Business New Europe November 2012 edition

Inside this issue: Ozon's stratospheric rise CEZ spurns a French kiss Take two in Serbia Retribution in Georgia November 2012 www.businessneweurope.eu

Special Report: Eurasian Bank Survey 2012

CORRUPTION TSAR Russia's point man in the fight against corruption faces a monumental task

How to invest in Eastern Europe and China

Rather than spending our time in an office, we travel around our region, meeting with over 1,200 companies a year. This tells us more about the markets than any index in the world ever could.

Read more about our award-winning funds at www.eastcapital.com.

Historic yields are no guarantee for future yields. Fund shares can go up or down in value, and investors may not get back the amount invested. Before investing, please read the prospectus carefully. Full information on East Capital’s investment funds such as the prospectus, simplifi ed prospectus and fi nancial reports can be obtained free of charge from East Capital, from our local representatives and are available on the website. Please also note that the funds, or some of the funds, may not be available for sale in your country.

bne November 2012

Contents

Editor-in-chief: Ben Aris (Moscow)

+7 9162903400

Managing editor: Nicholas Watson (Prague)

+42 0731582719

News editor: Tim Gosling (Prague)

+42 0720180811

Eastern Europe: Graham Stack (Kyiv)

+7 9266052742

Central Europe: Robert Smyth (Budapest) Jan Cienski (Warsaw) Mike Collier (Riga) Matthew Day (Warsaw) Tom Nicholson (Bratislava) Kester Eddy (Budapest) Steven Roman (Tallinn)

+36 19995200 +48 604994850 +37 129473192 +48 607291187 +42 1907732736 +36 308665550 +372 56665911

Southeast Europe: Justin Vela (Istanbul) David O'Byrne (Istanbul) Bernard Kennedy (Ankara) Ian Bancroft (Belgrade) Bogdan Preda (Bucharest) Branimir Kondov (Sofia) Guy Norton (Zagreb)

+90 5393614470 +90 5359210950 +90 535 7485120 +40 722580137 +38 513835929

Eurasia: Bureau Chief: Clare Nuttall (Almaty) +7 7073011495 Molly Corso (Tbilisi) Oliver Belfitt-Nash (Ulaanbaatar) +97688113149 Advertising & subscription: Elena Arbuzova +7 9160015510 Business Development Director Tatiana Alexeeva

+7 9168306850

Alec Egan Business Development Director (International)

+44 2030516548

Design: Olga Gusarova-Tchalenko

23

35 COVER STORY

CENTRAL EUROPE

6 The Insiders

26 CEZ spurns a French kiss

8 The corruption tsar

27 How much for Temelin II?

12 Perspective

29 Magnitsky case reaches Latvia

13 Chart of the month 30 Lithuanians vote against austerity and nuclear power EASTERN EUROPE 32 Easy money in Poland 14 The gloves come off 15 Gazprom in slow-motion crisis 17 Baring up well in Russia

+44 7738783240

I3

19 Russian Hedonism in London

Cover photo: © Photo ITAR-TASS/ Valery Sharifulin

21 Russian Post delivers

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

23 Ozon's stratospheric rise

33 Poland looks to build its future 34 Poland tries to handbag UK over EU budget 35 Hungary government gambles with business 36 Hungary unveils its latest revenue wheeze

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

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

Many talk about Investment Banking in Central and Eastern Europe.

bne November 2012

Contents

54

We do it.

66

45

SOUTHEAST EUROPE EU hopefuls a mixed bag

52

Retribution in Georgia

39

EU report on Croatia: Must try harder

54

Russia's new role in Central Asia

41

J'accuse in Croatia

56

Kazakh opposition leader jailed

43

Montenegrins stick (a bit less) with what they know

57

Business as usual in Kazakhstan

58

Armavia flies again

59

E-tailing in Kazakhstan

44

Best Regional Bank in Central and Eastern Europe

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

EURASIA

38

Bosnia's divisions revealed

45

Take two in Serbia

47

Turkish forecast raised as monetary policy remains stuck

48

Ratings Xmas present for Turkey?

49

A sorry sell-off saga in Romania

50

Feeling the collar of a Moldovan oligarch

SPECIAL REPORT 63

Eurasian Bank Survey 2012 – Banking in the time of cholera

66

Euro crisis squeezes Russian banks

68

EDB on course to fulfil its goals

69

EDB – monitoring mutual investments

UPCOMING EVENTS 70 OPINION 61

Azerbaijan – a new Gulf state

I5

6

I The Insiders

bne November 2012

Jim Rogers on the road to Damascus

Ben Aris in Moscow

J

im Rogers is not a complete stranger to Russia, having once driven across the entire country from Vladivostok to Helsinki in 1966. "I have seen more of Russia than most Russians," he blusters of the trip. But that doesn't mean he likes it. In 2003, Rogers famously got into an emailed duel with Dmitri Alimov, a Russian MBA student at Harvard Business School, where he enthusiastically rubbished Russia, saying he would never invest there.

That's why the announcement by Russian state-owned VTB Capital and the leading investment bank in the country that it had hired Rogers as an advisor to its new agricultural private equity fund was such a shock. Rogers has clearly had an epiphany and gushed about the exciting opportunities offered

by Russia today in an exclusive interview with bne that runs pretty much diametrically opposed to the mainstream investor view of the country. But then that is a trait that made him a celebrity investor in the first place.

Rogers' claim to fame is that together with his partner, billionaire philanthropist George Soros, their Quantum Fund broke the Bank of England in 1992, forcing the UK out of the Exchange Rate Mechanism and making them super-rich in the process.

Soros must be partly responsible for Rogers' previous animosity toward Russia and he visited Moscow with him in 1997.

The Hungarian-born Soros got caught up in the first wave of enthusiasm for Russia that saw the newly minted Russian stock market soar. At the peak of the bubble that year, Soros became the lead investor into the Mustcom consortium that paid $1.8bn for a 25% stake in Russia's fixed-line telephone monopolist Svyazinvest that year in the country's first big privatisation. The bubble bust a year later and Soros finally sold out of the stake in 2004, booking at least a $1.1bn loss. Soros later dubbed it "the worst investment of my life."

Food for thought After that experience, Rogers was vocally down on all things

Russian leading up to his famous exchange with Alimov, which was widely followed and ended up being written up by the New Yorker. So his new job with VTB is quite a turnabout.

Rogers says there are several reasons for his change of heart, but as an established commodities investor Rogers points to Russia's agricultural potential as the most compelling reason.

"Agriculture is going to be one of the best sectors for the next 20 to 30 years. Russia could and should be a great agricultural producer," says Rogers.

VTB's own team, headed by the CEO of VTB's private equity fund Tim Denchenko, will do the legwork of hunting out farms and firms to invest into; Rogers' job is to advise on strategy and spot the trends that these investments will play on.

He has also been impressed by the rhetoric both in President Vladimir Putin's public speeches and the private meetings he

"Agriculture is going to be one of the best sectors for the next 20 to 30 years. Russia could and should be a great agricultural producer" has had with the president. "I listened to everything he had to say and I agree with much of it. There is concrete evidence of change and that is what has changed my view of Russia," says Rogers. "Russia seems to be changing and outsiders are welcome to invest capital and bring their experience to play. Russia will benefit from this change as will the rest of the world."

But most convincing of all is the fact that the Kremlin is putting its money where its mouth is. Rogers says the establish-

bne November 2012

ment of the Russian Direct Investment Fund (RDIF), a massive state-backed $10bn private equity fund with the mandate to co-invest with the world's leading funds, is indicative of a new direction. "Putin and the government realise that they need to play by the same rules as everyone else. Now they will invest alongside and if you make money, they make money, and if you lose money, they will lose money. This has not happened before."

Image problems Nevertheless, all these things seem to be very little to go on when set against Russia's atrocious investment image. But that is what ballsy investors are supposed to do: weigh the evidence and pick the point when the story changes. "I am delighted that Russia has a horrible investment image, as that means it is cheap. If it was going to be easy and everything was transparent, then it would be the same as investing into Germany," says Rogers. "If you were looking at China in 1978 and said the same things that are being said about Russia now, everyone would have laughed at you. But if you recognised the changes in China, then the problems become huge opportunities for the investor."

The international debt crisis is also contributing to catalysing the changes in a market like Russia, says Rogers, who knows a thing or two about governments with financial problems.

As the only markets in the world showing any growth, emerging markets are moving from a risky punt to add something extra to a portfolio, to becoming a mainstream asset class.

The worse things get in the West, the more investors will be forced to raise their allocations in the new world. "Many of

the countries in the West are in decline and some of them will go bankrupt. Who are the strong countries in the world today, the biggest creditors? It's Taiwan, Japan, Singapore, Hong Kong and China. The West will have to take Russia more seriously as a result of this crisis," says Rogers, who is bringing up his two daughters in both Chinese and English.

Still, Rogers is too long in the tooth to be completely swept away by the rhetoric and Russia has allowed its image to fester for too long for there not to remain some lingering doubts.

"The process [of change] has just started. I have no idea what

"The West will have to take Russia more seriously as a result of this crisis"

Putin's motivation is: perhaps he is worried about his place in history or simply that he has had a change of heart and is transforming from a former KGB colonel into an international statesman," says Rogers. "But Russia's development won't be a straight path – change on this scale never is – but either I am early or I am wrong about Russia. Ask me again in 15 years' time and we will see."

8

I Cover story

bne November 2012

B

oris Titov would eschew the title "Russia's Corruption Tsar", but if he achieves half of what he is setting out to do, then that is what he will become.

Appointed Russia's new ombudsman for business by President Vladimir Putin in July, Titov's job is to try and make life easier for regular businessmen – and at the moment that means doing something about the endemic corruption.

Russia has been corrupt since the time of the Tsars and didn't get any better under the Communists. But corruption really took off in the middle of the last decade, illustrated by Russia's 1998 ranking in the Berlin-based Transparency International "Corruption Perceptions Index" dropping from 76 in 1998 out of a total of 182 countries, to a nadir of 154 in 2010. After Dmitry Medvedev launched his anti-graft drive in 2008 while president, things have improved a little and Russia's ranking has improved to 143 this year – but corruption is still a huge problem and an enormous drag on economic growth. "The main problem in the naughties has not been raiders or corporate wars, but the pressure of the administration on business based mostly on corruption. The state officials are capitalising on the opportunity to grow their personal wealth. It is the number one problem for business in Russia today," says Titov, sitting in his suitably small and unimpressive office in the business centre at the back of Moscow's World Trade Centre complex.

The corruption tsar Ben Aris in Moscow

Titov made his money as a champagne producer with the Krasnodar-based Abrau-Dyurso company and even sent 5,000 bottles of his finest vintage to the Kremlin in May, with which the collected dignitaries toasted Putin's health at his inauguration as president. But he is better known as a leading member of Delovaya Rossiya, a non-governmental organization set up by independent businessmen not involved in the oil sector to lobby the government. Titov was also a member of the Right Cause liberal opposition movement. Nevertheless, his pragmatic approach to lobbying won him the ear of the government, which has increasingly worked together with

Cover Story I 9

bne November 2012

the organisation to tackle some of Russia's worst problems.

Delovaya Rossiya went into a more formal partnership with the Ministry of Economic Development and Trade a year and half a ago, before Putin decided to create the position of ombudsman this summer.

The reluctant knight Fittingly, Putin announced the creation of the new post of ombudsman for business during his keynote speech at this year's St Petersburg Economic Forum in June. Technically, the role of the ombudsman is to deal with any issue that makes business more difficult to do, but Titov's job – as he sees it – is to provide a mechanism outside of government that people and entrepreneurs can turn to if they are victims of pressure from state officials who are attempting to extract a bribe from them. All the issues concerned with cutting through red tape or introducing electronic tax returns can wait for later, says Titov.

The process starts with a citizen filing a complaint to Titov's office. And since he was appointed four months ago, Titov says he has already received more than 500 cries for help. "Our job is to help the honest businessman," says Titov, swivelling in his chair in an open necked shirt and jeans. "The problem is that not all businessmen in Russia are honest. The first thing we have to do is check the complaint to make sure it is real."

Once this due diligence is complete, then Titov starts his own investigation to gather evidence before taking action – usually taking the case to court, but often he will also go directly to the ministry involved and pressure them to act. Despite only being on the job for four months, he says his team has already scored several successes. "We have already got seven people out of jail because of our work. The first steps have been taken, but I can see the problem is bigger than I first thought," says Titov.

In a typical case, a judge in Kostroma was recently disbarred for stealing RUB1.5m ($50,000) and her accomplice, the head of the local Federal Secu-

rity Service (FSB), was sacked thanks to Titov's intervention. In another case, Titov received three separate complaints from small businessmen in Nizhny Novgorod, all of whom were fighting off criminal investigations launched by the local interior ministry. "When we investigated, it turned out that all three complaints came back to the same official in the ministry, so we complained to the local head of the ministry, which launched its own investigation and fired the official," Titov relates.

he requires and he will have the power to halt any investigation or court process if he believes it is an abuse of administrative power.

New powers The creation of the ombudsman position is part of Putin's attempts to build up a more liberal pro-business cabinet, even if he personally keeps control of the most important sectors in his hands and under the auspices of the presidential administration by appointing his mates to the boards of the biggest state-owned companies.

These powers could make a huge difference. One of the problems both Delovaya Rossiya and Titov have had until now is that they rely on the state's own organs to take the fight to the corrupt officials: when he uncovers an abuse, the most he can do is to send a request to the local administration to act. "What happens then is the head of the administration gets a request to do something to help a businessmen, say, Ivan Pupkin – but the first thing he asks is, "who is Ivan Pupkin?" So he sends an order down the chain of command for more information.

