign investment into Azerbaijan increased 23.4%. The government has focused on various non-oil sectors, including manufacturing, construction, ICT, agriculture, food processing, tourism, chemicals, renewable and alternative energy and trans-

"Growth in the non-oil sector has averaged 10.6% a year for the last decade" of the country’s GDP is produced by the non-oil sectors and 83% of the economy is in private hands. The government launched its diversification programme in 2003, setting a series of goals. At the same time, the state has been investing heavily into infrastructure – both physical and social. “There are seven areas we are concentrating on where the oil and gas revenues are being spent according to the long-term strategy on the management of oil and gas revenues. These are (i) development of non-oil sectors, including regional and SME development, (ii) infrastructure development, (iii) poverty reduction and social development, (iv) promotion of intellectual and high-tech economy, (v) development of human capital, (vi) defence and, (vii) rehabilitation of liberated territories, refugees and IDPs,” says Mammadov. “Now, growth in the non-oil sector has averaged 10.6% a year for the last decade as a result of this strategy.” All this good news means investors have increasingly been translating curiosity into action. In 2003 and 2004, Azerbaijan was the world leader in terms of foreign direct investment (FDI) on a per-capita basis. A lot of this money has obviously been going into developing the country’s raw materials, but as incomes rise increasingly it is going into

port as strategically important sectors with a slew of projects in each. Construction and transport has attracted some of the biggest investments. Using its strategic geographical location, Azerbaijan turned into a key player in the region initiating projects vital to the region at large. A new seaport is being built on the outskirts of Baku together with a new shipyard. Likewise, the country already boasts six international airports and a new shiny, glass-fronted terminal is under construction in the capital. The country has initiated a number of oil and gas supply pipelines including BakuTbilisi-Ceyhan oil pipeline, Baku-TbilisiErzurum gas pipeline, and the Trans Anatolian Natural Gas Pipeline (TANAP). The latest developments on the Trans Adriatic Pipeline project will further increase Azerbaijan’s role in ensuring energy security in Europe. Road and railway infrastructure development is also among key priorities. The biggest ongoing project is the Baku-Tbilisi-Kars railway link that will not only join the main economies of the region together later next year, but make the Caucasus a transport bridge between east and west. “We have been investing into things like highways, airports and ports with the aim of creating a regional transport hub,” says Mammadov.

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The tourism sector is already well developed as Azerbaijan’s unspoilt mountains and coasts establish themselves as an increasingly popular destination for residents of foreign countries. “There was a tourism boom last year. In 2010, we had 2m visitors, rising to 2.2m in 2011 and 2.5m in 2012,” says Mammadov. “Most of our tourists come from neighbouring countries – Georgia, Russia, Turkey, Iran – but the fastest growing segment last year was from EU and Middle East countries. The country’s income from tourism has increased almost four times in the last three years. No wonder that the World Tourism Organisation placed Azerbaijan second in the world in terms of the percentage of growth of tourist inflows in 2012”. Azerbaijan is pursuing an active industrialisation policy. It used to be one of the most industrialised countries in the former Soviet Union. Since manufacturing facilities urgently required upgrade with modern technologies by the end of the last century, modernization of industry has been set as priority. “We

are very serious about industrialisation. In fact, Azerbaijan’s industrial output increased 2.6 times in the last 10 years,” says Mammadov. “Currently, we are working on various important projects. In order to boost the chemical sector, State Oil Company of Azerbaijan launched a very promising and large project, the construction of a petrochemical and gas complex. It will be strengthened with recently established Sumgait Chemical Industrial Park focused on downstream production. We established an ecoindustrial park close to the city of Baku specialised in processing of special types of waste. Some new industrial parks are in pipeline with specialisation in light industry and metallurgy. All these parks offer very attractive conditions strengthened by tax holidays, customs incentives and necessary infrastructure on the plugand-play concept”. The government declared 2013 as the official “year of ICT” in Azerbaijan, where the state has focused on promoting technology and the internet across the country in the hope of encouraging

