bne Magazine September 2013 by Ben Aris

Inside this issue: Another Faina mess in Ukraine Will Hungary's newest airline fly? Serbia's man for all seasons September 2013 www.bne.eu

Should Ivanishvili stay or should he go? Special Report: Fund survey 2013

SHE SELLS SHELL COMPANIES OFF THE SEASHORE

bne September 2013

Contents

Editor-in-chief: Ben Aris (Moscow)

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Managing editor: Nicholas Watson (Prague)

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News editor: Tim Gosling (Prague)

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

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COVER STORY 6 The Insiders 8 She sells shell companies off the seashore 12 Perspective 13 Chart of the month

EASTERN EUROPE

CENTRAL EUROPE 24 Emerging Europe looks to infrastructure 25 Eurozone recession exit helps Central Europe out of its hole 27 Czechs set for early elections 29 Areva's appeals fall on deaf ears

14 Russia provokes a potash crisis

31 Will Hungary's newest airline Solyom fly?

17 Russia steps up trade war with Ukraine

32 A LOT for Etihad to swallow 33 A mix-up over vodka

18 Russia flirts with recession 19 Daughters of fortune Please direct comments, letters, press releases and other editorial enquires to editor@bne.eu All rights reserved. No part of this publication may be reproduced, stored in or introduced to any retrival system, or transmitted, in any form, or by any means electronic, mechanical, photocopying, recording or other means of transmission, without express written permission of the publisher. The opinions or recommendations are not necessarily those of the publisher or contributing authors, including the submissions to bne by third parties. No liability can be attached to the publisher for these comments, nor for inaccuracies, errors or omissions. Investment decisions or related actions taken on the basis of views or opinions that appear herein are the responsibility of the reader and the publisher, contributors and related parties cannot be held liable for these actions. bne is the property of bne Media Ltd · Reg number: HE 185230 · Michalakopoulou 12, 4th floor, Suite 401, P.C 1075, Nicosia, Cyprus · Postal address: Schluterstrasse 19, Berlin 10625, Germany

21 Another Faina mess in Ukraine 22 Rig tenders? Not Natftogaz again

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bne September 2013

Contents

SOUTHEAST EUROPE

EURASIA

SPECIAL REPORT

Finding a way forward after Ergenekon

Kazakhstan seeks extradition of fugitive banker

Fund survey 2013

Plugging the gap in Turkey

Kazakhstan sees bumper harvest

UPCOMING EVENTS

Destination: Serbia 45

Serbia's man for all seasons

Kazakh retail moves to the regions

Serbia avoids snap electionsâ&#x20AC;Ś for now

Cursed mine claims another deadbeat bank in Mongolia

A Balkan exodus?

Should he stay or should he go?

Yerevan's summer of protests

Life after Armavia

I The Insiders

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Export credit agencies step into the breach

Nicholas Watson in Prague Fred Hochberg, head of the US Export-Import Bank

olding court on the terrace overlooking the lush grounds of the American Mission in Prague on a sweltering August day, Fred Hochberg, head of the US Export-Import Bank, is in ebullient mood. Seated next to him is Danny Roderick, president and CEO of Westinghouse, the US nuclear company that's one the main reasons for Hochberg's visit to the Czech Republic. Westinghouse is in the midst of a battle with Russia's Rosatom to win the right to build two new nuclear reactors in the country, in a deal worth €8bn-12bn, and Ex-Im bank wants to play its part by offering low-interest loans to companies that buy American equipment and services. "What Ex-Im Bank is successful at is keeping a level paying field, so that when Westinghouse goes into the marketplace our product is evaluated on quality and technical merits, not on some extraordinary pricing package offered by some other government or state-owned agencies [like Rosatom]," says Roderick. Hochberg, fresh from being confirmed in July by the US Senate for a second term as president of Ex-Im Bank, presided over a banner year in 2012 - and 2013 looks like it could surpass even that. The bank’s overall financing in 2012 exceeded $35.7bn, backing $50bn of exports by US companies. Exports in the year continued their recovery from the depths of the global crisis in 2008, with US exports reaching a then record high of $188.7bn set in December 2012. This was then surpassed in June this year when US firms exported a record $191.2bn of goods and services, according to data released on August 6 by the Commerce Department, suggesting a better year in 2013. Exports of goods and services in the 12 months to June totalled $2.2 trillion, which is 41.5% above the level of exports in 2009. US exports have been growing at an annualized rate of 10.4% when compared with the same period in 2009.

With many parts of the global economy in the doldrums and weak banks constrained in the amount they can lend to large projects such as those for transport and energy infrastructure, that has opened up a lot of space for multilateral institutions and export credit agencies like Hochberg's. "Banks with the new Basel III requirements have a big disincentive to make long-term loans. These are projects that require vast amounts of capital and the financial crisis has changed the appetite of banks for long-term loans," Hochberg says. "We, however, are backed by the full credit of the United States government." "As such, Ex-Im also offers capacity… We did a large [liquefied natural gas] project in Saudi Arabia last year worth $20bn – it's very hard to assemble $20bn of financing. These

"I'm very proud of our default rate – last year it was $37m on a portfolio of $106bn" infrastructure projects have gotten so large and on such a scale that it requires a much broader portfolio of credit, much more a consortium to do the financing – and export credit agencies are being called upon more and more." For example, in May Ex-Im approved an approximately $500m direct loan to finance the continued development of the giant Mongolian copper/gold mine Oyu Tolgoi, which upon completion will generate approximately 30% of Mongolian GDP. But Hochberg is keen to stress that it's not all about big business – a nod perhaps to Republican criticism that the bank is little more than a slush fund for a few big companies. Justin Amash, a Congressional Republican, has proposed a

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bill that would shut down the agency’s financing activities after a year, then turn them over to the Treasury Department before closing Ex-Im Bank for good. "There are two groups of US exporters who are having a particular challenging time getting financing: small businesses and very large projects, and it's in those areas where we excel," he explains. "The share of Ex-Im's loans to small businesses is up about 90% since President Barack Obama was elected and I got into this job in 2009. We've done more small business loans in four years under President Obama than eight years under President Bush. I think we have strong record when it comes to small business." New markets In terms of countries, the trend is definitely toward the emerging markets. In the 12 months to June, among the major export markets (ie. those with at least $6bn in annual imports of US goods), the countries with the largest annualized increase from 2009 were Panama (+28.6%), United Arab Emirates (+23.1%), Russia (+22.6%), Peru (+21.9%), Chile (+21.4%), Colombia (+19.5%), Hong Kong (+19.2%), Argentina (+18.5%), South Africa (+18.3%) and Venezuela (+18.1%). Hochberg say his institution has identified about eight or nine key markets that US companies are having a difficult time finding financing to help local companies buy their products. "US companies are sometimes selling to countries that are hard to finance into," he says. "Kazakhstan, South Africa, Colombia – these are more difficult markets for banks to be comfortable in."

Given the bank provides loan guarantees to foreign companies in 178 countries that do business with US exporters, clearly default rates are a key factor, but it's incredibly low even in this difficult economic environment. "I'm very proud of our default rate, we report to Congress every 90 days and we're running about 0.3% on our portfolio," he says. "Last year it was $37m on a portfolio of $106bn." Looking ahead, Hochberg says he's optimistic about the prospects for the world economy and global trade. "The global economy is having some teething problems right now, but I think the medium-term prospects are quite strong. There's more people joining the middle class and this is going to fuel a huge and unprecedented investment in infrastructure: they want better healthcare, better education, power 24 hours a day – all those things that will drive growth. And the US will get its fair share of that."

Ex-Im Bank Total Authorizations 40 – Amount Authorized(in billions)

One lesson Hochberg says he learnt from his first term as president is that as important as those key markets are, equally important are key sectors that need financing to close the deal – for example, satellite technology, nuclear power, energy in general, large commercial aircraft, transport and mining. "So we try to fill the gap on products that are hard to finance and countries that are hard to finance."

$35.8 $32.7

35 – 30 –

$24.5

25 –

$21

20 – 15 – 10

$14.4

2008

2009

2010

2011

2012

Fiscal Year

"The financial crisis has changed the appetite of banks for long-term loans"

I Cover story

She sells shell companies off the seashore Graham Stack in Berlin

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Cover Story I 9

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he Moonies are famous for holding mass weddings, but Russia's parliament appears to have been the centre of a mass divorce earlier this year. In April, it emerged that about 30 of the 450 deputies in Russia's Duma had divorced in the two months prior to them having to submit their income declarations. The difference this year: a new law introducing a complete ban on the ownership of foreign assets and bank accounts by Russian state officials, and while Russian law does not require MPs to report changes in their marital status, it does require them to declare their spouses’ assets in their income declarations. The most famous MP caught up in the strange phenomenon was Vladimir Zhirinovsky, head of the nationalistic LDPR party. Zhirinovsky announced after divorcing his wife of 30 years, who last year's tax return showed had made over $4m, that: "We are still married in the eyes of the Church, but not according to the law." The world has dealt for years with sham marriages, but sham divorces are a very modern day phenomenon – a symptom of today's widespread use of offshore tax havens to stash ill-gotten gains and keep other assets out of the reach of the taxman. To combat this, which is costing countries around the world billions in lost revenue and infecting financial systems with dirty money, governments have vowed to crack down on shell companies, the key vehicles used for tax evasion and money laundering. Russia is particularly prone to the use of shell companies that are used to whisk money out of the country. In the 1990s, hundreds of billions of dollars left, and following the 2008 economic crisis this capital flight reappeared and is currently running at the rate of $6bn-7bn a month. The former governor of the Central Bank of Russia, Sergei Ignatyev, shocked observers when he said in February that illegal transfers out of the country had reached $49bn in 2012 – more than half of the entire

capital flight for that year – and “one group” was largely responsible. Ignatyev didn’t name names, but it is clear he was talking about government officials. Putin followed through in his state of the nation speech, telling the assembled Russian elite: “Don’t clap – you won’t like this,” before introducing the complete ban on the ownership of foreign assets and bank accounts by ministers, officials and the top management of state-owned companies. Russia's efforts chime with those being taken elsewhere. In the US, senators Carl Levin and Chuck Grassley introduced the “Incorporation Transparency and Law Enforcement Assistance Act” in the US Senate on

However, as Russia's sham divorces illustrate, people will go to extraordinary lengths to hide their wealth – ending the practice of using shell companies will take more than fine words and good intentions. And as bne's tracking of a "meister creator" of such shell companies shows, the G8 efforts to end corporate anonymity will fail, unless the scope of the campaign is extended to cover the operations of murky banks in places like Latvia and Cyprus. A shell in every Port-Louis The recent moves by Russia, the US and UK will probably raise false hopes that merely closing loopholes in corporate law will combat money laundering; experts say governments need to tackle the banks that generate such

"The secretive bank-client relationship in countries like Latvia, Switzerland and Cyprus seems the real motor behind the creation of shell companies" August 3. The bill is intended to close down the US as a jurisdiction used by unscrupulous businessmen, often of Eastern European origin, to set up shell companies. "Our states don't require anyone to name the owners of the corporations being formed under their laws, practically inviting people to misuse our corporations," Levin said, introducing the bill. That move comes after June's G8 summit at Lough Erne, Northern Ireland, where leaders, including US President Barack Obama, resolved to legislate so that, "Companies should know who really owns them and tax collectors and law enforcers should be able to obtain this information easily.” British Prime Minister David Cameron has subsequently launched moves to create a national register of beneficial ownership, intended to eradicate the widespread use of the UK to set up shell companies, as bne has reported on in detail.

shell companies in order to shift funds around for their secretive clients. Tellingly, Obama's original letter of 2007 that first tried to introduce a corporate transparency bill picked out Seychellesbased nominee director Stella Port-Louis as a flagrant example of corporate abuse. Obama pointed to how PortLouis featured as director of over 100 companies alone in tiny Wyoming. It was later revealed that she was also director of hundreds of shell companies in New Zealand. Port-Louis was the employee of a company incorporation firm located in the Seychelles called Lotus Holding Company. Obama then seemed remarkably prescient when, in early 2010, PortLouis featured as director of four New Zealand companies that were named as laundering funds from Mexico's Sinaloa narcotics cartel via Wachovia Bank. The story then grew wings after a plane stuffed with anti-aircraft missiles was

I Cover story

intercepted in Bangkok, en route from North Korea to Iran – and it transpired the plane had been leased by another New Zealand company, SP Trading, which was set up by the same service provider.

bne September 2013

Holding Company, and featuring her as nominee director, were all listed at the Riga address of a Latvian incorporation company called Financial Group Omega.

Later, in 2010, following the death of Russian whistleblower Sergei Magnitsky in detention in Moscow, details emerged of how a massive fraudulent tax rebate had been siphoned out of Russia via shell companies, including by New Zealand companies featuring Port-Louis as director.

According to the Latvian company database, Omega was owned and headed by Latvian citizen Marks Reckins, who is also listed in online sources as head of the Seychelles company Lotus Holding. Rigabased Omega offers customers shell companies with nominees in a range of jurisdictions, in combination with bank accounts at Latvian banks.

Journalists had a field day exploring the connections, and pinned the blame on the company service provider Geoffrey Taylor, eccentric founder of the GT

No surprise then that the criminal New Zealand companies that hit the headlines in 2010 later proved to all have bank accounts in the Baltics. For

"Experts say governments need to tackle the banks that generate such shell companies in order to shift funds around for their secretive clients" Group, who had set up the New Zealand companies. The story of the colourful, but allegedly criminal, South Sea selfstyled lord produced great copy, but dodged the question of how Australiabased Taylor sourced his secrecyobsessed clients from the northern hemisphere. That question was then answered when a massive leaked database of British Virgin Island databases, obtained and made available online in 2013 by the International Consortium of Investigative Journalists (ICIJ), pointed to a different story about Obama's favourite nominee director, Stella PortLouis – a story connected not to the South Seas and eccentric colonials, but to the Baltics and its murky banks. Rigged in Riga The leaked database to the ICIJ showed nearly 1,500 British Virgin Island (BVI) firms that had been set up by Port-Louis' Seychelles employer Lotus

all the media brouhaha, the leaked BVI database indicates Taylor may have been merely the supplier of New Zealand companies and some nominee directors to Reckin's Riga-based head operation, which worked directly for the Baltic banks and their clients. According to Latvia's regulator, the Financial and Capital Market Commission, around 23% of the Latvian banking sector's non-resident deposits are incorporated in the BVI, 14% in the UK, and single figures for Cyprus, Belize, New Zealand, Panama, the Seychelles, the US and Russia – pointing to huge demand for shell companies on the part of the banks' clients. "I have no interest in talking to journalists," Reckins confides to bne, answering a Latvian mobile number. Reckins apparently closed Omega in Riga in 2010, and Port-Louis was struck off as a Seychelles director. But she was later reinstated on appeal, and Reckins

now operates as Lotus Corporate Services in BVI, whose address of 3A Little Denmark Complex scores nearly 20,000 Google hits, many for dodgy business such as online pyramid investment scams – and, where visible, with Latvian bank accounts. Alpine scamming bne traced Reckins' activities and discovered they extend to another famous banking secrecy region besides the Baltics – to the Alpine countries, where shell companies are also de rigueur for clients, among whom are many wealthy businesspeople and officials from the former Soviet states. In 2009, Reckins registered a Swiss company called Lotus Corporate Services at Ville delle Scuele 34, Lugano. That was also the address of a tiny new bank called Aston Bank, founded in 2007. In December 2009, Aston Bank was raided by armed police, and the manager-shareholders bundled handcuffed into vans. In January 2010, its licence was withdrawn. Swiss financial regulators found CHF20m (€16m) was missing from the bank's capital, and tens of millions of Swiss francs of client funds had also apparently vanished. News magazine L'Hebdo established the funds belonged to Russian-Israeli oligarch Vitaly Malkin, apparently managed for him by Luxembourg banker Pierre Grotz. In 2010, Reckins joined the advisory board of another freshly minted bank – Valartis Bank in Liechtenstein, acquired and rebranded by the Swiss Valartis group in 2009, and headed by Gustav Stenbolt, a former fund manager in Russia. According to its annual reports, Valartis "specialised in providing advice for high net-worth families and institutional investors… from Russia to Turkey, the Middle East and the Far East." Andreas Insam, board member of Valartis Liechtenstein, tells bne that the advisory board, on which Reckins serves for free, is "only a marketing tool to get closer to the bank’s markets," and that the bank has no relationship to Reckins' Lotus Corporate Services.

bne September 2013

Cover story

In early August, documents linked to a Liechtenstein money-laundering investigation were leaked to Maltese paper Il-Torca. The Liechtenstein investigation traced assets at Valartis that were linked to exiled Kazakh oligarch Rakhat Aliev, former son-inlaw of Kazakh President Nursultan Nazarbayev, who was accused in Kazkhstan of abducting two bank managers in 2007 before fleeing into exile. According to documents seen by bne, just under €10m in cash was anonymously paid into the Valartis account of Aliev's Panama offshore called Plotin Associated on it being opened in late 2007. According to sources cited by Maltese paper Il-Torca, which originally obtained the documents, the account swelled to around €212m before Plotin Associated was dissolved in 2012. Valartis said it could not comment on any client. Next generation Underscoring the central role of banks and their agents in generating demand for

mass-produced shell companies, a leaked audit of stricken Cyprus banks in April estimated that a whopping 75% of all accounts at the banks had been opened at the bank by "introducer structures", ie. company service providers like that of Reckins, which set up offshores together with bank accounts on behalf of clients. Such introducer structures conduct customer due diligence in lieu of the banks – one reason why banks love them. As a result, "customer business profiles are generally not properly established by Cypriot banks," found auditors Deloitte and Europe's anti-money laundering body Moneyval. Thus the secretive bank-client relationship in countries like Latvia, Switzerland and Cyprus seems the real motor behind the creation of shell companies around the world. Tightening up laws in UK and US, as Cameron and Obama propose, may simply prompt a search for fresh fields – and there are many. "Untraceable shell companies are in practice widely available,"

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

says Griffith University expert Jason Sharman. Offshore incorporators – including those who are agents for Latvian banks – are increasingly offering South African, Scottish and Canadian shell companies, and the cases of such companies implicated in East European dubious dealings are proliferating. Even squeaky-clean Denmark could become the "new New Zealand", according to market sources. In particular, the Danish equivalent of the UK's notorious Limited Liability Partnership (LP) – the kommanditselskab, or K/S – is being touted as the next hot thing, potentially providing anonymity and tax exemption in a jurisdiction with spotless reputation. Jan Breum Eriksen, Danish representative of offshore incorporator Sovereign Group, pitching to Moscow businessmen, even points to loopholes he claims can make a K/S completely invisible to law enforcement – meaning corporate rot could soon become a depressing feature in the state of Denmark.

What you need to know

I 11

www.bne.eu

I Perspective

bne September 2013

company OMV Petrom is particularly noteworthy, because it is benefitting from both high oil prices and the continuing liberalisation of the domestic gas market.