Of course, this usually lands on the desk of the very official that the complaint is about and the answer comes back up, 'He is a nobody – there is no problem here'."

After he retook office in May, Putin swept out the old guard from the top tier of government and largely repopulated the cabinet with young liberals;

In Soviet times, the classic question was "who is to blame" when one of the Gosplan's targets were missed – and the wrong answer could land the scape-

"The first steps have been taken, but I can see the problem is bigger than I first thought"

Titov says that on the highest rungs of the ladder there is a new commitment to clean out the stables, but the difficulties lie in the fact that most of the corruption happens amongst mid-level officials in the regions far away from the capital. "The top men in all the ministries are new and they are all committed to cleaning out these corrupt people from their ranks. The trick is actually doing it," says Titov.

And Titov's powers are about to be dramatically increased. At the start of December, the Duma is due to vote on a draft law that would give the office of ombudsman some real teeth: from January, Titov will be able to order any state body to give him any information

goat in the Gulag. This mentality is still pervasive today, but Titov's new powers should sidestep this problem. "If the law is passed, then it will take away the problem of responsibility: if the head of the administration acts on my request and things go wrong, then he is to blame; if he acts on my orders and if things go wrong, then I am to blame," says Titov with a shrug of the shoulders. "We will be inside the system and these guys will understand that the system is now working against corruption so the relations are totally different."

However, this doesn't mean that Titov is going to be some sort of Eliot Nesslike policeman. At his last meeting with Titov in the middle of October, Putin

I Cover story

was very explicit that the power of the ombudsman will come from being able to tap into the existing judicial system, "to defend business people whose rights have been violated without replacing courts."

bne November 2012

resources. The private sector is actually shrinking, as only 5% of the population are directly connected to the main source of money in the country and competition is low. Private people are superfluous to the economy and the gov-

"To get real change in Russia we have to change the Russian economic model"

"I would like Boris Yuryevich Titov and his colleagues who will work in the regions to defend business people whose rights are being violated, not lobby for the interests of businesses and defend those who are really violating the law," Putin said at one of his regular meetings with Titov. "All tools you create, all instances should not replace courts. The main thing is that you need to find your niche in the work aimed at improving the business climate."

In other words, it sounds a lot like Putin is attempting to make the rule of law in Russia work a bit better, with Titov as the point man to oversee the effort.

Perhaps not surprisingly, Titov himself doesn't seem very convinced it will entirely work. Certainly he expects to make progress and maybe even to make a difference, but he punctuates the conversation with maybes and probablies; he is under no illusion that the task ahead is going to be very difficult indeed. In an optimistic moment, Titov says he believes there are a lot of honest and decent people in the mid-tier of most ministries where most of the graft happens, so his work won't be in vain.

New economic model Part of Titov's scepticism is due to his belief that corruption is a symptom and not the cause of Russia's problems. This is one of the places where he disagrees with Putin strongly, but fixing this particular problem lies entirely outside his brief as ombudsman. "To get real change in Russia we have to change the Russian economic model. Today, 80% of revenues is from the export of natural

ernment needs to do something about it. But what is its answer? More state jobs?" says Titov, becoming increasingly animated once on the topic of economic policy reform.

In his 12 years in power, Putin has delivered on a promise of economic prosperity, which is the foundation of both his popularity (Putin's ratings were over 60% again in a poll conducted in October) and his political power. However, much of the increase in personal

needed order and control at the start of the last decade that led to Russia's renaissance and the subsequent boom that began in about 2004 or 2005. "Putin took over and brought the control that was needed. [Finance Minister Alexei] Kudrin came in and reformed the budget and tax system and imposed central control of the state's finances. Plus there was more political stability," says Titov.

"All this was fire fighting. But by 2005 the economy was doing every well. We should have changed model to go for growth and development. The government should have let go, but they stuck to the fire-fighting style for too long."

It is no coincidence that corruption also took off again in about 2005. As the economy recovered, the state should have stepped back, handing the baton to private enterprise. But the state continued to expand and tighten its grip even more, culminating in the Law on Strategic Sectors in 2008 that banned foreign investment into nearly 40 of Russia's most attractive industries (a law that has since been undone). Corruption flourished, fed and watered by the tor-

"State officials are capitalising on the opportunity to grow their personal wealth – it is the number one problem for business in Russia today" incomes has come from windfall oil profits; the state's continuing heavy presence in the economy provides for an extremely efficient "trickle down" mechanism that passes much of the oil money to the population. As a result, the size of the state has continued to expand on Putin's watch and now numbers almost 2m state employees – about twice the size of the Soviet-era peak. "The balance of power is with the government," says Titov. "The main policy of the Putin government is macroeconomic stabilisation and the economy is stable now. We are calling not for stability, but development and growth.

As Titov sees it, after the chaos and stealing of the 1990s Putin brought badly

rent of cash flowing through the state's hands as oil prices rose from a long-term average of $25 a barrel to the peak of near $150 in just a few years.

Kudrin's stranglehold over the country's finances was the tonic a sick Russia Inc. needed immediately after the 1990s, but it is becoming increasingly problematic now. As such, Titov would like to see a new economic model and, unlike most western observers, welcomes Kudrin's departure from the government. Russia, he argues, needs to promote nonresource businesses that is supported by a revamp of the tax code. However, this would also mean the state has to abandon its grip on the oil sector and reduce its own size and control of the economy,

bne November 2012

which is a risk he doesn't believe the government is prepared to take.

Titov's talk of the need for a "new economic model" echoes the talk of the liberal economists that staff Russia's cabinet now. Sergei Guriev, rector of the New Economic School and the intellectual force behind Russia's reform programme these days, has called for exactly the same change: a switch from the state's "big push" to revive growth to "nurturing" the economy. But like Titov, Guriev is sceptical and doesn't believe the Siloviki (the security/military services old guard) is willing to give up its control over the economy.

Indeed the phrase "new economic model" was on the lips of most of the speakers (mostly liberal ministers from the new government) at the annual "Russia Calling" investment summit held by state-owned investment bank VTB Capital. Even Putin used the phrase during his panel session at event. But Putin has also stacked the presidential administration with his buddies from the Siloviki, which has left economic policy caught between these two worlds.

Cover story

complaints and this August he toured the country appointing regional level ombudsmen as his representatives in the regions. In October, Titov revealed to the Moscow Times that by the end of the year the "Red Button" programme will literally feature red buttons on state websites that direct complainants to Titov's organisation and provide instructions for filing a complaint. Working groups have also been set up at the interior ministry and the General Prosecutor's Office, Russia's top policeman, but Titov realises he is at the very beginning of the task. "There are lots of problems on the way," says Titov. "Enforcement is the key. I will have my own powers too and can go to court on behalf of people or companies, and I can order any government process to stop while that

The most visible manifestation of the new economic model being pushed by the liberals are the various roadmaps that the government is drawing. These give some more detail to the reforms of various key sectors. Four have already been submitted to the government for approval, and in the case of the power sector the previous plan was canned completely in September only a year after being adopted by the government after much blood and tears; the responsible ministry ordered to go back to the drawing board and produce a new plan by 2014.

Russia is currently a horse and cart labouring along the road and Titov has been charged with greasing the wheels, he says of himself. However, what is needed is to change to a car, "otherwise you will only ever have one horse power."

Still, at the end of the day, if he produces any results it will make a difference and then his office could be flooded with thousands of complaints on a monthly basis. "It's true," says Titov. "That is why it's more than just me. That is why we are building a system."

Titov too is getting a roadmap, which is being thrashed out now. He has already set up a methodology to deal with

Corruption vs GDP in Russia 180 160

2009

140

2005

120

2006

2010 2007

2008 2011

100

1998

80

2000

2003

2004

2002

60 40 20 0 5000

7500

10000

I 11

case is going on. Then I can also ask for the help of the interior ministry and the general prosecutor, but the problem is the system has to fix itself."

Roadmap to somewhere The upshot is that Russia will do what it always does: meander along, making some progress but not enough to make anyone really happy. However, this time the plan is to at least have a map for the journey.

TI corruption index rank

10

12500

15000

GDP per capita $PPP Source: Transparency International, IMF. Note the lower the ranking the better

17500

12

I Perspective

bne November 2012

remains president, with some significant powers – including the ability to appoint regional officials and veto legislation.

As such, Georgia is in for a “very strange cohabitation between two groups who basically want to destroy each other.” Indeed, the outgoing government’s tax authorities had reportedly conducted what many saw as vengeful audits and other actions against businesses associated with Georgian Dream interests. That bad blood will not drain away quickly.

Georgia on our minds

As such, the outgoing UNM is likely to see its support fall sharply, from 40% to 20%, without the support of the government bureaucracy. It will likely rally around outgoing Prime Minister Vano Merabishvili, who pioneered reforms in the police service, for example. But de Waal predicts a backlash against Saakashvili personally, as scandals and questionable relationships largely suppressed under the previous government receive attention.

Michael Moran of Renaissance Insights

T

he newly elected Georgian government, led by billionaire metals and banking magnate Bidzina Ivanishvili, has taken steps since its October 1 election victory to calm fears of a backlash against foreign investment or against the banks and other Georgian firms that have thrived on close ties to the previous government, led by President Mikheil Saakashvili’s United National Movement (UNM).

Thomas de Waal, a senior associate in the Russia and Eurasia Program at the Carnegie Endowment for International Peace in Washington, said on October17 that there were elements of both a peaceful democratic transition and a counter-revolution in the Tbilisi air. “We’ve seen four or five ministers fleeing the country, possibly with suitcases stuffed with cash... we don’t know that yet,” he told a Renaissance Insights conference call.

“We’ve seen TV stations changing hands.”

But de Waal, a long-time Caucasus expert with deep ties to Georgia, said that most of the new coalition’s public statements and cabinet appointments appear to reflect a desire to “illuminate some of the darker corners of the Georgian economy” and deal with the cronyism that beset Saakashvili’s government during the later years of its tenure.

Very strange cohabitation The fraught political scene in Georgia following the election has led to questions about the country’s relatively open approach to foreign direct investment (FDI) and the risk that the country’s new leadership will move against banks and other firms that thrived under the Saakashvili-allied government.

De Waal, who wrote a detailed look at the Georgian political scene earlier this year for Carnegie, said it would be wrong to downplay the complexities of the situation. While the Georgian Dream coalition won 85 seats in Georgia’s 150-seat parliament and 55% of the vote, the current transitional rules stipulate the formation of a new government after the October 2013 presidential election. Until then, Saakashvili

Renaissance Capital's global chief economist, Charles Robertson, notes in a piece that Ivanishvili’s victory sent a chill through foreign investors, as did his appointment of many ministers drawn from the early post-Soviet administration of Eduard Shevardnadze. But, according to Robertson, Ivanishvili has since “decried government intervention, praised the private sector and – aside from reiterating his support for agricultural investment – appeared to promise little change in the economy. Our base case is that Georgia will continue to thrive on the back of reforms already put in place, and that radical new reforms are unlikely.”

De Waal agrees, and particularly feels that the laissez-faire approach of the previous government to one of Georgia’s most important sectors – agriculture – would be ended.

“The amount of cultivated land in Georgia has actually gone down” in recent years, de Waal said, leading to such absurdities as Georgia importing Turkish tomatoes. “If we’re looking long-term in Georgia, this is a key sector of the economy. It’s a very rich agricultural economy and agriculture was neglected for many years."

Big brother Improved relations with Russia, which has all but banned Georgian wine, mineral water and other agricultural exports since the 2008 war on specious “sanitary” grounds, will go a long way towards remedying this. De Waal feels that GeorgianRussian relations are bound to improve to some extent no matter who replaces Saakashvili, whose administration many now blame for bumbling into the disastrous conflict (even if they see Russia’s actions before and since as arrogant and chauvinistic).

“There’s only so far they can go in normalising relations with Russia,” de Waal said – adding, however, that Ivanishvili’s deep contacts inside Russia, where he made his fortune, could change the dynamics of the relationship over time.

Nevertheless, De Waal views the large Russian market as the obvious one for Georgia’s wares. “The 150m Russians are the main drinkers of Georgian wine,” and under Ivanishvili “we’ll probably see [Georgian] mineral water get back into the Russian

Perspective I 13

bne November 2012

market – and wine... That should be very healthy for Georgia’s economy.” It would not be too much of a climb down for Russia to state that Georgia has now met Moscow’s sanitary standards for wine and food, and thus reopen its market to Georgian products.

De Waal also shed light on some of Ivanishvili’s cabinet choices – all of which are to be confirmed by parliament before they take office. A significant early issue is the ongoing dispute over who will run the National Bank of Georgia. Current governor, Giorgi Kadagidze, has been criticised by the Georgian Dream coalition for allegedly overstepping his authority in levying penalties against Ivanishvili-owned Cartu Bank during the election campaign. The new government wants his resignation, but the separation of constitutional powers makes it unclear whether the government can force Kadagidze to resign.

Regardless, as Robertson notes, it is hard to imagine any significant change in monetary policy if there is a change of central bank governor, since “the National Bank of Georgia has been gradually easing its control over the exchange rate, and has delivered low inflation (a negative average rate is likely in 2012), while encouraging a gradual de-dollarisation of the economy.”

Of Ivanishvili’s other economic picks, de Waal said he has heard “cautiously good reports” about Nodar Khaduri, the government’s proposed finance minister. Economics minister-in-waiting Giorgi Kvirikashvili has already stated his intention to fold the ministries managing infrastructure and natural resources into an enlarged Ministry of the Economy.