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innovation and generally supporting the education of the population. “There are a number of projects to make ICT easily available to the population, use ICT as a tool for reducing red-tape, increasing efficiency of public services and boosting high-technologies in our economy. We have high-technologies park, IT fund and IT university. 70% of the population is already online,” says Mammadov. There is also agriculture, the most important non-oil sector. Agriculture employs 38% of the population. A traditional supplier of food in Soviet times, today the country continues to export billions of dollars of agricultural products to the other countries of the CIS and more recently it broke into the European and Middle Eastern markets. “We export things like pomegranate juice to markets as far away as the USA and New Zealand. We had very encouraging results from launching Azerbaijani wine in France earlier this year, at a food exhibition in Alsace. Definitely, the list of exported agri and food products is quite long and potential is even bigger,” says Mammadov.

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PASHA, Azerbaijani banks look to the future

INTERVIEW:

zerbaijan’s banking sector came through the 2008 crisis relatively unscathed thanks to the very conservative policies of the central bank, and is now growing fast on the back of the rapid development of retail lending and the diversification of the economy. PASHA Bank was set up in 2007 as the first non-universal bank in the country to cater to the needs of the growing industrialists. It's now starting to expand into the other countries of the region on the back of the increasing amounts of inter-regional trade and investment. While many countries hit by the banking crisis in 2008 are still suffering, Azerbaijan has already emerged from the worst and is looking to the future. “The governor [of the Central Bank of Azerbaijan] met with the leading banks in 2012 and warned them of the overheating consumer lending,” says PASHA Bank's erudite chairman, Farid Akhundov. “It has already restricted the express credit via shops and doesn’t want consumer borrowing to be as easy as it is now, as it is afraid of a boom and bust in consumer loans.” Neighbouring Kazakhstan came a cropper by allowing its leading banks to expand their assets by several hundred percent a year, but the Central Bank of Azerbaijan (CBA) is trying to hold retail lending growth rates to about 15-30%, says Akhundov. There are also good economic reasons for putting the breaks on consumer lending. Most of the loans taken out

are spent on things like consumer electronics and cars, which Azerbaijan doesn’t make. As such, this sort of spending doesn’t stimulate economic growth but does drive up the import bill. At the same time, the CBA doesn’t want to see the relatively financially naïve population over-borrow and get into trouble.

deposits and offering real interest rates of about 12%. However, this is putting them under pressure if they are going to maintain their margins at 8-10%. It means all the banks need to pay more attention to improving credit risk management and will have to accept working with lower margins,” says Akhundov.

However, the CBA has been wearing kid gloves in dealing with these problems, as it always wants to see the sector grow and flourish. Last year, rather than imposing administrative caps on borrowing the CBA issued a letter “recommending” that commercial banks publish not the actual rates on loans to consumers, but “effective annual interest

PASHA Bank has left these issues to be handled by the other universal banks, but it is branching out to take advantage of the groundswell of private enterprise by focusing intently on the burgeoning segment of small and medium-sized enterprises (SMEs) since 2011. “Now an SME strategy is important to our new operations,” says

"Azerbaijani banks won't be able to ignore the international markets forever"

rates.” As these include things like charges and can be significantly higher than the basic rate, borrowers would be made more aware about the real costs of borrowing.

Akhundov. “In 2012 we launched our ‘open for business’ campaign targeting SMEs and want SMEs to make up half our loan portfolio in the strategic period to the end of 2014.”

The commercial banks are as conservative as the CBA and fund almost all their lending from deposits, shying away from tapping the international capital markets. This has only added to the robustness of the sector. “Banks have been very aggressive in attracting

The rapid development of both the banking sector and the economy means Azerbaijani banks won't be able to ignore the international markets forever. PASHA Bank has been a pioneer in this regard and raised a very successful $30m international