Is Romania a new capital market superstar? Peter Elam Håkansson of East Capital

ince the financial crisis swept over Emerging Europe in 2008, Poland and then Turkey became the standout performers in an otherwise struggling part of the world. However, with the gloss coming off Poland as its economy stutters and Turkey from the fallout from the antigovernment protests, Romania appears a good candidate to take their place. After Romania and Bulgaria became EU member states in 2007, the process of change in these countries has continued at a rapid pace. Romania in particular is a country we like to visit often during our travels to the region. There are several reasons for that. The first is that the country’s economy is doing relatively well. The International Monetary Fund (IMF) has recently adjusted up expectations for this year and next year’s economic growth to 2.0% and 2.2% respectively. The low budget deficit (the target for this year is 2.4% of GDP) and low public debt (38% of 2012 GDP) are key ingredients for that strong economic performance. Supporting this is a new IMF/EU/World Bank stand-by loan deal agreed on July 31 worth €4bn. This is now the third loan that Bucharest has obtained from these institutions since 2009.Under the present agreement, Romania has committed to reducing its structural deficit from 2.7% of its GDP in 2012 to 1% of its GDP in 2015. The other reason is the resolute fight against corruption, with several leading politicians having been arrested and convicted in court. A third reason is the strong performance of large companies on the stock exchange. Romanian

But the most important thing for us as financial investors is the country’s impressive plan for privatisations, with the Romanian state listing the companies on the stock exchange as a step in the process. Regular readers of our newsletter know that we often emphasise how important a functioning capital market is for a country’s growth. The superstar when it comes to capital markets in Emerging Europe has been Poland’s Warsaw Stock Exchange for many years now. But it looks as if Romania and the Bucharest Stock Exchange have decided to give the Poles a run for their money. Well-stocked Why is this happening now? There are two primary explanations. One of them is that Fondul Proprietatea, a large fund that is a part-owner of many public sector companies, is pushing to bring visibility to the values in its portfolio and IPOs are the best way to do that. The other is that the IMF is heading in the same direction, ie. is encouraging the privatisations of several companies. So far this year, a large investment in shares has taken place in the form of a secondary share offering, which involved shares in Transgaz, an operator of the domestic pipeline system for gas. We are also expecting the green light in the coming days for an IPO of Nuclearelectrica, Romania’s nuclear power company. In addition, an IPO is being planned this year and next year for Romgaz, Romania’s largest gas producer, and Hidrolectrica, which produces nearly all of the country’s hydropower.

"If all of these IPOs go through, the Bucharest exchange will attract lots of attention from investors" If all of these IPOs go through, the Bucharest Stock Exchange will attract lots of attention from many international investors. It is already attracting a lot of attention, because the market is also benefitting from the investor trend of seeking out frontier market investments, and Romania is classified as such a market. For those of us at East Capital, Romania has for many years been one of the countries in Emerging Europe we give the highest priority to, not just a destination we enjoy travelling to. In light of the trend we are seeing at this time, there is a good chance that this will be the case in the future as well. Peter Elam Håkansson is a founding partner of East Capital

Perspective I 13

bne September 2013

CHART:

New shores

he September issue of bne's magazine is all about shell companies and tax havens, and the chart here shows how quickly money can switch from one to another in today's shadow financial system. According to data from the Central Bank of Russia, financial flows from the country to Cyprus – the favourite destination for Russian money, both legal and illicit – remained fairly stable in the nine months of 2012, with little of any significance going to the British Virgin Islands (BVI), another notorious tax haven. However, as it became increasingly clear that Cyprus' financial system was headed toward an almighty crash,

money flows from Russia began dropping off in the fourth quarter of 2012, falling to about half in the first quarter of 2013. On March 16, Cyprus agreed a €10bn bailout deal with the European authorities, though then tried to institute a one-off bank deposit levy of 6.7% for deposits up to €100,000 and 9.9% for higher deposits, a move later overturned, as well as strict capital controls. But that money had to go somewhere, and in the first quarter of 2013 the flows to the BVI jumped to $31bn from less than $5bn in the fourth quarter. St Kitts, another Caribbean tax haven, also had a big quarter, picking up just over $1bn in Russian investment, its largest quarterly flow in two years, according to the central bank data.

Where is Russia's offshore money going? Cyprus

British Virgin Islands

$31 billion

Q1 2012

Source: Bank of Russia

Q2 2012

Q3 2012

Q4 2012

Q1 2013

I Eastern Europe

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Photos: www.uralkali.com

Russia provokes a potash crisis Ben Aris in Moscow

id Russia just screw Belarus? In August, Uralkali, Russia’s biggest producer of the pink mineral fertiliser potash, suddenly pulled out of an eight-year sales partnership with Belarus’ stateowned Belaruskali and shook the global fertiliser market to its core. The collapse of the cartel will probably cut the cost of potash in half, and as one of Belarus’ biggest money earners could tip the already wobbly economy over the edge. Potash is seen as an essential fertiliser in many countries – especially China and Brazil – that can double crop yields and protect against disease. The Uralkali-Belaruskali partnership, known as the Belarusian Potash Company (BPC), exported millions of tonnes of the stuff around the world and the two companies together

controlled just over two-fifths of the global supply, giving it considerable pricing clout.

President Alexander Lukashenko cancelled BPC's exclusive right to export Belarusian potash.

But like any cartel it was prone to cheating and relations between the two sides became increasingly tense. As the Belarusian economy has slid towards the abyss, Belaruskali has been selling potash on the side to make a little extra cash. And last December Belarusian

"Following the issue of the decree, Belaruskali has made a number of deliveries outside BPC," Uralkali CEO Vladislav Baumgertner claimed. "We have repeatedly informed our Belarusian partners that such actions were unacceptable."

"We have repeatedly informed our Belarusian partners that deliveries outside BPC were unacceptable"

Eastern Europe I 15

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But the Russians have been doing the same; at the start of this year, Uralkali signed an independent agreement to supply China with 500,000 tonnes of potash, cutting the Belarusians out of the deal completely. Commoditisation The consequences of the break-up will have far reaching consequences for the sector. First of all the price of potash is likely to tumble by a quarter, turning what was an oligopolistic market into a straightforward commodity. Belarus earned $3.2bn from potash exports last year, which made up 7.1% of its total exports. As Belarus’ exports have already taken a beating thanks to the economic slowdowns in both Russia and the EU, a fall in potash prices to $300 a tonne by year-end that's being forecast by Uralkali will shave nearly $1bn off Belarus’ export revenues, something the country can ill afford at the moment. In the first quarter of this year, Belarus was already running a $2.4bn trade deficit, or 17% of GDP, compared with a small surplus in the same period a year earlier. Certainly the Belarusians are hopping mad. Belaruskali CEO Valery Kiriyenko has vowed never to talk to Uralkali again. “I will never cooperate with Uralkali… after what they had done,” Kiriyenko said on August 18 shortly after the bust-up was announced. “Maybe under another ownership... No way under the current policy.” The price of potash played a key role in the dispute. China was BPC’s biggest customer, but stockpiled potash last year and has failed to sign a new deal for this year, hoping to force the price down below $400 a tonne.

Russia steps up trade war with Ukraine

bne Russia imposed restrictions on all Ukrainian imports, the Federation of Employers of Ukraine claimed on August 14. The escalation of Moscow's trade war against its neighbour appears a bid to step up pressure on Kyiv to drop any ambition it has to move towards the EU. The Russian Customs Service has included all Ukrainian suppliers in a “risky” list of imports that are subject to stricter customs control, the Interfax news agency reported on August 14, citing the Federation of Employers of Ukraine. Beginning August 14, all Ukrainian suppliers to Russia are subject to customs control that will result in a delay in the flow of goods into the country by weeks or even months, the federation stated. The claim comes two days after local media reported that a list of 46 Ukrainian companies had been categorized as “risky”. That followed a July 29 ban placed by Russian consumer rights watchdog Rospotrebnadzor on Ukrainian confectionery producer Roshen. One of Ukraine's largest exporters, Donetsk-based steel producer Metinvest confirmed to Interfax that it has experienced tougher controls on its products at Russian customs since August 13. The move from Russia comes as analysts continue to wonder how Ukraine – struggling with dwindling reserves and increasing pressure on the local currency, the hryvnia – can stave off another crisis without caving in to the demands of either Moscow or Brussels in return for help. "The conflict comes at the worst possible time since pressure on the hryvnia usually escalates in early autumn," point out analysts at Concorde Capital. The backdrop to the dispute is a battle for influence. Ukrainian President Viktor Yanukovych has long been playing Russia and the West off against one another, with the general consensus being that the powerful oligarchs that back him don't want to see either strict EU oversight and transparency, or rapacious Russian competition for assets. However, that strategy appears to have run its course. Brussels has recently tried to up the ante. The EU has now said that Ukraine must sign off on a long-delayed free trade agreement in November, or the process will go back to square one. That would see any deal put back by years. However, the clear condition to reach an agreement is for Yanukovych to release jailed opposition leader Yulia Tymoshenko – a move the president is resisting. Russia is also turning the screw. The Kremlin demands Ukraine join the Customs Union that it set up with Belarus and Kazakhstan in 2010, and has been waging a low-intensity war via its dominance of the country's gas supply. The ace up its sleeve of the "take-or-pay" clause in the 2009 gas agreement that was negotiated when Tymoshenko was PM (and led to her jailing), which could cost up to $10bn.

Vladislav Baumgertner, CEO, Uralkali

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bne September 2013

Baumgertner told bne in an interview at the start of August that Uralkali would not drop its prices and simply scale back production if China didn’t agree to its prices. However, the game has changed now. Uralkali is now saying that it will follow a high-volume, low-price strategy. After the acquisition of potash producer Silvinit in December 2010 and

Belaruskali badly, it will also make several large potash deposits under development, mostly in Canada’s Saskatchewan province, economically unfeasible. Shares in some of the other leading world producers like Canada’s Potash Corporate have already tumbled on the news. Uralkali’s own shares fell by a quarter. “Their new sales strategy shocked me. It

"Why is the market dead? There is no bottom price" several new deposits under development that will bring total production to 14m tonnes a year out of total global demand for 60m tonnes, the Russian producer clearly thinks it can simply steamroll the competition. If Uralkali really goes through with its threat to radically shake up the whole potash business, then the new lower price levels will not only wound

also affected the consumer. Why is the market dead? There is no bottom price. Why should we buy today if tomorrow somebody will offer a lower price?” Belaruskali’s Kiriyenko said. Politics could also be playing a role in the row. Russia stepped in and bailed Minsk out in 2011 after a financial crisis saw the Belarusian ruble devalue by 65%. Moscow gave Minsk a $3bn loan

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under the auspices of the EurAsEC AntiCrisis Fund, but extracted promises for some major privatisations, including the sale of Belaruskali. Moscow is mad that President Lukashenko valued the company at about $25bn – equivalent to about 40% of the country's annual GDP – which is way beyond Russian estimates of its worth, essentially scuppering any takeover deal. Russia has been throwing its weight about in the region recently, starting a trade war with Ukraine in August among other things, as it grows impatient with its former vassal states to play ball. One of the consequences of the break-up of BPS and subsequent crisis is that Minsk would become more desperate for cash than ever just as the capitalization of Belaruskali shrinks dramatically. All said and done, Lukashenko would probably prefer to swallow his pride and go cap in hand to the International Monetary Fund for help before he would contemplate selling what he regards as the family silver to the Russians. Still, he has been backed into a tight corner now.

What you need to know

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bne September 2013

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Central Europe, it is still an early phase of recovery.”

Russia flirts with recession Ben Aris in Moscow

ussia never does things by halves. Before the global crisis of 2008, the talk was of an economy overheating. But the latest data showing second-quarter GDP grew just 1.2% from a year ago suggests the country is sliding toward recession and the government seems, at first glance, powerless to stop it. Russia today is a very different place from the boom years. Growth is well down from the 6-8% it was enjoying pre-crisis, and this year has been particularly disappointing. Russia has just turned in the sixth consecutive quarter of falling growth, meaning growth in the first half of the year was 1.4% versus the 4.5% in the same period a year earlier. And the 3.5% rate widely forecast for the whole of 2013 at the start of this year is now clearly unattainable. There is a lot of confusion over what is causing Russia’s deepening slowdown. Ongoing capital flight, currently running at $6bn-7bn a month, and pathetic levels of investment are big contributing factors. High interest rates and poor corporate borrowing are also slowing growth at the superficial level. Going a bit deeper, the lack of internal structural reforms and external drag

caused by the pan-European malaise are also serious drags on growth. If the causes are external, then despite the recent poor results the Kremlin should be buoyed, as an economic recovery in Europe seems to be gathering momentum. "There are more convincing signs of a GDP rebound [in Central and Eastern Europe],” Piotr Kalisz of Citigroup Capital Markets said in a note at the end of August. “In

If the causes are internal, then Russia watchers should also be encouraged. The Kremlin has launched, albeit halfheartedly, a major anti-corruption drive and on the same day he retook office, President Vladimir Putin signed off on a raft of administrative reforms designed to lift Russia from 120th place on the World Bank’s "Doing Business" index to 20th by 2018. Still, it will take several years for either of these reforms to have an impact. Whatever the mix of reasons, the economy appears to have just passed through the trough and is widely expected to recover in the second half of this year. Domestic demand growth accelerated in July, retail sales rose 4.5%, capital investment reversed its previous fall to gain 2.5% and inflation dropped to its lowest pace in eight months of 6.5%, down from a high of 7.4% in May, according to Rosstat. “July’s activity data for Russia points to a modest improvement in the economy at the start of third quarter... The data is encouraging, almost all indicators were much stronger than we expected,” Liza Ermolenko of Capital Economics said in a note at the end of August. "But although this supports our view that growth is likely to pick up over the

"It is still too early to speak of a recovery" Poland economic growth accelerated to 0.8% year-on-year (from 0.5%) and was in between our and consensus forecasts. Czech GDP increased by 0.7% quarter-on-quarter in the second quarter, just a tick above below our forecast, which helped to reduce the pace of contraction to 1.2% year-onyear. More importantly this was the first quarterly expansion in the Czech Republic since mid-2011. Finally, Hungarian second quarter GDP grew by 0.5% year-on-year, slightly falling short of our and market expectations (0.6%). While growth is picking up in

coming months after the disappointing first half of the year, it is still too early to speak of a recovery." What is not clear is how strong the economic recovery will be, nor how fast that recovery will gather momentum. Russia’s critics are dismissive of both the anti-corruption campaign and the Kremlin’s ability to push through meaningful reform, so they forecast a lackadaisical performance. But what the naysayers miss is that, uniquely in Europe, much of Russia’s slowdown is a self-inflicted wound.

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Daughters of fortune

bne With Moscow about to vote for a new mayor this September, opposition blogger and candidate for the job Alexei Navalny is doing what he does best: exposing the sweet little earners that come from being well connected. In this case it is Anna Sobyanina the daughter of Moscow’s incumbent mayor, Sergei Sobyanin. Anna is a 25-year-old entrepreneur who founded the Forus Group, a nice little business that decorates offices with posh furniture. The thing is, when you scroll through the list of clients and completed projects it turns out they are exclusively government buildings in Moscow, St Petersburg and Khanty-Mansiysk - all places where her father happened to have served in government. Navalny goes on to point out that Sobyanin has a very plush 308-squaremetre apartment on Rochdelskaya Street in the heart of Moscow that is worth well over a million dollars. The trouble with this is that the apartment used to belong to the state and although it can be privatised, Russians are only allowed to privatise one state-owned apartment in their life. Sobyanin has already privatised one apartment in Tyumen, where he used to work. "The apartment on Rochdelskaya Street is either government housing, which cannot be privatised, or it is obtained for public lease [for free] ahead of the queue, which is possible if Sobyanin is an orphan, suffers from epilepsy or a hurricane blew away his Tyumen apartment," Navalny wrote on his blog. It doesn’t end there. Two weeks after daughter Anna’s 25th birthday, she bought a 204-sqm apartment in the heart of St Petersburg that Navalny estimates is worth RUB116m ($3.5m) now - or just over four-times what Sobyanin officially earned in total over the last ten years. "How does the 25-year-old daughter of a civil servant, whose maximum salary for the last 10 years was RUB27m, come to have an apartment worth RUB116m? Perish the very thought that Civil Servant Sobyanin gave this magnificent apartment in the center of St Pete’s as a gift to his daughter for her 25th birthday,” Navalny wrote. Not that anyone in Russia will be surprised by this revelation. Kseniya Sobchak is Russia’s best-known "It girl" and thought to be worth a bundle. When police raided her apartment after she appeared at an opposition rally they found over a million dollars in cash in various currencies. How she amassed her fortune is unclear, but she also happens to be the daughter of the former mayor of St Petersburg, Anatoly Sobchak. Navalny’s allegations would be enough to cause a major scandal in the West, but Sobyanin is almost certain to walk away with a first round win in the Moscow mayoral election and Navlany will have done well if he gets over 13% of the vote. For world-weary Muscovites, it's just another case of plus ça change, plus c'est la même chose.

bne September 2013

High interest rates, spending cuts While other European countries have been forced to slash interest rates to almost zero and push up their debt levels to unsustainable levels to finance spend-to-grow policies, Russia has kept interest rates high, cut real spending for the first time in two decades and left its cash mountain of reserves largely untouched. Russia has forgone the policy of throwing money at the economy that passes for a rescue strategy on the rest of the Continent and an option long since exhausted by most of Europe, because Russia’s financial policymakers believe it would only create bubbles or drive up inflation. The goal of this policy is not to boost growth, but improve the long-term health of the economy. Unlike any other European country, Russia’s $500bn cash pile and massive borrowing capacity gives it unrivalled spending power, but perversely it is now that the authorities have chosen to introduce a “fiscal rule”, which in effect ties spending to historic oil prices and so sets revenue targets, rather than guessing what the price will be in the next year. The upshot of this accounting change is that government spending has been cut in real terms for the first time in two decades, when previously it was growing by at least 20% a year since about 2000. Likewise, while the rest of the central banks in Europe have been forced to slash rates to next to nothing, the Central Bank of Russia (CBR) has flummoxed repeated predictions of a rate cut and kept interest rates high at 8.25%, being more concerned with bringing inflation down than boosting economic activity. Inflation is falling now and the CBR will probably start cutting rates from the September policy meeting, but even then it is highly likely to cut in small 0.25-percentage-point increments.

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needed to keep the weaponry out of the hands of Somali rebels. The crew finally walked free after five months' captivity.

Another Faina mess in Ukraine Graham Stack in Kyiv

wo maritime scandals involving Ukraine shipping companies unfolded at the end of July, featuring one import consignment of cars with a surfeit of parties claiming ownership, and an export consignment of armoured vehicles apparently still in search of a willing owner. The events point to how Ukraine's weak rule of law disrupts relations with potentially lucrative trading partners. In the last week of July in Libya's eastern city Benghazi, three leading politicians were assassinated, 1,200 prisoners escaped jail after riots, and two car bombs ripped through the city – but the biggest headache for 25 local Libyan businessmen were apparently unscrupulous Ukrainians. According to the businessmen, in March the Ukrainian-owned cargo ship Faina was transporting a cargo of 600 Hyundai, Kia, and Toyota vehicles from the Jordanian port of Aqaba to Benghazi. After proceeding through the Suez Canal, the ship mysteriously veered off course and vanished – only to reappear at Ukraine's Black Sea port of Illichevsk, near Odesa, where it has remained ever since.

The Libyan businessmen rushed to Odesa and hired lawyers, only to have their worst fears confirmed – according to documents supplied to Maritime Bulletin and confirmed to bne, the entire ship's cargo had already been sold for $20m to a Ukrainian one-man company registered in Odesa called Alco Invest, by a Panamanian offshore vehicle called Wellgos PQ. The cargo ship Faina, and its owner Odesa-Israeli businessman Vadim Alperin, are no strangers to controversy.

This time round, it is again Alperin's crews who are taking the brunt of the dispute – on July 17, the infuriated Bengazi businessmen seized what they believe to be another of Alperin's ships, the Etel, which had docked in Benghazi, and barricaded the crew of 19 in their quarters. Emergency diplomacy then kicked in to control the situation, with Ukraine acknowledging the linkage to the Faina's missing cargo. "Whatever the motivation of the attackers, it does not justify the use of force against people, intimidating them and endangering their lives and health," Ukrainian Deputy Prime Minister Konstatin Hryschenko said August 1, during a visit to Tripoli to conduct talks on the issue. Carjacked Back in Ukraine, the battle for the cars is now being waged in courtrooms. "Alperin, as shipper of highly sensitive state weapons consignments, is very well connected in Ukraine and can fight his corner," renowned investigator Mikhail Voitenko of Maritime Bulletin tells bne. Voitenko was involved in mediating the Faina controversy in 2008, and then fled his native Russia in 2009 after breaking the story of the mystery ship Arctic Sea, apparently hijacked in the Baltic Sea, and suspected of carrying a secret

"The entire ship's cargo had already been sold for $20m to a Ukrainian one-man company registered in Odesa" In 2009, the ship's name hit world news when it was seized by Somali pirates – and revealed to be carrying a shipment of 33 Soviet-made T-72 tanks, ostensibly bound for Kenya, but in reality for government of South Sudan, then still part of Sudan and subject to arms embargos. Frantic activity was then

Russian arms cargo. "According to the Libyan side, Odesa police initially acted correctly in launching an investigation of the cargo at their request, but then the General Prosecutor's office intervened from Kyiv to take control of the case, and the investigation slowed to a crawl," Voitenko says.

