bne:Magazine - March 2015 by Ben Aris

Inside this issue: What triggered the Maidan massacre? Russian coal keeps UK lights on To arm or not to arm Ukraine March 2015 www.bne.eu

A salty outburst against Orban Ethnic riots dent image of Kazakh utopia Special Report CEE Real Estate

AFTER DEBALTSEVE

bne March 2015 Senior editorial board Ben Aris (Moscow) editor-in-chief

Contents

+7 9162903400 baris@bne.eu

James R Hammond (Boston) +1 6178525441 publisher jhammond@bne.eu Nicholas Watson (Prague) managing editor

+42 0731582719 nwatson@bne.eu

Robert Anderson (Prague) news editor

+42 0603517867 randerson@bne.eu

Liam Halligan (London) +44 7801799279 editor-at-large LHalligan@newsparta.net Central Asia Naubet Bisenov (Almaty) bureau chief

+7 7015933810 nbisenov@bne.eu

Eastern Europe Graham Stack (Kyiv/Berlin) bureau chief

+49 15152162803 gstack@bne.eu

Central Europe Tim Gosling (Prague) bureau chief

+42 0720180811 tgosling@bne.eu

Southeast Europe Clare Nuttall (Bucharest) bureau chief

+7 7073011495 cnuttall@bne.eu

Michael Dragoyevich (London) +44 7715412938 commercial director mdragoyevich@bne.eu Design Olga Gusarova (London) art director

COVER STORY 6 The Insiders

Advertising & subscription Elena Arbuzova (Moscow) +7 9160015510 business development earbuzova@bne.eu

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8 After Debaltseve 14 Perspective

CENTRAL EUROPE 28 Central Europe’s media searches for key to independence 29 Still glad to be gay in Slovakia

15 Chart of the month 31 Hungary: investing in Hell

EASTERN EUROPE

32 A salty outburst against Orban

16 What triggered the Maidan massacre?

33 Hungary’s industrial dreams punctured

17 Dodging the draft in Ukraine

34 Poland’s politics, banks, investors feel Swiss franc effect

20 Russian coal keeps UK lights on as winter grips 22 Russian bikers given a heads-up 24 Belarus wary of the ‘Russian World’ 26 Trade finance proves safe haven business for Russian banks

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Cover photo: Separatists pose on a Gvozdika self-propelled howitzer abandoned by retreating Ukrainian forces outside Debaltseve. Demotix / Maximilian Clarke. Print issue: ¤68 / year Basic online package: ¤180 p/user, p/year Full subscription package: ¤500 p/user, p/year

bne March 2015

Contents

SOUTHEAST EUROPE

Nagorno-Karabakh: no war, no peace

The fall and rise of the Moscow property market

Russia in rush to build "Turk Stream"

Armenia and Turkey battle over centenary events

Booming IT sector drives Romanian real estate market

Hungary market recovering but government is wildcard

CEE property investment volumes soar

Gulen dealt another blow as Bank Asya seized OPINION

Divergent economic paths

A new guv’nor in Albania

More power to the people

Wasted chances in Romania’s recycling sector

EURASIA 46

Ethnic clashes dent Kazakhstan's utopian image

Asian Development Bank ups game in Eurasia

The ‘burbs come to Mongolia

Mongolian government Got (No) Talent

Minsk deal offers Ukraine tough long-term opportunities

It’s the economy, stupid

Sowing the seeds of an oil-price rise

Film review: Few Russians left unmoved by “Leviathan”

To arm or not to arm Ukraine

Book review: A year in Hungarian Politics

SPECIAL REPORT

Obituary: Zhelyu Zhelev, Bulgaria’s first freely elected president

NEW EUROPE IN NUMBERS

UPCOMING EVENTS

ARTS, CULTURE & PEOPLE

Zlota 44 – a towering problem in Warsaw

Turkey no longer forever blowing (property) bubbles

I The Insiders

bne March 2015

West needs new tactics to deal with assertive Russia

bne IntelliNews Over 100 participants attended the inaugural bne IntelliNews Debate at Cass Business School, London, on Tuesday January 27, 2015.

ore than 100 participants at a feisty bne IntelliNews debate in London expressed frustration with the apparent failure of Western sanctions to modify Russia’s belligerent behaviour, with some suggesting it is time to try new tactics to ensure the fighting in the east of Ukraine is ended for good – a new ceasefire took effect February 15 – and head off similar flashpoints in the future. A sign of the contentiousness that epitomises the subject, several speakers at the Cass Business School on January 27 even took issue with the debate’s title, “East-West Conflict – Temporary Lapse or New Normal?” “There is no ‘East’,” spluttered Sir Andrew Wood, a former UK ambassador to Moscow, “it’s Russia – Russia is the problem.” For Erik Berglof, director of the Institute for Global Affairs at the London School of Economics, it was the idea that somehow what we are seeing in Russia-EU relations is normal. There is nothing normal about this so-called ‘new normal’,” said Berglof, “it’s very abnormal.” Not so, pointed out Sir Rodric Braithwaite, another former UK ambassador to Moscow on the panel: “Suspicion, fear, mutual disapproval and occasional bouts of violence have always characterised the relationship between Russia and the West – they are the norm.” Something that most of the speakers and attendees at the debate – the first that bne IntelliNews intends to hold over the coming months – could agree on was that the sanctions were starting to seriously hurt Russia. “There’s no question that the sanctions are having a negative effect on Russia’s economy and the investment climate,” said

audience member Michael Calvey, a founder of the big Russian private equity outfit Baring-Vostok Capital Partners. However, few expected a quick resolution to the current struggle between Russia and the West, and opinion was deeply divided over whether sanctions would ever be effective in forcing Russian President Vladimir Putin to modify his current behaviour toward Europe. “Sanctions are effective in terms of damaging the counterparty and damaging yourself – I’m not very confident that they will affect behaviour,” said Berglof. Indeed, others argued that sanctions are having precisely the opposite effect, actually pushing the Russian leadership away from engagement and into adopting a more aggressive, isolationist stance. Ben Aris, editor in chief of bne IntelliNews, argued that sanctions were reinforcing Putin’s domestic position and were

“Sanctions will not change Putin’s mind at all” therefore counter-productive. “Sanctions will not change Putin’s mind at all,” he said, adding: “If anything, [they] have only made him stronger.” Pippa Malmgren, a former Special Assistant to the US President for Economic Policy on the National Economic Council and founder of the consultancy DRPM Group, took this a step further, arguing that the sanctions were actually making Putin act contrary to the desired conduct. “The greater

bne March 2015

the economic pain, the greater the inclination to engage in a military response,” she argued, adding that the problems between Russia and West are not isolated to Ukraine, but are part of conflicts ranging “from the Arctic to Mediterranean, to the Black Sea and beyond” that could in the future even include the threat of nuclear weapons. Even Edward Lucas of The Economist, a noted hawk on Russia, conceded that the track record of using sanctions to make countries do what the West wants “is fairly weak”, citing Zimbabwe as a case in point. He argued that sanctions needed to be made tougher to be more effective. “If we really wanted to impose sanctions, we would go after the Russian dirty money in the West,” he said, pointing out that this money meant, “we [in the West] were riding first class in the Kremlin gravy train.” “We are reinforcing all the bad traits in Russia,” said Berglof. “We need to find a way back. We need to find areas where there is a positive sum game. We need to find some kind of conversation where we can engage.”

Top: Liam Halligan, Edward Lucas, Erik Berglof, Sir Andrew Wood and Ben Aris Middle: Sir Andrew Wood, Ben Aris, Sir Rodric Braithwaite Bottom: Valery Morozov, Former Kremlin Advisor

I The Insiders

bne March 2015

The former chief economist of the European Bank for Reconstruction and Development said that trade talks between the EU and the new Eurasian Economic Union could offer such an area for a constructive conversation. Ben Aris, editor-in-chief of bne IntelliNews, argued that talks on a new strategic framework for Europe could also be worth trying, though Sir Rodric Braithwaite, former UK ambassador to Moscow, dismissed this as impractical in the current environment. Better the devil you know While “engagement” was generally agreed to be better than “shouting” and “shooting”, some questioned whether it was possible for the West to deal with the current crop within the Kremlin who were driving policy. “My starting point is whether Vladimir Putin and the people who advise him are rational actors who can be deterred,” said Professor Michael Ben-Gad of City University.

“If we really wanted to impose sanctions, we would go after the Russian dirty money in the West” This has worrying implications for the conflict spreading into other parts of Europe. “Given the way the West has ignored the commitments it made to Ukraine under the 1994 ‘Budapest Memorandum’, it’s an open question why Putin should take Nato’s Article V commitments to, say, Estonia any more seriously,” said Professor Ben-Gad. So we need to talk about Vladimir. Lucas and Sir Andrew argued that the goal of the West must now be to bring down Putin. However, Aris and speakers from the floor warned of the risk that what might come after could be even worse. “We might miss him when he’s gone,” Professor Ben-Gad noted wryly. There was more agreement on the need to bolster Ukraine in the face of Russian aggression, which, if it works, could encourage change in Russia itself. “The solution is much more about trying to do the right thing in Ukraine,” said Berglof. “If Ukraine manages to get through this very difficult transition… that is the road to real change in Russia itself.”

Top: Michael Calvey, Senior Partner of Baring Vostok. Middle: Prof Michael Ben-Gad and Dr Pippa Malmgren. Bottom: The debte was webcast to a global audience.

However, change in Russia is rarely smooth or without violence. “The question is, when will Russia begin to change its system of government and can it change it without a violent end?” summed up Sir Andrew.

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I Cover story

bne March 2015

After Debaltseve Ben Aris in Moscow, Nicholas Watson in Prague

t was either an “orderly, pre-planned” withdrawal of the Ukrainian army (President Petro Poroshenko), or a massacre of 3,000 demoralised, battleweary troops (pro-Russian separatists). But whatever the taking of the eastern town of Debaltseve was, it signals a new phase in the Ukrainian crisis that will have massive repercussions for Europe. What does Russia, which is clearly destabilising Ukraine to get its way in a standoff with the EU over the country’s future, actually want? The press is full of speculation, but the truth is that the situation remains highly unpredictable and could go in several directions, ranging

The latest deal agreed in Minsk on February 12 between Russian President Vladimir Putin, Poroshenko, the EU, plus the leaders of the rebels fighting in the Donbas region, appears at the time of writing to be a ceasefire in name only.

following Sunday on February 15. The fighters on the ground had every incentive to try and grab the last few kilometres before the line was locked in and heavy weapons withdrawn under the terms of the deal. The rebels, backed by Russian weaponry and allegedly troops, began attacking the strategically important railway hub town of Debaltseve even as the deal was being signed in Minsk. It ended with Ukraine's army there being surrounded and Kyiv forced to concede a humiliating defeat on February 18.

The Minsk deal was flawed from the outset; the leaders met on the Friday but the ceasefire didn't go into effect until the

Debaltseve is strategically important for the rebels – it is a major transport hub, the loss of which would have proved

from a decades-long armed insurrection in the east, to an economic boom in the rump of pro-Western Ukraine that could offer investors the last unfulfilled great investment opportunity in Europe since the fall of the Soviet Union.

Cover Story I 11

bne March 2015

hugely disruptive for economic activity in the territory held by Russia’s proxies in the east of Ukraine. Its capture also bolsters the rebels' position as they look to build up their economic independence from the rest of the country. The defeat of the Ukrainian army at Debaltseve could prove to be a decisive point in the conflict. There are several ways to read this result. The first is the "it’s almost over" scenario and the battle for Debaltseve was simply a mad rush to grab a strategic asset before the ceasefire came into effect on February 15, freezing the line of demarcation. Certainly bond and equity investors were encouraged by the rebels' capture of Debaltseve and believe it clears the way for the beginning of the end of hostilities. Russia’s junk-rated corporate bond market has started to lift in the last month from a six-year low hit on January 13, with the number of issuances in the last month doubling from the year before, according to Bloomberg, with yields moving out of distressed asset territory. "The nation’s equities and the ruble have rallied the most in the world this month. Corporate bonds returned 6.2% in the past one month, the best performance among emerging markets except Venezuela. And sovereign-bond yields have fallen to the lowest level since December 11," the newswire said the same day as Debaltseve fell to the rebels. Germany was less impressed with the fighting that continued beyond the deadline, condemning the battle as a "massive violation" of the ceasefire. But highlighting the West's extremely weak hand once again, Berlin went on to say that the Minsk deal was "damaged but not dead". "The German government resolutely condemns the military actions by the separatists in Debaltseve. It is a massive violation of the ceasefire that went into effect on Sunday," Chancellor Angela Merkel's spokesman said in a statement. "We believe the Minsk process is under strain, it has perhaps been damaged, but we still believe it makes sense to continue working." The second "it's not over yet" scenario is that Putin did not get what he wanted in

Minsk and was demonstrating to both Kyiv and Brussels his military superiority on the ground and his ability to turn the fighting on and off at will. Germany was putting a brave face on an unstable situation, as a clearly "shaky" ceasefire was obviously already an understatement only days after the ceasefire was supposed to start. Already on February 20 the Ukrainian military was reporting that fresh fighting had broken out near another strategic town, the Ukrainian port city of Mariupol. Taking this back from the Ukrainian army, which wrested it from the separatists’ control last year in in heavy fighting, would provide the Russians and their proxies with a land bridge to the Crimean peninsula, which Moscow annexed in March last year, and

scenario, where the country is wracked by terrorism and rebel raids for decades, fuelled by arms and money from both the US and Russia. Indeed, the situation on the ground in Ukraine today already looks similar to the fights against the Tamil Tigers in Sri Lanka or the Farc rebels in Columbia at their worst points. At the other end of the spectrum is the optimistic (and currently implausible) outcome that the west of Ukraine still controlled by Kyiv accepts the loss of the east and starts to build a modern, democratic EU candidate state. Of all the countries in the former Soviet Union, Ukraine has fallen the furthest behind. The average income in Kyiv in per capita terms ($8,970 in 2013,

"It is easy to turn these militias on but it is a lot harder to turn them off again" is widely seen by many commentators as one of Russian President Vladimir Putin's top goals in the conflict. "Debaltseve, defended by very significant Ukrainian forces, sends a clear signal that Russian-backed rebels have the potential, almost at will, to further extend gains into Donbas, and even the rest of Ukraine," says Tim Ash, head of research at Standard Bank. The long view Looking further ahead, there are four possible outcomes of this conflict over the next year. The most pessimistic outcome is that the militias used by both sides to fight what is in effect a proxy war between East and West are so steeped in death and hate that they continue to battle on irrespective of deals made in Kyiv and Moscow. It is easy to turn these militias on, but after they have lost so many fathers, brothers, uncles and sons, it is a lot harder to turn them off again. Putin and Poroshenko could simply lose control of the situation. This is a Sri Lankan-like

according to the World Bank) is a third of that in Russia ($23,190) and it is the only country (apart from Kyrgyzstan) where the average income is less than it was at the end of the Soviet Union. Ukraine has missed out on most of the catch-up growth enjoyed even by the likes of Belarus ($16,950). If stability, reform and real investment arrive in Ukraine, the economy could soar. It remains the last great investment opportunity in the former Soviet Union where investors can earn triple and even quadruple-digit returns if things go well. Neither of these scenarios is very likely. Europe won’t tolerate a low wattage war sputtering in its backyard and would continue to turn the sanction-screws on Russia until it at least produced a frozen conflict. Likewise, after two decades of dysfunctional government and endemic corruption, Ukraine's leaders are unlikely to be able to transform the system overnight to attract the billions of dollars needed to pay for it. Ukraine is not Estonia. At this point the third option, a frozen conflict, similar to Transnistria in Moldova or Nagorno-Karabakh that lies

I Cover story

between Armenia and Azerbaijan, looks the most likely outcome. The problem with the Minsk summit is that it focused exclusively on halting the shooting. None of the substantive aims that Russia is demanding were addressed and the Kremlin is unlikely to back off until it gets what it wants. Putin will turn the hostilities back on again if these negotiations go badly. "Before last year, eastern Ukraine had no history of ethnic conflict. Well-armed ‘separatists’ emerged on the scene only when Russian President Vladimir Putin

bne March 2015

Moreover, the mood on the street in Kyiv is becoming increasingly ugly. The Maidan demonstrations began as a protest against the now exiled former president Viktor Yanukovych’s decision to reject the EU's free trade and association deal. However, the protests quickly metamorphosed into an effort to oust the kleptocratic Yanukovych regime. But no one on Maidan signed up for a civil war and the mood is now swinging against the government as standards of living drop and the body count mounts. At the same time, so many people have died (just under 6,000 according to the latest UN count)

“The ‘civil war’ that ensued is an artificial conflict run by Russian security. It will last as long as the Russians want it to last” ordered them there. The ‘civil war’ that ensued is an artificial conflict, run by Russian security and enhanced by a sophisticated pan-European disinformation campaign. It will last as long as the Russians want it to last," Anne Applebaum opined in a recent Washington Post column. Finally, a slightly more optimistic version of this end game is that Poroshenko does manage to placate Moscow with promises of no Nato membership; a trilateral trade deal between Ukraine, the EU and Russia is struck; and Ukraine pushes through a sufficiently radical reform programme to unlock foreign investment and substantial Western aid. This is Europe's preferred outcome and it is easy to argue that the West's best response to Russia's aggression is to ensure a strong and prosperous Ukraine, as that in itself would undermine Putin's power over the country. Maidan III The problem is that Poroshenko is now in an almost impossible position. He may have easily won the presidential election, but he doesn’t have a clear mandate from the people after his eponymous political party came a narrow second to that of his much more hawkish prime minister, Arseniy Yatsenyuk in the parliamentary elections.

that no-one is in the mood to make any compromises with Moscow. "What Moscow wants is now fairly clear to all sides – Ukraine to be pulled from its current Western orbit, back into Russia's sphere of influence, and for a government to be formed in Kyiv more amenable to Russian interests. Russia probably also wants a resetting of the European post-Cold War security structure, and recognition as a result of the war in Ukraine of clear Russian spheres of influence, pushing Nato expansion back beyond Ukraine's Western border," says Ash. However, if Poroshenko concedes any of these points, then he very likely will face a Maidan III – this time directed against him. It is hard to see what Poroshenko, as the head of a militarily weak and economically broken state, can do to plug the gap, especially following the defeat at Debaltseve. "Public mood will deteriorate and weaken the position of the authorities in Kyiv, both domestically as well as in negotiations with Russia [following this defeat]," writes Witold Rodkiewicz, Rafal Sadowski and Andrzej Wilk of the Centre for Eastern Studies (OSW) in a paper. But one thing is clear: Poroshenko can

count on little help from the West. "The continuing military pressure has several aims: to gradually expand the area controlled by the rebels (who have laid claim to the whole of the Donetsk and Lugansk regions); to weaken the morale of the Ukrainian armed forces; to provoke a split among the Ukrainian political elite; and to deepen the mood of fatigue and resignation among the Ukrainian public. At the same time, the Kremlin is seeking to demonstrate the complete powerlessness of its Western European partners and force them to recognise that the establishment of a lasting peace in Ukraine will be possible only on Russian terms: the federalisation of Ukraine and the abandonment of its pro-Western course, while receiving financial assistance from the West," the OSW analysts believe. If the fighting does stop, then Poroshenko will have his hands full placating the growing dissatisfaction in his government's performance. Whatever optimism outside observers have for the prospects of long-term peace, within the country the people are on the verge of revolt. “People are slowly starting to come to the realisation, though, that a great deal of the Maidan’s ‘transformative’ impact has been imaginary. The New Yorker recently ran an excellent dispatch by Sophie Pinkham, a Columbia University doctoral student who is currently writing a book about Ukraine, which detailed just how slow change has been in coming,” says Mark Adomanis, a commentator for bne IntelliNews. “In her account you meet Ukrainians who have gone without electricity, water or modern medical care, Ukrainians who have lost their jobs, Ukrainians who have seen the purchasing power of their meagre salaries and pensions almost entirely destroyed by rampant inflation. These people are not terribly satisfied with the ‘new world’ that has been ushered in by Maidan, and they would surely meet with incomprehension anyone suggesting that their country is now an example unto others.” The OSW argues that there is a crisis of confidence in public institutions in Ukraine, with a poll showing a clear

bne March 2015

Tactically, Putin has been exemplary in his battle over Ukraine with the West. Strategically, it could go badly for him. The Russian president since he came to power has single-mindedly tried to transform Russia from being a petrol pump to the world into a modern, technologically advanced country with Western standards of living. But for this he needs Western investment and know-how, which could now be out of Russia’s reach for years to come. Thus Putin could find that Russia once again reverts to being little more than a petrol pump to the world – and not a very well paid one at that. Putin must be banking on divisions in Europe he has successfully exploited. The EU sanctions on Russia, which require a unanimous vote, are due to expire in June and if there is a semblance of peace in Ukraine, then disunity amongst the EU members could make it difficult to renew them. The US sanctions are permanent unless action is

87.1% 80.0%

82.9% 80.0% 75.5%

70.0%

77.4% 74.0%

60.0%

2014

2013

2012

2011

53.7% 2010

By overplaying his hand at what should be the beginning of the end of the conflict, the West is more likely to leave debilitating sanctions on Russia, cutting the country off from the investment and technology that it so badly needs to modernise the country.

Gross external debt to GDP: 2008-present (%) Gross external debt to GDP: 2008-present (%)

2009

Russia’s folly Putin has been playing hardball in Ukraine and seems to be holding all the aces at the moment. However it could well be that while he has won the battle, he has lost the war.

Even if Ukraine has lost all the battles, the obvious strategy for the West now is to ensure that it can make the transformation so many of its people have fought and died for. And this is pretty much the only effective policy left open to Brussels at this point – but don’t hold your breath. The EU has been long on rhetoric, but short on action,

2008

The first real test for Poroshenko will be the regional elections in East Ukraine that were part of the Minsk deal. The rebels cannot and will not allow open and free elections in their region that are organised from Kyiv, and they are bound to produce another flashpoint or at least institutionalise the Donbas' separation from Kyiv, producing a frozen conflict.

Sources: CEIC Data; Concorde Capital

Hryvnia rate to the US dollar: 2008-present

26.5

25.0 20.0 15.0 10.0 5.0 4.9 2009

2011

2013

2015

Source: Oanda

Total reserve reserveassets assetsand and import import cover: cover:2008-present 2008-present Total 40K

* Total reserves

30K

20K

Minimum recommended level of reserves

10K 2009

2011

Source: State Statistics Service of Ukraine

I 13

complains Standard Bank's Ash. The fall of Debaltseve may have represented a turning point in the Ukrainian crisis and the standoff between Russia and the West over the country. But most likely the “hybrid war” will turn to a “hybrid peace”, in which Ukraine is left to wither and both sides hunker down behind their respective red lines, glaring at each other.

taken to remove them.

$ millions

majority of the population not trusting the parliament (56.9% of respondents), the government (54.2%) or local government (51.8%). In this climate, Putin only has to spin out the conflict and eventually Poroshenko will face yet another popular rebellion.

Cover story

2013

2015

I Perspective

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Russia's investment climate deteriorates bne IntelliNews

survey into Russia's investment climate by Detail Communications found that investment confidence has halved since the crisis hit. However, a third of respondents – a mix of portfolio managers and analysts from some of the most prominent investment banks, asset management firms and hedge funds – expect the Russian stock market to bounce off the bottom this year and put in double-digit returns. "Russia is arguably facing its most challenging times in modern history. For the country, 2014 was marked by tensions in Ukraine, sanctions, plummeting oil prices, change in ownership of Crimea, currency devaluation and economic recession. Needless to say, this did not go down well with investors. By the end of the year, the market capitalization of the entire Russian stock market was less than that of one single corporation – Apple," said Timofey Pletz, CEO of Detail. Even so, Detail found that, "Almost a third of the respondents showed great optimism and expect to see double-digit growth from the Russian stock market in 2015. That’s despite the fact that none of them forecast economic growth in 2015." Despite expectations of a big 'dead cat bounce' this year, similar to one that saw a tripling of asset prices in the spring of 2009, investor confidence remains close to historical lows. On a scale of 1 to 10, Russia had an average score of 5.6 for its investment climate before the crisis, which has since Russia's macro invest confidence before and after crisis Investment climate in Russia before the financial crisis and events in Ukraine 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Current investment climate in Russia 10 points (highest) 9 points 8 points 7 points 6 points 5 points 4 points 3 points 2 points 1 points (lowest)

more than halved and is now equal to 2.5, the survey found. Around 70% of investors gave Russia two of the lowest possible scores. Investors are concerned with a smorgasbord of problems, but political risk and geopolitical tension are top of the list. That said, one of the worries that don't appear to faze investors is the fear that Russia will default on its debt: 92% of the investors are either completely not worried or have only slight concerns about Russia defaulting on its debt. "A Russia default is also out of the question, with only 8% [of respondents] saying they are very worried about it," says Pletz. It’s an issue that bne IntelliNews raised in a recent chart, questioning whether rating agency Standard & Poor's recent decision to downgrade Russia to junk status was justified; a look at the macroeconomic fundamentals raises a big question mark over the decision. Investors are also pretty pessimistic about the prospects for near-term economic recovery: none of the respondents expects the Russian economy to rebound in 2015. The largest share (44%) believe it will happen in 2017. Almost 20% say it will happen only in five years’ time. As for attractive investment opportunities, oil and gas remains the standout sector of choice for investors. "Despite underlining the concern about how dependent Russia remains on oil prices, which plummeted in 2014, almost half of the investors (38%) named the oil and gas sector as the most attractive industry," says Pletz. These companies are the big winners from devaluation, as their costs are in rubles but most of their revenue is in foreign currency. Tied in second place are the metals and mining industry, also a big winner from devaluation, along with agriculture. Interestingly, the survey finds that domestic issues are top of the pile when it comes to making Russia a more attractive investment proposition: almost 50% of investors say reform and diversification of the economy is the top priority to make Russia more attractive to investors. Peace in Ukraine and sanctions being lifted are in third and sixth place, respectively, the survey found.

Chart I 15

bne March 2015

S&P downgrades Russia to junk, but figures tell different story

CHART:

tandard & Poor’s downgrade of Russia to junk status on January 27 was met by the Kremlin with accusations of US-influenced politicking. Russian news agency RIA Novosti quoted Deputy Foreign Minister Vasily Nebenzya as saying that he has “no doubt that this was done not even on the prompting but on direct orders from Washington”. While there is little argument that 2014 proved to be a damaging year for the Russian economy, a closer look at some basic macroeconomic figures bears out Russia’s complaints – especially when compared to other economies still ranked investment grade.

highest non-investment grade – was the country’s newfound lack of access to international capital markets. The implicit message there is that, in the not-too-distant future, Russia simply will not be able to service its debt obligations. The widely used metric of public debt as a percentage of GDP is seen as a broadly reliable indicator of a country’s level of indebtedness. A glance at the bne:Chart

below reveals not only how healthy Russia is in this respect, at 9.2% of GDP, but also the comparative fragility of other nations – including those whose sanctions led to the S&P downgrade. Without access to capital markets, Japan would have to use more than two years’ total GDP to service just a single year of public debt. Russia, on the other hand, could pay its own off with little more than a month of output.