Among other portfolios, the big surprise to many outsiders was the naming of a Georgian football hero – former AC Milan defender Kakha Kaladze – as energy minister. De Waal notes “he has no higher education,” but he is “quite a pin-up in Georgia, quite a popular figure.” He also described him as a very clever man judging from his frequent participation in campaign events.

Ultimately, de Waal believes, the appointment is likely a reward for the strong support he gave the Georgian Dream coalition (emerging as the top vote-winner on the coalition’s electoral list).

That said, de Waal holds in particularly high regard the proposed justice minister, Tea Tsulukiani, who has pledged to free the judiciary from government influence – a topic of great interest to foreign investors. Tsulukiani, a well-known international legal expert, spent 10 years working at the European Court of Justice in Strasbourg, France.

Ivanishvili’s choices for the two so-called “power” ministries – Maya Pandjikidze at the Ministry of Foreign Affairs and Irakly Alasania at the Ministry of Defence (as well as proposed deputy prime minister) – are also known quantities with ties to Shevardnadze’s former governments. Additionally, Alasania is the son of a Georgian general killed during the Abkhazia fighting and is likely to lead policy regarding the region.

In summary, De Waal largely backed our view that near-term risks mean investors should stay cautious on Georgia.

Michael Moran is editor-in-chief of Renaissance Insights

IFO business confidence clock running backwards

CHART:

A

s if we needed more bad news: the German business confidence index from the Ifo institute is a proxy measurement for a recovery in all of Europe at the moment – and it has been running backwards this year.

A relatively optimistic 18 months or so starting in 2010 made it look like Europe might be starting to climb out of its hole, and that the crisis might have a "normal" duration of about four years. However, in the second half of 2011, the Ifo's business climate index suddenly turned tail and wandered back into the "recession" box of this month's chart from Erste Bank. In September, the index dropped for a fifth straight month to its lowest level in more than two and a half years.

ifo business clock Eastern Europe (quarterly development) 10

Upswing

Boom

Economic expectation

8

Q3 10 Q3 11

6

Economic situation Q3 09

4

Q3 12 Q3 08

In an ideal world, the pattern would sweep in a circle around the clock. In that scenario, after ticking from Boom to Downswing and then passing through Recession and Upswing, the measurement should then smoothly head into Boom once more. However, due to the sudden fork, we're getting a second helping of recession.

2

Recession

0 0

Source: Datastream

Downswing 2

4

6

8

10

14

I Eastern Europe

bne November 2012

It's a government that suffers from bipolar disorder – good on some days and downright scary on others, depending on who is in front of the cameras. Putin seems to have been in a rush to reassert his authority and took a leaf out of former president Boris Yeltsin's playbook. A consensus-builder during his first two terms as president, Putin has consciously appointed people to the cabinet and his own team with explicitly overlapping jobs. Yeltsin used the same tactic, which guarantees the machinery will seize up after the inevitable turf wars break out, only for him to descend Deus ex machina and break the deadlock, making himself indispensible in the process.

Seconds out, round one It was only a matter of time before Dvorkovich came to loggerheads with Igor Sechin, Russia's "Siloviki-in-chief" and a close personal friend of Putin.

Dvorkovich's job is to oversee great swathes of the economy, and the oil sector in particular. Sechin, a former spy, is CEO of Russia's state-owned oil major Rosneft, as well as being in control of the Rosneftegaz holding company that formally holds the government shares in Rosneft and gas giant Gazprom, amongst other things. Sechin's power was further bolstered in June when Putin set up the Presidential Commission for the strategic development of the oil and gas industry and ecological protection, with himself as chairman and Sechin as secretaryin-charge. This think-tank more or less replicates Dvorkovich's responsibility to make policy for the oil sector.

The gloves come off bne

I

t was the first head-to-head clash between the young liberal team in Russia's cabinet and the old guard Siloviki faction in the presidential administration. On balance, the liberals are seen as having sneaked a win.

The battle lines have been drawn since Russian Prime Minister Dmitry Medvedev appointed a surprisingly reform-minded government in May, led by several fresh faces with established pro-market credentials. At the same time, Putin took in the fleeing Siloviki (those with ties to the security/ military service) that dominated his

last government when he was PM, giving many vague "consultant to the president" jobs or putting them in charge of big state-owned companies.

The make-up of the government has left Russia watchers confused. There is

correspondent Ed Lucas) were buoyed by the youthful ministers, such as First deputy Prime Minister Arkardy Dvorkovich and Finance Minister Anton Siluanov, who are seen as professional and competent. The Russia-bashers could point to the concentration of

"Round one goes to the liberals" something for everyone there: the "rah rah Russia" crowd (as Russia-optimists were famously dubbed by Economist

former spies surrounding Putin, where the real power is thought to lie, and argue that nothing has changed.

Eastern Europe I 15

bne November 2012

Tensions between Putin and Medvedev were already rising in the spring as the government got its first budget together. Putin publicly chewed out several minsters as well as Medvedev at televised cabinet meetings. Medvedev lost his cool, snapping back at an irate Putin: "When I worked as president, I never liked [the budget] either. But I always remembered and realised how difficult it was to glue together a budget, especially in the conditions of a crisis."

The first actual shots were fired in September when Finance Minister

Gazprom in slow-motion crisis

bne Russia’s bluest blue chip and foreign policy tool, Gazprom, is in a slowmotion crisis, beset by a rebellion amongst its customers in Europe who have demanded cheaper prices, while struggling to meet the long-term challenges as the nature of the global gas market changes fast.

President Vladimir Putin brought the problems into sharp relief on October 23 when he called on the gas behemoth to "respond to the development of the liquefied natural gas (LNG) and shale gas markets", and develop a new export policy.

The advent of shale gas has been a game changer, bringing new, cheaper sources of gas to Europe, Gazprom’s traditional stomping ground, where profits were already falling this year due to weak demand.

French, German, Slovakian and Turkish companies have all managed to renegotiate their contracts for gas, which led to the company paying out a RUB78bn ($2.4bn) rebate in the first quarter of this year. Lithuania went further, filing a $1.9bn legal claim against Gazprom, while Polish gas monopoly PGNiG has launched an arbitration procedure over alleged price gouging. Added to this is the European Commission’s decision to launch an antitrust investigation into Gazprom’s long-term contracts, which could cost the company billions in fines.

Gazprom is also facing increasing competition at home where nimble independents, led by private gas producer Novatek, now make up a quarter of supplies. Gazprom attempted to slap down these upstarts in September by cancelling purchase contracts, but the Kremlin quickly stepped in and rescinded the decision. There is even speculation Novatek will be given the right to export gas, thus breaking Gazprom’s lucrative monopoly.

Talks with China on building a big gas pipeline over the Siberian border could make a huge difference to Gazprom’s bottom line, but they are going nowhere. And the other new export route of Nord Stream may be strategically important, but it will also cost Gazprom some $1.5bn in extra transit fees by 2015, say bankers.

Clearly the government is not happy with the way the company is run and is looking to tighten its control. The Ministry of Economic Development and Trade warned Gazprom recently of the "urgent need to improve the efficiency of investment, otherwise it may become uncompetitive both in foreign and domestic markets,” specifically highlighting US gas exports to Europe that are expected to start in 2016. The ministry has suggested appointing two of its own to Gazprom’s board, taking over the strategic and investment committees, while Deputy Minister of Economic Development Sergey Belyakov wants Gazprom’s investment programme to require government approval.

Gazprom is in the process of drawing up a roadmap to protect Russia’s energy security that is supposed to be approved in November. The next 12 months could prove key to the long-term prospects of Russia's biggest company.

16

I Eastern Europe

Siluanov insisted that Rosneftegaz pay out 95% of its RUB132bn ($4.3bn) cash pile to the government as dividends to plug a hole in the budget. The state has already ordered all state-owned companies to pay out 25% of their profits as dividends, but Siluanov's suggestion was regarded as an aggressive attack on Sechin. Medvedev backed the idea and Dvorkovich picked up the baton, personally leaking a letter to the press saying Rosneftegaz doesn't need so much money to run its business, but the budget does. The letter brought the whole fight into the public arena – another aggressive move, as Sechin prefers to operate in the shadows.

The liberals' beef with the cash pile is that it was clear Sechin never intended to spend the money on Rosneft. Since the start of the year, Sechin has been making a play to consolidate the entire energy sector under the umbrella of a new national energy champion Rosneftegaz, using this money to buy up stakes in some of Russia's most attractive utilities.

Sechin has got better at play-acting in front of the cameras and jovially admitted during the Sochi Investment Forum in mid-September that the cabinet has every right to distribute government assets as it deems fit, before delivering the zinger: "but only if there is a directive approved by the country's president."

bne November 2012

will follow over the coming years.

The crucial point is that whatever Sechin says, Putin has no actual formal power to decide anything in this case.

"About the Rosneftegaz dividends... they do not demand formal approval by the presidential administration," Dvorkovich told reporters at the same investment conference. "But the government is conducting such consultations."

Ironically, Medvedev holds all the cards in this game. Veteran Russia-watchers will remember that despite changing the constitution in 1993 to give the president vastly increased powers, Yeltsin spent the rest of the 1990s battling an irascible Duma. Medvedev could have chosen to confront Putin and cause a political crisis.

On October 8, the results of the backroom deal began to emerge.

Dvorkovich wrote an order to Rosneftegaz to pay RUB50.5bn ($1.6bn) of dividends, or some 38% of its cash pile. This is still a lot more than the 25% the other state-owned companies have to pay, but a lot less than 95%; Sechin was left with RUB82bn ($2.6bn) of the cash.

As bne went to press, it seems that Sechin has got his national champion

Eastern Europe

after all, albeit in a different from.

On October 23, Rosneft announced that it would buy out both BP and its Russian partners in the the TNK-BP joint venture, at a total cost of $45.1bn in cash and 12.84% of Rosneft shares, though will get back $4.88bn from BP in return for selling it a further 5.66% stake. Sechin estimated the total value of the deal at $61bn. However, the financing of the $40bn in cash needed for this deal has yet to be worked out.

Rosneft will become the largest listed oil company in the world and the merged companies will produce just under half of Russia's daily oil output.

But the decision on the key issue of the power sector consolidation, bankers in Moscow believe Sechin has been persuaded to drop his bid to take over the utilities sector. "Dvorkovich has won," says Roland Nash, chief strategist at Verno Capital. "Sechin is not going to buy in and instead there is an investment boom going on there. More generating capacity is coming on line in the next few years, paid for mainly by private investors, than Russia has seen since the last boom in the 1970s."

"Round one goes to the liberals," he concludes.

Horse trading And there's the rub. Most Russiawatchers outside of the country interviewed for this piece assumed that Putin would back Sechin up. But many bankers who live and work in Russia said Dvorkovich was probably going to win – which is testament to how confused politics in Russia is at the moment.

As the weather closed in and the leaves began to fall, everything went quiet for a few weeks while the serious horse-trading started. The outcome of this fight is key, as it will say a lot about the power of the liberal cabinet and indicate the direction that Russia

bne November 2012

"About the Rosneftegaz dividends... they do not demand formal approval by the presidential administration"

I 17

another one in five investments turn out significantly better than expected at the time of the initial investment. "We have never lost money on investments in natural resources, but we broke even on some of them. The trick is to have a few home runs as well, like Burren Energy," says Calvey.

Baring up well in Russia Ben Aris in Moscow

A

t a time when most investors are clinging to their cash in anticipation of yet another financial firestorm, Russia's leading private equity firm Baring Vostok Capital Partners just raised $1.15bn for its fifth fund, Baring Vostok Private Equity V LP, and another $350m in a co-investment fund.

Private equity investment in Russia has never been particularly popular, but when Baring Vostok goes cap in hand to the market it has to turn investors away: the fund-raising had a hard cap at $1.5bn, says partner Michael Calvey, and was oversubscribed.

Baring Vostok has never spoken publically about its performance, but Calvey points to its investment in Burren Energy as an example of a "home run" – the fund invested $27m in the company from 1995 to 2000 and made a return of about 15-times when it exited following an IPO on the London Stock Exchange in 2003. "If you are a global investor, China is so big you have to have a strategy for it, but not so for Russia: you don't have to be here," says Calvey. "Our investors don't invest into Russia for pedestrian returns."

Eye for good business Baring Vostok has a knack for spotting good companies early on and takes any-

thing from a small minority investment through to complete control as part of the process of growing the company to its full potential. For example, it invested $5m in the early days of Yandex – Russia's leading search engine that is now five-times the size of Google in Russia – which was the only capital Yandex ever raised before its eventual IPO in May 2011. That deal valued the company at about $8.0bn, making it one of the larg-

The key to operating in a such a volatile environment is to understand the people you are dealing with. Calvey is an American, but he runs the fund together with his co-senior partners, Russian nationals Elena Evashentseva and Alexei Kalinin.

"We have 13 partners in our firm and 11 of them are Russian," says Calvey. "They have the same mentality, culture and background as the entrepreneurs we are backing. There is alignment of interests and a common vision for the future, otherwise we won't invest. There is really not much room for passive investors in private companies in Russia.

Russia's private equity business is far too immature to have developed specialist funds and Baring Vostok invests in everything. However, the types of company can be broken down into four main blocks.

The first is software and the internet, which has been a staple of the portfolio.

"Russia will continue to grow much faster than the developed markets, but people need to lower their expectations a bit as Russia is starting to mature" est internet companies in Europe and another "home run" for Baring Vostok.