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Alperin could not be contacted for comment.

Malgin, who also hold a majority stake in Belarus bank Minsk Transit bank.

According to bne's enquiries, the Libyans' claims are very credible, and show that major business structures may indeed be involved on the Ukrainian side, apart from the cargo shipper itself. Wellgos PX, the Panama company the Libyans claim fraudulently sold the car-cargo to an Odesa shell structure, is owned by three companies – Norwell Inc, Kenmark Inc. and Platinex Corp., all registered at the same address in the Commonwealth of

Intriguingly, Atlanta-M is not the only major Ukrainian car importer to have connections to the same obscure Dominican address. “International Business Group Limited”, also at Copthall 8, Roseau, owns an Odesa customs brokerage with the same name, which in turn owns two dealerships, ZS Avtoelit and Luks Avtoservis. The former company owns Odesa's main Audi dealership, Audi Centre Odesa South, according to

"The cargo ship Faina, and its owner OdesaIsraeli businessman Vadim Alperin, are no strangers to controversy" Dominica, a low-profile offshore haven in the Caribbean known to specialists for its extreme level of secrecy. The address of all three owners of Wellgos PX – at Copthall 8, Roseau, Dominica – is that of a company registration agent, Isla Offshore. According to the Interfax Spark database, about a dozen Ukraine companies have owners registered at the Copthall 8 address. Among these companies is major Ukrainian car importer Intercar Ukraine, the official Volkswagen dealer in Ukraine. Intercar Ukraine is a subsidiary of the Belarus-based company Atlant-M, which holds 37% of the Belarusian new car import market, and lesser shares of the Russian and Ukrainian markets. Intercar Ukraine is owned by Global Cars Corp., registered at Copthall 8, Roseau, and two major Atlant-M dealerships in Kyiv are linked to other offshores at the same address – Automotion Corp. and Prime Provisions Corp. "Atlant-M has no relationship to the incident with the Faina," the company assured bne. Atlant-M is apparently still owned by the trio who set it up in 1991, Sergei Savitskii, Oleg Khusaenov and Igor

Interfax Spark. The companies are run and believed controlled by prominent local businessman Evgen Deev. Deev declined to comment to bne. According to the Ukrainian embassy in Libya, as quoted by media, a Ukrainian court of first instance found in favour of the aggrieved Libyan merchants on August 1, and ordered the cargo to be shipped on to Benghazi. "Our sailors will be released as soon as the vehicle cargo arrives in Bengazi," an assistant to the Ukrainian ambassador in Libya told media August 2. But with strong Ukrainian business interests potentially likely to keep pressing their claims in the courts, it may be too early for Ukraine's long-suffering sailors to get their hopes up. Cracks in Iraq In parallel to the new Faina mess in Libya, a major Ukraine shipment of armour to Iraq was reported stuck on board its cargo ship for months, after Iraq refused to accept the allegedly defective consignment. A local Odesa news site quoted a source in the Odesa company White Wale Shipping on August 2 as saying that the SE Pacifica cargo ship had docked in

Iraqi port Umm Qasr in the spring, but the Iraqis spotted cracks in the bodies of the 42 APCs and refused to unload the cargo. Since then, online vessel trackers confirm that the SE Pacifica has been loitering in the northern part of the Persian Gulf – apparently fully loaded and unsecured – and the shipping company has not been compensated for its losses. As bne has reported, in 2009 Iraq agreed to purchase $560m worth of Ukraine-built APCs and Antonov An-32 planes, but the deal hit the rocks after power in Ukraine changed hands in 2010. The original contract envisaged around 20% of the sum to be paid out in commissions, roughly half to Iraqis, and half to Ukrainian "lobbyists" incorporated in UK, Singapore and BVI, apparently linked to the former management of state arms exporter Ukrspetseksport. But the company's new leadership, closely linked to the ruling Party of Regions as of 2010, was apparently loath to make the payments as planned, to either side. The Iraqis had consequently shown increasing reluctance to accept deliveries under the contract, under the pretext of real or imagined defects in the equipment. In 2011, it appeared that deliveries had started moving again, but the apparent plight of the SE Pacifica points to renewed problems. In a sign of panic about the deal, on July 11 Ukrspetseksport got a new acting CEO, Oleksandr Kovalenko. Kovalenko had been first deputy head of Ukrspetseksport in 2004-2010 under former president Viktor Yushchenko and thus part of the old guard who set up the deal in 2009. In the spring of 2010, as the former management was removed root and branch, he went into semi-retirement – and his return now looks like a last gasp attempt to get the deal back on the road, perhaps by bringing the original Ukrainian "lobbyists" back on board. Kovalenko is believed to be currently in Iraq in talks. Ukrspetseksport declined to comment to bne on the shipments, citing confidentiality.

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Riga Shipyard, owned by Ukraine-born Vassily Melnik, had no prior experience of building or repairing offshore rigs, but Naftogaz touted the company's victory in the tender of October 2011 as a triumph for transparency. "Journalists had every chance to observe the entire process of the tender and to personally convince themselves in the transparency of the decisions taken at all stages,” Naftogaz CEO Evgen Bakulin announced at the signing ceremony for the sale on November 2, 2011.

Rig tenders? Not Natftogaz again Graham Stack in Kyiv

Norwegian firm has revealed its subsidiary Standard Drilling directly sold an offshore drilling platform to Naftogaz in 2011 for $220m, contradicting claims by the Ukrainian state-owned oil and gas company that it acquired the rig for $400m from Latvia's Riga Shipyard via an open tender. The discrepancy will revive allegations of corruption at Naftogaz. In a presentation recently uploaded to its website, the Norwegian financial company Ferncliff lists the buyers of all the rigs divested by Ferncliff subsidiaries, including Standard Drilling. Until now, only one buyer for a Ferncliff rigs had remained undisclosed – that of Standard Drilling's B319 rig. Standard Drilling said in September 2011 it had been sold to an "undisclosed buyer incorporated in the UK". Now parent company Ferncliff has revealed that the rig was sold while still under construction to Naftogaz for $220m, after having ordered it from leading Singapore producer Keppel Fels in December 2010 for $179m. The CEO of both Ferncliff and Standard Drilling, Martin Nes, declined to comment to bne. The disclosure may indicate that Ferncliff now regards the

mystery UK buyer to have been an agent of Naftogaz. Naftogaz held a tender for the procurement of a drilling rig in October

The transparency feted by Bakulin derived from the victory of a genuine foreign shipbuilding company in the tender, rather than an anonymous offshore shell company as is so often the case. Riga Shipyard owner Melnik personally attended the signing ceremony, accompanied by Latvia's current economy minister, Daniels Pavluts. “The decision taken to attend the ceremonious signing of agreement (took) into account that this is one of the biggest tenders Latvian companies have ever won abroad, with significant positive impact for the Latvian economy,” Pavluts tells .

"Ferncliff's declared payment of $220m from Naftogaz for the rig clashes sharply with Naftogaz's payment of $400m for the same rig to Riga Shipyard" 2011, in which it acquired the same B319 rig for $400m from Riga Shipyard. Naftogaz had declined to respond to enquiries about the discrepancy within three days of asking, citing the need for extensive security checks before it could release information pertaining to the tender. Smoke and mirrors Ferncliff's declared payment of $220m from Naftogaz for the rig clashes sharply with Naftogaz's payment of $400m for the same rig to Riga Shipyard, and is likely to revive allegations of widespread corruption in procurement at the state company.

According to unofficial minutes of Riga Shipyard's shareholder meeting held in May posted on the internet, which have not been confirmed by the company management, Melnik acknowledged that Riga Shipyard had itself sourced the B319 rig from a broker, for $393.3m. “We didn't build this rig. We bought the rig from a broker that was trading this platform, already existing. Our work was only engineering work… and the reconstruction in Turkey when the platform legs were assembled – this was a unique task, which no one performed before us. And for this work we received €5m. I consider this a very good result – primarily because we gained great

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experience in engineering,” he told the shareholder meeting. But according to sources, the Latvian shipyard played no role in the engineering work performed in Giresun, Turkey in the fall of 2012, when the rigs' legs were reinstalled after transiting under the bridges of the Bosphorus. Rather, the work was performed by the Singapore rig manufacturers Keppel Fels and its subsidiary Caspian Shipyard, two local Turkish companies, and a rig crew supplied by Naftogaz offshore unit Chornomornaftogaz, according to site manager Salih Fidan. Nor did the tender victory have the stimulating effect hoped for by Latvia's economy ministry. According to Melnik, the Latvian company booked around $7m in profit on the $400m transaction. But to the chagrin of Riga Shipyard's minority shareholders, the monster transaction stayed off the company books, making it impossible to verify Melnik's words. The rig deal was implemented through a special-purpose UK subsidiary, Northsale Logistics. Riga Shipyard sold the subsidiary five days before the end of 2012, which, according to Latvian legislation, absolves it from mandatory consolidation on the parent company accounts. "We believe the transaction with the drilling rig was largely a fiction," leading minority shareholder in Riga Shipyard, Linards Baumanis, tells bne. Tragedy then farce Naftogaz's purchase of the controversial drilling rig in October 2011 from Standard Drilling repeated an equally controversial tender in March 2011 for an offshore rig, as a result of which Naftogaz acquired an identical Keppel Fells rig, B312, also for $400m – but this time from a shadowy UK vehicle, Highway Investment Processing. The B312 rig had been previously owned for a brief time by Norwegian offshore driller Seadrill, which disclosed its sale for $248.5m in April 2011 to an "undisclosed buyer incorporated in the UK." In an interview with in 2012, Seadrill's then chief financial officer Esa Ikaheimonen, who has since left the company, acknowledged that Seadrill

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had sold its rig to the UK company Highway Investment Processing. Ikaheimonen and Seadrill's vice president, Jan Olav Osthus, told bne that Seadrill had had no contact with Ukrainian state officials or state company executives during sale talks. But according to enquiries, a team of rig engineers from Chornomornaftogaz – Naftogaz's offshore drilling unit – headed by chief rig engineer Vladimir Perminov inspected Seadrill's rig at its drilling location in Myanmar in March 2011, before the deal with Highway Investment was closed. Perminov posted photos of the visit on his social network page. Following an outcry when details about the tender leaked out in the press, Naftogaz ordered an audit by oil service giant Halliburton of the total cost of the ex-Seadrill rig, to justify the price tag of $400m. According to the audit, as seen by bne, beside the original purchase price of $248.5m for the rig, the $400m included the total cost of the operation to remove and then reassemble the rig's legs for Bosphorus transit at $71m, with another $21m paid for a helicopter, $16.4m for winterization, $15m for dry tow and $16m for an electric line unit. None of these expenses was foreseen in the original tender and contract, as seen by bne, where point of delivery of the rig was specified as Singapore. Highway to the underground While Naftogaz countered corruption allegations regarding the first tender by flourishing the Halliburton audit, enquiries indicate that Highway Investment itself functioned as part of a Ukrainian money-laundering platform, or "conversion centre". bne tracked down a payment made to Highway Investment entirely unrelated to the massive $400m drilling rig deal. This was a payment of €270,000 in November 2010 made to Highway Investment by a unit of regional plant Zhitomir Cardboard Plant (ZKK), to purchase an offset printing press from Germany. But no delivery ever took place, and the payment was flagged up by Ukraine's Ministry of Economy as a violation of foreign currency regulations, with an ensuing court case. According to documents seen

by bne, obscure Lugansk businessman Pavlo Dvulichanskii held power of attorney for Highway Investment Processing. Tellingly, Dvulichanskii features as owner and director of another company receiving payments from ZKK, Lugansk company PP Oriens. According to court proceedings, Lugansk tax police regard Dvulichanskii's PP Oriens as “a member of a single financial-industrial group that was created for the provision of tax minimisation services, for the conversion of funds (into cash), and for the creation of VAT credits to reduce VAT payments – ie. a money-laundering platform or "conversion centre" that receives wired funds from clients under fictive contracts and returns them as "black" cash. The symmetrical dubious payments by ZKK to two companies where Dvulichanskii features as director, Oriens and Highway Investment, indicates that Highway Investment was part of the same “single financial-industrial group” as Oriens. Independent paper Ukrainskaya Pravda later investigated another Lugansk company, Lugpromstroisantekhmontazh, named by tax police as being part of the same "single financial-industrial group" that was also receiving suspicious payments from the Zhitomir plant ZKK. The newspaper traced payments made to the company by numerous politically connected firms – including those linked to President Viktor Yanukovych's 129-hectare estate at Mezhgirya near Kyiv. The Latvian bank – Trasta Komercbanka – where Highway Investment banked has been previously linked in court cases to funds flowing from suspected moneylaundering platforms in Ukraine. The bank is also linked via business partners to Ukrainian gas oligarch Dmytro Firtash, who is regarded as a patron of Ukraine's energy minster at the time of the controversial tenders, Yury Boiko. The bank denies any connection to money-laundering. In December 2012, Latvian police announced they had opened a money-laundering investigation in connection with the Highway Investment rig acquisition.

Eastern Europe I 23 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

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What you need to know

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

I Central Europe

bne September 2013

Emerging Europe looks to infrastructure Nicholas Watson in Prague

urope may be in the doldrums, though large infrastructure projects, crucially backed by multilateral lenders and export credit agencies, look set to give Emerging Europe's economies a fillip over the next couple of years.

motorway operators and sell off the country's shipyards.

"The outlook for infrastructure projects is better, definitely we've seen a better start in 2013 and that will continue in 2014," says Werner Weihs-Raabl, head of infrastructure finance at Erste Bank Group.

First is that the region's economies are, by and large, doing better than their western counterparts. The European Bank for Reconstruction and Development (EBRD) said in May it expects the eight economies of Central Europe to

"Romania and Croatia, for example, are building realistic projects; a few years ago it was rather castles in the sky," he says, referring to the large Romanian road projects of ComarnicBrasov, the Bucharest South-Ring Belt and Craiova-Pitesti, and the tender to monetize the debt of Croatian

The better outlook for financing and building infrastructure in Central and Southeast Europe is a combination of various factors.

experience average economic growth of 0.8% this year, while the eight in Southeast Europe will grow by 1.4% this year â&#x20AC;&#x201C; meagre, but still much better than further west. With Europeâ&#x20AC;&#x2122;s shrinking banks struggling to meet new capital requirements, asset managers, pension funds and insurers are now looking for new opportunities in infrastructure such as power plants, renewable energy, liquefied natural gas facilities, toll roads, railways and ports, which should

"Romania and Croatia, for example, are building realistic projects; a few years ago it was rather castles in the sky"

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provide higher stable, inflation-linked returns in this super low-interest rate environment. The withdrawal of banks from many infrastructure projects, which require much longer-term financing, has left a void that is being increasingly filled by multilateral lenders, notably the European Investment Bank (EIB), and other state-backed credit institutions. "These are projects that require vast amounts of capital and the financial crisis has changed the appetite of banks for long-term loans," Fred Hochberg, president of the US Export-Import Bank, tells bne during a recent trip to Prague. "We offer financial capacity for these infrastructure projects that have gotten so large… they require a much broader portfolio of credit, much more of a consortium approach to do the financing, and export credit agencies like us are being called upon more and more." The EU estimates Europe's infrastructure needs in transport, energy, and information/ communications technology at €1.5 trillion to €2 trillion between now and 2020, a good proportion of that in the new member states, which are suffering from decades of under-investment by governments and the private sector. The EIB, EBRD together with the World Bank have agreed on a plan to support economic recovery and growth in Central and Southeast Europe that includes more than €30bn of joint commitments for 2013-2014. Given the scale and number of infrastructure projects across Emerging Europe, relying on bank funding alone in this economic climate clearly won't be possible. One of the European Commission's ideas is to use EU budget funds and the EIB's recently bolstered balance sheet to attract more capital market financing into these long-term infrastructure projects. So projects are first funded in the bank loan market, then when construction is complete and revenue starts flowing in, institutional investors such as pension funds, asset

Eurozone recession exit helps Central Europe out of its hole

bne The Eurozone finally pushed its way out of recession in the second quarter. That saw growth – albeit fragile – return to the economies of Central Europe. As forecast on the back of improving industrial production and other data for April-June, the Eurozone economy saw expansion for the first quarter in seven. Mirroring the contraction suffered in the first three months of the year, the single currency area put in growth of 0.3%, reported Eurostat. Despite the relief of exiting recession at last, analysts warn that the recovery remains fragile. "The Eurozone will grow only modestly in the second half of 2013 before the pace picks up gradually in the coming years," forecasts Zach Witton at Moody's Analytics. "The main growth driver will be higher exports, particularly to the US and emerging economies. However, high levels of public and private sector debt in fiscally troubled countries, and slow progress towards banking and fiscal union, will weigh on the recovery." Of particular note for Central and Eastern Europe, the main driver of the improved Eurozone performance was strong growth in Germany and France. The German economy – which expanded 0.7% following a stagnant first three months of the year – dictates a huge chunk of the region's economic fate via its demand for exports. It was no surprise then that the Czech Republic also finally crawled out of recession – the country's longest-ever, matching the Eurozone's six quarters of contraction – to record a 0.7% economic expansion. The statistical office said that exports did most of the legwork, with investment and consumption both falling on an annual basis. Analysts at Komercni banka expect a slow but steady recovery from the recession, which wiped out a full 3.1% of the economy. "Industry conditions are slowly starting to improve," they note. "The hard-hit construction sector should start to stabilise slowly, helped by the postflood recovery. Finally, households should enjoy better times, too." Hungary had escaped its recession in the first three months of 2013 with 0.6% growth, so it was disappointing to see the country lagging this time around. Although the economy registered its first expansion on an annual basis for over a year, it could manage no more than 0.1% quarter on quarter. "As for the outlook," write analysts at Erste bank, "the picture is mixed. Although we expect car production to be better in July-August and beyond, poor export figures in May-June warn that other sectors of the industry are not performing well Summing it up, we stick to our view that there can be only a very low growth in Hungary this year (we currently see it at +0.2%). For 2014, we see growth at +1.2%."

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management firms and insurers can take on that debt using the capital markets. "Institutional investors are redefining their investment and risk diversification strategies," European Commissioner for Economic and Monetary Affairs Olli Rehn said in a speech at the turn of the year. "A return to infrastructure financing is clearly on the menu worldwide as international investors look for better return opportunities." For example, the world's largest asset manager, New York-based BlackRock, announced in November last year it was planning to start investing clients' money into European infrastructure projects, by offering debt and equity for new projects, as well as buying existing debt portfolios from European banks withdrawing from project finance deals. To gee this process along, the EIB and European Commission launched this year the "Project Bond Initiative," whose first deal at the end of July was €1.4bn of bonds from Spain’s private sectorowned Castor Gas Storage. The idea behind the scheme is for the EIB to make the deal more attractive to investors by providing credit enhancement in the form of a subordinated instrument ($500m in the case of Castor Gas Storage) to support the senior debt issued by the project company. "The success of [the Castor Gas Storage] deal highlights the demand that exists in the market and investors' increasing comfort with structures that provide the support necessary to help kick-start

capital market investment for large-scale strategically important infrastructure projects," says Charles Poole-Warren, finance partner at Allen & Overy, which advised Banco Santander, the global coordinator of the deal. Infrastructure investments are also proving increasingly popular among sovereign wealth funds. During a visit to Warsaw in April last year, Chinese Premier Wen Jiabao announced a plan to launch a $10bn fund to finance joint projects in infrastructure, high-tech and green energy in Emerging Europe. Weihs-Raabl says that where a project has good local support then "crowd funding – where a collective of individuals pool their money to fund civic projects that can't raise bank loans – is also an option. "We must find an alternative to just bank financing. With a power project, for example, you can use project finance initially, then when it's connected to the grid, then refinance it using other players," Weihs-Raabl says. There is some scepticism, however, about how much institutional money can actually find its way into these infrastructure projects. For example, many such investors look for fixed rates of interest, but project finance debt is mostly issued on a floating-rate basis. EU insurers will also from January 2014 be bound by the Solvency II Directive, which more strictly regulates the amount of capital that they must hold to reduce the risk of insolvency.