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club loan in January. Akhundov says it is planning to tap the market with another later this year. The domestic capital market has also started to grow in importance and PASHA Bank has also been a pioneer in its development. The bank has already helped several other leading banks in the country organise other issues. With this business clearly growing in importance, PASHA Bank is also now setting up an internal investment banking division to deal with this business, as it is also the biggest trader of domestic bonds on the domestic exchange. “We work with a number of corporate clients on bonds starting in 2011. IPOs will be next, but it will be at least 18 months before we see one. IPO amounts will be small amounts and list only on the domestic market as a convenient way to tap the domestic liquidity pool,” says Akhundov. With domestic business well in hand, the bank is also following its biggest customers into the neighbouring markets. Ties with the progressive Georgian market and the regional giant Turkey are going especially fast. “Georgia is a good market and the banking sector is very well developed,” says Akhundov who opened a PASHA Bank branch there in 2013. “The business in Georgia is to cater the growing needs of corporate and SME clients and Azerbaijan is the second biggest investor after the USA there.” “The growth in business ties between Georgia and Azerbaijan has gone a lot faster than we were expecting, and we expect it to only increase as time passes,” says Akhundov. But the big prize will be Turkey where Azerbaijan is also the second biggest investor. This year PASHA Bank has started extensive market research in Istanbul and expects to make decisions soon. “We are a corporate investment bank, but facilitate trade with Turkey together with Georgia, an axis that is coalescing into a trade block as the ties between these three markets grows closer,” says Akhundov.

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Leasing grows in Azerbaijan

bne Leasing in Azerbaijan, where manufacturing has traditionally been dominated by large industrial holdings, was slow to gain traction, but thanks to the government’s efforts to diversify the economy, deal volumes have been doubling in size every year. AzLeasing is one of the top leasing companies working in Azerbaijan out of a field of 20. It was set up at the end of 2008 with $6.2m of capital by the The Islamic Corporation for the Development of the Private Sector (ICD) and has built up a portfolio of about $20m over the last four years. “We have signed deals for construction equipment, real estate, transport and consumer transport like cars,” says Jeyhun Naghiyev, general director of AzLeasing. “We are already amongst the top three biggest players in the game and boast one of the most experienced leasing teams in the country.” The government has embarked on a major effort to transform the economy and diversify away from its traditional reliance on oil and gas production, which has created demand for investments across the board – especially in infrastructure. “Azerbaijan is developing rapidly and there are some good projects to get into. Following the crisis, the residential real estate market took a hit, but the recovery in industrial construction has been rapid. There is a demand now for roads, industrial objects, bridges, factories and so on,” says Naghiyev. However, the business is stymied to some extent by two restraints – the big role the industrial groups play in the economy and the regulatory regime. “Leasing in Azerbaijan is not so interesting to the big companies, because if a purchase is financed by leasing, then you can’t deduct VAT, but if you use debt you can. The upshot is the big companies don’t use much leasing,” says Naghiyev. AzLeasing has been lobbying the government to change the rules and put its business on the same footing as debt. But while the government is aware of the issue, there is no momentum to change the law as yet. In the meantime, AzLeasing has concentrated more on small and medium-sized enterprises (SMEs), which don’t have as easy access to bank credits and prefer to finance their purchases out of revenues anyway. That suits AzLeasing, which works closely with all the suppliers of equipment, who like the close relations they have with the leasing company as it adds an extra layer of comfort in the transactions. Despite the contrasts, the leasing business has been growing fast. Naghiyev says the portfolio has doubled in size in the last year and hopes to get to a total portfolio of $40m in the next three years. And with Azerbaijan due to host the inaugural European Olympic Games in 2015, there should be plenty of work for everyone.

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Azerbaijan is a major agricultural producer, but the infrastructure remains underdeveloped. The basic idea was to build warehouses where products could be stored following the harvest and then sold later out-of-season when prices peak.

Private equity takes first small steps

zerbaijani capital markets are in their infancy, but Caspian International Investment Company (CIIC) was set up in 2007 with $40m as one of the country’s first standalone private equity funds. “The concept was to set up an equity fund and gather together a pool of investors into the special-purposes vehicle (SPV) dedicated to the country,” says the ebullient Jafar Babayev, CIIC’s executive director. Without a fully functioning domestic capital market, potential exit routes from investments will be limited. But as the Islamic Corporation for the Development of the Private Sector (ICD), which founded CIIC, is a pseudodevelopment fund, the plan is to cross this bridge when the fund gets to it. “Exiting is hard here,” says Babayev. “In most cases, the co-owner in the project buys the shares at a premium as people in general don’t want outsiders in their businesses. The other option is to sell to one of the large groups that have a strategic interest in the sector.” Finding investors has also not been easy, but there is a small pool of powerful investors to tap. The lead investors have been the ICD; the Islamic Development Bank; Aref Investment Group, one of the largest Kuwaiti conglomerates;