Still, investing in Russian and other companies in the Commonwealth of Independent States is not easy. Calvey says about one in five investments go badly wrong; even Burren Energy needed several rounds of financing before its business turned around and it became seriously profitable. However, the high risks bring high rewards and

In addition to Yandex, the fund was an early investor into Ozon.ru, Russia's answer to Amazon.com, which has since branched out to become a general retailer. More recently, the fund invested in ivi.ru, Russia's answer to TV streaming site Hulu.com. "ivi.ru streams movies but makes its money from advertising; the pay-per-view model doesn't work in Russia. There are other competitors in this space, but we are betting that it can get to critical mass and become the category

18

I Eastern Europe

Viva la RDR! It's the Russian version of the 1949 movie “Passport to Pimlico.” Residents of the city of Domodedovo south of Moscow have declared independence from the Russian Federation, founding the Russian Democratic Republic. The Russian Lawyers Association for Human Rights group has officially applied to the EU for official recognition of the new state.

In their letter to the EU, the Russian Democratic Republic action group claims the Russian authorities have grossly violated the principles of democratic society by ignoring the results of a 2007 referendum when almost 100% of Domodedovo residents voted against the building of a toll motorway within city limits.

The RDR has asked for formal membership of the EU and want to be recognised by other countries as having a special status within the Russian Federation, but with the right to self-determination. The republic’s emblem is a nosediving one-headed eagle.

bne November 2012

leader," says Calvey. "Russia has one of the best computer programming talent pools in the world and we have had lots of success with software companies."

The second block is financial services – one of the best ways to play on the growing middle class and rising income story. Russian bank assets were growing at between 40% and 50% a year before the crisis and are still growing at about 25% post-crisis, but the level of financial service penetration is still very low by European standards. Amongst the fund's investment is the Tinkoff Credit Systems, a credit card specialist and Russia's first purely virtual bank; automotive leasing company Europlan; the express credit outfit Vostochny Express Bank; and Caspian Bank in Kazakhstan. "Rus-

bne November 2012

Eastern Europe

Baring Vostok has its own team of technical experts and geologists, and focuses on resource companies that have already finished the exploration stage but are looking for capital to go into production. "The risks in these sorts of projects are mainly in the execution, infrastructure and technical issues, but we are willing to take these sorts of risks if we believe in the management team," says Calvey.

Back in favour The success of Baring Vostok's fund-raising suggests that investors are becoming more interested in Russia again and certainly Calvey says Russian private equity is becoming more competitive. On the one hand, the oligarchs are increasingly investing their billions in new ventures

"Our investors don't invest into Russia for pedestrian returns"

Russian Hedonism in London

sia is still very underpenetrated in terms of financial services – there is still 10-15 years of fast growth ahead in the sector," reckons Calvey.

Jahan Hoggarth in London

The third block is businesses that cater directly to the consumer. Here the selection is broad, as nearly every sub-sector is missing services or those that exist have a lot of development work to do.

"We have invested into things like medical services, clinics, Borjomi [mineral] water, beer companies. Some of these sectors are by now well developed, but lots of them are still in 'catch-up' mode so their growth rate is stronger than GDP growth overall," says Calvey.

The first three blocks are all connected in some way to the rise in incomes, but the fourth caters to Russia's traditional strength – natural resources. "This is still the richest country in the world for mineral and hydrocarbon deposits. About 90% of the resources are being exploited by the major, state-owned companies, but that still leaves about 10% of the resources that are being developed by small independent players, many of whom don't want to partner with an oligarch or the state," says Calvey.

I 19

as a way to diversify from the business that made them rich. On the other, the state has poured tens of billions of dollars into things like the Russian Direct Investment Fund, Rusnano and Rostekhnologii – part of its drive to diversify the economy. A few western funds are also starting to eye the market, according to bne sources.

However, the heady days of excessive gains are probably behind private equity funds in Russia as the country becomes increasingly normal. According to the UN Development Agency, Russia is already a "developed market" in the middle-income bracket, unlike all its BRIC peers. And as the country stabilises the returns will become more normal too, says Calvey. "The big returns we earned between 1999 and 2008 are probably a thing of the past. Over that period, the economy grew nine-fold in size. That will never happen again," says Calvey. "In the next 10 years, Russia will continue to grow much faster than the developed markets, but people need to lower their expectations a bit as Russia is starting to mature."

S

ituated on the most exclusive section of Davies Street in the heart of London's Mayfair is Evgeny Chichvarkin's new wine store, Hedonism Wines. Once you've managed to find a rather disguised entrance and entered the shop, words like "twinkling" and "lustrous" immediately spring to mind – not to mention "exhorbitant".

With guitar rock music streaming unobtrusively in the background, and staff hovering almost invisibly around the shop, you are left on your own to admire double magnum champagne bottles (6 litres to you and me) and snake-shaped crystal decanters with a starting price of £2,000.

The floor-to-ceiling library shelves are artfully stacked with the world's best rums, gins, liqueurs, vodkas, whiskies, grappas, ports, cognacs and brandies – anything and everything the world of high-class hedonism has to offer. "Not just anything – only the best," notes

Chichvarkin, a Russian millionaire and the founder of Hedonism Wines.

And the "best" according to Chichvarkin, is in the luxury goods market. "The market is growing as the consumption of luxury goods is back to where it was before the crisis. It's the fastest growing market. Luxury is walking tall around the planet, but London is still the world capital of luxury retail," says Chichvarkin.

And his Mayfair wine store is a good example.

Serving the Establishment Lavishly furnished with crystal, oak and intricate cast iron interiors, and with 5,500 lines of fine wines, priced between £15 and £125,000 per bottle, Hedonism Wines is set to prove his point. According to some experts, by the end of 2015 the world's total luxury goods market will reach $500bn, and is currently estimated at $400bn.

A Muscovite trendsetter and a trader since he was a teenager, Chichvarkin is embracing his new lifestyle as an unconventional wine merchant and a keen polo-player. "I'm done serving the middle classes. I like my new extremely rich, capricious and unreasonably demanding clientele," says Chichvarkin.

He insists he is not old enough yet to join the "Establishment", but considers the UK and London to be the financial centre of the world. And he's not alone.

Attracted by the UK's investor-friendly tax and predictable political systems, fair courts and multicultural tolerance, Russian wealth is rapidly shifting towards the British Isles. And it's not just the privilege of the super-rich.

After Vladimir Putin's re-election as president, the core of Russian emigration has begun to change, with well-educated and intellectual middle class professionals finding refuge for their financial and intellectual wealth in the UK. In 2011 there were over 100,000

20

I Eastern Europe

bne November 2012

Russian-speaking children educated in London schools.

Chichvarkin talks with a coolness about Russia's future, yet there is a glimpse of boyish glee in his eyes when he talks about his pet project – a unique model village in Russia, purpose built for tourism, but also aimed at restoring ethnic Russian craftsmanship and centuries-old skills. "We wanted to attract local craftsmen and artists to run workshops and teach people how to carve wood, make cheese and even brew their own beer!"

An unusual hybrid of modern capitalist and utopian romantic, Chichvarkin speaks at length about his vision of new Russia. Yet his dream of restoring the best in Russia has had to take a backseat.

Like many before him, Chichvarkin was driven out of Russia after a long and increasingly dangerous brush with Putin's regime. The former telecommunications tycoon and co-owner of one of Russia's leading mobile phone companies, Yevroset, Chichvarkin was accused of kidnapping and extortion. The charges against him were dropped in 2010, but after selling his 100% interest in Yevroset to Alexander Mamut in 2008 (purportedly for $400m), Chichvarkin fled to the UK. "There is no point in investing in Russia while Putin is running the country," he says, convinced that without Putin, Russia would be the third most developed country in the world after the US and Japan. "If there was no Putin, of course I would never have moved out of Russia. After selling Yevroset, I told everyone that I wasn't going to move my money abroad… Until Putin is carried out of Russia, I am not going to invest there."

bne November 2012

Wind and dined An intellectual, and expensively eccentric, Chichvarkin has an aura of the gregarious Russian merchant with exclusive tastes and astute business instincts. Having looked around for business ideas for over six months, Chichvarkin spotted a niche in the luxury goods market in London. "When I first came to London and was looking to buy some expensive wine, I struggled to find much on offer. Everything had to be ordered and I had to wait for days for the delivery." Hedonism Wines offers free delivery within an hour across central London or same-day delivery to a private jet.

Eastern Europe

the investment attractiveness of the company," Fitch said in the statement.

Stamp of approval Along with Sberbank, Russian Post is one of those few Soviet-era institutions that remain popular and relevant to modern life.

Photo: www.russianpost.ru

According to the company's CEO, Tatiana Fokina, some of the bottles in the shop were bought at various charity auctions, while the proceedings from their most expensive bottles have been given to the Water Aid charity.

Russian Post delivers

Chichvarkin's decision to invest in fine wine was not only based on his personal tastes in luxury products, but also on the longevity of the product. "The good thing about investing in wine is that it won't go off or out of fashion, and the longer you keep it, the more expensively you can sell it."

ussian Post (Pochta Rossii), the national postal service, was deemed one of Russia's most reliable and creditworthy companies in Russia at the end of September when Fitch awarded it an investment grade rating that propels into the “blue chip” league. It will have to be, as it gets ready to be transformed.

And as the wine industry saw such chain stores as Oddbins and Wine Rack going out of business by 2011, while Harrods' fine wine department has almost trebled in size, the time to open Hedonism Wines seemed right. "Having analyzed all of this, I decided to invest in fine wine in the UK. In my shop we have the best collection of wines and spirits in the world available for sale. This business is my life and I hope the second half of my life will be spent in this shop or around it," Chichvarkin says.

"Luxury is walking tall around the planet, but London is still the world capital of luxury retail"

I 21

Ben Aris in Moscow

R

Fitch awarded the company a 'BBB' rating, which makes the company one of the four best rated companies in Russia – on a par with gas behemoth Gazprom, the Russian Railways transport monopolist and state-owned oil major Rosneft.

“Fitch Ratings has assigned FSUE Post of Russia (PR) a Long-term foreign and local currency rating of 'BBB', a Shortterm foreign currency rating of 'F3' and a National Long-term rating of ‘AAA(rus).

The Outlooks for the Long-term ratings are Stable. The rating action also affects the company’s outstanding domestic bonds (RUB7bn),” Fitch said in its announcement of the new rating.

The rating is important, as the post office is about to be transformed along the lines of a modern logistics company similar to those in Europe – and it looks

like it will have to pay for most of its modernisation by itself.

The company has announced it plans to issue three tranches of seven-year bonds totalling RUB3bn each later this year.

This would follow a hugely successful debut bond in March 2011, which was a RUB7bn issue with a yield of 8.25% that was nearly seven times oversubscribed.

Following the Fitch rating, the next round of bond issues should be even more popular. The company's investment-grade status will widen the circle of possible investors and following the opening of Russia’s

A population scattered across a vast territory that spans 9 time zones needs to be able to send things to each other quickly and inexpensively, and Russian Post has 42,000 branch offices (about twice as many as Sberbank’s) covering the entire Russian Federation and delivers some 1.5bn letters to over 50m addresses a year. At the same time, the post office remains one of the main points of contact between the state and the people, being, among other things, the paymaster for state pensions as well as enabling retail payments and settlement services.

Surprisingly, the service is regarded by many as actually pretty good. "We sold to Russians right across the country and relied entirely on the postal service to deliver the goods and we had no complaints," says Pascal Lament, the founder of PPE, Russia’s first consumer catalogue business. "The longest anyone had to wait for a delivery was two weeks."

And the international service is set to improve too. The senior management of Russian Post were in Qatar at the end of September at the "25th Universal Postal Congress", at which postal workers from around the world gathered to talk international cooperation. Russian Post

"Surprisingly, the service is regarded by many as actually pretty good" capital markets to international investors, expected to happen in November, these bonds would be an obvious target for international investors as well. "This creates opportunities for the qualitative and quantitative expansion of the pool of potential investors, and increase

signed a series of agreements that will speed up the delivery of letters and parcels from abroad and improve the reliability of international deliveries, by doing things like pre-sorting letters in the country from which they are sent into those destined for Russian cities and those due to transit Russia to Asia.

22

I Eastern Europe

bne November 2012

Sorted The state has been talking about modernising the post office for years, but the pace has picked up recently and the new rating is part of a broader plan to give the postal service a comprehensive makeover.

"The post office is about to be transformed along the lines of a modern logistics company similar to those in Europe" In September, the Ministry of Communications and Mass Media was finalizing a draft bill to reorganize the post office that is supposed to be presented to the Duma this autumn.

The post office development is based on a strategy worked out by consulting firm Boston Consulting Group and the draft bill removes the ban on the sale of shares in the company as well as creating two types of postal companies in Russia: a universal mail provider and courier companies similar to America’s UPS and Germany’s DHL, which will be able to set commercial unregulated tariffs for post deliveries.

The couriers are not expected to cause major financial losses to Russian Post since the state company's profits from express mail are fairly small. But the introduction of a relatively cheap national courier service will open up a raft of business opportunities to retailers that are currently focused on the 13 biggest cities. Indeed, as a precursor to the changes, Russian Post has already been in cooperation talks

bne November 2012

Eastern Europe

I 23

with companies like online retailer eBay, which opened an office in Moscow earlier this year.

Bond issues and other forms of financing are a key part of the modernisation plan. The post office has been called on to match the state’s investment into its modernisation ruble for ruble, and funding for the first stage will probably come out of the post office’s own pocket as there is no investment allocation in the 2013 budget that was approved in September, says Fitch.

Fitch expects the company to increase its debt by up to RUB24.5bn by 2014, which still leaves it with "a conservative net debt/Ebitda below two-times in 20122014," says Fitch, adding that the bulk of the company’s debt is long term with no refinancing risks until 2014 when the original bondholders have a put option on the RUB7bn debut bonds.