"Russia could pay its public debt off with little more than a month of output"

S&P’s main justification for downgrading Russia to ‘BB+’ – its

Debt as % of GDP 211.7 200

150 132.6

92.1 79.5

United Kingdom

76.9

Hungary

47.1

Germany

46.8

Poland

Czech Republic

69.7

79.2

United States

100

36.9 9.2 Japan

Italy

Spain

Kazakhstan

Belarus

Russia

I Eastern Europe

bne March 2015

What triggered the Maidan massacre? Graham Stack in Berlin

wo separate investigations by Germany's Frankfurter Allgemeine and the BBC have produced evidence that opposition demonstrators on Kyiv's Maidan fired on police on February 21, 2014, in the run-up to an ensuing police massacre. The two accounts help explain the events that culminated with the flight into exile of Ukraine's pro-Russian president Viktor Yanukovych hours later. In the early hours of February 20, 2014, Ukrainian security forces successfully used three riot-control vehicles fitted with water cannons – newly acquired from Russia – to drive protestors back down from the steep hill leading up to the government district and onto Independence Square (known as Maidan) itself. Towards morning, police and interior ministry troops came in behind the riot-control vehicles to take up positions on the square itself, for the first time since the start of

the opposition protest camp in early December 2013. Apparently concerned to avoid any scenes of violence that might trigger sanctions against the government, as threatened by the EU, the riot police and interior ministry troops used Western methods of crowd control – moving in

no answer against the water cannons – except that one of the vehicles was reportedly disabled by a petrol bomb – it seemed that the protestors' camp would soon be dispersed. Then something happened that seemed at the time to the protestors to be a miracle – the police abruptly pulled back

“Self-defence turned into cold, indiscriminate killing” behind the water cannons, linking arms and using their massed weight to start dividing up the protest camp crowd – which at the start of working day totalled at the most a few thousand. With the police taking up positions on Maidan itself, and protestors having

from the square and disappeared back up the hill on Institutksa, towards the government district. Seeing the police retreat, scores of protestors – with their trademark improvised riot shields, miners' helmets, petrol bombs and sticks –

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rushed up the hill after them, intending to re-erect barricades further up Institutska road. It was then that the security forces started shooting, killing scores of protestors in the following hours, in harrowing scenes that then flashed round the world on YouTube. Why did the police pull back so suddenly, snatching defeat from the jaws of victory? And why, having refrained throughout the night from using even truncheons against protestors, did security forces suddenly open fire on protestors with live rounds? Fired on In the year of chaos that has followed Yanukoych's departure, which has since led to a global security crisis, these questions have remained unanswered. Now two accounts have come to largely the same conclusion: the police, having moved onto Maidan, and apparently gaining the upper hand against the protest camp, pulled back abruptly because they were fired upon by armed groups within the protest camp. BBC reporters have now talked to a man who claims he was equipped with a high-velocity hunting rifle as a member of an armed Maidan unit housed in the Kyiv Conservatory. That Conservatory directly overlooks the part of the Maidan where the water cannon-mounted vehicles had entered from Institutska. The man called Sergei tells the BBC that his unit started firing on police in the morning of February 20. “I was shooting downwards at their feet," Sergei claimed. "Of course, I could have hit them in the arm or anywhere. But I didn't shoot to kill." The BBC quoted pro-Europe MP and former journalist Andriy Shevchenko as saying that a police chief in charge of officers on Institutska called him frantically to inform that his men were under fire from the Conservatory, and that casualties were mounting. The BBC also identified a Ukrainian photographer

Dodging the draft in Ukraine

Graham Stack in Kyiv With Russian-backed rebels threatening to raise a 100,000-strong army and the fighting in eastern Ukraine becoming increasingly bloody, the ceasefire deal comes at just the right time for a Ukrainian army facing massive draftdodging. The Ukrainian defence ministry on January 20 launched its fourth wave of mobilisation of the country's reservists since its "anti-terrorist campaign" started in April 2014. The army reserves comprise men who have undergone one year of mandatory national military service. The ministry said a total of just under 62,000 reservists had already received their draft papers in the new wave, half of the overall target number. But writing on Facebook, presidential advisor Yury Biryukov said that draftdodging, which is punishable by by up to three years in jail, had become endemic, even in West Ukraine – the traditional heartland of Ukrainian patriotism. According to Biryukov, 57% of those called up in the western region of Ivano-Frankivsk, named after a national poet, had simply ignored their draft papers, while an estimated 37% of those called up had crossed the border into Romania. “Unofficial sources tell us that hotels and motels on the other side of the border with Romania are packed with draft-dodgers,” he wrote. In the Facebook post – which he later deleted after a storm of controversy – Biryukov alleged that 14 village councils in Ivano-Frankivsk had refused to allow the distribution of draft papers in the villages. The same is true of other West Ukrainian regions, Biryukov said, adding that 17% of draftees from neighbouring Chernivtsi region had left for Romania. Biryukov said that the draft was proceeding “normally” in southern and central areas closer to the conflict, such as Odesa, Mikolaevsk and Dnipropetrovsk. Other reports, however, spoke of difficulties there as well. The army commissioner for Poltava region in central Ukraine on January 27 said that 50% of draftees had failed to show, Interfax Ukraine reported. In the town of Kremenchug, the responsible official said that only around 10 reserve officers had showed up for service out of several hundred registered locally. One district council in Odesa region has resorted to tough measures to improve the draft, posting on its website an order prohibiting reservists from leaving the district until all call-up papers had been issued. The order was later removed from the website. Other reports speak of widespread corruption in the call-up system allowing draftees to buy themselves free. Some military analysts argue that draft-dodging is a necessary evil to sort the wheat from the chaff, with the patriotically motivated who answer the call of far greater value to the army in action.

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Initial records of police casualties for that week show that three policemen died between 9.30am and 10.30am on February 20 from injuries sustained on Institutska. “As the first men [from the riot police] were injured, everyone stormed forwards. Everyone who was on the barricades stormed up the Institutska Street... Our boys used their weapons only once,” Parasyuk said, “as they were storming [up the hill].” According to Parasyuk, as quoted by FAZ, this was the moment that police marksmen opened fire. “They started to provide covering fire for the retreating [police units]” Parasyuk said. According to FAZ, “The perpetrators, whoever they were, may initially have been in a sort of defensive position, but then exceeded everything that could be regarded as justified in this position. Self-defence turned into cold, indiscriminate killing,” FAZ reports. A source staying in the Ukraina hotel overlooking the Maidan and Institutska also told bne IntelliNews of an opposition rifleman demanding entry to guest rooms and then firing from the window. Parasyuk's role in the events of February 20, 2014 has largely remained unknown until now. It was only the following day, on February 21 that he made his name with a dramatic public debut.

Volodymyr Parasyuk in his 'defence' days.

who saw and photographed armed men in the Conservatory at the time. The man apparently in charge of the riflemen in the Conservatory was 27-yearold Volodymyr Parasyuk – today an MP, but at that time simply leader of one of the 'Hundred' units, responsible for the defence of the city centre protest camp. In an interview with Germany's establishment newspaper Frankfurter Allgemeine Zeitung (FAZ), published on

February 9, Parasyuk said many in his group were armed. “A lot of lads came to us then, who said we should take up arms and attack… Many had guns with them, often hunting rifles,” he was quoted as saying. Parasyuk confirmed to FAZ that his men fired on the police, saying that this was in response to initial police fire. The police started firing over the barricades, and the protestors “defended themselves using their guns,” Pararsyuk said.

The government and opposition had reached an EU-negotiated powersharing deal at around 1:00pm on February 21, 2014 that envisaged Yanukovych remaining in power until elections towards the end of 2015. At an emotional opposition rally on the Maidan on the evening of February 21 to commemorate the slain, the then-unknown Parasyuk seized the microphone to fiercely denounce the deal and the parliamentary opposition that had signed it. Parasyuk told Yanukovych that if he did not resign by 10:00am the next day, his armed men would come and storm the presidential residence. The crowd cheered this intervention, and Parasyuk has since been given credit

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for prompting Yanukovych's flight from his residence that same night, paving the way for the pro-EU opposition to come to power. Parasyuk in his first press interview, given to Ukrainskaya Pravda on February 24, three days after his dramatic intervention from the stage

Eastern Europe

guard stood nonchalantly outside, where only hours before hundreds of special forces and interior ministry troops had thronged. Municipal workers were already clearing away the rubbish they had left. Security forces also withdrew on February 21 from Yanukvych residence

“Our boys used their weapons only once”

of the Maidan, made no mention of any use of firearms during the protests. But asked why he wore army fatigues, he said he had had paramilitary training with a range of nationalist groups in his native West Ukraine. He also said that it was his group, numbering around 50, that were occupying the Conservatory. Flight of Yanukovych Parasyuk's alleged connection to a smallish armed wing of the protest camp may explain one of the biggest riddles about Ukraine's February 2014 revolution: Why did Yanukovych quit power so quickly after winning a deal that secured it? One factor may have been the direct physical threat to Yanukovych from an apparent armed wing of the protesters not under control of the parliamentary opposition. This may have scared Yanukovych so badly because, in the afternoon of February 21, all security forces pulled out of the centre of Kyiv, as well as from Yanuokovych's Mezhyhirya estate outside Kyiv, as part of the political deal. Suddenly roles were switched: Yanukovych was left almost entirely without security, while the Maidan camp remained intact and had shown that it could shoot. By 4:00pm on February 21, a bne IntelliNews reporter walked right up Institutskaya – where shots had still rung out in the morning – to the building of the presidential administration, and knocked on the door. One unarmed

at Mezhyhirya, deputy head of the state guard service, Mykola Reshetnyak, told bne IntelliNews the next day. Given Parasyuk's alleged connection to an armed group, and that Yanukovych had been stripped of his security, Parasyuk's threat may have sounded very real to Yanukovych.

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Yanukovych fled by helicopter under cover of darkness to East Ukraine, and thence to Russia. This was an astonishing political turnaround, considering that police appeared to have won the upper hand over protestors on the previous day. Parasyuk's own career has continued upwards from that point – leading a division of volunteer fighters against Russian-backed rebels in East Ukraine, before entering parliament as an independent MP for his native Lviv region in elections on October 25, where he has continued to be a thorn in the side of the establishment in parliamentary sessions and talk show appearances. With hindsight, the events of nearly one year ago, on a patch of central Kyiv the size of a soccer field, have not only determined the fate of Europe's largest country, but the chances for global peace.

"Parasyuk's threat may have sounded very real to Yanukovych"

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and say he’ll be sending Russian coal east not west this year,” he says. The players Russian coal has the benefit of quality and geography, says Nigel Yaxley, managing director of the Association of UK Coal Importers. The proximity of Russian ports in Murmansk and the Baltic makes Russia well placed to compete in the Atlantic market alongside Colombia, the US and South Africa. However, while the Western sanction lists do not name any individuals linked to coal companies, that could change: the big Russian coal companies importing to the UK are all led by people with close ties to the Kremlin.

Russian coal keeps UK lights on as winter grips Nick Kochan in London

s winter grips the UK, a group of Russian coal companies with leaders closely linked to President Vladimir Putin is enabling British power companies to keep the country’s lights on – a precarious position as the sanctions rhetoric rises once again. Three Russian firms, SUEK, KRU and SDS Coal, produce most of the imported coal to a country whose energy system is creaking. These firms export to the UK just under a $1.5bn worth of coal a year, according to Greenpeace. EU data show that the UK heads the list of European importers of Russian coal; it imports about 20mn tonnes of Russian coal each year, most of which is bought by the six big power generators. Tony Lodge, a research fellow at the London-based Centre for Policy Studies think-tank and the author of “Clean Coal – A Clean, Secure and Affordable Alternative”, notes that while most of the talk is about Russian oil and gas, the UK has “a real liking for Russian coal coming from the Baltic in summer

or Archangel in winter. I know of traders who are looking to double their coal import contracts to the UK now. This is hard stuff. It’s about keeping the lights on.” At a time when the rhetoric on sanctions grows louder as the situation in Ukraine deteriorates, relying on

Siberian Coal Energy Company (SUEK) – whose latest annual report notes the UK is now the company’s most important export market after China, with 41% of “Atlantic” sales – has Andrey Melnichenko as its major shareholder and chairman. His companies are listed as strategic enterprises in Russia, allowing them in some cases to rely on the support of public institutions on a priority basis, and he is reported to be close to the inner circle of Putin. Melnichenko’s business empire had its origins in the purchase of MDM Bank in the mid-1990s, but in the early 2000s he went on to acquire coal assets including

“If Cameron says he does not like what Russia’s doing in Ukraine, Putin can always turn round and say he’ll be sending Russian coal east not west this year” growing quantities of Russian coal to bridge an energy shortfall is a dangerous position to be in, warns Chris Kitchen, general secretary of the National Union of Mineworkers. “If Prime Minister David Cameron says he does not like what Russia’s doing in Ukraine, Putin can always turn round

SUEK and the nitrogen and phosphate fertilizer company EuroChem. A heavily publicised lawsuit with Shaft Sinkers, a contractor hired to drill a mining shaft, put it at odds with the trio of oligarchs who hold shares in Eurasian Natural Resources Corporation (ENRC), a major scandal-hit shareholder in Shaft

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Sinkers. This has caused EuroChem, and its founder, some embarrassment and expense. Melnichenko, 42, is a very colourful character – even by the standards of Russian oligarchs. He is worth an estimated $11.4bn (according to Forbes rich list in 2014) and owns one of the world’s most striking super-yachts, the ‘A’, (named after his wife Aleksandra, a former Serbian model). The yacht was designed by Philippe Starck. Other assets include a Boeing 737, a villa in Antibes, an apartment overlooking New York’s Central Park and a £24mn property called the Harewood Estate in Ascot, Surrey. Melnichenko also has connections to the British establishment. His long-standing advisor is George Cardona, once a special advisor to former chancellor

Eastern Europe

that the company’s coal production had fallen 3% on year in January-September 2014 to 32.58mn tonnes. This partly reflects the falling price of coal, which is down about 50% over the last two years. Sibirskiy Delovoy Soyuz (SDS) – a subsidiary of the Siberian Business Union – produces more than 20mn tonnes of coal a year and is headed by Vladimir Gridin and Mikhail Fedyaev, who are close associates of the Russian president. Gridin serves in the State Duma for Putin’s United Russia Party and is deputy chairman of the Transport Committee. Fedyaev's son Pavel became State Duma deputy for United Russia in 2011. Disruptive behaviour Yaxley of the Association of UK Coal Importers says that if there were a breach in Russian supply for whatever

“Melnichenko is a very colourful character – even by the standards of Russian oligarchs” Geoffrey Howe. Cardona is on the boards of SUEK’s parent companies (the Cypriot Madrake and the Bermudan company Westline), EuroChem and seven other Melnichenko companies. Kuzbassrazrezugol (KRU) is majorityowned by a Russian copper company headed by Iskander Makhmudov called UGMK (also known as UMMC). About 15 years ago, Makhmudov brought in Andrei Bokarev to run KRU. A measure of Bokarev’s achievement was the award of the Alexander Nevsky prize for services to the Sochi Olympics in April 2014. This was seen as an indication that he falls within Putin’s circle of trusted industrial advisers. Bokarev, who heads up Transmashholding, is involved as director, shareholder or board member in three different companies that have been placed under sanctions by the US, namely Kalashnikov, Rosneft and Transoil. At the end of 2014, when announcing its third-quarter results, KRU revealed

reason, there are plenty of companies with coal ready to take up the slack. “This is a very flexible market,” he says. However, even the most diehard proponents of sanctions on Russia cannot the escape the fact that it would be both costly and disruptive for the UK to sever imports of Russian coal. The Russian coal companies for their part have found a market that is an eager buyer of Russian coal. Declining demand from China is likely to push them further into the UK market. Coal may be a more flexible energy source than gas, but the UK shows no signs of taking up the available alternatives. The scale of imports are such that customers would not be prepared to pay the higher costs that would result from importing coal from further away. Nor would the government want to in an election year. For the moment, Russian companies have a tight grip on the UK market and this is unlikely to loosen any time soon.

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Putin's daughter steps into limelight Ekaterina Tikhonova – reportedly the younger daughter of Russian President Vladimir Putin – is to oversee a $1.7bn expansion project at Moscow State University, thrusting her into the public limelight for the first time. Tikhonova, 28 – who according to Russian media reports uses her mother Ludmilla's maiden name – is currently head of a firm drafting plans for the expansion of Moscow University facilities to include a new science campus, a project appraised at $1.7bn. News outlet RBK published an investigation into the expansion project, and Tikhonova's role leading the design firm Innopraktika, on January 29. But the investigation did not mention that Tikhonova was Putin's daughter, an indication of the sensitivity of the topic; since Putin became president in 2000, his daughters Ekaterina and Maria have been hidden from public view, with no reliable photos of them available, making confirmation of Tikhonova's identity difficult. Nor did it mention her previous career as acrobatic dancer. The RBK article merely questioned how a woman without any previous known activity in science research or administration had been given such a role. Kremlin-critical blogger and journalist Oleg Kashin first made explicit the Kremlin connection in a subsequent blog post, while also posting footage of dance routines. In comments to Forbes Russia, long-serving Kremlin press secretary Dmitry Peskov then said he "did not know" whether Tikhonova is Putin's daughter. "I don't know who she is. I cannot judge, I don't know. Many girls have claimed before to be the daughters of Vladimir Putin", Peskov said. Now that Tikhonova has apparently taken on a public role, attention will focus on any signs that she could be destined for a higher state position, or even potentially become successor to Putin, who is due to step down in 2024 at the latest.

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lasers, projects the map onto the inside of the helmet's visor. The whole thing is controlled by voice, basically using the same sort of technology as Apple's Siri service. And it works. On activation, a map will appear on the inside of the visor of your helmet and using voice commands you can choose your destination, change the view or call up other services. Once underway, a series of arrows will appear in the middle of your field of vision showing the way to go. Even if you turn your head sideways, the 3-D display just swings as if on a gimlet to continue pointing the guiding arrows in the right direction.

Russian bikers given a heads-up Ben Aris in Moscow

n the last 20 years Russia has produced precisely one hi-tech consumer-product – the Yotaphone, a smartphone distinguished by its two screens: a regular one on the front and an e-book reader screen on the back. However, in May Russia should see the second hi-tech consumer product to be launched since the fall of the Soviet Union: the LiveMap 'heads-up' interactive GPS map that is projected in full colour onto the inside of a motorcycle helmet visor. It's a fairly obvious idea and pretty cool to use. While GPS maps for cars have become ubiquitous, there is still nothing analogous for motorcycles. You can have a TomTom taped to the speedometer on your motorbike, but that means you have to look down and refocus to see where you are, which can be dangerous, especially when driving at speed. "I went online and searched for heads-up motorcycle map devices, but I couldn't find anything at all," says CEO Andrew Artishchev, who founded LiveMap and put the development team together about six years ago.

Some companies have tried to solve the problem by adapting a Google Glass splitter and using it as a motorcycle helmet display, but this is less than satisfactory, as the image is extremely small and displays next to your eye meaning the refocusing is even more extreme. Other companies have increased the size of the display by mounting an attachment

Challenges Artishchev has not done anything technologically revolutionary, as much of the technology already exists. What he has done is overcome various engineering and business problems to put the helmet together. LiveMap draws on Russia's long-standing world-class aviation technology; avionics is one of the few places where Russia remains a leader. Heads-up displays for fighter pilots already exist, although these helmets come with a set of problems to overcome. The first is that the helmets are extremely cumbersome. Second, they draw their power from the plane, but Artishchev wanted his heads-up display to be powered by battery. Third, the display itself is monochromatic: the fighter pilot helmets only use green lasers. And

“I began searching in 2008 for experts who had some experience in aviation helmets” to the outside of the helmet. However this ruins the aerodynamics of the helmet and the turbulence it causes at high speed can buffet the head. Plus, it still doesn’t solve the refocusing problem. Artishchev has got round both these problems by building a projector into the habit that comes over the top of your head and, using low powered

finally the cost: fighter pilot helmets go for a cool $25,000 apiece. The voice recognition software and operating system was developed by Russian software engineers, another of Russia's strengths. Artishchev then hooked up with US and Japanese producers of aspherical lenses in order to produce a projector. These are special

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non-symmetrical lenses that have a much more accurate point of focus, so the projector tube can be much shorter and lighter. Finally, the helmet itself is made of carbon fibre – an extremely lightweight material that is stronger than steel. "I began searching in 2008 for experts who had some experience in aviation

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you can buy it off the shelf with the retail price of $2,000 per unit. The pre-orders should produce enough money to finance the production of the first helmets." Artishchev has been talking to a few venture funds. German car company Audi has such a fund that was looking

“We are going into commercial production in May with a retail price of $1,500 per unit for pre-orders” helmets,” says Artishchev. "I ended up meeting some technicians from Moscow's Baumann Institute and from a university in St Petersburg who had worked on military helmet heads-up designs. We also have as a shareholder Anatoloi Yurlov, the chief engineer at [Russian search engine] Yandex, who is in charge of developing their search engine." The projection system also proved to be a problem. Producing laser light consumes a lot of power and Artishchev wanted to avoid using a cable attached to the bike for power. In the end, he found the pico projector that produces low-powered laser light in a complete spectrum of colours. Heads up, money in The easiest bit seemed to be raising the money. Despite the Russian government's drive to promote innovation, the various state-backed funds and institutes have produced almost no commercial viable projects since they were founded. Artishchev got a $1mn grant from the Skolkovo institute, a high-tech hub sponsored by the government, and another $300,000 from the Russian Ministry of Sciences, as well as putting up a significant amount of his own cash. "We tried to avoid going to venture capitalist companies as we wanted to develop this project on our own," says Artishchev. "And we should be able to finance the production out of the revenue stream. We are going into commercial production in May with a retail price of $1,500 per unit for pre-orders. After that,

at Artishchev's heads-up display and also thinking of distributing the helmet together with its Ducati motorcycles, an Audi-daughter company. However the deal fell through.

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The car companies might in future be interested in this sort of heads-up display because they would work just as well on a car screen as they do on a motorcycle helmet visor. "We have decided to stick with motorcycle to begin with simply because we have no competition and so it should be easy to sell. In cars there are already a wide range of alternatives that are much cheaper and so there the competition will be more difficult. But once we are established, it’s an obvious place to go," says Artishchev. Artishchev has high hopes for the launch of the helmets. They go on sale in the US in May and Artishchev is expecting in the first year to sell 10,000 units, rising over the next five years to 500,000 units a year across the globe.

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isolation from Europe and the US,” Kazakevich tells bne IntelliNews. He adds that the very structure of the alliance between Belarus and Russia is based on the premise that Russia always acts as a supplier of financial resources and economic benefits for Belarus. In 2014 alone, Russia provided $2bn in government loans to Belarus.

Belarus wary of the ‘Russian World’ EurAsEC, which previously rescued Belarus from a balance-of-payment crisis in 2011 by offering a $3bn aid package. According to initial agreements, the final tranche should be worth $440m. However, its fate has been unknown since late 2013.

Belarus has been trying to negotiate a new support programme with the IMF since late 2010, when the previous standby loan programme for the country ended. However, the multinational lender has repeatedly stated that it wants to see “a credible commitment to a comprehensive package of consistent and strong macroeconomic policies and deep frontloaded structural reform” in Belarus.

Andrei Kazakevich, director of the Vilnius-based Institute for Policy Studies Palitychnaya Sfera (Political Sphere), believes that Russia will be the principle source for maintaining the country’s international reserves, because refusal to do so would

However, the Belarusian government has not completely abandoned the idea of cooperating with the global lender. A new visit to Belarus by IMF experts is scheduled for March, and the authorities could once again raise the question of possible funding,

Sergei Kuznetsov in Minsk

elarus' foreign government debt repayments have reached a peak and the government is facing a serious shortage of funding. The country is required to pay $4bn this year, while its foreign currency reserves stood at just $4.7bn as of the beginning of February. The Belarusian authorities are confident that Russia will again provide financial support, but at the same time Minsk appears increasingly worried about a possible threat from Moscow to its sovereignty. “We do not want to take on more loans… However, if we encounter real trouble, Russia will lend us a shoulder,” Alexander Lukashenko, the president of Belarus, said during a press conference on January 29. Lukashenko added that he “has a solid agreement” on this matter with his Russian counterpart as well as with the Russian prime minister. Lukashenko said his government is still relying on the final tranche of a loan from the bailout fund of the Russialed Eurasian Economic Community,

IMF conditions Stanislav Bogdankevich, former governor of the National Bank of Belarus, also believes that Russia will continue to provide financial support to Belarus. “To obtain a loan from the International Monetary Fund (IMF), it would be necessary to change the existing economic model, to change course. The latest statements by Lukashenko suggest no willingness to do so. He does not intend to abolish manual economic governance,” Bogdankevich tells bne IntelliNews.

“If we encounter real trouble, Russia will lend us a shoulder” inevitably entail in a "reformatting" of the Belarus-Russia relationship. "This would not be very favourable to Russia now, because of the instability in Ukraine and its general political

despite the low chances of a success. “We continue to work with the IMF. In March a planned mission of the organisation will work in the country to study our situation. We are not ruling

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out any possibilities as far as financial cooperation is concerned. But the consideration of these matters will need time, at least several months,” Finance Minister Vladimir Amarin said on January 29.

part of it – because of the domination of the Russian language in Belarus, existing traditional ties [with Russia], and the existence of a Union State [Belarus-Russia bilateral integration formation],” Kazakevich says.

It's a 'Russian World' Despite their confidence in Russia’s largesse, the Belarusian authorities appear to have started worrying about the Kremlin’s new aggressive policy towards post-Soviet states. Moscow

After the eruption of the Ukraine crisis and the active intervention of Moscow in the situation there, including military support for the separatists in the Donbas, Lukashenko’s rhetoric towards Russia has become tougher. “There are

“There are several interpretations of the concept of the ‘Russian World’. In most of them, Belarus is considered a part of it” considers post-Soviet countries that have a significant Russian-speaking population and traditional economic and interpersonal relations with Russia to be part of the so-called “Russian World”, and in Ukraine it has shown its readiness to defend its influence there, even by military force. “There are several interpretations of the concept of the ‘Russian World’. In most of them, Belarus is considered a

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Russia over the region which belongs to the ‘Russian World.’” Minsk has also become increasingly ambivalent about the Eurasian Economic Union (EEU), a trade bloc recently created by Russia, Kazakhstan, Belarus and Armenia. During his press conference on January 29, Lukashenko said that Belarus could leave the EEU if the agreements between its member states are violated. “If the agreements we have reached are respected, we will honour everything with regard to the EEU. If they are not respected, we reserve the right to withdraw from this union,” Lukashenko said.

some ‘wiseacres’ who claim that Belarus is, as they say, part of the ‘Russian World’ and even almost Russia. Forget about it: Belarus is a sovereign and independent state,” Lukashenko said on January 29.