Al-Ahmar Group for Trading, Industrial and General Agencies, a group from Yemen and Azerbaijan Investment Company OJSC, the state-owned Azerbaijani investment company. “We went first to the people around us, however, raising money from the West is difficult as investors there don’t know anything about the country,” says Babayev. “Big oil projects in Azerbaijan can attract money easily enough, but raising small amounts on the order of $3m-5m is a lot harder.”

The second investment was into the Villa Badam real estate development, a luxury complex of homes some 20km outside of Baku and the country’s first gated community. “There are 177 villas in total and we bought 28 of them,” say Babayev. “The project will be finished this September after four years of work and everything has been done to the highest standard. We are hoping to sell for an average of half a million dollars per house over the next two years and have already closed a few deals. Finally, the third project was into A-Agro, a purveyor of top-end locally grown fruit and veg to all the best restaurants and hotels in Baku. “We also supply McDonalds here and we are the only local producer to do so,” says Babayev. “Recently they accredited us as a global supplier, which means we have the right to supply our products to McDonalds around the world, but especially in the other CIS markets.” With an investment of AZM1.5m, this was the fund’s smallest investment but it

"Big oil projects can attract money easily enough, but raising small amounts is a lot harder" Still, there is plenty for the fund to do, which has focused on greenfield projects as well as providing expansion capital for more established ventures or partners that are known entities in the business world. The fund so far has distributed half its funds in three projects that are typical of investment projects into the republic. The first investment the fund made was AZM5m ($7m) into a domestic firm with cold warehouse storage in the city of Ganja in the north of the country in 2009.

is also already earning a profit. And the company is planning to move into the retail business supplying ready-to-eat salads and some other high quality prepackaged food products. The fund is still on the hunt for more interesting projects. For this year the fund’s strategy has identified six key sectors: agriculture, food processing, construction materials, IT, logistics and petrochemicals. Of all these, food processing probably remains the most attractive with the most potential projects to choose from.

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IBA offers Islamic banking window into Azerbaijan

Jahan Hoggarth in Baku

s the emerging markets of Central and Eastern Europe look west for investments, Azerbaijan is eying the east. And the interest is mutual. Azerbaijan's economy has long been attracting a steady flow of foreign investment and, increasingly so, from the neighbouring Arab world. To encourage this flow further and to facilitate Gulf investors, the International Bank of Azerbaijan (IBA) was the first local bank to introduce an "Islamic window", which allows a conventional bank to offer Shariacompliant banking services and products. “When we saw the growing interest from local businesses in Islamic banking and the flexibility it offers within its financing, we knew there was a great potential for Islamic banking in Azerbaijan” says Behnam Gurbanzada, Director, Islamic Banking Department at IBA. Islamic banking is based on risk sharing, ie. the bank shares the profits and loss equally with the client and prohibits charging interest on money loans. As it also prohibits investing in goods or services considered contrary to Islamic principles, such as gambling or alcohol, it is also considered as ethical banking. Operating since 2012, IBA’s Islamic banking window has its own front office, sub-treasury and financial services, as

it’s important for Islamic banks to keep their activities and money separate and not to mix them with the conventional banking system. “The deposits received from our clients do not mix with conventional deposits; we keep them separately in our sub-treasury. Our services are dedicated to Islamic banking clients only” Initially, the idea of setting up the window came from IBA’s need to diversify its portfolio of investments. Looking east made economic sense for Azerbaijan, with its 95% Muslim population, historical ties and more significantly the long-term nature of Arab investments. “Islamic investments tend to be long term,” says Gurbanzada.

bet. The growing construction industry also created new investment trends in Azerbaijan. "SME (small and medium enterprises) financing and trade industries are popular with investors at the moment," says Gurbanzada. "Also, investors are increasingly interested to finance the large state projects, such as in the oil and gas sector, the infrastructure. Alternative energy is another growing investment trend" IBA’s Islamic window currently offers a number of Sharia-compliant services, such as Ijara (leasing), which assists the customers to purchase properties or other real assets, and Wakalah, which are deposits received from customers to be used for Islamic bank activities