"There is some scepticism about how much institutional money can actually find its way into infrastructure projects"

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announced he would do on August 28. The election is expected to be called for October 25 and 26. Sorry saga The vote brings the curtain down on a particularly depressing period in Czech politics, even by the country's fairly low standards. The tawdry end to this parliament stands in contrast to how it all began when Necas was sworn in as prime minister on June 28, 2010. Then, he headed a three-party centre-right coalition of his Civic Democrats, TOP 09 and Public Affairs, which holding an 18-seat majority in the lower house promised to push reforms that had been stalled for years by a succession of weak and minority governments.

Czechs set for early elections Nicholas Watson in Prague

n August 20 a parliament that had begun three years ago with much fanfare about what the new Czech government with a solid majority could achieve, ended with a rare show of unity as it voted to dissolve itself, paving the way for early elections. The proposal to dissolve parliament was tabled by the three main parties and was backed by 140 legislators in the 200-seat Chamber of Deputies, exceeding the necessary three-fifths majority. The vote ends weeks of political turmoil since former prime minister Petr Necas was forced to resign in June over a bribery and spying scandal, a situation that was exploited by the new left-leaning president, Milo Zeman, to install his own "government of experts" â&#x20AC;&#x201C; or to its critics, "government of cronies" â&#x20AC;&#x201C; against the wishes of the parliament. Inevitably that government, led by

long-time Zeman ally Prime Minister Jiri Rusnok, lasted no longer than the five weeks it took for a confidence vote to be held, which it duly lost on August 16. Zeman has been trying to

Yet it didn't take long for the sleaze, corruption, money-grubbing and infighting to begin, leading to an endless series of confidence votes over the years, all defeated but with everdecreasing certainty. The most notable policy of the government over the years has been its austerity measures pushed through by the bibulous former finance minister, Miroslav Kalousek. His fiscal consolidation drive won international plaudits for bringing down the budget deficit through a series of deep

"The vote brings the curtain down on a particularly depressing period in Czech politics, even by the country's fairly low standards" use the vaguely worded constitution to nevertheless keep the Rusnok government in power until the next scheduled elections in May 2014, but the August 20 vote has put paid to that. Under the constitution, early elections have to be held within 60 days of the president formally dissolving parliament, which he has since

spending cuts and tax hikes, moves that were rewarded by bond investors. In July, the rating agency Standard & Poor's promoted the country into its top 10 of the world's least risky issuers. However, it also led to the longest ever recession in the Czech Republic, with the country only crawling out of the slump in the second quarter when GDP managed to grow 0.7%.

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Vinyl redux A Czech vinyl record-producing firm decided in the late 1980s to stash its pressing machines in garages at the company's backyard rather than get rid of them – that decision is now paying dividends as vinyl makes a comeback. GZ Media, located in a small town near Prague, is now producing records for the likes of the Rolling Stones, U2, Bob Dylan and David Bowie, according to Reuters. Last Christmas, GZ Media made a special Beatles recording gift box approved by Paul McCartney and is now working on a special gift packaging of The Who discography. With 7m records made in 2012 and an expected 10m this year, GZ Media says it is the world's biggest vinyl record producer, making records for Universal Music Group, Sony Music and now Warner Music. Vinyl record production accounts for about 30% of GZ Media's sales, which reached CZK1.8bn (¤70m) last year. "Vinyl is an inscrutable animal," Jiri Hasek, the company's commercial director told Reuters. "Everybody is waiting for when the growth will slow, but instead it keeps accelerating."

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Despite Zeman's best efforts to put off snap elections, he and the opposition Czech Social Democratic Party (CSSD) – the party he led as PM a decade ago, before falling out with many of the current leadership – should be the main beneficiaries. CSSD is the overwhelming favourite to win the upcoming election after the implosion of the ODS. In an interview with Reuters on August 20, CSSD leader Bohuslav Sobotka said his party hoped to win the support of a third of all voters and then form a single-party government most likely supported by the Communist Party (KSCM). "It is definitely possible to expect negotiations with KSCM. It can be only KSCM or it can be more parties [that will support a minority government]," Sobotka was quoted as saying. However, Sobotka stressed CSSD would not invite the Communists, who oppose Nato membership, to enter a coalition government with them. "We are proponents of European integration and we are proponents of our membership in the Nato. The Social Democrats do not intend to accommodate the program of the Communist party in any way," he told Reuters. Whether Sobotka will be the new PM will depend much on Zeman, who dislikes him intensely and is pushing to rebuild influence within CSSD. The populist president – who, alongside predecessor Vaclav Klaus, has lurked over Czech politics for close to two decades – pledged to increase the powers of his office after he was swept

into Prague Castle in the country's first ever direct presidential election in January. He has spent the months since carrying out a campaign to do just that, hacking away at the vulnerable Necas government and, some suspect, even having a hand in the scandal that brought him down. With his "government of experts" now discarded, few doubt he will attempt to reassert his influence over CSSD, pushing Sobotka aside (perhaps making him finance minister) and then installing his own man at the top. The Czech Republic, argue some critics, is rapidly heading toward becoming a quasi-presidential political system with little or no constitutional debate. In terms of polices, the centre-left CSSD will roll back the austerity measures and look to kick-start the economy by boosting spending on infrastructure and housing with the help of EU money. Nevertheless, Sobotka has pledged to keep the budget deficit below the EU-prescribed limit of 3% GDP and make sure the country meets all the criteria to adopt the single currency. To square the circle that will mean tax rises, among them, says Erste Bank: the reintroduction of progressive taxation of personal income and thus the abolition of the flat tax rate; higher taxation for small unincorporated entrepreneurs; special taxes and/ or tax rates for specific sectors (telecommunications, banks, energy companies), 30% has been floated; and higher corporate tax income for all companies, from 19% to 21%.

"Sobotka stressed CSSD would not invite the Communists to enter a coalition government"

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However, this is not the only problem for CEZ's nuclear tender. On July 23, CEZ was forced to admit that its goal to pick a winner and sign the contract by the end of 2013 is unlikely to be met because of the spectacular collapse of the centre-right government in June over a spying and bribery scandal. Now the final contract might not be signed until the autumn of 2014, said Pavel Cyrani, a CEZ board member. Into the political vacuum has stepped President Milos Zeman, who since assuming the presidency in March has repeatedly thrown constitutional caution to the wind, and over the objections of all the major parties in parliament installed a “government of experts” consisting of his close allies, some with dubious pasts.

Areva's appeals fall on deaf ears Nicholas Watson in Prague

he French nuclear firm Areva in July lost the latest appeal against its controversial ejection from the Czech Republic's giant nuclear tender, leaving it vowing to continue legal proceedings in the administrative court of Brno. The state-controlled utility CEZ disqualified Areva from the estimated €8bn-€12bn tender to build two new reactors at the Temelin nuclear power plant back in October 2012 over what it said were "serious shortcomings" in its preliminary bid. This left the Russian-Czech consortium of Skoda JS, Atomstroyexport and Gidropress duking it out with the Japanese-US firm Westinghouse. Since then, Areva has launched a serious of appeals against its exclusion that have all failed, with this latest one to the chairman of the Czech antimonopoly office (UOHS) being dismissed by Petr Rafaj, who said in a

statement he agreed with his office's initial decision in February that Areva had not met the tendering conditions. Areva responded in a statement that it "is resolute to defend its rights in all available instances and will now open legal proceedings against the UOHS decision in the Brno administrative court."

Zeman is a big advocate of nuclear power and has close ties to Russian business. While both he and Prime Minister Jiri Rusnok claim the new cabinet won’t make any decision on the nuclear tender, it's clear the president intends to use the vaguely worded constitution to keep his allies in power until the next scheduled elections in May 2014, leaving many to suspect that choosing a winner is indeed what will happen. For the remaining two bidders in the tender, Atomstroyexport and Westinghouse, it's business as usual. On July 25-26, Fred Hochberg, president of the US state ExportImport Bank, which lends money to

"Zeman is a big advocate of nuclear power and has close ties to Russian business" Sources have told bne that Areva has also already approached the European Commission about its concerns and could yet continue appealing the decision all the way to Brussels. That process could take years.

foreign companies that do business with American exporters, was in town, accompanied by the president and CEO of Westinghouse, Danny Roderick. In an exclusive interview with bne, Hochberg said the Temelin expansion "right now has got our full attention."

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"It's a very good time to go ahead with the Temelin project"

Financial backing from the likes of Ex-Im Bank is key to Westinghouse's bid. The economics behind Temelin have come under scrutiny, with many believing that without state support, such as through price guarantees for the electricity produced, the project is unviable. Rosatom, the Russian nuclear holding company of which Atomstroyexport is a part, has stated in the past it would even be prepared to offer full financing for the project. Roderick admits the political crisis is causing some unforeseen delays,

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

but that the main three reasons why the project was launched in the first place will still be there regardless of which government is in power. "There's the concern about long-term energy security; the concern about greenhouse gas emissions; and the concern about economic growth and jobsâ&#x20AC;Ś It may take a while more for the government issues to shuffle out, but at the end of this those same three things will still be present and that will drive the plan to go forward," Roderick tells bne. He adds that with interest rates at historic lows and a good buyers' market existing, this is the ideal time to press on with mega-projects like this. "Keep in mind that interest rates are going to go up in the future and when rates go up, so do the costs of supplies and materialsâ&#x20AC;Ś It's a very good time to go ahead with the project."

What you need to know

www.bne.eu

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world" by 2017. Emphasising its role as a traditional, rather than no-frills carrier, it envisages a fleet of 50 aeroplanes, comprising 20 regional, 20 narrow-body and 10 wide-body jets, by 2017.

www.planespotters.net

Will Hungary's newest airline Solyom fly? Kester Eddy in Budapest

olyom Hungarian Airways, a new and decidedly "patriotic" Magyar airline, is to take delivery of six leased airliners by the end of September, initially to fly between Budapest and major European capitals. The new carrier will also be seeking to re-establish Budapest's role as a hub for Eastern and Southeast Europe, the airline's spokesperson tells bne, though some question whether the whole venture will fly. Despite a massive increase in low-cost and traditional carriers flying to Budapest in the wake of the collapse of Malev, the nation's former flag-carrier, early last year, these new flights are overwhelmingly point-to-point operations, meaning the Hungarian capital has lost its hub function serving destinations such as Tirana, Chisinau, and the capitals of the Yugoslav successor states. "First we plan to fly major capital cities of the EU, especially major hubs like London, Paris, Frankfurt, Amsterdam, Rome, Brussels, Zurich and Stockholm. Then we would like to extend our destinations with Central-Eastern Europe, Mediterranean, Middle East and Gulf Region," says Solyom's Tamas Hevizi, director of communication.

Hevizi said he was "sure" that Solyom "can restore the positions of the former national airline, because we will have transfer connections which has been disappeared after Malev collapse. We have a strategic cooperation with

Asked for details, Hevizi says: "We calculated for start-up; AVRO RJ 85/100 regional jets, for narrow body we will use Boeing 737 Classic and Airbus 319/320/321 family. For wide body, Airbus 330 or Airbus 340 preferred." He added that "after 3 years," Solyom plans to replace its used fleet with "regional CRJ or Embraer 175/195, narrow body Boeing 737Max or Airbus 320/321NEO and Airbus 350." The list price of the fifty aeroplanes would total €4bn, he asserts. Questions of finance Quite how this operation will be financed, however, is far from clear. According to its press release, Solyom is currently owned by three Hungarian businessmen, chief executive Jozsef Vago, Robert Hurtyak and Janos Lucsik. The airline also said it has concluded agreements with two strategic investors, an unnamed "tourism enterprise,"

"They may be cheap to buy or lease, but I wouldn't start an airline today with those aircraft" Budapest Airport which has the biggest potential in Central and Eastern Europe." The nascent carrier said it would take delivery of six Boeing 737-500 aircraft within the next two months via a "multi-year" lease contract with a company called European Aviation Limited (EAL). Solyom – the name means "falcon" in Hungarian, although the airline prefers to translate the word as "hawk" – has ambitious targets. In a press release issued on July 24, it revealed ambitious plans to fly to 31 destinations this year, expanding to 51 in 2014 and fully 96 destinations in 55 countries "around the

registered in Muscat, Oman, and a "well-capitalised investor with extensive international relations, registered in Dubai, UAE… with… financial resources necessary for the development of the airline." Hevizi declined to reveal any further financial details to bne. If successful, the new carrier would provide a huge boost to Budapest, re-establishing the city as regional centre with excellent flight connections. However, the reaction among air professionals has bordered on incredulity – hardly surprising given that Hungary's ailing economy was unable to support Malev, which at the time of its demise was operating just 22 aircraft

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A LOT for Etihad to swallow

bne Fresh from securing a deal to take over Serbia's JAT Airways, Etihad Airways is reportedly now in advanced talks with the Polish government over the sale of a large minority stake in LOT Polish Airlines. Warsaw needs to offload the struggling flag carrier before it is forced to act on threats to let it sink or swim. Reports that the United Arab Emirates airline was sniffing around its Polish counterpart emerged in early August. Then unnamed sources confirmed to Aviation Week on August 9 that negotiations with the Abu Dhabi-based Etihad are already at an advanced stage. However, they also noted that it could be several months before any deal is reached. Both airlines refused to comment, while the Polish Ministry of Treasury would say only that "seeking an investor for LOT is in progress." Should the deal in Poland go through, LOT would be the fourth European airline in which Etihad holds equity. It has stakes in Ireland's Aer Lingus and low-cost carrier Air Berlin, and on August 1 it agreed to take a 49% stake in the newly christened Air Serbia for $40m plus another $60m investment. A sale would be a godsend for Warsaw, which like many other European governments has been trying to find a strategic investor for its national airline for some time. With the crisis hitting demand and high oil prices sending fuel bills skyrocketing, like many of its regional peers LOT has seen years of losses. Last year it had predicted it would be back in the black, but ended with a Â¤38m loss. The government has been forced to prop the airline up with hand-outs for years, but said late last year that it would not allow it to become a "bottomless pit". Despite that pledge, allowing LOT to sink would clearly be an unpopular move politically for a government that has seen its approval ratings sink in recent months. LOT CEO Sebastian Mikosz confirmed on August 5 that he has applied for another loan, which should be handed over next month. Penned in by EU rules on state support, LOT joins other European airlines in facing a bleak future without finding a partner ready to buy a significant stake. With European airlines mostly struggling, the main candidates are found among Middle Eastern and Asian operators seeking a European hub. However, EU rules prevent majority ownership in its airlines from outside the bloc. Turkish Airlines was close to buying LOT last year, but backed off at the last minute, reportedly due to that rule. The two sides of the equation appear to be adapting. Next door, the Czech Republic agreed a deal to sell 49% in Czech Airlines to Korean Air earlier this year, though gave it management control, a similar arrangement to what Etihad agreed with the Serbs.

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and served some 50 destinations. Asked for his comments on Solyom, Jozsef Varadi, chief executive of Wizz, the regional low-cost carrier, said it would be "more profitable to sell sand in the desert than to start a new airline in the EU," according to Hungarian media. Eli Abeles, a London-based airline consultant, commenting on the initial choice of Boeing 737-500 jets, says "these are old, noisy and very fuel thirsty. They may be cheap to buy or lease, but I wouldn't start an airline today with those aircraft." The Hungarian media also appear to view the launch with suspicion â&#x20AC;&#x201C; the daily Nepszabadsag writing that the Hungarian transport authority had turned down Solyom's application for an air operator's certificate (AOC), an essential paper for commercial passenger flights. The authority would also examine the financial background to the airline, the paper wrote. Solyom said that none of its applications has been rejected by any authority so far. In another twist, European Aviation Limited, a UK-based company, failed to respond to an emailed enquiry by bne asking for confirmation of the leasing deal announced by Solyom. According to its website, EAL has just three B737500s available for lease. Abeles, however, noted that any leasing deal with European Aviation might mean Solyom planned to "piggy-back on the EAL air operator's certificate," although such a cross-border arrangement would be "unusual," he added. Solyom, which expects to take on between 700 to 1,000 employees this year, says it would be recruiting staff from August 1. "The Hungarian Conquest is just beginning as you read this. The registration mark on the first airplane is HA-SHA... named after the Grand Prince of the Magyars, Ă lmos, who was the first head of the Hungarian tribes. Others will follow very soon," the press release concluded.

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On August 2, SPI said it is "very optimistic" that there would be a breakthrough in talks with the activists advocating the boycott. "We have been active in setting the records straight – that we stand on the same side and that we hate to be associated with the attitude and actions of the Russian government on this issue," the company told AP in an email.

A mix-up over vodka Tim Gosling in Prague

atvian gay rights groups on August 1 called on US counterparts to drop a boycott of Stolichnaya vodka, claiming they've got their geography wrong. With Russia's draconian laws against homosexual "propaganda" the target, gay rights groups in the US are running a spreading campaign to stop bars serving Stolichnaya, with publicity stunts including pouring the vodka into the gutter. However, Latvian gay rights group Mozaika has joined forces with SPI Group – the Luxembourg-based company that owns the brand – to point out the famous tipple is these days made in Latvia, not Russia. Although one of the most widely recognized "Russian" vodka brands, Stolichnaya is actually produced by Latvijas Balzams, the pair sought to make clear in a press release. Nearly 90% owned by Luxembourg-based SPI Group, Latvijas Balzams is described as employing 600 and being one of Latvia's largest exporters. That doesn't of course prevent SPI claiming on its website that: "Today

we are the biggest exporter of Russian vodka in the world – and one of the most successful groups in our home country." At the same time, it insists that ingredients for the vodka are sourced in Russia, while the label on the bottle features a picture of a famous Moscow landmark – the recently re-built Moskva Hotel. Still, Mozaika complained in a statement that the action is misdirected. "This campaign will only harm Latvia, Latvia's economy and employees of the company Latvijas Balzams." "Latvia was under Soviet occupation for over 50 years," Mozaika board member Kaspars Zalitis wrote in a post on the group's Facebook page, lamenting that many foreigners still mistakenly consider the small Baltic nation to be part of Russia, according to the LA Times. "Latvia is a proud member of the European Union and is striving to be an open, democratic country. We would kindly ask you to reconsider your actions in regards to 'Dump Stoli! Dump Russian Vodka!' as this campaign will only harm Latvia, Latvia's economy and employees of the company Latvijas Balzams."

