bne:Magazine February 2014

Inside this issue: Kaluga – Russia's regional pioneer Out with the new, in with the old in Latvia Serbia heads back to the polls February 2014 www.bne.eu

Eurasia's golden triangle of investment Special Report: Outlooks 2014

WHY THIS MAN IS NOT FIT TO BE UKRAINE'S PRESIDENT

bne February 2014

Contents

Editor-in-chief: Ben Aris (Moscow)

+7 9162903400

Managing editor: Nicholas Watson (Prague)

+42 0731582719

News editor: Tim Gosling (Prague)

+42 0720180811

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

28

+38 50 0639722

+48 604994850 +37 129473192 +42 1907732736 +36 308665550

17

+90 5359210950 +40 722580137 +38 513835929

+7 7073011495

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

+7 9168306850

Alec Egan Business Development Director (International)

+44 2030516548

Design: Olga Gusarova-Tchalenko

I3

+44 7738783240

COVER STORY 6 The Insiders 8 Why this man is not fit to be Ukraine's president

CENTRAL EUROPE 24 Out with the new, in with the old in Latvia 26 Another day, another Czech coalition

12 Perspective 13 Chart of the month

28 Road rage in the Czech Republic

EASTERN EUROPE

30 Hungary govt trumpets success as elections approach

14 Klitschko rallies opposition for fight of his life

31 Hungary gets cash for going nuclear with Russia

15 Ukrainian polls show presidential race up in the air 17 Kaluga – Russia's regional pioneer Please direct comments, letters, press releases and other editorial enquires to editor@bne.eu All rights reserved. No part of this publication may be reproduced, stored in or introduced to any retrival system, or transmitted, in any form, or by any means electronic, mechanical, photocopying, recording or other means of transmission, without express written permission of the publisher. The opinions or recommendations are not necessarily those of the publisher or contributing authors, including the submissions to bne by third parties.

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

19 China buys up Russia's backyard 21 Russian IPOs could take off in 2014 23 Belarus tempts investors

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

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

We do them.

3

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

bne February 2014

Contents

I5

56

49

40

SOUTHEAST EUROPE

EURASIA

SPECIAL FOCUS

32

Serbia's EU dream is closer, but no cigar

46

Eurasia's golden triangle of investment

34

Serbia heads back to the polls

49

Kazakhstan's regional headaches

36

The "plot" thickens in Turkey?

50

Kazakhstan steps up military production

61

Russia's growth model runs out of steam

38

Kurdish oil to Turkey only a matter of time

51

Sacked in Turkmenistan

63

CE to follow in Eurozone's stuttering steps

52 40

Russian oligarch suffers metal fatigue in Montenegro

Mongolia's "godfather of corruption" plots return

65

Political risk stalks Southeast Europe

43

Bulgaria's political left splinters

67

Eurasia to stand on shoulders of giants

45

Politics dog Romania's improving economy 70

UPCOMING EVENTS

53

Follow us on twitter.com/bizneweurope

56

ICD supports Central Asia's SME sector

OUTLOOKS 2014

Mongolia's clownish press

6

I The Insiders

bne February 2014

2014 looks a promising year for M&A in CEE

Helen Rodwell of CMS

A

lthough the first three quarters of 2013 still showed a drop in M&A activity across Europe, towards the end of the year the overall mood among M&A practitioners seemed to be improving. Not only did the fourth quarter see a healthy stream of transactions, market rumours and public announcements seemed to indicate a promising pipeline for 2014. This cautious optimism is supported by the European M&A Outlook, a study published by CMS in cooperation with Mergermarket, which gauged the expectations of 225 Europe-based corporate executives about their experiences in the continent’s M&A and economic climate, along with their expectations for the future.

Executives in Central and Eastern Europe are particularly upbeat, with 64% expecting an increase in M&A activity in the 12 months ahead. And indeed, Europe-wide CEE was mentioned as the second most promising region in this respect, only just behind the Nordics. Investors from Germanspeaking countries are expected to be the most active in crossborder acquisitions, and the economies in CEE closely linked to those countries – such as the Czech Republic and Poland – are likely to benefit from this.

On the buy-side, deal-flow in CEE is expected to be driven by increased appetite from foreign acquirers, followed by the availability of undervalued targets and private equity buyouts. On the sell-side, the biggest catalysts to deals will be non–core asset sales and distressed M&A. In the midmarket, succession issues are a sale-side driver which is characteristic for many CEE markets. However, despite the appetite for transactions, it is still not uncommon for the buyers and sellers to struggle to reach agreement either on price or the assumption of risks arising from conservative buy side due diligence.

Moreover, the profile of buyers in Europe has changed.

Strategic investors with strong balance sheets are active in the mid-market, particularly with bolt-on acquisitions. AsiaPacific based companies, particularly Chinese and Korean, are aiming to expand internationally and are increasingly turning to Europe. In Central Europe, there has been a

retreat by foreign investors from certain markets due to the general market conditions as well as the sluggishness of regulatory and other legal reforms and consequential compliance risks. Central European buyers are now more often than not local buyers. In addition to strategic investors such as CEZ or MOL that have been investing outside their home markets for some time, a number of regional financial and private equity type investors have become frequent bidders on big tickets transactions in CEE. The changed circumstances, both in terms of the economic environment as well as a new roster of bidders, have also affected the legal terms of most transactions. M&A practitioners across Europe – whether lawyers, private equity investors or strategic investors – are having to accommodate some new preferences in order to successfully market assets to the current pool of buyers.

New market standards in M&A transactions Buyers, and the financing banks supporting them, are increasingly risk averse. Any troubling due diligence findings prior to the signing of a transaction can mean the end of a deal. Risks that would have been priced and then swallowed in the pre-crisis market, are now often deemed to be untenable for buyers and absolutely need to be remedied if the deal is to go ahead.

Potential buyers also require a greater depth of understanding of the target business before going ahead with the acquisition.

The level and extent of information required to be disclosed as part of pre-signing due diligence is more extensive than before and unanswered questions or undisclosed documents can stall or undermine the success of a signing. The buyer process, specifically internal decision making and corporate approval, is more time consuming than before.

Sellers have become increasingly aware of the profile of the new buyers and tend to accommodate their preferences.

Timelines for auction processes tend to be more generous, particularly for the due diligence phase and buy-side approvals.

bne February 2014

A vendor due diligence is typically followed by a period in which findings of non-compliance or imperfection are remedied by the target, thereby reducing the number of possible buy-side findings and concerns from due diligence.

Both parties work towards due diligence issues being eradicated prior to signing, and the risk of not closing is therefore minimised. Additionally, warranty and indemnity insurance is an increasingly common tool used by sellers to increase the level of warranty cover offered to buyers. It is not uncommon for sellers in auction processes to offer an insurance policy as part of the warranty package to increase the chances for a deal going ahead. In these instances, the benefit of the insurance is for the buyer and the premium is paid by the seller.

by the statistics is the discrepancy between buyers’ and sellers’ price expectations. As a seller, if you want to ask for, and receive, the premium, the valuation must be backed up by quality and highly detailed information which will allow the buyer to justify the price you expect. A remedial approach to any existing issues of non-compliance or imperfection pre-sale will be appreciated by the buyer pool and a generous pre-signing timeline will help to manage sellside expectations.

Helen Rodwell is Head of CEE Corporate for the law firm CMS

Sellers are alive to cultural differences in negotiating and contracting with non-European investors. The standard contracting terms in the US differ, at least in part, to what is standard in the European market. This will often be reflected in a US buyer’s mark-up of transaction documents (for

"Despite the appetite for transactions, it is still not uncommon for the buyers and sellers to struggle to reach agreement" example, more use of MAC clauses, earn outs and purchase price adjustments based on working capital criteria). Chinese investors often require regulatory approvals at home which can be time consuming and create some uncertainty around closing. Russian investors are commercially focused and more often leave the contractual details to the lawyers.

Return of a level playing field The new modus operandi in the pre-signing phase has tended to result in the return of a level playing field with regards to the negotiation of contracting terms. Having dealt with any identified risks pre-signing – either by walking away from the deal or remedying the issue – parties are contracting on a more equal footing. After the peak in “buyer-friendly” market conditions in 2007-2008, contracting terms have largely returned to the pre-crisis norms – particularly in terms of the limitation of liability of sellers and the use of earn out clauses. The locked box, favoured by financial investors, continues to be an attractive alternative to a purchase price adjustment and is gaining popularity with strategic investors.

The moral of this story is that, more than ever, sellers will need to plan well and prepare fully for any asset disposal. For owner investors, vendor due diligence can be invaluable in ensuring that an asset is presented to the market at its best.

One of the main obstacles to M&A going forward identified

"Timelines for auction processes tend to be more generous, particularly for the due diligence phase and buy-side approvals"

8

I Cover story

bne February 2014

Why this man is not fit to be Ukraine's president Ben Aris, Graham Stack and Nicholas Watson

Cover Story I 9

bne February 2014

E

vents in Ukraine are spiralling out of control and no one in Kyiv, Washington, Brussels or Moscow can be quite sure where they will end.

But whatever the eventual outcome, much rests on the fate of one man who stands at the centre of the maelstrom engulfing his country and who has played a crucial role in its chaotic politics for the past decade.

restricting freedom of speech and assembly, which were much of the cause of the descent of the protests into violence.

Viktor Yanukovych was elected the president of Ukraine in February 2010 with almost 50% of the vote, in a presidential runoff that was hailed at the time by western observers as fair and "truly competitive." It made Ukraine one of the very few in the former Soviet Union that has held what the West deems a truly democratic election.

The constitution states that the authority of a president is "subject to an early termination" in cases of:

Since then, his administration has shown itself to be incompetent, corrupt and chaotic, bringing the country to the edge of a full-scale economic meltdown at the end of last year and resulting in the fateful decision in November to abandon a long-standing deal that would have brought Ukraine closer to the EU, instead caving in to Russian pressure and signing some murky deals with its giant neighbour.

The opposition is in a constitutional bind, as for better or for worse – and clearly the latter – the people chose Yanukovych as their president in 2010 in an internationally acknowledged democratic election. Simply bringing the country to a standstill in an effort to force the president’s resignation has dubious legality. With no indication that Yanukovych intends to resign,

The upshot of this incompetence is protestors battling it out with riot police on the streets of Kyiv and other cities, the grinding to a halt of government business by the occupation of ministries and regional administrative centres, and a further deterioration in Ukraine's already precarious financial position. The situation is clearly unsustainable and described by group of former US ambassadors to Ukraine on January 28 as "on the verge of spinning out of control."

Yanukovych appears to be making efforts to diffuse the situation; on January 28, Mykola Azarov, the prime minister, resigned, while in a rare show of bipartisanship the pro-government Party of Regions joined with opposition lawmakers to repeal two-thirds of the laws that were rammed through parliament the previous week

Yet most protestors and a significant chunk of the country want Yanukovych to resign before his term of office ends with the next presidential election in 2015.

1) resignation; 2) inability to exercise presidential authority for health reasons; 3) removal from office by the procedure of impeachment; 4) his/her death.

roughshod over the constitution that is supposed to guarantee democracy in Ukraine.

At this point it should be noted that no one has raised the topic of impeachment, partly because it is at the moment politically unworkable, given the ruling Party of Regions’ domination of the Rada. But that is no reason for not proposing it, as it remains one of the only legitimate mechanisms for forcing Yanukovych out of office. And the case against him is already very strong; if he were a western leader, he would have been impeached long ago.

Russian ties that bind Yanukovych is worth hundreds of millions of dollars. This is a man who was a truck driver in the 1980s and spent the next two decades as a logistics expert before being appointed governor of the eastern region of Donetsk in 1997. He has never worked in the private sector, nor does he publicly own any successful company.

The sheer size of his fortune raises big question marks.

An extensive investigation into the Yanukovych family's wealth conducted

"With no indication that Yanukovych intends to resign, and few signs of ill health, the constitutional route to getting rid of him is impeachment" and few signs of ill health, the constitutional route to getting rid of him is impeachment, for which there is a procedure "if he commits treason or other serious crime." bne lays out its case that Yanukovych has indeed committed crimes that are of an impeachable nature. He is demonstrably corrupt; he has fixed elections and the chances of a fair and free vote for the presidency in 2015 are already low and diminishing; and he has already proven he is willing to ride

by the PEPWatch NGO uncovered detailed evidence of corruption and international money laundering. "We believe that the authoritarian regime of President Viktor Yanukovych has been fuelled by proceeds of corruption laundered via the international financial system through the network of shell-companies and professional intermediaries," says PEPWatch, presenting the results of the work of the country's leading investigators from websites Nashi Groshi and Ukrainskaya Pravda.

10

I Cover story

According to PEPWatch, Yanukovych's palatial Mezhihirya estate outside Kyiv, built partly with public money, is owned via a UK company Blythe (Europe) UK, while his vast hunting grounds encompassing 75,000 hectares at the Suholuchchya estate are held via another UK company Astute Partners Limited.

bne February 2014

shares that were sold via his offshore holdings. The fact that Shuvalov and Yanukovych share the same lawyer, the same sort of secret offshore company network and are both intimately connected to the workings of Gazprom should also raise another huge red flag given Gazprom’s central role in RussoUkrainian relations.

“One vote at Ukraine's by-election in five parliamentary single-mandate districts goes for UAH400. Sometimes some food is thrown in"

bne inquiries have also implicated Yanukovych and his closest associates – former prime minister Azarov and the hardline head of the presidential administration Andriy Klyuyev – with structures held via a family of Austrian lawyers with links to the Kremlin.

What all these foreign holding structures used by Yanukovych and his associates have in common are past and present links to Reinhard Proksch, an Austrian provider of corporate services, both via directorships as well as via holding structures that Proksch used to set up companies for clients.

Contacted by bne, Proksch insists that none of the companies mentioned in the press ever "received any funding from Ukraine nor do any of these companies hold any cash assets. We never distributed any 'commissions' or other payments. No link to Mr Yanukovych exists," he told bne.

Yet company filings show that he has acted as a director for at least one of the shell companies used to control assets linked to Yanukovych. And Proksch's name also comes up in connection to assets belonging to Russia’s first deputy prime minister, Igor Shuvalov, probably the third most powerful man in Russia.

In 2011 the Russian press exposed a scheme where Shuvalov had bought tens of millions of dollars of Gazprom

That the Kremlin's hold over Ukraine may not be restricted to the geopolitics, but include shadowy financial strings to the president should be a cause of worry to Ukrainians of all stripes. After all, the Yanukovych administration has accused jailed former prime minister Yulia Tymoshenko of betraying national interests when as PM in January 2009 she signed a ruinous agreement with Russia over gas price increases.

According to her foes, Tymoshenko was blackmailed into signing the agreement due to leverage the Kremlin had over her, deriving from a Russian criminal case opened from the 1990s relating to her gas trading company's debts.

According to her critics, she agreed to punitive gas prices for Ukraine in return for the case being closed.

The fix is in Yanukovych has form when it comes to fixing elections. He was the establishment’s candidate who opposed Viktor Yushchenko in the disputed 2004 presidential election. Widespread irregularities in the vote ended in street protests and the Orange Revolution, which forced the presidential runoff to be rerun and victory for Yushchenko.

And Yanukovych was back at his old games just last December. Fraud and voter manipulations were so high during the 2013 parliamentary in five constituencies – Cherkasy, Kaniv, Pervomaisk, Obuhiv and Kyiv – that

even the Yanukovych-controlled Constitutional Court said the votes there had to be rerun. Exit polls taken by independent observers showed that the opposition won clear victories in three of the five whereas the official tally produced only one opposition victory.

“One vote at Ukraine's by-election in five parliamentary single-mandate districts on Dec. 15 goes for (hryvnia) 400. Sometimes some food is thrown in. But the payment, cunningly, comes in two instalments. The first half is paid when the person agrees to vote for the right candidate, and the other half is given after the voter presents photographic proof of the vote as they exit the polling station,” Ukrainian election observers were quoted by the Kyiv Post as saying at the time.

Subverting the constitution But the most blatant abuse of power was the parliamentary vote on January 16 that pushed through the so-called “dictatorship laws” that sparked the widespread riots a few days later.

Widely condemned by both the protestors and the international community, these laws were pushed through by ruling Party of Regions deputies in just a few minutes, with no debate at all, and by a simple show of hands after opposition deputies blocked access to the electronic voting system.

After the meeting, the counting commission frankly admitted to the press that it was unable to count the votes and just “assumed that all the Regions deputies were present and made a majority,” and recorded a vote of 235 for the motion. Other video footage showed some deputies voting for absent colleagues.

Subsequently, opposition activists used photos from the floor of the Rada to count the hands and came up with the number 84 – far from the 225 votes required to pass the law.

Quite apart from blatantly ignoring parliamentary protocol, the new laws also broke several articles of Ukraine’s constitution including: Article 84 that

bne February 2014

guarantees voting in the Rada will be open, inclusive and insists that deputies vote in person; Article 5 that says the people are the ultimate power in the country and their rights cannot not be usurped; Article 22 that guarantees the people’s basic human rights; and Article 60 that says no one has to “execute directions or orders that are manifestly criminal.”

What next?

Yanukovych’s hand had been forced into making conciliatory gestures after protestors had taken over the regional administration of at least 10 regions, leaving only four regions clearly under the government’s control. His administration looks close to collapse, but the situation remains extremely fluid and the future impossible to call.

The protestors have dug in their heels and are insisting on nothing less than early elections. In the middle, the opposition leaders together with the international mediators are still hoping to find a solution that avoids more fighting, but any compromises that leave Yanukovych in power will be hard to sell to the street. And finally Yanukovych is desperately trying to hang on to power until the February 2015 elections.

A move to impeach the president has so far remained ignored, yet politicians in Ukraine are by and large a venal and craven lot, who can certainly be swayed if their access to money and power looks to be cut off. Indeed, on January 29 there were reports coming out of Switzerland from Ukrainian journalists that several oligarchs are already having trouble getting credits from banks there and moving their money about.

In theory it is possible to persuade Party of Regions deputies to rebel and vote for impeachment if the situation becomes desperate enough – and the situation is already pretty desperate.

The group of former US ambassadors argue in their open letter for US and European officials to engage directly with Yanukovych’s inner circle and the oligarchs who back him in order to help

Cover story

force a settlement, with the threat of visa bans and financial sanctions as a stick.

"It is in Europe that Ukrainian oligarchs close to the president park their money, buy luxury residences, travel on holiday, and send their children to school," the four former ambassadors – John Herbst, William Green Miller, Steven K. Pifer, William B. Taylor Jr. – write in their open letter. "People such as the oligarch Rinat Akhmetov must understand that they have a personal stake in achieving a peaceful, democratic settlement."

And to add substance to the threats, bne has reported that Dmitry Firtash, one

I 11

of Ukraine’s richest and most powerful oligarchs, has already been barred from entry into the US. For all concerned, if Yanukovych refuses to resign and appears intent on fixing the next election to keep himself in power, removing the president by such democratic means as impeachment remains Ukraine's best hope of staying on a democratic path and avoiding a descent into widespread and uncontrollable violence. After all, Yanukovych still has the option of sending in the troops to retake control of the country – an outcome nobody wants.

"People such as the oligarch Rinat Akhmetov must understand they have a personal stake in achieving a peaceful, democratic settlement"

12

I Perspective

bne February 2014

Storm clouds over emerging markets... not Liam Halligan in London

"S

torm clouds gather over emerging markets," boomed the Financial Times' influential leader column in mid-January. This inclement headline was whipped up after the paper chose to focus on a "disorderly adjustment scenario" outlined across just a few paragraphs of the latest edition of the World Bank's twiceyearly "Global Economic Prospects" report.

The 150-page tome is, in large part, about the western world, not emerging markets. The question at its heart is whether the "advanced" economies, having remained sluggish since the 2008 sub-prime collapse, are now staging a proper return to growth. "For the first time in five years," reads the opening lines of the latest report, "there are indications a self-sustaining recovery has begun among high-income countries – suggesting they may now join developing nations as a second engine of global economic growth."

Economies across Africa and Asia, in other words, along with the emerging markets of Latin America and bne's home region of Central and Eastern Europe and the Commonwealth of Independent States (CEE/CIS), are performing quite well.

These nascent capitalist societies are the "engine of global economic growth," says the World Bank.

The report then poses the most important conundrum facing the world economy today: can the West now join the emerging economies and start to actually help, rather than hinder, the global recovery given "the normalization of policy… the gradual withdrawal of quantitative easing (QE)."

Back in the immediate aftermath of the Lehman Brothers collapse, few mainstream economists dared publicly to question QE. Financial markets were tanking. Western politicians (and police chiefs) were scared. So it wasn't long before the too-big-to-fail banks got their "extraordinary monetary measures" – despite the warnings from history.

When the US' QE began in November 2008, it was billed as a $600bn programme. Its British equivalent, starting five months later, was to be £50bn. Eurozone policy bosses dismissed sub-prime as "an Anglo-Saxon problem," claiming

the European Central Bank wouldn't need QE to survive "America's credit crunch."

Since then, of course, the virtual printing presses have been at full pelt. Over the last half decade, the US has unleashed $3.2 trillion of QE as the Federal Reserve tripled its balance sheet. The ECB, hiding Euro-QE behind a wall of obfuscation, is catching up fast. The Bank of England has spat out £375bn of funny money, almost eight-times initial estimates, and now holds over a third of UK government bonds. Such rapid monetary expansion and self-financing of state debt is unprecedented in modern times. Yet it's happened with barely any Congressional or parliamentary debate.

The West now needs to wind down QE, as this World Bank report highlights. In January, the US Federal Reserve is to cut its $85bn-a-month money-printing habit to $75bn. Such "tapering" is a long way from tightening. Between 1913 when the Fed was founded and 2007, the US' monetary base grew to $800bn. Since then, under QE, base money has grown on average by $530bn a year for six years.

No one knows if this can be deflated slowly – including no one at the Fed. Just the hint of tapering last May sent the 10-year Treasury yield spiralling above 3% by the end of 2013, up from 1.76% at the start of the year. The Fed, after all, just like the Bank of England, is the largest buyer of its own government bonds.

We could see another "taper tantrum" over the coming months, with Treasuries spiking again, sending higher borrowing costs rippling across the western world. Tapering would then be postponed, with QE possibly getting faster before it starts significantly to slow.

What has all this got to do with emerging markets – not least those such as Poland, Turkey and Russia? Possibly quite a lot – in terms of short-term equity prices. Over the eight months since "tapering" was first mooted, global investors have become spooked about systemic dangers. Sentiment has switched to "risk off", hitting emerging market shares disproportionately, despite their far superior fundamentals.

Perspective I 13

bne February 2014

Since May, as tapering has come into view, the MSCI EM index of all emerging market equity indices has fallen 8%, while the S&P500 has surged 15%. The World Bank is now worrying aloud that if the QE unwind results in a "disorderly adjustment scenario," with bond and equity markets overshooting, capital flows from the West to the emerging markets could "contract by as much as 80% for a period of several months", inflicting "significant economic damage and throwing some countries into crises."

No matter that the World Bank's "baseline" scenario sees only a "modest retrenchment" in emerging market capital inflows and this is "the most likely outcome". The FT still showcased "storm clouds" over the relatively fast-growing emerging economies.

If tapering goes badly, emerging market equities will obviously suffer. But so will all equities – and, given the

gross excesses of QE, pumping up Western share indices to repeated all-time highs despite unconvincing growth and weak earnings, equities in "advanced" nations have much further to fall.

The big picture is that, over any medium-term investment horizon, the rising eastern economies will grow faster than their western counterparts, their companies displaying fatter margins. QE has done nothing to change that reality – even if the unwind is nasty.

The fundamental danger isn't, anyway, that western money quits the East. Capital markets across Asia, Latin America and CEE/CIS have become far deeper, and more resilient, in recent years. Western bank fragility and fiscal weakness – a plight highlighted by QE – means that the far bigger risk is that capital from the emerging markets pulls out of the West. Far from sneering at eastern skies, the FT should look overhead.

Most former Soviet states see more harm from breakup

CHART:

F

or many, life has been hard since the Soviet Union was dissolved in December 1991, with wars, revolutions, coups, territorial disputes and multiple economic collapses blighting the region. So it should come as no great shock that a recent Gallup poll found that people in seven out of 11 countries that were part of the USSR are more likely to believe its collapse harmed their countries than benefited them.

The countries where the number of people who believed that the breakup did more harm than good was greatest in Armenia followed by Kyrgyzstan, Ukraine, Russia, Tajikistan and Moldova. This could be good news for Russian President Vladimir Putin, who called the collapse of the USSR the "greatest geopolitical catastrophe of the century", as he is busy trying to recreate the bloc in the form of the Eurasia Economic Union.

The split in Belarus is more balanced, though still skewed toward more harm than good. Belarus is still run to all intents and purposes like a Soviet state – the former US secretary of state, Condoleezza Rice, dubbed it Europe's "last true dictatorship" – where its people have been protected from the worst excesses of moving to a market economy.

Only Georgians, and to a greater degree Azerbaijanis, Kazakhstanis and Turkmens are more likely to see greater benefit than harm from the breakup.

There is a clear generational split in respondents' attitudes.

Adults between the ages of 15 and 44 – some of whom were not even born or were very young at the time of the break-up – are nearly three-times as likely as those 65 and older to say the collapse benefited their countries. Older residents in all 11 countries (the survey was not conducted in Uzbekistan and the three Baltic states) whose safety nets, such as guaranteed pensions and free healthcare, largely disappeared when the USSR dissolved are more likely to say the breakup harmed their countries.

Breakup of Soviet Union more harmful than good?

In general, did the breakup of the Soviet Union benefit or harm this country?