However, Lukashenko later toned down his rhetoric. The president said in an interview with a Russian TV channel on February 14 that the trade union is beneficial for Belarus and that the country “sees prospects in it”. On the other hand, Lukashenko underlined that “if it is too painful and tight [for Belarus], there is a possibility of leaving any agreement, even the [EEU].”

Kazakevich says that Russia’s approach to the “Russian World” could indeed be a potential threat to the Belarusian state, because the concept “envisages the political and cultural domination of

As Bogdankevich predicts, “Lukashenko will maintain the eastern vector [of his foreign policy] alongside moderate liberalisation of his relations with the West.

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bne:Trade

Trade finance proves safe haven business for Russian banks Ben Aris in Moscow

ollowing Western sanctions and the collapse of the Russian ruble's value in December, you would have thought that the trade financing business for Russian banks would be in desperate trouble. But actually it is doing well and has turned into something of a safe haven business line for those banks that offer the service. Four Russian banks dominate the business: Alfa Bank, VTB Bank, Sberbank and Promsyvazbank (PSB). The sanctions imposed on a handful of Russia's leading state-owned banks (including VTB and Sberbank) have affected the whole business, and made funding trade deals a lot harder. "Syndication has become much more difficult, but we have no problem financing or issuing letters of credit for export," says Alexander Mesheryakov, managing director of PSB and head of global transaction banking. "Foreign banks have limited operations to state banks to a maximum of 30 days as per the terms of the financial sanctions. PSB is not under sanctions; all our problems have more to do with the general deterioration of the Russian economy and the negative outlook for this year, than anything like the Russia sovereign downgrade." PSB managed to close a syndication loan to fund trade financing deals in the autumn of 2014 after sanctions were imposed, although Mesheryakov says it remains impossible to issue Eurobonds. Still, this has proven to be less of a problem. PSBâ&#x20AC;&#x2122;s funding needs have fallen due to the general drop in volumes, but more importantly the bank has seen significant inflows of fresh deposits. "We are over-liquid now. Our customers are not panicking, but we have seen lots of people switch banks looking for more stable banks and we have had a big inflow of new deposits," says Mesheryakov. Trade finance deals come in three flavours: letters of credit, letters of guarantee and trade loans. While the first two instruments are still in use, Western banks now refuse to contemplate trade loans, which means that if the trade deal is done on debt, PSB has to lend the money from its own resources, whereas before it could borrow to fund the transaction. The sanctions have also hit Russia's export business with Asian counterparties. While countries like China have openly supported Russia in its clash with the EU and US, Asian banks

still rely on funding from US banks and these lines of credit have been closed to anything involving Russian companies. The Russian state has stepped in and PSB has increased the amount of work it does with the Russian export credit agency, which can guarantee deals or provide funds. Political problems notwithstanding, 2014 was actually a good year for trade in Russia, with trade financing growing by 13-14% in cash terms in the first three quarters. But volumes fell sharply in the last quarter as the ruble went into freefall and trade volumes tumbled by some 30-40%. Imports were obviously hard hit by the devaluation of the ruble, which lost about half its value in the last few months of 2014, however exports have done well. "Oil producers were hurt, as in addition to the devaluation, the price of oil itself fell heavily. But all the other products â&#x20AC;&#x201C; such as machinery, coal, timber â&#x20AC;&#x201C; have done well, as their costs are in rubles and revenue in hard currency," says Mesheryakov. "Even when you factor in devaluation, these companies are still making significant profits and buoying trade finance." Thus trade finance has become something of a safe haven business line for banks in times of crisis; irrespective of the value of the ruble or extent of the hostilities, companies still need oil, gas and wood to make things.

"The sanctions have also hit Russia's export business with Asian counterparties"

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Central Europe’s media searches for key to independence Tim Gosling in Prague

ournalists may be among the least trusted people on the planet, but they're still not as disliked as billionaires and politicians. That has seen Central Europeans rally round editorial teams as they jump from major newspapers that are being snapped up by the region’s oligarchs. Yet that support is unlikely to be enough to keep the myriad new, independent media companies they're launching alive and kicking. When Penta Group bought Slovakia’s respected largest daily SME in October, Editor in Chief Matus Kostolny and four deputies walked out. The murky Slovak financial group had clashed with the newspaper in recent years, in particular over its reporting of alleged corrupt deals that Penta made with senior government officials over the past decade. In trying to buy Sme through the acquisition of the Petit Press holding, the

editorial team insisted Penta was not a financial investor but seeking political influence, and that would put editorial independence at risk.

a wave of public support for independent journalism. "We're looking at different models to combine investors and paid readership," he reported.

By November 13, the former Sme team had launched a temporary website named Projekt-N, and launched a full

Conundrum It's a conundrum many are facing in the region. The crisis has seen losses piling

"Quality journalism is not cheap!" subscription-based site – dennikn.sk [www. dennikn.sk] – early this year. The case made a big splash in Slovakia, and former SME deputy editor Tomas Bella told bneIntelliNews in the immediate aftermath of the walkout that the team knows it must move fast to tap into

up at media publishing companies in the small markets in Central and Eastern Europe. That has the international giants that moved in during privatisation in the 1990s selling out to powerful local business groups, and even politicians. The highest profile case was the

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purchase in July 2013 of Mafra Group – publisher of several of the largest newspapers in the Czech Republic – by Andrej Babis. Owner of the country's largest employer Agrofert, the billionaire became finance minister in January at the head of his own political party ANO, and is viewed as increasing his power on an almost daily basis. However, many other titles in Slovakia, the Czech Republic and elsewhere in the region have seen similar changes of ownership. That has seen editorial teams walking out one after another to form new ventures. Now they face difficult decisions to find the investment and business models that can sustain independence, even as the global media industry struggles to adapt to new realities. While projects across the region talk of an impressive amount of public support for their principled stance, that will only go so far when it comes to paying salaries, printers and web servers. There are some non-profit alternatives, says Vaclav Stetka, a senior researcher at Charles University in Prague, such as community-based funding or foreign NGO grants. "However, [most projects] can only hope they find a workable business model," he adds. With large question marks hanging over profitability in the region's media sector, and therefore the motivations of any large investor, that puts the onus on readers and advertisers. Bella says the Project-N model relies on payment from users. "The one big advantage in Slovakia," he suggests, "is that paying for online content is much more developed, and readers are used to it." That's a reference to the Piano Media paywall system, which many Slovak media titles went behind in 2011. Bella is a co-founder and board member at Piano Media. bne IntelliNews went behind a Piano Media paywall in November. Bella says Projekt-N is also looking at other business models in the region. The Slovak journalist has been discussing the project with Dalibor Balsinek, who left Czech daily Lidove noviny when

Still glad to be gay in Slovakia Benjamin Cunningham in Bratislava Just 21% of eligible Slovak voters took part in a February 7 referendum that sought to limit the rights of same-sex couples, far below the 50% needed to make the result legally binding. However, with around a million approving the motion, the vote offers more evidence of the shifting political winds in Slovakia. It was a triumph of apathy rather than a sign of liberal leanings on the part of the wider public that the referendum failed. Those that did turn out overwhelmingly supported all three questions on the ballot, which was promoted by the Alliance for Family (AZR). The first, seeking to define marriage as between a man and woman, received 94.5% support, while a second which sought to ban adoption by same sex couples was given the nod by 92.4%. Meanwhile, 90.3% voted for legislation that would allow parents to opt children out of sexual education classes in school. Outright fatigue was also likely a factor in the low turnout. This was the fifth time Slovak voters have taken to the polls in the past 12 months. Just 13% made it to vote during European Parliamentary elections last May, a new EU low. "I don't care, it's none of my business," said Alena Duharova, a 55-year old entrepreneur from the western Slovak city of Dubnica nad Vahom, who did not vote. "All this was created because of the church." Slovakia's constitution already bans gay marriage. Parliament adopted a constitutional amendment defining marriage as between one man and one woman last year. Still, leaders from the AZR argued that more was needed to protect children. They were able to collect 400,000 signatures on a petition to pave the way for the vote, well over the 350,000 required for a publicly-driven ballot initiative and a sign of grassroots political organising clout. Campaigning in recent weeks had taken an interesting turn, with major media – public and private – declining to air AZR advertisements. Referendum organisers complained of censorship and accused broadcasters of bowing to political pressure, although it is unclear from where pressure would come. Church leaders, including the Bishops Conference of Slovakia, were outspoken in backing the referendum. For his part, Prime Minister Robert Fico kept his cards close to his chest. Whilst he told media he planned to vote, he didn't specify which way, and did little to urge supporters to cast ballots. Leaders from the LGBTI community simply asked supporters to stay at home. Speculation now focuses on whether the leaders of the conservative AZR will seek to parlay their referendum efforts into a wider ranging political project. Even given the low turnout, around 1mn offered support. That's comparable to the number of votes carried by the ruling Smer in the 2012 general election, which saw them secure an outright majority in parliament. That may be part of the reason AZR leaders felt able to claim a victory on February 8. "The process has been important; people are more oriented toward family values than before," Anton Chromik, one of those at the forefront of the movement, told bne IntelliNews. "We will try again if needed."

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Babis bought Mafra to set up the Czech "internet daily" Echo 24. Bella suggests that a regional network of independent news sites, including the likes of Hungary's 444.hu, could be "imagined" in the future. However, some may already be finding the funding challenge a little too daunting. One commentator speaks of "specu-

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months was unrealistic. "The investment needed was much bigger," she says. While instinct might suggest that starting a new media company is simpler and cheaper in the age of the internet, many argue exactly the opposite. The weight of competition is so great, and revenue options so limited, that the

"Lots of people are concerned at the moment about corruption, and the threats to democracy and media freedom" lation Echo24 is backed by similar sort of guys to those they were running away from." That refers to suggestions that Martin Roman – disgraced former chief of Czech state-controlled power giant CEZ and reputed political power broker – is ultimately behind the project, albeit there's little evidence. Balsinek failed to respond to a request for an interview from bneIntelliNews. Eye of the tiger Yet Project-N can look to much of CEE for inspiration and potential business models. "There's the same kind of readership and concerns across the region," points out Stetka. “Lots of people are concerned at the moment about corruption, and the threats to democracy and media freedom." Latvia's Ir is the great survivor, having launched under very similar circumstances to Projekt-N in 2009, when the daily Diena was sold to local oligarchs. Like Bella and his colleagues, the editorial team there looked to harness the anger that the events threw up in the country quickly, says Editor-in-Chief Nellija Locmele. "We got small amounts, typically around LVL5-10 (¤7-14), and with around a dozen or so investors that gave us a start up of around LVL200,000," she estimates. However, she warns that the team's initial hope of getting the new project off the ground within three

likes of Ir went to the other end of the spectrum. Ir was a hardcopy magazine from day one, and relies on selling a quality product, notes Locmele. "We said from the start we're not cheap," she says. "Quality journalism is not cheap!" Readership is around 60,000, the editor says, pointing out that's a big number in a country of just 2mn. Michal Musil at the glossy Reporter magazine in Prague – set up by another set of Mafra orphans – says the team had been eyeing the impact of online media on the industry with concern since 2011. The acquisition by Babis was just the kick out of the door on a project

The funding and business model remains fluid, Musil notes. Around a year ago, the non-profit Reporter Foundation was set up for donations, however the business model focus at Reporter, which mixes political features with culture and lifestyle, is firmly on advertising. "If we tried starting with a website we'd struggle to gain enough traction to attract advertisers," he points out. "We would have needed a big investor. We didn’t have one." Instead, Reporter has gone straight to banks, financial services firms and travel companies to pay for a printed magazine. Sponsorship packages, including cover mounted logos, features and a slice of the 30,000 print run to hand out, accounted for around 70% of the first issue he estimates. Similarly, he guesses revenue is split 30-70 between donations from "those that know of the Babis issue" and from ads. That illustrates that the big question for the range of independent media projects now cropping up across the region – Stetka mentions several more have set up, especially in Hungary and Romania – remains. Without the promise of large profits or political influence, the motivation at first for larger investors in Ir was ethical, suggests Locmele; mostly drawn from the diaspora or members of the business

"It's nice as a journalist to feel some support from the public for a change" they had been working on for around 18 months before they put out the first issue in September. "The time of the big media houses is clearly coming to an end," he suggests. "A small organization can better control costs and revenue. The big companies are hardly able to start contemplating change to keep up. The old, single publication model is dead. Society is fragmenting."

community interested in a free Latvian media. However, that can't replace fundamentals. "Our aim is to be profitable, and we are," the Latvian states. "Media independence starts with financial stability." For the meantime, "it's nice as a journalist to feel some support from the public for a change," laughs Musil.

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ket while supporting growth through a “predictable” regulatory and legislative environment. Triumph of hope over experience All sides hailed the agreement – originally proposed by Erste – as a turning point in the previously stormy waters of Hungarian government-banking relations, while stressing it also had positive ramifications for the broader economy. After admitting to the earlier “difficult relationship” between the banks and the government, the time had come “to move forward”, EBRD chairman Suma Chakrabarti told MTI, the state news agency, after the signing.

Hungary: investing in Hell Kester Eddy in Budapest

ungary is backing investments in Hell. Really.

The Hungarian Investment Promotion Agency (Hipa), the state office charged with boosting trade and investment, has signed a “cooperation agreement” designed to “support the expansion” of Hell. A deal with the devil? Not quite. Hell, in this instance, is a Magyar energy drink that Hipa is keen to promote: so it's all just a catchy marketing stunt. The joke, however, is probably lost on those investors whose Hungarian experience has proved diabolical. The list is long: it includes electricity, gas and water utilities, banks, telcos, retail, real estate, agriculture, media and recycling companies, all of whom complain – sometimes publicly, more often in private – of sudden legislative changes, usually enacted without consultation, that have turned their business model upside down, and sometimes closed it altogether, often to the benefit of

domestic competitors. Most, but not all, affected are foreign-owned, typically with German, French, Austrian or a US parent. Common to all these complaints is a government led by Viktor Orban, a former law student and anti-communist firebrand who heads Fidesz, the party he helped found in 1988 and which today claims to be “moderate conservative”: critics label it nationalist-populist, even autocratic. But on February 9, in a surprise deal, Orban, for the Hungarian state, along with the European Bank for Reconstruction and Development (EBRD), signed a memorandum of understanding to each take up a 15% stake in Erste Bank's Hungarian subsidiary. Erste pledged to support the Hungarian economy with a new loan package worth €550mn, while the government promised to both reduce the bank tax and provide a level playing field for all in the banking mar-

The markets certainly welcomed the news: shares in OTP, Hungary's largest bank, jumped almost 5% on the day of the announcement, adding another 4.4% the following day. But while the news was universally welcomed, long-time observers of Orban's Hungary were understandably cautious. “Perhaps it's hope over experience, in the sense that the government will take a less interventionist approach, [but] I think the government has finally realised that if the banks are hit with extra taxes, plus the effects of the forced exchange of FX loans into forint, it severely hits their ability to do business,” Nigel Rendell, economist with London-based Medley Global Advisors, tells bne IntelliNews. Part of the problem for Orban's government is what Rendell termed the “artificial measures” to encourage lending to business, primarily the central bank's 'Funding for Growth programme', which has proved “less successful than many in government had hoped,” he says. And with Orban famously pledging to create 1mn new jobs prior to elections back in 2010 – a pledge looking ever more difficult to honour half way through the time plan – action was needed. “Therefore, much better to cut the taxes, leave the banks alone to do what they do best – lend to the private sector. This should boost the domestic economy and ultimately the country's longer term growth potential,” he says.

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A salty outburst against Orban

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But, as even the EBRD's Chakrabarti admitted, rebuilding trust after a sustained period of unpredictable behaviour is “always the most difficult thing”.

Kester Eddy in Budapest Lajos Simicska, a Hungarian media mogul long seen as one of the closest oligarchs to Viktor Orban, has lashed out at his boyhood friend in a series of media interviews that could cause lasting damage to the prime minister’s future. Simicska, who shared a college dormitory room with Orban in the 1980s, accused the mercurial prime minister of seeking to build a dictatorship, muzzle independent media and of leading Hungary into a dangerous liaison with Russia in a flurry of expletive-rich media interviews published on February 6. “Viktor Orban is spunk,” he declared in his most outrageous comments, incensed at what he views as the “traitorous” defection of senior editors at his three main media outlets out of loyalty to the PM. Andras Petho, co-founder of Direkt36, an investigative website, points out that “spunk” is probably the worst thing you can call someone in Hungarian. “That word is so nasty you would hardly ever see it in newspapers, until now,” he says. “There have been rumours since the April elections that this alliance [between Orban and Simicska] had broken up, but there was no hard evidence. The events of February 6 made it clear in a very spectacular way that these rumours are true.” Quite what caused the schism remains unclear. Various pundits have mused that Orban, high on confidence after his second consecutive (and resounding) victory in elections last spring, was keen to reduce his financial dependency on Simicska. Speculation of a rift grew in January after reports emerged of a meeting between Orban and pro-government media owners in which the PM declared the government would drastically reduce its advertising spending in private media channels. Added to this, changes to a controversial advertising tax are set to raise by a factor of five the tax on Simicska's media businesses. It was this that appears to have precipitated Simicska's declaration of a “media war” against Orban – a declaration that in turn triggered the defections of Simicska's leading editorial staff who wanted to appear loyal to the prime minister. Simicska, however, appeared indifferent in his various media outbursts to any future financial worries caused by the modified tax: rather, he voiced various, hitherto unexpressed, political and moral concerns. “You may think it funny, but I am a committed democrat. I don't fucking like the methods the boys [ie. Orban and his government] are using in this country,” he told Magyar Narancs, a current affairs weekly. “You can believe it or not, but my alliance with Orban started out because we wanted to demolish the [communist] dictatorship and post-communist system. It turned out that was no easy thing – we had to sweat at that. But no fucking way was there the intention of raising another dictatorship in its place. I'm no partner in that.” Reporters questioned Simicka's about the risk of reprisals by Orban, given the former party treasurer's intimate knowledge of Fidesz's economic history. As he noted to Magyar Narancs: “I've known him [Orban] 35 years – does that tell you something? I know him, and I know a lot about him, sure. And? What are they going to do, shoot me? Let's hope it doesn't come to that.”

Rendell is less diplomatic: not only has Hungary become “an unpredictable destination for many foreign investors” under Orban, but investor sentiment has been further damaged by his praise for Russia and Turkey during last summer's infamous “illiberal democracies” address, he said. Some relief Clearly, the big question is whether Orban can be trusted to hold to the deal. Erste feels that the role of the EBRD is, if not a trump, at least an ace in the arrangement. The London-based bank has pledged to “strongly support” and “carefully monitor” the deal, which is subject to six-monthly reviews. This, along with the personal involvement of Prime Minister Orban at the signing, points to a “strong commitment” by the government to carry this through, Axel Reiserer, the EBRD spokesperson, tells bne IntelliNews. “Thirdly, and this goes beyond the EBRD, but we think is the strongest point, having acquired more than 50% of the Hungarian banks, I think the government has begun to realise that bashing the banking sector is no longer productive… it's shooting itself in the foot,” Reiserer said. Although it was unusual for the EBRD to partake in a deal which enlarged state ownership of any sector, in the Erste case it was an encouragement for Erste, as a large, private bank, to stay in the country, Reiserer argued. Of course, even assuming the Orban administration keeps its word, as Mihaly Varga, the economy minister admitted on February 10, the bank tax will still remain “quite high” after the planned cuts. For the banks then, the new deal will bring positive relief, but no return to the heady, heavenly profits attainable before the crash of 2008. A kind of purgatory, perhaps – but that's still better than investing in hell.

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Central Europe

Hungary’s industrial dreams punctured Kester Eddy in Budapest

he “Hungarian model” is really working very well and recent results prove this, declared Peter Szijjarto, Hungary's foreign minister, as the foundation stone was laid at a new manufacturing facility in the south-western town of Zalaegerszeg on January 27. The new plant, a HUF4.5bn (¤14.5mn) investment by Edelmann, the German printing and packaging company, will create 100 new jobs and make Zalaegerszeg the second largest of the group's six European production bases, according to state news agency MTI, citing Dierk Schroder, Edelmann's managing director. A day of photo-shoot grins for Schroder, then; but for every German industrialist smiling in Hungary right now, a dozen or more are gnashing their teeth. On New Year's day, Budapest introduced a new road freight registration and tracking system – known by its Hungarian acronym as Ekaer – for all but the smallest of commercial deliveries by road. Ekaer requires a mass of detailed data about commercial consignments, including the contents, value, sender, recipient, truck registration numbers, and times of arrival and unloading – all to be sent to the tax authority in advance of shipping. Any failure to comply, if discovered by mobile inspectors, can result in the confiscation of goods and fines of up to 40% of the shipment's value. The new regulations, the government says, are needed to combat VAT fraud rackets involving phantom cross-border consignments of goods. But industry leaders and hauliers alike are condemning the measures as a bureaucratic nightmare. “Ekaer… is an extra administrative burden, it imposes unnecessary costs and weakens the competitiveness not just of our company, but of the whole

Hungarian automotive industry,” Thomas Faustmann, managing director of Audi Hungaria, a flagship German investor in the Magyar auto industry, told autopro. hu, a industry-specialist website. Faustmann, whose plant in western Hungary produced more than 135,000 cars and almost 2mn engines last year, continued: “Just think about it… every day we receive nearly 30,000 parts from 1,500 suppliers. How is it possible to administer all these item by item in the new system? We just don't have the capacity for this”. Audi Hungaria would have to recruit 20 more staff for each of three shifts simply to administer “this pointless task”, he explained, adding: “I fully support the fight against VAT crooks. But not at such a price.” Audi Hungaria declined to comment further to bne IntelliNews, only confirming that the autopro.hu story was accurate. Other industry professionals and associations support the German car maker's lament. “This is terribly time and cost consuming. I will have to take on at least 10 more staff, only for this job of typing in administration,” Arpad Vasarhelyi, head of DB Schenker, part of the German-based logistics group, tells bne IntelliNews. Asked how much this would add to costs, Vasarhelyi replied: “It's very hard to say. It's all so very [uncertain], every single day we get new information, other information is no longer valid”. In a press statement, the Hungarian Association of Logistics, Purchasing and Inventory Management (MLBKT), which has 600 members, demanded that the law be rescinded in its present form, calling the new system “chaotic, contradictory" and saying it wouldn't achieve its initial aim. “Ekaer… puts law-abiding and fair producers, traders and freight

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forwarders into a difficult situation. The initial aim was to prevent VAT fraud... the law still leaves lots of loopholes to avoid paying taxes,” the MLBKT said. Second thoughts? Not for the first time, the Hungarian government has been accused of failing to consult with industry professionals when preparing legislation. “Parts of the law are simply unenforceable: companies are often obliged to provide data that are impossible to receive in time from their international partners,” said the MLBKT. And while the initial intention was “good willed,” finding a genuine solution to VAT fraud “must involve thorough professional preparation and collaboration with economic actors,” it said. As a result of the mass outcry, and somewhat belatedly, the government appears to be having second thoughts. Asked to comment on the industry's complaints, a spokesman tells bne IntelliNews that the government had extended what it terms the “trial run” of Ekaer, meaning it will not impose penalties if hauliers are found to have paperwork out of compliance with the new system, until March 1. “In light of remarks and proposals received from market participants and experiences gained during this two-month period, the Ministry for National Economy will evaluate the necessity and possibility of amending the regulation,” the spokesman says. For Hungary's frazzled industry leaders, it offers a glimmer of hope. Yet, as Audi's Faustmann pointed out, the entire affair makes a mockery of the government's supposed long-term intentions of becoming Central Europe's “centre of industrial production”. “For this, you need to create framework of appropriate conditions. This is also in line with our strategic agreement, signed with the government”, Faustmann told autopro.hu, adding, as a warning, that Hungary could easily lose out if the mess continued. “In the neighbouring countries – in Slovakia, the Czech Republic, Romania and Poland – dozens of factories are on the lookout, just waiting for orders,” he said.

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Poland’s politics, banks, investors feel Swiss franc effect

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Jan Cienski in Warsaw

boom, the value of the zloty had peaked at just under PLN2 to the franc.

Poland has taken Hungary's place as the Central European country most exposed to the vagaries of the Swiss franc. Hungary's government pushed through several schemes that have more or less ended the issue of foreign currency loans, but they remain a significant problem in Poland. In all, francdenominated loans account for about 9% of Poland's GDP, making up 14.6% of outstanding loans and 37% of household debt.

Policy-makers immediately scrambled to help minimise the shock of the stronger franc. Polish banks were put under enormous pressure to feed through Switzerland’s negative interest rates to their customers, and to reduce their often rapacious spreads – the fees charged to convert zlotys into francs to make mortgage payments.

he Swiss National Bank's decision to end its franc's peg against the euro in mid-January ricocheted in Poland. It caused nightmares for the 550,000 people with mortgages denominated in Swiss francs, played havoc with the share prices and values of local banks, and is causing growing political problems during an election year.

In Poland, as elsewhere in Central Europe and Austria, Swiss franc loans had been enormously popular before the 2008 economic crisis. By the turn of the millennium, much of the region had established modern banking systems and for the first time banks started offering long-term mortgages. However, interest rates in Polish zlotys, Hungarian forints and Romanian lei were significantly more expensive than those denominated in francs. Austrian banks, which had spread across the CEE region, were already familiar with the product, as it was very popular with Austrians, and enthusiastically lent Swiss francs. But borrowers, banks and regulators all underestimated the risk of borrowing in a foreign currency. The size of that gamble became apparent with the advent of the economic crisis, when the value of CEE currencies plummeted against the Swiss franc, which became a global safe haven. Drowning Poles The latest lurch in the value of the Swiss franc has been particularly painful for Poles. The franc briefly hit PLN4.30, before settling just below PLN4. Before the 2008 crisis, a period which marked the high point of a Polish real estate

As a result, many mortgages are under water, with borrowers owing more than the value of their properties, and the overall size of most loans is significantly larger today than on the day the mortgage was taken, despite eight years of payments.

But there is a growing sense in Poland that a more systemic approach will have to be taken to finally cleanse banking

"I can only say that if I had to choose between the interests of the banks or the interests of those who took such loans, I will stand on the side of the people" balance sheets of the Swiss franc mess. So far only 3.1% of franc loans are in trouble, compared with a 3.6% nonperforming ratio for zloty loans, but there are worries that the franc's strength could worsen those numbers. “The rapid appreciation of the Swiss franc, if sustained, will likely increase the cost of installments for borrowers, negatively affecting their debt-servicing capacity, and likely lead to nonperforming loans for this asset class surpassing the level of

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nonperforming loans of the zloty-denominated mortgages,” said Moody's Investors Service, a rating agency. The issue has become political. The ruling Civic Platform party of Prime Minister Ewa Kopacz is in a tight race with the opposition Law and Justice party ahead of this autumn's parliamentary elections. Most franc borrowers are from the urban middle classes, Civic Platform's natural electorate. While they may not be enticed to shift to Law and Justice – which has been making sympathetic noises about their plight – they may simply not bother to vote, hurting Kopacz. “I can only say that if I had to choose between the interests of the banks or the interests of those who took such loans, I will stand on the side of the people,” Kopacz said in a recent interview, quickly adding however that any solution that helps franc borrowers “should not be done at the cost of the budget”.