And Russia Post is already profitable, earning about RUB700m in 2011 on revenues of RUB3.4bn, against RUB480m of profits in 2010, the company said at the start of this year, with postal services accounting for 45% of the revenues and financial services another 38%, with the sales of goods and services making up the rest.

The upgrade of Russian Post would require from RUB50bn up to RUB100bn of the budgetary funds. "However, since the budget situation is rather complicated, we primarily pay attention to sources of interior effectiveness [of Russian Post]," Communications and Mass Media Minister Nikolai Nikiforov said at the start of September.

Ozon's stratospheric rise Ben Aris in Moscow

W

as traditional organised retail, where supermarkets are gradually eating into the market share of the open-air markets that are still the most popular place to shop in Russia.

hen Maelle Gavet first arrived in Russia in the first days following the fall of the Soviet Union as a student, the shops were empty and the phones didn't work properly. In those days, the internet was just a distant dream for science fiction writers, but two decades on and she heads Russia's leading e-commerce site Ozon.ru – Russia's answer to Amazon. com – that is growing by leaps and bounds.

a functioning internet in Russia," says Gavet. "We are lucky, as we have shareholders with a very long-term horizon."

A French national who took Russian at university, Gavet spent some time in a regional university before returning to work in Russia full time in 1998. Like most of the buccaneers that arrived on the shores of Russia, she dabbled in business, founding a small regional corporate event company before taking a job at the US consulting firm Boston Consulting Group, where she stayed for six and half years and moved to Ozon after completing a consultancy job as its director for marketing.

"Ozon was very early into the game, launching even before there was really a functioning internet in Russia"

Ozon was well ahead of its time, launching only two years after Amazon and at a time when even bricks and mortar retail in Russia was in its infancy.

"Ozon was very early into the game, launching even before there was really

Shares in the company have changed hands several times, with Pascal Clement, the owner of internet company incubator Fast Lane Ventures being one of the notable early investors. But things got serious after leading private equity

Starting life as an online bookstore that had half an eye on Russian expats in places like Germany, Ozon has grown into by far the largest e-commerce business in Russia. "Ozon.ru is made up

firm Barings Vostok bought majority control of Ozon in 2000 for $3m and the company was re-capitalised again with another $18m when Bertelsmann's digital investment arm Holtzbrinck Ventures and Swiss-based information technology specialist Index Ventures both invested into the company in 2007.

of four businesses," said Gavet, sitting in the company's relatively modest offices in the leafy Sokol district of northern Moscow. "Ozon.ru is an online retailer, O'Courier focuses on shipping, Ozon.

Travel, and our most recent acquisition Sapato is the leading online shoe and accessory retailer."

Market leader It is still very early says for Russia's e-commerce sector, but the development of the sector is following the same path

The revenues from Russia's internet are growing at 30% a year. A VTsIOM survey conducted in September suggests that 60% of the population now uses

24

I Eastern Europe

bne November 2012

the internet compared with just 24% in 2006. And the volume of the online business is growing even faster: last year, Russians spent an estimated RUB554bn ($17.8bn) on goods bought from online shops. Consumers also sent RUB167bn through the internet using online payments systems, while advertisers spent RUB24bn on contextual ads and another RUB16bn on media advertising such as banner ads, according to September a survey by the Russian Association of Electronic Communications and the Higher School of Economics.

As the market leader, Ozon is growing even faster. Total sales have grown from $19m in 2005 to top $300m in 2011 and were up 80% in that year alone. Gavel

But few would disagree that if the sector continues to grow at the current pace, the value of the online retail sector is likely to hit $100bn by 2020, matching bne's estimate of $103bn in our March cover story Russian XXL that argues Russia will become the largest consumer market in Europe by that time.

A race is developing, to an extent, between traditional and online retailing.

Due to its vast size, Russia is ideally suited to online retail, as it is the cheapest and easiest way to get goods into the country's far-flung corners.

The Russian postal service is one of the few Soviet institutions that work and is about to undergo a huge modernisation programme. "It's possible that Russia will skip over parts of the development of

"Before the Mail.ru IPO, investors were mainly looking at China and India amongst the emerging markets, and little else"

says the goal is to become a billiondollar-a-year company and that it is "not going to take another 10 years to get to that point."

Despite the impressive growth, online retail is still very much in its infancy.

As a whole, it only had a 1% share of the RUB660bn ($22bn) that Russian consumers spent in 2011, compared with Europe where online retail already accounts for between 5% and 8% of total retail turnover.

Judging the true size Russia's online retail trade is very difficult, as that 1% share of total retail turnover would imply the total size of the online market was worth $200m in 2011, less than Ozon's own revenues. Other estimates put the value of the total online business much higher at $6bn, which is equivalent to about 25% of the official retail total. Part of the problem is that much of Russia's retail happens in the shadows, making estimating the size of the sector difficult.

traditional retail like it did with the move from land line phones to mobile phones," says Gavet. "But that was only possible thanks to the massive investment by the mobile phone operators that ran into the billions. The same will have to happen with distribution and logistics for it to happen with e-commerce."

bne November 2012

the billions of dollars. "We spent nine months meeting with investors when Mail.ru floated. The reaction and the level of knowledge of the Russian market changed dramatically as a result and significantly increased awareness of RuNet," says Gavel. "Before the Mail. ru IPO, investors were mainly looking at China and India amongst the emerging markets, and little else."

Although Gavet says the money was raised with no particular purpose in mind, most of it was spent on buying the shoe retailer Sapato.ru. Acquisitions are part of Ozon's strategy, but at this point they are mostly opportunistic, as the quality of targets on offer are very mixed. "There are a lot of 'cookie cutter' companies out there – that are simply trying to copy an idea from the West and they are not always good copies," says Gavet.

Most of the development will come from building up the services that the company already offers. Like Amazon, Ozon has moved away from selling just books to transform itself into a general store carrying thousands of different products.

The next stage will be to metamorphise again to become simply a sales platform that other companies can use to sell to the general public. "Ozon is on its way to becoming the biggest online platform in Russia. We have all the key logistics and marketing pieces in place, but there is still a lot of work to do," says Gavet. "The plan is to build up direct sales, where we

Eastern Europe

will buy goods from suppliers and sell them on to customers. This is already happening on ozon.ru."

Distribution and fulfilment are the key parts in the puzzle where the economies of scale come into play. Already Ozon's distribution can handle 90% of its own deliveries, reaching every major city and town in the country. In addition, Ozon has set up a string of "pick-up points" where customers can come to collect their goods. A quirk of Russia's internet is that e-commerce appeared before credit cards, so customers are used to being able to pay cash-on-delivery (COD), which is unusual in the West.

"It was very strange when you first meet it, but in the West customers were never given a choice: they had to prepay and wait for the delivery," says Gavet.

"If they don't like the goods, they can return them and get a refund. In Russia, no one wants to prepay and everyone expects to pay in cash after they have actually seen the goods."

The COD system adds heavily to costs, as customers are not always home and can refuse to buy the goods once they have seen them. By contrast, the pick-up points not only cut costs (some of which is passed to the consumer), but they also act as shops and earn extra revenue.

The front end of the business is to develop the platform function. In a recent experiment, Ozon wanted to

try out the coupon business, which is already well developed in Russia.

Rather than trying to compete with the existing companies, it organised a tender that was won by KupiKupon, who are providing a white label service called "Ozon Bonus". "The site is already running and in just a few weeks we have seen the number of users up several hundred percent. It is early days now, but for us it is very interesting, as this is just another channel for us to sell our services and tap into a much wider audience offered by Ozon," says Iskander Khanbaev, head of marketing and development at KupiKupon.

Well established as the leading e-commerce company in a country that is well on its way to becoming the largest consumer market in Europe, Ozon is destined to become the third big RuNet IPO. Gavet says it is the dream of every internet entrepreneur to IPO from day one, but there are no specific plans yet.

"We have no calendar for an IPO, as we are still very early in our development.

We want to reach a billion dollars of turnover first. There is still a lot of work to do," says Gavet. "About half the population is already online and of that some 20% have bought something using the internet. In 2011, there were about 10m to 15m buyers online, but this is still growing very fast and expect this to rise to 20m this year. E-commerce companies are all looking for that famous scale effect and this is still not happening."

Russia's Internet revenue breakdown 2011 Raising money Ozon is already a big company by any standard, but it has pulled off the difficult trick in Russia of raising serious cash. With more billionaires per square metre in Moscow than anywhere other city in the world, raising $100,000 to $1m is relatively easy for a Russian start-up. But raising the second round of financing, from $5m to $25m, is a lot more difficult and few Russian companies have managed it.

In 2011, Gavet managed to bring in $100m of fresh investment and her life was made easier by first the Mail. ru IPO in London and then the Yandex IPO, which valued both companies in

Segment

Online retail Online payments Contextual online advertising Media advertising Web design Search Engine Optimization Online content, games Hosting services, domain development Social media marketing (SMM) Software-as-a-Service (SaaS) Video advertising

Total revenue in 2011, bln rbl

Growth in 2011, %

Growth forecast for 2012, %

309.4 166.7 24.24 15.83 9.83 8.56 8.24 5.32 2.98 1.89 0.8

30 34 53 41 31 18 26 25 43 46 53

27 32 39 33 27 19 27 21 40 46 59

Source: Russian Association of Electronic Communications (RAEC) and the Higher School of Economics

I 25

26

I Central Europe

bne November 2012

here for the next 60 to 100 years, and we are making that clear to the Czech government," Lazo said, referring to the fact that the sensitivity and size of this project means the decision will be made at the highest levels.

Insiders tell bne that out of the tens of thousands of pages included in its tender submission, CEZ has highlighted only 9 – none of which it had called Areva to ask about or clarify.

Nuclear option Areva and Paris are furious, understandably so since in some ways the French bid was superior to the others, not least because Areva is the only one whose reactor design, the EPR, is actually licensed in the EU. As such, there are questions about how far the French are willing to go, including measures that could bring the tender to a halt. Nucleonics Week, an industry publication, quoted a lawyer with Kinstellar in Prague as saying the appeal process could take "months or a year" and cast uncertainty over any CEZ negotiations with the rival bidders.

Areva could ultimately file an injunction to stop the tender.

CEZ spurns a French kiss Nicholas Watson in Prague

A

spokesman for the French foreign ministry was speaking for many when he said that the October decision by CEZ to exclude Areva from the multi-billion euro tender to build two nuclear reactors was "surprising". What this decision means for the already controversial tender is unclear, as are the full reasons behind the Czech utility's shock decision to reduce the bidders to just Toshiba's US subsidiary Westinghouse and a consortium led by Russia's Atomstroyexport.

As it's free to do so under the tender rules, Areva appealed the decision

by CEZ to disqualify it because of its alleged failure "to meet statutory requirements for building two new units", and "some other crucial criteria defined in the tender." In July, the three pre-qualified bidders in the roughly CZK200bn (€8bn) tender to build two new nuclear units at CEZ's 2-gigawatt Temelin nuclear power plant had submitted their bids.

"Areva firmly believe we have met all the tender criteria and we look forward to addressing the issues raised by CEZ," a spokesperson for Areva told bne. "We are confident our offer to CEZ is the most competitive one and our commitment to the Temelin completion project remains absolute."

CEZ didn't go into specifics – which it said involved both commercial and legislative reasons, which analysts say

exhausted. CEZ is still in the process of responding to that appeal on whether to readmit Areva to the tender.

The decision certainly came out of the blue. Just hours before CEZ informed Areva of the decision on the afternoon of October 4, bne was interviewing Areva's chief commercial officer, Ruben Lazo, who was saying that Areva fully expected to win the tender, arguing it is the only bidder currently constructing

"Areva has admitted that it lacks the political lobbying heft of the Americans and Russians"

could mean anything from personnel issues to technical or legal problems – explaining that because Areva can appeal the decision, it is unable to say more until that process has been

reactors in Europe and is the most "reliable" nuclear partner for CEZ. "The nuclear industry is not a transactional, commercial operation, it is a longterm partnership we are talking about

Central Europe I 27

bne November 2012

Given such high stakes, there are inevitably questions being raised about why CEZ should take the nuclear option and turf Areva out before the whole process is concluded some time in 2013.

After all, if the decision-makers were committed to seeing the French bid fail at the last, they could've pointed to the major flaw in Areva's bid, namely that its reactors are much larger and consequently more expensive than the others. Areva is offering two of its EPR reactors with a total output of around 3,300 megawatts (MW), while Westinghouse and the Atomstroyexport consortium, which includes Skoda JS and Gidopress, are offering two reactors with an output of around 2,200 MW. Some point to the lack of political clout in Areva's bid. Areva officials have admitted to bne that it lacks the political lobbying heft of the Americans and Russians. Westinghouse has received strong support from the White House; the Russophile Czech President

COMMENT:

How much for Temelin II?

Jan Ondřich of Candole Partners In June 2011, the chief financial officer of CEZ, Martin Novak, dismissed the suggestion that the Czech utility would not have the resources to pay for the construction of two new nuclear reactors at its Temelin plant. He stated that by the time construction is underway, CEZ will be making so much money that it will be able to pay for the project in cash. Either the CFO was thinking that the 2016 start date for construction is unrealistic and that construction would begin much later, or his colleagues were working from faulty assumptions.

Our analysis published in 2012 shows that it will be impossible to finance Temelin without either a state guaranteed loan or a photovoltaic-like subsidy scheme. The country's industry minister has now arrived at the same conclusion. The recent energy policy concept assumes a subsidy scheme known as "contracts for difference". The Ministry of Industry and Trade assumes that the subsidy would be equal to the difference between a regulated tariff, which the ministry intends to set at a level of ¤60 per megawatt hour (MWh), and wholesale electricity price, with this difference being covered by consumers.