However, US gay rights campaigner Queer Nation contended to AP that SPI remains an appropriate target for a boycott. "Though the company claims to be friend to our community, it was silent as the Russian government considered this horrific law, and it said nothing after the law was enacted," it said in a statement. "Stolichnaya only spoke up after the boycott was announced." SPI is controlled by Yury Shefler, a Russian-born billionaire who left the country a decade ago. The press release claims his exile began after he fell out with the Kremlin over his support of opposition political parties, and his opposition to just the kind of official prejudice exhibited in the new law targeting gays. Indeed, Shefler left Russia in 2002. However, his flight also came in the midst of a tussle that's still ongoing with the state over SPI's rights to 43 vodka brands, including Stolichnaya. With the state claiming the trademarks were acquired illegally – as many assets were in the 1990s – the reputed billionaire was charged with threatening to kill a former deputy agriculture minister who led Moscow's crusade. Russia continues to fight SPI for the Stolichnaya trademark. In July 2012, the Court of Appeals at The Hague confirmed that Shefler did not operate in good faith in obtaining the trademarks, and ruled that the rights to the brands Stolichnaya and Moskovskaya belong to the Russian Federation. SPI is reported to be appealing the finding.

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Finding a way forward after Ergenekon David O’Byrne in Istanbul

here are few surprises in Turkish politics these days and the guilty verdicts handed down on August 5 to 254 of the 275 suspects in the trial of senior former army officers alleged to have been plotting a coup against the Justice and Development Party (AKP) government of Prime Minister Tayyip Erdogan certainly were not among them. The five-year trial which has bitterly divided Turkish society resulted in full life sentences handed down to the former commander of the Turkish military Ilker Basbug, and 18 others including six other senior generals, other senior military officers, journalists, bureaucrats and laywers. Other journalists and writers, bureaucrats and politicians were among those receiving shorter – albeit still long by any standards – sentences.

Charges against those found guilty centred on the alleged existence of a clandestine ultra-nationalist organisation known as "Ergenekon," which held hidden supplies of weapons and money that it was alleged were used to further illegal activities including propagandising against, and plotting the overthrow of the government of Prime Minister Tayyip Erdogan.

• those who support the government and believe the charges against the defendants that they "belonged to" an illegal organization and were plotting to overthrow the government and hence, the verdicts and the sentences, are justified;

With the indictment alone running to close on 5,000 pages and the evidence sifted by prosecutors reported to extend to several hundred thousand pages, it's little wonder that most observers, and indeed most Turks, found the process contradictory and confusing.

• and those who strongly oppose the government and believe that the defendants are a random selection of people whose positions and/or views have brought them into conflict with a government that has used a flawed legal process to silence them. And, importantly, even in any instances where the charges could be substantiated, the defendants were acting out of patriotism and in defence of their country.

Little wonder, too, that as a result opinion has broadly been divided into two camps:

Broadly, but not entirely. Anyone who has been following Turkish politics for any length of time

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cannot fail to have been aware of the mysterious force known as "deep state," which was allegedly behind just about every otherwise inexplicable event in the country. Or of the fact that the military had organised full-on tanks-on-the-street coups in 1961, 1970 and 1980, as well as allegedly being the instigator of 1998's so called "post-modern coup." For that reason, many who share no ideological or religious ground with the AKP were in favour of the initial stages of the Ergenekon investigation, because it promised to shed light on some of the darkest moments in modern Turkish history: the murders, extrajudicial killings, disappearances, drug smuggling, money laundering and a host of other illegal activities of the 1980s and 1990s, and which have to date largely eluded official explanation, but have left lasting scars. However as the investigation broadened in scope, dragging in many whose connection with the core allegations was at best tenuous, many began to question whether the focus had shifted from a criminal investigation to a broader pursuit of the more vocal, and perhaps powerful critics of the governing AKP. There were also worries about the alleged involvement of exiled Turkish cleric Fetullah Gulen, whose organisation is viewed by its critics as itself shady and "clandestine," and whose supporters are alleged to have infiltrated the police force and judiciary and who were – until recently at least – rumoured to have considerable influence in Ankara. This "mission creep" has led to a blurring of lines, with many who initially supported the investigation uneasy with its results. "When I look at the trial politically I support the results, it has helped the democratisation and normalisation of Turkey, but when I look judicially I think there are some problems," says Oral Calislar, columnist on Turkish daily Radikal, who as an influential left-wing commentator has

Plugging the gap in Turkey

bne Turkey's current account deficit, the economy's Achilles heel, narrowed to a seven-month low in June. However, the full-year figure is still likely to come in above the government's target. The current account gap shrank to $4.45bn in June, a far better performance than the $7.3bn in May, central bank data released on August 15 showed. The result beat a forecast of $5.1bn by a Bloomberg survey, and approached the $4bn or so it stood at a year ago. Analysts say the improvement was down to the impact of the Gezi Park protests, the foreign exchange adjustment that is cooling domestic demand for imports, and increased output in the services industry. Recognising the issue as the economy’s biggest vulnerability, Prime Minister Recep Tayyip Erdogan’s government managed to reduce the shortfall to about 6% of GDP last year, from above 10% in 2011. As such, the narrower deficit in June should be cause for celebration. However, a wider look at the figures shows that with the June data included, the current account deficit totalled $35.9bn in the first half of the year. That's $5.9bn higher than in the same period of 2012. "The year-end expectation [for the current account deficit] in the Medium-Term Program is $60.7bn," Economy Minister Zafer Caglayan said in statement. "We're already past half of this amount. For now, it seems like the data will come slightly higher than the Medium-Term Program estimation." While he believes the current account deficit this year will be lower than the consensus of $55bn-60bn, Tim Ash of Standard Bank suggests it will still be very high by historical comparisons. It will also be difficult to finance, given the weight of short-term debt falling due, resistance by the central bank to higher interest rates, and a weaker lira. "Over $160bn in short-term external debt falls due over the next year, putting the gross external financing requirement up at around the $210bn mark, huge both by historical and peer group comparisons," he notes.

"The trial doesn't bring anything new, there is still the split between the İslamic and the secular people"

I Southeast Europe

bne September 2013

long been at odds with Turkey's ultranationalist right and who was himself jailed after both the 1970 and 1980 coups. "And as a human being, I would never want anyone to spend so many years in a prison cell," he adds. Unease with the process is even evident among those normally viewed as supporters of the current government. Writing on the Middle East news website Al Monitor, Turkish commentator Mustafa Akyol, himself a former columnist for the Gulen-owned Today Zaman newspaper wrote: "It certainly would be wrong to condemn the whole case, and disregard that it helped put the nail on the coffin of Turkey's dark era of military coups. But it also arguably put some innocent people in jail." What now? With the verdicts announced, all eyes are on the appeal court and on the

possibility of some or all the sentences being overturned or shortened. Commenting on the case, Turkish President Abdullah Gul expressed his "sadness" at the conviction of General Basbug, pointing out that the two had worked together for several years and noting that the judicial process is not yet complete. Prime Minister Erdogan, however, has perhaps predictably taken a far sterner line, both praising the verdicts and slamming the leaders of the two main opposition parties for their criticisms of both the trial and the verdicts, describing their criticism as itself "a crime." These comments only seem to underline recent criticism that Erdogan's "style" has become increasingly, and worryingly, authoritarian â&#x20AC;&#x201C; the more so in the wake of the protests which wracked the country through June and July.

outspoken critics have gone further, warning that while the trial may have ended the threat of military intervention in Turkish politics, it has not improved the quality of Turkish democracy. True believers in Turkish democracy have no wish to see a return to the days when the armed forces repeatedly "came out of the barracks." But now they fear that military hegemony over their country has simply been replaced by AKP hegemony," wrote Cenk Sidar, owner of the Washington-based consultancy Sidar Global, in Hurriyet Daily News. He is not alone in fearing that something is missing from the process. "It [the trial] doesn't bring anything new, there is still the split between the Ä°slamic and the secular people," says Oral Calislar. "What we need is compromise and conciliation, that would offer a way forward."

According to Akyol, the trial has helped to further polarize Turkish society. More

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

What you need to know

www.bne.eu

bne September 2013

Southeast Europe

I 37

managed to outstrip any other Southeast European country in 2011 (except Turkey), including EU members Bulgaria and Romania.

Destination: Serbia Nicholas Watson in Belgrade

t was a good week for the Serbian economy: a day after the prime minister attended a July 31 ceremony to break ground on a new $35m Cooper-Standard auto component plant, the deputy PM was shaking hands with the head of United Arab Emirates airline Etihad over a €40m deal that will save JAT Airways from the same fate as some of the region's now-defunct airlines. The JAT deal is a particular coup for the coalition government and its largest member, the Serbian Progressive Party; the previous Democratic government made two unsuccessful attempts to sell the loss-making airline in 2008 and 2011, and with several other airlines in the region either bankrupt, most notably Hungary's Malev, or in danger of going that way, finding a saviour was a top priority. The deal is essentially the same as that which saved another regional airline, Czech Airlines. To get around EU rules on ownership by foreign entities, Etihad will have only a 49% stake in the newly-christened Air Serbia, but have management control. James Hogan, head of Etihad, told reporters that Etihad will invest some €40m. Deputy PM Aleksandar Vucic, the powerful head of the Progressives, boasted to bne in an exclusive interview that it was his strong personal

relationship with UAE's prime minister, Sheikh Mohammed bin Rashid Al Maktoum, that finally secured the deal. "He is my friend, I met him in Scotland to seal the deal." However, the fact Etihad chose JAT over other flag carriers in the region, notably that of new EU member Croatia, probably speaks more about how Serbia has regained its position as the top destination for foreign direct investment (FDI) after years in the wilderness following the wars that accompanied the

That year saw the bulk of the €1.3bn investment from Italian carmaker Fiat in the rebuilding of the old Zastava plant in Kragujevac – a sector which accounts for the largest share, about 12%, of the nearly $25bn incoming investment since 2000. Fiat directly provides about 3,000 jobs in the ultra-modern plant that has the capacity to churn out 600 Fiat 500Ls a day. Though with the Serbia Investment and Export Promotion Agency (SIEPA) aiming to have 85% of components made locally, the number of associated jobs could dwarf that at around 10,000. Fiat's gamble to move a big part of its production to Serbia was a combination of several factors: the wage differential, a workforce with a long history in the auto industry (at its peak in 1989, Zastava produced 181,000 of the Yugo cars), generous tax incentives (an investment of €9m that creates more than 100 jobs will mean 0% corporation tax for 10 years), and free trade agreements with both the EU and Russia. In April, PM Dacic said Russian President Vladimir Putin had promised to allow customsfree sale of 10,000 of cars made in

"Serbia has the unique position that not only is it now an EU accession country, but it also has free trade agreement with Russia – so the best of both worlds" breakup of the former Yugoslavia and the independence of Kosovo. According to the United Nations Conference on Trade and Development's (UNCTAD) "World Investment Report 2013" released June 26, FDI into Serbia in the years 2007-2012 was $12.7bn, which is 25% of the total that flowed into the Western Balkans during those years. With $2.7bn in 2011, Serbia

Serbia, at a time when the Kremlin is putting pressure on car imports from other countries in a bid to protect and develop its domestic industry. "Serbia has the unique position that not only is it now an EU accession country, but it also has free trade agreement with Russia – so the best of both worlds," says Bozidar Laganin, director of SIEPA.

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Bumper harvests The second largest recipient of FDI at 11.5% of the total is the food, beverage and agriculture sector. Serbia is still very much a farming country, where the 6m hectares of agricultural land produces around 25% of the country's exports worth €4.5bn and accounts for one-third of the labour force. Some estimates put the potential of the sector at nearer €12bn a year.

ashamed when I compare the English ability of my German compatriots with those here in Serbia, and I put this down to the fact that Serbian TV is never dubbed, as it is in Germany," says Dirk Bantel, director of the plant, who is a German national. This language ability has also given rise to a growing service industry of call and service centres. NCR, a US computer hardware and electronics company that provides products and services around the world, has established one its largest centres in Belgrade, where 700 people provide services over the phone in seven different European languages.

Qatar, UAE, Saudi Arabia and China have been big buyers of land directly, though the value-added food processing industry has attracted a number of big name investors, such as Agrokor, Rauch and Nestle, as well as the international brewers Heineken, InBev and Carlsberg.

Ironically, the rise of this business has been put down partly to Serbia's relatively late arrival to the process of transition that had taken hold in the rest of Emerging Europe since the end of communism; the last remaining economic sanctions on Serbia were only lifted in 2008. "We were late to transition, which has created an opportunity as we will be a pocket of near-shoring for the next five to seven years," says Borsi Vujicic, chairman of the Belgrade-based outsourcing service company Trizma.

Electrical and electronics is a growing source of employment. Panasonic, which has a plant 110 kilometres outside Belgrade that makes components for the lighting industry, set up there because of the experience the company had with workers from the former Yugoslavia in its German plants, who it found worked hard and spoke excellent English – a trait many investors cited as a reason for setting up there, as well as the recent political stability and relatively cheap workforce.

Bandel says the average net salary at his Panasonic plant is €280 per month,

"Language is very important. I am

FDI by country (Ranking by number of projects)

which even though it's far above the monthly €188 minimum wage in Serbia (even less than China's €200), still offers a huge cost advantage to Germany, to where 100% of the components are shipped. This big wage differential goes a long way to explain why Serbian projects are among the most labour intensive in Europe, creating 132 jobs each on average, according to Ernst & Young in its "2013 European Attractiveness Survey" that was released in July. Nevertheless, the Balkan wars cast a long shadow and Serbia is still, despite the recent advances, handicapped by a negative image around the world, which will take many more years to finally shake off. Just 1% of the investors in E&Y's survey picked Serbia as the most attractive FDI destination in Central and Eastern Europe, worse even than Turkey's 2%, yet in reality the country scooped up 13% of CEE's FDI projects in 2012. "This glaring mismatch suggests these countries face perception problems among foreign investors," the report concludes. "The governments of Turkey and Serbia may need to do more to educate business leaders about the opportunities their countries offer."

FDI by country (Ranking by jobs created)

Rank Country

2011

2012

Change

Share (2012)

Rank Country

2011

United Kingdom

679

697

2.7%

18.4%

United Kingdom

Germany

597

624

4.5%

16.4%

Russia

France

540

471

-12.8%

12.4%

Spain

273

274

0.4%

7.2%

Belgium

153

169

10.5%

Netherlands

170

161

Poland

121

Russia

Change

Share (2012)

29,888 30,311

1.4%

17.8%

8,362

13,356

59.7%

7.8%

Poland

7,838

13,111

67.3%

7.7%

Germany

17,276 12,508

-27.6%

7.3%

4.5%

France

13,164 10,542

-19.9%

6.2%

-5.3%

4.2%

Serbia

13,479 10,302

-23.6%

6.0%

148

22.3%

3.9%

Turkey

7,295

10,146

39.1%

6.0%

128

0.0%

3.4%

Spain

9,205

10,114

9.9%

5.9%

Ireland

106

123

16.0%

3.2%

Ireland

5,373

8,898

65.6%

5.2%

Turkey

-2.1%

2.5%

Romania

5,985

7,114

18.9%

4.2%

Serbia

16.4%

2.1%

Slovakia

4,007

6,299

57.2%

3.7%

Finland

21.0%

2.0%

Czech Republic

5,168

5,508

6.6%

3.2%

Czech Republic

-3.0%

1.7%

FYRO Macedonia

3,040

4,670

53.6%

2.7%

Switzerland

-38.4%

1.6%

Bulgaria

2,680

4,379

63.4%

2.6%

Italy

-25.0%

1.6%

Hungary

5,237

3,941

-24.7%

2.3%

Others

669

569

-14.9%

15.0%

Others

19,834 19,235

-3.0%

11.3%

Total

3,907

3,797

-2.8%

100%

Total

157,831 170,434 8.0%

Source: Ernst & Young’s European Investment Monitor, 2013.

2012

100%

bne September 2013

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I 39

journalists on the terrace of a swanky restaurant on the bank of the Danube. That he even turned up is perhaps testament to how powerful he has become. While other ministers begged out of appointments as the fraught negotiations over a reshuffle of the threeparty coalition reached their climax, only hours after dumping finance minister Mladjan Dinkic and his small URS party, Vucic was relaxed enough to enjoy a three-hour boozy dinner of fish and seafood, while waving off aides trying to pass on desperate phone calls from the PM and other ministers.

Serbia's man for all seasons Nicholas Watson in Belgrade

leksandar Vucic adopts his gravitas mode: head thrust forward, speaking quietly in short, sharp, bursts of words, Serbia's politician of the moment wants everyone around the restaurant table to know that although he took the tough decision in April to abandon the Serbs in northern Kosovo, he still has their interests at heart. "We were not informed in advance," Vucic says of the arrest by the EU police force in northern Kosovo on July 29 of two Serbs suspected of the attempted murder of a local official, which promoted the inevitable rock-throwing demonstrations and road barricades. "It's not the way to build confidence and trust – how can we convince our people [in northern Kosovo] to ease the tensions and leave the barricades now?" Northern Kosovo is proving to be the crucible where Vucic's remarkable transformation from hardline Serbian nationalist to pro-EU, pro-free market libertarian has been played out to an international audience. In a marathon series of talks brokered by the EU, Vucic and his Serbian

Progressive Party achieved in April what has eluded the country since its erstwhile, ethnic Albanian-dominated province of Kosovo unilaterally declared independence in 2008: to get the pockets of Serbs in the north of the country to accept rule from Pristina. Belgrade still – like many other countries, most notably Russia – won't recognise Kosovo as a sovereign nation, but the normalisation of relations with Pristina proved to be enough for the EU to reward Serbia with a date to start talks about joining the bloc. Vucic described his May visit to northern Kosovo to explain his government's decision to the people there, virtually all of whom regard it as no less than an act of betrayal, as "one of the most difficult days in my political career." But for the powersthat-be in the European capitals, it was a supremely brave act from a 43-yearold who looks set to dominate Serbian politics for the foreseeable future. Power behind the throne Fluent in English from his time spent as an 18-year-old student living in London's Gloucester Road, Vucic regales, cajoles and lectures his audience of foreign

Vucic and his Progressives now rule with Prime Minister Ivica Dacic's Socialist Party. Even though Vucic modestly remains deputy PM, few doubt where the power really lies in the government. Does he want to become prime minister one day? He brushes off the question, airily saying his government has too much to do to think about such trifles. Indeed it does, given that Serbia has spent the best part of a decade as an international pariah since the Balkan wars of the 1990s and absent from the economic transition the rest of the region went though following the end of communism. But since the Progressives at its first attempt since splitting from the ultranationalist Radical Party in 2008 won both the presidential and the parliamentary elections in May 2012, the party has racked up a series of notable economic achievements to go with the political ones of Kosovo and a highprofile anti-corruption campaign that has already snared the country's richest oligarch, Miroslav Miskovic. Chief amongst them is foreign direct investment (FDI). So far this year, Serbia has pulled in €400m of FDI, with the central bank predicting the full-year total will exceed €700m. Part of that will be the rabbit out of a hat the government managed to pull by getting the United Arab Emirates' Etihad Airways to save the near-bankrupt JAT Airways (to be newly christened Air Serbia) with a $40m loan and a further $60m of investment in return for a 49% stake and management control.