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For now, the slight strengthening of the zloty against the franc, plus steps like passing through negative interest rates, are mitigating some of the shock caused by the Swiss central bank’s unexpected decision. Furthermore, the banking sector is solid; stress tests last year showed that a 30% rise in the franc would cause the sector’s Tier 1 capital ratio to fall by only 20 basis points to 13.28%. Demetrios Efstathiou of Standard Bank says that Poland would be hit hard by any further swing in the Swiss franc, but it’s arguably best placed to deal with it. “Poland has a strong economy with 2014 GDP growth rate at 3.3%, and a similar rate expected in 2015, with per capita GDP now over USD14,000. Meanwhile, its banks are well capitalised,” he notes.

Mateusz Szczurek, the finance minister, has been sceptical of any quick move to help franc borrowers, remarking that if mortgages were recalculated into zlotys at the rate they were first taken out, banks could see a one-year PLN20bn (€4.8bn) hit to their bottom lines. Andrzej Jakubiak, head of the Polish Financial Supervision Authority, is suggesting a plan that would convert franc loans into zloty ones at a cost of about PLN1.2bn a year over the next two decades. Banks are cool to any such idea, and the sector is discussing the issue with regulators. Scaring investors The uncertainty surrounding the issue is also worrying investors. Some of the most aggressive franc lenders like Bank Millennium, a subsidiary of Portugal's BCP, and Getin Noble, a Polish bank, have seen their share prices plummet in recent weeks. Shares in Getin, with about a fifth of its outstanding loans denominated in Swiss francs, have fallen by 24% in the last month. The Swiss problem is also affecting the sale value of banks. Several banks, many with a Swiss loan portfolio, are being considered for sale. The latest is Raiffeisen Polbank, the Polish subsidiary of Austria’s Raiffeisen Bank International, which is offloading its Polish operation because the cost of growing its market share is simply too high. Martin Gruell, RBI’s chief financial officer, told a conference call recently that he had no intention of selling the bank on the cheap. “In Poland we expect a price above book value,” he said. But potential buyers are warier, in large part because of the €2.8bn in Swiss franc loans on the books of the Polish subsidiary. Luigi Lovaglio, CEO of Bank Pekao, the country's second largest and a unit of Italy's UniCredit, told reporters that he has no plans of paying above book value. “Currently it is very difficult to buy a bank above book value, not just in Poland,” he noted.

"The Swiss problem is also affecting the sale value of banks"

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Photo: Dusan Milenkovic

Russia in rush to build "Turk Stream" David O'Byrne in Istanbul

f the offer made by Russian President Vladimir Putin last December to re-route his South Stream gas pipeline through Turkey came as a complete surprise to Ankara, then the offer made by Gazprom CEO Alexei Miller on January 27 to deliver the first gas to Turkey by the end of next year appears to have convinced Ankara of Russia's serious intent. Commenting on the offer, Turkish Energy Minister Taner Yildiz suggested discussions over the project would now continue at a more serious level. The venture is not without its risks, though. Developing major international gas pipelines takes years of planning before a single pipe is welded. Promising to lay close on 900 kilometres of pipeline through the inhospitable and surprisingly deep Black Sea in order to deliver

gas within two years implies seriousness verging on desperation. Putin's offer to reroute his pet 63bn cubic metre a year (cm/y) South Stream gas pipeline was made not through any altruistic intent to Turkey, but rather to avoid having to bow to EU rules stipulating that should the line follow the preferred route through Bulgaria, it would have to be open to third-party

because the sole reason for constructing South Stream was to bypass Ukraine, with which Moscow has long running "issues", in order to maintain absolute control over its main gas export route to Southeast Europe. According to a statement by Yildiz, Russia's latest offer involves developing the new "Turk Stream" pipeline, as it has been dubbed. It will consist of four

"Ankara will need to tread carefully if it wants to avoid annoying either Russia or Azerbaijan"

access. This is a condition that Russia is in no mood to comply with, not least

separate lines with annual capacities of 15.75bn cm/y, the first of which

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will be laid via the Black Sea to deliver gas to Turkey's European province of Thrace, through which Turkey currently receives 14bn cm/y of supply from Russia via the Transbalkan pipeline from Ukraine. That gas supplies both Turkey's main residential and industrial conurbation of Istanbul and surrounding cities, as well as the power plants which supply most of north-west of Turkey with power. Leverage The offer makes sense for Russia, despite the huge expense of laying a single offshore line across the Black Sea to supply a single customer, which is unlikely to be able to pay for itself, even before Turkey's long-standing request for a 15% discount on the price it pays Gazprom for the gas it already buys. On the one hand it will be able to make use of pipe and onshore facilities already ordered for the now cancelled South Stream line, while also replacing the gas it already supplies Turkey in Thrace at the point it currently receives it – addressing many of Ankara's concerns about the project. At the same time it would avoid all the time-consuming bureaucracy that would be needed to lay a new line largely overland through Turkey – a process which would involve host government agreement, an inter-governmental agreement, an environmental impact assessment, compulsory excavation of any archaeological sites on the route etc. Turkey already ratified an agreement to allow South Stream to pass through its Exclusive Economic Zone (EEZ) in the Black Sea, which would only have to be modified to allow landfall and a short overland section. It also allows Russia the option of halting or severely reducing gas flows through the existing Transbalkan line, thus cutting supplies to Ukraine as well as most of Southeast Europe without affecting Turkey. It wouldn’t then have to restart supplies to Southeast Europe until it got round to completing the other three planned "Turkish stream" lines – a useful bargaining chip for a regime which appears to have no intention of backing down on either its covert mili-

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Anadolu gobbles up Migros

David O'Byrne in Istanbul Turkish banking officials in February seized control of Bank Asya, an Islamic bank believed controlled by supporters of US-based cleric Fetullah Gulen, on the same day Turkey's foreign ministry confirmed that Gulen's Turkish passport had been cancelled. The future of Bank Asya has been the subject of speculation for more than a year, following the collapse of relations between Gulen's Hizmet movement and Turkish President Recep Tayyip Erdogan’s Justice and Development Party (AKP) government. Turkey's banking regulator, the BDDK, said it had authorised the seizure of 63% of the equity of Asya Katilim Bankasi (Bank Asya) by Turkey's Savings and Deposits Insurance Fund (TMSF), the body that guarantees bank deposits, on the grounds the bank does not have "transparent and clear partnership structures and organisation schemes" allowing effective auditing of the institution. According to disclosures made on February 4 to Istanbul’s stock exchange by Bank Asya, the TMSF has taken over the rights of 120 unnamed shareholders and appointed a new board to administer the bank. After a series of political scandals over the past year that the government accused Hizmet of being behind, a number of public institutions and stateowned companies removed deposits held at the bank, causing deposits to fall by 25% over the first half of last year and leading to trading in Bank Asya shares on Borsa Istanbul being twice suspended during 2014. Shares in the bank are down by as much as 70% over the past year. The TMSF takeover of Bank Asya guarantees deposits held at the bank, as well as any dividends payable to the bank's shareholders. However, it is unclear what the long-term future of the bank will be. Gulen left Turkey for self-imposed exile in the US in 1999. The precise reason for the collapse in relations with the AKP is unclear, but Erdogan has made repeated statements over the past year blaming Gulen’s movement for being behind a series of graft probes against his government, and accusing the movement of forming a "parallel state". The investigations launched in December 2013 resulted in allegations of widespread corruption at the highest levels of government and the resignations of four senior ministers. Subsequently the corruption inquiry was halted, with thousands of police, prosecutors and judges sacked or transferred to other posts. The first anniversary of the launch of the graft probe was marked by a Turkish court issuing an arrest warrant for Gulen, leading to calls for his extradition. A foreign ministry official confirmed to bne Intellinews that a Turkish court had cancelled Gulen's passport on January 22 on the grounds that it had been obtained fraudulently and that news of the cancellation had been transmitted to Gulen and to the US authorities. However, he was unable to confirm whether any application had been made to the US for Gulen's extradition, suggesting that such a move would have to be made by Turkey's justice ministry.

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"The offer makes sense for Russia, despite the huge expense of laying a single offshore line across the Black Sea to supply a single customer"

tary involvement in the insurrection in eastern Ukraine or on its apparent intention to use gas as a "weapon" to get what it wants from the EU.

jarto, who announced in Ankara also on January 27 that Hungary has already launched talks with Turkey, Greece, Macedonia and Serbia over transiting the gas to central European markets.

When and how those other three lines with their total 47.25bn cm/y capacity will be built is unclear, although it seems safe to assume that unlike the first line, the other three will be constructed more exclusively over land, cutting costs and increasing development time, which again could prove to be a useful bargaining tool.

Turkish officials later denied that they had opened any such talks, mindful perhaps of the possible effects on its own existing plans to transit Azeri and possibly Turkmen gas through the planned 31bn cm/y TANAP pipeline, which is also planning to supply Central European markets, albeit via Italy.

Interest in the gas that these lines will supply has already been expressed by Hungarian Foreign Minister Peter Szij-

Whatever decision it opts to take over Putin's "South Stream" offer, Ankara will need to tread very carefully if it

wants to avoid annoying either Russia, its main gas supplier; or Azerbaijan, the single biggest source of foreign investment in Turkey and soon to become its second biggest gas supplier. It remains to be seen just how much Ankara takes into account its difficult relations with Russia over other issues, namely Russia's treatment of its own Muslim minority populations such as the Chechens, and its role in arming and supporting the Assad regime in Syria, which Turkey has vowed to help overthrow. Not to mention its actions in Ukraine, a country which has for decades been Russia's main conduit for gas exports to Europe and which now faces the twin prospects of losing large swathes of territory and its gas supplies.

Image: gazprom.com

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mies, and incomplete implementation of structural reforms,” the report says. “On the positive side, certain factors could lead to a stronger-than-expected boost to global and EU growth stemming from low energy prices.”

Divergent economic paths Clare Nuttall in Bucharest

conomic growth rates in Southeast Europe will vary dramatically in 2015, with Turkey expected to achieve the continent’s fastest growth at 3.7%. At the other end of the scale, Serbia, whose economy was hit by flooding in 2014, will contract by 0.3%, while at just 0.2%, Croatia’s growth forecast is the lowest in the EU. The European Commission’s winter forecast, published on February 5, reveals that for the first time since 2007, all EU member states will show positive growth. Contributing factors include falling oil prices, the European Central Bank’s (ECB) quantitative easing decision, and a new Investment Plan for Europe, according to the Commission. "Europe's economic outlook is a little brighter today than when we presented our last forecasts,” said Pierre Moscovici, European Commissioner for Economic and Financial Affairs, Taxation and Customs, in a statement. “The fall in oil prices and the cheaper euro are providing a welcome shot in the arm for the EU economy. Meanwhile, the Investment Plan for Europe and the ECB’s important recent decisions will help create a more supportive backdrop for reforms and smart fiscal policies.”

However, their impact across the 28-country bloc will vary, with both Bulgaria and Croatia expected to have minimal growth this year, and a modest increase to just 1% in 2016. The Commission’s report acknowledges that, “the divergence in economic performance across the EU is likely to continue". Deleveraging rates differ strongly across the EU, while the impact of falling oil prices on European economies will depend on the country’s energy mix. Oil producers such as Albania and Romania will not benefit to the extent of those countries that rely wholly on imports. Alongside this divergence, the Commission’s report also identifies an increase in uncertainty over the economic outlook. “This is due to geopolitical tensions, renewed financial market

Out of recession Rising exports are the sole reason behind Croatia’s expected emergence from its six-year recession this year, while other factors will continue to drag on the economy. Domestic demand growth will remain negative as investments continue to contract. Uncertainty over whether Croatia’s numerous Swiss franc debtors will be able to continue to service their loans, together with the weak labour market, will result in flat private consumption. Bulgaria managed to weather a year of political uncertainty to achieve 1.4% growth in 2014, but this is expected to dip to just 0.8% this year. Confidence in the banking sector was eroded by the run on Corporate Commercial Bank in mid-2014, and the future of the bank, which was taken under central bank administration, is still uncertain. Private sector consumption is also expected to take a hit from fiscal tightening and the expected weak growth in real disposable income. Meanwhile the recovery in investment seen since mid-2013 is coming to an end, and public sector investment is expected to decline in 2015, while private companies are also expected to either freeze or postpone investment plans. By contrast, both public and private sector investment are expected to rally in neighbouring Romania after falling in 2014. Along with higher private consumption, this will contribute to Roma-

"Europe's economic outlook is a little brighter today than when we presented our last forecasts" volatility in a context of diverging monetary-policy across major econo-

nia’s “above potential” growth of 2.7% in 2015, rising to 2.9% in 2016 – though

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A new guv’nor in Albania

bne IntelliNews The Albanian parliament voted overwhelmingly on February 5 to appoint career banker Gent Sejko as the new governor of the Bank of Albania (BoA). Sejko will replace Ardian Fullani, who was sacked in 2014 after a decade at the helm when thefts of around ¤5mn from the central bank were uncovered. 105 MPs voted in favour of Sejko’s appointment at a session late on February 5, with just three dissenting votes and four abstentions, in a rare show of unity in the parliament. One of Sejko’s main tasks will be to restore confidence in the BoA, after an internal audit revealed ALL715m (¤5mn) in cash had been stolen from the bank’s vaults. Speaking to BoA staff on February 6, Sejko promised that, “the Bank of Albania will be an institution meriting the trust and respect of the public". The scandal broke in July 2014 when seven BoA employees were arrested. One economist confessed to police that he had smuggled banknotes out of the building inside his clothes or old books. Ardian Bitraj told police he used the money to gamble, stealing notes daily during the 2014 World Cup. Fullani was taken into police custody on September 5. Two weeks later, the parliament voted to dismiss him from his post for alleged abuse of office, though he has not been accused of direct involvement in the thefts. He is now among 19 former central bank officials awaiting trial. A statement from Albanian prosecutors said that Fullani, together with the bank’s inspector general Elivar Golemi, “because of their inactions, have created conditions to violate the security of money in the administration of the Bank of Albania". The revelations about the lack of supervision at the bank also raised concerns about how effectively it carried out its role of supervising the Albanian banking sector. The theft scandal threw the spotlight onto the high level of corruption in Albania, which is one of the most corrupt countries in Europe. Transparency International’s “2014 Corruption Perceptions Index” puts Albania tied with Kosovo, in 110th place out of 175 countries, the lowest rank of any European country except Belarus, Russia and Ukraine. While Albania was accepted as an EU candidate country in 2014, EU foreign ministers told Tirana that progress on fighting corruption and organised crime must be made if the country is to progress towards EU accession.

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Photo: Boby Dimitrov this represents a modest slowdown compared to 2013 and 2014. Romania is unusual among EU countries in this respect, since across the bloc, “sputtering investment has so far prevented a broader and more robust acceleration of domestic demand", according to the report.

Slovenia’s strong 2014 performance was driven by EU-funded investment together with rising exports. However, this year, higher private sector investment is expected to only partially compensate for a deceleration in investments co-funded by the EU, resulting in a modest fall a slight slowdown 1.8% growth this year, before rebounding to 2.3% in 2016. Slovenia’s fiscal deficit has also dropped substantially from 14.6% of GDP in 2013 to just 5.4%, and the Commission expects that decline to continue given that the risks of “additional bank related one-off costs affecting the 2015 deficit appear to have been mitigated”. By 2016, the deficit is expected to drop further to just 2.8% of GDP. With the exception of Serbia, growth in Southeast Europe’s EU candidate countries is set to outstrip most existing member states. In Turkey, the region’s fastest growing economy, private domestic demand and falling energy prices are expected to be the main factor behind the forecast 3.7% and 4.0% growth in 2015 and 2016 respectively. A rise in consumers' purchasing power will offset the decline in output growth caused by falling exports to Russia, Ukraine and the Middle East, and the appreciation of the lira. Strong growth is also expected this year in Macedonia (3.5%), Albania and Montenegro (both 3.0%), Public infrastructure projects will be the driving force for growth in both Macedonia and Montenegro, though in Montenegro in particular this has raised concerns about fiscal risk connected to a hike in the government’s infrastructure spending.

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January 1 has proved to be unrealistic. “When it comes to household customers, there is a formal opening of the markets in most contracting parties, but not a real opening,” says the Energy Community's secretariat deputy director, Dirk Buschle. While customers formally have the right to choose their supplier, and suppliers the right to supply any customer, “when we look at how many customers are actually supplied by alternative suppliers, things look different”.

More power to the people Clare Nuttall in Bucharest

ost would-be EU member states from Southeast Europe met the January 2015 deadline for a full opening up of their electricity markets, though in reality few households yet have the ability to select their supplier. While only Macedonia backed away from its commitments, adopting a new law that will delay liberalisation until 2020, governments across the region have shied away from full market opening amid fears of the political impact of rising prices. In October, the Macedonian parliament approved amendments to the energy law that will postpone full liberalisation of the electricity market for five years, until July 1, 2020. The decision was clearly politically motivated. When Economy Minister Bekim Neziri announced the plans on October 9, he cited research indicating that liberalisation would result in price hikes of up to 20% for consumers. The price of electricity “has a social note”, he added, according to the Macedonian daily Dnevnik. “To us it is important to protect citizens from possible price shocks.”

Skopje pushed ahead with amending the law, despite strong opposition from the Energy Community – an international organisation established between the EU and several third countries to extend the EU internal energy market to Southeast Europe. As well as being “a very clear breach of the Energy Community Treaty” that aims to bring prospective EU members into line with EU energy policy, the law would also leave consumers “stuck with the incumbent utility EVN”, the secretariat’s director, Janez Kopač, warned. Infringement procedures were launched against Macedonia on January 30. Virtual liberalisation While Macedonia is an extreme example, an immediate and full opening of local electricity markets enabling all households to choose their supplier from

Even in Serbia, considered the frontrunner in energy sector reforms within the region, state power company EPS has retained its dominant position. EPS director Aleksandar Obradovic said in a December interview with Serbia’s state news agency Tanjug that he did not expect EPS to lose household customers, since the price set by EPS is 30% below the market price in the region. This has already proved to be the case with corporate customers. Among large and medium-sized power consumers, who saw their markets opened in 2012 and 2013 respectively, some 97% were still EPS customers as of late 2014. While the electricity market was fully opened for households from January 1, smaller consumers will keep their right to supplies from EPS at prices set by the Serbian Energy Agency (AERS), and consumers deemed to be “underpriviledged” will receive a free monthly electricity allowance, Tanjug reported. Fear of price hikes in a deregulated market is unsurprisingly a concern for governments. Rising electricity prices recently sparked demonstrations in both Albania and Kosovo. Buschle believes that without taking the risk of full liberalisation, neither governments nor consumers will get to see the benefits of a competitive energy market. In addition, most subsidies are applied to all

"When it comes to household customers, there is a formal opening of the markets in most contracting parties, but not a real opening"

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households rather than focusing on vulnerable customers. “We have a vicious circle, a situation where prices are being regulated pretty much across the board for household customers, so there is no incentive to change supplier or for new customers to come into the market,” he says. “As a result, we fear that the state will not give the markets the freedom to develop, and they will never find out what happens when prices are determined by the market.” Private sector companies are deterred from entering markets where they cannot compete on equal terms with the incumbents, but according to Buschle the incumbents also suffer. The situation, “puts a lot of strain on national electricity companies who have to supply customers at prices which do not cover their longterm costs, thereby draining money that under normal circumstances would be available for investment,” he says. Positives and negatives A spokesperson for Norway-based Statkraft, Europe’s largest producer of renewable energy and a pioneer in entering the Albanian market, told bne IntelliNews that the “positive attitude from the authorities in order to develop and deregulate the electricity market” was a

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deciding factor alongside the country’s “untapped hydropower resources, economic growth and increasing demand”. Despite the decision of its partner, Austria’s EVN, to drop out, Statkraft started construction work on the ¤535mn Devoll hydropower project in 2013. “In the case of Albania there has been, and still is, a strong interest from private sector investors to participate in the

in Albania which are necessary steps to move in the direction of gradual liberalisation of the market,” Sayed says. In particular, Tirana has launched a campaign to tackle the chronic problem of electricity theft, setting prison sentences of up to three years for those found guilty of stealing power. Theft and arrears by state companies were among the reasons for the failure of Czech utility CEZ’s 2009

"We fear that the state will not give the markets the freedom to develop"

domestic and regional market,” says Tahseen Sayed, country manager for the World Bank office in Albania. “This should bring benefits to consumers and the economy while enhancing security of supply.” However, Sayed notes that a competitive power market needs customers to pay their bills, power utilities to provide quality of service and be accountable to consumers, and a well functioning independent and competent regulatory authority. “These are all steps being taken

investment in Albania. Demonstrating how seriously the government is now taking the issue, in December Deputy Environment Minister Diana Bejko was sacked for allegedly failing to pay electricity bills for her summer house. At around 42%, technical and commercial losses in Albania are among the highest in the region, according to the World Bank, which also has the effect of pushing up prices for paying customers. Given the high poverty levels in Albania, “It is important that all consumers face the same reasonable tariff for energy and that government maintains a wellfunctioning safety net to ensure that poor families have access to a minimum amount of power as well,” Sayed tells bne IntelliNews. High poverty levels across the region are at the root of why a full opening up of Southeast Europe’s energy markets for households is a gradual process. Buschle points out that not only would-be EU members, but also many long-standing member states also use their regulatory powers to keep down power prices for households. The difference in Southeast Europe is that incomes are considerably lower than in Western Europe, and electricity bills make up a higher proportion of total income, increasing the incentive for governments to ease the financial burden on households.

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out into manufacturing numerous types of waste. Using technologies developed in Asia, the company started recycling plastic bottles into synthetic fibre for the automotive industry. And since 2009, it has set up plants to treat electrical and electronic waste, and recycle light bulbs and glass. “We strongly believe in the concept of the circular economy. Maximising utilisation of the resources around us can create another stage of development for industries currently in crisis,” Damov tells bne IntelliNews. “We have created 2,000 jobs by turning lazy resources that nobody wanted into a new industry.”

Wasted chances in Romania’s recycling sector Clare Nuttall in Bucharest

ecycling levels in Romania are among the lowest in the EU, held back by a lack of economic incentives and education. Green Group has overcome considerable obstacles to introduce new recycling technologies to Romania, becoming a market leader that is now poised to expand at home and internationally. Back in 2002, when Green Tech, the first company within Green Group, was launched, its co-founders – Constantin Damov, the head of the Romanian Recycling Association, and Taiwanese investor Clement Hung – were faced with a market that barely existed. Packaging use was growing sharply at the time, but there was virtually no collection of recyclable materials. Difficulties in sourcing materials for the company’s PET processing plant in Buzau, southwest Romania, meant that collection and transportation costs exceeded the value of the finished

products, resulting in heavy losses in the first two years of operation. Fortunately, concerns about the explosion of plastic littering encouraged the Ministry of the Environment and Climate Change to step in with incentives

Today, Green Group has a substantial share of the Romanian market. In 2014, the group handled around 50,000 tonnes of PET and 10,000 tonnes of glass. However, while its business has grown, Romania’s recycling industry has not developed at a similar pace. European Environment Agency data show that Romania along with Bulgaria had the lowest level of household waste recycling in the EU; Romania recycled just 1% of municipal waste as of 2010. Intelligent waste Despite the emergence of numerous small-scale collection and sorting businesses, low collection rates remain one of the biggest obstacles. Bucharest and other major cities boast recycling bins on many street corners, but a closer look shows that they are used to deposit all types of household rubbish indiscriminately. Formal collection rates are further reduced by the large number of homeless scavengers who rifle through the bins in

"We believe SIGUREC is a 21st century solution to replace the 20th century solution of bins in the street" for waste collection. Although they only lasted for three years, it was enough to get fledgling collection and sorting businesses off the ground, and to create a sector strong enough to continue functioning without government subsidies. Since then, Green Group has branched

search of anything they can sell, including plastic bottles and other recyclables. While working with a large number of small collectors, Green Group recently launched its own intelligent waste disposal stations, SIGUREC. The electronic depositories allow users to choose by

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touch screen how to be compensated for their deposits, issuing hypermarket discount vouchers or donating funds to charity. “We believe SIGUREC is a 21st century solution to replace the 20th century solution of bins in the street. Like the recycling bins, our system is based on education, but it also places a commercial value on the waste generated by households, and rewards citizens for using it,” says Damov. “There are no subsidies – it’s a self-sustaining system based on the commercial rules of the market.” By cutting out the middlemen, it also speeds up the process – a bottle deposited in a SIGUREC station can be recycled within 24 hours. The system has proved to be popular. 25 stations have already been installed, and Green Group expects to have more than 70 in action by the end of this year, increasing to 200 across the country before long. Landfill full However, Romania’s recycling sector also suffers from a lack of government action on landfill taxes, which are currently set at between €10 and €15 per tonne. As a result, for businesses looking to minimise costs landfill is a better

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option than sending waste for recycling. Damov blames political populism for the lack of progress, saying the debate over recycling is “very superficial”. “Unfortunately it’s like debating football – everybody can understand it, everybody has an opinion, but at the end it depends what the players are doing in the field,” he says.

Currently, Green Group is present in Germany as a buyer, but the group is considering an investment in Germany and possibly the UK as well to set up its own synthetic fibre production. “We would like to process this material, which is going on a 14,000km round trip to China, in Europe,” Damov tells bne IntelliNews.

Lack of raw materials has forced Green Group to look outside Romania for supplies, setting up collection and processing operations in nearby countries such

“Not many west European companies produce fibre from plastic waste; most have bottle-to-bottle systems. They also have high costs for collection, sorting

"Romania can play the role of Europe’s China" as Macedonia and Serbia where the sector is at a similarly early stage. It also imports from Western European countries like the UK and Germany where domestic recyclers cannot keep up with the high collection rates. Surplus PET waste from the two countries is now shipped to China for recycling and the synthetic fibres are re-imported – 90% of the synthetic fibre used in Europe’s automotive industry is imported from Asia.

and recycling because these are labour intensive. However, technologies are advancing and we don’t see why this transformation can’t be done locally in Europe. Romania can play the role of Europe’s China,” he says. Green Group may also make the transition to investing in local recycling plants in other Balkan countries, if this proves to be economically viable. Currently, it carries out collection, grinding and washing, but when enough raw materials are collected locally, it may invest into recycling plants. Back in Romania, Damov is confident about the future potential of the market. At just over half the EU average, packaging waste in Romania is steadily rising. Collection rates are also expected to increase. Just catching up with the rest of Europe would require a sixfold expansion of the sector. In addition to rolling out new SIGUREC stations, Damov wants Green Group to double its recycling capacity in Romania, including by building a new plant in Transylvania, which would give it a presence in the northwest of the country. The group also plans to branch out by recycling waste from construction and demolition, and wood waste, as well as setting up a waste-to-energy plant.