Benefit

Harm

Neither

Don't know/Refused

Total*

24%

51%

15%

11%

Armenia

12%

66%

10%

12%

Kyrgyzstan

16%

61%

8%

14%

Ukraine

23%

56%

10%

10%

Russia

19%

55%

18%

8%

Tajikistan

27%

52%

12%

10%

Moldova

26%

42%

10%

22%

Belarus

26%

38%

15%

21%

Georgia

37%

33%

9%

21%

Azerbaijan

44%

31%

8%

18%

Kazakhstan

45%

25%

12%

19%

Turkmenistan

62%

8%

9%

22%

Survey conducted in 2013. *This question wasn't asked in Uzbekistan, Estonia, or Latvia, which were also part of the Soviet Union. Source: Gallup

14

I Eastern Europe

bne February 2014

Klitschko rallies opposition for fight of his life INTERVIEW:

Harriet Salem in Kyiv

S

tanding over 2 metres tall and weighing in at 112 kilograms, Vitali Klitschko, the PhD-holding world heavyweight champion who is one of a troika of Ukrainian opposition leaders, has never been knocked down in a professional boxing bout. But the descent of the protests in Kyiv into violence is leaving Dr Ironfist, as he's nicknamed, looking a little battered and bruised.

One of the iconic pictures of the protests so far is that of Klitschko, leader of opposition party United Democratic Alliance for Reform (UDAR,

which means "punch" in Ukrainian), being sprayed with a fire extinguisher and forced to retreat. He has tried to calm tensions between the protestors and the police on the other side. But without gaining anything in the way of concessions from Ukrainian President Viktor Yanukovych, he made a speech on Independence Square, commonly called the Maidan, on January 22 that appeared to signal he does not intend to shirk from the coming fight.

Choosing his words very carefully, he told the crowd, who generally regard him as the most credible opposition

leader: "If the president does not make concessions, we will go on the offensive".

Even without concessions, Klitschko makes it clear to reporters on the ground that the protests represent a victory for the Ukrainian people over a corrupt regime, which by withdrawing from the long-negotiated free trade and association agreement with the EU has sold out the people's European future for a quick financial fix from the Russians.

By failing to sign the EU deal, Ukraine has ended up back in the clutches of

Eastern Europe I 15

bne February 2014

Russia due to a mid-December deal between Yanukovych and his Russian counterpart Vladimir Putin, which saw Moscow purchase $15bn in risky government bonds, provide another $6bn credit to pay for a nuclear power station, as well as slash natural gas export prices from $400 per 1,000 cubic metres to $268.50.

Ukrainian polls show presidential race up in the air

bne

Headed for a runoff 36 29.80 27 21.80 18 11.80

9

10.30 5.80

3.80

ko en

ok Si

m

on

yb hn

he ro s Po

Source: Democratic Initiative Fund

Ty a

nk o

uk ny se Ya t

its

ch

ko

h

0

Kl

Publicly, Yanukovych is saying that the agreement with Russia does not preclude Ukraine's future cooperation with Europe. Klitschko, however, is dismissive. "The Ukrainian president

Just who the opposition candidate will be remains up in the air. Klitschko has already declared he wants to run for office, but he may not be allowed to. On January 12, Ukraine’s Supreme Court upheld a law passed by the Rada in December that disqualifies anyone who is not a tax resident of Ukraine from running for president. Klitschko has been a long-time resident of Germany and pays his taxes there. Moreover, Yanukovych may follow through on a plan to change to a simple firstpass-the-post system, nixing the 50% threshold requirement.

yc

Change or be destroyed The boxer's UDAR party fought the 2012 parliamentary election on an anticorruption platform and came third with 13.97% of the vote. Nepotism and backroom deals remain rife in Ukraine. Last year the country tanked in Transparency International's annual "Corruption Perceptions Index" to end up in 144th place tied with the Central African Republic, Iran and Nigeria, making it the most corrupt place in Europe. "The whole government is involved in corruption – this is normal politics here," Klitschko tells bne.

A poll by the independent Democratic Initiative Fund (DIF) on January 9, when the protests were in full swing but before they had turned violent, found that Yanukovych was polling at 29.8%, followed by Vitali Klitschko at 21.8%. Yanukovych it seems is still far from the 50% needed to be re-elected at the first go. Other polls have shown that if the vote goes to a second round, then the combined protest vote would consolidate around whoever stands as the opposition candidate, giving them victory in a run-off.

uk ov

There is also widespread speculation that the backroom deal involves, as yet, undisclosed concessions from Ukraine – most likely an agreement that the country will join the Putinbacked Customs Union after the 2015 presidential election, or offer Russian giant Gazprom a stake in Ukraine's strategically important gas pipeline network, which feeds Europe. "It is clear that our government has not been honest with the people… this [money] is not a gift from Russia," says Klitschko.

If Yanukovyh manages to hang in there until the February 2015 presidential election, chances are he will lose in the second round, according to polls.

Ya n

The Moscow agreement has provided Ukraine's beleaguered economy with a much-needed immediate boost, but Klitschko warns that the deal leaves his country at the mercy of Russia's whims. "Our government has gone for this fish and ignored the hook," he tells bne in an interview, a reference to the caveat of quarterly reviews of the gas price that are built into the Russian agreement.

16

I Eastern Europe

The Lion, the Witch and the permanent winter in Russia Where is Aslan when you need him? If Russia were Narnia, then the Snow Queen seems to have won the fight for control: a Russian Duma deputy has proposed a law that would impose permanent winter time on Russia.

“With the adoption of this bill Russians will begin to live according to astronomical time, as in nature,” Sergei Kalashnikov, chairman of the Duma Health Committee and one of the bill’s authors, said in January, adding that more than 100 Duma deputies had already signed the bill.

At the moment, Russia is living on permanent summer time, after Prime Minister Dmitry Medvedev ordered the end of daylight savings time in March 2011, during his brief stint as president.

Medvedev said it would benefit farming and be better for Russians’ wellbeing, though in many parts of the country it now stays dark until after 10:00am in winter. It also plays hell with business, as in the winter it increases the time difference between London and Moscow to four hours instead of three.

However, the change to permanent wintertime is little better. The problem is most of Russia is so far north – St Petersburg lies on the edge of the Artic circle and has 24 hours of sun in the middle of summer – that in the winter days are extremely short with little sunshine.

bne February 2014

and government are not motivated to sign [the Association Agreement], the people in power here benefit from the status quo," he says.

"This is a decision about whether to change or be destroyed," he argues. "We can say the situation here is similar to if a person is sick with cancer: you can take pills against the pain, or money from Russia, but this will not address the underlying cause of the sickness. For this you need immediate surgery."

Certainly, the bitter medicine of deep structural reforms regularly dished out by the EU and International Monetary Fund (IMF) worked in other countries with spectacular success in the 1990s.

But the process is long and slow. Critics argue Yanukovych is not a man of vision and isn't looking beyond the presidential election in 2015.

A senior financial figure in the country, who asked not to be named, says the truth is that Ukraine has no real good options available. "Realistically, either way Yanukovych went [on the EU issue] there would be protests on the streets and a prolonged period of political instability. If he had signed the Association Agreement, then the economic situation here would have been exceptionally grim in the short term."

Klitschko, however, is quick to emphasise that the choice between Russia and Europe is not just about cold hard cash. "People here are protesting against the entire system," he says.

"This money from Russia will only make people happy for a very short period of time… but our economy needs reform.

It does not work. Small and mediumsized businesses are failing. Foreign investors are leaving."

Indeed, the situation is now so dire that Klitschko believes the only means of achieving real change is through fullscale revolution. "We must topple the whole system," he tells bne, "We must change the constitution, the whole set of rules by which we are playing… Every citizen must now be aware his future depends just on him."

Yet how to do this is less clear. Klitschko's boxing-esque tough talk appears to have done little to perturb Yanukovych, who remains, after all, the democratically elected leader. A pre-2005 Orange Revolution political veteran, the president is well accustomed to the rough-and-tumble of Ukrainian politics.

The problem for the protestors battling it out on the streets is that there is no legal or constitutional way they can oust Yanukovych until the 2015 presidential election.

"The whole government is involved in corruption – this is normal politics here"

bne February 2014

Eastern Europe

I 17

companies from the pharmaceutical, food processing, high-tech and fast-moving consumer goods sectors.

Grand Tourismo Kaluga is not an isolated case. With nearly a decade and half of strong growth in the bag and incomes that have expanded some 16-fold since the era of Boris Yeltsin, today that are some 28 regions with attractive investment climates out of a total of 83, according to a rating issued

by Business Pulse in October. (Another 26 are deemed 'neutral' and 21 'negative'.)

Kaluga – Russia's regional pioneer

Geography has played a role in Kaluga's success. Moscow is only 400km away to the north, providing a market the size of most countries in Central and Eastern Europe. But Artamonov complains that the capital is also a disadvantage, as it sucks out resources from Kaluga, especially well-qualified people, by offering better salaries.

Ben Aris in Moscow

M

oscow is home to much of Russia's wealth and has always been treated as a country and an investment destination in its own right. But over the last decade a handful of regions have got their act together and now are emerging as even more attractive to investors than the capital.

Kaluga has a good claim on the title of "Russia's best region."

Located some 400 kilometres south of Moscow, Kaluga didn't have much going for it other than some fairly large military-industrial facilities following the fall of the Soviet Union and appeared mired in a middle rank of economic misery with the bulk of the country.

However, Anatoly Artamonov, the Kaluga Oblast's energetic governor, has lifted the region up by its bootstraps, following a no-nonsense policy to bring in investment and improve the lives of the residents. "We didn't concentrate on success – we simply determined a path for development and followed it," says Artamonov in an exclusive interview with bne. "The region produced weapons and lots of unemployment. We understood that if the people were unemployed, then this would lead to a collapse and no money in the budget."

Artamonov should be more famous than he is, as he is clearly one of Russia's most capable administrators. Kaluga has risen from 48th place in terms foreign investment per capita in 2005 to being among the top few in the last three years. And Kaluga twice topped the tables in terms of industrial production per capita for the whole country, with

So what is Artamonov doing right? After taking office, Artamonov did what most progressive governors do: he went on a world tour to see how success is achieved elsewhere, visiting other prosperous emerging markets to learn from their experiences, including China and South Korea, as well as more developed markets like Germany, Sweden and Finland. On his return, Artamonov set out a list of

"In the last 15 years I have never heard one complaint about corruption in my region" annual growth of 145% in 2010 and 125% in 2011. "In the last few years, official unemployment has been one of the lowest in Russia; Kaluga is one of the regions of Russia where the number of jobs significantly exceeds the number of people willing to work," says Artamonov, who has been governor of the region since 2000.

In short, the region is flourishing.

International car producers were the first major investors to move in, but recent years have seen the arrival of

priorities. "We needed to invite investors to industry, as we need technology and new facilities. We also asked our Russian investors why they were not coming to our region. They said it was a combination of heavy bureaucracy, corruption, lack of infrastructure (especially the difficulty of getting power), high taxes and inefficiencies in the labour force," Artamonov tells bne at the region's Moscow residence.

That list closely tallies with the worst results Russia scored in the factors

18

I Eastern Europe

that make up the World Bank's "Doing Business" ranking. So Artamonov's solution was to implement a liberal list of policies to make life easier for investors, including the building of industrial parks.

Role model The bureaucrats in Kaluga's Moscow mansion joke that the building has the feel of a museum due to the constant stream of visitors, comprising potential investors but also increasingly apparatchiks from other regions curious to find out how Kaluga works its magic. Artamanov's programme has become a textbook case on how to develop a regional economy. "We invited investors to our territory and showed them there was no bureaucracy as everything was already built. They

bne February 2014

the wrath of the governor, so the power to block and stymie is broken, leaving little space to extract a bribe.

Providing adequate infrastructure and eradicating corruption are probably the two most significant factors in Kaluga's attractiveness, but the region also offers significant tax breaks for investors. "The tax regime in Kaluga is a good deal for investors," says Artamonov. "They see the territory like the EU and maybe even better, as there is a cadre of people ready to work and a number of industrial clusters already in place."

The key reform was to create a series of business parks that come fully equipped with the infrastructure, power and IT needed to do business. A total of 134 companies – both domestic and foreign

"The point with industrial parks is they need to be diverse" received all the permissions they needed from a 'single window' and we set up a consultancy [run by the administration] to liaise with the investors to deal with their problems," says Artamonov.

As for corruption, for which Russia is notorious: "In the last 15 years I have never heard one complaint about corruption in my region."

How so? Artamonov's solution was to put all supply contracts, permissions and tenders out in the open. All investors' deals go through a regional committee and are done in public. It sounds simple, but it's the devilish details that are the make or break of anti-graft measures.

And there is Artamonov's fail safe: he is famous for handing out his mobile phone number to any and all investors.

If a company has a problem it can't solve on its own (aka the shakedown), it can call the governor directly. However, Artamonov says that he has never been called; no official appears willing to face

– have invested over $7bn in facilities between 2006 and the first half of 2013 in the ten industrial parks that the region boasts.

From the outset, Kaluga focused on the idea of building up mutually beneficial clusters, of which the automotive complex is probably the best known.

Today, Kaluga's automotive cluster is ranked third in Russia in terms of output and brings together 28 companies including Volkswagen, PSA Peugeot CitroĂŤn, Mitsubishi Motors and Volvo. In addition, there is another layer of parts manufacturers that are springing up around this core and another layer of non-related manufacturers that have moved into the same business park.

Another thread in the cloth has been the region's focus on producing qualified workers for all these factories.

Education remains a mainstay of the region's policy to attract investment.

"Early on, we opened a training centre for automotive workers to produce

the 'future employees' for the industry.

8,500 people were trained and now the other regions are starting to copy this innovation."

In addition to the technical university and vocational training, the governor also holds regular seminars and in-house training for the local administration's staff, who have to attend weekend seminars once a month to study things like crowdsourcing and management techniques. "The training is designed to develop the right-hand side of the brain," says Artamonov, who has taken up painting in his spare time to help the development of his own right hemisphere.

Clusters of clusters Kaluga has moved beyond establishing simple industrial parks and Artamonov hopes to develop clusters of clusters.

The automotive cluster is already self-sustaining and next up will be a pharmaceutical cluster, which is developing around the German firm Hemofarm, which already makes products not only for the Russian market, but exports to Europe and the US as well. Companies from the UK, Italy, Denmark and Sweden also have definite plans to invest in the cluster.

"The point with industrial parks is they need to be diverse. If there is a crisis, then a mono-themed park will die, as there will be no work," says Artamanov.

And several other projects are in development. Artamonov has plans for the rail sector where the region intends to build rolling stock, locomotives and provide logistical services. Other new directions include logistics, mining equipment, power turbines, radio equipment, timber and paper production.

The second plank for the region's development is to focus more attention on promoting small and mediumsized enterprises. "SMEs are the most important factor for the stability of the local economy, as they provide profits and employment," says Artamonov.

"SMEs already account for 30% of the gross regional production."

bne February 2014

Eastern Europe

China buys up Russia's backyard Ben Aris in Moscow

R

ussia spent the end of last year battling the EU for control over Ukraine (and won). But should the Kremlin have been paying more attention to what has been going on its southern border instead? In the last three months, the Chinese have swept through Central and Eastern Europe (CEE) and Central Asia, buying up Russia's backyard in a string of billiondollar deals.

Chinese President Xi Jinping was set for a summit in Moscow in September last year, where Russian President Vladimir Putin was hoping to conclude a crucial natural gas deal that would see a gas pipeline built to connect Russia's Siberian fields with China's underdeveloped northwest territories.

The pipeline project was agreed on years ago, but the deal has been held up, as the two sides can't agree on the price of the gas that will flow through it.

However, instead of flying directly to Russia's northern capital, President Xi went on a whirlwind tour of Central Asia. It was like a visit from Santa Claus as Xi distributed billions of dollars of deals along the way.

In what must have come as a shock to the Kremlin, during his last stop in Turkmenistan Xi signed off on a $60bn energy investment deal that includes $10bn to develop the massive Galkynysh gasfield which has gas reserves of some 1.3 trillion cubic metres – enough to meet China's needs for several years.

The Turkmen deal makes Gazprom's deal largely superfluous.

Chinese Premier Li Keqiang followed up a few weeks later with the second "16+1" China/Central and Eastern Europe summit held in Bucharest on November 26. Prime ministers from 16 Emerging European countries

respectfully lined up with their caps in hand and the gold rained down.

China is clearly on an aggressive westward expansion and trying to spend their accumulated treasure of dollars before anything untoward happens to the currency. Chinese overseas investment rose to $80.2bn in the first 11 months of 2013, the latest data available – more than the $77.2bn that was invested in all of 2012. And outbound investment calculated on the basis of deals closed was up 28.3% in January-November.

The reason why Russia didn't complain about the Turkmen gas deal or any of the other deals in Central Asia is because Russia is one of the biggest recipients of this bonanza: Chinese investment into Russia surged 685%

I 19

The Emerging Europe effort is going to be coordinated by China Civil Engineering Construction Corporation (CCECC), which is opening offices in Romania, Hungary and Bulgaria. In addition, Beijing has launched a $10bn fund to finance the projects. "We are interested in revamping railroads, bridges, tunnels, highways. Our company is willing to collaborate with local firms to benefit from European funding for such projects," said Zhang Zhenhai, general manager of the company's Eastern Europe department, during a China-Central and Eastern Europe forum in November. There are also plans for a Shanghai Cooperation Organization-backed (SCO) development bank in the works.

Further east the deals are being struck on a case-by-case basis and are mostly done at a governmental level. The overall goal is to double the trade between China and CEE, says Li. In Russia's case, trade has already soared to $89bn by the end of 2013, making China Russia's biggest trading partner.

"China-CEE trade accounts for one tenth of China-EU trade," Li said during a visit

"Chinese investment into Russia has surged 685%" over the same period. The issue of the day is not whether Ukraine will become a vassal of Russia's new Soviet Union Inc, but if Russia will become just one of China's many raw materials appendages.

Materials and infrastructure As we move into the new year, the promises that Xi and Li made are now starting to bear fruit and there is a steady stream of announcements as each of the deals come to a conclusion.

The deals come in two flavours: raw materials (and especially hydrocarbons) and infrastructure. In general, most of the deals cut in Central and Southeast Europe are infrastructure deals, whereas those in Eastern Europe and Central Asia are energy and mineral deals.

to Romania. "We need to strive to double our trade volumes... in next five years...

We need to work together to build largescale infrastructure projects."

• Turkmenistan China's deal over the Galkynysh gasfield may have been a shock to the Kremlin, but it was only one of many struck. The China South Locomotive and Rolling Stock Corporation (CSR), the largest locomotive construction company in the country, plans to build two passenger locomotives for Turkmenistan. CSR has already fulfilled four orders and exported more than 200 locomotives to Turkmenistan.

• Mongolia The story in Mongolia is almost exactly the same: China has recently brokered a mix of energy and infrastructure

20

I Eastern Europe

projects designed to feed its economy with the inputs it needs.

China has been developing the Tamsag basin oil deposit with Mongolia for a decade, but in January Ulaanbaatar agreed to build its first oil export line at a cost of $1.5bn to China. Gas pipelines are the geopolitical equivalent of marriage, as they cost a lot to build and can't be moved once completed.

bne February 2014

took a 8.33% stake in the North Caspian Operating Company (NCOC), the multinational consortium developing the massive Kashagan oilfield in the Kazakh sector of the Caspian Sea, which is encountering technical problems but is due to come on stream this year

Infrastructure projects are rapidly tying the Mongolian economy to China: late last year it signed off on a plan to build a very short rail link across its southern border to China – a link Ulaanbaatar has been trying to avoid because it ties the two economies "too closely" together.

Most recently, the Chinese mining company Shenhua said in December it is considering investing up to $8bn in coal production in Kazakhstan, one of the biggest ever deals. "The Chinese company has had a series of talks with the local governors of Karaganda Oblast to develop a coal deposit. The production unit plans to produce 6m tonnes of coal a year," said the agency's deputy chairman, Kairat Karmanov, at the end of last year.

The Mongolian government is trying to balance the influence of all its large neighbours. That is going to be hard, as Mongolia already leads the world in the share of its exports that go to China, sending 87.6% of its goods over its southern border. And with the new pipeline and rail link, that share will only go up.

• Kyrgyzstan Tiny Kyrgyzstan doesn't have much in the way of resources, but took in $400m of Chinese money to build a road running from the north to the south of the country, Transport and Communications Minister of Kyrgyzstan Kalykbek Sultanov said following his meeting with Li in November.

• Kazakhstan Central Asia's hydrocarbon king has tied its economy closely to its neighbour China, but President Nursultan Nazarbayev has shown himself a master of international diplomacy, as he has managed this without annoying his other big neighbour Russia.

• Uzbekistan China is one of the largest investors in the Uzbek economy with 488 enterprises operating in the country that have invested a total of $6.5bn.

China already accounts for a big chunk of Kazakh exports. Kazakhstan produced some 82m tonnes of oil in 2013. A third was exported via the Caspian Pipeline Consortium (CPC) pipeline that runs over Russian territory to the west. Small amounts were sold via Azerbaijan and Iranian swaps, but most of the rest went to China via a pipeline that was built several years ago.

At the same time, China has quietly been buying into the Kazakh oil sector and already accounts for a quarter of the country's production, according to the press service of the Kazakh Oil and Gas Ministry. And in December, China upped its share again when the China National Petroleum Corporation (CNPC)

The two signed 20 bilateral agreements at a business forum in Tashkent in November including a $350m investment deal to build a railway tunnel linking the Uzbek Fergana Valley to the country's main rail network in December.

In a second major deal textile company Chinese Henan Sine said it will invest $80m over the next two years into the bankrupt Bobur textile company in the Andijan region. Bobur was commissioned in 1982 and is one of the largest textile companies in the Fergana region.

• Romania Outside Central Asia, China is looking at Romania as a second manufacturing bridgehead in Europe in addition to Belarus.

In November, Li and his Romanian

counterpart Victor Ponta agreed to cooperate in building high-speed railways in Romania. The two leaders also reached comprehensive consensus on deepening cooperation in such fields as trade, energy and infrastructure.

During the same trip Chinese telecommunications equipment producer Huawei said it will invest in research and education programmes in Romania and will open a regional centre in Bucharest, according to Ponta.

And Romania and China signed two nuclear cooperation agreements to clear the way for the Chinese company to take a role in building new reactors on the Cernavoda site, in a project being led

by Canada's Candu Energy, owned by Montreal-based SNC-Lavalin. CGN, a Chinese energy company, has promised to supply part of the financing for the $5.4bn project.

• Belarus Belarus is also set to be a major manufacturing bridgehead for China in Europe. A new Chinese-Belarusian industrial park is going up outside of Minsk and Huawei also said in December it was interested in opening an R&D center in Belarus as one of several projects.

In January, Belarus and China agreed on a programme to promote an all-round strategic partnership in 2014-2018 and Minsk is hoping China will become a major investor into its economy.

• Serbia- Hungary rail link China will participate in building a railway link between Serbia and Hungary, Li said after meeting the Hungarian and Serbian prime ministers in the Romanian capital in Bucharest in November.

Flanked by Hungarian Prime Minister Viktor Orban and his Serbian counterpart Ivica Dacic, Li said: "We reached important agreement... we agreed to begin cooperation on the construction of railway linking Hungary and Serbia…

The three parties agreed to immediately set up a joint working group to launch the project as soon as possible."

bne February 2014

Eastern Europe

I 21

with only fertiliser company Phosagro and TCS ending the year lower than their IPO price.

The pent-up demand for IPOs is enormous and just the state companies that want to list as part of Russia's stalled privatisation drive launched in 2008 runs to an estimated $100bn, say bankers.

Russian IPOs could take off in 2014 Ben Aris in Moscow

W

ith a little bit of luck, Russian IPOs could make a comeback in 2014, say bankers, after investors' appetites were whetted last year.

After almost five years of inactivity due to fears of a second wave of the crisis, 2013 saw several successful Russian IPOs get off the ground. All in all a total of $7.9bn was raised via five IPOs ($3.2bn) and four secondary share offerings ($4.7bn). That is more than double the $3.7bn raised in 2012, note analysts, but still a long way from the record year of 2007 when $33bn was raised.

Online payment system QIWI, mobile operator Megafon, online retail credit bank Tinkoff Credit Systems (TCS), international software engineer company Luxoft and several others managed to sell shares and saw their stock prices rise dramatically. "The best performing Russian stock was QIWI, which rose 229% from its May IPO listing price, followed by another new listing, Luxoft, which finished the year up 118%. The top five performers were

all in the IT/Media sector and all US listed," says Chris Weafer, senior partner with Macro Advisory, a consultancy advising macro hedge funds and foreign companies looking at investing in Russia.

These are remarkable numbers for Russia. Pre-crisis, owners tended to be greedy and set their asking price too high; only a fraction of Russian IPOs beat the indices and several – most

The privatisation programme could be a big source of funds, but the two state sales in 2013 were both in effect private placements and getting a true state IPO away will remain a hard sell. The official plan pre-crisis was to sell $15bn of stateowned equity a year. "The $3.3bn raised from the sale of VTB equity [in 2013] was an issue from the company to boost its balance sheet. The state did not sell any equity nor did the Federal Budget receive any cash. The only public listing was the state's participation in the Alrosa IPO in October. The issue raised $1.3bn in total and the proceeds were split almost equally between the federal budget and the Yakutia regional budget," says Weafer.

Still, selling the stock of private companies should be a lot easier. Weafer estimates there is another $25bn worth of placements from the private sector in the wings and nine companies have already expressed a firm interest in trying to list in the next 12 months.