Our argument, that CEZ would need this consumer financed scheme in order to build Temelin, is now accepted even by the company's CEO, Daniel Benes. In October, he went so far as to estimate the expected size of the subsidy, stating that it would amount to CZK5bn (¤200m) a year, and would increase consumer electricity prices by 1%.

We believe that both the industry ministry and CEZ underestimate the real size of the subsidy, perhaps as a way to prepare the public for the inevitable increase in the level of the tariffs at a later date. Our calculations show that the breakeven tariff for Temelin would have to be set at a level of ¤90/MWh. In comparison, French utility EDF is asking the British government to set the tariff at a level of between £100-140/MWh, or almost four-times the wholesale price of electricity.

We are being conservative in our calculation of ¤90/MWh only because we make the assumption that the published investment cost of CZK200bn will be adhered to. Experience of large investment projects in this country show that original estimates should be increased at least three-times to arrive at the true, final price.

And even if we stick to our conservative estimate of ¤90/MWh and average wholesale price of ¤51/MWh, we calculate that the subsidy scheme would cost Czech consumers almost CZK17bn a year, or over three-times more that Daniel Benes stated in the Czech media.

This would mean that a household with an average annual consumption of 4,500 KWh would pay CZK1,430 more than it pays today. This assumes that the burden of the subsidy is shared equally between industry and households. More likely, the burden will be unequally loaded upon the backs of households.

28

I Central Europe

bne November 2012

including one that would see it become a shareholder in CEZ itself. Neither of the other bidders are either willing or able to do this. This move by Rosatom

Vaclav Klaus already hinted at the end of last year he would favour the Russian-led bid.

"The appeal process could take months or a year "

Atomstroyexport's parent, nuclear holding Rosatom, has also sweetened the Russian offer in March by stating that it is ready to offer full funding for the project, and would consider any type of strategic partnership,

is regarded by observers as crucial, since CEZ is clearly struggling to come up with funding for the project without state guarantees that the Czech government has repeatedly ruled out (see accompanying box). In May, CEZ

bne November 2012

Central Europe

provoking a massive international outcry. Hermitage founder William Browder and associates have been waging a campaign against the officials they claim were involved since, and have succeeded in getting both the US and EU to implement sanctions against dozens.

said it is considering launching a parallel tender to select a strategic partner for the project.

Perhaps the answer, some accuse darkly, lies in the fact that certain segments of the Czech elite are committed to seeing the Russians win. Russian influence in the Czech economy is undoubtedly growing, smoothed by large sums of money, both legal and illicit.

None of this is particularly encouraging for those who want to avoid the Czech Republic's energy policy reverting to how it was 30 years ago – reliant on Russia.

Magnitsky case reaches Latvia Tim Gosling in Prague

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

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

What you need to know

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

www.bne.eu

I 29

L

atvian prosecutors are set to investigate claims implicating several of the country's banks in the alleged Russian tax fraud scheme that blew up into an international incident when it led to the 2009 death of lawyer Sergei Magnitsky (pictured) in detention in Moscow, according to investigative journalism NGO Re:Baltica. The cast of characters implicated represents a roll call of Latvians that have regularly cropped up in relation to questionable Russian and Ukrainian state deals.

The Latvian prosecutor's office announced late on October 2 that it has reversed an earlier decision by the state police not to investigate whether Latvian banks helped to launder at least $63m out of Russia in 2007. The funds are claimed to stem from a huge tax fraud operation alleged by Hermitage Capital against members of Russia's tax police.

Alexander Cernisovs, chief prosecutor responsible for organized crime, told journalists that having studied the evi-

dence from Latvian banks, he has determined that the state police's decision not to start a criminal investigation was contrary to law and unjustified, reports Re:Baltica. He said he has sent the evidence of Latvian banks' involvement back to the police for re-investigation.

Until 2007, Hermitage was one of the biggest investors in Russia. However, the fund's executives fled the country

Browder is now pressing Latvia to follow up the claims that some of the cash was routed through the country. Re:Baltica reported earlier that, according to Hermitage representatives, the Latvian authorities had until now responded only formally to requests to investigate the case. The agency responsible for regulating banks, the Financial and Capital Market Commission, had pointed out that it lacked the power to freeze the bank accounts through which the money was allegedly laundered.

Scheming In July, Re:Baltica sent a report to the Latvian regulatory authorities outlining schemes illustrating the banks and offshore companies (registered in New Zealand, Panama, Seychelles Islands and the UK) engaged in the alleged money laundering. The total amount that travelled from the Russian treasury to Latvian banks is more than $63.2m, according to the report. Close to $20m arrived into Latvian banks through two Moldova-registered firms, BuniconImpex SRL and Elenast-Com SRL, it claims. Some of these millions were used to make investments, including in Dubai real estate, and some spent on luxury cars.

"Browder is now pressing Latvia to follow up the claims that some of the cash was routed through the country" after authorities accused Hermitage of making fraudulent claims for a $230m tax rebate, with the executives claiming that on the contrary Hermitage was the victim of officials who had in fact stolen the cash. Magnitsky, a lawyer retained by the fund, was arrested as he investigated the claim and died in custody,

Another $43m was reportedly deposited in Latvia's Privatbank by UK firm Technomark Business, the director of which is Latvian citizen Juris Vitmanis. The owner is Fynel Ltd, a company domiciled in Cyprus – a favoured offshore destination for Russian and Ukrainian entities – which was founded by Stan-

30

I Central Europe

islavs Gorins. The directors of Fynel Ltd include Juris Vitmanis, Eriks Vanagels, Daniels Bangers, and Martins Rauda.

Many of these names will be familiar

bne November 2012

chases in Russia and Ukraine, operating through Latvian- and UK-registered companies. Re:Baltica also claims that more than one of these names is con-

"The appeal process could take months or a year " to bne readers as they've cropped up in several investigations detailing their alleged involvement in questionable schemes, mainly surrounding state pur-

nected to Gints Poiss, former council head at Parex Bank, which collapsed to devastating effect in 2008 and had to be bailed out by the government.

Viktoras Uspaskich

Lithuanians vote against austerity and nuclear power Ben Seeder in Riga

L

ithuanians dealt a double blow to the country’s unpopular right-wing government on October 14 and October 28, as voters overwhelmingly rejected its plan to build a €6bn nuclear power plant in the country and handed three leftist opposition parties a majority in parliament.

Although the Homeland Union-Christian Democrat party led by Prime Minister Andrius Kubilius is set to be the second

Hermitage representatives have told Re:Baltica that they hope Baltic authorities will investigate the Magnitsky matter, and that they have asked the Latvian General Prosecutor and the Latvian bank supervisor Financial Capital and Market Commission to freeze relevant accounts at Aizkraukle Bank, Baltic International Bank, Baltic Trust Bank, Rietumu Bank, Trasta Kommercbanka and Paritatas Bank.

biggest party in parliament, the Social Democrats led by PM favourite Algirdas Butkevicius won 38 seats and the centrist Labour Party of former canned pickles magnate Viktor Uspaskich won 29, which combined with the 11 seats of junior partner Paksas wrapped up a majority for the new coalition in the 141seat parliament.

Kubilius' ruling Homeland UnionChristian Democrats took just 15% of

the vote in the first round on October 14, which was in line with pollsters' predictions that the electorate, dismayed by strict spending cuts and high unemployment, would trounce the government. The conservative government, under Kubilius, became deeply unpopular after it raised taxes and slashed public sector salaries by up to 30%, and pensions by 11%, in 2009.

The government said the belt-tightening was necessary to help the country cope with the global financial crisis, during which unemployment in the Baltic nation of 3.2m hit 18.3%.

This was the first parliamentary elections since the introduction of strict campaign financing laws, and the campaign saw less advertising, but more public relations – both the good and the bad kind, according to Ignas Zokas, general manager at Vilnius polling company Sprinter Research. He points out the release by a state-funded website of names of Lithuanians alleged to have collaborated with the KGB intelligence agency in Soviet times. The allegations of collaboration with the KGB – a serious charge in Lithuania, where memories of Soviet repression are still fresh – forced several candidates from the race.

Comeback A Labour Party victory in the first round of the election is a stunning comeback for Uspaskich, who is still under investigation in Lithuania for allegations of fraudulent party finance. In 2006,

bne November 2012

he was forced to resign as economy minister over an alleged conflict-ofinterest with Russia, and was suspected of using a fake diploma from a Moscowbased university.

Labour, along with the Social Democrats, oppose the present government's plan to adopt the European single currency in 2014; they say instead Lithuania should wait for the crisis in the Eurozone to resolve itself before joining. Both parties have advocated an end to the present government's strict spending controls, and have proposed boosting

Central Europe

dismayed not by the concerns over safety, but by the €6bn price tag of the project, says Sprinter Research's Zokas.

"Lithuania is already a nuclear country, people are very familiar with the technology, so the unpopularity of this project isn't about that – it is about cost," he says.

Meanwhile, voters solidly rejected a government plan to construct a 1350-megawatt (MW) nuclear reactor in the country, in a referendum on the issue that ran alongside the general election. Based on over 80% of ballots counted, 62% opposed construction of the plant, while just 35% favoured it.

The result was a blow for Kubilius, who championed the nuclear plant as a solution to Lithuania's energy reliance on Russia. Since 2009, when the EU forced the closure of Lithuania's old Soviet-era nuclear plant, Lithuania has been 70%-reliant on electricity imports from Russia.

The government signed a concession agreement with Japan's Hitachi to build the new nuclear plant in an effort to reduce the reliance on Russian power.

Yet voters in the referendum were

bne:infrastructure

The Social Democrats' energy spokeswoman, Birute Vesaite, also told bne her party wants to investigate the project to build a liquefied natural gas (LNG) terminal at the port of Klaipeda. This terminal was the Kubilius government’s other flagship policy

"Allegations of KGB collaboration– a serious charge where memories of Soviet repression are still fresh – forced several candidates from the race" the minimum wage from its current level of LTL800 (€230) to over LTL1500 – something that Kubilius said the country cannot afford at present. Other policies include improving the country’s strained relations with Russia, and reducing the cost of heating in winter.

I 31

designed to move Lithuania away from its reliance on expensive gas transported from Russia via pipelines.

Lithuania currently pays around $490 per 1,000 cubic metres (cm) of gas – one of the most expensive rates in the EU. It is this high price of gas that is thought to be pushing up prices around the country for central apartment heating – one of the biggest issues on voters’ minds, according to Zokas. "We are now coming into winter, and this season, it is predicted that heating prices for apartment buildings around Vilnius will exceed the level of the minimum monthly wage for the first time," he said.

Heating prices came to the forefront of the election campaign when it emerged that Vilniaus Energija, one of the country’s largest heating companies, earned over €15m in net profits in 2011, despite operating in a market with highly regulated prices. The disclosure prompted Lithuania’s non-partisan president to condemn the company, and the Lithuanian Financial Crime Investigation Service to announce a probe.

The economic crisis has hurt all the economies of the world, but now governments across the Central and Eastern European region are planning to spend trillions of dollars on infrastructure investment as the most effective form of economic stimulus to put their economies back on a sustainable growth path.

This investment was badly needed even before the crisis hit 18 months ago. Decades of work lie ahead, which presents a unique opportunity for investors of all kinds.

Every two weeks, bne will publish an online a round-up of the main investment projects, analysis, commentary, regulatory changes, investment plans, and funding news in bne:infrastructure.

Register and sign up for the list here: www.businessneweurope.eu/ users/register.php

32

I Central Europe

bne November 2012

to calls to clamp down on the financial sector. That, however, doesn't quite tally with Poland's need to stimulate the economy right now. Domestic demand has been the saviour for this large EU state over the last few years, helping it to become the only EU state to ward off recession in 2009, and pushing it to star status amongst investors early in 2012 as analysts forecast it would again shrug off the Eurozone crisis to record robust growth.

Easy money in Poland bne

H

ot on the heels of a new state investment fund, Poland unveiled another plank in its plan to revive the flagging economy on October 15, as financial regulator KNF outlined a scheme designed to boost borrowing by easing the terms and conditions on consumer and mortgage loans.

"At the moment consumer loans are the only lending category showing declines," KNF chief Andrzej Jakubiak told a press conference. "We think these regulations will help slow down the process, but there are other factors at play here like borrowing costs that affect demand."

The market watchdog, which has strongly policed the country's foreignowned banks to stem capital outflows, said it could relax requirements for credit worthiness procedures in banks which sport capital adequacy ratios above 12%, and Tier 1 ratios of above 9% during the last six months.

Those restrictions on the banks that can accept the eased terms from consumer borrowers are part of a concurrent attempt by the KNF to reduce the role of

the shadow banking sector. The goal is "to enable lending growth of the banking sector vis-a-vis lending institutions from outside the regulated sector," the KNF chief said.

Loan sharks Current regulation on the consumer credit conditions have encouraged many to seek loans from unregulated financial companies. Demand has been so strong that banks opened special entities to

However, five years of crisis are now catching up, and the Polish population – beset by unemployment and low wage growth – are slowing consumer spending, sending economic growth plummeting. Poland's private consumption growth slowed to 1.5% in the second quarter, from 2.1% in the first, while banks' consumer lending has been on the decline since the end of 2010, reports the WSJ. Facing growing unrest, Warsaw – previously pushing tough austerity – is finally reacting to the slowdown. On October 12, Prime Minister Donald Tusk unveiled a new state-backed fund designed to boost private investment into infrastructure (see accompanying box). At the same time, the National Bank of Poland is widely expected to kick off an easing cycle in early November.