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Ethnic clashes dent Kazakhstan's utopian image Naubet Bisenov in Yntymak, South Kazakhstan Region

murder does not usually merit much attention in Kazakhstan, but when an ethnic Tajik killed an ethnic Kazakh during a row over money in the country's denselypopulated, ethnically-mixed south in February, the crime made headlines due to the resulting inter-communal riot – an occurrence which so far has been extremely rare in post-independence Kazakhstan. As ethnic Tajik property was attacked and set on fire on the night of February 5, the Kazakh authorities scrambled to control the situation, deploying heavily armed security personnel and cutting off mobile and internet communications in the area. Embarrassingly, all this took place on a day that President Nursultan Nazarbayev had celebrated "the unity of our people and accord in our multiethnic society".

The incident took place in the village of Yntymak (which ironically translates from Kazakh as "unity" or "solidarity"), when protests by a group of ethnic Kazakh men culminated in an angry raid on Tajik neighbourhoods. Although no physical harm was inflicted on any ethnic Tajiks – who hastily organised self-defence groups – the rioters broke windows and burnt several cars and lorries, as well as a number of houses belonging to Tajiks. Although some Kazakh houses were hit in reprisals, the material damage in the village seemed to be selective. Some local Kazakhs said the violence was intended as a warning to Tajiks and other minorities. "People's anger has been building up for years and this murder was just a pretext to warn Tajiks that they have become too audacious," a local Kazakh who gave his name as

Ospan told bne IntelliNews. "This will also serve as a lesson to other ethnic groups to behave." Such talk belies President Nazarbayev's cultivated message of ethnic harmony. Since independence in 1991, the Kazakh president has portrayed the country as an island of political, economic and inter-ethnic stability in a sea of intercommunal strife elsewhere in the former Soviet Union. The relative stability of Kazakhstan, a home to some 120 ethnic groups, was achieved largely thanks to an oil-fuelled economic boom in the decade to 2008. "Kazakhstan is one land, one people, one future," Nazarbayev declared on February 6, citing a popular slogan trumpeting unity. Nazarbayev was speaking at a session of the Assembly of Kazakhstan's People, a pro-government body of ethnic groups

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set up 20 years ago, designating this year as the “Year of the Assembly of Kazakhstan's People”. "Our Kazakh path is a path of peace, accord and development," he said ingratiatingly.

Asian Development Bank ups game in Eurasia

Yet many ordinary Kazakhs are growing increasingly sceptical of the government's assertion that the many ethnic groups in Kazakh society live together in a tatu-tatti manner (which translates from Kazakh approximately as "lovey-dovey"). If this is true, people mutter, why do inter-ethnic conflicts occasionally erupt in different parts of the country?

Ben Aris in Baku

Troublemakers Ethnic Tajiks, who number 9,000 in Saryagash District's 310,000-strong population, told bne IntelliNews that they did not see the raid coming following the personal dispute over money for leasing greenhouses. They expressed anger at being singled out for collective punishment for the crime of one man, who is now under arrest. Some speculated that the raid was carried out by outsiders, by Kazakhs not from the area – a view indicative of the lack of reliable information that surrounds such events, due to the government’s kneejerk clampdown on the press and social media, which inevitably gives rise to wild rumours and assumptions. Ethnic Tajik villagers spoke on condition of anonymity, fearing reprisals from the local authorities, who imposed a blockade on the village in all but name. Tajiks said the raid was a deliberate and planned provocation. In support of their suspicions, they said mobile networks had gone down a few hours before the violence started – a claim bne IntelliNews could not independently confirm. Four days after the night-time incident, Yntymak still remained cut off from the internet, while mobile telephones supported only limited 2G services. By shutting down the internet and 3G services in the entire South Kazakh Region, the authorities hoped to prevent videos of the riot from leaking onto YouTube and other video-sharing websites, and stop trouble spreading to other parts of the country. According to

If you hear the name Asian Development Bank (ADB), the first thing you are likely to think of is China. But after a decade of transformation the Middle Kingdom is doing well on its own, so the development bank has spread its wings across Eurasia. The ADB has 64 members from both the developing and developed worlds that provide the funds to encourage development. "The focus was initially on Asia and the Pacific Rim when we opened our doors in 1994, but we have expanded since," says Betty Wilkinson, Director of the Public Management, Financial Sector and Trade Division for Central and West Asia at the ADB. China remains the most important country in the patch, but the ADB limits its lending there to $1.5bn from a total of about $11bn a year of lending – and even then these investments are very targeted at things like renewable energy. "It’s amazing how fast and aggressively China dealt with the issue of poverty. We have a saying at the ADB: if you have a good idea and the Chinese like it, then you better put your running shoes on as you are going to be running to keep up," says Wilkinson. The ADB does two types of lending: ordinary capital instruments, which are offered to countries that are already well on the road to recovery, and assisted instruments for poorer countries that are still struggling. "The Chinese take loans for things like renewable energy projects, but the other [poorer] countries borrow to build things like infrastructure. We do a lot of transport, especially roads, and energy projects," says Wilkinson. The bank has a wide brief and also supports some urban development, water and sanitation, financial sector and education projects. The ADB has been working for a long time in Central Asia with a lot of Kazakh projects under its belt, but more recently it has become more active in the other countries in Central Asia and the Caucasus, traditionally the stomping ground of Western development banks like the World Bank and European Bank for Reconstruction and Development (EBRD). To highlight its increased interest, the ADB will hold its annual general meeting this year in the Azerbaijani capital of Baku in May, a few weeks after the EBRD’s annual shindig in the next-door Georgian capital of Tbilisi. "We overlap with the other development banks, but according to our estimates the infrastructure spending needs through to 2020 runs into the trillions of dollars so there is plenty of work to go round," says Wilkinson, who gave a talk on online innovations that banks can use during the “Azerbaijan Banking and Finance Forum” that was organised by Adam Smith Conferences in Baku in February. And the help is welcome. The whole region is feeling the aftershocks of the collapse of the Russian ruble in December and those countries without natural resources to fall back on are in serious trouble, notes Wilkinson.

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a statement handed to bne IntelliNews on February 9 at the police headquarters set up to investigate the murder, the situation in the area "has been fully stabilised" and "all services are operating in a routine mode". The police refused to admit the conflict was inter-ethnic, maintaining it was "domestic". Zaure Khamzayeva, head of the Saryagash District internal policy department, also denied to bne IntelliNews that the conflict was interethnic and said it was a "domestic conflict between two former friends". Asked why there were so many heavily armed security officers if the conflict was purely domestic, Khamzayeva replied: "In order to maintain accord between people." The local authorities in South Kazakhstan Region, the country's most populous

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It is not yet clear where and when he will be tried, but one police officer told bne IntelliNews on condition of anonymity that the trial would likely be soon, in order to show that justice can be delivered. This would go some way to appeasing locals who complain that corrupt police, prosecutors and courts often allow rich offenders to evade justice. Greenhouse effect There is some evidence this latest ethnic flare-up is the result of social problems and the growing rich-poor divide in the region. "You won't find a Tajik who doesn't drive a good car," lamented one Kazakh man who declined to give his name. South Kazakhstan Region had the highest share of the population living below the poverty line at 6.9% versus the nationwide level of 2.9% in the third

"Our car was burnt down and our house was damaged. Will we be compensated for that?" region with the highest share of a minority population apart from ethnic Russians – ethnic Uzbeks constitute nearly 17% of its total population – play down the ethnic factor in the conflict, fearing it will cast doubt on the government's claim that Kazakhstan is a land of inter-ethnic harmony. Yet this is not the first time that the region has been shaken by a dispute involving minorities. In 2007, a Kazakh mob attacked ethnic Kurdish families over suspected sexual abuse against a four-year-old Kazakh boy by a 16-year-old Kurdish adolescent. In order to ensure the security of the Kurdish families whose houses were burnt down, the authorities had to relocate them to a safer place. With the aim of pacifying angry Kazakhs in this latest event, the authorities announced the detention of the suspected killer and his extradition from Uzbekistan, where he had fled after the murder (Saryagash District borders Uzbekistan) within three days.

quarter of 2014, which grew to 8.9% in rural areas (4.6% nationwide). Yet ethnic Tajiks appear relatively well-off, as evidenced by the bigger houses in their neighbourhoods. Tajiks themselves explain their relative wealth by hard work as crop farmers. Weather conditions allow locals to grow tomatoes in a myriad of greenhouses dotted around the Saryagash District – one of which became the catalyst for the conflict, sparked by the Tajik lessee's debt to the Kazakh lessor. Tajik farmers complained that they can't now reach their plots because of the police presence, and as well as now fearing for their security they have to find money to repair their trashed houses. A middle-aged Tajik woman told bne IntelliNews that her plans for tomato greenhouses had been crushed by the attack: a mob tried to set her house ablaze and burnt a new car she had recently bought with two years' worth

of savings. While her holding is not big – only 1,200 square metres – it generated enough revenue for her family of three children and four grandchildren to live off. She said she had hoped to make around $8,000 this year by growing tomatoes like in previous years, but the loss of the car and uncertainty over her family's personal safety would make it difficult to grow a good harvest. "Our car was burnt down and our house was damaged. Will we be compensated for that?" she asked rhetorically. Not just farmers but other businesses are also suffering from the aftermath of the riot. Since the authorities blocked communications networks in the district, people have complained about temporary problems with buying car insurance or dealing with their pension accounts, as insurance and pension agents could not access online databases. Even the local Tajik-language school, whose glass entrance was broken by a stone thrown by the attackers, was temporarily shut for security reasons. Not so lovey-dovey In the aftermath of any riot, the big question is what impact this will have on community relations elsewhere in the country – something this Kazakh government is fixated on to the point of obsession. President Nazarbayev styles himself as the guarantor of the constitution and stability in society, and this latest inter-ethnic conflict will be hugely concerning for the elites in Astana, not least because it could hurt the country's image abroad. That image was already tested by the violent suppression of striking oil workers in Kazakhstan's western Mangystau Province in December 2011, which left at least 14 protestors dead in the oil town of Zhanaozen. Such ethnic clashes raise questions about how stable inter-ethnic relations really are in Kazakhstan. Given it is hard for the authorities to admit the presence of ethnic tensions as it would imply a failure of Nazarbayev’s policy, the true picture cannot be discerned or discussed in an open and transparent way until it is too late and the situation boils over.

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Eurasia

The ‘burbs come to Mongolia Terrence Edwards in Ulaanbaatar

here is no hint when standing in the desolate Yarmag district in Ulaanbaatar that you are near the centre of one of the world's fastest growing economies. But what today is just a mostly empty valley, for developers will be the next magnet for Mongolia's rising middle class – unless a property crash happens. The growth of Mongolia's capital city has been fuelled by the floods of money from the export of the country's vast mineral resources to China and elsewhere. But troubles in Mongolia’s mining sector and slowing growth in its southern neighbour have put the brakes on its own economic expansion. Ulaanbaatar, which translates as “Red Hero”, was built by the Soviet government in the 1950s in the Tuul river valley. The central business district is where companies such as the global mining conglomerate Rio Tinto are locally headquartered, within walking distance of the country's parliament and some ministries. Companies such as Asia Pacific Investment Partners (APIP) are continuing to build in Ulaanbaatar despite the economic slowdown since 2011 (though growth should still have been around 7% last year), even in such far-flung areas as Yarmag. Although this suburban area is decades away from catching up with the more developed city centre, the difference is less stark when compared to the city centre of 13 years ago. That was when APIP CEO Lee Cashell first began renting out apartments to project workers in the early noughties. “The city was a big village,” he says. “You could still see horses down streets. It was a good time to get to know the area and explore the city created by the Soviets.”

Cashell's company has since grown from a small rentals operation utilising three Soviet-style apartments purchased at $10,000 each, into a large-scale property developer for luxury homes, with subsidiaries for property management and producing construction materials. Head for the hills The wide open spaces in Yarmag strongly contrast with the city centre, where developments are practically piling up on top of one another. APIP's Village @Nukht was built in Yarmag with eight penthouse units as well as shopping and office space, with the expectation that the area would develop into a new urban centre. Other more affordable options are appearing too, along with schools and shopping centres. It's also where Ulaanbaatar's city administration has long-term plans to relocate its offices. “We've been watching Yarmag for a number of years, and the real estate agency has done transactions at

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coal and sometimes even harmful substances such as plastics from their trash to stay warm. The smoke emitted from neighbourhoods where these homes are clustered are causing birth defects and lung disease, health experts say. Although Ulaanbaatar has partnered with local groups and the World Bank to try to combat the “airpocalypse”, there’s been little progress. The government's long-term strategy is to get those living in gers into apartments and houses hooked up to the city's central heating grid – an admirable strategy but one that will take years. Not built to last In the rush to meet the growing demand for housing in Ulaanbaatar, many of the new apartment buildings and houses were thrown up and are notorious for their poor quality. Many new homeowners are unhappy with what they've bought. Some complain they were cheated, as the shoddily built homes quickly need expensive repairs or renovation. Many construction workers also lack the skills in modern building techniques to provide decent standards of construction. “I think there's a big lack of trust in construction,” says Gabrielle Francesch, director of business

“I think Ulaanbaatar will grow faster than Kazakhstan, and luxury in Kazakhstan is still double the price of what's in Ulaanbaatar" Nukht Valley where the wealthy are living and currently building,” says Cashell. Yarmag also provides escape from Ulaanbaatar's choking air pollution. The World Bank considers the Mongolian capital one of the most polluted cities in the world. During winter, when temperatures can dip below -30°Celsius at night, the Red Hero transforms into the Smoky Hero, or Utaabaatar. Residents living in the traditional whitefelt tents known as gers burn low-grade

development for Ulaanbaatar-based construction and design firm Global Ideas. “People distrust anyone in construction because there's so much bad work being done, and its not very professional still.” Francesch, who is also a managing partner, says his firm has fared well in the last few years, despite the economic slowdown, by relying on skilled foreign architects to deal with the unique challenges found in the world's coldest capital city. For instance, while some

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spaces can get relentlessly hot from the radiators connected to the city's central grid, other new buildings need to produce their own heat and manage sewage for themselves. “We look for expertise in detail and technical solutions,” says Francesch. “Not for the foundations, but more for insulation, heating ventilation, detailed drawings and other complicated things people in Mongolia can't do at the same level.” Whether or not prices can be sustained at the current levels is also becoming a concern. The fear is that rampant speculation and oversupply will lead to a property market crash. Mongolia no longer has the mining boom that was attracting foreign investors in droves up to 2011, when the economy grew an astonishing 17.5%. Although the government hasn't released last year's growth figures, most analysts don’t expect anything much above 7%. Mongolia's unresolved disagreements with foreign mining companies caused foreign investment to slump 74% last year. Cashell says his properties locally range between $2,300 and $2,900 per square metre. But as many of the high-end homes remain empty in another growing district called Zaisan, fears are growing that prices are set to fall. Cashell, though, says he isn't worried, since prices are still well below those of other growing cities in Southeast Asia as well as Almaty, the capital of neighbouring Kazakhstan. The oil-based economy in 2008 suffered a real estate crisis as the global credit crunch took hold, sending property values down 40%. “I think Ulaanbaatar will grow faster than Kazakhstan, and luxury in Kazakhstan is still double the price of what's in Ulaanbaatar,” says Cashell. Despite these concerns, developers do not appear to have slowed the pace of building, banking on the idea that economic growth will soon pick up again. Mongolia's new prime minister has made getting the country's largest mining projects going again a priority. Meanwhile, a new international airport near to Ulaanbaatar is bringing in fresh investment, and many are hoping that work will finally begin on long-awaited power plants.

bne March 2015

Mongolian government's Got (No) Talent

Terrence Edwards in Ulaanbaatar Simon Cowell and Mongolia both cheered when a deal was made last year to bring the “Got Talent” TV show to the formerly remote Soviet satellite. But Mongolian voters were less than enthused when Mongolia's new prime minister, Chimed Saikhanbileg, took a page from Cowell's book by asking citizens to take to their phones to vote how they think he should run the country. Only 10.3% of the 3.3mn mobile phone subscribers bothered to respond. The poor turnout may be a sign of cynicism among voters who have turned out in high numbers for official elections – even though those figures too are steadily declining. Some 74% of voters went to the polls for the 2008 parliamentary elections and 65% in 2012, compared with 98% for the first democratic election in 1990. Those that did bother to vote in the referendum chose the less painful option of reinvigorating the mining sector over more budget cuts. Mongolia is attempting to recover from an 85% collapse in foreign investment between 2013 and 2014. Referendum participants who responded by texting “1”, voted for the government to work with private partners to get the country's largest mining projects growing again. That includes launching work on a $5.4bn expansion project for the Oyu Tolgoi copper mine. The second option rejected that path, instead calling for budget cuts and savings. The low turnout, however, made the vote virtually irrelevant. “I don't think [the PM] actually conducted this survey to really get public opinion,” said Gan-Erdene Tsendmaa, a 26-year-old office manager. “He just needed support for doing something confidently, but lots of people are really sceptical about what he's doing and how he'll improve the economy.” The economic downturn that prompted the referendum is largely an effect of troubles in the mining sector, which fuelled the 17.5% economic growth recorded in 2011 compared with expectations for around 7% this year. Although Mongolia has repealed laws that had deterred foreign investment, a dispute with global mining giant Rio Tinto over developing the Oyu Tolgoi mine drags on and is souring the investment climate. Oyu Tolgoi missed a fourth deadline in two years on December 31 for a $4bn project financing package to fund the construction of an underground mining network that is needed to extract most of the resources there. The project financing required will be one of the largest in the world, but any lenders need to see some resolution to the dispute with the government before they will open their wallets. Erdene Lkhagva, one of the producers that is bringing “Got Talent” to Mongolian TV, said they were still trying to figure out how they will implement their own voting system to prevent tampering. He, too, wondered about the veracity of the government poll. “We haven't figured it out yet on ‘Got Talent’, but I am very sceptical on the SMS poll,” he said. “This kind of impromptu involuntary poll sampling will only get the responses from the crazies and most radical.”

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Minsk Group – to cut through the Gordian knot. On January 27, the Minsk Group released an unusually strongly-worded statement “deploring the upsurge in acts of violence resulting in loss of lives, and [calling] on the sides to demonstrate responsibility and avoid steps that would lead to further escalation”. In 2014 the two presidents, Azerbaijan’s Ilham Aliyev and Armenia’s Serzh Sarkisyan, resumed face-to-face talks and they have met three times between August and November, but have been unable to narrow their differences. As diplomacy fails, soldiers wait on opposing sides a few hundred metres away from each other in WWI-like trenches along the 100km ceasefire line. Only six international monitors are left to oversee the line.

Nagorno-Karabakh: no war, no peace Monica Ellena in Tbilisi

According to Thomas De Waal, senior associate at the Carnegie Endowment for International Peace and author of “The Black Garden: Armenia and Azerbaijan Through Peace and War”, Azerbaijan, the losing side in the conflict, has more of a reason to keep the ceasefire unstable so as to remind the world that the line cuts across the internationally recognised territory of Azerbaijan and that territories behind it lie under Armenian military control. “However, although the Azerbaijani side is probably responsible for a greater quantity of ceasefire violations, the Armenians also like to demonstrate their power,” he wrote recently.

ince the 1994 ceasefire the Armenian-Azerbaijani conflict over Nagorno-Karabakh has languished in a state of “no war, no peace”. A landlocked mountainous region, Nagorno-Karabakh is an enclave in Azerbaijan’s territory, a de facto independent statelet in the hands of its ethnic Armenians, backed by Yerevan.

The fighting hasn’t cooled down in the New Year.

But after two decades, the last 12 months of the frozen conflict – one of three in the South Caucasus alongside Georgia’s Abkhazia and South Ossetia – have been more about fire than ice.

“The Azerbaijani side is probably responsible for a greater quantity of ceasefire violations, but the Armenians also like to demonstrate their power”

Skirmishes have been common since the ceasefire, but last year tension started brewing and violence has become a daily routine, peaking in early November 2014 when Azerbaijani forces downed what Baku said was an Armenian military helicopter east of Nagorno-Karabakh, killing three crew members. It was the first time an aircraft had been shot down in the conflict zone in the past 20 years.

“We were very used to measuring ceasefire violations by the number of shots fired,” says Richard Giragosian, director of the Yerevan-based independent think-tank Regional

Studies Centre. “Unfortunately, now the escalation is so serious [that] we measure ceasefire violations by the number of casualties.” Face-to-face The clashes have thwarted international efforts – led by the Organisation for Security and Cooperation in Europe’s

The immediate trigger for the escalating violence is in the growing regional tensions in the relationship between Russia and the West which have also begun to disturb the South Caucasus, according to Neil Melvin, director of the programme on armed conflict and conflict management at Stockholm International Peace Institute Research Centre.

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“When Armenia rejected the EU’s Association Agreement and opted for the [Russia-led] Customs Union, this immediately raised the question of whether [Nagorno-] Karabakh would be integrated into the Union through Armenia which a number of countries have opposed,” he says. The political uncertainty initiated by these events was the catalyst for violence but longer term trends prepared the ground, notably the

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Events unravelled and by the time the USSR started melting from Riga to Bishkek, Armenia and Azerbaijan were engaged in a fully-fledged war. A Russian-brokered ceasefire in 1994 left Armenian-backed forces in charge of the region and seven surrounding Azeri districts, with more than 30,000 dead and half a million Azerbaijanis displaced. The ethnic Azerbaijanis, about 25% of

“Domestic politics has been a key factor in preventing both sides reaching a peace agreement on Karabakh” transformation of the Karabakh conflict into an interstate conflict between Armenia and Azerbaijan.” A contested cradle In the dying days of the Soviet Union, Nagorno-Karabakh was one of the first clashes between the principles of peoples’ self-determination and the republics’ territorial integrity in the USSR and its successor states. In 1988 the majority Armenian population asked the central Soviet authorities in Moscow for the region to join the then-Soviet republic of Armenia.

the pre-war population, left their homes, while ethnic Armenians fled the rest of Azerbaijan. Neither group has returned home since the end of the conflict. Armenia, an ally of Russia, and Azerbaijan, oil-and-gas rich, got very close to solving the stalemate, notably in 2001 in Key West, Florida, but neither of the then-presidents, especially ageing Heydar Aliyev, pushed the deal home. After two decades of reciprocal isolation, harsh rhetoric and propaganda – pleasing to public opinion at home- trying to

make peace is a daunting task. A peace deal remains on the table, but as De Waal puts it in his book, “it asks to do something that runs against the grain of their national narrative for two decades”. “Domestic politics has been a key factor in preventing both sides reaching a peace agreement on Karabakh,” agrees Melvin. Leaders [in both countries] have used the threat of conflict around Karabakh to justify their rule and crackdown on opposition forces.” Arms race Last year Azerbaijan looked past falling crude prices and increased military spending by more than a quarter to AZN5bn ($4.8bn). So did Armenia, whose defence outlays reached AMD200bn ($446mn), from AMD64.4bn in 2005. Azerbaijan’s oilrich economy dwarfs Armenia’s limping economy as the defence allocation of the former exceeds the latter’s total budget spending by $3.2bn. “The Armenian forces, however, are very well dug in and have significant defensive capabilities,” explains Melvin. “In the mountain areas, the Armenians enjoy advantages. In this context, an Azeri attack would likely endure high causalities and there is still no guarantee of military victory. Given this, the primary aim of Baku’s weapons purchases has been seen to break Armenia’s economy through an arms race rather than provide the capacity to launch a military attack.” Whatever the reason, Azerbaijan is flexing its muscles. On February 2 the Defence Ministry announced it had started military exercises involving all units of military forces – including 20,000 soldiers, 300 armored vehicles, 200 missile launchers and artillery units, and up to 20 military jets.

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including Presidents Barack Obama and Francois Hollande, for a large-scale set of events to mark the 1915 events. In an open letter to Erdogan released in January, the Armenian president stated that the move shows Turkey is continuing “its traditional policy of denialism.” Erdogan’s spokesperson labelled Sargsyan’s remarks on Turkey as “insults and hate speech”.

Armenia and Turkey battle over centenary events Monica Ellena in Tbilisi

Poor timing Every April Armenians around the world mark the Medz Yeghern, the Great Crime, referring to the hundreds of thousands of Armenians who died when the Ottoman Turks deported them en masse from then-western Armenia, now eastern Turkey, to the Syrian desert and elsewhere in 1915-16. They were killed or died from starvation or disease. Remembrance Day is set on April 24 – the day (also known as Red Sunday) that the Ottoman authorities rounded up and arrested 250 Armenian intellectuals and community leaders, in then Constantinople. Turkish officials say that the mass killings were a result of widespread chaos in the dying days of the Ottoman empire, but argue that there was no systematic attempt to destroy the Christian Armenian population and that many Turks also died in the turmoil of war. The total number of dead is disputed. Armenians say 1.5mn died, Turkey says the number is up to half a million. In 2014, the Turkish

t looked like an olive branch. When in 2014 Recep Tayyip Erdogan, then Turkey’s prime minister, offered an unprecedented expression of condolence for the “inhumane” massacres that Armenians suffered at the hands of Ottoman soldiers in 1915, the world hailed it as a sign of softening in the Turkish rhetoric.

"A new front in the war over those terrible events has broken out"

The historic first, however, did little to satisfy Armenians, who want the deaths of an estimated 1.5mn people recognised as genocide. And now a new front in the war over those terrible events has broken out between the two adversaries in the run-up to centenary events to be held in April.

day that Armenians will observe the centenary of the Armenian massacre. The move has raised a few eyebrows, including in Turkey, and sparked a RSVP war between Ankara and Yerevan.

To remember the 100th anniversary of the World War I battle of Gallipoli on April 24, Erdogan, now president,

Sargsyan had little choice but to refuse the invitation. Armenia is preparing its own roster of international guests,

has invited over 100 heads of state to Turkey, including Armenian President Serzh Sargsyan. But this is the same

foreign ministry criticised a US Senate resolution that described the killings as genocide, arguing that it “distorts history and law”. The Gallipoli campaign, also known as the Dardanelles Campaign (or Canakkale Savası in Turkish) marks one of the Allies’ major defeats during WWI. It is also a defining moment in Turkey’s

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history and it led to the founding of the Republic of Turkey eight years later under Mustafa Kemal Ataturk, who rose to fame as a commander at Gallipoli. It is also considered the birth

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Centre Studies, although adds that “each declaration not only offers and expands the space for dialogue and engagement, but also helps to at least 'sustain the momentum' and to foster a

“There is a deep divide and stark split over the genocide issue”

of a national consciousness in Australia and New Zealand: the two countries remember their fallen soldiers on April 25 when their army corps landed on the peninsula (hence Anzac Day). Turkey, on the other hand has traditionally commemorated Gallipoli on March 18, the date that 18 British and French battleships, guarded by other warships, first attacked the Dardanelles forts. The decision to move the commemoration back to April 24 is certainly “bad timing”, wrote Richard Giragosian, director of the Yerevanbased independent think-tank Regional

new environment more conductive for both sides to re-engage”. Confronting the past According to the Armenian National Institute, 21 countries officially recognise the Armenian genocide, including Switzerland which is currently at the centre of a high-profile legal battle at the European Court of Human Rights focusing on Dogu Perincek, leader of the Turkish Workers Party, who called the Armenian genocide “an international lie” while in the country in 2005. While until a decade ago talking about the 1915 events was a feat of bravery, today critical voices calling for Turkey

to confront its past are growing inside the country. “Turkey has long lost the battle of truth. The destruction of the Armenian population on its ancestral land is a sheer fact, whatever else you might call it,” wrote Cengiz Aktar, a senior scholar at the Istanbul Policy Center. The issue is highly sensitive. “While many in Turkey see the selection of 24 April as a mistaken and obviously disingenuous move to counter the Armenian genocide commemoration, many also feel that Turkish moves to return property and to discuss the 1915 events are not adequately appreciated,” Giragosian says. On February 2, for example, the Turkish authorities returned the ownership of an historic Armenian cemetery in central Istanbul to the Armenian community, in the wake of new legal amendments that allow the return of properties seized from minorities. And on January 29, Erdogan said that Turkey is ready to “pay the price” if found guilty of the mass killings of Armenians a century ago, adding that his country would take the necessary steps if historians conclude that it was at fault for the World War I-era massacres that Armenians say amounted to genocide. In a twist of fate, the Turkish Foreign Ministry has mistakenly published a picture of the Armenian Genocide monument in Yerevan amidst a collage of photos for an official day planner that has been prepared to commemorate the 100th anniversary of the Battle of Canakkale. The foreign ministry vowed to find and punish the person responsible. “There is a deep divide and stark split over the genocide issue,” sighs Giragosian.