First out of the gate should be major Russian children's goods retailer Detsky Mir, controlled by billionaire Vladimir Yevtushenkov's AFK Sistema. The

"There is $25bn worth of placements in the wings and nine companies have already expressed a firm interest in listing in the next 12 months" famously the "people's IPO" of the bank VTB – are still underwater. Technology companies, in particular, are currently en vogue and have rewarded their investors handsomely. Of the nine issues in 2013, six made money for investors,

company said in January that it may hold an IPO as soon as July, but would like to list in the second half of this year.

Two other major retailer chains – Lenta, controlled by leveraged buyout firm TPG Capital, and the German-owned

22

I Eastern Europe

Putin goes topless The irony of Russia’s campaign against homosexuality is that President Vladimir Putin himself has become a gay icon as the “sexiest president in the world.” The ruler of the "Evil Empire" has a penchant for going in front of the cameras with his top off – and he is in pretty good shape for a man who recently turned 60.

What is he thinking? Well, despite the rubbishing of Russia’s commitment to democratic principles, Putin, like all leaders, is actually very concerned with his rating numbers. Putin's macho-man image plays extremely well with his core constituency – the legions of blue-collar workers who are, to put it politely, not the most sophisticated voters in the world. And it seems to work. According to the independent pollster, the Levada Centre, Putin’s popularity was up 10% in December to 68%, the highest level since 2002, making him one of the most popular presidents in the world.

Still, even the Russians are a little uncomfortable with the homoerotic image the president paints.

When quizzed by a journalist in January why Putin goes around topless so often, his erudite spokesman Dmitry Peskov shot back: “If you think that he deliberately posed topless in front of the cameras, you are again mistaken… Putin is often accompanied by a personal photographer and a personal cameraman. And the president simply lives his life – either he works, or is on holiday.”

bne February 2014

Metro – have also said they might offer shares in the first half of this year.

"Russia is still seen as a very attractive consumer market, the average income has increased so much," Erik Depoy, an equity strategist at Gazprombank, says.

"A lot of that will reflow back into the economy. If we assume that liquidity conditions globally will remain plentiful, the primary market will have a decent year."

Shoemaker Obuv Rossii, based in the Siberian city of Novosibirsk, also plans to raise as much as RUB2bn ($60m), owner and CEO Anton Titov told reporters in October.

Chances of success Still, despite the desire the outlook for IPOs in 2014 remains uncertain. The main problem that Russian businessmen face is the collapse in confidence amongst Russian companies. This has driven down investment and led to companies selling off their inventories rather than make new goods. The upshot is that although the labour market is drum tight and there is no output gap

The second unknown is just how the US Federal Reserve will handle its plan to unwind its quantitative easing programme. In January, the Fed said it would start slowly phasing out the free cash it has been pouring into the capital markets since the financial collapse in 2008. In addition to the impact on sentiment, the so-called "tapering" will also directly affect the amount of liquidity in the market, a large chunk of which has wound up in Russian assets in the past.

Stock pickers are being suitably cautious, which in itself could be a reason to buy: Russian stocks are currently ridiculously cheap. Russian shares were trading at a 25% discount to their emerging market peers as of the end of 2013, which is actually an improvement from the 50% discount that Russian shares were marked down to in the depths of the crisis in 2009, says Weafer.

As the year started, Russian stocks had the cheapest valuations among 21 emerging market economies monitored

by Bloomberg, with shares on the

"Stock pickers are being suitably cautious, which in itself could be a reason to buy" between supply and demand, businesses have not been investing for growth, which is leading to economic stagnation.

VTB is upbeat and argues that the government needs to do very little in the way of pump priming in the form of infrastructure investment in 2014 to get things moving again.

So economists will be watching the investment numbers closely in the months to come, as investment is set to overtake consumption as the main economic driver this year. "The key to the valuation of the Russian equity market is not among assets, but rather in investments," says Alexey Zabotkin, an analyst with VTB Capital. "Only once the investment pattern changes will the Russian market start to re-rate."

benchmark trading at 4.5-times projected 12-month earnings compared with a multiple of 10.4 for the wider benchmark MSCI Emerging Markets Index.

The consensus target for the leading RTS index for this year is about 1,500 with a few banks like VTB Capital and Uralsib being a little more optimistic and predicting 1,600. However, this is still way off historical valuations for the market. Pre-crisis the rule of thumb was the fair value for the RTS is simply 20-times the price of oil, which implies the index should be at 2,000, whereas it started 2014 at 1,390. If the market returns to "normal" (whatever that means post-crisis, as clearly things have changed), Russian equities should be on track for a thumping good year.

bne February 2014

Eastern Europe

Belarus tempts investors Sergei Kuznetsov in Minsk

T

hrough February 5, the government of Belarus is accepting bids in another attempt to sell a 51% stake in state-controlled Mobile TeleSystems (MTS), the Belarusian mobile phone operator that's a joint venture with the eponymous Russian telecommunications group. The starting price has been cut by the cash-strapped Belarusian government to $863m in an attempt to attract an investor, but will this be enough to secure a deal?

Over the past few years, the government of Belarus has tried in vain to sell a 51% stake in MTS, but the asking price of $1bn was considered too high by potential buyers. Cutting the price was made possible after President Alexander Lukashenko, who had repeatedly insisted on the $1bn price, announced in October he would sanction such a reduction given the current economic climate. “If today the price were not $1bn, which was set when the market was high, but $900m, I would sell it,” he told journalists.

Russia's MTS, which already controls a 49% stake in the joint venture, has previously expressed an interest in purchasing the remaining shares, but the company insisted the price of $1bn is too high. And it appears the new lower price has not made much of an impression on the Russian firm.

Vladimir Evtushenkov, chairman of the board of AFK Sistema, the conglomerate that controls MTS, was quoted by Russian business daily Vedomosti on December 23 as saying that the price is still too high, given “today's market and the state of the telecommunications industry.”

“Unfortunately, the telecommunications industry is gradually transforming into a low-margins business. It is searching for its place in the new paradigm, after the

appearance of Facebook and Google,” Evtushenkov explained. “We understand the position of the Belarusian side: they want to sell us [the asset] for as high a price as possible. It would be foolish to think that they should do us any favours.

Therefore, there is a normal dialogue, including over the upcoming tender."

Money matters Oleg Andreyev, managing director of investment banking at Minsk-based EnterInvest, tells bne the fair value of the Belarusian mobile operator is nearer $1.1bn-1.4bn, given the company’s financial results as well as the risks that exist in the struggling Belarusian economy, which is considered hyperinflationary. “This means that a 51% stake in MTS cannot go beyond the range of $600m-750m, taking into consideration a possible premium which could be paid for control.”

“These figures correspond to a persubscriber cost of $220-260, which is at a similar level to neighbouring countries,” Andreyev adds.

Andreyev admits that the sale of a 51% stake to Russian MTS would be the “most obvious” solution to the situation.

“Russia's MTS is currently the only company which would be willing to pay

I 23

companies in Russia, in particular Rostelecom, which is Russia's largest long-distance telephony provider.

Indeed, last year a representative from Rostelecom visited Minsk to attend a presentation of MTS aimed at potential investors. "We are looking at all options.

For now we are studying the Belarusian market," Rostelecom’s M&A department director Andrei Poluektov was quoted as telling local media at the time.

The fresh attempt to sell the MTS stake is part of a wider privatisation effort by the Belarusian government, initiated toward the end of 2013. In October, the Belarusian State Property Committee published a list of state-run enterprises that would be offered to potential investors, including a number of assets that could be considered as part of the “family silver.”

Among the candidates, there's talk of a 42.76% stake in the Mozyr refinery (one of the country’s two oil refineries) being sold together with a stake in MNPZ Plus, a state-run company that controls a 12.25% stake in the Mozyr refinery. Belarus is also apparently ready to negotiate the possible privatisations of Horizont Group, a producer of household appliances, and Transaviaexport, the commercial cargo carrier, as well as a 25% stake in BATE, producer of starters and alternators for engines. Moreover, the government has announced plans to sell in the near future a stake in state-controlled MZKT, the military vehicles producer.

Experts consider the latest privatisation moves an attempt to show the government’s readiness for structural

“If today the price were not $1bn, which was set when the market was high, but $900m, I would sell it” a premium for obtaining full control of the Belarusian asset,” he says.

Even so, analysts say it's likely the Belarusian firm will be the subject of interest from other large state-owned

economic reform, a necessary step in order to negotiate new loans with multinational lenders, such as the International Monetary Fund and the bailout fund of the Russian-led Eurasian Economic Community (EurAsEC).

24

I Central Europe

bne February 2014

Photo: Toms Norde, Valsts Kanceleja

Out with the new, in with the old in Latvia Mike Collier in Riga

"L

ose weight, exercise more,” will have been the New Year's resolution of more than one person for 2014. But in the case of Latvia's government it is more likely to read: “Stay fat, avoid doing too much.”

After two months of increasingly absurd negotiations on the formation of a new government following Valdis Dombrovskis' surprise resignation in November last year in the wake of the Zolitude supermarket disaster that killed 54 people, Latvia is finally ready to have someone in charge again.

The good news is the country will take an important step forward by having its first ever female prime minister in

former agriculture minister Laimdota Straujuma. The bad news is the government itself appears to have taken two steps back by bringing the oligarchcontrolled Union of Greens and Farmers (ZZS) into the new coalition, which will now consist of four actual parties and six “independent” MPs of dubious provenance.

Talk of Straujuma as “Latvia's Angela Merkel” sadly extends no further than a passing physical resemblance to the German chancellor. Both women are products of a communist bloc upbringing, rather short and stout, and with an endearingly scatter-brained edge to them. But Straujuma will also need her lookalike's ability to make violently opposed parties work together

if she is to be anything more than a stopgap.

In one of the last acts of his premiership, Dombrovskis did manage to achieve his ambition to see Latvia into the Eurozone. bne was there outside the HQ of Citadele bank (still for sale after being rebranded from the notorious nationalised Parex) as he withdrew a €10 note from an ATM and held it up to polite applause. Yet even in that act Dombrovskis was trumped by his Estonian counterpart Andrus Ansip, his guest for the evening, who elicited cheers when he revealed a hitherto unknown ability to speak at length in faultless Latvian.

On January 10, a trio of EU heavyweights – or rather two

Central Europe I 25

bne February 2014

heavyweights and a makeweight, in the forms of Jose Manuel Barroso, Olli Rehn and Herman van Whasisname – arrived in Riga to offer their own congratulations, having given themselves a week to make sure the currency switch wasn't a disaster. In fact, euro adoption took place with commendable smoothness and despite a lack of widespread public enthusiasm for the move, the Latvian public has taken to using euros with unfussy stoicism. “Latvia's membership shows that the euro remains attractive and

dipped below 10% of the workforce for the first time in four years.

Further upgrades to Latvia's credit rating are probable and on January 15 the country successfully sold €1bn of seven-year Eurobonds that yield 2.815%. Demand exceeded supply by a factor of four – suggesting that maybe the price was too low – and a further foray into the markets is likely later in the year. “Economic growth, accession to the Eurozone and improvements in Latvia’s credit ratings obtained up to

"I think not very far from now we will have all the three Baltic states members of the euro"

open to those that meet the required conditions. We are already working with another Baltic country, Lithuania, so I think not very far from now we will have all the three Baltic states members of the euro," European Commission President Barroso said during a "press conference" that involved all of one question before cracking open the champagne at a celebratory reception.

With just eight months until the next scheduled elections in October, the "new" old-style government is unlikely to press ahead with any major reforms and will be characterised by jostling for position ahead of the vote, particularly when the dead-man-walking Reform Party is absorbed into Dombrovskis' Unity party, as now seems a certainty.

So the big question is whether an ineffective administration can screw up the country's current rosy economic outlook and if so, how fast.

Economic prowess Latvia is expected to top the EU's growth chart for a third year in a row when 2013 data is released on February 10, with GDP expected to have risen by more than 4%. Inflation data is already in, showing average annual inflation of zero for last year, and joblessness has

a relatively fat year for Latvia."

But even such optimism comes with a worrying undertone. The last person to talk about “fat years” was the suitably rotund prime minister Aigars Kalvitis, the self-styled “guarantor of stability” who blithely piloted the country from 2004 to 2007 through its period of massive fiscal imbalances and oligarchdominated politics that led directly to one of the deepest economic recessions in history.

Kalvitis' coalition was not a million miles away from the one that has just taken charge. And come October the resemblance could become even stronger, turning the recent years of genuine reform into a temporary feelgood interlude rather than an ongoing long-term improvement. Such is the fate of most New Year resolutions.

now have allowed Latvia to borrow in international markets on favourable terms,” Finance Minister Andris Vilks said following the issue. "The successful sale of bonds clearly continues to testify to foreign investors’ high evaluation of the work accomplished in Latvia's economy as well as the credibility of the state in general."

Nordea Bank's chief economist Andris Strazds agrees the current macroeconomic picture is optimistic.

“The most important question now is

"If more populist forces or vested interests come to power, reforms could stop and growth could falter in 2015" what will happen in October 2014. If more populist forces or vested interests come to power, reforms could stop and growth could falter in 2015,” he tells bne. “Prices for most services continue to slowly rise, indicating that domestic demand is still relatively strong. In combination with a revival of demand, growth in the main export markets should mean that 2014 will be

26

I Central Europe

bne February 2014

the makeup of the cabinet, and had objected to several potential candidates. Despite Sobotka publicly rejecting the president's claim to have any say, horse-trading has clearly been going on. The coalition now says it will appoint "expert" deputy ministers, meaning Zeman can park his supporters in important positions. The presidential office announced he would swear in the remainder of the cabinet on January 29.

Bohuslav Sobotka is appointed prime minister

by President MiloĹĄ Zeman. www.demotix.com

Another day, another Czech coalition bne

T

he Czech Republic is set to gain an elected government for the first time since the summer, with President Milos Zeman announcing on January 23 that he was finally ready to approve the coalition cabinet. Many, however, are already wondering how long the new government will last.

Bohuslav Sobotka, head of the Czech Social Democrat Party (CSSD), was sworn in as prime minister on January 17, nearly three months after his party took the most votes in snap elections in October. The centre-left CSSD has spent the intervening time thrashing out a coalition agreement with the centrist Ano 2011 and Christian Democrats (KDU-CSL).

A caretaker government of figures close to Zeman has run the country since August, despite objections from all political parties. The power-hungry president has extended the life of his cabinet by pushing the boundaries of his office, but has finally run out

of time and had to appoint Sobotka, having failed to dislodge him in the wake of the October vote via an attempted party coup.

Despite the CSSD's disappointing performance in the election, which saw it take just 21% of the vote, Sobotka told the Wall Street Journal he is "convinced the Czech Republic very soon will have a strong coalition government with a [solid] majority

While it looks likely then that Zeman and Sobotka have found a compromise to allow the new government to take the reins, the longstanding hostility between them – said to hark back to 2003 when Zeman broke with the CSSD – is barely concealed. The new PM has said the coalition will prepare constitutional changes to limit the president's scope of action. Zeman will likely use his continued influence inside certain sections of the CSSD to stir up more trouble.

Combustible cocktail That's the last thing Sobotka needs, as he faces the threat of a potentially combustible cocktail to his government.

His party's failure to properly capitalize at the snap election, which came after the centre-right coalition collapsed amid one scandal too many, did little to shore up his position. Meanwhile, the population has signaled it is weary of politicians of all stripes.

That was the key to the 19% of the vote taken by Ano 2011, a new group headed by billionaire Andrej Babis that has promised to clean up corruption. Such

"Ano threatens an even greater destabilizing effect than previous new parties" in the parliament." After it is sworn in, the new cabinet will face a vote of confidence in parliament.

Zeman had insisted for weeks that he had the right to interfere in

protest parties have enjoyed power in the recent past, but more often than not merely injected instability into the political system. The coalition commands 111 seats in the 200-strong lower house, but the weight of

bne February 2014

Central Europe

governing has often impacted smaller Czech political parties in recent years, helping to bring down coalitions.

It was the splintering of the minor Public Affairs (VV) party in 2011 that set things in motion for the previous government. It put the centre-right administration headed by Petr Necas

was accused, among other things, of buying off unruly backbenchers with jobs at state companies for their support in a vital parliamentary vote.

Ano threatens an even greater destabilizing effect than previous new parties given that it has the weight of support to challenge Sobotka directly;

the coalition agreement has already seen Babis, who will be finance minister, water down the CSSD's plans to raise taxes and loosen fiscal policy. "Our main priorities will include restarting economic growth,

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

supporting the creation of new jobs, improving the functioning of the state and restoring people's trust in politics as such," Sobotka said following his swearing in ceremony.

At the same time, there is concern over Ano's control of the finance ministry.

Babis made his billions from Agrofert – an agricultural, food processing and chemical conglomerate which is the largest employer in the Czech Republic – and he has refused to put control of it in a blind trust, so the potential conflict of interest is stark.

"Ano threatens an even greater destabilizing effect than previous new parties"

under constant pressure over the last 18 months of its time in office. With its majority cut to one seat, the coalition struggled to pass coherent policy and eventually fell as a direct result: Necas

Investors, however, are well versed in shrugging off Czech political instability.

Sobotka will be the 11th PM since 1993, and despite three months of unelected government and the questionable constitutionality of the president's practices, investor appetite for Czech assets remains undimmed.

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

What you need to know

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

I 27

www.bne.eu

28

I Central Europe

bne February 2014

Road rage in the Czech Republic Nicholas Watson in Prague

R

oad construction in the Czech Republic is a notoriously murky business. But insiders grumble new depths for the industry have been plumbed following the barrage of criticism aimed at the plans to renovate the main D1 motorway and a dispute over Prague's €1.3bn Blanka tunnel complex that temporarily halted construction on the now almostcomplete project.

Remaining work on the Blanka tunnel complex was stopped in December after the country's largest construction firm Metrostav and the Prague city authorities failed to find a solution to a legal dispute over the initial contract drawn up to build the project. The fight centred on the stunning revelation on November 19 by the City Council that the contract drawn up between the city of Prague and Metrostav ahead of work beginning on Blanka back in 2007 was invalid from the very start and it wasn't prepared to pay out any more until legal questions are resolved. "The city has paid tens of billions of crowns without a legitimate reason and it cannot continue like that," Mayor Tomas Hudecek said at the time.

The contract that awarded the work to Metrostav was signed by ex-mayor Pavel Bem, whose eight years in office were tainted by corruption allegations, most

notoriously when Mladá fronta Dnes published stories based on purported transcripts of surveillance tapes on which Bem discussed with lobbyists topics such as how to influence sales of state property.

Metrostav filed a complaint with an arbitration court over CZK2.1bn (€76m) it claimed Prague owed it for construction work on the tunnel. And on January 23, in a preliminary ruling the court dismissed claims raised by Prague City

Originally scheduled for completion in 2011 at a cost of CZK27bn, the Blanka tunnel complex is now predicted to open in June 2014 at a cost of CZK37bn.

According to the industry information provider encompassme, Metrostav will get 36% more than it originally claimed for the construction of the Blanka tunnel complex. Another contractor, CKD DIZ, will get 21% more, while Inzenyring dopravnich staveb will get CZK217m, more than double the CZK95m it was due under the original contract.

However, the project has admittedly been a large and complicated one; designed to eliminate through-traffic from Prague's Unesco historical centre, the tunnel complex is 5.5 kilometres long, including the longest driven tunnel in the Czech Republic. And industry players say it is not so unusual to see such complicated projects going over budget, especially if they involve underground work.

Metrostav did not comment on questions raised in this story, though bne did receive some answers of a sort from Pavel Pilat, general director of Metrostav, at a press conference in 2012 held to trumpet the builder's tie-up with Westinghouse in the US company's bid to win the tender to expand the Temelin nuclear power plant. As is construction

"All projects are modified in order to maximise profits – I am sure that all projects are a third to a half over priced" Hall that the contract with Metrostav on the Blanka construction was invalid and that work on the project should resume.

Enough blame to go round In this case, the court found Metrostav to be the aggrieved party. Yet where Metrostav is at fault is that this project is way over budget and has been plagued by safety violations. For example, the Czech Mining Office in 2010 fined Metrostav over the collapse of one of the road tunnels three times.

companies' wont, Pilat blamed any lapses in the project on changing parameters by the government and lax subcontractors. "There was definitely no negligence on our part," Pilat sniffed indignantly.

However, a 2011 report by Miloslava Posvarova, a former employee for the UK engineering firm Mott MacDonald, laid out in forensic detail how it is that constructing roads and bridges in the Czech Republic goes so over budget, so

bne February 2014

past deadlines, yet is of such poor quality that roads buckle and bridges collapse, including one notorious instance in 2008 that killed eight people.

An illustration of the scale of the problem can be found in a survey last year by the Supreme Audit Office (NKU), which showed that of 28 projects relating to motorways and high-speed communications started after 1999, all had their deadlines extended by up to seven years and investment costs rose by a total of CZK35bn (€1.37bn), or about 68%.

The rise in corruption is reflected in Transparency International's "Corruption Perceptions Index 2013", released December 3, which showed the Czech Republic falling another three places to 57th spot, putting it on a par with countries like Croatia and Namibia.

Posvarova's 2011 report, which was prepared for the National Economic Council, a government advisory body, highlighted a basic conflict of interest in construction projects, in that companies that prepare plans for road construction for the Czech state often work at the same time for the winners of the said tender. This too-cosy relationship also means contractors often succeed in getting approval from the project coordinator for changes in the project's specifications, which causes the cost increases, delays to the project and helps the contractor avoid being lumbered with unforeseen extra costs. Notes one industry insider, Czech contractors are constantly on the look out for viceprace (additional work, in English), once the contract is signed.

Another industry insider says it's also common for construction firms to use academics, often poorly paid and easily swayed, who are brought in to give any changes to projects a veneer of authority. "State agencies are servants to a cartel of contractors who do not accept the views of those interested in keeping a lid on costs," says the insider.

"All projects are modified in order to maximise profits – I am sure that all projects are a third to a half over priced."

Metrostav, which was established by

Central Europe

the communists in 1971 to build the Prague metro but was privatised by management led by Jindrich Hess in the 1990s, is finding itself at the sharp end of a number of investigations by the Czech authorities recently.

Never the most transparent of companies – its main shareholders are listed, not very enlighteningly, on the website as DDM Group a.s. (51.34%), DOAS SK, a.s.

(23.17%) and DOAS CZ a.s. (17.04%) – it has refused to comment much on corruption accusations levelled against the company over the past three months by the police.

In October, it was revealed that the Czech police have filed charges against Metrostav in connection

I 29

The main highway of the Czech Republic, the D1, which connects the two biggest Czech cities of Prague and Brno, is by all accounts a national disgrace. Buckled in places, falling apart in others, this busiest of roads has only two lanes at the best of times, but is often restricted to one lane as emergency repairs are made to a road whose life has already been extended by 10 years.

Thus the government has begun this year a CZK22bn project to modernise the road. But the manner in which it is undertaking the project has drawn huge criticism from people working in the industry, from contractors to consultants to engineers, few of whom are in any doubt that, true to form, it will cost

"The project is a totally wrong concept of rehabilitation of D1 because it's very expensive, very risky" with the high-profile corruption case against the former governor of the Central Bohemian region, David Rath, who is accused of accepting bribes in connection with public tenders. Frantisek Polak, spokesman for Metrostav, would only confirm to the Czech press that the company had received notification from the police about the initiation of legal proceedings, though it rejected the charges and said it would not comment further on the case until it is resolved.

Then on November 28, the online news site ihned.cz published details of an alleged case of tender fixing in the CZK300m reconstruction of the Czech National Stables, in which the police accuse Metrostav of having paid off its competitors to ensure they would submit bids that were too high to win.

D1 to hell But even as the fiasco that has been the Blanka tunnel complex nears completion, another financial disaster in construction looms.

considerably more than CZK22bn by the time it's completed late.

"The project is a totally wrong concept of rehabilitation of D1 because it's very expensive, very risky and a seven-year period to do modernisation of this main connection is totally wrong," says Jiri Petrak, who adds that together with other industry professionals he formulated his own report on the project and sent it to the Road and Motorway Directorate, as well as the Ministry of Transport.

No response was forthcoming, so the group of professionals created an NGO with a website that plans to review and comment on the country's main infrastructure projects such as D1, so the hard-pressed taxpayer and media can be more fully informed. "The D1 is just the prime example of the wrong way of doing things – there are many others," says Petrak.

"But for Blanka, it's too late to do anything about that now," he sighs.

30

I Central Europe

bne February 2014

demand, and that ruined our external balances,” he says.

Hungary govt trumpets success as elections approach Kester Eddy in Budapest

L

ate Saturday night, and Erzsebetvaros – Budapest's hip, downtown quarter, packed with trendy restaurants and take 'em as you find 'em "ruin pubs" – is abuzz.

Even in January, any stranger happening upon the many revellers stumbling along the irregular pavements could well believe the government of Viktor Orban, Hungary's former anti-communist student dissident-turned-conservative prime minister, has got it right. "Hungary's Performing Better", so the Magyar rulers' slogan reassures the ruled on every available occasion. And the out-of-season jollity in Budapest's very own Bohemian quarter would seem to support this thesis.

Of course, such fleeting street vignettes could never justify serious conclusions regarding a national economy: for that, one needs hard data. The government is more than happy to provide: with the economy bottoming out – or as the authorities would prefer it, turning to growth – in 2013, and elections due on April 6, its communications staff are on overtime cranking out the positive.

Just three of the latest headlines on

the government website read: “New record high, 4 million 12 thousand … in work,” (economy ministry, January 7); “Economic sentiment index at 10-year high,” (January 9); and “Record low inflation in December” (January 16).