I Southeast Europe

Serbia avoids snap elections… for now

Nicholas Watson in Belgrade The Serbian government looks as though it will continue through the end of the year, even after the departure of the smallest party of the now former finance minister Mladjan Dinkic. In a long drawn-out reshuffle of the three-party coalition, Serbian Prime Minister Ivica Dacic of the Socialist Party moved to oust Dinkic on July 30, angering the largest party in the government, the Progressive Party, though not enough to cause the coalition to collapse and force early elections. "I wanted to preserve the coalition, but Dacic didn’t want to," Aleksandar Vucic, deputy PM and the powerful head of the Progressives, told bne in an exclusive interview. The Serbian government announced August 15 that Lazar Krstic, an unknown 29-year-old Yale graduate currently employed at the consultancy McKinsey & Company, would take over as finance minister. Sources call Krstic "uber smart," though his lack of policymaking experience jars with the scale of the current economic problems that he will have to deal with, such as twin deficits, rising public sector indebtedness, the continued need for fiscal consolidation and deep seated structural reforms. Vucic refused to say why Dacic wanted to get rid of Dinkic, though clearly the Socialist PM shared little with the finance minister's fiscally conservative United Regions of Serbia party (URS). Many questioned why such a marginal party offering only 16 seats was given such a powerful portfolio in the first place. Without the 16 seats of Dinkic's URS, the coalition still has a slim majority in parliament. But his departure is unnerving for investors worried about Serbia's growing budget gap and public debt, which have all but buried hopes of a new precautionary loan deal with the International Monetary Fund. "I don't think Dinkic himself was absolutely central, but his participation and his party's participation in the coalition was important to counterbalance the centre-left Dacic," says Standard Bank analyst Timothy Ash. Dacic threatened he would pull his party out of the coalition if Vucic didn't accede to his demand, which would force early elections in a country that was only just beginning to enjoy a period of political stability in its turbulent history since former strongman Slobodan Milosevic was ousted in 2000. Vucic said he feels there is too much the current coalition can and needs to achieve – securing the recent agreement over Kosovo, stabilising the economy and securing that IMF deal – so is clearly minded to keep the PM happy. "It's not realistic to hold elections tomorrow," Vucic said. However, if new elections were held soon, the Progressives would be the overwhelming winner, perhaps even more so than in last year's election, in which this new party, an offshoot from the ultra-nationalist Radicals, won 24%. According to a recent Faktor Plus opinion poll, the Progressives had 40.9%, the Socialists on 10.6%, and URS at 4.6%, ie. less than the 5% threshold required to get parliamentary representation.

bne September 2013

Again Vucic was at the centre of this, claiming that it was his personal relatonship with the UAE's prime minister, Sheikh Mohammed bin Rashid Al Maktoum, that finally secured the deal. "He is my friend, I met him in Scotland to seal the deal." Given that Serbia has for some years now been retaking its place as the top investment destination in the region (in the years 2007-12 the total was $12.7bn), Vucic acknowledges that the previous Democratic Party regime of former president Boris Tadic deserves credit for rebuilding the country in the turbulent years after the fall of Slobodan Milosevic in 2000. "I can't say [the Democrats] didn’t do anything, it would be a lie – they did things, but not fast enough," he says. And that's the crux of Vucic: he's a young man in a hurry. His way of speaking, adopting a grave tone when mentioning Kosovo, declaring "I don't care" in a loud voice with a steely stare when asked whether the Serbian people might not sign up to the pace of change he's pushing, are all done in the manner of someone whose character formation is struggling to keep pace with his meteoric rise. Like an extremely tall, slightly baby-faced Travis Bickle practising phrases in the mirror. A former politician of the Democratic Party of Serbia (DSS) – the only nationalist party still left in the parliament – says he simply can't read Vucic. After all, this is a man who just a decade ago was the de-facto leader of the Radicals while Vojislav Seselj, his "political father", languished in a Hague prison cell on suspicion of war crimes. Vucic is disarmingly honest about how he, now President Tomislav Nikolic and 19 other radicals deserted Seselj to form the Progressives and embrace a European future for Serbia. “I was wrong, I thought I was doing the best for my country, but I saw the results and we failed, we need to admit that… We cannot remain trapped in the past," he says. That too sounded a little rehearsed, but you get the feeling it's also true.

bne September 2013

Southeast Europe

A Balkan exodus? bne

obs in Bulgaria are increasingly hard to come by, though even by today's standards the decision of the 54-year-old former prime minister Boiko Borisov to register as a professional football player in August is perhaps a bit extreme. Moving abroad to find a job, however, is not such a stretch â&#x20AC;&#x201C; something that's exercising the minds of people in the UK as the country prepares to lift restrictions on Bulgarians and Romanians living and working there from 2014. August saw the hysteria level over potential immigration from those countries reach a crescendo, as data from the Office for National Statistics (ONS) showed the number of Romanians and Bulgarians working in the UK rose by nearly 26% to 141,000 between April and June from 112,000 in the previous three months. The rise was 35% over the yearearlier period. Romanians and Bulgarians have had the right to come to the UK without a visa for seven years already, and at present they can work in Britain only if an employer has supported a visa, if they are self-employed or come on a temporary basis for tasks for which there is a labour shortage. The data was seized on by those who worry that the UK faces another wave of migration following the one experienced in 2004, when it threw open the doors to the new Central European members of the EU. Despite the government of the time insisting that migration from places like Poland would be moderate, over half a million Poles moved to the UK in the years after Poland joined the EU. They now make up around 1% of the population â&#x20AC;&#x201C; even more than Irish-born residents. Migration Watch UK, an NGO that campaigns for tighter controls on immigration, said the figures were in line with its estimate that net migration from Romania and Bulgaria would stand at about 50,000 a year for the

next five years. "We hadn't expected this early uptakeâ&#x20AC;Ś nine months before our labour market is open, and I think it does suggest that there's a good deal of interest in these countries in coming to work here," Migration Watch's chairman, Andrew Green, told the BBC. Picking fruit This reading of the figures is, unsurprisingly, disputed. Some of the increase is certainly down to the seasonal agricultural workers scheme, under which 21,250 Romanians and Bulgarians have been allowed to work on farms and in food processing for up to six months. The ONS figures include Romanians and Bulgarians doing this seasonal work in the UK for less than six months, unlike

I 41

in The Guardian. "But will the lifting of labour market restrictions lead to a sudden increase in immigration from these countries? It's simply not possible to say, and this latest data doesn't provide any answers to that question." A cross-party lobby group, Migration Matters Trust, reckons that the number of Romanians and Bulgarians who will arrive in the UK next year could be as few as 20,000. Migration Matters says its analysis is based on historical EU migration patterns, macro-economic factors such as the impact of the recession on the UK, and limited job opportunities in areas such as manual labour. Referring to an estimate of 1.5m arriving over five years cited by Godrey Bloom of the UK Independence Party, a rabidly antiimmigration party, Atul Hatwal, director of Migration Matters, accuses the antiimmigration lobby of crying wolf once too often. "Their claim is that as many as 300,000 new migrants will arrive from Romania and Bulgaria over the course of

"August saw the hysteria level over potential immigration reach a crescendo" the government's official migration figures which only include people migrating to the UK for at least a year.

2014. In truth we believe that figure will probably peak at around 20,000," Hatwal said in a statement.

The rest of the increase, it is postulated, could be down to people from Romania and Bulgaria arriving early in order to bag any work before others are free to do so from January.

"While it is likely there has been some rise in the numbers of Romanians and Bulgarians working in Britain, the scale of the rise and its value as a predictor of migration in 2014 following the end of transitional controls, is much more uncertain," he said.

Carlos Vargas-Silva, an economist and senior researcher at the University of Oxford who specialises in migration issues, says that while the data is certainly interesting, it doesn't provide any real evidence of what will happen after January 2014, it simply shows what is happening now. "Rather than showing that the new wave of immigrants has suddenly begun, what the data actually shows is that increasing immigration from A2 countries [those in the EU] has been taking place regardless of the labour market restrictions," he writes

What all agree is that the trend over time has been one of increasing numbers of Romanian and Bulgarians coming to the UK, regardless of the labour market restrictions. The government itself has so far refused to put a figure on the likely influx, clearly not wishing to repeat the mistake of the previous government, which was held hostage by its woeful underestimation of the numbers. Currently 96% of ministers are no doubt hoping that remains the case.

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bne September 2013

Kazakhstan seeks extradition of fugitive banker Clare Nuttall in Astana

azakhstan is among several countries trying to secure the extradition of fugitive oligarch Mukhtar Ablyazov. With months to wait until the French courts decide whether – and where – to extradite Ablyazov, his arrest and the deportation of his family have thrown the spotlight onto Kazakhstan’s justice system and Astana’s relationship with several European governments. Ablyazov, the former head of Kazakhstan’s BTA Bank, was arrested by French special forces at MouansSartoux, a village near Cannes, on the afternoon of July 31, following an extradition request from Ukraine. Kazakhstan issued its own request three days after the arrest. Although Kazakhstan does not have an extradition treaty with

France, Kazakhstani officials are still hopeful that they can obtain Ablyazov’s extradition. A spokesman for Kazakhstan’s prosecutor general’s office, Nurdaulet Suindikov, pointed out to a press conference on August 6 that there had been an increase in extraditions between Kazakhstan and EU member states despite the lack of a treaty, giving Astana hope that Ablyazov, who fled Kazakhstan in 2009, might stand trial in his home country. “[It] should be noted that recently there has been a positive tendency of extradition of accused persons from European countries on the basis of reciprocity, that is, even in the absence of bilateral agreements,” Suindikov told journalists. Meanwhile, Kazakhstan’s financial police, the Agency for Economic and Corruption-Related Crimes, said the

following day that it has launched eight new criminal cases against Ablyazov and his associates. If returned to Kazakhstan, he could face a prison sentence of up to 13 years. Bank bust Ablyazov left Kazakhstan for the UK shortly after BTA, Kazakhstan’s largest bank by assets before the financial crisis hit in 2009, was nationalised and put under the control of Kazakhstan’s sovereign wealth fund Samruk-Kazyna. BTA’s new management have been pursuing him through the British court system, launching a series of claims worth over $5bn through the English High Court of Justice in an attempt to recover assets they say were embezzled by Ablyazov and his associates. The Kazakh oligarch has been on the run since February 2012, when the UK

Eurasia I 43

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Supreme Court sentenced him to 22 months in prison for contempt of court and other charges. Ablyazov is believed to have escaped to France by coach, travelling on a false passport, and his whereabouts since then had been unknown. However, the net had clearly been closing recently. His wife Alma Shalabayeva was detained by Italian police during a raid on her home near Rome on May 29. Along with the couple’s six-year-old daughter, she was flown to Kazakhstan on a private jet, accompanied by Kazakhstani diplomats. Writing on his Facebook page following the deportation, Ablyazov accused Kazakhstani President Nursultan Nazarbayev of “kidnapping” his wife and daughter and holding them “hostage”. Shortly afterwards, Shalabayeva was given a non-custodial sentence for using a fake passport. Ablyazov has a tumultuous relationship with the Kazakhstani elite. After a brief stint as energy trade minister, he co-founded the opposition Democratic Choice of Kazakhstan movement. Shortly afterwards, he was sentenced to six years in prison for abuse of power, but pardoned by Nazarbayev in 2003 after just a few months in jail. For the next five years, his financial support for the opposition Alga! DVK party and media such as the Respublika newspaper and the K+ television channel were allowed to pass, in part because the level of support for the opposition was relatively low and never became a large-scale challenge to the government. This changed dramatically after the December 2011 Zhanaozen tragedy, when at least 14 rioting oil workers were shot dead by police following a seven-month strike. Ablyazov, who is accused of supporting the striking miners and enabling opposition leaders to stir up the situation, became, as Aleksandra Jarosiewicz of the Center for Eastern Studies (OSW) points out, “public enemy number one” in Kazakhstan. While BTA had been keen

to bring him to justice in order to recover lost assets, pursuing Ablyazov has now become a political, rather than merely a financial, issue. Trial by media Ablyazov and the Kazakhstani government have been fighting a PR war since the takeover of BTA. Ablyazov has always denied the fraud charges against him, and claimed the bank’s nationalisation was unnecessary. As part of his defence in the UK courts, Ablyazov accused top Kazakhstani officials of masterminding the takeover in a project dubbed “SuperKhan” – an argument that was dismissed by the court. “In the confrontation between the ruling elite (and President Nursultan Nazarbayev personally) and Ablyazov, both sides are trying to disparage their opponents and gain the sympathy of European public opinion,” writes Aleksandra Jarosiewicz of the Center for Eastern Studies (OSW). “The results of the fight is a worsening of Kazakhstan’s international image, Astana’s increasing assertiveness towards the West’s demands for democratisation, and also Ablyazov’s increasingly effective imagebuilding as a political refugee fighting the regime in Astana.” The deportation of Ablyzov’s family triggered a diplomatic crisis between

Kazakhstan and Italy, bringing Italy’s fragile government coalition under increasing pressure. Italian opposition leaders on July 15 called on Interior Minister and Deputy Prime Minister Angelino Alfano – an ally of former PM Silvio Berlusconi – to resign. Although Alfano denies advance knowledge of the deportation, the opposition claims he allowed it to go ahead despite Kazakhstan’s dubious record on the treatment of prisoners. International human rights groups including Amnesty International and Human Rights Watch have also weighed into the debate. “The Kazakhstani authorities want Mukhtar Ablyazov at all costs... The French authorities must carefully consider all the angles to Ablyazov’s case and make absolutely sure that he is not sent to any country where he will be at risk of harm or of subsequently being loaded on to a plane to Kazakhstan,” said the director of Amnesty International’s Europe and Central Asia programme John Dalhuisen in an August 1 statement. Astana is now waiting for a decision from the French courts, which is expected in early 2014, that will determine Ablyazov’s fate. Both sides are expected to step up efforts to sway European public opinion in the coming months.

“The Kazakhstani authorities want Mukhtar Ablyazov at all costs"

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Kazakhstan sees bumper harvest Clare Nuttall in Astana

azakhstan has raised its forecasts for the 2013 grain harvest as the agricultural sector rebounds from last year's severe drought. The country is one of relatively few worldwide expected to considerably boost food production in the coming decades – provided farmers diversify to alleviate the impact of climate change. Kazakhstan’s agriculture ministry is currently forecasting a harvest of 16m-17m tonnes of grain, chairman of the ministry’s state inspection committee, Saktash Khassenov, told a press briefing in Astana on August 13. This is well above earlier forecasts of around 15m tonnes. The ministry has, however, warned that wet weather in the Kazakh grain belt and an expected fall in global wheat prices could be a setback. Agriculture Minister Asylzhan Mamytbekov told journalists the harvest would be “difficult”, with crops set to ripen later than usual and humidity causing concerns about storage. Even so, the 2013 harvest should be well above the disastrous 2012 harvest, when around 47% of crops were damaged by drought. Kazakhstan managed to maintain exports thanks to surplus stocks left over from 2011, but the poor harvest still contributed to lower-than-expected GDP growth. Overall, agricultural production has been on an upward trend for the last decade following the slump in the 1990s, due to increased government and private sector investment. In February, Astana approved a KZT3.1

trillion ($20bn) long-term programme aimed at boosting production to 1.5-times its current level by 2020. Better infrastructure Currently, farmers face many bottlenecks, starkly illustrated by the record 2011 harvest when elevators ran out of capacity. Research at the Shortandy institute near Astana shows that while crops planted later have performed much better than early sowings, many farmers plant early to ensure they don’t miss out on elevator space. This is being addressed as new storage and processing capacity is added, most recently with the opening of the Tonkeris granary near Astana on August 16. As well as better infrastructure, farmers also need access to modern seed varieties, high-quality fertilisers and reliable forecasting in order to improve productivity, according to Glen Anderson of Engility, who is working on

“Farmers lose money in bad years, but can also find it difficult to take advantage of good years – by saving money for future investment – because when the harvest is good, prices fall,” Anderson tells bne. While the project includes working with the Kazhydromet meterological service to improve forecasting, “this only benefits farmers if they take advantage of this information to make the right decisions about what and when to plant, and have access to, for example, drought-resistant seeds, and other inputs,” he says. Shortandy and other research institutes are experimenting with different crops and techniques, including organic farming, introduction of new highyield varieties and diversification. Speaking during a visit to the institute on August 5, Irina Babek, a farmer from North Kazakhstan oblast, says that given the impact wide variations in weather have on productivity, she is working to diversify and introduce new technologies. Farmers are considering the introduction of different varieties of wheat as well as other crops such as chickpeas, sunflowers and rapeseed. Diversifying is also one of the main tools for Kazakhstani farmers to respond to climate change. Along with Western Europe and North America, Kazakhstan is expected to see an increase in crop yields, while productivity in most world regions will decline as a result of climate change. While the impact of climate change can only be measured over a period of several decades, Kazakhstan may benefit from

“Farmers lose money in bad years, but can also find it difficult to take advantage of good years" the Improving the Climate Resiliency of Kazakhstan Wheat and Central Asian Food Security project launched by Kazagroinnovations, the United Nations Development Programme and the United States Agency for International Development.

global warming if it results in longer summers and earlier springs. However, as Anderson points out, it may also cause problems for farmers by leading to more variability in precipitation and wider heat extremes – two factors that are already causing farmers to struggle.

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region and expand quite aggressively. That includes rollout plans not only for Kazakhstan, but elsewhere in the region which includes Mongolia, to some degree Turkmenistan and the other ’stans, and the Caucasus,” says James Palmer, partner at Veritas Brown Cushman & Wakefield. An important tipping point came in 2010, when franchiser Fawaz Alhokair brought Zara and other Inditex Group brands to Kazakhstan. The following year, Inditex announced that it would buy out the companies operating its brands in Kazakhstan in a strong sign of confidence in the market.

Kazakh retail moves to the regions Clare Nuttall in Astana

etail has remained the bright spot in Kazakhstani real estate as the sector makes its slow recovery from the crisis, with numerous international brands pouring into the two largest cities Almaty and Astana. Demand for new malls is high, especially in regional capitals, as companies looking to expand are thwarted by a lack of modern retail space. A lot has changed since five years ago when Kazakhstan was seen as a far-flung frontier market, with rising incomes offset by its remoteness from existing distribution networks, lack of suitable space and customs barriers. This situation changed with the construction of new malls, steadily improving logistics infrastructure and Kazakhstan’s entry to the Customs Union alongside Russia and Belarus. Kazakhstan saw retail trade volumes reach KZT409.7bn ($2.7bn) in July 2013, up 36% compared with July 2011, according to the Agency of Statistics of the Republic of Kazakhstan. Overall, retail trade volumes increased

more than five-times between 2001 and 2011. The share of “formal” retail trade – as opposed to trade through bazaars and other informal channels – has also increased. Back in 2001, just 25.7% of trade was formal. In 2011, thanks

Previously, just a handful of international brands such as Benetton and Mango had been present in Kazakhstan, but the market has gained momentum with the launch of other brands operated by companies including Arts Group – operator of Promod and Parfois – and Kazakhstan’s Union Space, which operates Mexx, Motivi, Vero Moda and other chains. More are set to follow, including supermarket chain Tesco’s clothing line F&F. Challenges Kazakhstani real estate companies report continuing interest from

“Across Central Asia, retail is the most exciting area in property investment at present" to a combination of market forces and government pressure, the formal segment finally overtook the informal sector, accounting for 51.5% of total retail trade. More than any other real estate segment, retail has seen a remarkable rise, with construction projects moving ahead through the crisis years, while those in the residential sector were put on hold. “Across Central Asia, retail is the most exciting area in property investment at present, with many brands keen to come to the

investors in particular from Russia and the Middle East, looking at both the two capitals, Almaty and Astana, and the potential for regional expansion. However, there are still challenges to investing into Kazakhstan, including the need to find professional local partners. “It can be difficult to enter the market, because unlike in Europe where each brand is established individually, they are brought to Kazakhstan as franchises, and the franchise holders need to find local partners to set up and operate the business. As a result, there’s a long lead-in,” says Palmer.