According to KNF estimates, banks controlling 90% of the sector's assets will meet the criteria to take advantage

"At the moment consumer loans are the only lending category showing declines"

offer loans to consumers outside the banking sector and sidestep steeper regulatory obligations concerning loan size, and necessary documentation and checks before approving loans.

of the new rules. The regulator wants to pass the new rules by the end of the year, with a three-month interim period so banks could start to benefit by April 2013.

However, recent disasters such as the Amber Gold scandal, which saw investors lose around PLN70m, have led

Key elements of the new proposal contained in the draft recommendation include separation of regulations on

bne November 2012

cash loans from regulations on mortgage lending, elimination of stiff debt/income thresholds, simplified credit procedures for smaller sums or for clients with long-term relationships with the lending bank, creation of strictly-defined stress tests and definitions of "significantly engaged" banks in the segment for whom regulations might be tighter, a KNF letter to banks shows, according to the newspaper The Warsaw Voice.

On the same day that Jakubiak outlined the plan, Moody's Investors Service released a report suggesting that lowered asset quality is a growing risk for the Polish banking sector as it slows. "The slowdown in economic growth has placed banks' performance under pressure by weakening credit demand and reducing 'bankable' lending opportunities in Poland," the report says, fretting over "banks' potential exposure to a significant asset-liability mismatch risk". The report also adds that as profitability drops in the sector, the temptation of the capital held in Polish units for parent banks in Europe such as UniCredit and Santander is only likely to grow.

However, Jakubiak's deputy, Wojciech Kwasniak, also spoke to the press on Monday, reiterating that the KNF will continue to keep a close eye on capital flows at the country's foreign-owned banks. Insisting it expects them to retain "at least" 25% of 2012 profit, the official announced the watchdog will discuss individual cases before the end of the year, reports Reuters.

"We will adopt an individualised approach, we will announce it (individual rules for banks) at the end of November or at the start of December," Kwasniak said. Foreign parent banks would have been over the moon to be able to payout 75% of 2011 profit in dividends, with the KNF managing to push most well below 50% this year.

Central Europe

I 33

Poland looks to build its future

Tim Gosling in Prague With the Eurozone crisis making up sudden and rapid ground on Poland's economy, the government announced a set of plans to boost slowing GDP growth on October 12. The trick is to find cash to pump into the country's infrastructure push without worsening the state's precarious finances.

Ahead of a 233-219 victory in a confidence vote called by the government to bolster its economic policy, Polish Prime Minister Donald Tusk announced that a new infrastructure fund – backed by state assets – is to be set up. The plan is designed to pump investment into the country to stimulate growth without worsening the state's stretched finances. "There is no other way for Poland than sustaining growth through investments," Tusk told parliament in a speech. "Poland has a real chance to defend economic growth and make it translate into more jobs."

The PM outlined a list of road, rail, power and gas infrastructure projects totalling around PLN220bn, although the majority were announced in earlier government programmes. "All of these projects have to be safe from the point of view of the deficit," Tusk reiterated.

Officials say that state assets will be transferred to an off-budget fund named Polish Investments, which be administered by state-owned bank BGK. "According to calculations... we should create leverage for investments and credits worth around PLN40bn to 2015, and around PLN90bn if we count over six years,” Tusk said.

The key to the plan is to attract private funds to power the projects, and therefore the growth, because the government is in no position to do so.

Warsaw is pushing hard to hit ambitious fiscal targets, and scrabbling for every cent in order to keep the budget deficit below 3% this year. It has also pledged to reduce state debt from a current level of around 54% of GDP. Even without that promise however, a constitutional ceiling of 60% means the government has little leeway to boost the economy directly.

Under the plan, the guarantees would be held in a non-state vehicle, and so would not be classified as debt.

The idea of a "guarantee fund" to push infrastructure investment was first discussed in public in early October. As bne reported, Polish officials had to push the plan, modelled on funds already in operation in Brazil and South Korea which use state-controlled assets to guarantee private sector investment, past objections from some quarters of the government – possibly the Ministry of Treasury, which currently holds state company stakes. Officials from the treasury said on October 13 that it could accelerate the privatisation drive ahead of handing state assets over to BGK.

34

I Central Europe

bne November 2012

Growth contributor Elzbieta Bienkowska, the regional development minister, estimates that about half of Poland's GDP growth in 2009 – when every other EU country was in recession but Poland managed to eke out a 1.7% expansion – was due to structural funds. She estimates that the country's growth rate over the last three years has been 0.7 percentage points higher than would be the case without the injection of structural funds.

© European Union EP-PE 2011/Pietro Naj-Oleari

Poland tries to handbag UK over EU budget Jan Cienski in Warsaw

E

U structural funds helped save the Polish economy from recession in 2009 and modernise the country, which is why Warsaw is pushing so hard to ensure that the next EU budget is at least as generous as the current one. That has put the centre-right government of Prime Minister Donald Tusk on a collision course with the UK government of David Cameron, which is leading the resistance to a large budget for 2014-2020.

"Do you know what hypocrisy is?" Tusk asked at a recent summit of leaders of the European People's Party, the grouping to which his Civic Platform party belongs. "Hypocrisy is when politicians call for 'more Europe' and then the next day in the same place say 'a smaller European budget'."

For Poland, another generous budget is key to the country's hopes of continuing to swiftly catch up to Western European living standards. "I am convinced that Polish ambitions of a sum of PLN300bn (€73bn) – which will enable Poland to keep up growth and its tempo of

development – is a realistic but difficult goal," Tusk told parliament recently.

Poland has been the largest beneficiary of the current 2007-2013 budget, and the results of that €67bn in EU funds can be seen around the country, from new sewerage plants to hi-tech incubators, new computers for civil servants and, most visibly, an enormous construction programme that has seen Poland finally

Poland has been shoring up its case for a generous budget by arguing that the billions it receives in EU funds also benefits older member states, claiming that for every euro Poland is set to receive from 2004-2015, 46 euro cents flow back to the EU-15 in the form of sales and contracts.

bne November 2012

But those hopes now look to be in increasing danger in part due to British resistance and in part because of growing donor fatigue among the richer members of the EU. An added danger is the growing pressure to create a separate budget for the Eurozone, something that could be worth as much as €20bn – which the UK wants to link with the broader EU budget but which most member countries want to keep separate.

"This, at least in the short term, does not create a danger for us," said Radoslaw Sikorski, the foreign minister.

Finance Minister Rostowski has been a bit more ambivalent, saying: "We feel that this would not be an especially good idea, although one can could imagine a situation where the current European budget would be the same even so. And if the Eurozone countries were to contribute

Central Europe

towards an additional budget for just the zone then we would not have anything against that as it is in Poland's interest for the Eurozone to be stable and safe."

everyone benefits, because highways or internet networks built from EU funds benefit companies for all sorts of EU countries," said Sikorski.

Warsaw is also trying to pressure the UK to give up its fight. In a hard-hitting

Sikorski in October urged Euro MPs from the right-wing opposition, which

"Warsaw is trying to pressure the UK to give up its fight" interview with the Gazeta Wyborcza newspaper, Sikorski warned that Poland is paying towards the UK rebate won by Margaret Thatcher. "A generous budget and structural funds, used to finance infrastructure projects, is an effective way of stimulating economic growth and

So far Poland has signed contracts worth PLN223bn in EU funds, 79.6% of the country's allocation for the 2007-2013 budget, and it's almost certain that Poland will manage to get all the money coming to it, in the same way that it absorbed all available EU funds in its first EU budget from 2004-2006.

T

Those kinds of figures have put the fight into Polish diplomats during the current negotiations over the next EU budget. A few weeks ago, Poland was fairly certain that the next budget would be even more generous than the current one. Jerzy Buzek, a former prime minister and head of the European parliament, said recently that he was confident that Poland would

get as much as €80bn in the upcoming budget. "That is an enormous sum," he told the newseria agency. "Even if it turns out that Poland gets a few percent less – and at the moment I don't see such a possibility – that would mean we'd get €75bn or €77bn."

sits in the European Conservatives and Reformists grouping in the European parliament together with the British Conservatives, to use whatever influence they have to sway the British. "This is the moment to use influence for a key issue for Poland," he said.

he Hungarian government's capricious policy-making has once again put it on a collision course with the rest of Europe, with Hungarian slot-machine owners gaining support from Euromat, the European Gaming and Amusement Federation, in their fight against the government's sudden move October 1 to ban slot machines in all but three state-concessioned casinos.

The Brussels-based lobby group, in a letter to the European Commission on October 4, denounced the move by Budapest as "anti-competitive," and "against the private sector to the direct benefit of its state-owned casinos."

"Do you know what hypocrisy is? Hypocrisy is when politicians call for 'more Europe' and then the next day in the same place say 'a smaller European budget'" acquire the rudiments of a modern highway system. "Five years ago we hardly had motorways. We now have key motorways covering much of the country and will be completing the network to 2020," says Jacek Rostowski, the finance minister.

I 35

Hungary government gambles with business Kester Eddy in Budapest

It also argues that the Hungarian government had circumvented Commission "standstill" regulations designed to allow for proper consultations with the industry on false grounds. "In order to bypass the three-month standstill period... the Hungarian Government has invoked the provision which allows for a waiver of the standstill period in the case of the national measure being of a fiscal nature. This is not a fiscal measure but rather a protectionist move in favour a particular sub-sector of the

36

I Central Europe

bne November 2012

"It's a bit hard to imagine how slot machines pose a deep national security threat to the country" gambling sector dressed up as a fiscal instrument," Euromat stated in its appeal to the Commission.

While the Euromat move may add to the long-term pressure on the government of Viktor Orban – which has gained notoriety in the business sector for its unpredictability – it is unlikely to change things on the ground for members of the Hungarian Gaming Association (HGA), who were faced with an abrupt fait accompli.

Russian roulette After an unscheduled cabinet meeting on October 1, the government announced it was banning slot machines, with parliament passing the legislation 24 hours later via a fasttrack procedure. Janos Lazar, head of the Prime Minister's Office, denounced one-armed bandits as "immoral, unacceptable" and "against our core

beliefs", claiming they tempt many poor families into bankruptcy.

The gaming association was equally emotional in response. "This affects 1,200 gambling halls and up to 18,000 bars and restaurants with slotmachines, putting 40,000 jobs at risk," István Schreiber, HGA president, tells bne, adding via a written statement: "We sadly experience that the Hungarian Government can abolish a whole sector with obscure reasoning, by the stroke of a pen."

The industry, which had restructured in the wake of a five-fold increase in the special tax on slot-machines – raised from €360 to €1,440 per month from last November – paid HUF70bn (€245m) into the budget last year, Schreiber said. Most, if not all of this, would be lost to the state.

The government played down the HGA

claims, estimating the loss to state revenues at between HUF20bn-30bn, which could be recovered from other gaming taxes, and emphasising the social damage caused by the industry.

"According to the Ministry of National Economy, there are 4,520 slot machines registered in Hungary, most of which are in catering units and serve only as supplementary service. The [HGA claims] would mean that one machine gives jobs to nearly 10 people! On the contrary the reality is that one slot machine can ruin the lives of at least 10 families," a spokesperson tells bne.

all]. The NAV [tax authority] Gaming Control Head Department carries out 15,000 checks annually on the slot machine sector; they found an offense in only 0.3% of all [cases]. This data would do credit to any industry," the HGA said in a statement.

But the government also hinted at another reason for the Blitzkrieg legislation – an alleged security threat from criminal gangs that control large segments of the gaming industry through links to highly placed state officials, which the daily Nepszabadsag reported on October 4.

Although Schreiber hinted that government-friendly "business interests" might be behind the move, given the lack of transparency surrounding the affair analysts could only speculate on the unspoken causes for such rapid government action. "The allegations that some government politicians could be corrupted by the gambling sector, hence the 'national security threat' – who knows? But it's a bit hard to imagine how slot machines pose a deep national security threat to the country," says Peter Kreko,

While the government declined to comment on the story, the HGA described the allegations as "manufactured"."This is... the most regulated and controlled industry [of

Hungary unveils its latest revenue wheeze

bne It's off again then. No sooner had investors started to believe Budapest's hype that a deal over an international bailout loan is close, than the government unveiled a raft of tax rises that are designed to protect the country's EU cohesion funding, but will annoy the International Monetary Fund (IMF) by hitting the banks once more.

Economy Minister Gyorgy Matolcsy signalled the latest step in the world's longest rendition of the hokey cokey as he announced revenue-raising measures to the tune of HUF367bn (¤1.3bn) in a bid to avoid a threat from Brussels that it would cut close to ¤500m in cohesion funds unless Hungary finally pulls itself out of the EU's Excessive Deficit Procedure – for the first time since it

bne November 2012

joined in 2004 – by bringing the budget deficit in below 3% of GDP. However, the measures are set to provoke the IMF, which is demanding Budapest rein in its "unorthodox" economic policies before it will agree a new loan programme. Top of the list of annoyances is Matolcsy's announcement that the banking sector tax will not, as originally agreed, be halved in 2013, a move designed to raise HUF72bn. In addition, the country's new financial transactions tax (FTT) – set to start in January – is also to be doubled to 0.2%, offering another HUF90bn or so.

Other measures include a tax on utilities infrastructure, and higher taxes on employee benefits.

But the left-leaning Nepszabadsag, which is typically critical of the Orban regime, praised the move in an editorial, saying it was wise to "consider the future of the health, social and personal costs" when assessing the merits of slot machines.

Central Europe

I 37

of Political Capital, a Budapest thinktank.

But the move is in line with the government's strong "law and order" rhetoric about closing shady businesses, and about solving problems quickly and efficiently, he said.

In the end, though, it can be chalked down to another example of the many hastily drafted, ill-thought out laws that have been a feature of the Orban government's first two years in office.