Such claims cannot, surely, be without substance? Despite the unorthodox measures, the hurried, punitive taxation measures meted out from 2010 on utilities, telecommunication firms, banks and large retailers (perhaps not coincidentally, all sectors predominantly owned by foreign investors), and despite the legislative upheavals which have had resulted in European watchdogs questioning Hungary's commitment to democratic norms – is Hungary on the mend?

Gyorgy Barcza, economist with Szazadveg, a right-leaning think-tank and editor of business daily Napi Gazdasag, is in no doubt. “Any assessment of Hungary should be based on facts, not feelings… I think last year was proof that things have started to improve. For the first time in 40 years, Hungary has been accelerating on a balanced path, [whereas] usually the economy accelerated based on domestic

The key data appear straightforward enough. In the third quarter of 2013, year-on-year economic growth – adjusted for calendar effects - hit 1.6%. Headline inflation for December, at a new record low of just 0.4%, meant average inflation for last year came in at 1.7%. With the base interest rate trimmed for the 18th consecutive month to a record low of 2.85% on January 21, the budget deficit set to come in at around 2.7% of GDP, and unemployment dipping to 9.3% – a four-year low – government trumpet blowing is understandable.

Even abroad, observers have reacted positively: in a particularly upbeat January analysis, Charlie Robertson, of Renaissance Capital, noting the “best business confidence figures for 15 years,” forecasts 2.5% GDP growth this year, and 4% in 2015 – well above consensus predictions of 1.8% and 2.0% respectively. “Hungary’s recovery is strong, broad-based and good news,” Robertson concludes.

Not all are so bullish. William Jackson, at London's Capital Economics, says that while the economic confidence figures would imply economic growth surging to around 5.0% in the fourth quarter, there have been previous instances when the headline figures have spiked, but resulting growth has been muted.

Jackson is awaiting further data before making any revision to his prediction of 2% expansion this year.

In Hungary, opposition politicians are predictably more critical. Lajos Bokros, former finance minister and author of the 1995-1996 austerity programme, emphasises that, despite the recent economic expansion, output is sill below pre-crisis levels. “Three things are missing in Hungary: economic growth, investments and jobs. In all these respects Hungary is far behind the Visegrad and Baltic countries, which are useful reference points.

Hungary has not yet achieved its precrisis output; the rate of investment is just 16%, which is below replacement rate; and the job numbers have been

bne February 2014

created exclusively by the state in bureaucracy and public works,” he says.

Bokros, an economist who now heads the “Movement for a Modern Hungary” (a small party he terms “genuinely conservative” in the western meaning of the words), stresses that both the low unemployment and high labour participation rates are further massaged because the statistics include large numbers of Magyar workers based abroad.

Laszlo Akar, vice-president of GKI Economic Research Institute, a leftleaning think-tank, largely concurs. “Quite clearly the figures show improvement, but growth in 2013 was mainly due to the nice weather, as agriculture was up more than 20% [on 2012]. There has been no improvement on the 2010 performance,” he says, the recent data, at least in part, are “window-dressing.”

Further, the improved budget deficit figures are at the cost of what he terms the “anti-reform” government measures to nationalise the private pension system.

Akar, who forecasts just 1.3% economic growth for 2014, says the Orban government's hostility and drive to nationalise the foreign-owned banks and big utilities, along with unpredictable economic policies has ruined business confidence, deterring both domestic and international investors in the real economy.

All this means that, prior to the elections, the government will continue with both rhetoric and its PR offensive on the perceived achievements, while avoiding genuine high-risk moves, such as any drastic efforts to solve foreign-currency loans, since this could undermine the forint.

Nevertheless, “drastic interference,” Akar warns, “cannot be ruled out.” He adds: “It's not a main scenario, but it's a potential danger."

The markets seemed to have noticed.

The forint has weakened around 1.7% since the New Year, making it the worst performing currency in Central and Eastern Europe.

Central Europe

I 31

Hungary gets cash for going nuclear with Russia

bne Russia is to hand Hungary funding of up to ¤10bn as part of a deal struck on January 14 giving Moscow the contract to upgrade the Paks nuclear power plant without a tender.

On a visit to Moscow, Hungarian Prime Minister Viktor Orban and his host President Vladimir Putin observed Sergei Kiriyenko, head of Rosatom, and Hungarian Development Minister Zsuzsanna Nemeth sign off on a deal that will see the Russian state nuclear corporation build two new 1,200-megawatt (MW) capacity blocks at a cost of ¤10bn-12bn. Putin claimed the contract will help "improve Hungary's energy independence and help solve issues associated with energy security." Orban labelled it an "excellent professional deal."

Suspicion that Hungary was preparing to scrap plans to run a tender for the project had been building again in recent weeks, as officials in Budapest hinted at deepening energy ties to Russia on the back of the state's takeover of Hungarian utilities. The offer of cheap Russian cash appears to have sealed that new mood of cooperation.

Kiriyenko said the final volume of funding has not been defined, but that it would be below the project's minimum cost of ¤10bn. The exact amount will depend on power prices and the plant's technical parameters. The preliminary agreement covers three areas, he added: construction of the new blocks, fuel supplies, and servicing.

Orban's chief of staff, Janos Lazar, told Reuters that the loan will have a 30-year maturity and will cover 80% of total costs of the project. The new blocks, he added, are unlikely to come online before 2023. He also pointed out that the plan to expand Paks has been approved by the EU. However, Brussels will likely be less impressed by Budapest's decision to hand the country's biggest contract ever without holding a formal bidding process – something which contravenes the bloc's procurement rules.

Some suggest Orban et al will look to dodge this via a loophole, and claim the contract is not affected by such regulation. "In this case," an unnamed source told Gazeta.ru, "we are only talking about the expansion of an existing plant and not the construction of a new one. Based on this, we can hope that the EU leadership will not have substantial complaints about the tender's annulment."

32

I Southeast Europe

bne February 2014

Serbia's EU dream is closer, but no cigar Harriet Salem in Brussels

S

erbia may have opened its EU accession talks January 21, but the bloc's stringent restrictions on smoking have not yet permeated the Serbian Embassy on Boulevard du Regent in Brussels. Reclining in a large armchair, Serbia's prime minister and leader of the Socialist Party, Ivica Dacic, puffs on a fat cigar to celebrate what he described as, "the most momentous and most important day for the country since the end of World War II." Less than a decade ago talk of Serbia joining the EU would have been laughable. Following the brutal wars surrounding the collapse of Yugoslavia, the country was subject to heavy economic sanctions, and widely regarded as the pariah state of Europe.

But since coming to power 18 months ago, this is an image that Dacic and his

coalition colleague Aleksandar Vucic, deputy prime minister and head of the leading coalition member Serbian Progressive Party (SNS), have fought hard to change.

And with the formal opening of EU talks, the unlikely duo, both ultranationalists during the 1990s, can certainly claim a victory in taking Serbia closer to Europe than it has been in decades; the PM hopes Serbia will be a member by 2020. Yet both agree that the real hard work is yet to come. "Many countries would today call a seven-day holiday celebration," Dacic told reporters at a press conference January 21. "But tomorrow we will be back at work, even harder than before."

Economic woes There's plenty to get on with. Serbia's

economy, whilst slowly improving, is still struggling to say the least. The 2014 budget foresees a deficit of 4.6% of GDP, and debt tops 60% of GDP. Unemployment stands at around 20%, and the average wage is below â‚Ź400 per month. "Improving the economy is now the biggest challenge ahead of Serbia, unfortunately a lot of time has been wasted and we now lag far behind other countries in this respect," Dacic tells bne in an interview.

Attracting foreign investors to boost the country's beleaguered economy has been a key focus of the government over the last year and a half. Thus far, most interest has come from the east, notably Russia, China and, intriguingly, the United Arab Emirates (UAE). In the past year the latter made a $40m equity investment in Serbia's indebted JAT

Southeast Europe I 33

bne February 2014

airways and an $800m loan-investment deal in agriculture, while in December it was announced that UAE businessman Mohamed Alabbar is set to put a further €2.5bn into a project known as Belgrade

However, while investments and loans have undoubtedly helped stimulate the economy, Dacic acknowledges that on the other side the government "must also decrease unnecessary spending."

"Many countries would today call a seven-day holiday celebration, but tomorrow we will be back at work" on the Water. "We have shown that there are lots of opportunities for investment," Dacic tells bne. "In agriculture, in infrastructure, energy."

But Serbia hopes that its commitment to attracting foreign direct investment and closer ties with the EU will now open up yet more new sources of funding, particularly in the West.

"Securing an arrangement with the IMF [International Monetary Fund] as soon as possible is crucial to stabilising the country's economy in the year ahead," Dacic says.

The PM also expressed optimism that Serbia's progression toward the EU would act in favour of increased investment in the country by the European Bank of Reconstruction and Development, which will meet in February in London with governments from across the Western Balkan region.

At least one high-profile western businessman is already looking to put his money into the country following the opening of EU talks. US tycoon Donald Trump, who met personally with the PM in New York two months ago, sent his team to Belgrade during the Serbian New Year festivities – celebrated according to the Orthodox Julian calendar on Jan 14 – to look at a range of potential opportunities in the city's entertainment industry. "I can say that it looks likely that investment in a hotel will go ahead," Dacic confirmed to bne.

"Tourism is an area where Serbia has a lot of underexplored potential, currently it accounts for only about €1bn of revenue, but it could be much more."

More than 500,000 people have already lost their jobs says the PM, and if the government sees through its promise to further trim back the burgeoning, inefficient public sector and shut down so-called ghost companies, many more will follow. This will likely be a "painful and difficult process" for the public, admits Dacic, "but a strong government must stand by its decisions".

The ever-contentious Kosovo issue also could also stir up public opposition in the year ahead. Moving towards the EU has already entailed Serbia making tough concessions including a commitment in the Brussels-brokered April Agreement – co-signed by Dacic and his Kosovan counterpart Hashim Thaci – to relinquish its control over Serb enclaves in the north of

Snap polls Snap elections may also be on the cards.

The increasingly powerful deputy PM, Vucic, is rumoured to want to cash in on his high poll ratings before the tough times in EU negotiations kick in. Dacic has a vested interest in avoiding an imminent vote; he would almost certainly lose his position to Vucic. But as the PM points out, elections at such a crucial time could also prove a major setback for the country. "This would occupy political parties. Election campaigns are not the time for making difficult decisions," he tells bne. "So the question here should be, what is better for Serbia?"

Despite all the uncertainties ahead, Serbian officials still say they hope to complete all their membership bid commitments by 2018, in time for 2020 budget allocation. It's an ambitious timeframe. The EU will be watching developments more closely than ever before. Accusations of allowing insufficiently prepared countries – namely Romania, Bulgaria and Croatia – cat flap-accessions to the bloc have led to a tightening of accession procedures.

"Lessons have been learned," European Commissioner for Enlargement and European Neighbourhood Policy Stefan Fuele told the press on January 21.

In previous waves, aspiring EU countries were allowed to start with policy areas,

"Election campaigns are not the time for making difficult decisions" its erstwhile province. But some EU countries, most notably Germany, are pushing for wholesale recognition of Kosovo as a prerequisite for Serbia's admission into the EU. The demand may prove to be a step too far. "We will stick to the negotiating framework [and] we are open to a permanent solution on Kosovo," Dacic says.

"But Serbia is not going to change its position," he adds, tellingly.

known as "chapters," deemed easiest for their government, but this time round the European Commission have insisted that Serbia begin the process with the two most challenging; chapters 23 and 24, which address fundamental rights and the rule-of-law.

No public confirmation of the timing for the first set of talks has yet been given, but according to whispers in Belgrade and Brussels, bar unexpected setbacks, June 25 is the date to watch.

34

I Southeast Europe

bne February 2014

universal – view about the election is that it is intended to strengthen the Progressive's position, place Vucic as prime minister and shift out the current premier, Ivica Dacic of the Socialist Party.

Vucic, a former ultra-nationalist, has been the main powerbroker in the government in the year and a half since it was formed following the last general election in May 2012. He has portrayed himself as a reformer, not only supporting Dacic's compromise deal with Kosovo last year, but making blood-and-thunder warnings that Serbia is close to bankruptcy and needs to cut the public sector workforce – the former exaggerated, the latter rather less so.

Serbia heads back to the polls Andrew MacDowall in Belgrade

S

o Aleksandar Vucic has taken the gamble. Serbia's forceful deputy prime minister, who appears to covet the premiership, has called for early elections to be held on March 16, which means that the vote will almost certainly go ahead as his party is the largest in the coalition. While the snap poll has been widely portrayed as a move to win a mandate to continue with tough fiscal and structural reforms, whether that will indeed be the outcome is open to question.

"Serbia is in transition between the very bad and the unknown," says Milan Parivodic, a former minister and now advisor to both foreign investors and the government. "Elections always bring an element of risk, and I hope that they don't produce a government that returns to the counterproductive policies of the past. Then there is always the risk of a financial crisis – I don't believe there will be, but we can't dismiss the possibility."

Vucic is head of the Serbian Progressive Party (SNS), the largest in parliament, and on January 25 called for a "fresh full mandate" to allow Serbia to

Vucic has pursued trade and investment deals with alacrity, including with the United Arab Emirates (UAE), which has offered €3bn in loans. Abu Dhabi's national airline Etihad took control of a 49% stake in Air Serbia (formerly known as JAT Airways), with full management control for five years, in a deal that is already paying dividends in improving the connectivity of Belgrade and thus its position as a regional business centre.

Serbia certainly has some strong competitive advantages for investors. It has a central location in Europe, a low cost base, preferential access to markets

"A new IMF deal would be a belt around the belly of someone who likes to eat too much" "move forward faster and better."

The election bid has been expected for many months, as Vucic and the Progressives have looked to cash in on popularity linked to progress towards EU membership (formal accession negotiations began earlier in the week), renewed economic growth and a popular anti-corruption drive.

Promotion The widespread – indeed almost

in the EU and beyond (including Russia), and active government incentives for major investors. Sectors with potential include manufacturing (Fiat invested €1bn here and exports as far afield as the US), ICT and agriculture.

But there is no doubt that Serbia needs economic reform, including action to tackle its fiscal problems, labour market liberalisation and restructuring of a

bne February 2014

number of burdensome state-owned companies.

Even with tax rises and some spending reductions, the World Bank expects Serbia to run a budget deficit of 6.5% this year, while public debt crept over 60% last year – significantly above the legally-mandated ceiling of 45%. The country's public administration is widely regarded as top-heavy, and to get an idea of complex structure of state-owned enterprises, the large and influential national gas company has at times relied on earnings from a chicken farm it took over in a debt-for-equity swap to offset losses from its core business.

Southeast Europe

we might see some fiscal loosening into election season, but I don't expect the outcome to be as uncertain as it has been in previous elections. SNS should win a comfortable majority, giving it plenty of political room for manoeuvre towards greater fiscal and structural reforms, including a deal with the [International Monetary Fund]. This time is different – early elections are positive for Serbia."

The IMF suspended a $1.3bn stand-by loan deal with Serbia in January 2012, under the previous government, over the country's rising debt and deficit. The Dacic-Vucic administration has flirted with the institution over a new deal that

"SNS should win a comfortable majority, giving it plenty of political room for manoeuvre towards greater fiscal and structural reform" The Progressives' energy minister has proposed restructuring the gas company, seen as a Socialist fief. And while the economy is recovering, it is hardly a stellar performer: growth is generally expected to come in at 2% or below in 2013 and 2014.

But can an election really deliver a government able to push through reform, or will it just kick the can down the road like so many others before it?

Political risk Aside from the fact that the administration is now in a state of battle engagement, and barely able to focus on governing, let alone push through belt-tightening, the lengthy process of forming a viable coalition means that it will be some time until the country has true political clarity again.

But among the analysts bne canvassed, the consensus was that an election might cause temporary problems, risks are on the upside. "I actually view the early elections as possibly the trigger for a set of positive developments in Serbia," Abbas Ameli-Renani, an emergingmarkets analyst at RBS, tells bne. "Yes,

would, as one observer puts it, "be a belt around the belly of someone who likes to eat too much." An IMF mission is expected in Belgrade in the days before the election, but without a government in place, a new loan package will have to wait.

Two serious questions have not been posed enough: firstly, what will be the parliamentary arithmetic after the election – with whom can Vucic form his supposedly pro-reform coalition?

I 35

And secondly, is Vucic really a reformer?

Dacic has certainly espoused reform himself, and has arguably gone further than Vucic in building bridges with Kosovo and promoting EU membership.

The Socialist vote base may be instinctively suspicious of economic reform, but so is much of the electorate.

Other supposedly economically liberal parties are weakened, discredited, and/or at war with the Progressives.

If the election results in a very similar Progressive-Socialist coalition but with Vucic as premier, it will just seem like an exercise in musical chairs to little practical effect other than bolstering an ego.

Some see the election as just that, and question whether Vucic really wants change. A former ultra-nationalist, he is accused by his critics of authoritarianism, even megalomania. But given his apparent efforts to take Serbia by the scruff of the neck, and economic progress where his liberal predecessors fell short, international partners and the markets are for the time being giving him the benefit of the doubt.

Ivan Kurtovic, of regional brokerage InterCapital Securities, tells bne that the election will certainly delay reform, and possibly imperil it in post-election horse-trading. "But in case one option, ready to deal with the reforms, results from the election, it could be very powerful mandate to have," he says.

"Let's see."

36

I Southeast Europe

bne February 2014

attention from a scandal that threatens to undermine an increasingly unpopular administration. And up to a point it is just that. Turkey is two months into an 18-month election cycle involving local elections in March, presidential elections later this year – in which Erdogan is expected to be a candidate – and culminating in next year's general election, campaigns for which many are expecting to be highlighted by further "revelations".

However, at the same time few in Turkey would deny his allegation that the corruption probes were implemented by a "hidden force" aimed at undermining his government, with fingers pointing at the US-based Islamist preacher Fetullah Gulen.

The "plot" thickens in Turkey?

David O'Byrne in Istanbul

A

ddressing a conference of Turkish ambassadors in the capital Ankara on January 15, Turkish Prime Minister Recep Tayyip Erdogan outlined what he expected of those bureaucrats charged with representing his government abroad.

"We expect you to exert more effort to defeat this treacherous plot targeting Turkey by telling your counterparts the truth. I request you to underline that what's going on is not a corruption operation but a coup in the form of a corruption operation," he claimed.

What Erdogan was referring to was a series of corruption investigations launched by Turkish Police on December 17, involving dozens of arrests and resulting in 24 people, including the sons of Economy Minister Zafer Caglayan and Interior Minister Muammer Guler and the CEO of state owned Halk Bank, facing charges.

Both ministers were forced to resign along with Environment Minister Erdogan Bayraktar, whose son was arrested and questioned but not charged, while a resulting cabinet reshuffle also saw the unpopular

Entryism Gulen's Hizmet movement has long been accused of using entryism – a political strategy in which an organisation encourages its members or supporters to join another – to gain influence within the Turkish police and judiciary. The group is believed to have been pivotal in the prosecution and jailing of 300 Turkish military officers in the controversial "Ergenekon" and "Slegehammer" trials. Indeed, Zekeriya Oz, the prosecutor who instigated the ongoing corruption probes, was also responsible for the Ergenekon trial.

But Gulen was until recently also a strong supporter of Erdogan, credited by many as having helped the PM's

"We expect you to exert more effort to defeat this treacherous plot targeting Turkey "

minister in charge of EU negotiations, Egemen Bagis, replaced following revelations of close contacts with an Iranian businessman also facing charges as a result of the probe.

Erdogan's call might look like a desperate attempt to help deflect

Justice and Development Party (AKP) come to power and remain there for 11 years almost unchallenged.

That era is reckoned to have ended around 18 months ago with Erdogan reportedly unhappy at the extent of Hizmet's influence within Turkey and

bne February 2014

Hizmet unhappy at the AKP's attempts to rein in its operations, including legislating to ban the movement's highly lucrative chain of university cramming schools.

Since the start of the corruption probe, Erdogan has been vociferous in his condemnation of what he describes as an illegal "gang" operating within the state and judiciary, even describing them as "assassins" – a mild enough jibe to western minds, but deeply insulting to devout Sunni Muslims for whom the Shia Assassin sect remains heretical and evil, even 750 years after it was wiped out. Yet to date Erdogan has stopped short of directly naming Gulen or Hizmet.

Gulen for his part has commented only to deny any attempt at targeting the government, although journalists writing for newspapers belonging to Hizmet-affiliated companies have been less reticent, describing Erdogan as a "dictator" and warning against his "authoritarianism".

None of this, however, means that the corruption investigations were not justified. Allegations of impropriety relating to zoning and building permits in some AKP-controlled areas of Istanbul, and to Halkbank's handling of payments for oil and gas imports from Iran, are well documented.

Details of the charges to be levelled have yet to emerge. In commenting on his forced resignation, former environment minister Bayraktar complained that whatever he had done had been done with the full knowledge of Prime Minister Erdogan. If he was obliged to resign, he argued, so should Erdogan.

Yet rather than resign, Erdogan and his government have launched a war of attrition against the Turkish police and judiciary, with hundreds of senior police officers and state prosecutors either sacked or transferred. Many of those prosecutors responsible for pursuing the corruption probes have found themselves removed from the cases and three of them

Southeast Europe

are now themselves the subject of investigations launched by Turkey's justice ministry.

The first result of the crackdown appears to have been the halting of a second round of corruption probes, with police refusing to act on instructions from prosecutors to arrest 41 people, including several leading Turkish businessmen and the

I 37

Rumours abound that if the AKP suffers major losses in the coming local polls, current president and party co-founder, Abdullah Gul, may return to lead the party. Although such a transition would not be smooth, it is not so unlikely a scenario.

Turks traditionally vote with their wallets and while AKP stewardship of the economy has generally benefited

"Erdogan and his government have launched a war of attrition against the Turkish police and judiciary"

Saudi businessman Yasin al-Qadi, who spent 12 years on a UN Security Council blacklist accused of links to Al-Qaeda.

Repeated claims in the Turkish media that those to be detained included Erdogan's son Bilal Erdogan were denied on January 16 by Turkey's justice minister, Bekir Bozdag.

More worryingly still, the government has announced plans to amend the constitution to give it direct control over Turkey's Supreme Council of Judges and Prosecutors (HSYK) – a move that would curtail judicial independence and which has already been criticized by the Council of Europe. Further, it plans new legislation governing the internet that will allow officials to quickly block content deemed to be "violating privacy" without a court order – restrictions which, it has been noted, were not available three years ago when both main opposition parties were rocked by sex scandals as a result of videos posted anonymously online.

Not surprisingly, those opposition parties, the Republican Peoples' Party (CHP) and the nationalist Action Party (MHP), are hoping to benefit from the turmoil which has already seen eight of Erdogan's MP's quit the AKP.

the majority of its voters, the recent instability has not.

With Turkey relying on imports for the bulk of its oil and gas needs, the 19% deprecation in the Turkish lira since last May has been reflected both in retail energy prices and in the current account deficit, which continues to feed inflation. Erdogan's accusations of nefarious plots may be widely believed by his supporters and his strong personal popularity may still mitigate against his removal as AKP leader, but it remains to be seen how long voters will tolerate having to pay for the results of such a strategy.

38

I Southeast Europe

bne February 2014

Contrary to recent suggestions by both the KRG and Ankara that an agreement with Baghdad to allow crude exports to start should be little more than a formality, Baghdad's position appears to remain unchanged: that it alone holds the right to award contracts to exploit the Kurdistan region's mineral reserves and state oil marketing company SOMO alone has the right to sell the oil.

By contrast, the KRG continues to insist that Iraq's federal constitution does give it the right to award contracts and export, and all that remains is to conclude a formal agreement on revenue sharing with the central Iraqi government.

Kurdish oil to Turkey only a matter of time David O'Byrne in Istanbul

T

he long-running question of whether Turkey would allow the semi-autonomous Kurdistan region of Iraq to export its crude through Turkey's pipeline network appears to be close to receiving an answer – namely, that supplies will commence irrespective of whether an agreement is reached between the Kurdish Regional Government (KRG) and the Iraqi Central Government in Baghdad over the control of oil exports.

Turkish Energy Minister Taner Yildiz confirmed before Christmas that test flows of Kurdish crude had begun through the smaller of the two pipelines that makes up the KirkukCeyhan pipeline, with the larger line continuing to carry crude from the Baghdad-controlled fields around the KRG capital.

After Christmas, Yildiz confirmed that following successful tests crude is continuing to flow and was being stored in tanks at Ceyhan in Turkey, initially suggesting it would be held there until the KRG and Baghdad had

concluded an agreement allowing for oil exports to start and on a formula for revenues to be divided.

With storage space at Ceyhan limited, analysts had concluded that exports from the Ceyhan terminal would begin during January even before the KRG announced that it was inviting bids from prospective buyers for 2m barrels, rising to 4m in February, 6m in

Predictably, Baghdad's reaction to the impending exports was not positive, with an official statement accusing Turkey of breaching the Iraq-Turkey pipeline agreement by attempting to undermine the Iraqi constitution. It warned that any companies buying the crude would face legal action for "smuggling", and threatened Turkey and the KRG with both legal action and unnamed "other measures".

Fait Accompli?

Whatever interpretation of the Iraqi constitution is correct, observers suggest that once Kurdish oil starts to be exported to Turkey, only the physical cutting of the pipeline will cause that to stop.

That, though, is a distinct possibility.

Neither northern Iraq nor southeast Turkey can be described as particularly

"Observers suggest that once Kurdish oil starts to be exported to Turkey, only the physical cutting of the pipeline will cause that to stop" March and rising to 10m-12m barrels for December. While those figures tally with previous announcements

by Kurdish and Turkish officials that they expect exports from the region to plateau at around 300,000-400,000 b/d, no mention was made of any agreement with Baghdad.