"Our services are dedicated to Islamic banking clients only" “Gulf and Asian investors are interested in growing their money in Azerbaijan at least over the next four to six years” This has led to the rapid development of the construction industry recently in Azerbaijan. And with property markets generally on the rise, investing in construction seems as a fairly safe

and the result (profit or loss) is shared between the bank and the customers. “The money is kept in portfolio for a year and for that period the client basically becomes our business partner and investor.” Another product is IBA’s Islamic credit card – with no added APR, customers

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are charged a fixed annual fee of 10% of the total credit limit, independent of the amount spent. Customers can top up their credit at their convenience and spread the repayment of the fixed fee throughout the year at no extra charge. With the average 24-35% APR charged by most conventional banks in Azerbaijan, Islamic credit cards make a very attractive option. On the other hand, debit and savings accounts in Islamic banks have no interest added or charged to them, as collecting or paying interest on money is prohibited under Sharia law. Despite the wide range of services offered, Gurbanzada is determined to increase the activities of its Islamic window. "Our biggest obstacle is the lack of necessary legislations, and that prevents us from introducing a full range of Islamic banking services, as we can and would like to offer more in this sector." New Islamic banking legislation is still a sore subject for Gurbanzada. "At the moment, Islamic banking has to be

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flexible and comply with conventional banking regulations, and sometimes Islamic banks have to be 'creative' in order to comply with these regulations. And that’s what we’re trying to overcome in Azerbaijan. That’s why we want to develop pure Islamic legislation which will allow us not to simply dress a conventional banking product in Islamic banking 'clothes', but to introduce the real Islamic banking products on the markets." But its success is already apparent. As market leaders, IBA’s Islamic window has no competitors in the region and is keen to utilise this position. "We aim to become the regional hub in the whole of CIS region and turn Azerbaijan into an investment gateway through which Arab countries will gain access to CIS markets," says Gurbanzada. Keen to debunk stereotypes about Islamic banking, Gurbanzada says it is just an alternative way of banking and is an ethical choice rather than religious. “I would like to make it absolutely clear that Islamic banking is not about

spreading Islam. We have Christians and Jews among our customers in Azerbaijan and we welcome anyone wishing to work with us, independent on their race, culture or religion.” With their current assets portfolio of €200m, IBA’s Islamic window is actively supporting a large number of projects in Azerbaijan from a wide range of sectors, such as dairy farms, methanol production factories and furniture manufacturers. And with its eyes firmly fixed on the east, IBA is planning its expansion into Qatar. "There is a lot of liquidity in the market and Qatar investors are very keen to invest in Azerbaijan, bringing that liquidity with them," Gurbanzada says. "Bank profits in Qatar are quite small and are on average 1.5-2.0% per year, whereas in Azerbaijan they can be around 5.0%. We plan to begin our banking activities in Qatar next year and if our market expansion plans are successful, we hope to raise our profit to $500m by the end of 2014, Inshallah."

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Azerbaijan to increase hydropower generation Jahan Hoggarth in Baku

he government of Azerbaijan plans to increase electricity generation by adding to its existing hydropower capacity.

The State Agency was established in 2009 and was tasked with doubling the share of renewable energy sources in Azerbaijan to 20% by 2020.

The state is actively developing its alternative and renewable energy resources in an effort to eventually wean itself off the republicâ&#x20AC;&#x2122;s hydrocarbon dependence.

Three wind turbines with total capacity of 2.7MW, solar panels with capacity of 1.8MW and a 1MW power plant running on biogas have already been built at the Gobustan landfill near Baku. The capacity of Gobustan will be increased from the current 5.5MW to 8MW by 2015.

"Some 10% of the power produced in the country falls to the share of hydropower plants. However, the country has major opportunities to generate solar and wind energy, as well as for construction of small hydropower plants," Deputy Director of the State Agency for Alternative and Renewable Energy Sources Jamil Melikov said at the Baku Futures Forum in June. The new production will be centred on the Samukh agro-energy complex, which is in development and provides for the creation of hybrid power plants running on biogas and with total capacity of 16 megawatts, Melikov said. The facility is expected to come online in the next two years.