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Opinion

bne March 2015

Minsk deal offers Ukraine tough long-term opportunities

STOLYPIN:

Mark Galeotti of New York University

ith the ceasefire brokered in the second Minsk summit seemingly in trouble, the gap between a brittle and temporary ceasefire and a true and lasting peace remains broad and unlikely to be bridged by Minsk-2. Instead, what we are likely witnessing is the transformation of the conflict to a new stage, one dominated by a longer-term struggle over governance as much as warfighting capability. This is a struggle in which Moscow begins stronger, but Kyiv actually has some opportunities to level the field. The Minsk-2 accords lay out a roadmap for peace which envisages first a withdrawal of heavy weapons from the front line, then local elections in the rebel-held areas and also constitutional changes in Kyiv to decentralize powers to the regions, and then the return of control of the border to the

â&#x20AC;&#x153;This is a struggle in which Moscow begins stronger, but Kyiv actually has some opportunities to level the fieldâ&#x20AC;?

or share power if others won. These will be at best tainted and at worst wholly fraudulent snap elections, which Kyiv and outside observers will essentially have to accept or watch the whole peace process unravel. Given that Moscow is also relying on the local leaders in this new confederalized Ukrainian state to be its agents and veto, especially in case of renewed moves to align the country more directly with the west, Russia also will need to ensure its allies win. Furthermore, while Ukrainian President Petro Poroshenko may be willing to commit Kyiv to this constitutional reform, he needs to get it through a fractious and divided Rada. Already nationalists have been making bloodcurdling threats, not least to assassinate any pro-Russian legislators elected from the Donbas region in the east, and they may well spearhead resistance to reforms that appear to reward rebellion. Should the ceasefire fail, then the risk is magnified that the nationalists might be able to surge on the resulting public anger and push for an even more intransigent line. Without these changes, without accepting deeply questionable local elections in the south-east of Ukraine, and without being able to control its own soldiers, including the notoriously freewilled ultra-nationalist militia units, then Kyiv will be unable to enjoy the fruits of Minsk-2. Not least among them is regaining control of the border over which currently freely flow Russian troops, volunteers and weapons.

government. This all makes sense in theory, but as many have already noted, there are numerous weak links in this chain of events.

There is thus a depressingly good chance that this ceasefire will not hold, especially not long enough for the full peace process to be carried forward.

The rebel leaderships, for example, have hardly demonstrated themselves to be self-effacing servants of the democratic principle. They are unlikely to allow a free and fair election campaign in the regions under their guns, let alone surrender

Advantage Kremlin Whom does this benefit? Moscow may well be calculating that this is to its advantage. The outcome is likely to be a frozen conflict, the creation of local pseudo-states under its control

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that are not valuable in themselves – unlike Crimea, the southeastern Ukrainian campaign was never intended as a simple land grab – but as instruments to continue to destabilize and influence Kyiv. With part of its country outside its control, and an economy continuing to be depressed by the war and Russian manoeuvres, then regardless of its aspirations, Ukraine would not be joining Nato or the EU in the foreseeable future. Meanwhile, the Kremlin is likely calculating that without actual fighting taking place, Western attention will soon waver and redirect. Some new crisis will monopolize public attention, perhaps one in which Moscow’s help might be convenient. Those voices calling for a more placatory policy would be more likely to be heard. Businesses suffering because of sanctions would lobby for a relaxation. At the very least, the pressure to arm and fund Kyiv will diminish. Of course, an unspoken central assumption of the Kremlin’s is that this is a moment of temporary and unexpected weakness. This is a product of the fall in oil prices, as well as the unusually sustained and vigorous Western outrage at events in Ukraine, stoked by the “bad luck” – as the Kremlin would see it – of the MH17 shootdown. Thus, a delaying action makes tactical sense. If Kyiv cannot be forced to acknowledge Russian hegemony now, freeze the conflict and wait a while for the correlation of forces and circumstances to be more propitious. However, it could well be that time is not on Russia’s side. Already, the economic crisis is having an impact on the security apparatus. The intelligence and law enforcement agencies are having to absorb cuts of 10% or more in their budgets and some military procurement plans are quietly being put back. Russia’s economic woes are not going to end soon, so the costs of supporting client states, continued military reform and balancing the guns vs. butter equation – perhaps best regarded as “might abroad vs. popularity at home” – will become all the more onerous.

Opinion

political and administrative challenges they face, while maintaining a strong but dignified stance towards Moscow, they may begin to gain serious credibility in the West. At present, they are, to be honest, viewed with more pity than respect. The second is governance. Whatever the flaws of the actual vote, it is hard to question that most Crimeans genuinely did want to join Russia. This owes less to historical affinity than to a sense that Kyiv had failed them for more than two decades. If rump Ukraine can develop as a better-run, transparent, working liberal democracy and market economy, then the people of the south-east may well see their future in the west. Just ask the ethnic Russians of the Baltic states, who may grumble about “prejudice” against them, but have no desire to head to Russia instead. Finally, Kyiv could use the time to prepare the ground militarily, too. One of many reasons for its lack of success in the war has been that its underfunded and undertrained army was still in many ways a shadow of its Soviet self, geared for a mass war in the west rather than counter-insurgency in the south-east. Over the coming months, even if Kyiv cannot afford to mobilize larger forces, it can at least retrain, reorganize and rearm for this mission. In short, Minsk-2 is just a lull in the war, not an end. However, while Moscow clearly feels it is getting the best out of the deal, it does offer Kiev some interesting opportunities. But only if it is serious, daring and determined enough to take them – and the West continues to be willing to help.

Mark Galeotti is Professor of Global Affairs at the Center for Global Affairs, New York University. He writes the blog In Moscow’s Shadows.

Counterattack on 3 fronts Ukraine, of course, hardly looks in a good state. Even with the International Monetary Fund's (IMF) latest $17.5bn loan, it faces lean, hard years. To that can be added the challenges of a still largely unreformed bureaucracy (sad to say, but Ukraine’s is more corrupt and arguably even less efficient than Russia’s), sharp political divisions, and unrealistic public expectations. However, with a right combination of domestic political will and external financial and technical assistance – and it is hardly a given that either will actually materialize – then it is not impossible that the country will begin to find its feet. In this context, then Kyiv actually can begin slowly to mount a counter-attack on three fronts. The first is geopolitical. Kyiv has been assiduous in courting the West, but as a victim more than a partner. If the Ukrainians begin seriously to start tackling the fundamental economic,

“In short, Minsk-2 is just a lull in the war, not an end”

Opinion

bne March 2015

MACRO ADVISER:

It’s the economy, stupid

ill Clinton famously won the first of his two presidential elections using the slogan: “It’s the economy, stupid”. He recognised that while support for the first Gulf War had been strong, people were starting to focus much more on the poor state of the US economy and fearful about their jobs. The incumbent president, George Bush Snr, had mistakenly assumed that war euphoria would remain strong enough to carry him to a second term. British wartime prime minister Winston Churchill also found that out in 1945 when he finally ran out of war victory credits and lost the general election to the Labour Party, which had focused on jobs and social welfare reforms. Is Russian President Vladimir Putin about to learn a similar lesson which, while not exactly costing him a re-election in March 2018, might substantially reduce his currently very strong majority support and lead to much less social and political stability during his fourth term in the Kremlin? Or, will the combination of growing public concern and weakening economy lead to a greater effort to calm the situation in eastern Ukraine, bring an early end to sanctions and finally put Russia on a more serious path towards long overdue reforms? Cracking support Throughout most of 2014, Russian public support for the government's stance in eastern Ukraine remained very strong. A majority of people initially supported even the absorption of the region into the Russian Federation, although that changed relatively quickly to support for independent statehood with close ties to Russia. But remember that was against a backdrop of a stable ruble, high oil and generally stable macro trends. That strong support for the Kremlin’s position on Ukraine has started to noticeably crack in recent months as the deteriorating trend in the economy has become much more noticeable. A growing percentage of the population are now less convinced the country is heading in the right direction,

albeit a majority still does, and are focusing much more on the rising rate of inflation and on the fear of wage cuts or job losses. And they are certainly right to be concerned. The next three to six months will be awful in terms of economic indicators and that is bound to have an impact on public support for the government and the president. Russia’s economy managed to record modest growth of 0.5% for 2014 which, frankly, was a good result given the huge headwinds battering the country. As expected the growth in the consumer sectors, which have been the main engine of

“Right now the Kremlin is in what can best be described as survival or damage limitation mode” growth for most of the past dozen years, fell sharply to only 2.5% and investment spending, which expanded by over 6% two years earlier, contracted by 3.5% last year. The steady rise in the cost of borrowing, declining wage growth, rising inflation and the growing uncertainty over the future of the economy all combined to cut activity. But against these negative trends, there was a positive in the form of import substitution. The sharply weakening foreign exchange value of the ruble and the block on some imported food from last August helped boost demand for locally produced goods. That helped the manufacturing sector grow relatively strongly in the latter months of the year, ending with full year growth of 2.1%. Year of living dangerously The trend for the next few months will be severely

Opinion

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downwards. A contraction of up to 5% is expected in the current quarter and, possibly, for the first half year. Retail sales will be hit hard as the cost of servicing existing debt was pushed up even more by the Central Bank of Russia’s decision to raise its Key Rate to 17% in mid-December, albeit it has pulled that back modestly to 15% since. Headline inflation was already at 15% by early February and seems destined to reach 20% in the coming months. The CBR will not cut its Key Rate again until convinced that inflation has peaked and is heading lower. That may not be until the midJune policy meeting. Last year real disposable incomes fell by 1% and that was the first contraction since 2000. This year that contraction will be larger, as nominal wage growth will be a lot lower than the expected inflation rate. Russian companies have a preference for cutting wages rather than jobs during times of crisis, albeit we are already seeing more of both since the start of 2015. Across the board, indicators are expected to be well down on last year, as already evidenced by the 25% cut in the volume of new vehicle sales in January when compared with the same month of 2014. That said, the trend in industrial production is expected to remain positive because of the import substitution effect plus the still fast rising spending in the defence modernization programme. The oil price is the critical factor for the economy and the key determinant for the country’s fiscal and monetary policies. However, sanctions, especially the block on accessing external credits beyond 30 days, are also hurting. Russia will do nothing to try to revive the oil price, but easing the financial sector sanctions later this year will help to stabilize the economy. Hence the greater impetus to try and achieve a peace deal in eastern Ukraine; the assumption probably being that if a deal can be achieved and peace holds, then there is a greater likelihood that the most damaging sanctions may not renewed by the EU when they expire on August 1. Although the US is expected to keep a tougher position, ie. especially by the candidates for the November 2016 election, the hope is that the White House may be pressured by the EU to at least ease on some restrictions if the war has stopped. The forecasts in the table below represent our base-case assumptions. The core assumptions are that sanctions start to ease from the EU expiry date, albeit not entirely removed until mid 2016, and that the oil price tests the 2009 lows of $40 per

barrel in the coming months but has a more solid rally in the autumn. A more optimistic scenario, based on financial sector sanctions easing earlier and oil staying close to the $60 per barrel level, is possible and would result in a stronger second half rally. Equally, the case for greater pessimism can be made and lead to a much larger contraction in the economy, also extending into 2016. Survival mode Right now the Kremlin is in what can best be described as survival or damage limitation mode. The CBR’s Monetary Policy team has been restructured, which along with some administrative changes in the ruble market, should help prevent a repeat of the volatility seen late last year. The Finance Ministry has provided RUB1 trillion to support the banking system, which may not be enough but is a strong commitment to prevent a crisis. Almost 200 companies have been designated as strategically important, which means that they can get fast access to state support should they need it. Inevitably, many companies will have financial problems this year but the bigger companies should not. Survival mode can only go so far of course. The actions taken, and others expected in the next few months, should prevent a credit crisis or a collapse in the important industries. There is enough money in reserves to allow for that if managed efficiently. But by late spring or summer the pressure will have grown for a more effective response if, by then, there is not a clearly improving trend in key indicators such as inflation and interest rates, and stability in the ruble market. The table below shows that while most people are not interested in taking part in street protests, a rising number believe that these are possible if the trend in the economy continues to weaken. The next parliamentary elections will take place in December next year. If the poor state of the economy and low confidence in the government’s management is not to dominate that election, there needs to a more effective response later this year. A greater effort to bring peace to eastern Ukraine and, hopefully, an easing of sanctions later this year, are at least part of the required response.

Chris Weafer is Senior Partner at Macro-Advisory, which offers bespoke Russia-CIS consulting.

Is Russia Headed in the Right Direction?

Jan '15

Dec '14

Nov '14

Oct '14

Aug '14

Yes

55%

56%

59%

60%

66%

27%

20%

23%

19%

Don't know

18%

19%

17%

15%

Source: Levada Center

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bne March 2015

INVISIBLE HAND:

Sowing the seeds of an oil-price rise Liam Halligan in London

s the oil price crash over? In mid-February, Brent crude traded at $63 a barrel, up from a $45 low a month earlier. Does that sharp rise mean oil will now climb steadily back above $100? Triple-digit oil prices, after all, have become the normal in recent years. The black stuff spiralled to almost $150 in late 2008, ahead of the global financial crisis – before falling back, as the world economy endured it worst peacetime shock for 80 years and asset markets collapsed. As global growth returned, though, and traders remembered that the populous emerging markets were still becoming more populous, their energy demands ever rising, oil quickly recovered. During the three and a half years from early 2011 to mid-2014, oil was above $100 pretty consistently. Prices then started falling last June, by some 60% to their mid-January low. But Brent crude is now up 36% during the four weeks to the time of writing. So has the oil market now turned? Temporary dip Forecasting the oil price is a mug’s game. But crude is so important to modern life, and the path of the global economy, that for all the prediction pitfalls, any decent economist needs to take a view. With energy importers like the US and EU benefitting from cheaper oil and exporters suffering, price predictions can often appear partisan – driven more by emotion than rational analysis. During these recent months of East-West conflict, I’ve heard numerous Western analysts express pleasure at the impact of cheaper crude on the Russian economy, for instance, while happily predicting further falls – perhaps without thinking about the painful impact on their own energy producers (in the UK’s North Sea, for instance, or US shale fields). My (entirely data-driven) opinion is that the price dip is temporary and, even after the recent increase oil remains heavily over-sold. But prices aren’t always driven by data, of course. So we could easily see oil temporarily drop further, in another speculative short-selling frenzy. Eventually, though, supply-and-demand realities apply. In

my view, the fundamentals – high drilling costs and pitiful discovery rates on the supply-side, coupled with ever-rising global demand – point to oil between $80 and $120. I’d also say that – beyond the hype, and the fact that traders must react in the short term to hype if everyone else is reacting, even if they don’t accept it – such fundamentals are widely understood. As such, unless we see another 2008-style systemic meltdown on global markets, I’d venture $100 will be back in sight towards the end of 2015. To understand why oil prices are likely to recover, we must understand why they fell. One major reason is Janet Yellen. Last autumn, the Federal Reserve chairman announced that the US is to rein-in quantitative easing. Since then, on the strength of less virtual money-printing, the dollar has surged. The passing of the QE baton back to Japan, with the Eurozone about to follow, has helped drive the greenback to a near seven-year high against the yen and the euro to an 18-month dollar low. Given that oil is priced in dollars and all major Opec producers peg their currencies to the dollar, when the US currency rises, the quoted oil price axiomatically falls – which is what we’ve seen since Yellen made her move. I believe that, for all the huffing-and-puffing between Athens and its creditors, a deal will soon be cut to keep Greece in the Eurozone. Germany has blinked during every previous euro crisis and Berlin has too much political capital invested in

“My (entirely data-driven) opinion is that the price dip is temporary” monetary union to allow “Grexit”, which could then see other “Club Med” countries leave, threatening not just the euro but the entire “European project”. After a Greek settlement, and once euro-QE kicks in, the single currency will strengthen. That will push the dollar down over the coming months, raising headline oil prices.

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Another reason oil prices fell from last autumn, of course, aside from the dollar, was the wave of new crude extracted from “tight” oil formations in America. Since 2009, US shale oil production has grown from almost nothing to 4% of global output. That’s driven the US' total crude production up from 7.5mn to around 10mn barrels daily – approaching peak US production of 11.3mn barrels back in the 1970s.

While judging between falling US rig counts and high stockpiles, traders have also lately absorbed news that in 2014 global oil discoveries fell for the fourth year in a row – the longest run of annual declines since the 1950s, despite the incentive of $100-plus crude during much of that period. The 16,000 barrels of oil-equivalent found last year was less than half of total 2014 consumption and the lowest for six decades.

A supply increase of this magnitude clearly didn’t go unnoticed by the Opec exporters’ cartel. At a time of souring relations between the US and Saudi Arabia – not least due to American overtures to Iran in the battle against Islamic State and support for Qatar, a key backer of the anti-Saudi Muslim Brotherhood – Opec decided not to cut their export quota. Riyadh convinced other cartel members to suppress prices, instead, protecting Opec’s market share by squeezing upstart US shale producers – which have high production costs and often heavy debts – so as to knock them out of the market.

While “conventional” crude costs up to $60 per barrel to produce, unconventional oil – shale, deep-water and tarsands – generally absorbs $80-$100. Over the last decade, more than two-thirds of the 12mn-barrel rise in daily global oil production that has prevented prices spiralling in the face of fast-growing demand has come from “unconventional”

When oil is below $80, many shale producers, particularly the relatively small outfits that have driven US' recent production increase, simply don’t make money. So production stops, as does investment in future wells. American energy companies, large and small, are now rapidly laying off field workers in response to cheaper oil. In January, the US “rig count” was down 10% on the month before, amounting to a drop of no less than a third since October. The number of active domestic US wells has, over just four months, plunged to a three-year low. Discovery drought The oil price rise since mid-January admittedly reflects other supply-side developments, not least concerns over fighting in the Middle East. Violence in Libya has lately shut all major ports, reducing oil exports to just a trickle. Iraq's semi-autonomous Kurdistan Regional Government has also threatened to withhold crude exports as part of a broader dispute with Baghdad. Having said that, many traders have been struck by the extent to which high-cost US shale outfits are now suffering due to cheaper oil. While some such producers have hedged their price exposure, many are unhedged as well as heavily indebted, which puts them in a very weak position. Depleting far more quickly than conventional wells, ongoing shale production when prices are low and below cost requires ever more debt capital, which is currently scarce. No wonder, given increasing market chatter about the non-performing loans of US shale producers potentially sparking another “Lehman moment”. Oil market bears point out, rightly, that after four years of rising US shale production, and an on-going ban on almost all energy exports, US crude stocks are now high at almost 420mn barrels. That puts downward pressure on prices. Having said that, with the US still importing a net 9mn barrels of oil daily, a long way from “energy independence”, this stockpile could quickly deplete. The threat that cheap crude poses to domestic production will also eat into inventories.

“The fundamental supply-side trends point to more expensive energy” sources. Lower prices make much of that production uneconomic while deterring investment in future capacity – sowing the seeds of an upcoming price rise. The fundamental supply-side trends, then, point to more expensive energy. Then there’s the demand side, where the fast-growing emerging markets now account for over half of total global consumption. In each of the last three years, world production has lagged actual usage by upwards of 3mn barrels daily, mainly due to rising emerging market demand. While this reality has lately been overshadowed by the US “shale revolution” and the drama of Riyadh defying Washington, the insatiable energy appetite of the East, in the face of ever-rising oil production costs, remains one of the defining economic trends of our time. It will soon reassert its grip on the global market for crude.

Liam Halligan is Editor-at-Large of bne Intellinews.

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bne March 2015

To arm or not to arm Ukraine Mark Adomanis in Philadelphia

s the war (there's no point any longer in using hedging words like "crisis" or "conflict") in eastern Ukraine has intensified over the past several months, an idea that would have once been considered radical has rapidly gained traction among mainstream pundits. I'm talking, of course, about the prospect of sending weapons, “lethal defensive aid” in the parlance of Pentagon bureaucrats, to assist the Ukrainian military. In a debate that was already rather contentious, the issue of “defensive*” weapons has stood out for the extreme intensity of views on both sides. The normally rather staid world of security think-tanks has erupted into the rhetorical equivalent of a bar fight. People whose prose normally is replete with phrases like “engagement with a broad group of multilateral stakeholders” are now openly calling their opponents “apologists” or “warmongers” or any number of other epithets that you would never normally encounter in elite foreign policy debates. The point is not to laugh at the awkwardness of the situation, but to highlight how worked up and agitated everyone is. Most analyses are unambiguously and openly partisan: giving weapons to Ukraine is either the equivalent of Lend-Lease or it is going to be the start of World War III. There is merit in trying – as calmly, clearly and honestly as possible – to lay out the pros and cons. The pros Proponents of providing weapons make several distinct but related armaments. The first, and most basic, is that a more capable Ukrainian military would "change Putin's calculus" by raising the costs of intervention. Most analysts focus on the direct financial costs that Russia would incur to replace lost equipment. Facing a Ukraine armed with high-tech US weapons, Putin would have to feed more and more materiel into the cauldron of eastern Ukraine merely for the separatists to maintain their current position. Given Russia’s tenuous economic situation, the hope is that even a modest increase in the Ukrainian army’s combat efficacy would bring the Kremlin’s finances to the breaking point.

Other analysts, clearly a minority but by no means a tiny one, place a higher emphasis on indirect costs, namely the political damage that Putin would suffer from ever-larger casualties in the Russian military. This line of thought holds that the Kremlin would rapidly lose support among the Russian public once it was widely understood that Russian soldiers were fighting and dying on the territory of another country. While Putin might be able to maintain his hold on power, these analysts suggest that mass casualties among the Russian armed forces would inevitably cause a wave of public resistance and would make continuation of the campaign in East Ukraine impossible. In general, then, proponents of arming Ukraine assert that deliveries of Western military equipment will make the Ukrainian army a substantially more potent fighting force and

“Escalation dominance means that if the West gives Ukraine 20 new tanks, then Putin will send 40 into the Donbas”

will, through a combination of elevated financial and political pressure, force a change in Russian policy. The cons In comparison to proponents, who by and large fall into two distinct groups, the skeptics of arming Ukraine are a somewhat more diverse cast of characters. Given space constraints it isn’t possible to list every argument they’ve made, but the most significant ones can be reviewed. Probably the single clearest rejoinder is the idea that Putin enjoys “escalation dominance”, meaning that he is willing and able to meet or exceed any amount of assistance that the West

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Opinion

provides Ukraine. In crude fashion, escalation dominance means that if the West gives Ukraine 20 new tanks, then Putin will send 40 into the Donbas.

People will have to make their own minds up about the advisability of arming Ukraine by answering the following questions:

“Realist” opponents of arming Ukraine also highlight the hierarchy of interests: Ukraine is quite simply a much higher foreign policy priority for Russia than it is for the West. Great powers rarely compromise when it comes to their core security needs, and since Ukraine is a core Russian interest (perhaps even the core Russian interest), these analysts say that we shouldn’t expect the Russians to back down.

1. What price is Russia willing to pay to keep Ukraine out of the West’s orbit?

Another group of people who argue against arming Ukraine focus more on the defects of the Ukrainian state. This argument doesn’t so much concern Russian capabilities or desires, but the simple fact that the Ukrainian army is a broken and ineffective institution whose problems run much deeper than a simple lack of high-end Western weapons. These analysts tend to have more exposure to the lived reality of modern armed forces, and note that without substantial improvement to the Ukrainian military’s "command control and communications" (eg. where to put weapons and how and when to use them) new hardware won't have any impact. The takeaway There aren’t any easy answers to the war that Ukraine now faces, no quick solutions to a nightmare of increasing severity.

2. To what extent is the Russian public supportive of their government’s current policy in Ukraine? 3. Would Western assistance to Ukraine elevate or reduce the Russian public’s level of support for the separatists fighting in Donetsk and Lugansk? 4. How easily would the Ukrainian military incorporate new systems? *I’ve never read an adequate explanation for what a “defensive” weapon is, but for the purposes of this article let’s accept the dubious proposition that there are weapons which can be configured in such a way as to make them nonthreatening to anyone but an attacker.

Mark Adomanis is an MBA/MA student at the Wharton School of Business and the Lauder Institute. Follow him on Twitter @MarkAdomanis

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Zlota 44 – a towering problem in Warsaw Jan Cienski in Warsaw

he views from the apartment on the 50th floor of the Zlota 44 tower are stunning, with floor to ceiling windows showing the whole of Warsaw’s skyline as the Vistula river curls off into the distance. The only problem is that the apartment is so far the only completed residence of the 52-storey building, which has been under construction since 2008. The tallest residential tower in the EU was designed by Daniel Libeskind, the American architect with Polish roots, and its steep point is supposed to evoke the Polish eagle soaring off into the sky. It was the signature project of Orco Property Group, a Franco-Czech developer with properties scattered across the region. During the launch of

the project almost eight years ago, eager punters crowded into Warsaw’s national theatre to listen to Libeskind and to take

About 20% of the building’s planned 266 apartments were sold – but the project is still very far from completion, and it

“Critics complain it has been finished with cheaper materials, giving it more of a plastic look that does not follow Libeskind’s glassand-steel design” a look at a mock-up of what a future flat would look like. This was at the peak of Warsaw’s pre-crisis property boom, where plunking down €10,000 per square metre of property seemed like a sensible idea.

won’t be Orco that finally finishes Zlota 44. The developer sold off the unfinished building last year for €63m, after reportedly spending about €166m on the project. After paying a contractor, Orco put €50m towards its bottom line.