"secure". The Turkish section of the Kirkuk-Ceyhan line was damaged by sabotage attacks on over a dozen occasions in 2012, with suspicion falling on the Kurdish separatist group the Kurdistan Workers party (PKK), which operates from bases inside the KRG region, albeit without KRG support.

bne February 2014

Southeast Europe

At the same time, Turkish Energy Minister Yildiz recently complained that the flow of Iraqi crude from Kirkuk had been halted on 112 occasions since last July – some of which at least can also be ascribed to sabotage by extremist Iraqi groups rebelling against Baghdad.

be made available to Turkey as early as 2017 – a date confirmed by Genel which in its January trading statement announced plans for exports to Turkey from two gasfields it is developing in the region of 4bn cm in 2017 rising to 10bn cm by 2020.

The risks, though, have not prevented those developers working in the region from continued investment. Genel Energy announced in mid-January that it would increase production from the Taq Taq field it operates, which is already flowing into the Kirkuk-Ceyhan line through a newly completed pipeline link, and also expects an increase in production from the Tawke field in which it holds a 25% stake. Gulf Keystone, which operates the Shaikan field, announced in January that it had started exports of heavy crude by truck through Turkey and plans to raise production to 100,000b/d.

The arrival of Kurdish gas would be both timely and advantageous cost wise. With the region having no other possible markets except through Turkey, Ankara has ample scope to leverage a significant discount on the prices it pays its main suppliers of Russia and Iran – which would be good news for both Turkish consumers and Turkey's booming current account deficit, a large portion of which is due to expensive oil and gas imports.

Gas hopes While the ramping up of Kurdish crude exports through Turkey will net Ankara a useful increase in transit fees as the supplies are routed on to Europe, arguably that alone is not worth the risk of increased regional tension and a possible war of attrition with Baghdad.

That, though, is not Turkey's primary aim.

In addition to crude oil, the Kurdistan region holds enormous reserves of natural gas, which some estimates put as high as 2.83 trillion cubic metres, or roughly three-times that of Azerbaijan and of the recently discovered reserves in the East Mediterranean. And constructing a gas pipeline link to Turkey would be both simple and cheap.

Turkey's gas demand is set to exceed its limited gas import portfolio in the next two to three years and with prices of liquified natural gas (LNG) on the spot market sky high, Turkey urgently needs new supplies of gas to meet its rapidly growing demand for power, which cannot be met in time from other sources such as nuclear.

KRG Oil Minister Ashti Hawrami said in November that gas from the region could

I 39

40

I Southeast Europe

bne February 2014

Russian oligarch suffers metal fatigue in Montenegro Nicholas Watson in Prague

M

ontenegro has long been a favoured destination for Russian money, but the Podgorica government – which has played fast and loose with foreign investment for several years now – appears to be now biting the biggest hand that feeds it.

On January 18, the Montenegrin government stepped up its increasingly bitter fight with Russian billionaire Oleg Deripaska by inviting bids for the Kombinat Aluminijuma Podgorica (KAP). The aluminium plant used to be under the control of the oligarch's Central European Aluminum Company Holding (CEAC) until – depending upon whom you believe – it was expropriated through forced bankruptcy proceedings or was a victim of mismanagement and fraud.

In a statement, the court-appointed bankruptcy administrators, led by Veselin Perisic, set a February 17 deadline for submitting offers for KAP's assets, for which the government hopes to get at

least €28m. "If multiple bidders submit equal highest offers, a well-known bidder from the mining and metallurgical sector ... (with) the best plan for KAP's ... future development, higher revenues and readiness to take over the workforce, will be favoured," said a statement from the administrators at the end of last year, though added that the assets could be sold piece by piece if necessary.

This move by the Montenegrin authorities comes despite CEAC, a Cyprus-based subsidiary of Deripaska's En+ Group, on November 26 launching international arbitration proceedings against the Montenegrin state in Vienna. In a statement, CEAC said it's seeking at least €100m in damages over the government's insolvency proceedings that removed CEAC from its operating role without awarding it any compensation for its massive investments. "CEAC claims that the Government of Montenegro acted inappropriately and breached the agreements entered into in 2009/2010," the statement said.

CEAC has been rewarded in its lobbying efforts to get the EU to acknowledge the issue. On January 21, the European Parliament’s foreign affairs committee adopted a draft resolution on the progress report on Montenegro’s EU candidacy that calls for the swift resolution of the dispute with investors in KAP, while also urging the government to do more to address the serious problems of corruption, lack of respect of the rule of law and the politicisation of the judiciary.

"For too long, Montenegro’s alleged progress in its reform programme has been grossly overstated, and we applaud the members of the European Parliament’s foreign affairs committee for having included some very important amendments to the draft report which highlight some of the extremely serious issues still facing the country," says CEAC’s General Counsel Pavel Priymakov. "It is encouraging to see that the European institutions are taking very seriously Montenegro’s apparent inability to ensure the rule of law and

bne February 2014

the protection of investor and human rights, and we call on the parliament as a whole to endorse this resolution in its plenary vote."

Smelted down The picking over the carcass of KAP is an ignominious end for what was once a giant of Yugoslav industry that in its heyday in the 1970s employed over 5,000 people. But its decline has been long-running, inexorable and, inevitably, complicated by twists and turns.

The company that was declared bankrupt by a Montenegrin court on October 9 had €459m in liabilities, with the biggest creditor being the state, which is owed €148m. Other creditors include Deutsche Bank, the state power firm Elektroprivreda Crne Gore (EPCG) and Deripaska's En+ itself. At the time of bankruptcy, CEAC owned 29.4% of the company, the same as the state, though it had been stripped of operational control. A 15% stake was held by Minerals Euro-Asia – a murky Mauritius-based company – and another 9% by "other legal entities". These are suspected to include Montenegrin oligarchs, perhaps with Russian ties.

At one time CEAC held a 65.4% stake in KAP, which it bought for €48.5m in a 2005 privatisation deal that was backed by the Russian government of the time.

According to Radio Free Europe/Radio Liberty (RFE/RL), top Russian officials such as then-Duma speaker Boris Gryzlov and then-emergency situations minister Sergei Shoigu visited the plant, which together with a nearby bauxite mine was to form the basis of a leading CEE aluminium producer that CEAC was building to meet the growing demand for the metal in the region.

The relationship between the two sides quickly soured, however, as a series of incidents served to undermine the deal, leading to suspicions the Montenegrin government was thwarting every attempt to allow the investors to make the plant profitable.

In May 2006, CEAC says, "various breaches of representations and

Southeast Europe

I 41

warranties" of the deal were discovered by accountants Deloitte, including KAP having “hidden” debts and obligations towards the state totalling tens of millions of euros. In addition, the government-certified 2004 accounts were deemed inaccurate when it came to working capital and other assets.

"It became evident to CEAC that KAP’s initial financial situation had been misrepresented," the company claims.

However, the truce was short lived.

Renewed disputes over electricity prices and supplies, a new restructuring plan, and equity stakes eventually resulted in the company entering bankruptcy procedures on July 8, which the government claimed were "in line" with the law. "It did not make a move which was not in accord with domestic and international legal provisions concerning KAP."

The following year, CEAC says, political disputes in the Montenegrin parliament led to the cancellation of the tender to expand the Pljevlya power plant, which supplies the smelter. "As a result, KAP was left without the long-term supply of competitively-priced electricity," claims CEAC. "The prices for electricity supplied to KAP by the state-owned power producer EPCG skyrocketed from 20 euro to almost 80 euro per megawatthour."

Arrested development The claims and counterclaims notwithstanding, the Montenegrin government's actions since the 2009/2010 agreement do, at times, seem to have been designed to disadvantage CEAC.

Failure to find a compromise saw a claim submitted to the Arbitration Tribunal in Germany in August 2008. The global financial crisis struck the next month, which triggered a collapse in demand

Two days after the bankruptcy procedures began, CEAC-appointed chief financial officer, Dmitry Potrubach – a Russian citizen - was detained as he crossed the border from Montenegro into Serbia in connection with "stealing electricity from the European grid".

Potrubach effectively remains under house arrest and barred from leaving Podgorica; he has appealed his illegal

"It is encouraging to see European institutions take seriously Montenegro’s apparent inability to ensure the rule of law and protection of investor rights" for aluminium. That saw market prices slump to $1,800 per tonne, even as the cost of production at KAP reached $3,500 per tonne due to the high price of electricity, overstaffing and relatively high salaries.

With KAP facing closure and the loss of approximately 2,400 jobs, the two sides struck a deal in 2009-2010 that involved a swap of equity in return for sovereign warranties on around €130m of debt.

This appeared to stabilise the business to the point where it started to make a profit in January 2012 - the first time since 2006, claims CEAC.

detention to the European Court of Human Rights.

There was indeed some skulduggery over electricity supplies to KAP. The European Energy Commission earlier this year discovered the unauthorised drawing of electricity by the Montenegrin utility Crnogorski Elektroprenosni Sistem (CGES) from interconnectors that link the grids of Balkans states; power which was then supplied to KAP. However, CEAC claims it was kept in the dark by the Montenegrins over the identity of KAP's electricity supplier ever since EPCG

42

I Southeast Europe

unilaterally terminated the smelter's electricity contract in September 2012.

"This charge [against Potrubach] is absurd… KAP had no direct connection to the regional interconnector and could not consume electricity without authorisation from CGES, the stateowned operator of electricity market in Montenegro as well as key Montenegrin government officials; and KAP had no say over whence any energy supplier sourced its energy," notes CEAC. "Lastly, the CFO had no decision-making power in electricity supply issue, which rested with the board of directors."

The arrest of Potrubach, argues CEAC, is only intended to "showcase to the European Energy Commission that Montenegro itself is innocent of stealing electricity."

The Montenegrin government has form when it comes to trashing the property rights of foreign investors. bne reported in 2011 on a dispute with

bne February 2014

In December, Balkan Insight reported figures from the European Court of Human Rights in Strasbourg that showed Montenegro tops the list for the number of citizens who have made complaints to the court. According to the report, the court has received 1,063 complaints filed against the state. Given the country has only about 600,000 inhabitants, that means there is roughly one complaint for every 600 people.

For some, the key to the episode over KAP is that Montenegro held a parliamentary election in October 2012 (won by Djukanovic's Coalition for a European Montenegro) and a presidential election in 2013 (won

by Filip Vujanovic of Djukanovic's Democratic Party of Socialists), bringing the election cycle to an end. With four years to rule, some observers believe the government thinks now is the best time to bring the curtain down on a company that, while still providing some 1,000 jobs and 30% of exports, is no longer

"The country has been cut a lot of slack for political reasons"

Ethemba Capital over its investment in Montenegrin steelmaker Zeljezara Niksic. The UK private equity firm took the unprecedented step of suing the bankruptcy administrator assigned to the company – coincidentally or not, the very same Veselin Perisic working on the KAP case – in the High Court in London.

Zeljezara Niksic was eventually acquired

by Turkey's Toscelik for €15m in May 2012.

Neither do Montenegro's own citizens trust their state, which has been controlled by the Democratic Party of Socialists (DPS) for the last quarter of a century. The party has been dominated during that time by Milo Djukanovic, as both prime minister (currently) and president, and accusations of corruption and impropriety against officials are legion.

viable. The International Monetary Fund, for example, has already this year recommended the government close KAP. Meanwhile, subsidies to state companies will become more of an issue as the country moves further toward joining the EU. "The politicians have obviously decided they can't sustain the cost of this any more, but they have made sure they got their parliamentary and presidential elections out of the way first so they have four clear years to try to put the pieces back together again. That all militates toward the view that government is playing out a strategy here," says David Webb, senior partner for corporate affairs at regional consultancy Webb Dowse. "For Deripaska, he's in the wrong investment at the wrong time."

Montenegrin politicians may also feel now is a relatively good time to take on Deripaska. The oligarch is somewhat of a wounded animal, having seen his core aluminium business (he owns the world's largest producer United Co. Rusal) clobbered hard by the crisis.

While many believe Deripaska has some grounds for complaint, others point to a rich irony that this Russian oligarch, who has a chequered past when it comes to respecting the property rights of minority investors, should find himself at the end of sharp practices. And inevitably, whenever Russia is involved, suspicions of Kremlin involvement follow.

Conspiracy theories abound, particularly at a time when former communist states trying to join the EU are coming under pressure from Moscow to look east rather than west. Podgorica-based political analyst Blagoje Grahovac told RFE/RL KAP's problems are part of a "geopolitical plot" to strengthen Russia's grip in the Balkans.

Whatever the truth, Montenegro is becoming an increasingly risky place to put your money. That won't help this tiny nation as it seeks to engineer an economic recovery and convince Brussels that its future lies in the EU. "I line up with the Montenegro skeptics," says Webb. "The country has been cut a lot of slack for political reasons – it was anti [former Serbian strongman Slobodan] Milosevic and compliant on Kosovo – but there are undoubtedly transparency issues and the government's approach to this dispute may be a bit complacent. As a result, one can see them getting mauled in an international court. This is big enough to merit [such action] and Deripaska has the resources to pursue his complaint."

In an interview with EurActiv published December 11, Montenegro's chief negotiator for EU accession Andrija Pejovic said the country has no “political issues” to solve and should be able safely to consider itself the next EU member.

A growing list of foreign investors, and indeed the EU, would beg to differ.

bne February 2014

Southeast Europe

I 43

sidelined in the makeover-cum-purge that Stanishev conducted in advance of the May 2013 parliamentary elections.

Petkov announced on January 20 that he was stepping down from the party chairmanship in his regional bastion of Pleven, promising a full statement of his position by the end of the month.

Bulgaria's political left splinters Sandy Gill in Sofia

T

here's trouble on Bulgaria's left.

With European parliament (EP) elections, due on May 25, seen as an important test for the country's embattled Socialist-led government, three of the left's heavyweights have so far declared their intention to support an alternative leftist ticket.

There's Georgi Parvanov, leader of the Bulgarian Socialist Party (BSP) between 1997 and 2001, who was twice elected president with its support thereafter and made an unsuccessful bid for BSP leadership in 2012 when his presidential term was up. He's attempting to displace his erstwhile protégé and immediate BSP successor Sergei Stanishev. A fortnight ago, with a view to the EP elections, Parvanov announced the revival of the Alternative for Bulgarian Renaissance – "ABV" in Bulgarian – a leftist forum he had sponsored while still president, but that had been put on ice after a year.

There's also Ivaylo Kalfin, BSPaligned rather than actually a member, a Parvanov adviser before he became foreign minister in the

coalition government of 2005-2009 and thereafter, unsuccessfully, the BSP's presidential candidate in 2011.

A notably capable Member of the European Parliament (MEP), he's lately been leader of the Bulgarian leftist group in the EP, a post from which he resigned earlier in January, citing a

All three say they're continuing to work within the BSP, with the alternative platform just serving to "build new bridges" to left-wing voters. However, Stanishev doesn't see it quite like that.

At a weekend BSP conference, Stanishev accused Kalfin of "grave political error" and political "schizophrenia," saying that those who worked with him were violating party rules – a hard line illustrated by exclusion from the conference of three regional party leaders who had not "made their position clear." The party executive has given ABV supporters a week to abandon the scheme of a separate ticket, or face expulsion from the BSP. Another fine mess?

Perhaps discontent among leftists isn't surprising, since the BSP has got itself into a strange and uncomfortable situation. Elections last May, following the resignation of the ebullient and macho centre-right prime minister Boiko Borisov in the face of popular protests at high electricity bills, produced some very tricky

"One theory is that the devious ex-communists are faking disagreements in order to present two faces to the world"

conflict between his ideas and the BSP leadership at home.

And there's Rumen Petkov, a political bruiser who has served as interior minister and as Parvanov's campaign manager. A tough organisation man, he's long been a power in the former communist BSP – though not enough of a power to prevent him being

parliamentary arithmetic. With no one willing to deal with Borisov or his GERB party – at 97 the largest contingent in the 240-seat parliament – the BSP and its ally the mainly ethnic Turkish Movement for Rights and Freedoms (DPS) had exactly half the MPs between them. That forced them to rely in certain situations on the votes – or at least the benevolent abstention – of

44

I Southeast Europe

the extreme nationalist Ataka and its erratic leader Volen Siderov, a strange bedfellow for both Socialists and Turks.

Having come to power amid righteous indignation at apparent wiretapping and alleged vote-rigging by Borisov and his henchman, the interior minister Tsvetan Tsvetanov, the

bne February 2014

that for the first time in years VAT refunds to the country's beleaguered businesses were complete by endDecember. Flagging power exports, a serious problem for the previous Borisov government, have been revived by revamping price mechanisms. Two household electricity price cuts have been implemented – though arguably

"Parties will be looking at the EP election results and calculating accordingly" government quickly blotted its copy book by appointing controversial MP and media mogul Delyan Peevski, a kingpin of the DPS, as chief of a newly strengthened State Agency for National Security (DANS). This provoked mass demonstrations, which – even though the appointment was reversed within days – have carried on for months with the broader demand that the government, representing "oligarchic" interests, should resign. And a court ruling in October reinstating Peevski as an MP provoked a student occupation of Sofia University, followed by similar moves at other colleges.

Yet the government – headed by putative "technocrat" Plamen Oresharski rather than BSP party leader Stanishev – has stood firm against the demonstrations, showing no inclination to resign. Big protests are, for the moment, in abeyance, though the groups and networks formed in the process are now busily thinking up new strategies and policies. In parliamentary terms, the government doesn't seem under threat: two GERB MPs have gone independent, reducing the reliance on Ataka, while Ataka itself might not relish the nationalist competition it would face in the event of early elections.

Moreover, the BSP-led government has achievements of a sort under its belt.

Oresharski, a less-than-charismatic finance expert, was able to boast

with grave potential consequences for the system's financial stability.

And the government has undertaken what Vladimir Shopov, a Bulgarian political scientist who is no fan of the Oresharski cabinet, calls "the biggest social spending splurge in a decade."

Even so, the government just isn't popular. In December its approval rating fell below the psychologically crucial 20%. Those demonstrations may not have "succeeded" in the sense of getting rid of the government, but they've certainly struck a chord.

A poll early in December by Alfa Research – one of the country's least distrusted pollsters – found

And when the students occupied Sofia University, Alfa Research found that 60% of Bulgarians approved, with just 36% disapproving. Stanishev should be worried: when the stolid citizenry supports student sit-ins, one would think something's amiss. With the BSP having experienced more than one catastrophe in government since the fall of communism, some comrades might well be thinking, somewhat like Oliver Hardy, that Stan has "gotten them into a another fine mess."

Brussels pouts It's not just internal disapproval that the BSP has to worry about. On January 22, the European Commission published its latest monitoring report under the Cooperation and Verification Mechanism (CVM), a device introduced in 2007 to track progress on judicial reform, corruption and organised crime issues in the iffy new member states of Bulgaria and Romania.

Overall, as expected, it wasn't favourable. It admitted that advances had been made in some areas and conceded that the consensus needed to achieve progress had not been helped by the fact that the country had had three governments in the last year. But it said that progress "is still insufficient and remains fragile." And, without naming names, it alluded to "appointments having to be aborted due to integrity

"In December the government's approval rating fell below the psychologically crucial 20%"

that 41% of Bulgarians wanted parliamentary elections as soon as possible and another 39% wanted them simultaneously with the EP elections in May. Another poll by Gallup International at around the same time found that over 20% of respondents were prepared to take part in demonstrations, implying that the protests could reignite impressively when appropriate.

issues" as one important problem. Some media have trotted out the stock epithet of "scathing."

Shopov's not impressed, though, arguing that Bulgarian politicians have become adept at dealing with EU reports, knowing how to put their own spin on such reports, to use the "noise" of diverse punditry and other news stories to dilute their impact. "The government started

bne February 2014

managing the impact of this one well beforehand – about a month before, they were saying it wouldn't be a good report," he says.

And though billed in advanced leaks from Brussels as politically explosive, the report itself proved, well, boring and failed to "join the dots". "Of the options available to the EC [European Commission] linguistically, it has gone for the most conservative and constrained one, the one providing least phrases for the opposition to latch onto," argues Shopov. "The Commission has chosen really sterile language to describe the appointment of Peevski.

But it has also played down the massive significance of the big shift of power and functions from the Interior Ministry to DANS that took place at the same time. This was effectively the creation of a leviathan, making power in this sphere as concentrated as it has ever been in the post-communist period.

But the EC has just talked in tedious administrative terms of functionality, redistribution of roles, smoothness of transition, and so on. And it's treated the questions of creating this leviathan and of who is to be put in charge of it as unconnected ones."

All in all, Shopov thinks, this report hasn't added much to Stanishev's problems. Especially, one might add, as Brussels also announced the same week, somewhat unexpectedly, that Bulgaria is ready for membership of the Schengen area – exclusion from which has long rankled with proud Bulgarians.

True, member states have to approve this unanimously, which could be a problem. But a bit of good news always comes in handy.

Southeast Europe

Politics dog Romania's improving economy

Nicholas Watson in Prague Romania issued $2bn of 10-year and 30-year dollar bonds on January 14, giving the country the longest tenure of dollar-debt in the Southeast European region.

The low yields – 5.02% and 6.26% respectively – and long maturities are reward for what analysts say has been the government's prudent fiscal management, its progress with structural reforms and keeping the International Monetary Fund on board.

With Romania’s total financing needs for 2014 set at ¤12.3bn and no international bonds maturing this year, the issuance of the two tranches meets virtually all of the government needs on the international market for this year," writes RBS analyst Abbas Ameli-Renani. "There is just €0.5bn [of international borrowing] left for the rest of 2014. We expect the government to avoid coming back to the international market until Q4, at which point it would want to start pre-financing for 2015. The continued welcoming mood of the market may however induce an earlier return by the treasury."

Romania's economic fundamentals look increasingly strong. Tight control over spending translated into a 2013 budget deficit likely to come in at 2.5% or under, and a further reduction is forecast in 2014. The current account deficit tightened from 4.4% in 2012 to likely below 1.3% in 2013, while public debt is stable at around 38% of GDP. "We’ve heard from government authorities that 2013 growth may have been as high as 3% - considerably above our forecast of 2.5% and the government’s 2.2% official expectation," writes Ameli-Renani.

Yet this being Romania, political risk is never far away. The danger has lessened since the 2012 bust-up between President Traian Basescu and Prime Minister Viktor Ponta's Social-Liberal Union (USL) coalition, but analysts say some concern remains.

The 2012 bout paralyzed government, put the country on a collision course with the EU, and threatened the fragile economic recovery. It only ended after the nine-member Constitutional Court ruled that a referendum to impeach Basescu, called after Ponta managed to get parliament to suspend the president, was invalid because the turnout fell short of the required 50% of the 18.3m electorate. In the referendum, 88% of those who voted wanted Basescu out. However, the turnout was only 46%, in no small part because Basescu had called for a boycott of the vote. "[We are] wary of possible tensions between PM Ponta and President Basescu, and/or between the PM and his coalition partner and deputy, [Crin] Antonescu," remarks Ameli-Renani. "The potential for the latter, in particular, has been more important in our view as it could have threatened a break-up of the ruling USL coalition, which is formed of PM Ponta’s Socialists and Deputy PM Antonescu’s Liberals. That risk has now receded in our view with announcements earlier this week that Antonescu will be nominated by USL for the presidential elections in November."

I 45

46

I Eurasia

bne February 2014

GEORGIA

AZERBAIJAN

TURKEY

Eurasia's golden triangle of investment Clare Nuttall in Astana

T

urkey, Azerbaijan and Georgia are building a "golden triangle" of mutual investment, as the three very different but prosperous countries located at the crossroads of Europe and Asia look to benefit from each others’ advantages.

The synergies are almost as good as those between Russia and China. Turkey has the people that go to make up the largest consumer market in the region.

Azerbaijan has the energy resources and cash that comes from being an oil producer. And Georgia is one of the most progressive reformers in the former Soviet Union.

Both needs and geography are tying these countries together – but need is a good foundation to start with and Azerbaijan and Georgia in particular have been moving together steadily for

the last few years. Now both are looking to the Turkish market as the best place to continue their growth and scale up their businesses.

The cornerstone of the relationship is energy and money. As rich as Azerbaijan is in energy, Turkey is poor. Multi-billion-dollar investments

by Azerbaijan’s state oil company Socar into Turkey have established Azerbaijan as the country’s largest energy investor, and add to the steadily growing economic and infrastructure ties between Azerbaijan, Turkey and Georgia. All three countries are crucial elements in the Southern Gas Corridor – an EU energy initiative – but future trends in their economic cooperation depend in part on the ever-changing geopolitical landscape in the south Caucasus and the efforts by other regional players,

in particular Russia and Iran, to build their own alliances.

Socar’s investments in Turkey are concentrated in the Izmir region, where the Azeri company acquired petrochemicals giant Petkim in 2008.

On November 19, the head of Socar Turkey, Kenan Yavuz, announced that Azerbaijan was investing between $17bn and $20bn into Turkey, thereby becoming the country’s top source of energy sector investment. Plans in the Petkim peninsular include construction of the Star refinery and Turkey’s biggest container port. Socar’s local subsidiary, Socar Turkey Enerji, is set to become Turkey’s largest company by 2018.

For Azerbaijan, Turkey is a crucial link in the energy transport corridor to European markets. Since Socar’s initial Petkim investment, Turkey has

Eurasia I 47

bne February 2014

also been connected to Azerbaijan’s new energy strategy, under which it is moving from the export of crude oil to the export of petrochemical products.