Melikov said that if an additional 1,000MW of generating capacity from alternative and renewable energy sources can be created this will allow Azerbaijan to export an additional one billion cubic meters of gas per annum. The Asian Development Bank has already agreed to invest $40m into Azerbaijani alternative and renewable energy sources in May. The International Finance Corporation (IFC), the commercial arm of the World Bank, has also approved its first loan of $15m to Azerbaijan to finance renewable energy and energy efficiency projects.

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of this block will not take much time," Socar President Rovnag Abdullayev said earlier according to reports. The company also plans to start exploratory drilling in the prospective areas of Babek, Zafar, Mashal, Nakhchivan, Shafaq, Asiman, and is currently looking for foreign investors to participate in these projects. Socar has already signed an $800m investment deal with Singapore's Keppel for the construction of a new offshore drilling rig to develop large gas finds in the Caspian Sea, which is due to be delivered in the last quarter of 2016.

Socar has big plans for gas production in the next decade

the Caspian Oil & Gas conference in Baku on June 5.

The resource-rich republic has proven gas reserves of 2.2 trillion cubic metres (cm) and plans to double its natural gas output to some 54bn cm a year by 2020, reports www.azernews.az. Since 1994 the company has already invested $45bn in the oil and gas sector, while 665bn cm of gas and 1.8bn tonnes of oil have been extracted.

"We forecast gas reserves in the ACG deep-lying strata at 300bn cm. Although usually arranging such works takes 7-8 years, according to the detailed study the development

zerbaijan’s national oil company Socar has big plans to boost its production in the years to 2020 and will also start producing gas at some of the world’s biggest untapped fields at the same time, potentially transforming the country.

"According to the plan, gas production at Babek field with reserves of 400bn cm of gas and 80m tonnes of condensate will start in 2019. In 2020 production will start at the Karabakh field with reserves of 20bn cm and 20m tonnes respectively, and in 2023 – at the Ashrafi field with reserves of 13bn cm and 17m tonnes," Socar Vice President Suleyman Gasimov said at

Socar has already launched gas production from the Umid field and production at the Azerbaijani-ChiragGuneshli (ACG) oil and gas block in the Caspian Sea will also begin in 2019, says Gasimov.

The deal is important as Socar has a shortage of rigs with much of its existing equipment tied up in the development of the giant ACG oilfield and its giant gas twin, Shah Deniz. All in all Azerbaijan's gas output could double by 2021 on the back of development at the Umid field and phase two of the Shah Deniz project, according to Matthew Shaw, senior expert at energy and mining consultancy group Wood Mackenzie. "Umid [is a] significant source of production ramp over the next decade or so. Under provisional forecasts [it] will peak at 6bn cm/year by mid-2020," Shaw said speaking at the June Baku conference. Phase two of Shah Deniz is expected to produce produce 16bn cm a year of gas from 2017, with 6bn cm/y going to Turkey and another 10bn cm/y to European markets via the recently picked Trans Adriatic Pipeline.

"All in all, Azerbaijan's gas output could double by 2021"

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Events

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Upcoming events 2013

Invest Mongolia 7th Annual Investment Conference (2- 3 September) Frontier Conference Ulaanbaatar, Mongolia www.frontier-conference.com

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

Mobile & Digital Finance (14 - 16 October) Adam Smith Conferences +44 20 7017 7444 events@adamsmithconferences.com www.adamsmithconferences.com

10th Anniversary Russian CFO Summit (21 - 24 October) Adam Smith Conferences +44 20 7017 7444 events@adamsmithconferences.com www.adamsmithconferences.com

2013 RUSSIA, CIS&CEE

IV Cbonds Fixed Income Conference: Russia, CIS & CEE Hosted by:

Lead sponsors:

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September 12â&#x20AC;&#x201C;13, London

One of the biggest Londonbased events on Russia, CIS and CEE fixed income markets steadily gathering over 170 delegates representing more than 100 companies across the deal chain. Register before July 31 to get 10% early bird discount www.cbonds-congress.com

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