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Construction of new malls in Kazakhstan’s largest city Almaty is forging ahead, with projects including the Dostyk Plaza and the expansion of the existing Mega Center underway. Nursultan Kassenov, managing director of NAI Aristan, warns that, “while the market remains interesting, it may reach its first saturation in the next three to five years.” The rapid rise in Astana’s population has sparked the launch of new projects in the new town, where, according to Nursultan Kassenov, managing director of NAI Aristan, “several shopping centres with very similar concepts and similar tenants opened close together on the left bank in 2008-09. Since then there has been an evolution, with each mall trying to distinguish itself by finding a new competitive niche.” Meanwhile, the Soviet-built old town, where the majority of Astana’s

population lives, is underserved, with no modern shopping centres opening in the last five years, despite a very high level of interest from retailers. There is a similar problem in other Kazakhstani cities, as retailers look to expand within the country. Relatively high incomes in Kazakhstan’s industrial northern cities have made them attractive to retailers. The oil rich west is also of interest, again because of relatively high incomes and the large number of expatriate workers; the downside in the remoteness of the region’s main cities. “There had been quite a bit of interest in Aktau and Atyray, where we have had more work in the last 12 months than ever before. Retail is a key driver, as these two markets are the next in line after Almaty and Astana, although with difficulties in establishing the logistical networks,” says Palmer. “Kazakhstan as a whole is still very under-subscribed

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

with room for many more retail concept offerings.” Kassenov agrees that, “Almaty and Astana are the first priorities for international retailers. The next is Atyrau, which is a promising location for property developers because the city is rich but the infrastructure is poor, with no professional shopping centres on the market yet.” Meanwhile, despite its large and rapidly growing population, the south of the country has not yet attracted a high level of interest, due to its relatively low incomes compared to other regions. However, as the markets of Kazakhstan’s two largest cities become saturated, more retailers are expected to explore the next frontier - regional expansion.

What you need to know

www.bne.eu

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A government source familiar with the matter tells bne that Mongolia’s central bank was aware that Savings Bank's financial situation had been deteriorating since 2011, and had discovered that the bank had been lending to its subsidiaries in excess of the 5% limit legally allowed for loans outstanding. Savings Bank was declared insolvent on July 22 after affiliated companies defaulted on loans, leaving an approximately $122m hole in its balance sheet. Photo by Alaia Telleria

Cursed mine claims another deadbeat bank in Mongolia Terrence Edwards in Ulaanbaatar

gold mine in Mongolia that locals are calling jinxed has laid claim to another banking victim, and highlighted a potential problem in the banking sector of mineral rights being used as collateral for loans. Most baffling about the collapse of Khadgalamj Bank – or Savings Bank as it is called in English – and its subsequent takeover on July 19 by the governmentowned State Bank (Toriin Bank) is this was the third time that the same gold mine, Olon Ovoot, was at the centre of a Mongolian bank's downfall. When Anod Bank filed for bankruptcy in 2008 and then Zoos Bank folded in 2009, both times it was because the Mongolian firm Mongol Gazar had defaulted on a loan that used Olon Ovoot as collateral. In this latest instance, the majority shareholder of Savings Bank's parent company Just Group, Sh. Batkhuu, took out a $109m loan using Olon Ovoot. Just Group had purchased the mining rights to what Batkhuu thought was 13.5 tonnes of gold at Olon Ovoot in 2009. But the mine didn’t have as much reserves as registered, says Batkhuu, and

he found himself in position where he could no longer service his debts. Batkhuu claims the loan was to be used for the expansion of Savings Bank's business, though even before the loan was made the country's fifth largest bank was in problems, say industry players. "It was clear from the outset after its merger with Mongol Post Bank in 2009 that Savings Bank had high levels of non-performing loans,” says

Consolidation The takeover by State Bank means the state's once small banking operation in the capital now stretches to all corners of the country, lifting it into fourth spot in one fell swoop. There is talk of an IPO of State Bank, which would mean Savings Bank's problems proved a happy coincidence for the state. But some consolidation in Mongolia's banking sector is probably overdue. Before Savings Bank collapsed, there were 14 banks serving a relatively poor population of just 2.9m, which some analysts see as overkill. “In a country with 13 banks but only 3m people, some moves towards banking sector consolidation aren’t such a bad thing,” says Nick Plummer, an analyst at the Economic Policy and Competitive Research Center. Mongolia's banking sector has been an area of concern for investors throughout the mining boom, as bank loans have

"It was clear from the outset after its merger with Mongol Post Bank in 2009 that Savings Bank had high levels of non-performing loans” Randolph Koppa, president of competing bank Trade and Development Bank of Mongolia (TDB). “Earning levels had been low and as the central bank stepped up capital requirements, the bank didn’t seem to either generate enough earnings or to attract additional capital investment.”

been the most readily available source for capital in the country. Moody's Investors Service gave Mongolia's banking sector a negative outlook amid the rapid growth in lending, describing the situation on the ground as “an economy that is increasingly exposed to commodity-driven boom-bust cycles.”

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That portrayal seems to be no exaggeration, as backing loans with mineral deposits is not uncommon among Mongolia's commercial banks. According to 2013 data from the Mineral Resource Authority of Mongolia, the largest lender TDB has 40 loans backed by mineral deposits, while number-two bank Golomt has 26, followed by the third largest Khan with 27. Savings Bank had just seven loans with mines used as collateral, but it only took one mine that Batkhuu says has less reserves than was registered with the Mineral Resources Authority to send the whole institution crumbling.

against us in corporate banking,” says Koppa, “Our credit quality ratios are continuing to improve, and at present we have a fair amount of liquidity.”

TDB's Koppa defends the practice, though: “When lending to operating mining companies, it is common practice to take the mining licences as part of the collateral package. The security interest in such licences can be perfected by registration of the lien, and the value of the mine can be determined based on the volume of reserves recognised by the mining authority.”

As for Batkhuu and Just Group, the Savings Bank debacle seems to have taken the rest of his assets with it, including a profitable food processing firm and oil firm. And he's promised to pay back the government the $122m debt it has shouldered from Just Group. And for all that's happened, Batkhuu has not yet been charged with a crime. Rather than a remorseful appearance at his press conference, Batkhuu has been eager to pat himself on the back for transferring all his assets (including his debts) to the state, thereby maintaining depositors' savings.

On a brighter note, the same Moody's report noted that the negative outlook for the sector as whole contrasts with the stable outlook on Mongolia's topfour banks. Koppa, too, says the failure at Savings Bank should not be taken as representative of the sector as a whole, given that TDB's business model differs greatly, and that although Savings Bank represented 8% of the market, it was not a significant lender. "In terms of TDB, Savings Bank really didn’t compete

Plummer echoes that sentiment, noting that the central bank has provided support to banks and the economy through looser monetary policy, as well as through its price stabilisation programme and mortgage loan subsidies. "At the same time, the Bank of Mongolia has been enhancing banking sector supervision. These measures should improve the performance and stability of the financial system,” he says.

When asked what he planned to do next, he replies: "I got up at 9:00am, I used to work for long hours every day. I will relax. Then I will pay back the loan. It is unsuitable to be in business as the director of a bank. Business is too risky.”

“When lending to operating mining companies, it is common practice to take the mining licenses as part of the collateral package"

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Should he stay or should he go? Molly Corso in Tbilisi

fter less than a year in office, Georgian Prime Minister Bidzina Ivanishvili is flirting with leaving politics. While it's still unclear if he will actually resign by December 31, analysts say an early departure will have a lasting impact on the country’s political development and stability one way or another. Political observers are split on whether Ivanishvili will actually leave power or if his coalition can survive without having him in office – not to mention the possible impact of an unplanned transfer of power on the country’s wobbly economy. But leaving before the end of his term could be a positive trigger for Georgian democracy, suggests Lincoln Mitchell, an associate research scholar at Columbia University's Harriman Institute. Ivanishvili, the 57-year-old oligarch who swept to power after his coalition won the October 2012 parliament elections, has never made a secret of the fact he hates politics. Formerly a recluse known for his fabulous wealth (around €4bn by some counts) and philanthropy, Ivanishvili has repeatedly stated he would like to leave office early – if conditions in the country “permit” his exit from politics. “Politics has never been my interest. I had to go into politics as a duty to the people. I intend to depart before the year’s end. I have done what I could, and I do not intend to return to politics,” Ivanishvili was quoted as saying in a July 20 article published in Lietuvos Rytas. Ivanishvili stressed his intent to break down Georgia’s legacy of strong leaders when he officially launched Giorgi Margvelashvili’s presidential candidacy on August 12. By supporting the philosopher and former education minister in the October presidential elections, Ivanishvili said: “We are

destroying an entrenched stereotype in Georgia that the president should be a superman and everyone’s patron, who will decide everything instead of us.” Mitchell, who served as an informal advisor to Ivanishvili's Georgian Dream coalition, said if Ivanishvili decides to leave the post of prime minister before the end of his term, it could break the “cycle” of strong leaders and weak parties that lead to regime collapse – a trend that has haunted Georgia’s political development since it regained independence following the collapse of

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one-man-show parties have to finish, it is time already to have normal parties.” Ivanishvili’s coalition, the Georgian Dream, is made up of six very diverse parties spanning brand new political alliances like the PM’s own Georgian Dream party and the Republic Party, one of Georgia’s largest political parties. But none of them come close to Ivanishvili’s popularity rating, notes political scientist Koba Turmanidze. Even party leaders, like the Republic Party's Davit Usupashvili – currently speaker of the parliament and the most highly rated politician after Ivanishvili, according to a June survey by Caucasus Research Resource Center – is riding on the prime minister’s wide support amoung voters, Turmanidze says. Georgia’s fundamentally weak party system could undermine any potential benefits of Ivanishvili giving up power, especially if he is planning to remain

“Politics has never been my interest"

the Soviet Union. “We can tell each other stories that Georgia is a competitive two-party system and those stories make us feel good for a lot of reasons… it makes those of us who really care about Georgian democracy feel good because it means Georgia is more democratic, moving in the right direction,” Mitchell tells bne in a phone interview. “We western observers cannot, on the one hand, decry the extent to which personalities dominate Georgian politics and, on the other hand, say well we don’t want this guy to leave.” One-man bands If Ivanishvili decides to voluntarily leave, it could be a boost to Georgian democracy, agrees political scientist Alexander Rondeli, but not if the country’s weak political parties are unable to fill the power vacuum. “If you don’t have strong leaders, it means you have to have strong and normal welldeveloped political parties,” he says. “Our

at the head informally, Turmanidze believes. “The loyalty of that coalition is based on all his personal achievements or perceived future achievements as head of state… The coalition – although he says differently – cannot afford to lose him,” he says. “It is not real that he will step down, he will not play a real role in the coalition and the parties will compete with each other – that is absolutely [untrue]. These parties are, in the best case, clubs of friends. They are not real parties.” But Mitchell stresses that in the event that Ivanishvili does resign, even if that means the Georgian Dream coalition collapses or the government becomes less efficient, the precedent could make the country’s democracy stronger. “There is a lot of talk about what might happen if the Georgian Dream coalition collapses or breaks apart,” he says. "What happens is democracy would move forward."

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Parking City Service, has been selected to collect street-parking fees from motorists electronically. Like public transport users, drivers face a price increase, as they will now pay AMD100 per hour for parking, rather than a fixed fee of AMD100 however long they park.

Yerevan's summer of protests Clare Nuttall in Astana

hrugging off efforts to placate them, Armenian protesters against planned changes to Yerevan’s transport systems kept up the pressure through July and August. While the unrest in the Armenian capital is focused on a handful of specific issues, it highlights the growing lack of tolerance for corruption and a willingness by Armenians to challenge the authorities. The demonstrations continued for several weeks despite a pledge from the mayor of the Armenian capital, Taron Markarian, to back down on a controversial fare hike for public transport. That saw Markarian announce on August 6 that reintroducing the fare increase cannot be ruled out, though the city council will wait for the verdict of an ad hoc commission set up to consider the issue. Markarian is also determined to push ahead with unpopular changes to the car parking system in the city. Fares on buses, minibuses and trolleybuses in the Armenian capital were due to increase from AMD100 ($0.24) to AMD150 from July 20. However, Markarian was forced to suspend the plans after six days of

protests involving hundreds of activists – an echo of the protests in Brazil that were sparked by public transport fare increases. In addition to refusing to pay the extra AMD50, opponents also organised a high-profile “Free Car” campaign, in which politicians and celebrities offered lifts to Yerevan residents. A sit-in outside government offices was also started. On August 1, police prevented protesters from putting up tents, claiming they needed an official permit to do so. This sparked clashes

Opponents of the scheme have criticised both the higher costs and the decision to allow Parking City Service to take 70% of fees paid, with just 30% going to the municipal budget. At a meeting on August 4, hundreds of activists backed plans for more protests and a mass boycott of the new system. The mayor now insists the new parking system will come into force on September 1, and has threatened a police crackdown on parking attendants who do not comply. The price increases have been linked to a recent sharp increase in gas and electricity tariffs. Armenia's Public Services Regulatory Committee (PSRC) approved the tariff increases after Gazprom said it would raise the price of gas by 18% starting in July. The large share of Armenian electricity generated at gas-fired power stations means electricity bills have also increased, triggering a rise in inflation. Murky links Activists accuse government officials and members of the city council of having links to transport operators set to profit from the changes. On August 1, Markarian denied allegations in the local press that he owns minibus

“Clearly this is indicative of an end to apathy”

between police and activists, who are demanding the resignation of top transport officials within the Yerevan administration. In addition to the opposition to higher public transport fares, a storm is also brewing over planned reforms to car parking in the city. A private company,

lines, saying the reports were “idle speculation”, but he appears to be caught between Yerevan residents who are fiercely opposed to the price increases, and the powerful owners of the city transport networks. The owners of Parking City Service are also rumoured to be close to President Serzh Sargsyan.

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Tolerance for corruption is falling in Armenia, with officials coming under increasing scrutiny from the population. This is partly due to the influence of neighbouring Georgia, one of Armenia’s main trading partners, where reforms introduced since the 2003 Rose Revolution have seen a dramatic fall in corruption. As a result, Armenians are starting to demand similar steps at home. “Clearly this is indicative of an end to apathy,” says Richard Giragosian, director of the Regional Studies Center in Yerevan. He points out that many of those who have taken up the fight against the city authorities are first time protesters with no political affiliations. “The public transport price rise not only affected a broad cross-section of the population, it also had a disproportionate effect on the more vulnerable lower and lower middle class, making it much more of a socially explosive issue.” Meanwhile, Armenian opposition parties have had relatively little involvement with the recent wave of protests in Yerevan, and have so far failed to catch up with the grassroots activism over social disparities of wealth and income – one of the pressing issues within Armenian society, according to Giragosian. A similar weakness was demonstrated after Armenia’s February 2013 elections. The most significant action by the opposition so far has been by the Barev Yerevan opposition bloc in the Yerevan city council – linked to former presidential candidate Raffi Hovannisian's party – which on August 7 filed a lawsuit asking for directives signed by Markarian raising public transport prices to be declared illegal.

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Life after Armavia

Clare Nuttall in Astana The Armenian government plans to hold a tender for airlines to operate flights to three world regions in September, part of plans to liberalise the air transport sector after the country's largest carrier Armavia filed for bankruptcy. The process is due to be launched in mid-September, two months later than previously planned. The rights to operate flights to Europe, Russia and the Commonwealth of Independent States, and the Middle East will be put up for tender, with a decision to be made based on flight safety, the condition of the carrier's planes, the ticket sales system, and the carrier's financial stability, a spokesperson from the Armenian civil aviation department told ArmInfo. The winning bidders will be awarded a five-year licence to operate on selected routes. Yerevan has had to rethink its strategy on the development of the air transport sector following the bankruptcy of the country’s main carrier Armavia earlier this year. The Armenian government is currently working with the consultancy McKinsey & Company on plans to increase competitiveness in the sector. In May – a month after Armavia stopped flights as it entered bankruptcy proceedings – the government announced plans to liberalise the sector. The following month, the government adopted new concept for development of the air transport sector that will see a gradual liberalisation. Speaking to journalists on June 6, the head of the General Department of Civil Aviation, Artyom Movsisyan, said that the government does not plan to sponsor domestic airlines. However, he added that since local companies are not yet established in the market, it is too early to talk about an "open skies" policy, News.am reported. A department spokesperson told bne that work was in progress, and more information on plans for the sector would be released in October Armavia grounded its flights on April 1 after announcing that it would begin bankruptcy proceedings due to being unable to repay around $50m of debts mainly to Yerevan's Zvartnots international airport and several Russian airports. The airline's owner, Mikhail Baghdasarov, told journalists that he was unwilling to continue subsidising it from his other business operations. Armavia had the exclusive right to operate on several routes out of Yerevan, not including the Brussels, London and Vienna routes. The rights were offered as part of the government's deal with Baghdasarov when he took over the international licence of the bankrupt Armenian Airlines in 2003. However, the ten-year agreement was due to expire in March shortly before the airline filed for bankruptcy. Since then, several airlines from Russia and Ukraine have been authorised to increase the frequency of flights serving routes to Moscow and other cities during the summer, the busiest time of year.

Special Report: Fund Survey 2013

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FUND SURVEY 2013:

End of an unsustainable run Nicholas Watson in Vienna, Prague

he run had to end eventually, and it did in spectacular fashion when the last week in June saw around $5.5bn sucked out of emerging market bond funds, their worst week on record. That was the fifth weekly withdrawal on the trot for emerging market bond funds, a trend that began in May when the head of the US Federal Reserve, Ben Bernanke, gave the first signal the US central bank would begin reducing its asset purchases later this year. "We saw significant outflows, probably the strongest since [the crisis in] 2008 and this was a re-pricing of risky assets â&#x20AC;&#x201C; in emerging markets a kind of cleaning out of the investor base and this 'crossover' money," describes Peter Svoboda, senior co-fund manager of Erste Asset Management's "ESPA Bond Danubia" fund, which returned 4.0% over the bne survey period from June 30, 2012 to June 30, 2013. Certainly bonds from emerging market issuers like those from Central and

Eastern Europe and the Commonwealth of Independent States (CEE/CIS) have enjoyed a remarkable couple of years. Last year's bne fund survey saw Erste's "ESPA Bond Emerging Markets Corporate" fund take top spot in the fixed-income category with a huge return of 8.0% on the back of the robust fundamentals in much of CEE in terms

Even with the $12.5bn outflow seen in the last five weeks to the end of June, Daniel Vernazza, an economist at UniCredit Group, pointed out at the time that it only undid a little more than half of the $22.8bn inflows seen in the first half of 2013, leaving a net inflow of $10.3bn. "Looking at longer time horizons, in the last 52 weeks there

"This was something not sustainable"

of higher growth, better fiscal positions and lower debt. These solid economic fundamentals, together with the tame inflation, higher interest rates, rising local currencies, and tightening spreads on the hard currency side as central banks continued their quantitative easing, attracted a huge amount of bond investment over the past two years.

has been a net inflow of $35.0bn and, since the data was first collected back in late 2006, net inflows total $91.2bn," Vernazza said. This year, the winner of the "bne Best Fixed-Income Fund 2013" is Raiffeisen Capital Management's "Raiffeisen Eastern European Bonds" fund with a