While Socar’s mega projects have grabbed the headlines recently, the volume of trade and investment between Azerbaijan and Turkey has been steadily growing over the last two decades. The two countries’ historic and cultural ties – the Azeri and Turkish languages are mutually intelligible – have helped to boost economic links, as has government-level encouragement. In June, Azerbaijani Economic Development Minister Shahin Mustafayev announced that at $4.5bn Azerbaijani investments into Turkey are around three-times higher than Turkish investments in Azerbaijan, Fineko/abc. az reported.

Many of these investments are by small and medium-sized enterprises from both countries. According to the Azerbaijan Export and Investment Promotion Foundation (AZPROMO), some 1,100 Azerbaijani companies are operating in Turkey in sectors including construction, tourism and real estate, as well as energy. The Turkish presence in Azerbaijan is even larger in terms of the number of companies, with more than 2,000 companies with Turkish capital registered in Azerbaijan – 36% of all foreign companies registered.

“As Azerbaijan and Turkey are strategic partners, the volume of mutual investment and trade are expected to increase in the following years.

The governments of both countries continuously work on further development and intensification of bilateral cooperation,” AZPROMO head Rufat Mammadov told bne. Mammadov forecasts that the Azerbaijani government’s economic diversification policies will open up new opportunities for foreign investors.

The third point in what is emerging as a “golden triangle” of investment and trade in the south Caucasus is Georgia, which counts Turkey and Azerbaijan as its top two trading partners. Aside from their geographic proximity, all three

countries bring different qualities to the table economically.

Southern Gas Corridor Azerbaijan is a major oil and gas producer that supplies Georgia and Turkey as well as exporting to Europe, and has accumulated large amounts of capital that it is investing at home and abroad. As well as Socar’s investments in Turkey, Azerbaijan’s sovereign wealth fund SOFAZ was a cornerstone investor in the $6bn Georgia Co-Investment Fund launched in September. Turkey is one of the world’s top 20 economies in GDP terms. In May, the European Bank for Reconstruction and Development (EBRD) chief economist Erik Berglof identified Turkey as one of three countries – alongside Russia and Poland – with the economic weight to influence their regional economies. While Georgia is the smallest of the three economies, it has pursued far-reaching economic and political reforms since the 2003 Rose Revolution. There is also a political dimension, since Azerbaijan and Turkey’s hostile relationship with Armenia, and Georgia’s with Russia, pushes the three countries closer.

Lacking large amounts of oil and gas, Turkey is stronger in other industries. It has thus become a natural partner for Azerbaijan as Baku seeks to diversify

cooperation among the three countries, given Azerbaijan’s status as one of the main oil and gas producers in the Caspian Basin. The Southern Gas Corridor strategy developed by the European Commission sees Azerbaijan as one of the main supplier nations as Europe seeks to reduce its reliance on Russian gas by tapping other sources in the Caspian and Middle East.

The construction of the Baku-TbilisiCeyhan (BTC) oil pipeline, which was completed in 2006, opened up a new route from the Caspian to European markets, bypassing Russia. Plans to build gas pipeline infrastructure from the Azeri sector of the Caspian via Turkey to Europe are now underway. The TransAnatolian Pipeline (TANAP) is an AzeriTurkish project that will carry gas from Azerbaijan’s offshore Shah Deniz field to the Turkish-Bulgarian border, from where the Trans-Adriatic Pipeline will transport the gas into the heart of Europe.

Cooperation between the three countries has also increased outside the oil and gas sector. The other major project in progress is the Baku-Tbilisi-Kars (BTK) railway. The line will connect the three countries’ rail networks, facilitating cargo transport between China and Europe across the Caucasus. It will restore links severed when Turkey

"The cornerstone of the relationship is energy and money"

its economy and ease the traditional reliance on hydrocarbons. “Turkey is the biggest foreign investor in the nonhydrocarbon sector of the Azerbaijani economy. Its share in the total volume of non-oil foreign direct investment since 1995 exceeds 23%,” Mammadov says. “Turkish investors contribute to the development of almost all the sectors of Azerbaijan’s economy.”

However, the energy sector remains the single most important basis for

closed its border with Armenia in 1993, forcing the Kars-Gyumri-Tbilisi line to shut down. The first pilot trains are due to run on the BTK railway in 2014, and when it reaches full capacity it will carry up to 30m tonnes of cargo a year.

In the electricity sector, the AzerbaijanGeorgia-Turkey Power Bridge Project was established in 2009. The opening of the Borçka-Akhaltsikhe electricity transmission line – an important part of the project – on December 12 makes it

48

I Eurasia

Central Asia’s stolen SUVs under investigation Two Central Asian republics have come under scrutiny as the believed destination of numerous cars stolen in Germany and other European countries.

A diplomatic row is brewing between Tajikistan and Germany after reports in the German press that the family and cronies of Tajik President Emomali Rakhmon were driving stolen cars.

In neighbouring Kyrgyzstan, it also emerged in January that up to 50% of the SUVs driven there – the elite’s vehicle of choice – are also believed to have been stolen in Europe or the CIS. According to German daily Bild, the German authorities have been investigating the thefts of around 200 expensive cars, including 93 BMWs. While German cars often surface in Poland and other east European countries, Berlin detectives are reported to have been surprised when GPS anti-theft devices showed they were over 4,000 kilometres away in Dushanbe.

The accusation against members of Rakhmon’s inner circle has sparked anger in Dushanbe, where appeals from the German authorities to investigate have been ignored. In October, Foreign Minister Hamrokhon Zarifi cancelled a planned visit to Germany in protest at the slur.

Meanwhile, local news reported in January there are currently between 3,000 and 4,000 luxury cars in Kyrgyzstan, including Toyota Land Cruisers, Lexus, Porsche Cayennes, Range Rovers and high-end Mercedes Benz, of which around half are believed to be stolen. The Delo No daily cited the Corruption Control Service as saying that cars are often trafficked via Kyrgyzstan to Tajikistan, where they are exchanged for heroin that is then transported back to Russia and Europe.

bne February 2014

possible to transmit electricity initially from Georgia and later also from Azerbaijan to Europe via Turkey.

meeting with his Armenian counterpart Eduard Nalbandyan did not appear to yield any concrete results, and as such is unlikely to affect the status quo.

Private sector companies are also pursuing expansion opportunities across the three countries. Azerbaijan’s Pasha Bank, for example, launched its first international branch in Tbilisi in 2013, and is now considering strategies to enter the Turkish market. Azerbaijan’s Akkord Industry-Construction Investment Corporation has expanded into Georgia as well as other former Soviet countries. In the opposite direction, Georgian companies such as TBC Bank and marketing consultancy ACT made their first international moves by setting up in Azerbaijan.

Any major political changes in the region could have knock-on effects economically. The change of government in Georgia, for example, has led to a tentative rapprochement with Russia this year. Russian President Vladimir Putin announced during a visit to Armenia on December 2 that Moscow plans to build up its presence in the south Caucasus. “As far as Transcaucasus is concerned, Russia has never intended to go away from here. On the contrary, we are going to strengthen our positions in the Transcaucasus,” Putin said.

While these infrastructure projects and the rise in trade and investment has a solid business case for the three countries, and further cooperation is planned, future relationships are also

A greater Russian presence in the region could mean that Moscow’s interests may need to be considered when drawing up regional energy projects – even though Azerbaijan’s status as a major

“Turkish investors contribute to the development of almost all the sectors of Azerbaijan’s economy” influenced by the evolving political landscape in the Caucasus.

Stratfor analyst Eugene Chausovsky points out that increased investment between Azerbaijan and Turkey “is very much steered by the geo-political situation... Turkey is trying to boost this even further in order to strengthen its ties in the region, especially as Russia has grown its influence there over the past couple of years. Now Iran could become a stronger player in the region as a result of talks with the US that are still at an early stage but potentially significant,” he tells bne.

In another recent development, on December 12 Turkish Foreign Minister Ahmet Davutoglu made his first visit to Armenia since the failure of a 2009 attempt to normalise relations between two countries. However, Davutoglu’s

energy producer has given it greater independence from Russia. “Azerbaijan’s relationship with Russia has always been the most complicated among the three south Caucasus countries.

To an extent, Azerbaijan has become more cooperative with Russia recently, but at the same time Baku is wary of Russia’s influence in the region,” says Chausovsky. “While they talk more with the Russians about energy and economic ties, they are also talking with other players like Turkey and Israel to balance that relationship.”

Even with a greater Russian presence in the region, the ties between Azerbaijan, Turkey and Georgia are likely to remain strong – given the good political relationships among the three countries and the existing momentum of smalland large-scale investment and regional infrastructure projects.

bne February 2014

Eurasia

I 49

Gagarin blasted off in 1961 to become the first person in space. However, this has made it more difficult for the region to develop away from its reliance on oil and gas production. While the region has no deposits on the scale of the Kashagan or Tengiz fields, oil and gas and mining account for around 50% of the regional economy, which increases to two-thirds if related services companies are taken into account. The region also has one of the world's top five vanadium deposits, which could potentially supply up to 10% of global demand for the metal in future, the mayor, or akim, Krymbek Kusherbayev announced in 2013.

Kazakhstan's regional headaches

Speaking at the Kyzylorda Invest conference in November, Kusherbayev said the region had seen the largest increase in investments of any Kazakhstani region. "We are working to improve the business environment and conditions for investors," he said.

Clare Nuttall in Astana

K

azakhstan's regions are the source of the country's mineral wealth, but still lag far behind its two main cities, Almaty and Astana, in living standards, which has become a major source of resentment. Motivated by both political and economic considerations, the government has embarked on new efforts to develop regional economies and attract investment outside the natural resources sector.

Many of Kazakhstan's regions share a similar set of problems – small populations scattered over a wide area, poor transport infrastructure and over-reliance on single industries. The problem is particularly acute in areas where oil or mineral deposits are nearing the end of their productive life. But even where production is booming the benefits have been slow to trickle down, meaning little is being done to diversify local economies and increase living standards.

"A lot of regions have a strong focus on mining or oil and gas, and many single industry towns. Transforming them into developed, diversified economies is a challenge for policymakers, as Kazakhstan is a large, landlocked territory without very good

infrastructure," says Jibran Punthakey, economist with the OECD Eurasia Competitiveness Programme, a threeyear programme to diversify regional economies in Kazakhstan and make them more attractive to foreign investors.

"Most of Kazakhstan's regions have a small economy, with populations typically under one million, so growth potential in the internal market is limited. This means they need to look to markets elsewhere in Kazakhstan or internationally, and attract investment from outside the region. However, it is difficult to bring foreign investors into remote areas," Punthakey adds.

The case of Kyzylorda Kyzylorda, which occupies the southwest corner of Kazakhstan, faces all of these obstacles. The region has a population of just 700,000, mostly living along the SyrDarya river, which winds its way through an area of semi-desert the size of the UK to what remains of the Aral Sea. Kyzylorda's remoteness from Central Asia's main population centres was the reason for its choice as the Soviet Union's first rocket launch centre, the Baikonur Cosmodrome, where Yuri

At the same forum, Deputy Minister for Industry and New Technologies Nurlan Sauranbayev acknowledged that, "Kyzylorda oblast has been underestimated and under-valued... it is a treasury of valuable elements that are in high demand all over the world."

Some of this income has trickled down to the general population, at least in the region's centre Kyzylorda, where new cafes and restaurants – including locally grown coffee and patisserie chain Brownies, which recently opened its fifth outlet – are mushrooming.

Residents say the state of city has improved since February 2013 when Kusherbayev, a former deputy prime minister and presidential adviser, was appointed.

Roads and parks have had a facelift and a no-tolerance policy on littering was introduced. Although Kyzylorda still has potholed, barely lit roads outside the city centre, provision of electricity, heating and other utilities has improved and new housing – one of the top gripes of Kazakhstanis across the country – is being built along the Syr Darya.

There have also been attempts to create a local manufacturing sector. Unfortunately, given the small regional economy, the

50

I Eurasia

Kazakhstan steps up military production

Clare Nuttall in Astana December saw progress on two major new defence-related factories in Kazakhstan, where demand for military hardware is set to grow as Astana continues to modernise its armed forces.

On December 13, South Africa’s Paramount Group started building a factory to produce military armoured vehicles and civilian buses in Astana, working with local manufacturing company Kazakhstan Engineering and its subsidiary Kazakhstan Engineering Distribution. The factory will produce between 120 and 230 vehicles a year when it goes into operation.

Paramount chairman Ivor Ichikowitz said at the launch ceremony that production would be targeted at both Kazakhstan and other markets in the region. “It is our intention to establish a fully-fledged armoured vehicle and land forces manufacturing facility to engage not only in manufacturing but also in research and development,” Ichikowitz said, according to a statement from Paramount.

Three days earlier, the Kazakhstan Aselsan Engineering defense facility, a Kazakh-Turkish joint venture to produce electron-optical devices for defence applications, opened. It will initially produce electronic plates used in vehicles ranging from submarines to space vehicles, and will later start production of infrared lenses.

Another Turkish company, Otokar, announced in October 2012 that it will set up a production line in Kazakhstan, shortly after winning a contract to supply armoured vehicles to the Kazakhstani army. Kazakhstan Engineering is to build the factory, while Otokar will provide technical know-how and components, as well as training for army officers.

Despite enjoying friendly relations with its neighbours as well as regional heavyweights Russia and China, over the last decade Kazakhstan has considerably stepped up its investments into the military. As well as replacing the obsolete weapons and equipment inherited from the Soviet Red Army, Kazakhstan is also building a professional military and phasing out conscription. In October, the army's chief of staff General Saken Zhasuzaqov said the armed forces would be fully professional by 2016.

In line with Astana’s strategy of investing into local manufacturing, President Nursultan Nazarbayev has set to the target of producing 80% of Kazakhstan’s military equipment domestically by 2020. A report from Companies and Markets forecasts that spending by Kazakhstan's defence industry will grow by a compound annual growth rate (CAGR) of 8.13% over the next five years, from an expected $2.7bn in 2014 to $3.7bn by 2018.

However, given the size of Kazakhstan’s economy, the figure is modest by international standards, and defence spending is actually expected to drop as a percentage of GDP from 1.2% in 2014 to 1.1% in 2018.

bne February 2014

bulk of production would have to be exported outside the region, which has been held back by poor transport links, though this will change when the Western Europe-Western China highway, currently under construction, is completed.

As part of the government drive to attract more investment, investor service centres have been opened across Kazakhstan.

Kyzylorda's opened in mid-2013, and is staffed by a team of young, enthusiastic English speakers, who say their initial aim is to promote the region. "The first step is to promote the region to Europe, the US and Asia," Gabit Auyelbek, main manager of the centre, tells bne. "Later we expect to see an agricultural cluster and a metallurgical cluster set up. The opening of the Western Europe-Western China road will create opportunities for hotels and cafes to open."

Explosive situation Across Kazakhstan, the standard of living is considerably lower outside Astana and Almaty, with the trickle down of wealth slow even in the western oil towns. Poor local governance, high corruption levels and low standards of housing and utilities provision have all led to growing discontent. This came to a head in December 2011, when a sevenmonth strike by oil workers in the town of Zhanaozen erupted into rioting. At least 14 people were shot dead by police in the worst outbreak of violence in independent Kazakhstan's 22-year history.

In the two years since then, the government has stepped up its efforts to develop the regions and reduce dependence on the extractive industries.

Funds have been channeled into Zhanaozen and other mono-industry towns, and a new ministry for regional development was launched in January 2013. The state accelerated an industrial and innovative development programme, which was launched in 2010 to help create new industries and diversify production, and in the aftermath of the 2008 crisis it has absorbed projects across the economy. The follow-up programme, currently being discussed within the government, is expected to have a tighter focus on diversification and the manufacturing sector.

bne February 2014

Eurasia

Sacked in Turkmenistan Clare Nuttall in Astana

T

urkmenistan's president has sacked the head of the national gas company and the central bank governor as part of a reshuffle of key economy officials. The changes came a month after parliamentary elections in December, in which two parties participated for the first time, though this made no difference to President Gurbanguly Berdymukhamedov’s hold on power in the authoritarian country.

At a televised government meeting on January 10, Berdymukhamedov criticised Kakageldy Abdullayev, who has headed state gas company Turkmengaz for just a year, for allowing the sector to underperform. In particular, the official was lambasted for failing to diversify the country's gas industry. "State concern Turkmengaz should take effective measures to implement the industry's export potential," Berdykukhamedov complained, according to state news agency TDH. "For example, you can increase the volume of production and sales of liquefied gas and other products that are in high demand in the global markets."

Abdullayev's replacement is Charymuhammed Hommadov, whom Turkmen state media describes as "a person with great experience of work in the gas sector". The performance of state oil company Turkmennebit also came in for criticism from Berdymukhamedov, who frequently berates ministers and other top officials on state television.

The decision to sack Abdullayev comes despite increased gas exports to China helping drive economic growth of 10.2% in 2013. Turkmenistan has become China's largest gas supplier since the launch of the Central Asia-China gas pipeline in 2009.

Exports to China from the world's second largest gasfield, Galkynysh,

began in September, and Ashgabat plans to boost exports to the Chinese market to 65bn cubic metres a year by 2020. Meanwhile, Turkmenistan is keen to diversify the markets it serves.

It is pushing to build the TurkmenistanAfghanistan-Pakistan-India (TAPI) pipeline, which would deliver gas from the Caspian to south Asia.

Financial problems However, it's not just the energy sector that has the president in a tizzy.

Berdymukhamedov also sacked Governor Tuvakmammet Japarov from the Central Bank of Turkmenistan, as well as the heads of state banks Presidentbank and Dayhanbank. Gochmirat Myradov, the former chairman of state-owned Turkmenistan Bank, will take over the running of the central bank.

Ashgabat has taken some steps to reform the state-owned financial sector, including the introduction of International Financial Reporting Standards (IFRS). However, a report from the International Monetary Fund (IMF) in August insisted "bold

I 51

of Industrialists and Entrepreneurs of Turkmenistan (PPT), which was launched in August 2012, ran alongside the ruling Democratic Party of Turkmenistan (DPT) in the election, but with both parties firmly behind Berdymukhamedov there was no real choice for voters.

The PPT, which was launched in August 2012, took 14 seats in the election, to the DPT’s 47, with the remaining seats in the 125 seat parliament going to trade unions, women's groups and other progovernment organisations.

Keen to imply a move towards greater political openness, Berdymukhamedov quit the DPT in August, saying the move was intended to give the two parties an equal chance in the upcoming elections.

In its 22 years of independence, Turkmenistan has never held an election deemed free and fair. The last presidential election, in December 2012, saw Berdymukhamedov take 97% of the vote – a high figure even by Central Asian standards. While Ashgabat has proudly heralded the creation of a multiparty state, there has been no evidence so far of any genuine political pluralism.

In the run-up to the parliamentary election, the International Partnership for Human Rights (IPHR) and Turkmen

"The last presidential election saw Berdymukhamedov take 97% of the vote – a high figure even by Central Asian standards reforms" are still needed. "Efforts should now focus on allowing market-based mechanisms in the determination of interest rates and lending activities, improving banking supervision and risk management practices, and introducing corporate governance standards in banks," the report said.

The reshuffle comes less than a month after parliamentary elections, which for the first time saw more than one party fielding candidates. The Party

Initiative for Human Rights (TIHR), warned in a joint statement that voters would “be deprived of meaningful choice as both political parties are staunchly loyal to the president... none of the 283 registered candidates run on an independent line.

A December 12 report from Amnesty International said that despite the recent changes, the election was taking place in an "atmosphere of total repression" and "all-permeating fear".

52

I Eurasia

bne February 2014

two are not unrelated. "It's common understanding that the money he used to pay off old Soviet debt was with Ivanhoe money," says Badral Munkhdul, head of the market intelligence firm Cover Mongolia.

Mongolia's "godfather of corruption" plots return Terrence Edwards in Ulaanbaatar

A

vow to return to politics made from a hospital bed in South Korea by one of Mongolia's most popular yet controversial politicians threatens to rock the country's fragile coalition government and complicate tricky negotiations with foreign investors.

The reappearance on the scene of the jailed former president and prime minister Nambar Enkhbayar after a presidential pardon cut short his twoand-a-half-year prison sentence for corruption is certain to have a dramatic effect on Mongolian politics and the delicate relationships that exist within the coalition government. After recuperating in South Korea from a hunger strike he took in protest at his jailing, Enkhbayar hopes to lead once again his four-yearold Mongolian' People's Revolutionary Party (MPRP), which won enough votes in the 2012 parliamentary elections to participate in the coalition by running a populist campaign heavily critical of the massive Oyu Tolgoi copper-gold mine and of the company running it, the global mining giant Rio Tinto.

"It was quite evident [Enkhbayar] would come back, it's too early for him

to retire," says Luvsandendev Sumati, head of the Sant Maral Foundation polling agency. "2014 is actually quite an important time to start an election campaign."

The player Enkhbayar has been a central figure in Mongolian politics throughout the country's over 20-year history as a democracy. He held both the office of the presidency and PM for the nowopposition Mongolian People's Party,

It is his alleged involvement in these kinds of deals that earned him the nickname "the godfather of corruption".

That reputation finally caught up with Enkhbayar when he was arrested and stood trial in the summer of 2012 on four counts of corruption, including the illegal privatisation of a newspaper and the prime-located Urgoo hotel. His sister Enkhtuya is suspected of acting as an accomplice and is still wanted by Interpol. Based in Singapore before she disappeared after her brother's arrest, Enkhtuya's alleged crimes include money laundering and the sale of the Mongolian flag to illicit sea vessels.

Rather than ruin him, Enkhbayar's arrest actually resulted in a surge in popularity, according to data from the polling agency the Sant Maral Foundation. Data collected just before and after his arrest shows Enkhbayar's popularity quickly climbed from the second-most popular politician to the first.

Although President Tsakhia Elbegdorj's administration insisted the arrest was legitimate, it did serve to effectively prevent Enkhbayar from running a campaign for parliament that summer.

Enkhbayar spent much of his year of

"It was quite evident Enkhbayar would come back, it's too early for him to retire" all the while amassing great wealth. His accomplishments include the repayment of debt to Russia that Mongolia had wracked up as a Soviet satellite state, as well as serving as president during nearly all of the negotiations for the Oyu Tolgoi investment agreement with Ivanhoe Mines, now called Turquoise Hill Resources and majority owned

by Rio Tinto. Many believe that the

incarceration in a Mongolian hospital due to his ailing health while his party and supporters held numerous demonstrations outside Mongolia's Government Palace in Ulaanbaatar calling for his release. Supporters of Enkhbayar finally got their way a month after the 2013 presidential election, when Elbegdorj gave Enkhbayar a full pardon.

bne February 2014

Behind the scenes Even if his conviction bars him from holding office again, Enkhbayar could still exert significant influence behind the scenes. "No one will prevent him from running politics behind certain leaders," reckons Sant Maral's Sumati, adding that Enkhbayar's chief concern will likely be expanding the influence of his party, which he formed in 2010 following a feud within the Mongolian People's Party.

How Enkhbayar might choose to influence progress in talks over the Oyu Tolgoi project as well as the litany of other smaller projects under development is not clear, says Cover Mongolia's Munkhdul.

Mongolia is still reeling from the last

Eurasia

time the government intervened in the project, when last summer it stood in the way of a $4bn project-financing package.

That money would go in part towards financing a $5bn underground mine that Rio Tinto says would unlock 80% of the mine's wealth. Rio responded by putting construction on hold until every outstanding issue between itself and the Mongolian government was settled. "At this moment in time I think he would be described as a populist politician, but... I would describe it as his current political strategy more than his own political views," says Munkhdul.

For many, Enkhbayar's return, as well as the reduced sentences for many

I 53

other public officials arrested for corruption, demonstrates a lack of conviction in Mongolia's battle against corruption. President Elbegdorj made fighting corruption a major focus of his first term, partly in the interest of creating a legitimate business climate for investment. "I think the biggest achievement of his [Elbegdorj's] campaign against corruption was changing the public perception that tolerance for corruption has lessened," says Munkhdul.

What happens next could determine whether the message sent to investors is that Mongolia is open for business or is once again for sale.

come with different packages for their approach, with some writing business proposals where they say they will cover you and your campaign. Some even approach businessmen, politicians and teachers to scare them. I call them racketeers. They're blackmailing them for work," Lkhavga says.

Mongolia's clownish press Terrence Edwards in Ulaanbaatar

W

hen reports emerged on December 10 that McDonald's would open its first branch in Mongolia, the media and the internet were abuzz with speculation the US fast food franchise would be serving "McMutton burgers" and "goat milkshakes". The only problem: Ronald McDonald wasn't actually coming and neither were his burgers.

In fact, the "news" about McDonald's was a publicity stunt by one of Mongolia's newest TV news

broadcasters, Mongol TV, to highlight how easily corporations and politicians can pay to have stories published that, among other things, are used to cast aspersions on controversial mining projects such as Rio Tinto's Oyu Tolgoi or Centerra Gold's Boroo.

Erdene Lkhavga, an executive producer at Mongol TV who took part in the ruse, says the main intent of the fictitious press release was to catch reporters and news groups in the act of compromising ethics for financial gain. "[Reporters]

Lkhagva explains he phoned nine of Mongolia's major news outlets in television broadcasting and print to push the story, paying out between about $115 and $350 to get it covered.

Then on December 11 Mongol TV confessed live on its 9 o'clock news programme that the story was a prank and named every print newspaper and broadcaster that had run the story, including the Mongolian National Broadcaster. bne did not cover the story, though last year it did report correctly on how another fast food franchise KFC plans to open up in Ulaanbaatar.

The response from those news groups was fierce. "Some journalists wrote hate [mail] to us and our reporters," sighs Lkhagva.