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Despite that, the company still owes €186m on a portfolio worth €322m, and is still having trouble covering its debt payments. Shareholders have taken a bath. Orco shares have lost about 99%

bne March 2015

at giving Orco any more funds. The exterior of the building is completed, so the tower is no longer an eyesore on the Warsaw skyline, although critics complain that it has been finished

“This was at the peak of Warsaw’s pre-crisis property boom, where plunking down ¤10,000 per square metre of property seemed like a sensible idea” of their value over the last five years, and are trading on the Warsaw Stock Exchange at PLN1.54 (€0.37). Orco the killed whale Orco was founded in 1991 in Prague by French developer Jean-Francois Ott and rapidly grew as Central Europe shook off communism and the region’s economies started to revive. The problem was that he over-extended himself and took on too much debt – something that just about killed his company after the collapse of Lehman Brothers in late 2008. Ott put Orco under the protection of a French court while negotiating with bondholders. As the region emerged from crisis, he put a lot of hope on the Zlota 44 project as a way of reviving his company’s fortunes. But the building was jinxed with enormous problems. Construction began in March 2008, but stalled a year later with 17 floors built when Orco ran into financial difficulties. Then Warsaw authorities blocked construction because of issues with the building permit. After that, neighbours in surrounding buildings objected to the design, causing yet more delays. Construction finally restarted in January 2011, and the plan was to have the building completed by mid-2014. The sale of the rest of the apartments was going to provide a massive cash injection that would help right Orco. Instead, the developer got into a huge fight with its general contractor and construction stopped last year after banks financing the project baulked

with cheaper materials than originally proposed, giving it more of a plastic look that does not follow Libeskind’s glass-and-steel design. But the interior is nothing more than floor after floor of grey concrete. Orco’s problems and the construction delays, coupled with a decision to increase prices to €15,000 a metre in order to underline its desirability, made it almost impossible to find buyers. The final construction is now in the hands of BBI Development, a Warsaw property developer, and Amstar, a USbased property fund, which bought the project from Orco last year. The partners expect to spend about PLN180mn190mn and to have the building completed by the second quarter of next year.

Just who will buy the flats is a little problematic. Almost all of the initial investors are people from outside of Warsaw. The capital’s luxury property market is still a far cry from the optimistic days of 2008. Zlota 44 also has more competition. The completed Cosmopolitan Tower, just a couple of blocks away, has 250 luxury flats (where prices are reportedly about €6,000 a metre), while Platinum Towers development, also in central Warsaw, is selling for about €4,000 a metre. For now, the new owners of Zlota 44 are sticking with top-end prices for their flats, but it is not clear that there is enough demand at the top end of the market. Their hope is that the luxury market follows the broader trend in Polish residential property. Reas, a property analysis firm, reports that last year marked a record for transactions in the country’s six largest cities. “Over 43,000 flats were sold on the six analysed markets in the whole of 2014, up by nearly 20% as compared to the record-breaking 2007 and 2013, when around 36,000 units were sold in each year,” the report noted. The problem is that average property prices in Warsaw are stable, hovering at around €1,800 a metre. Zlota 44’s new owners will have to justify the enormous gap between those prices and those for flats in their building if they want to avoid Ott’s fate.

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executive presidency, with the predictable effects on sales of big ticket items such as property. Little wonder then that sales over the first ten months of 2014 registered a fall of 1% to 926,932, against the same period in 2013 when sales were themselves affected by the countrywide protests in June, July and August.

Turkey no longer forever blowing (property) bubbles David O'Byrne in Istanbul

espite repeated claims of a growing property market bubble in Turkey, all the indications are that while there may have been speculative pricing in some small geographical areas, the overall market remains healthy and will continue to be so for the foreseeable future. Mitigating in favour of such an optimistic prognosis are Turkey's continued economic strength and the demographics of its still growing population, which analysts concur should be more than sufficient to ensure continued buoyancy in the face of other factors that might otherwise have put downward pressure on sales. "People are always predicting a bubble but not much has changed. There are some regional bubbles in areas where prices are above TRY10,000 per square metre, but overall the market is still very buoyant," says Kerim Gokoz, real estate analyst at Istanbul’s Garanti Yatirim. Certainly the figures for 2014 bear up

that analysis. On the face of it last year should have seen a far more cautious market given that Turkey went through a particularly tense period of electoral uncertainty. Countrywide local elections in March led to a period of heightened tension as results in many areas were disputed amid allegations of electoral malpractice. Tensions were further heightened with speculation that then prime minis-

In the event, the presidential poll was completed without incident and sales in the last two months of the year rallied, reaching 1.165mn for the whole year, a shade under 1% up on the 1.157mn recorded in 2013. An impressive result given the challenges. The more so given that the sales figures for both years were all-time records, suggesting greater buoyancy yet to come should Turkey manage to keep a lid on its perennial political tensions. The results for 2014 were even more impressive given that in addition to political uncertainty the year also saw a major hike in mortgage rates from an average 9.7% in 2013 to an average 11.9% last year – a rise that saw the number of mortgages granted over the year fall by 15% to 390,000. Equally encouraging despite far from ideal conditions were the sales of property to foreigners – a key factor in a number of regional housing markets. Sales rose by 56% across the country as a whole from 12,181 in 2012 to 18,959 in 2014. Encouragingly this included a market recovery in sales in the Istanbul area,

"People are always predicting a bubble but not much has changed”

ter Tayyip Erdogan would run as the governing AKP's candidate in Turkey's first ever popular votes for the country's president in June – a move feared by many to be a first step towards an

which had been badly affected by the protests in 2013 an effect which could have been expected to continue in 2014 given the continued political uncertainty.

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In the event sales in Istanbul rose from 20% of total sales in 2013 to 29% of total in 2014, when 5,580 properties were sold while sales in other areas popular with foreign retirees also registered volume rises albeit with their overall share of sales declining. Sales in the most popular region, Antalya, for example declined from 45% of total to 34% last year although actual sales rose from 5,481 to 6,446. The one dark cloud hanging over the property market in 2014 was that of office property, which analysts concur is distinctly lacking in buoyancy. Vacancies in Istanbul's central business district rose from 16.2% in the last quarter of 2013 to 235 by the third quarter of 2014, leading to warnings that average rental yields may fall from the current rate of 6.5%.

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Optimistic outlook Overall, though, the prospects for 2015 are reckoned to be similar to 2014 with no fall in demand or sales anticipated. Unlike much of Europe, continued growth in Turkey's GDP is accepted as inevitable with the OECD predicting 3.25%, the World Bank 3.5%, and Turkey's own central Bank 4.0%. Garanti Yatirim concurs with the 4.0% growth prediction and adds that it expects the construction sector to grow by as much as 5.0% on the back of an anticipated pre-election spending spree. Priming the pumps ahead of the June poll may indeed prove to be a major factor in boosting property sales, with Turkish Prime Minister Ahmet Davutoglu announcing on January 28

that his government plans to help firsttime buyers by contributing as much as 155% of the sum necessary for a down-payment. No details have yet been announced, but it is safe to assume that they will be made public in plenty of time to accrue maximum benefit ahead of the June polls. Coupled with a widely expected drop in interest rates on the back of improved inflation figures and increased government pressure on the central bank, any move to help first-time buyers looks certain to boost the property market. "45% of sales in 2014 were to first-time buyers so anything that helps them will increase sales," says Gokoz, pointing out how increased interest rates affected the market during 2014.

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The current cycle has its roots four or five years back as developers with access to plenty of affordable FX financing took on, quite reasonably, ambitious expansion projects starting a new post-crisis real estate cycle. Across all sectors, record levels of stock came to the market. Given the expectations of economic growth at the time as well as the massive undersupply of quality commercial real estate space, there should have been sufficient demand to absorb the supply created by megaprojects such as Moscow City.

COMMENT:

The fall and rise of the Moscow property market Tom Mundy of JLL

ne of the more surprising aspects of Russia’s current downturn has been the pace with which the commercial real estate market has responded to the dislocation in the rest of the economy. As the ruble has crashed and the cost of borrowing has soared, Moscow’s commercial real estate market has adjusted with impressive efficiency. Prices have moved without the lag that that one should expect in a market with such little transparency and which we experienced during the 2008-2009 crisis. In this short paper we look at why look at why this has been the case by considering the reaction of three important real estate indicators: the cyclical nature of rising vacancy rates; falling rents driven by economic downgrades and ruble volatility; and finally a slowdown in completions as developers adjust their expectations. In the residential market, which behaves quite separately to the commercial market, mortgage issuance (a common

proxy for residential sales volumes) was driven up aggressively by rapidly worsening ruble assumptions before being strangled at the end of last year by intolerable lending rates. Vacancies The first indicator that has reacted has been vacancy rates. Vacant space, that is to say the amount of available stock in a building, had been building gradually

As economic expectations ebbed away through 2014, it became abundantly clear that all this extra space could not be absorbed in the near term and vacancy rates moved out with alarming speed. From 18% at the end of 2013, the average vacancy rate for Class A office space had climbed to 29% by the end of 2014. In some areas, such as Moscow City, Class A vacancy rates have reached 45% already and could well climb further. Rent The second area where the impact of the economic downturn is clear is through the rapid adjustment in the rents that tenants pay. Rents have been heavily impacted not just by the increase in vacant space, but also because development is financed almost exclusively in FX. This means that rents are denominated in FX as well. Hence companies that derive revenue in rubles and pay their costs in FX are absorbing a very painful currency mismatch and are seeking to reduce their costs by either renegotiating rents down in FX terms,

“Contrary to popular belief, there is little evidence to suggest Russians have become more active in real estate purchases abroad” through 2014 across all sectors, mostly due to the nature of the real estate cycle. Saying that, the collapse in demand towards the end of 2014 did exaggerate the pressure as vacancy rates soared in the last quarter.

or by switching to an effective ruble rental rate. The latter is, however, not a straightforward alternative for landlords with FX debt who will be limited by their lender’s willingness to accept rouble exposure. Furthermore, for an

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asset valued in FX a switch to ruble rent will have an impact on valuations given the slimmer income that the asset will generate. Thus, while it is clearly a tenantâ&#x20AC;&#x2122;s market right now, and many landlords are giving temporary respite by offering ruble terms, it is unlikely that this window for renegotiation will be open too long. We would also assume that in many cases it is not the landlord that is setting the limit to what is tolerable, rather itâ&#x20AC;&#x2122;s the bank who will determine at what rental rate the landlord can service their interest payments. Rents across all sectors have already fallen a long way and we would suggest that with rates that are already below the worst point in the 2008-2009 crisis, they may not have much further that they can go. It is notoriously difficult and perhaps disingenuous to calculate an average

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rent given the individual circumstances of each landlord, but we would estimate that compared to the end of 2013, in dollar terms, Class A office rents were 20% lower by the end of 2014 and have fallen at least a further 10-15% since the start of the year. Completions The third area that is already being affected is the level of completions. As suggested above, developers have to adjust their expectations to account for the fall in demand and the availability of debt. In the current environment, projects are increasingly likely to be either postponed or cancelled entirely if they are at an early stage. However, the good news for landlords is that quite quickly, assuming some improvement in demand as the economy levels out, as completions become more

Moscow average Office Vacancy Rates.

Moscow Mortgage Transactions per month

Source: JLL

scarce vacancy rates will move down in turn, supporting an upward revision in rental rates. Thus, though we are well aware that the market looks gruesome at the moment, the structural undersupply of space across all real estate sectors (Moscow has less Class A office space per capita than Bucharest), will help landlords more quickly through the cycle as the demand supply equation comes into balance quicker than many casual observers would expect. Indeed, we anticipate office and industrial rents to level out through the middle of 2016 and given current oil price assumptions possibly be back to pre-crisis levels in dollar terms by the end of 2017. No home abroad Finally, unsurprisingly, the weaker ruble has pushed Muscovites looking for the safe-haven of bricks and mortar to invest heavily in the residential market. According to central bank figures, the number of mortgage transactions increased in 2014 by 23% against the previous year. This dynamic built through the year until December, when central bank policy rate hikes effectively strangled the mortgage market. Given that the residential market, unlike the commercial market, is financed largely through pre-sales, as funding and financing dry up, completions will inevitably follow in turn. Like the commercial market, it will not be long before the residential market also finds its equilibrium. One of the more surprising trends through 2014 was that contrary to popular belief there is little evidence to suggest that Russians have become more active in real estate purchases abroad. This may have its roots in the political environment where state officials have been reluctant to be seen moving assets out of Russia. It is more likely, though, that it has more to do with the pace with which the ruble moved. In a few short months last year, real estate in London doubled in price in ruble terms. As shocked Russians contemplated their next move, Asian and Middle Eastern buyers snapped up what little London stock there was.

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December 2015. The company has already started work on its second business park, AFI Business Park, with the first part to be finished in 2017.

Booming IT sector drives Romanian real estate market INTERVIEW:

Clare Nuttall in Bucharest

omania’s booming IT and outsourcing industries are boosting demand for office space in Bucharest, as a growing number of international companies expand their operations in the Romanian capital. Romania has been establishing itself as a hub for the IT industry and shared services such as business process outsourcing (BPO). As well as international companies taking advantage of the educated and relatively cheap workforce, its closeness to Western Europe and North America compared to Asian offshoring centres, domestic IT and services companies have also expanded both in Bucharest and regional cities such as Iasi and Timisoara. This has been a major factor behind the increase in demand for high-end office space, according to David Hay, CEO of property developer AFI Europe Romania. “There has been an increase in demand in the last two to three years, due to two main sectors – IT, and business process

outsourcing and shared services,” Hay tells bne IntelliNews. “This is a real expansion, you can feel it in the market. The office segment is very active at the moment, with many pre-lease deals being signed.” Multinationals such as Endava, Microsoft and Oracle have been expanding in Romania, creating an impetus for the many new developments now going up in both Bucharest’s main business district and in the centre-west of the city around Bucharest polytechnic, which is emerging as a new hub for the sector. As of late 2014, between 100,000 and 120,000 square metres (sqm) of new office space was being developed. AFI Park was one of the first major office developments to be built in centre-west Bucharest. Three of the development’s five buildings are fully leased, mainly to multinationals in the IT sector, while the third, completed in January, is leased to Endava Romania and TELUS International. Two further buildings are due to be completed by

More malls The company is also the developer of Romania’s largest mall, AFI Palace Cotroceni, which opened in 2009 with a gross leasable area of 81,000 sqm. Hay is optimistic about the long-term growth of the retail sector, where turnover increased by 8.6% in the first half of 2014, according to the National Statistics Institute. “During the crisis it was difficult for everybody, I think we saw the start of change only in 2014,” Hay says. “People are spending more, and since Romanian GDP is well below the EU average there is the potential for catch-up. The growth of industries such as IT is resulting in increased spending power.” Hay believes there is room for more malls in Bucharest, where the amount of retail space per 1,000 people is much lower than in other Central and Eastern European capitals such as Budapest, Prague or Warsaw. Some of Romania’s secondary cities are also under-served, and AFI, which opened the first modern mall in central Ploiesti, an industrial town 60km from Bucharest, in 2013 is now considering opening in other regional centres. While the retail and office markets have been forging ahead, Romania’s residential property market has been subdued since 2008, when a boom triggered by Romania’s EU accession was brought to an abrupt end by the onset of the international economic crisis. However, AFI’s Hay believes the longdormant residential sector is on the verge of a turnaround, after first hints of a revival in 2014. “The turnaround started in 2014, with a slow and very tiny increase in demand and prices. We expect a further increase in 2015 and 2016.” AFI already has land for a future residential development, however, Hay says, before it launches construction work, “we are waiting for the residential market to again become a healthy market, with healthy demand and prices.”

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driven mainly by good macroeconomic factors,” says Tamborsky. “If the economic environment remains stable and without any unexpected events, the recovery should continue.” And there’s the rub; Viktor Orban’s government is anything but predictable and already has form when it comes to hurting foreign investors.

Hungary market recovering but government is wildcard

bne:Funds

Nicholas Watson in Prague

ungary’s real estate markets have been showing signs of life over the past year, but actions by the country’s mercurial government threaten to derail this. After bottoming in 2013, a broad-based recovery in Hungary’s property markets – office, retail, residential and logistics – was observed in 2014, which some analysts expect to continue this year and next. The office segment of the market has been especially buoyant, with Erste Group Immorent reporting that new office completions more than doubled in 2014 to 66,000 square metres (sqm), while the vacancy rate decreased 2.2% on higher demand from international companies like Vodafone, British Telecom and SAP, as well as local IT companies. The net absorption stood at 125,000 sqm, which is the highest level since 2011, and if the net absorption stays stable around the average of the last four years, then Martin Tamborsky, author of a recent Erste research report covering the Hungarian real estate market, predicts a decrease of the vacancy rate to 14.5% by 2016. In addition, “The rents

have been stable over the last two years and we do not expect any significant change this year,” he says. The logistics market performed even better than the office part last year as industrial production remained high. The vacancy rate of leased stock fell by 5.5% to 15.7% in the greater Budapest area. In 2014, new supply was 390,000 sqm; big names like Lego and Bridgestone expanded by more than 100,000 sqm each. Net absorption was at a six-year high of 130,000 sqm. The residential market also started recovering slowly in 2014, with construction activity and prices growing slightly after six years of decreases. Retail remains subdued, with no new shopping mall currently under construction and none expected in 2015 and 2016. However, the retail market environment is favourable, driven by a recovery in private consumption and falling unemployment, while wellknown retailers like H&M, Desigual and Massimo Dutti are expanding their stores. “We are expecting good performing real estate markets in the following years,

To add to a long line of business sectors that have been targeted by the Fidesz government for special taxes and laws, Hungary's retail sector saw legislation passed before Christmas that bans Sunday and overnight trading at all but the smallest shops. Furthermore, inspection fees for businesses with incomes of over HUF50bn (€160mn) are to become progressive, leading to a leap in total fees for the largest companies from HUF2bn in 2014 to HUF30bn this year; and, from 2017, any business above the same HUF50bn threshold that reports losses for two consecutive years must be closed down. The large foreign-owned retailers, which see themselves as the main target of this new package of laws, say all this will seriously affect their businesses and inevitably hit profitability. On January 12, Tesco, the country's largest retailer and pioneer of 24/7 trading in Hungary, said it would close 13 out of a total of 222 stores in Hungary, with the loss of “about 500” jobs. Other supermarket chains have also muttered about job losses. Gyorgy Vamos, general secretary of the Hungarian retailers association (OKSz), told bne IntelliNews that this will affect not just the stand-alone supermarkets, but also shopping centres and malls, which all contain supermarkets. As a result, loss of customers will inevitably have a knock-on effect on “all sorts” of associated businesses, from cinemas to cobblers, hotels and catering, he says. Then on New Year's Day, the Hungarian government introduced a new road freight registration and tracking system – known by it's Hungarian acronym as Ekaer – for all but the smallest commercial deliveries by road, which

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bne March 2015

threatens to impact the industrial and logistics real estate market. Ekaer requires a mass of detailed data about commercial consignments, including the contents, value, sender, recipient, truck registration numbers, and times of arrival and unloading – all to be sent to the tax authority in advance of shipping. Any failure to comply, if discovered by mobile inspectors, can result in the confiscation of goods and fines of up to 40% of the shipment's value. The Hungarian Association of Logistics, Purchasing and Inventory Management (MLBKT), demanded in a statement that the law be rescinded in its present form, calling the new system “chaotic, contradictory" and saying it wouldn't achieve its ostensible aim of preventing VAT fraud. Thomas Faustmann, managing director of Audi Hungaria, said in an interview with autopro.hu that the entire affair makes a mockery of the government's supposed longterm intentions of becoming Central Europe’s “centre of industrial production”. “For this, you need to create framework of appropriate conditions, Faustmann said. “In the neighbouring countries – in Slovakia, the Czech Republic, Romania and Poland – dozens of factories are on the lookout, just waiting for orders.” What these measures against foreign investors will do to the gradually growing real estate investment volumes, which are still low compared to other Central and Eastern European markets, remains to be seen. Erste expects solid investment volumes in 2015, after Hungary saw approximately €450mn-460mn of income-producing and €130mn-140mn of non-income producing real estates transactions in 2014. “There is a lack of core assets available for sale on the market,” says Tamborsky. “Value-added assets are expected to be on transaction list in 2015. Investors from the EU15 and US are expected to be increasingly active on the Hungarian market.”

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CEE property investment volumes soar

Colliers International Fuelled by steady demand for office and retail assets, and increasing investor appetite for the industrial and logistics sector, Central and Eastern Europe saw last year’s investment volumes significantly exceed expectations in nearly every market. Accounting for more than 17% of all transaction volumes in 2014, which is significantly higher than the EMEA average of around 9%, this boom in demand for industrial and logistics properties illustrates the changing composition of the market from being heavily dominated by office and retail to include a greater share of other sectors. “Overall, 2014 closed with a healthy level of investment volumes across the CEE region, with the majority of countries posting a positive result,” commented Damian Harrington, Regional Director of Research for Colliers International, Eastern Europe. “Despite the continuing crisis in Ukraine, investment volumes for the region closely matched 2013 levels, which should provide confidence to investors seeking investment opportunities across the region in 2015.” The core Visegrad markets of Poland, Hungary, and the Czech and Slovak Republics all performed exceedingly well in terms of investment volumes, with Poland leading the market for the entire region. Living up to a similarly high level of transactions recorded in 2013, Poland saw just over ¤3bn exchanged and accounted for 30% of the region’s activity. Additionally, investment volumes in Hungary and the Czech and Slovak Republics all increased significantly on a year-on-year basis by an impressive 70-80%. The Czech Republic posted investment volumes close to ¤2bn, accounting for 19% of all investment volumes in the region, while Slovakia completed its best year on record with more than ¤500mn transacted. Similar volumes were also reported in Hungary, indicating that improvements in the economy and investor sentiment are beginning to filter through at a country level. Outside of the Visegrad markets, Romania and Bulgaria experienced a drastic turnaround in investment volumes, witnessing a year-on-year rise in activity of almost 300% and 160%, respectively. This increase pushed investment transactions in Romania to over ¤800mn, significantly exceeding its 2013 levels, and points to a shift in market sentiment toward Tier 2 and 3 locations across the region as well. “Countries across the region should continue to benefit from these favourable market conditions, provided that funds seeking commercial real estate opportunities continue to invest,” added Chris Sheils, Director of Investment, Colliers International, Czech Republic. “The current cycle is expected to run for another couple of years, during which time, I believe the CEE markets will continue to maintain this outstanding growth rate so long as they remain competitively priced against their EMEA counterparts.” A new generation of trends such as pan-European distribution, e-commerce and multichannel retail operations are all contributing to this expansion of the industrial/logistics sector. Given investors are already assessing opportunities across the CEE region, this sector is expected be one of the most dynamic investment preferences over the coming years.

ARTS CULTURE & PEOPLE

bne March 2015

FILM REVIEW:

Few Russians left unmoved by “Leviathan” Anna Kravchenko in Moscow

ndrei Zvyagintsev’s “Leviathan”, probably the most anticipated film in post-Soviet Russia, hit the screens of more than 600 cinemas on February 5. The film made RUB7.2mn (€97,000) in its first day of release, an impressive sum for the Hollywood-dominated Russian distribution market. Weekend box office is not counted yet, but it’s expected to reach RUB55mn-60mn, according to Booker’s Bulletin, which is one and a half-times more than "Birdman" on its premiere day and three-times more than the total box office receipts of Zvyagintsev’s previous film, “Elena”. "Leviathan" has already won a number of prestigious international awards, including best screenplay at the 2014 Cannes Film Festival and a Golden Globe. Before the film was released at home, Russian Minister of Culture Vladimir Medinsky slammed it as “extremely opportunistic” and said that taxpayers should not pay for films that "openly spit on" the government. Medinsky’s criticism drew attention to the film like no prize could. On January 10, a copy of the film was leaked online and was downloaded 30,000 times during the first two hours, and up to 6mn times by the end of January. What was happening around “Leviathan” quickly became as complex and interesting as the film itself. After “Leviathan” won the Golden Globe for best foreign film and received an Oscar nomination, it was impossible to open Facebook or a news site related to the film without finding a heated discussion below of whether the film portrays Russia and Russians accurately. "Leviathan" has split viewers, leaving very few of them indifferent to it. Officials hurried to join Medinsky. Communist Party leader Gennady Zyuganov called the film “anti-national”. He added that this is another Russian film that illustrates Russian life using the example of a ramshackle village, which one can find in any country. Sergei Markov, member of Russia’s Civic Chamber, called for Zvyagintsev to publicly repent, Raskolnikov-style. “What the film does is it dehumanizes Russians, and thus justifies a genocide of Russian people. If I were Zvyagintsev, I would

recall the film release, come to Red Square, fall on my knees and ask for forgiveness,” Markov said in an interview with GovoritMoskva radio station. Putin’s press secretary, Dmitry Peskov, took the opposite tack. “It’s great that we have films like this. A film should provoke discussion,” Peskov said. He also said he would support "Leviathan" in the Oscar race. That put a stop to officials’ commenting on it, but not the numerous discussions on social media. Traditional storytelling Leviathan’s story-telling style is conservative – it is a traditional drama, with spelled out motives and heavyhanded symbolism. Yet it’s truthful and powerful, and, despite showing the grim life of a poor village, heightened and poetic. A corrupted mayor of a small town in Russia’s north is after a piece of land where Kolya, a talented car mechanic and a drinker, built his house. Kolya, his wife, and son will have to

“I, of course, despise my motherland but it vexes me if a foreigner shares this feeling with me” leave. Kolya’s army friend, a lawyer from Moscow, digs up some dirt on the mayor. Inevitably, it all ends tragically. Many saw the film as an attack on Russians. Viewers also complained that the film is too grim and hopeless, with no “positive characters”. “Many of us have enough fear in real life to be willing to experience it in cinema,” reads one of the Facebook comments. Zvyagintsev also broke the rule about washing one’s dirty linen in public. Some commentators expressed concern about what foreigners might think. Russian poet Alexander Pushkin reflected on that same issue two centuries ago: “I, of course,

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despise my motherland but it vexes me if a foreigner shares this feeling with me”. Do Russians drink that much? Are they that helpless in the face of corrupt authority? Are rotary dial phones still used? Many believe the director figured out that the film that answers ‘yes’ to all those questions would please Europeans and Americans. “If not for the beautiful landscapes, the film would be just a politically biased pamphlet. It reminds me of the selfflagellation films of Perestroika,” one commentator notes. “If Leviathan was not a chernukha, nobody in America would pay any attention to it,” another comment runs, referring to films popular in the 1990s characterised by a pessimistic and cynical view of Soviet society. Those who loved the film argue that these kinds of stories happen in Russia all the time. The film starts with crashing waves, and the fear of a wild force threatening destruction is a feeling known to anyone who has lived in Russia long enough. “From the beginning, I felt myself in Serebryakov’s [actor who played Kolya] place. The scariest thing is, in all the circumstances, I would act exactly the same. And the outcome

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I 75

would be the same. There are thousands of stories like this. I’ve been working as a lawyer for 18 years, and I say thank you to Zvyagintsev,” a supporter of the film writes. “Don’t know about others but it sparks a healthy anger in me, and energy to resist. I want to get up and throw out this ‘authority instituted by God’… It urges you to change things,” another comment reads. The reaction to Zvyagintsev’s film shows how dramatically the mood has changed in Russia, where anti-nationalist sentiment is suffocated by the government and its supporters as the economy tanks and the war in Ukraine grinds on. Made in 2013, Alexander Veledinsky's “The Geographer Drank His Globe Away” was also set in a deprived province with a drinker as protagonist, but went almost unnoticed compared to the hysteria that has followed “Leviathan”. “Leviathan unexpectedly and probably to the authors’ surprise, turned out to be an ideal film for Russia in the era of trolling,” film critic Stanislav Zelvensky says in his review for afisha. ru. “A country where trolling has become the basis of at first internal and then foreign policy, desperately needs a statement from which one can step up… The main thing is to have the opportunity to comment, then comment on the comment, and then softly dive into exhausting fight leading nowhere.”