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II Special Central report Europe

return over the survey period of 5.4%. "The good performance of [the fund] was mainly due to the exposures in Hungary (smaller exposure but high returns) and Poland (smaller returns but high exposure)," says Ronald Schneider, head of Global Emerging Markets and Eastern Europe (Fixed Income) at Raiffeisen Capital Management. This was closely followed ELANA Fund Management's "ELANA Eurofund" (5.3%), Citadele Asset Management's "Citadele Eastern Europe Bond Fund" (5.2%), the "ELANA Cash Fund" (4.9%) and Pioneer Investments' "Austria Central & Eastern Europe Bond" (4.7%). The first five months of this year continued that tremendous 2012, which saw a 12-13% performance in emerging market and corporates bonds, high yield bonds at 20%-plus, and triple-C rated bonds around 30% as investors, flush with money to invest, searched for better yielding instruments than those found closer to home. "This was something not sustainable," says Svoboda. And so it came to pass, when from the start of May the US yield curve began to steepen dramatically as investors switched out of emerging market bonds that were trading at ridiculously low yields. Investors say hard currency emerging market bonds were trading at an average spread of 230 basis points (bp) before the May sell-off began; now these bonds are trading 100bp higher. Looking ahead, fund managers say the recent shakeout that has left mostly dedicated bond investors is perhaps no bad thing. Given a medium-term investment horizon of three to five years, they say investors should realistically look for an annual yield of 3.5% to 4.0%, which will be driven by the ongoing – albeit slowing – convergence process of the region to Western European standards. There will be no repeat of the impossibly high yields of the past two years. The average yield of the bonds in the "ESPA Bond Danubia" fund portfolio, for example, is about 3.7%. Local currency bonds, in particular, are expected to do well. According to Thomson Reuters' "European Fund Market

bnebne September 2013 May 2008

Mid-Year Review 2013", published in August, the 7th best-selling fund asset class in the January-June period was "Bonds Emerging Markets - Local Currency" with €8.63bn. "It's a good moment to be entering the local currency bond market," says Erste's Svoboda. Taking stock On the equity side, funds had a much better year than last year. In the last survey, the winner was Erste's "ESPA Stock Istanbul" with a performance of minus 0.2%. Even so, the environment remains fragile, with the Fed's suggestion of a "tapering" of its quantitative easing causing a sharp reversal in sentiment, which hit emerging market equities, as well as bonds and currencies. "It's a difficult market," admits Alexandre Dimitrov, head of CEE equity fund management at Erste Asset Management. "It's not really only about the asset, but also about the pricing of the asset. Even if you see interesting assets, the whole question is about timing. It's not about the asset per se – if we do like the asset, it's more about the timing, when we take a position and how to execute that position." "The last year was actually timing," Dimitrov says, "and if you ask me about the next six to twelve months, it will also be about timing." If that's the case, then it was surely a good time to invest in the Balkans and Turkey, but still not so much for the frontier markets of the Caucasus and Central Asia. This year's winner of the "bne Best Equity Fund 2013" is East Capital Asset Management's "East Capital Balkan Fund" with a return of 19.5% over the period. (The "ELANA High Yield Fund" actually returned slightly more, 20.9%, but it's small size of less than €2m precluded it from being a contender in our ranking.) This East Capital fund mainly invests in shares in companies in Romania, Bulgaria, Croatia, Serbia, Turkey and Slovenia. As market conditions change, the fund manager says it might also invest in other countries in

the region such as Bosnia-Herzegovina and Macedonia. The fund’s strategy is to enter the market at an early stage, and to buy inexpensive shares in companies in sectors benefiting from long-term development trends, such as EU convergence and growth in domestic consumption and investment. Within the Southeast European region, Turkey is still, like last year, the investor darling – though clearly the violent ant-government protests earlier this year have taken the shine off that. East Capital cut its exposure to Turkey in its Balkan fund to just over 30% in June. The "HSBC GIF Turkey Equity Fund" returned 17.7% during the survey period, while the "East Capital Turkish Fund" returned 12.7%. "Turkey was really the one market which made us happy in 2012," says Dimitrov. "The political issues did not really surprise us – with every big country you have these problems. What was surprising was the magnitude of the protests." The Baltics too looked a good place to invest money over the past year, a result perhaps of the markets having been oversold for so long. The "East Capital Baltic Fund" returned 17.7% and the "Citadele Baltic Sea Equity Fund" returned 11.4%. Kristiana Janvare, senior portfolio manager at Citadele Asset Management, puts the success of the "Citadele Baltic Sea Equity Fund" down its flexibility to focus on the markets and segments with the best growth prospects at any given point in time. "Thus, in the surveyed year when investors demonstrated selective risk appetite and Eastern European equity markets overall showed weak performance, the fund managed to achieve a return of 11.4%, thanks to its exposure to the Baltic equities, which outperformed due to the relatively strong economic recovery in the region, and due to its investments in German and Scandinavian equity markets." However, the frontier markets in the CIS remained unforgiving, with Ukraine a particular concern. The "Citadele Caspian Sea Equity Fund" was down 11.3% and the "Citadele Ukrainian Equity Fund" down 22.2%. The "Sturgeon Central Asia Equities Fund" was down

bne 2013 bne September May 2008

17.5%, and the "Swedbank Central Asia Equity Fund" down 3.5%. However, the "East Capital Bering Central Asia", winner of the "bne Best Alternative Fund 2013" with a huge 22.0% return, shows that the tide maybe turning in the region. Clemente Cappello, founder and CEO of Sturgeon Capital, notes that after the exodus from frontier markets during the economic crisis, there are signs now that investor interest is at last returning. "We are starting to see some green shoots,” says Cappello. "In the short term Central Asia is under-performing, but I see it as like steering a ship – these things take a lot of time to play out." In general, the outlook for equity funds is on the up. According to the Thomson Reuters mid-year review of European funds, lying just below the local currency bonds in 8th position was the fund segment "Equities Emerging Markets", which pulled in €7.385bn during the January-June period. Ivaylo Penev, portfolio manager of the "ELANA Balanced EUR Fund", which is the winner of the "bne Best Balanced Fund 2013" with a return of 18.5%, says after a couple of hard years around the time of the global financial crisis, he started to clear out the portfolio of companies that were too leveraged and to look for safer growth stories or those that were immune to the macroeconomic problems of Europe. "As risk appetite is increasing, it is time to add some beta by rotating out of investments that depleted their potential to second-tier names, which are starting to improve their numbers," Penev says. "This will be the strategy for the next 12-18 months and we hope that if we do our homework, the results will be no less stellar." Mark Mobius, the emerging markets investment guru at Franklin Templeton Investments, says the recent sell-off in reaction to suggestions of a “tapering” off of US quantitative easing ignores the fact that the reason a reduction is under consideration at all is because the Fed perceives a strengthening of the US economy, which is positive for global emerging markets. In addition, and

Special report

most important in the long term, "we believe that many Central and Eastern European markets, notably Turkey, retain the potential for strong growth as technological catch-up, urbanisation and demographic effects play out." "Eastern European markets are not immune to changes in global equity market sentiment, but over the longer term we believe that economic growth could feed into rising corporate profitability," Mobius told investors at the end of June. "Our research suggests that a considerable number of Central and Eastern European stocks trade at valuations that do not reflect their attractive longer-term prospects." Bricks and mortar Finally, the performance of our survey's real estate funds would appear to bear out the findings of a July report from Colliers International Eastern Europe, which found that increasing asset allocation to property looks set to continue as investors shift out of equities and bonds in search of lower volatility. This increase in the weight of money relative to a fairly illiquid supply of prime assets, it believes, will harden real estate prices and ultimately shift money into second-

"The last year was actually timing and if you ask me about the next six to twelve months, it will also be about timing" ary property assets and locations. "With no dramatic changes in rents anticipated on the downside, prime office property continues to look a good bet and warrants the shifts in allocations being reported and realised," Colliers says. The winner of the "bne Best Real Estate Fund 2013" is Renaissance Real Estate Company's "Renaissance - Nedvizhimost" fund with a huge return of 25.97%, followed not so far behind by its "Renaissance - Business - Nedvizhimost" fund with 19.56%. The "East Capital Baltic Property Fund II" returned 11.23%.

I 55

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II Special Central report Europe

bnebne September 2013 May 2008

CEE and CIS funds

Fund manager

Name of fund

Type of fund

Geographic allocation

Berenberg

Berenberg East European Equity Selection

Equity (long only)

Eastern Europe ex Russia

Citadele

Citadele Eastern Europe Bond Fund â&#x20AC;&#x201C; EUR

Bond

CEE

Citadele

Citadele Russian Equity Fund

Equity

Russia

Citadele

Citadele Baltic Sea Equity Fund

Equity

Baltic Sea

Citadele

Citadele Caspian Sea Equity Fund

Equity

Central Asia/Caspian

Citadele

Citadele Ukrainian Equity Fund

Equity

Ukraine

Da Vinci Capital Management Limited

Da Vinci CIS Private Sector Growth Fund Limited

Closed Ended

Russia / CIS

DWS

DWS Russia

Equity

Russia

DWS

DWS Osteuropa

Equity

CEE

East Capital Real Estate AS

East Capital Baltic Property Fund II

Real Estate

Baltics, focus on Estonia

(Cayman) Ltd

East Capital Bering Central Asia

Alternative Investment

CIS

East Capital Asset Management AB

East Capital Baltic Fund

Equity

Lithuania, Estonia, Poland, Latvia

East Capital Asset Management AB

East Capital Turkish Fund

Equity

Turkey

East Capital Asset Management AB

East Capital Balkan Fund

Equity

Turkey, Romania

ELANA Fund Management

ELANA Eurofund

Fixed Income

Eastern Europe

ELANA Fund Management

ELANA Cash Fund

Fixed Income

Eastern Europe

ELANA Fund Management

ELANA Balanced EUR Fund

Balanced

Eastern Europe

ELANA Fund Management

ELANA Balanced USD Fund

Balanced

Eastern Europe

ELANA Fund Management

ELANA High Yield Fund

Equity

Eastern Europe

Erste Asset Management

ESPA STOCK EUROPE-EMERGING

CEE Equities

Central and Eastern Europe

Erste Asset Management

ESPA BOND DANUBIA

CEE Bonds

Central and Eastern Europe

HSBC

HSBC GIF Turkey Equity Fund

Pure Equity

Turkey

Pioneer Investments

Pioneer Investments Austria - Eastern Europe Stock

Equity

CEE

Fixed Income

CEE

East Capital Alternative Investments

Eastern Europe, Balkans,

Pioneer Investments Austria Pioneer Investments

Central & Eastern Europe Bond

bne 2013 bne September May 2008

Special report

I 57

Return since inception Size

Return 1 year (to June 30)

Return YTD (June 30)

(Total unless otherwise stated)

Total expense ratio

$19m

2,68%

-13,87%

-8,37%

1,45%

n.p.

5,21%

-1,54%

4,91% (annualised)

n.p.

4,54%

-11,65%

7,63% (annualised)

n.p.

11,37%

-2,09%

3,08% (annualised)

n.p.

-11,35%

-10,39%

-19,54% (annualised)

n.p.

-22,22%

-17,32%

-32,90% (annualised)

n.p.

1,7x gross cost multiple and returned over 52% of initial $90m

6,19%

0,5%

commitments to Fund's investors since inception, IRR of 15%

1,3x

¤951m

-9,3%

-9,4%

81,70%

n.p.

¤338m

-7,0%

-9,5%

396,20%

n.p.

¤24m

11,23%

3,76%

10,35%

n.p.

$48m

22,00%

18,32%

-51,0%

n.p.

SEK779m

17,70%

11,00%

454,26%

n.p.

SEK2,012m

12,74%

-7,00%

-2,77%

n.p.

SEK875m

19,49%

-1,00%

14,70%

n.p.

¤670,272

5,33%

2,86%

5,27% (annualised)

0,60%

¤10.166m

4,93%

2,43%

6,54% (annualised)

0,48%

¤2.250m

18,54%

10,89%

0,48% (annualised)

1,40%

¤3.294m

17,56%

10,13%

0,76% (annualised)

1,35%

¤1.729m

20,88%

14,92%

-1,4% (annualised)

2,11%

¤94.7m

-0,26%

-12,04%

78,80%

2,00%

¤577.2m

4,01%

-4,42%

173,00%

0,80%

¤211m

17,72%

-7,97%

102,72%

2,15%

¤103.9m

4,98%

-10,7%

130,05% (since 1 Dec 1993)

2,34% (as per May 2012)

¤196.3m

4,74%

-5,24%

147,85% (since 28 Oct 1999)

1,26% (as per Feb 2013)

58 58

II Special Central report Europe

bnebne September 2013 May 2008

Fund manager

Name of fund

Type of fund

Geographic allocation

Pioneer Investments

Pioneer Investments Austria - Russia Stock

Equity

Russia CEE and Middle East

Pioneer Funds - Emerging Europe and Pioneer Investments

Mediterranean Equity

Equity

Raiffeisen Capital Management

Raiffeisen Eastern European Equities

Equity

Raiffeisen Capital Management

Raiffeisen Eastern European Bonds

Fixed Income

Russia, Romania

Renaissance Asset Managers

Renasset Eastern European Fund A EUR

Equity

Eastern Europe, Russia

Renaissance Asset Managers

Renasset Ottoman Fund A EUR

Equity

Turkey

Renaissance Asset Managers

Renaissance Russian Equity Allocation Fund C USD

Equity

Russia

Real Estate

Russia

Real Estate

Russia

Russia, CEE, Turkey, Kazakhstan Poland, Ukraine, Turkey,

Eastern Europe, Russia,

"Closed-end investment rental fund Renaissance Real Estate Company Ltd.

""Renaissance - Nedvizhimost""" "Closed-end investment rental fund

Renaissance Real Estate Company Ltd.

""Renaissance - Business - Nedvizhimost"""

Listed Equity Luxembourg SICAV Sturgeon Capital

Sturgeon Central Asia Equities Fund

UCITS IV

Central Asia

80% Listed Equity/20% Fixed Sturgeon Capital

Sturgeon Central Asia Balanced Fund

Income Dublin-listed Closed-End Central Asia

Sturgeon Capital

Sturgeon Central Asia Fund

Multi-stratgy Cayman OEIC

Central Asia

Swedbank Investeerimisfondid

Swedbank Central Asia Equity Fund

Equity

CIS

Swedbank Investeerimisfondid

Swedbank Eastern Europe Equity Fund

Equity

CEE

Swedbank Investeerimisfondid

Swedbank Russian Equity Fund

Equity

Russia and CIS

Franklin Templeton Investments

Templeton Eastern Europe Fund

Equity

CEE

Long-Short Blue Chip Equities UFG Advisors

UFG Russia Select Fund

Hedge Fund

Russia & CIS

Long-Biased Small-Mid Cap UFG Advisors

UFG Russia Alternative Fund

Equities Hedge Fund

Russia & CIS

UFG Private Equity

UFG Private Equity Fund II

Private Equity

Russia & CIS

UFG Real Estate

UFG Real Estate Fund II

Real Estate

Russia & CIS

bne 2013 bne September May 2008

Special report

I 59

Return since inception Size

Return 1 year (to June 30)

Return YTD (June 30)

(Total unless otherwise stated)

Total expense ratio

¤43.9m

1,01%

-11,81%

216,11% (since 18 Nov 2002)

2,40% (as per Oct 2012)

¤367.2m

3,94%

-8,71%

146,28% (since 18 Dec 2000)

2,14% (as per Dec 2012)

¤476.6m

7,74%

-11,49%

353,67% (8,12% p.a.)

2,22%

¤189.0m

5,37%

-4,33%

148,02 (7,15% p.a.)

1,11%

¤194.336m

1,00%

-0,5%

36,10%

2,28%

¤56.31m

15,60%

-9,8%

800,90%

2,13%

$9.19m

-9,18%

-9,2%

-24%

2,41%

$58.9m

25,97%

13,43%

101,08%

3,90%

$95.2m

19,56%

n/a

216,42%

3,00%

$14m

-17,5%

-16,2%

-17,5%

2,24%

$38m

-12,5%

-11,1%

-12,1%

3,75%

$17m

-42,2%

-15,5%

-5,2%

2,07%

¤5.07m

-3,5%

-0,2%

-61,4%

n.p.

¤41.2m

-2,6%

-13,1%

-24,7%

n.p.

¤45.6m

- 3,1%

-5,3%

22,30%

n.p.

0,89%

n.p.

5,69%

n.p.

$137,915,740

-3,21%

-7,3%

198,5%

not publicly disclosed

$86,909,014

3,5%

-5,21%

3,7%

not publicly disclosed

$225,000,000

N/A

IRR: 113%

not publicly disclosed

$81,400,000

N/A

IRR: 43%

not publicly disclosed

n.p. = not supplied

60 60

II Special Central report Europe

bnebne September 2013 May 2008

And the winners are…

bne Best Equity Fund 2013

East Capital Balkan Fund

bne Best FixedIncome Fund 2013 Raiffeisen Eastern European Bonds

bne Best Real Estate Fund 2013 Renaissance – Nedvizhimost

"Our long-term view that the Balkan markets offer significant investment opportunities finally started to materialize over the last period. Negative sentiment towards smaller markets due to the slow economic recovery, partially exacerbated by the crisis in Greece, pushed valuations to very low levels, but at the same time there are plenty of companies that were doing well throughout the difficult times. Being on the ground and constantly monitoring the situation, we actually increased our exposure to some of the excessively beaten down markets like Slovenia and Greece after summer last year. We have done this through selective stock picking and that has paid off in very solid returns that outpaced most of emerging market world. At the same time, we were very active in some of our key holdings, pushing for better corporate governance and higher dividends."

"The good performance of Raiffeisen-Eastern-European-Bonds (July 2012 to June 2013) was mainly due to the exposures in Hungary (smaller exposure but high returns) and Poland (smaller returns but high exposure). Following the ECB’s announcement that it would buy EUR government bonds, the strains in the Eurozone debt crisis eased and risk premia have been priced out of the markets. Disappointing economic dynamics paired with falling rates of inflation and strong risk appetite supported local bonds. Further reinforcement was provided by rate cuts in Poland, Hungary and Turkey. CEE Eurobonds also made a positive contribution to the fund’s performance," says Ronald Schneider, Head of Global Emerging Markets and Eastern Europe (Fixed Income) at Raiffeisen Capital Management.

"In 2013 the fund has successfully divested its major real estate asset (a regional retail centre) with a big premium to the latest valuation of the property, despite the limited institutional investors’ demand for commercial property outside Moscow and St Petersburg. This has effectively proved our investment approach that is based on in-depth market knowledge, conservative investment strategy, thorough selection of unique investment opportunities and pro-active, value-added asset management. We are honoured to receive a new bne recognition as testament to the dedication, expertise and commitment of the Renaissance Real Estate team that was able to demonstrate superior results throughout the fund’s six years entire investment cycle," says Ekaterina Konstantinova, Head of Renaissance Real Estate.

bne 2013 bne September May 2008

bne Best Balanced Fund 2013

ELANA Balanced EUR Fund

bne Best Alternative Fund 2013

East Capital Bering Central Asia

Special report

I 61

"ELANA Balanced EUR Fund is one of the first funds in Bulgaria, begun in the years of glamour for our local capital markets. Its strategy is to balance income from debt instruments with growth from the riskier half of the portfolio and look for opportunities mainly on domestic ground, as well as throughout Europe. After a couple of hard years around the global financial crisis, we started to clear the portfolio out of too leveraged companies and to look for secular growth stories or solid immune to macro-issues businesses. By the end of 2011, we were positioned to profit from a long expected recovery in our own market, which lagged it's Eastern European peers big time. Eventually the catch-up started, but the market was very selective and quality outperformed. Our portfolio structure was well fit for that and the results followed. As risk appetite is increasing, it is time to add some beta by rotating out of investments that depleted their potential to second-tier names, which are starting to improve their numbers. This will be the strategy for the next 12-18 months and we hope that if we do our homework, the results will be no less stellar:" Ivaylo Penev, portfolio manager of ELANA Balanced EUR Fund and Head of Asset Management, ELANA Fund Management. "The good performance result of the Bering Central Asia fund is mainly attributed to a very positive development in the share price of our top holdings - namely, Bank of Georgia, the largest bank in Georgia listed on the LSE, and one of the largest Kazakh telecom operators, KCell, majority owned by TeliaSonera. The fund invested in KCell shares at its IPO in December last year and over the period the stock gained more than 50% in dollar terms. This return was even exceeded by the Bank of Georgia stock, that withstood the external pressures of political tumult in the country and returned 56% to its investors over the same period. In KCell we like the quality of its operational performance, corporate governance standards and one the highest dividend yields in our investment universe, while Bank of Georgia, equally singled out by investor community for the high professionalism of its management team and consistent performance, was discovered by us as early as 2006 and has been the largest holding in the BCA fund since its inception. Sizeable positive contribution came also from Teliani Valley, a Georgian winemaker, Halyk Bank, Kazakhstan's top lender, and Dragon Oil, an oil and gas E&P company located offshore Turkmenistan. The only bet among top five holdings with a negative return, was ENRC, one of the largest London-traded Kazakh mining companies, which is about to be taken private by its founders at a low valuation."

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