Truthiness "The major problem is the reliability of information in Mongolia," complains Davaasuren Bat-oktyabri, head of news at competing television broadcaster C1 Television.

54

I Eurasia

Kyrgyz MPs to leave AK-47s outside parliament A new law banning MPs from bringing weapons into the parliament building has been adopted in Kyrgyzstan. President Almazbek Atambaev signed the law on December 18, according to a report from the presidential press service. It will ban MPs, employees and visitors to the parliament from bringing weapons into the building.

The most democratic of the five Central Asian republics, Kyrgyzstan has five parties represented in the parliament, which has several times seen heated political debates erupt into full-on fistfights. In April 2011, 11 guns, including an AK-47, were confiscated at the parliament when security forces moved in after a fight between two MPs. Kamchibek Tashiyev of the nationalist Ata-Zhurt party threatened to quit the coalition government if corruption accusations against the then deputy PM Omurbek Babanov were proved to be correct.

Tashiyev then traded blows with a member of Babanov's party, Altynbek Sulaimanov.

Eighteen months later, Tashiyev and two fellow party leaders were arrested and accused of an attempted coup after they broke into the parliament building during an October 2012 demonstration.

Back in 2006, the then parliament speaker Akmanbek Keldibekov scuffled with his predecessor Omurbek Tekebayev, until other MPs stepped in to prevent the fight. Keldibekov has recently been arrested on corruption charges.

bne February 2014

Bat-oktyabri says little editorial oversight in newsrooms and a lack of fact checking are responsible for the dissemination of false information.

Part of the problem is the lack of professionalism and low pay. "If you look at the media business model now, it's not correct in the sense that people don't earn enough," he says. "The price [for advertising] is so low that most businesses shouldn't work. In recent months, many of the local TV stations are laying off hundreds of people."

Foreign companies are particularly vulnerable when facing large local conglomerates with ties to the Mongolian media. Rio Tinto's Oyu Tolgoi – a $6 billion-plus project that has been the centre of arguments over foreign investor influence in the economy and so a magnet for bad press – came under fire after announcing

in the headlines is a huge blow and has to be corrected immediately. She says setting the record straight, although not without obstacles in Mongolia, is paramount.

In addition to building strong relationships with media groups such as Unuudur newspaper or the Mongolian National Broadcaster, social media has become a viable option for engaging with the public. "There's close to 600,000-plus on Facebook, and that's growing quite a bit," Infante says.

That number is nearly a fifth of the Mongolian population.

Learning by example The entrance of US media groups into the market could also be a positive influence. Sponsored by the locally owned Trade and Development Bank of Mongolia, Bloomberg opened

"I think as a young reporter, working in a newsroom is an easy way to grow corrupt" innocently that some of the gold in the 2012 Olympic medals was sourced from Oyu Tolgoi.

However, an evening news report by local television network TV9 falsely claimed around the time of the start of the Olympics that the gold samples used for the medals were in actuality eight tonnes of gold smuggled out of the country, without any royalties or tax paid to the country.

On Oyu Tolgoi's website that claim is refuted, saying most of the metal used came from Rio's Kennecott Utah Copper mine. "The small portion of the ore provided from our newest mine at Oyu Tolgoi comes from core samples taken during exploration," it says.

Betina Infante, managing director of Breakthrough PR, which has in the past done work for Oyu Tolgoi, says any inaccurate reporting for such a high-profile project that is constantly

an affiliate television network in Ulaanbaatar in 2012. More recently, CNN entered into a partnership agreement with Eagle TV – one of the companies that reported the false McDonald's story. The CNN partnership will include training for the Mongolian staff. "Having that kind of competition is great for a media market. Raising the bar means everyone's going up," says Infante.

Meanwhile, Lkhagva has vowed that the Mongolian-owned Mongol TV will continue to expose bad practices in the media, while trying to set a good example of how responsible media should act. "I think as a young reporter, working in a newsroom is an easy way to grow corrupt, ideologically or by accepting payments for stories," Lkhagva says. "The pay is low and the pressure is high, and there are lots of people trying to feed you stories."

Special focus

bne February 2014

56

ICD supports Central Asia's SME sector Clare Nuttall in Astana The Islamic Corporation for the Development of the Private Sector (ICD) stepped up its investments in Central Asia in 2013, working with banks in several countries to extend financing to small and mediumsized enterprises (SMEs). As well as helping the Islamic finance sector to emerge in the region, the ICD is also expanding the funding options available to SMEs across the region.

The most recent deal was in Uzbekistan, where on October 29 ICD announced it had signed a Shariacompliant line of finance agreement with state-owned Halk Bank. Under the agreement, ICD is extending a $15m facility to the bank, as part of a $50m line of finance for Uzbek banks.

The facility will be used to finance eligible SMEs, thereby allowing the ICD to expand its investments into the sector, as well as supporting the development of Islamic banking and finance in Uzbekistan.

The Uzbek deal follows the signing of an agreement with Tajikistan's Orienbank in May. The ICD has extended a $6m line of financing to Orienbank for lending on to SMEs in the industrial, communications, technology, health, construction and agricultural sectors.

"SMEs have a crucial role to play in the country's growth and development, and ICD has big plans for them" "The small and medium-sized enterprises have a crucial role to play in the country's growth and development, and ICD has big plans for them," ICD

bne February 2014

Also in May, the ICD announced a strategic alliance with Kazakhstan's Zaman Bank. The ICD's mandate is to convert Zaman, a regional bank based in the north-eastern town of Ekibastuz, into Kazakhstan's second Islamic bank. This will contribute to the Kazakh government's ambitions to turn the country into an Islamic financial hub for the region. According to Al-Aboodi, the initiative "reflects ICD's continuous effort to play a catalyst role in the promotion of Islamic finance and private sector development in Kazakhstan."

Within the Central Asian region, Kazakhstan's government has been the most active in creating an Islamic finance sector, adopting legislation on Islamic banking and finance in 2009. The 2008-2010 crisis was a spur for Astana to explore Islamic finance as a

"The ICD's mandate is to convert Zaman into Kazakhstan's second Islamic bank"

becoming the largest shareholder of the newly founded company. Although there are eight leasing companies active in Tajikistan, ASR is the first – and currently the only – Islamic leasing company in the majority Muslim country, resulting in a strong pipeline of projects.

Looking forward, aside from its investments in the SME and leasing spheres, the ICD is also planning to support the growth of green technologies and alternative energy in Kazakhstan. In December, Kazakhstan's state-owned National Managing Holding Baiterek announced that it has signed an agreement with its subsidiary the National Agency for Technological Development (NATD) and the ICD to set up a fund to invest into the renewable and alternative energy sector.

The Central Asia Renewable Energy Fund LP will invest into alternative energy assets within Kazakhstan for a period of eight to ten years. The target size of the fund will initially be $50m, but may be increased to $100m in future, according to a statement published on Baiterek's Facebook page on December 11. It will operate in compliance with Islamic financial principles, with the ICD acting as an adviser. Its aim will be to support development of the green economy in Kazakhstan and prepare for the EXPO-2017 world fair, which will take place in Astana with the theme "Energy of the Future".

potentially lower risk alternative to traditional sources of funding. The state owned Development Bank of Kazakhstan issued the country's first Sukuk, or Islamic bond, in 2012.

Elsewhere in the region, the National Bank of Tajikistan is working with the Islamic Development Bank and local banks and consultants to prepare a law on Islamic banking and finance. There have also been moves towards creating Islamic finance sectors in Kyrgyzstan and Uzbekistan.

As well as the investment into Zaman, the ICD also joined the bank as a shareholder in the Kazakhstan Ijara Company (KIC), which was incorporated in April 2013. KIC is the first financial institution in Kazakhstan dedicated to Ijara financing, and will provide Islamic leasing to SMEs across Kazakhstan. The company's acting CEO, Nurlan Sembiyev, said in an interview with bne in August that it will be open to working with all nationalities and religious backgrounds, provided that deals are compliant with Islamic finance standards.

The ICD also made an equity investment into an Ijara provider in Tajikistan, ASR Leasing, in April 2013,

Islamic Corporation for the Development of the Private Sector P.O.Box 54869 Jeddah 21514, Saudi Arabia, tel.: (966-2) 6441644 fax: (966-2) 644 4427 www.icd-idb.org

Special focus

Chief Executive Khaled Al-Aboodi said in a statement after the deal was signed. "This is an important sector in all the member countries, including the higher income ones. ICD is now focusing on this sector by extending lines of finance to local banks and establishing Ijara leasing companies and investment funds."

57

bne February 2014

CORPORATE STATEMENT:

ICD expands presence in Central Asia bne

Special focus

The Islamic Corporation for the Development of the Private Sector (ICD) is expanding its presence in the Commonwealth of Independent States (CIS), at the same time as many of these countries are developing domestic Islamic finance sectors. Khaled Al-Aboodi, chief executive officer of the ICD, outlines his organisation’s mission and activities, and how it compares to other development institutions such as the World Bank's IFC. 58

bne: What is the ICD’s mandate?

Khaled Al-Aboodi: The mandate of the Islamic Corporation for the Development of the Private Sector (ICD) is to promote the economic development of its member countries in accordance with Sharia principles, through private sector development. Our vision is to become a premier Islamic multilateral financial institution for the development of the private sector. The ICD’s mission is to complement the role played by the Islamic Development Bank (IDB) through the development and promotion of the private sector as a vehicle for economic growth and prosperity.

Khaled Al-Aboodi, chief executive officer of the ICD

paid-up capital of $771m. The ICD’s capital is allocated as follows: 50% for the IDB, 30% for member countries and 20% for public financial institutions of member countries.

bne: Are there restrictions on where the ICD can invest?

KAA: ICD financing is available to each and every citizen from its member countries without any distinctions, provided the project is bankable and is majority privatesector owned. We are glad to serve all our member countries on an equal footing.

The ICD operates under Islamic financial principles, which tend to be a more socially responsible and ethical financial system. Islamic finance is simply a complementary way of providing investments and financing to the business community, as can be seen in Saudi Arabia or Malaysia where Islamic and conventional financial systems work in parallel without any conflict. The growing awareness and success of Islamic finance is demonstrated by London’s aim to become the Islamic finance capital of Europe and by the keen interest expressed by other major OECD countries.

bne: When was the ICD set up?

KAA: The ICD is a multilateral organisation within the Islamic Development Bank Group. It was set up by the IDB and its member countries in November 1999.

Shareholders include the IDB, 52 member countries and five public financial institutions.

The ICD encourages the establishment, expansion and modernisation of private enterprises through financing private sector enterprises and projects. The ICD also advises governments and private sector groups on enterprise policies, development of capital markets, best management practices and enhancing the role of market economy. Its operations complement the activities of the IDB.

bne: What exactly is the relation between the Islamic Development Bank and the ICD? KAA: The ICD is a fully autonomous entity and operates as the private sector arm of the IDB Group. The relationship between the ICD and the IDB is similar to that between the IFC and the World Bank. The ICD and the IFC have a fairly similar mandate, which is to further economic development of their member countries through financial support to the private sector. Both institutions are for-profit organisations working on a pure commercial basis, though with a strong development mandate. The major difference is that ICD operates under the principles of Islamic finance. One could be tempted to say that the ICD is the Islamic IFC.

bne: What resources does the ICD have?

KAA: The ICD has an authorised capital of $2bn with a

bne: What is the ICD’s interest in the countries of the former Soviet Union and Southeast Europe?

bne February 2014

bne: Are there any any regions or countries in which you are especially active?

KAA: We are increasing our investments and financing in the CIS region. Currently the total portfolio stands at $227m, with a further $127.9m in the pipeline for signing in 2014. The ICD has been particularly active in Uzbekistan where it has extended three lines of financing totaling $133m to local banks for onward lending to SMEs [small and medium-sized enterprises]. Nine banks qualified for the funding and as of today $78m has been successfully used to finance a total of 145 SMEs in various sectors including agriculture, industry, healthcare and oil and gas.

The ICD is also active in Azerbaijan where it has established a leasing company and an investment company, in addition to extending lines of financing worth $77m to several local banks for SME funding. In line with our new investment strategy, we recently set up a leasing company in Kazakhstan, together with international and local investors; the company has a fully paid up capital of $28m. The ICD has also recently established a leasing company in Tajikistan together with some prominent local partners. bne: Can you give me a couple of examples of your investments?

KAA: Food security is an issue of critical importance and is a key challenge in many member countries that are not producing sufficient food for their populations.

Most of our members are net importers of food. The ICD has teamed up with Robeco to launch a $600m Food and Agriculture Business Fund that will invest not only into food production but across the whole value chain.

Investments by the fund into new farming methods, production technology, logistics and food handling facilities will also ensure more efficient food production, better crop yields and crucially reduce wastage during transit.

Secondly, a loss of investor confidence in global markets has significantly dried up the flow of funds to the SME sector following the global financial crisis. I believe the health of the SME sector is crucial to every country in the world. This is the sector where most employment is created and new ideas are generated. To put it simply, SMEs are the engine of the economy. In several mem-

ber countries, we are setting up funds under our SME Programme to support and improve SMEs’ access to financing. One such fund, with a target size of 1 billion riyal ($267m) has already been launched in Saudi Arabia and several more are in the pipeline for 2014. I believe this type of fund will go a long way to support growth of the SME sector, generating many new jobs and helping to alleviate poverty in ICD member countries. bne: Does the ICD have a special role to play in countries like Tajikistan, which are often overlooked by western investors and development banks?

KAA: Actually, China is Tajikistan’s main trading partner and investor, accounting for more than 40% of all investments in the Tajik economy, followed by Russia. The ICD’s total portfolio for the country currently stands at $13.5m; a $10m commercial real estate project is in the pipeline for signature in 2014. The ICD’s portfolio comprises mainly of lines of financing facilities to local banks for onward lending to SMEs. bne: What are the prospects for growth and investment in the countries in which you operate?

KAA: The ICD is currently implementing a new “Channel Strategy”, which will have greater and more sustainable developmental impact, as well as generating substantial revenues for the corporation. The new strategy has four main pillars, one of which calls for the establishment of commercial banks, investment companies, leasing companies and Islamic insurance companies. As we roll out the implementation plan gradually over the next few years, the ICD will have a substantial portfolio of investments spanning across its 52 member countries. Africa holds tremendous growth potential. It’s always an exciting experiment to break into new markets; each part of the world is different and has its own challenges. bne: Islamic countries, in particular Arab countries, have been slow to invest in Central and Eastern Europe, but recently the pace has increased. What has changed?

KAA: I think the game-changing event that forced many Arab Sovereign Wealth Funds (SWFs) to take a closer look at their investment policies was the sub-prime crisis in the US and the ensuing global financial crisis.

That caused a lot of damage to SWFs, whose mandate is actually wealth protection. What we are seeing now, with the worst of the financial crisis over, is a rebalancing of investment portfolios to diversify away from markets which were traditionally seen as less risky. With oil prices at $100 plus per barrel, substantial budget surpluses are being generated. We will see more diversification in SWFs’ investment strategies in the future, as well as more investments in local and regional markets as the pressure from demographics, especially unemployment, bears down further on local governments.

Special focus

KAA: We are in the process of scaling up our activities in order to boost development in our member countries.

We have launched several programmes such as the SME programme, the Special Economic Zone programme, and the Islamic Finance Institutions programme, which will have a multiplier effect on development. However, the ICD’s activity is limited to its member countries.

Within this region, most are in Central Asia – Kazakhstan, Azerbaijan, Uzbekistan, Kyrgyzstan and Tajikistan.

We also manage a few projects on behalf of the IDB in some non-member countries in the region.

59

OUTLOOK 2014 Eastern Europe Central Europe Southeast Europe Eurasia

Outlook

bne February 2014

I 61

Russia's growth model runs out of steam Ben Aris in Moscow

2

013 was an annus horribilis for Russia. Indeed, it was probably the worst year the country has been forced to endure (that was not a crisis year) in the last decade and half.

The economy suffered from a "phantom crisis" that had its roots in the fears of a second global financial crisis starting in Europe in the summer of 2012. The state issued a mass of debt to build up its reserves, which crowded private companies and banks out of the market and created an atmosphere of fear amongst businessmen.

The results were soon to be seen as the economy started to slow in the autumn of 2012 and that slowdown became self-reinforcing. By the summer of 2013 growth had stalled completely and Russia underperformed, missing the 3.5% GDP target most analysts were predicting at the start of the year. At the time of writing in December, Russia looked unlikely to even manage 1.5% for the whole year. “Despite what can be viewed as a high oil price, real GDP growth slowed dramatically to 1.3% in the first nine months of 2013, compared to 4.0% in the first nine months of 2012, as have all major economic indicators,” said Aton Capital in its 2014 outlook.

Analysts totally underestimated the impact of the terrible sentiment amongst Russia’s businessmen. This climate of fear was only reinforced as the Kremlin ramped up its anticorruption campaign in 2013, which increasingly is breaking up the old business-politics client system and has exposed all to the possibility of arrest or confiscation of assets.

Perhaps the best illustration of the fears is that companies cut inventories in 2013, leading to a collapse in industrial production in the summer. This is a typical reaction to a crisis, but in 2013 it was being used prophylactically as a way to avoid tying up cash in product and keeping companies’ resources liquid.

At the same time Russian President Vladimir Putin introduced a new law that bans Duma deputies and state officials from owning property abroad or holding foreign bank accounts.

This is in effect the first capital controls that Russia has used since the 1990s and given the step from Duma deputies to businessmen is short, this measure further unsettled everyone.

And more recently the Central Bank of Russia (CBR) has

started a visible campaign to close some of the 800 smaller banks, which has introduced yet another note of uncertainty in the banking sector and the possibility of a domestic financial crisis.

On top of all this have been the poor external conditions and the slower-than-expected recovery in Europe. Access to international capital markets remains muted and the problems have been exacerbated by the bubble forming in developed capital markets due to the endless quantitative easing, which has seriously distorted flows of international capital.

These are some of the superficial reasons for Russia’s slowdown in 2013, but at a deeper level Russia’s growth model has also run out of steam and the economy will not pick up unless deep structural reforms are put in place. While oil prices held up at over $100 for the year, such high prices no longer deliver growth.

Consumption was the main engine for growth in 2013, but will probably fade in 2014 and was already slowing at the end of 2013. It remains moderately robust with nominal

"At a deeper level Russia’s growth model has also run out of steam" average incomes continuing to rise by an average of 10%, ahead of inflation at about 6.3%. “Personal consumption growth has remained positive, although, with the exception of real disposable income, it has slowed dramatically compared to last year,” says Aton.

All these problems have manifested themselves in the collapse of investment, which normally is one of the three big economic drivers (along with consumption and construction).

As bne pointed out in its 2013 Outlook, investment was going to be the key variable in 2013, yet the investment numbers ended up being hugely disappointing, mirrored by the low

62

I Outlook

bne February 2014

levels of corporate borrowing, which also contributed to the collapse of industrial production. “Most concerning is fixed investment, down 1.8% year-on-year in the first ten months of 2013, vs a full 9.1% year-on-year growth in the first ten months of 2012. Equally, industrial production growth has disappointed, being flat year-on-year in first ten months of 2013 compared to 2.8% growth in the same period last year,” says Aton.

Despite the slowing growth, the continued rise in incomes over inflation means that both companies and banks have been suffering from a sustained squeeze on margins, a problem only made worse by the high cost of borrowing, as the CBR has refused to cut interest rates while it battles stubbornly high inflation.

All this has led to talk of stagnation of the Russian economy. In a much-cited speech on November 7, Economic Minister Alexei Ulyukayev outlined a gloomy economic outlook for Russia, saying that GDP growth could likely average 2.5% per year until 2030, down from the previous estimate of an average of 4%.

This is a very pessimistic call and it is probably partly aimed at the statist elements in the government, to persuade them to allow for more liberal structural reforms. Growth of 2.5% would be below the expected average global growth of 3.5% for the same period. “Ulyukayev’s statement should be viewed as a clear acknowledgment by Russia’s leadership that the country’s economic model needs to be dramatically altered given the country’s dependence on oil and other structural and institutional deficiencies,” says Aton.

So is the Russian growth story over?

Several of the factors that have impaired growth in 2013

GDP forecast ATON

2%

EBRD

2.8%

President's economic advisor

3%

Russian Economics Ministry

2.5%

IMF

2%

Morgan Stanley

2.7%

will drop away in 2014, but the biggest fillip should come simply from an improvement of sentiment amongst Russian businessmen.

The main positive factors for growth in 2014 include: • Low base effect: the bad numbers in 2013 set a very low bar for 2014 and growth should pick up on a year-on-year measure on the basis of the statistical comparison alone; • Inflation to fall: the CBR has nailed its inflation-fighting flag to the mast. Confidence in its ability to deliver should bring down inflation, as one of the factors has been the high expectation of inflation amongst the population; • Food prices to fall: a second factor fuelling inflation was the poor harvest of 2012, which sent the price of food soaring.

However, the harvest in 2013 was good and this should reduce inflation towards its core level of 4-5% in 2014; • Interest rate cuts: falling inflation will allow the CBR to cut rates and reduce the cost of borrowing, which will help spur growth. However, the cuts likely won't begin until the first half of 2014 and take at least six months to have a positive economic impact; • Structural reforms: the slowdown has forced the Kremlin’s hand and it launched what could be argued are the first ever sincere attempts at making deep structural reforms epitomised in, but not limited to, Putin’s goal to improve Russia’s standing in the World Bank’s annual "Doing Business" ranking. Russia has become the best country amongst the BRICs for doing business this year (from 120th to 92nd place) and this process will continue. However, the economic benefits from these changes will take years to have a major economic impact; • External environment: in the shorter term a general pickup in the rest of the world increasingly seems to be on the cards and this will immediately benefit Russia, if for no other reason than it will remove fears of an imminent crisis elsewhere.

The bottom line is that recovery is on the way, but a sustained recovery will probably only kick in around the second half of 2014 – and then only if the main growth engine shifts from consumption to investment. For the full year, the consensus is that Russia will grow by about 3% in 2014, with the more pessimistic forecasters like the World Bank predicting 2% of growth and the more optimistic predicting 3.5%.

Outlook

bne February 2014

I 63

CE to follow in Eurozone's stuttering steps Tim Gosling in Prague

C

entral Europe's economies remain overwhelmingly dependent on export demand in the Eurozone. While that's partly a positive, as the Eurozone began posting steady signs of recovery in the second half of 2013, the lack of diversification is clearly a threat.

Central Europe has benefited from German growth and stability, but uncertainty remains. The periphery remains under huge pressure thanks to debt, deficit and unemployment. The single currency area's banking networks also remain fragile.

While the banks in most of Central Europe are stable, the markets are heavily dominated by large groups based in the Eurozone, which is one of the main channels of contagion for crisis.

The Eurozone has seen output spluttering somewhat in late 2013, and the rate of recovery is likely to remain slow. The European Commission expects unemployment in the single currency region to remain problematic, while further austerity can't be ruled out.

The International Monetary Fund (IMF) expects fiscal policy to offer more support to growth, but cautions that restricted credit markets will keep it capped. "In 2014, a major reduction in the pace of fiscal tightening, to less than 0.5% of GDP from about 1% of GDP in 2013, is in the offing," it says in its World Economic Outlook. "However, the support for activity from the reduction in the pace of fiscal tightening is dampened by tight credit conditions in the periphery."

Overall, the IMF forecasts the Eurozone will record growth of 1.0% of GDP in 2014 to follow -0.4% this year. The European Commission plumps for 1.1% next year.

Turning to Germany, which accounts for by far the largest chunk of Central European exports, the IMF expects the economy to move from 0.5% growth in 2013 to 1.4% next year. Analysts at Citigroup are more bullish, suggesting surging domestic demand will drive growth, which would help circumvent the fragility of the wider Eurozone picture for Central Europe.

Although domestic demand in the likes of Slovakia and the Czech Republic is finally starting to show signs of life after several years in the doldrums, that uncertain trajectory in the

Eurozone will keep a rein on most of the region. The exception is likely to be Poland, which although dependent on exports for around 47% of GDP in 2012 according to the UN, traditionally has a far greater weight of domestic demand than others in the region (the next smallest share of GDP taken up by exports is the 78% seen in the Czech Republic).

It is that element which kept Poland out of recession in both 2009 and 2013.

The European Bank for Reconstruction and Development (EBRD) suggests in its outlook for the year, published in November, that "overall, the CEB region [the Visegrad Four – minus the Czechs – the Baltic states, Croatia and Slovenia] will grow at 0.9% this year, before modestly recovering to 1.9% next year."

At the same time, that performance could yet improve given the benign inflation picture that developed in late 2013.

"Assuming the single currency manages to muddle through without spiralling into a fresh crisis, the conditions may now be falling into place for a Goldilocks period" Particularly for the likes of Poland, that has released pressure on monetary policy, allowing regulators to extend guidance of low rates and therefore offer additional stimulus to the economies.

Capital Economics suggests this could offer the perfect conditions for accelerating the recovery. "[A]ssuming that the single currency bloc manages to muddle through without spiralling into a fresh crisis… the conditions may now be falling into place in much of Eastern Europe for a Goldilocks period of relatively strong growth accompanied by low inflation," Capital Economics wrote in November.

64

I Outlook

Another bonus is that, in contrast to many CEE peers, the Central European markets look set to largely evade the expected effects of tapering by the US Federal Reserve. A second $10bn pullback of US central bank's bond-buying programme is expected in late January, and CE states leapt to beat it to the punch, despite being protected from the worst by relatively strict fiscal policy and low debt.

Slovakia managed to keep the premium over its existing bond yield curve to single digit basis points as it sold €1.5bn in 15-year bonds. Poland was pushed to a 12 basis point premium as it sold a €2bn Eurobond on January 8. It followed up with a $1bn bond a week later, with the finance ministry announcing with 90% of its 2014 borrowing now in the bag, it plans no further international raising for the year.