BOOK REVIEW:

A year in Hungarian Politics Kester Eddy in Budapest

014 was a watershed year in Hungarian politics: Viktor Orban, the pugnacious prime minister, and his nominally conservative Fidesz party, fought and soundly won three elections – for the national parliament, European Parliament and local municipalities. Furthermore, after four years of frenzied law making, once returned to power last Spring, Orban – or his righthand men – immediately continued with controversial and confrontational policies, for example alleging that non-governmental organisations (NGOs) critical of the government were agents of foreign powers, making warm

approaches to Russia and the east while denigrating the “failing” West, and embroiling Hungary in a diplomatic row with the US. Most infamously, in July Orban publicly enthused on the effectiveness of “illiberal” democracies, citing Russia, China, Turkey and Singapore as examples for Hungary to follow. How and why has Orban done all this? Where does it leave Hungary, politically, socially and economically? And what of the country's future? Gabor Gyori as author, and Andras BiroNagy as editor attempt to answer such questions in "Hungarian Politics in 2014" – an 80-page booklet just published on

ARTS CULTURE & PEOPLE

January 23 with the assistance of Friedrich Erbert Stiftung, a German foundation of Social Democratic heritage. Economic populism Gyori, who (along with Biro-Nagy) is a political analyst with Policy Solutions, a Budapest think-tank, makes no attempt to dilute what to him is clearly an unpalatable truth: “Fidesz returned with another landslide victory,” he declares in the opening chapter. Although Fidesz saw its share of the vote slip to 45%, almost 8 percentage points down on the 2010 result, by re-writing the election law it still won a two-thirds majority in parliament. Meanwhile, the opposition left-wing alliance “suffered another disastrous defeat”. Perhaps equally unsettling for the left-liberal camp, the far-right Jobbik strengthened its position, gaining 19.1% of the vote to become “firmly established as a prominent presence in the Hungarian political landscape”. Gyori cites a number of reasons why Fidesz succeeded in securing a “core base” of at least 1.5mn voters, including its re-writing of the electoral law and its dominance of the media. But he also argues that because economic developments in post-communist countries “tend to be more closely connected to the success of a government than in more developed economies”, the “timely” return of economic

“The dark underbelly of this economic policy is that it is based on keeping millions employed in cheap industrial labour, with little social mobility” growth and the impact of the government-mandated cuts in utility prices were particularly important for electoral success. “Fidesz’s economic populism (ie exceptional sectoral taxes on banks and energy companies, as well as intense state interference in setting utility prices) was bold enough to allow it to enact policies that run counter to economic orthodoxy and democratic principles… [This] satisfied the material desires of broad swathes of the electorate”, he writes. There are, however, dark clouds on the horizon for Fidesz: economic growth in 2014 was to a great extent “due to massive state outlay, including the well-timed conclusion of (largely EU-financed) infrastructure projects”, meaning the apparently healthy expansion is not sustainable. All this may not matter, at least in terms of political power, because in essence the Hungarian poor do not vote. And in

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Gyori's assessment, Orban has a vision of a highly stratified society in which a limited middle-class, mostly connected to Fidesz oligarchs, control the economic services while the masses are employed in cheap labour manufacturing – unwilling to complain for fear of losing even that limited income. “Apart from the blatant cronyism apparent in the lighter [tax and regulatory] burdens imposed on enterprises owned by Fidesz-aligned oligarchs, the other dark underbelly of this economic policy is that it is based on keeping millions employed in cheap industrial labour, with little social mobility,” he reasons, citing government tax and subsidy policy to aid the middle and upper income-groups, along with restrictions on higher education and unemployment benefits as evidence. It is a decidedly frightening vision, but one that is not at all removed from reality. But though Gyori notes that Orban's tax policies hitting foreign investors have specifically avoided the manufacturing sector for fear they may up sticks and leave, there is no reason why, if Orban needs the money, he might in future introduce some form of extra “temporary” taxation targeting foreign-owned manufacturers – albeit probably in a milder form than those levied on the banks and retail sectors today. The author seeks to analyse Orban's vision of “illiberal democracy” – what he terms “the attacks” on critical NGOs and, in a section entitled “Operation, capture, control and contain”, pays special attention to the Fidesz government's media policy. In his conclusions, Gyori avoids any hard and fast predictions on the economy, but warns that, “poverty is increasingly emerging as the single most important social issue facing Hungary”. Saying that 2014 for Fidesz has been “a successful year [that] ends on a bitter note”, he argues foreign pressure – mostly from the US, but also possibly from Germany – has tempered Orban's previously unbridled enthusiasm for Vladimir Putin (although the Russian president is visiting Budapest in February) and notes that the planned introduction of an internet tax stirred an unprecedented public show of discontent with Orban's policies. However, given the failure of spontaneous protests in the past, whether that develops into any meaningful political opposition is debatable. "Hungarian Politics in 2014" offers a grand critique of – and insight into – Fidesz's most controversial policies since elected in 2010. At the presentation on January 23, Biro-Nagy, the editor, claimed that it is the first annual review of its kind in English: given the complex and convoluted nature of the subject, many will hope it is not the last.

"Hungarian Politics in 2014" is downloadable, gratis, here: http://www.policysolutions.hu/en/news-read/hungarian_ politics_in_2014_yearbook

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OBITUARY:

Zhelyu Zhelev, Bulgaria’s first freely elected president Clare Nuttall in Bucharest

helyu Zhelev, the dissident philosopher and Bulgaria’s first democratically elected president, has died at the age of 79.

Born in 1935 in the small village of Veselinovo, Zhelev graduated in philosophy from Sofia University and briefly became a member of the Bulgarian Communist party. However, as his political views diverged from the prevailing ideology, he was expelled from the party in 1965 and banned from Sofia the following year. This was the beginning of Zhelev’s emergence as a leading figure in Bulgaria’s democratic opposition in the later years of the communist regime, a position that was sealed with the publication of his best-known book, The Fascism, in 1982. The book analyses three fascist societies, Nazi Germany, Fascist Italy, and Franco’s Spain. While the book did not overtly criticise the Bulgarian regime, the obvious similarities between the fascist societies it described and the situation within Bulgaria caused it to be banned three weeks after publication. This move backfired, as The Fascism became Bulgaria’s most sought-after book until the overthrow of communism in 1989. Zhelev and other opposition leaders had no direct involvement in the coup against Todor Zhivkov, Eastern Europe’s longeststanding communist dictator, who was deposed by the Bulgarian politburo. However, increasingly vocal criticism and mass rallies organised by the democratic opposition increased pressure on the regime as 1989 drew to an end. Zhivkov’s discrimination against Bulgaria’s large ethnic Turkish minority added to the unrest, as thousands of Turks went on hunger strike. His reputation as an outspoken critic of the communist regime made Zhelev an obvious figure to look to for leadership after 1989. Zhelev was one of the founders and the first chairman of the Union of Democratic Forces (UDF), set up by dissident groups in 1989. He was elected to the new parliament in 1990 and headed a round table created to draw up plans for a democratic Bulgaria. In August 1990 Zhelev was elected president by fellow MPs and, after the adoption of a new constitution in 1991, was

re-appointed in the country’s first direct and democratic presidential elections. The main achievements of Zhelev’s five-year term as president took place between 1992 and 1994. The November 1991 parliamentary elections resulted in a majority for the UDF, which formed a government alongside the mainly ethnic Turkish Movement for Rights and Freedoms (MRF), with Philip Dimitrov as prime minister. Numerous reforms, including the launch of a largescale privatisation programme and a new law on foreign investment, were launched under Zhelev and Dimitrov. Bulgaria was recognised internationally as a state forging ahead towards a democratic market economy. Other achievements included soothing tensions between Bulgarians and Turks, which averted ethnic unrest at a time when neighbouring Yugoslavia was descending into inter-ethnic war. However, with tensions rising both between the UDF and MRF, and within the UDF itself, Dimitrov lost a no-confidence vote in 1992. He was replaced by presidential advisor Lyuben Berov at the helm of an interim government supported by the Bulgarian Socialist Party (BSP), the MRF and some UDF MPs. In December 1994, the BSP, the successor to the Bulgarian Communist Party, returned to power, spelling the end of the brief period of reform under Zhelev’s presidency. Unsurprisingly the relationship between Zhelev and new Prime Minister Zhan Videnov was tense, with the two sparring frequently over the economy and foreign policy. Along with other East European transition economies, the final years of Zhelev’s term saw an increase in economic problems, with a decline in GDP, rising inflation and a slump in the value of the Bulgarian currency. Speaking at the World Summit for Social Development in Copenhagen in March 1995, Zhelev said that Bulgaria was facing difficulties on its path to a market economy, with economic liberalisation leading to a fall in living standards for many and an upturn in corruption. “There has been a growing sense of frustration and insecurity,” he acknowledged.

I New Europe in Numbers

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Kazakh retail deposits, 2008-2014, year end (billion tenge) 2008

2009

2010

2011

2012

2013

Russians appear blasé toward sanctions

2014

4,438

3,905

% of respondents

Foreign currency Tenge

3,371

Total deposits

2,995

3K Tenge (billions)

2,724

2,195 1,893

1,240 1,059 865

1,137

42 40 28

1,717

1,587

1,473

2,188

2,059

1,433

1,312

955

834

608

Continuation of the fighting in Eastern Ukraine and Donbass

The collapse of the ruble

American and Western European sanctions against Russia

New Year holiday and vacation

The continued drop in oil prices

With the low oil price and the weak currency of the country's main trading partner Russia, pressure is building on Kazakhstan’s central bank for another currency devaluation.

A recent poll by Russia’s Levada Center has shown that Western sanctions left scarcely more of an impression on Russians than their New Year holidays did.

As the bne:Chart shows, Kazakh’s faith in the stability of the tenge has taken a blow, as foreign currency retail deposits are now more than double tenge depoits.

As the bne:Chart shows, when asked January 23-26 what they considered the most important event of the last month to be, 28% said that they believed it to be continued Western sanctions – only 4% more than said it was their New Year holiday or vacation.

Russia's reserves and months of import cover, 2004-present

Standard & Poor’s downgrade of Russia to junk status on January 27 was met by the Kremlin with accusations of US-influenced politicking. A closer look at some macroeconomic figures does make the decision by the US rating agency look out of kilter.

2004 Fitch upgrade to investment grade

S&P downgrade to junk status

Months of import cover

600K

As the bne:Chart shows, at the time of its downgrade Russia had one-and-a-half times the months of import cover and over triple the reserves that it did when it was upgraded to investment grade by Fitch nine years ago – hardly the sinking ship that would warrant a junk rating.

500K

30 400K 25 300K 20 200K

International reserves (USD million

S&P’s main justification for downgrading Russia to ‘BB+’ – its highest non-investment grade – was the country’s newfound lack of access to international capital markets. The implicit message there is that, in the not-too-distant future, Russia simply will not be able to service its debt obligations.

15 International reserves 10

100K

Months of import cover 2005

2007

2009

2011

2013

2015

TO TA L FE DE R A L TA X

Top 10 regions by total federal tax revenue, Jan-Oct 2014 1

Khanty-Mansi Autonomous Area - Yugra (Total)

Moscow (Total)

RUB 1,401,113.5M

Yamalo-Nenets Autonomous Area (Total)

St. Petersburg (Total)

Republic of Tatarstan (Total)

RUB 184,058.9M

Moscow Oblast (Total)

RUB 182,702.1M

Krasnoyarsk Krai (Total)

RUB 137,357.5M

Samara Oblast (Total)

RUB 131,326.2M

Orenburg Oblast (Total)

RUB 118,264.4M

Perm Krai (Total)

RUB 103,464.8M

RUB 764,800.0M RUB 482,549.9M RUB 267,586.0M

RUB 0.0M

With oil, fuel and gas accounting for 70% of Russia’s $450bn exports in 2014, it is no surprise that seven of the 10 largest overall contributions to federal tax receipts came from regions whose economies are heavily energy-focused.

RUB 500,000.0M

RUB 1,000,000.0M

RUB 1,500,000.0M

Of the ten largest regions for total tax contributions, seven came from regions that also featured in the top ten for mineral extraction tax. Only the city of Moscow, the wider Moscow Oblast and St. Petersburg featured in the overall top 10 contributors for all tax types combined.

bne March 2015

New Europe in Numbers

2015 MACRO OUTLOOK: Ryszard Petru, Chairman of the Association of Polish Economists Henry Kirby in London

In spite of regional unrest, 2015 will be Poland’s best year for over half a decade, predicts Ryszard Petru, chairman of the Association of Polish Economists. “We haven’t been hit too hard by the Russian crisis, which is a positive surprise. Internally, prospects are very promising, with growth of 3.5-4.0%,” he explains. Consumer prices in Poland have fallen for six consecutive months, which Petru attributes to a fall in oil and food prices. This, along with a “3.5-4.0%” increase in wages, he says, will help fuel the projected growth for 2015 through higher consumer spending. Private investment is another area Petru sees playing a pivotal role in any growth that Poland is to enjoy after what he describes as “a sluggish” half a decade. “I don’t want to call it a very strong rebound, but I’d expect to see growth of 5-10% this year in private investment. That, combined with deflation and a new inflow of [EU] funds, will provide a boost to an extent we have not seen since 2007.” This spike in investment is not dependent on foreign interest, either, Petru says: “Foreign investments are of course important, but not to the extent that people seem to think. They do account for 20% of total investment. But 70% of investment in the country comes from local investors.” The Swiss Bank’s (SNB) decision in January to unpeg the Swiss franc from the euro is one issue that Petru says could, in conjunction with a potential Greek exit from the Eurozone, cause serious problems in the coming year. With over half a million Poles holding Swiss franc-denominated mortgages, Polish banks are now under pressure from Warsaw to slash rates to negative figures in order to ease the burden on mortgage holders saddled with higher repayments as a result of the Swiss franc’s appreciation against the zloty. “If things calm down, the Russian crisis does not escalate, and there is no Greek exit, then the zloty should appreciate and holders of Swiss franc mortgages should remain unharmed. “However, if things deteriorate and the zloty weakens, then politicians will start talking about it. It’s an election year, so there is a risk that they will make rash decisions on that front. While the resurgent Swiss franc could prove problematic for Poland, Petru believes that the fallout from Western-led sanctions against Russia pose less of a threat. “In a global sense, yes, it is relevant in terms of trade, but only 5% of Polish trade is with Russia. 25% is with Germany, 60% is with the Eurozone, and the EU makes up 80% of our trade. “Recently-published data shows that, despite the embargo, Poland was actually exporting more food than ever. All they have done is shift from Russia to other markets,” says, concluding that, “Without downplaying the situation, Russian sanctions are all but irrelevant to Poland.”

I 79

Moody's Investors Service assigned on February 6 a ‘Baa2’ rating to Bulgaria's ¤8bn Global Medium Term Note (GMTN) programme, the same as that of the sovereign. The rating reflects the country's weak economic growth outlook in an environment of moderate credit expansion and persistent unemployment, Moody's said in a statement. The EU has lost approximately ¤21bn because of sanctions imposed against Russia over the Ukrainian crisis, Spanish Foreign Minister Jose Manuel Garcia-Margallo said. Opec expects the world’s oil demand to rise in 2015 by 1.17mn barrels a day (b/d) to 92.32mn b/d. Non-Opec oil supply is projected to grow in 2015 by 0.85mn b/d, down 0.42mn b/d from the previous assessment. Oil is currently trading at $58 a barrel. The Albanian parliament voted overwhelmingly on February 5 to appoint career banker Gent Sejko as the new governor of the Bank of Albania. Sejko will replace longstanding central bank governor Ardian Fullani who was sacked in 2014 after thefts of around ¤5mn worth of cash were revealed. Investors' average confidence in Russia has more than halved since last year, according a poll by Detail Communications, a Moscow-based financial communications firm. The top concern was "political risk" (38%) followed by "geopolitical tension" (35%). Turkey’s automotive production rose 37% y/y to 102,574 units in January while passenger car output was up 16% y/y to 60,414 units in the first month of the year, the Automotive Manufacturers’ Association said on February 11. The domestic market grew 7% y/y during the month. Irish oil company Petroceltic plans to curtail its exploration activities in Romania, Bulgaria and Greece under a broader plan aimed at cutting operational costs and the capital expenditures. Investments will be focused on production and development operations in Algeria, Egypt and Bulgaria.

I New Europe in Numbers

bne March 2015

MACROECONOMIC INDICATORS

GDP composition (%)

Gross domestic product ($mn) Country

Total (2014)

YoY (% annual)

YoY (% qtr)

2015 Forecast

Per capita ($)

Agri.

Indus.

Albania

13,175

2.1

+0.7

+3.4

4,549

Armenia

10,703

2.6

+5.3

+3.3

3,551

Azerbaijan

77,239

+2.5

+3.4

Belarus

72,857

1.6

+2.0

Bos/Herzegovina

17,953

0.7

Bulgaria

53,752

Croatia

57,251

Czech Republic

203,014

Estonia

Budget deficit

Current account

Inflation (CPI) Unemployment Ind. prod.

Serv.

Bud% GDP

% GDP

Latest, YoY

Last year

YoY

-6.6

-11.0

+0.7 Dec

1.7

17.0

+11.6

0.0

-7.7

+4.6 Dec

7.1

17.1

+4.3

8,060

0.0

14.6

+1.3 Nov

2.7

4.9

+1.8 2013

+3.4

7,685

0.1

-8.5

+0.6 Dec

15.4

0.5

-1.4

+0.6

+3.4

4,735

8.1

26.4

65.5

0.0

-11.0

-0.4 Dec

-0.5

43.7

-2.9

1.4

+1.5

+0.8

7,418

6.7

30.3

-3.4

2.1

-1.0 Jan

-1.6

10.7

+0.9

-0.5

+0.5

13,415

-5.0

0.9

-0.5 Dec

1.1

19.6

+5.3

2.3

+2.4

+2.5

19,295

-1.3

-1.0

+0.1 Dec

1.0

5.9

+7.3

24,917

1.8

+2.7

+2.3

18,988

-0.4

-1.5

-0.5 Dec

2.1

4.7

+7.7

Georgia

16,997

5.4

+3.9

+3.2

3,785

0.0

0.3

+1.9 Dec

0.2

14.6 (2013)

+11.1

Hungary

130,200

3.9

+3.1

+2.4

13,182

68.7

3.3

4.1

-0.9 Dec

1.4

7.1

+7.1

Kazakhstan

234,065

4.3

+4.0

+5.0

13,438

4.6

0.3

+7.4 Dec

4.9

5.0

+0.8

Kosovo

7,308

+3.8

4,022

12.9

22.6

64.5

0.0

-7.7

-0.4 Dec

0.2

30.0 (2013)

Kyrgyzstan

7,515

+3.6

+4.5

1,279

20.8

34.4

44.8

0.0

-14.2

+11.6 Dec

6.0

2.4

-10.4

Latvia

31,762

2.6

+1.9

+2.9

15,973

4.9

25.7

69.4

-1.5

-2.5

+0.2 Dec

-0.4

9.0

-0.5

Lithuania

47,310

+2.4

+3.0

16,206

3.7

28.3

-1.2

0.1

-0.3 Dec

0.4

9.4

+3.8

Macedonia, FYR

10,466

2.4

+4.1

+3.4

5,066

-3.1

-4.6

-0.5 Dec

1.3

27.9

+0.7

Moldova

8,126

2.4

+5.6

+3.4

2,284

0.0

-6.2

+4.7 Jan

3.9

3.3

+12.7

Mongolia

12,207

+7.0

+7.5

4,069

0.0

-12.5

+10.7 Dec

9.9

6.4

+14.8 2013

Montenegro

4,547

2.7

+3.5

+3.0

7,334

-0.2

-14.2

-0.3 Dec

1.8

15.1

-7.0

Poland

534,622

3.3

+3.0

+3.2

13,888

33.3

62.7

-3.6

-1.3

-0.5 Dec

1.0

12.1

+8.4

Romania

195,327

+2.6

+2.7

9,794

-2.0

-0.9

+5.4 Dec

1.9

6.4

+3.1

Russia

2,109,358

0.6

0.0

-3.8

14,421

-0.5

3.2

+15.0 Jan

6.3

5.3

+3.9

Serbia

42,095

-1

-1.6

0.0

5,890

7.9

31.8

60.3

0.0

-5.4

+1.8 Dec

4.9

17.6 Sep

-5.3

Slovak Republic

98,069

2.4

+2.4

+2.5

18,090

3.1

30.8

-3.0

1.1

-0.1 Dec

1.0

12.5

+0.7

Slovenia

48,051

2.6

+3.2

+1.8

23,262

2.8

28.9

68.3

-5.4

5.9

+0.1 Dec

1.3

9.7

+0.1

Tajikistan

9,019

+6.7

+5.8

1,105

0.0

-2.1

+7.4 Dec

3.6

2.5

+7.1

Turkey

843,173

2.8

+0.4

+3.3

10,852

-1.3

-6.1

+8.2 Dec

7.7

10.7

+2.6

Turkmenistan

46,371

10.8

+11.5

7,875

7.2

24.4

68.4

0.0

0.2

+6.0 '13

5.3

Ukraine

162,881

-8.2

-5.3

-2.3

3,792

12.0

-9.2

+24.9 Dec

-0.1

9.5

-17.9

Uzbekistan

60,828

7.6

+8.1

+7.1

1,995

19.1

32.2

48.7

1.3

3.9

+11.2 '13

7.0

4.9 (2013)

+8.1

Sources: World Bank; CIA Factbook; CEIC Data; Statistical Office of the Republic of Slovenia; Central Bank of the Republic of Kosovo; Bloomberg; Finanzen; S&P: CapitalIQ; IMF: WEO October 2014; UNESCO Institute for Statistics; InFinancials; EuroStat; Trading Economics; International Labor Organization; Asian Development Bank; National Statistical Committee of the Republic of Belarus

*All data are latest available official figures or independent estimates

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bne March 2015

I 81

New Europe in Numbers

FINANCIAL INDICATORS

SOCIAL Total market cap., all publicly traded equities

Stock market

Literacy

Tertiary edu.

Month

12-month

Ytd

52-wk low

52-wk high

P/E

Latest $mn

YoY %$

YoY % local curr.

% adults

% pop.

Albania (-)

96.8

55.5

Armenia (-)

99.6

Azerbaijan (-)

99.8

20.4

Stock market index

Belarus (-)

99.6

62.6

Bos/Herzegovina (SASE)

-1.7

-0.4

-1.5

677.3

738.1

98.2

37.7

Bulgaria (SOFIX)

-4.6

-8.5

-4.4

494.0

622.9

6.3

4,914.2

-7.5

+3.9

98.4

91.4

Croatia (CROBEX)

-0.6

-2.2

+1.5

1,644.3

1,930.3

n.m.

19,125.6

-11.1

+1.0

99.1

64.1

Czech Republic (PX)

+6.2

-3.5

+6.7

901.3

1,046.1

23.3

26,411.7

-11.8

-5.5

76.6

Estonia (OMXT)

+9.3

+3.1

+12.8

729.0

856.6

2,046.7

-20.3

-5.1

99.9

27.9

99.7

61.6

+12.0

-12.8

+10.2

15,686.7

19,300.5

n.m.

13,436.3

-26.1

-12.2

99.4

59.6

-5.3

-10.9

-12.0

826.5

1,312.8

14.3

13,791.2

-30.8

-18.9

99.7

44.5

Kosovo (-)

41.3

Kyrgyzstan (-)

99.2

Latvia (OMXR)

+0.6

-11.1

+3.8

405.5

480.9

5.5

987.1

-26.1

-12.0

99.9

73.9

Lithuania (OMXV)

+3.4

+3.9

+4.6

478.3

428.3

11.7

4,114.8

-7.2

+4.1

99.8

65.1

Macedonia, FYR (MBI10)

0.0

+7.8

-0.5

1,586.1

1,877.0

259.3

-80.6

-79.7

97.5

40.1

Georgia (-) Hungary (BUX) Kazakhstan (KASE)

Moldova (-)

99.1

38.4

Mongolia (MSETOP)

-5.5

-16.8

-6.4

13,856.2

17,243.7

98.3

Montenegro (MONEX20)

+3.0

+17.2

+2.1

9,665.6

12,610.1

98.4

61.1

Poland (WIG)

-0.1

+2.5

+1.9

49,520.9

55,636.8

13.0

161,526.6

-14.0

+1.5

99.7

73.1

Romania (BET)

+2.1

+10.3

+3.2

6,135.6

7,278.0

8.9

20,979.1

-10.3

+6.2

98.6

51.5

Russia (MICEX / RTS)

+19.9 / +23.9

+13.3 / -43.3

+28.0 / +20.1

1,237.4 / 629.15

1,673.9 / 1,421.07

11.8 / 8.7

551,334.0

-30.7

-9.2

99.7

76.1

Serbia (BELEXLINE)

+1.1

+15.8

-0.2

560.0

706.6

3,278.5

+4.0

+30.8

98.2

52.3

Slovak Republic (SAX)

+15.1

+24.0

+14.4

202.9

254.7

35,650.5

+66..

+740.0

99.6

55.1

0.0

+12.9

+0.1

685.5

839.4

6,792.3

-1.0

+17.9

99.7

22.4

-2.8

+43.8

+0.4

61,189.2

91,412.9

12.8

209,992.6

+0.7

+7.9

94.9

99.6

69.3

Ukraine (PFTS)

+6.0

+26.8

+10.0

298.0

483.3

3.3

1,746.1

-95.2

-57.3

99.7

79.7

Uzbekistan (-)

99.5

Slovenia (SBITOP) Tajikistan (-) Turkey (XU100) Turkmenistan (-)

*Official figure or independent estimate

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I Events

bne March 2015

Upcoming events 2015 Russia Retail Forum 2015 (23 - 25 March) Moscow, Russia www.adamsmithconferences.com

Annual Investmet Meeting 2015 (March 30 - April 1) Dubai, United Arab Emirates www.aimcongress.com/en

Northeastern European Real Estate Awards (NEE Awards) (March 26 - 27) Minsk, Belarus www.europaproperty.com

European Bank for Reconstruction and Development (EBRD) 24th Annual Meeting of Board of Governors and Business Forum (May 14-15) Tbilisi, Georgia www.ebrd.com

The Banking Association for Central and Eastern Europe (BACEE) will hold the

30BACEE 30 BACEE ubileeB ankingConference J ubilee J BankingConference th th

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