Czech politics ignored Kommercni Banka expects Czech gross borrowing needs to rise sharply in 2014, to CZK 269.5bn, but says the country should maintain its status as a safe haven. That's despite the ongoing political stalemate. The country has been without an elected government for seven months. While CSSD leader Bohuslav Sobotka was finally appointed by power hungry President Milos Zeman on January 17, horse trading over the rest of the cabinet looks set to rumble on.

Sobotka has also had a struggle securing the tax rises and loosened fiscal policy his party believes is needed to expand growth following the previous government's harsh austerity, due to opposition from Ano 2011 – the new party formed by billionaire Andrej Babis that took 19% of the vote in October.

Questions of transparency persist as the country's largest employer prepares to take control of the finance ministry.

History also prompts concern over the stability of Ano, with several such protest parties having broken under the weight of governance in the past. However, as is the form, investors are largely unconcerned by the infamous instability of Czech politics.

bne February 2014

unemployment and ongoing deleveraging to keep spending contained."

At the same time, with questions remaining over the government's fiscal health, the central bank in its 15th month of an easing cycle, and the highest debt/GDP ratio in Central Europe at around 80%, Hungary's debt appears the most vulnerable in the region to Fed tapering. The forint is also a weak point, and feeds directly into government policy due to the huge volume of foreign currency debt held by households.

Polish populism to power rapid recovery With the additional boost of reviving domestic demand to add to the Eurozone-led recovery, Poland looks to be revving up for a strong economic expansion in 2014. It remains to be seen whether that will prove sufficient to breathe new life into the government's flagging approval ratings ahead of elections in 2015, raising worries of a more populist bent in policy that could hit fiscal policy and debt levels.

The IMF expects to see Poland post growth of 1.3% in 2013, with GDP expansion accelerating to 2.4% in 2014. The Commission says that while growth in the Eurozone will help out, it is clearly not the central element. "Foreign trade is set to support growth over the whole forecast horizon but at a diminishing scale. In 2013, the effect is expected to be particularly strong as Polish exporters increasingly expand their sales into non-EU markets, while import growth lags behind," the analysts write.

Erste is even more bullish, forecasting that domestic demand is set to take off once more. "Recent releases give a reason for upward revision of next year's growth (currently we see it at 2.7%)," the bank's analysts wrote in late November.

Slovakia searching for fiscal fat Slovakia is the most dependent of all the Visegrad Four on export demand from the Eurozone. While that suggests steady progress for the economy in 2014, limits on fiscal policy make a revival in domestic demand unlikely.

Fear and loathing in Hungary By way of contrast, Hungarian politics scare the bejeezus out of them right now. Although Hungary has spent recent months beating expectations on macro economics, that fear leaves the state the only significant driver of lending, and fixed investment is likely to remain suppressed. Elections are due by April, and polls suggest the rapacious Fidez party is set to retain office. While Budapest has avoided an expensive election budget as it reins in fiscal indicators, it has instead hit the utilities and the banks for cash.

Indeed, Slovakia is so anchored to the uncertain growth in the single currency area – and even within that it is overwhelmingly dependent on the auto sector – that economic expansion has remained somewhat capped in late 2013.

Unlike its regional peers, Slovakia's forecasts for 2014 have not moved through the year. The EBRD said in November that, "Growth projections… remain unchanged from our May forecast, at slightly under 1% for this year, and about 2% in 2014." The Commission plus several investment banks concur.

For 2013, the EBRD expects growth to be marginally positive, with GDP set to expand 1.2% next year. The EU – persistently at odds with Budapest since the ruling Fidesz party came to power in 2010 – is more positive, suggesting growth of 0.7% this year and 1.8% next. Domestic demand is expected to be the main driver, suggest analysts. However, without a broader investment base, the European Commission expects "high

A major element is that the government's hands are tied by fiscal concerns. It has spent the past couple of years desperately trying to keep pace with consolidation targets, as it has seen lowered tax income disrupt efforts to raise revenue.

While analysts have complained that the consolidation strategy is one sided, there is little fat to trim in terms of direct spending.

bne February 2014

Outlook

I 65

Political risk stalks Southeast Europe Nicholas Watson in Prague

G

rowth in the Southeast European region will likely continue recovering in 2014 from the very low levels seen recently, helped by the nascent recovery in the Eurozone, as well as favourable weather conditions that buoyed agricultural output and helped weaken inflationary pressures.

But political risk, particularly in Turkey, Serbia and Bulgaria, stalks the region.

At the top of the list is Turkey, whose horrible political problems in 2013 have become even worse as 2014 begins.

The Turkish lira plunged to a series of historic lows in January as a corruption probe launched in December, which led to the resignation of three Turkish cabinet members and eight MPs from the ruling party, added to concerns that began in 2013 with large-scale anti-government demonstrations. Those began over the proposed demolition of an Istanbul park and quickly morphed into wider protests against the government's creeping authoritarianism and Islamic bent.

Those fears about Prime Minister Tayyip Erdogan and his Justice and Development Party (AKP) have been given fresh weight by his reaction to the corruption probe. The PM claims the corruption probes were implemented by a "hidden force" aimed at undermining his government, with fingers pointing at the US-based Islamist preacher Fetullah Gulen. He has since begun an assault on the judiciary.

And things look set to get worse before they get better. The country has just entered a crucial 18 months of elections, for which the economy promises to be front and centre. In the coming cycle of local, general and presidential elections, the AKP will stress their stewardship of the economy since coming to power in 2002 as the major reason they should remain in power.

The AKP has indeed overseen a remarkable period of resurgence. Once a byword for instability and crisis, the Turkish economy grew at an annual clip of 5.25% on average between 2002 and 2011. At the same time, the AKP has strengthened Turkey’s geopolitical position both regionally and globally.

The IMF predicts growth of 3.8% in 2013, dipping to 3.5% in 2014. That said, the government and central bank face a much more challenging environment, both internally and externally, and will need to pull off a tricky balancing act.

At the heart of the problems with the €600bn economy lies the huge current account deficit and rising foreign debt levels.

Concerns over these issues will only increase during the election cycle, as the government might be tempted to throw caution to the wind to lure voters.

Balkan blues Serbia is another that's recent progress is being put in doubt by politics. On January 25, Serbia's forceful deputy prime minister, who appears to covet the premiership, has called for early elections to be held on March 16, which means that the vote will almost certainly go ahead as his party is the largest in the coalition.

The election bid has been expected for many months as Vucic and the Progressives look to cash in on popularity linked to progress towards EU membership (formal accession negotiations began in January), renewed economic growth and a popular anti-corruption drive.

"Political risk, particularly in Turkey, Serbia and Bulgaria, stalks the region" However, early elections may not prove to be the fix-all that Vucic anticipates. His Serbian Progressive Party winning an outright majority is by no means a certainty. And if it doesn’t, the setbacks to EU negotiations as well as crucial economic reforms could be substantial; the wrangling and backroom deal involved in forming a new coalition will likely take months.

Serbia’s economy is beleaguered. Public debt currently stands at more than 60% of GDP. And despite substantial recent improvements in attracting foreign investment – including a $10bn commitment by China to invest in a high-speed railway and a proposed €2.5bn investment by UAE tycoon Mohamed Alabbar – as well as a planned programme of fiscal tightening and generous loan deals from the UAE and Russia, not all are convinced enough has been done to fix the country's wobbly finances.

66

I Outlook

The International Monetary Fund (IMF) reportedly wants greater savings to be made in Serbia’s proposed 2014 budget before it will consider renegotiating terms for a new, muchneeded stand-by loan deal. Following the lead of Moody’s Investors Service, which downgraded Serbia’s rating in July last year, Fitch Ratings on January 16 kicked Serbia down to 'B+', or “highly speculative junk” status.

Bulgaria, where anti-government protests have continued on a daily basis for over six months, is making the country virtually ungovernable, the president has complained.

The protests began in June last year over the abortive appointment of controversial media mogul Delyan Peevski to head the State Agency for National Security. However, that complaint has been superseded by people's general dissatisfaction with the Socialist-led government that took office in May after its predecessor was brought down by earlier popular protests.

With daily demonstrations alleging corrupt ties between politicians and business groups, there appears no end in sight to the demonstrations. None of this is helping the economy, which despite being relatively sound in terms of a low budget deficit and public debt, is only expected by the IMF to grow by 1.6% in 2014, after growth in 2013 of just 0.5%.

"Two of the region's EU members, Croatia and Slovenia, face a dismal year" On December 12, Standard & Poor's revised its outlook on Bulgaria's 'BBB' rating to negative from stable noting high unemployment and political uncertainty, as well as the poor growth prospects. That indicates at least a one-in-three chance S&P could lower its rating within the next two years if the political environment deteriorates. "We expect economic stagnation in 2013, with higher public consumption and net exports almost completely offset by anaemic household consumption and private investment growth," S&P said. "We also believe that the uncertain political environment and the possibility of early elections will slow the adoption of reforms, weighing on potential economic output."

Ironically, Romania, whose febrile politics have done so much to hinder the country's economic development, is enjoying a period of relative calm in this regard.

This Balkan nation weathered a tricky 2013 reasonably well, and is predicted to continue in the same vein in 2014. The IMF reckons the economy will record growth of 2.0% in 2013 and 2.2% in 2014. While those are hardly Turkey-type levels, they're certainly good on a regional and global scale. Indeed, in the third quarter Romania registered the highest growth in

bne February 2014

the EU, up 1.6% against the previous quarter.

Analysts put that improved performance down to the contrast between the poor harvest of last year (agriculture was down 30% on the year in the third quarter) and the excellent one in 2013. In addition, industrial production has been driven by auto exports. "Who wouldn’t like a Dacia Duster 4x4 at those prices?" says Standard Bank. Others point to the low budget deficit (the target for this year is 2.4% of GDP) and low public debt (38% of 2012 GDP) as key ingredients.

With solid growth and a low fiscal deficit, in November Standard & Poor's, the only agency not to rate Romania at investment grade, improved its outlook on its 'BB+' rating to positive from stable. S&P said there's a possibility it could raise its rating in the second half of 2014 if the government sticks to its fiscal and reform programmes. "[S&P's] decision was backed by ongoing adjustment of external imbalances, ongoing fiscal consolidation, financial sector stability and prospects for gradual strengthening of economic growth in the following years," notes Raiffeisen Bank International.

However, politics will rear their ugly head toward the end of the year as the presidential elections approach, probably to be held in November.

Stress-related injury The region's other two EU members – Croatia and Slovenia both face a dismal year. Slovenia enjoyed some good news in December when an end hoved into view for the longstanding problem of what to do about the country's teetering banks, which have built up bad debts worth €7.9bn, equal to about 20% of GDP. The much-anticipated "stress tests" on Slovenia's rotten bank system revealed on December 12 that the government needs to inject €3bn into the three largest state banks – out of a total €4.7bn capital shortfall identified throughout the sector.

That's just about manageable for Ljubljana, meaning the government should avoid becoming the next Eurozone country to need an international bailout. The amount could be lower if better scenarios play out.

Slovenia's public debt levels are expected to increase to 75.6% of GDP after the recapitalisation of the banks, which is still low by wider European standards. The Eurozone average for state debt is 96%. As such, many analysts expressed satisfaction at the stress tests results.

Tim Ash at Standard Bank says it's now up to the Slovenian authorities to press on with a broader structural reform agenda. That should include "privatisation, further fiscal consolidation, plus reforms aimed at boosting competitiveness and laying the foundations for growth, to enable the country to grow out of its bank and debt problems," he says.

The immediate outlook for the economy is poor however, with recession set to continue. The IMF predicts a contraction of

bne February 2014

2.6% in 2013, which should improve somewhat in 2014 to a contraction of 1.4%. This will make Slovenia and its discredited quasi-market economy characterized by national ownership the out and out loser in the region in the coming year.

Things look only marginally better for Slovenia's neighbour and EU newcomer Croatia. The country's accession to the bloc on July 1 was a long time coming and broadly welcomed both inside and outside the country, but the subsequent six months of membership have been a damp squib, characterised by further economic decline and rising tensions at home and abroad.

On December 10, data showed that Croatia's GDP shrank by 0.6% on the year in the third quarter, driven by government austerity and the private sector reducing inventories. The IMF predicts a full-year contraction of 0.6%, the country's fifth year of recession, although this should turn around to 1.5% growth in 2014.

Given this weak performance, the budget deficit is expected to rise to 5.0-5.5% of GDP, compared with a 3.6% target. That

Outlook

I 67

would take the ratio of public sector debt/GDP above 60%.

The European Commission is threatening excessive deficit procedures (EDP) against the country. "Finance minister [Slavko] Linic has hinted in favour of pushing for a new IMF arrangement, which would presumably be pre-cautionary, as this would anchor reform and financing. His coalition partners in the ruling centre left appear unenthusiastic about going to the IMF without being pushed, and hence it seems that fiscal consolidation will have to await the EU’s EDP, with adjustment likely to be much slower," says Standard Bank.

Croatia's weaknesses remain myriad and hard to remedy.

Unlike the rest of Central and Southeast Europe, Zagreb has made little progress in reducing the budget deficit, which is seen as due to more the weakness of growth rather than fiscal largesse. As Capital Economics notes, Croatia has strong ties to the Eurozone’s weakest members, with 15% of its exports going to the periphery and its banks dependent on credit lines from parent banks headquartered in the same blighted countries. However, "these credit lines have been cut back, which has kept credit conditions tight," it adds.

Eurasia to stand on shoulders of giants Clare Nuttall in Astana

E

conomies across Central Asia and the Caucasus are set to continue to grow strongly in 2014, powered by natural resources investment. However, their fate also rests heavily on the giants of the neighbourhood.

Economies across most of the region grew strongly in 2013.

The launch of new natural resources projects in countries such as Kazakhstan, Mongolia and Turkmenistan puts all three countries on track for continuing growth in 2014. They are, however, vulnerable to various extents on the Russian economy and any slowdown in Chinese commodities demand.

Elsewhere, political uncertainty has held back growth in Georgia. Meanwhile, growing resource nationalism in Kyrgyzstan and Mongolia also threatens to deter investment.

Kazakhstan, the region’s largest economy, is on track for 5.6% growth in 2013, according to the European Bank for Reconstruction and Development (EBRD), which raised its forecast in October, and 5.5% in 2014. The government is

somewhat more optimistic, targeting 6-7% growth in 2014, which Visor Capital warns “looks challenging”.

Kazakhstan’s currency, the tenge, depreciated gradually against the dollar through 2013. The central bank’s foreign currency reserves dropped 20% in January-October. However, gold reserves increased to $6bn and the National Oil Fund to $68.7bn as of the end of October.

VTB Capital describes Kazakhstan as "an oasis of calm" compared to other former Soviet countries such as Ukraine and Belarus. It cites stable and relatively high oil prices, as well as steady increase in consumption and growing investment, contributing to steady growth through the year.

The long-awaited launch of production at the giant Kashagan oilfield in September 2013 has had little impact on oil production. Due to technical problems, the field has produced for less than three weeks overall, and it is not clear when production will restart. As of January 2013, the government

68

I Outlook

was forecasting oil production of 83m tonnes in 2014, with Kashagan contributing just 2m tonnes.

Exports are no longer a main growth driver for Kazakhstan, Visor Capital analysts wrote in November. "Internal demand, i.e. robust domestic consumption, contributes to the growth the most. Increasingly robust internal demand looks set to be the main driver of growth, contributing to significant growth in the services sector," the note said.

High levels of government spending on infrastructure and industrial projects has continued in Kazakhstan and other countries in the region. The government is now drawing up plans for the successor to its 2010-2014 accelerated industrial innovative growth programme. The initial programme was part of the government’s anti-crisis response, while the new programme is expected to have a stronger focus on diversifying the economy and high-tech development.

In early 2013, the government announced plans to return to the international capital market with Kazakhstan’s first sovereign Eurobond in over a decade. However, Astana’s plans to raise around $1bn were later put on hold due to international market conditions. The issue may take place in 2014 if conditions are right.

In 2013, Astana announced plans to nationalise the country’s pension funds into a single fund under the control of the central bank. The merger is due to be completed in the first quarter of 2014.

Five years after the international financial crisis hit Kazakhstan’s banking sector, the country’s banks are still

"The region is vulnerable to various extents on the Russian economy and any slowdown in Chinese commodities demand"

bne February 2014

has finally managed to find exits for the banking stakes that were nationalised in February 2009, striking deals to sell off most of its BTA Bank holding, all its Temirbank shares and a minority stake in Alliance Bank.

Elsewhere in Central Asia, despite a conspicuous lack of market reforms, Turkmenistan is one of the region’s fastest growing economies thanks to its huge reserves of natural gas. Coupled with high public sector investment, the economy is expected to achieve GDP growth of over 10% in 2014, according to the IMF Uzbekistan’s steady economic growth was overshadowed by a power struggle among the elite in the second half of 2013.

This has highlighted the political risks associated with the declining heath of 73-year-old President Islam Karimov. Despite the political uncertainty, Uzbekistan’s economy is set for 8.0% growth in 2014, the Asian Development Bank forecasts.

The withdrawal of international forces from Afghanistan in 2014 is a source of uncertainty for all the Central Asian republics, none more so than Tajikistan. Economically, the country is highly dependent on remittance flows from from Russia, which make up almost 50% of GDP. Any slowdown in the Russian economy in 2014 therefore could have a negative impact on Tajikistan.

The biggest question for Kyrgyzstan going into 2014 is how the stand off over the Kumtor gold mine – which accounts for around 12% of GDP – will be resolved. The government struck a new deal with owner Centerra Gold in December 2013, but it is not clear whether it will be passed by the parliament.

Despite concerns over political unrest and resource nationalism, Kyrgyzstan’s GDP recovered strongly in 2013, and the IMF forecasts growth of around 7% in 2014.

Mongolia is also in the midst of a tussle over a major mining project. Talks between the government and mining giant Rio Tinto over the $5.1bn second phase development of Oyu Tolgoi are still rolling onwards. One of the world's largest copper-gold deposits, the project is expected to be a major growth driver over the next few years – but it is not yet clear when work on the underground mine will begin.

struggling to work through non-performing loans. Since his appointment in September 2013, central bank governor Kairat Kelimbetov has stressed that resolving the asset quality issues is the main goal for the bank. He has set a target of bringing NPLs down to 10% by January 2016.

The ADB forecasts 13% growth in 2014. "The short- to medium-term prospects for the Mongolian economy are subject to trends in [China] and the global economy, and expansive fiscal policies historically make it vulnerable to external shocks," the development bank says.

Visor Capital analysts wrote on December 6 that 2014 "could mark a turning point for the Kazakh banking sector in terms of loan quality if NBRK takes firm action. Lowering NPLs significantly appears feasible for the banks that are fully provisioned." However, the report adds: "Overall, the banking sector in Kazakhstan is still convalescing and will not become healthy in the near term."

The largest economy in the Caucasus, Azerbaijan, achieved higher than expected growth in 2013, as oil production revived and the non-oil economy continued to expand, with government support. The IMF forecasts 3.5% growth for the country in 2013, rising to 5.6% in 2014.

However, Kazakhstan’s sovereign wealth fund Samruk-Kazyna

VTB analysts write: "Azerbaijan is a very likely new candidate to come to the international capital markets in the foreseeable future, with authorities recently cautiously highlighting such

Outlook

bne February 2014

I 69

2013 elections. However, the Georgian Dream coalition is now in control of both the presidency and the parliament, and a period of greater stability should be ahead.

a possibility, mostly in order to support private issuers." State oil and gas company SOCAR announced in mid-September that it may return to the international debt market in 2014 with an issue of up to $3bn. Azerbaijan’s largest bank, the International Bank of Azerbaijan, has also indicated it is considering a $500m Eurobond issue.

In the oil and gas sector, 2013 was a year of major decisions, with the international consortium developing the Shah Deniz field selecting the Trans-Adriatic Pipeline (TAP) to carry gas from the Turkish border into central Europe. Investment spending is set to increase in the coming years with work on the second phase development of Shah-Deniz, and construction of the TAP and Trans-Anatolian gas pipeline (TANAP). A final investment decision on Shah Deniz II was signed on December 17, which will trigger the start of exports to Europe by 2019.

By way of contrast, Georgia saw investment decisions on pause amid political uncertainty in the run-up to the October

While growth in Armenia accelerated to 7.5% in the first quarter of 2013, the ADB’s projection is for 4.5% growth for the year, rising slightly to 4.6% in 2014. The forecast is based on the expected slowdown in Russia and the dampened recovery in the Eurozone, as well as price hikes for gas and electricity.

"Overall, the banking sector in Kazakhstan is still convalescing and will not become healthy in the near term"

Commonwealth of Independent States: Real GDP, Consumer Prices, Current Account Balance, and Unemployment (Annual percent change unless noted otherwise)

Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections

Projections

Projections

Projections

2012

2013

2014

2012

2013

2014

2012

2013

2014

2012

2013

Commonwealth of Independent States (CIS)

3.4

2.1

3.4

6.5

6.5

5.9

2.9

2.1

1.6

...

...

2014 ...

Net Energy Exporters

3.8

2.2

3.5

5.2

6.8

6.0

4.1

3.2

2.6

...

...

...

Russia

3.4

1.5

3.0

5.1

6.7

5.7

3.7

2.9

2.3

6.0

5.7

5.7

Kazakhstan

5.1

5.0

5.2

5.1

6.3

6.3

3.8

4.3

3.1

5.3

5.3

5.3

Uzbekistan

8.2

7.0

6.5

12.1

12.1

10.4

0.7

0.2

1.1

...

...

...

Azerbaijan

2.2

3.5

5.6

1.0

3.7

6.3

21.7

13.3

9.2

6.0

6.0

6.0

Turkmenistan

11.1

12.2

10.4

5.3

7.6

7.0

0.0

0.2

3.8

...

...

...

Net Energy Importers

1.2

1.5

2.4

13.5

5.0

5.6

–7.4

–7.5

–7.2

...

...

...

Ukraine

0.2

0.4

1.5

0.6

0.0

1.9

–8.4

–7.3

–7.4

7.5

8.0

8.0

Belarus

1.5

2.1

2.5

59.2

17.5

14.8

–2.9

–8.3

–6.7

0.6

0.6

0.6

Georgia4

6.1

2.5

5.0

–0.9

–0.3

4.0

–11.5

–6.5

–7.8

15.0

16.7

17.3

Armenia

7.2

4.6

4.8

2.5

7.0

3.5

–11.3

–10.0

–8.6

19.0

18.5

18.0

Tajikistan

7.5

6.7

5.8

5.8

7.5

7.2

–1.3

–1.7

–2.2

...

...

...

Kyrgyz Republic

–0.9

7.4

6.5

2.8

8.6

7.2

–15.3

–9.6

–8.3

7.7

7.6

7.6

Moldova5

–0.8

4.0

4.0

4.6

4.4

4.3

–7.0

–7.6

–8.8

5.6

6.2

5.7

Caucasus and Central Asia6

5.8

5.8

6.1

5.2

6.9

7.0

4.8

3.9

3.1

...

...

...

Low-Income CIS Countries7

6.6

6.0

5.9

7.5

8.7

8.0

–4.2

–3.3

–2.8

. . .

. . .

...

Net Energy Exporters Excluding Russia

5.8

5.9

6.2

5.8

7.2

7.3

6.4

5.0

4.1

...

. . .

...

Memorandum

Note: Data for some countries are based on fiscal years. Please refer to Table F in the Statistical Appendix for a complete list of the reference periods for each country.

1 Movements in consumer prices are shown as annual averages. Year-end to year-end changes can be found in Table A7 in the Statistical Appendix.

2 Percent of GDP. 3 Percent. National definitions of unemployment may differ.

4 Georgia, which is not a member of the Commonwealth of Independent States, is included in this group for reasons of geography and similarity in economic structure.

5 Moldova predictions are based on data available for the first quarter of 2013.

6 Includes Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan.

7 Low-Income CIS countries comprise Armenia, Georgia, Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan.

Source: IMF

70

I Events

bne February 2014

Upcoming events 2014

4th Annual Turkey Acquisition Finance & Private Equity Forum (5 - 6 February) Euromoney +44 (0)20 7779 7222 Istanbul, Turkey www.euromoneyseminars.com

Agribusiness Ukraine 2014 (11 - 13 March) Adam Smith Conferences +44 20 7017 7444 Kiev, Ukraine events@adamsmithconferences.com www.adamsmithconferences.com

7th Annual Bancassurance Forum (11 - 12 February) Fleming Europe +421 257 272 144 Vienna, Austria will.hoss@flemingeurope.com http://finance.flemingeurope.com

Airport Development Russia & CIS (17 - 19 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

4th International Russian Insurance Forum (17 - 18 February) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com/AS2267BnBNE

17th Russian Automotive Forum (18 - 20 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

5th annual international Ukrainian Energy Forum (24 - 27 February) Adam Smith Conferences +44 20 7017 7444 Kiev, Ukraine events@adamsmithconferences.com www.adamsmithconferences.com

Russian Retail Forum (24 - 27 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

Derivatives & Risk Management Russia & CIS 2014 (4 March) Global Financial Conferences +44 (0)207 045 0932 Moscow, Russia Julia.Wallace@GFCconferences.com www.derivativesrussia.com

Bonds & Loans Russia & CIS 2014 (5 - 6 March) Global Financial Conferences +44 (0)207 045 0932 Moscow, Russia Julia.Wallace@GFCconferences.com www.bondsloansrussia.com

Russian CFO Awards & Dinner (23 April) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

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

What you need to know

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

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

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

72

I Events

bne February 2014