"For sure, it is a policy failure," says Kreko. "Originally, they wanted huge

"It can be chalked down to another example of the many hastily drafted, ill-thought out laws that have been a feature of the Orban government" revenue from this sector, and at the end of the day, they are having to realise a loss."

That has the banks, which have been fighting a bitter battle with the Fidesz government since it came to power in May 2010, up in arms once more. After long negotiations, they had been promised that the windfall tax – the highest on the sector in Europe – would be reduced as the FTT came in, in exchange for promises that they would return to lending to help prop up economic growth. The European banking giants that dominate the local market have been busy lobbying both Brussels and international lenders to help them in that fight over the past couple of years.

The Hungarian Banking Association didn't drag its heels to express its displeasure, issuing a statement that stated: "The measures announced by the government today – if passed by parliament – endanger predictable financing to economic players and all their elements reduce the lending ability of banks."

Hungary had finally managed to get the IMF to sit down to preliminary talks on a bailout in the summer, after

months of seesawing. The Washington-based lender – which is yet to announce a return for a second round of negotiations – left Budapest in July insisting the government should abandon ad hoc tax measures, focus more on sustainable spending cuts, and seek to restore the soundness of the heavily-taxed financial sector.

"The fiscal measures outlined are... aimed in exactly the haphazard and growth-unfriendly manner that the IMF is highly likely to deem as negative for the medium term outlook," says SEB in a note.

It's tough to find an analyst who is not convinced that Hungary is "doing a Turkey": stringing the IMF along with little intent to actually sign a deal, in a bid to keep the markets off its back. The country's hefty trade surplus is keeping it supplied with hard currency reserves, while domestic bonds have sold well, offering Budapest hope of making it through to the other side of the Eurozone crisis without accepting a bailout and the conditions that entails.

38

I Southeast Europe

bne November 2012

will not help Pristina wrap up Kosovo's independence," he told a news conference in Belgrade.

President Tomislav Nikolic went further in an interview with the newspaper Vecernje Novosti a week later. "If we were officially asked to choose between the EU and Kosovo, we would give up on the European path," Nikoloic told the paper.

"The EU is keeping its distance because of Kosovo. But they could shut us out for another 100 years because we won't change our position on our southern province."

In a pointed rebuke to Belgrade, however, the Commission gave the green light for Kosovo to start negotiating a Stabilization and Association Agreement (SAA) with the EU, even though five member states do not recognize its statehood. The SAA is the first step in the accession process and has already been granted to all other countries in the Western Balkans.

EU hopefuls a mixed bag bne

T

he European Commission's annual report, released on October 10, on countries lining up to join the EU was tough on Serbia and Turkey, but offered more hope for Albania, Kosovo and Macedonia.

The Commission said in its "2012 Enlargement Strategy Paper", which sets out the way forward for each candidate country in the coming year, that Serbia is not ready to start accession talks with the EU because of its tensions with its erstwhile province, but now independent state, Kosovo.

It also insisted that Belgrade needs to make more effort to reform its justice system and protect the independence of the central bank. Serbia won EU candidate status in March, but needs the Commission's green light to start

actual talks, which is a process likely to take years.

"Steps leading to the normalisation of relations between Belgrade and Pristina should also be addressed in the context... of further accession negotiations with Serbia," EU Commissioner for Enlargement Stefan Fule said following the release of the report on October 10.

The document says normalisation of predominantly Serb northern Kosovo,

which refuses to recognise Pristina's rule, should be achieved "while respecting the territorial integrity of Kosovo and the particular needs of the local population".

Serbian Prime Minister Ivica Dacic refuted the suggestion, claiming such remarks could jeopardise dialogue with Pristina and showed a "lack of (EU) understanding" for Serbia's efforts to speed up its EU bid. "Serbia

"If we were officially asked to choose between the EU and Kosovo, we would give up on the European path"

Southeast Europe I 39

bne November 2012

"As part of today's enlargement package, [the European Commission] has adopted a communication on a feasibility study for a Stabilization and Association Agreement with Kosovo," Fule said. "This study confirms that the Stabilization and Association Agreement can be concluded between the European Union and Kosovo in a situation where European Union member states maintain different views on status."

For Turkey, the report was even more disappointing, but no less surprising for that. The EU's familiar 's refrain to press on with political reforms, resolve concerns about the rule of law and normalize relations with Cyprus offered little hope to jump-start membership talks now stalled for more than two years. "Turkey is a key country for the European Union considering its dynamic economy, strategic location and important regional role. It is in our interest and Turkey's interest that accession negotiations regain their momentum," Fule said.

Turks, however, are losing faith in the whole EU process. Support for EU membership is declining rapidly, with

EU report on Croatia: Must try harder

Guy Norton in Zagreb After the best part of a decade, Croatia has inched further forward in achieving its long-cherished dream of securing membership of the EU. Or not, given the mixed international reaction to the latest monitoring report from the European Commission on the country's achievements toward meeting that goal of joining Europe's elite political-economic club.

Given growing skepticism (UK) about the further expansion of the EU within the existing bloc – in the northern part of Europe at least – it's no surprise that the latest report on Croatia's progress in meeting the criteria for EU membership has been greeted with a degree of disappointment or euphoria, depending on one's point of view.

Announcing the findings of the report, the EU's enlargement commissioner, Stefan Fule, claimed that it represented a further endorsement of Croatia's EU membership credentials. "I have no reason to believe that Croatia will not become the 28th member of the EU, and there is no need for further supervision after July 1, 2013," he said October 10 after the report's release.

While domestically at least there's so far been little or no controversy about the findings of the EU's latest report – set to be the penultimate one before its envisaged membership on July 1, 2013 – it's also fair to say that abroad there's been more than a little disquiet about adding Croatia to the EU pile in the wake of the less than successful addition of Bulgaria and Romania, which are widely seen as having been admitted to the EU ahead of time.

While acknowledging that Croatia has undoubtedly made progress in terms of improving the rule of law, the functioning of the public administration and justice systems, and an effective fight against organized crime and corruption, the report also said the Balkan state has still work to do in terms of meeting the increasingly high standards the EU has set for further enlargement in Central and Eastern Europe.

The monitoring report noted that out of 33 chapters regarding politicosocio-economic measures necessary for Croatia's EU membership, the country had almost completed 10 chapters, 15 present only a limited number of outstanding issues, while eight chapters covering issues such as finalising the restructuring of Croatia's shipyards as well as preparations to attract and invest EU development funds still needed to resolved. As such, the report admitted that the country would need to undertake further reforms if it is to meet the wishes of an increasingly powerful Germany, which as a result of its undoubted economic might is increasingly seen as the main political arbiter of the further expansion of the EU. In Germany, public opinion is turning against adding economically weak countries such as Croatia to the EU pack. German daily Frankfurter Allgemeine Zeitung (FAZ) claims Croatia has failed to meet at least 10 conditions of EU membership and it, like Bulgaria and Romania, could be subjected to post-EU membership monitoring if it failed to improve its adherence to EU standards.

40

I Southeast Europe

bne November 2012

an all-time low of 17% of participants in a June survey saying they believed the country would join the 27-nation bloc.

More hope The Commission issued its fourth successive recommendation for Macedonia to start negotiations for EU membership, saying talks could be started without the name dispute with neighbouring Greece having to be resolved beforehand.

Macedonia has been an EU candidate since 2005, but the EU Council has yet to set a date for opening accession talks because of Greece, which is blocking talks over a two-decade long name dispute between the two neighbours.

Greece claims the name of Macedonia

"Bosnia-Herzegovina still exists because the international community is attached to the ridiculous idea of debt repayment" implies territorial claims against its northern province of the same name.

According to the EU progress report, Macedonia has sufficiently fulfilled the political criteria and shows serious willingness for reforms. The report also pointed out several areas that have to be addressed such as the judiciary, freedom of speech and public administration.

"The Commission is ready to present a negotiations framework which takes the need to solve the name issue into account at an early stage of the accession process," Fule said.

"This means that the two processes accession talks and name row settlement – could be held simultaneously. For now, there is no deadline for solving the name issue," Aivo Orav, head of the EU delegation in Skopje, said.

The Commission also recommended that Albania receive conditional EU candidate status. "[The European Commission] recommends that [the European Council] should grant Albania

bne November 2012

Southeast Europe

Less than a week later, Gunther Krichbaum, chaiman of the Bundestag's Committee for European Affairs, expressed his concerns about Croatia's readiness to join the politico-economic bloc. "At present, the country is not ready for accession. Unless significant efforts and progress are made, there will be difficulties in the process of ratification in national parliaments, and not only in Germany," he told German daily Saarbrücker Zeitung.

the status of candidate country subject to key judicial and public administration reform measures being completed and the parliamentary rules of procedures being revised," Fule said.

Member states of the European Union will take a final decision on Albania's candidacy in December, provided the reform measures are enacted.

The European Commission faulted Bosnia-Herzegovina, an EU candidate country, for not moving forward with reforms. "Regrettably, BosniaHerzegovina has made limited progress towards meeting the political criteria and achieving more functional, coordinated, and sustainable institutional structures," Fule said. "It is disappointing that commitments under the high-level dialogue for the accession process have not been fulfilled or timelines met."

J'accuse in Croatia Guy Norton in Zagreb

Whether the divided Bosnian state can even manage to hold together long enough to join the EU remains an open question. The president of the Serb half of the country ­– based on the 1995 Dayton agreement reached at the end of the Yugoslavian civil war, Bosnia was cobbled together out of two entities, the Croatian Muslim Federation and the Serbian-majority Republika Sprska – called it an artificial country and a mistake, and hoped it would soon break up into its component parts. "BosniaHerzegovina still exists because the international community is attached to the ridiculous idea of debt repayment, since they invested so much money in it,'' Dodik told private Serbian TV B92. ''Between Belgrade and Sarajevo, I will always choose Belgrade."

I 41

I

n 1992, Croatian singer Sanja Trumbic recorded the ballad "Danke Deutschland", dedicated to Germany for its ardent support in ensuring that the EU recognised the war-torn country's desire for independence from Yugoslavia. The song's hyper-kitsch lyrics – it opens with "Danke Deutschland, meine Seele brennt. Danke Deutschland für das lieb 'Geschenk (Thank you Germany, my soul's on fire. Thank you Germany, for your precious gift) – won it unashamed scorn from critics, who bemoaned the sickly sweet manner in which it trivialised Croatia's hard-won fight for independence.

In the intervening 20 years, however, it has gone on to attract cult status as the archetypical example of highly sentimental Croatian war-era pop. The song has also formed part of a widely held belief that Croatian independence owed much to the diplomatic efforts of Germany. The then German foreign minister, Hans-Dietrich Genscher, in particular won widespread public recognition for his enthusiastic support of Croatia's freedom, with several towns and cities in the country erecting statues or naming streets in his honour.

It's therefore come as something of a rude shock to Croatians that in recent weeks there's been growing signs of skepticism in Germany about their country's upcoming membership of the EU, which Croatia is set to join on July 1, 2013.

Increased scrutiny Things started to take a turn for the worse with comments in the influential German daily Frankfurter Allgemeine Zeitung (FAZ), which claimed that according to the EU Commission's

Shortly after, Norbert Lammert, president of the Bundestag, Germany's lower house of parliament, told another German paper Welt am Sonntag that he was personally against Croatia's admittance to the EU in the near future. "We must take the European Commission's latest progress report seriously, especially in light of the experiences we had with (EU members) Bulgaria and Romania. Croatia is clearly not yet ready for membership," he said.

The German parliament has said it will only ratify Croatia's accession treaty following the filing of the final pre-accession report by the European Commission in spring 2013.

Meanwhile, another member of the Bundestag's Committee for European Affairs, Michael Stuebgen, warned that Croatia should not rest on its laurels.

"If the next European Commission report is also so critical, it could be problematic."

"It's come as something of a rude shock to Croatians there's growing signs of skepticism in Germany about the country's EU membership" latest report on Croatia in early October the country had failed to satisfy at least 10 conditions of EU membership and that Croatia, like Bulgaria and Romania, could still be subjected to post-EU membership monitoring if it failed to improve its adherence to EU standards.

Finally, another German politician Doris Pack, who is a member of the European parliament, also weighed into the debate about the merits of Croatia's EU bid, telling Croatian daily Jutarnji List the authorities in Zagreb must increase their efforts to remedy the faults identified in the European

42

I Southeast Europe

bne:infrastructure

The economic crisis has hurt all the economies of the world, but now governments across the Central and Eastern European region are planning to spend trillions of dollars on infrastructure investment as the most effective form of economic stimulus to put their economies back on a sustainable growth path.

This investment was badly needed even before the crisis hit 18 months ago. Decades of work lie ahead, which presents a unique opportunity for investors of all kinds.

Every two weeks, bne will publish an online a round-up of the main investment projects, analysis, commentary, regulatory changes, investment plans, and funding news in bne:infrastructure.

Register and sign up for the list here: www.businessneweurope.eu/ users/register.php

bne November 2012

Commission's latest enlargement report. "This is a clear message that should not surprise the Croatian government. You have to work harder to meet the conditions, and not waste time. Now time is running out and the government needs to seriously work on the fulfillment of the remaining conditions."

Conspiracies Pack's intervention in the debate has arguably provoked the fiercest debate in Croatia, coming as it did from a longtime passionate supporter of Croatia's independence and EU ambitions.

Pack, like Lammert, Krichbaum and Stuebgen, is a member of the ruling Christian Democratic Union in Germany, which has historically had close ties with the HDZ party that has ruled Croatia for roughly threequarters of the time since it declared independence, but which is now in opposition.

Speaking at a government session this week, Croatian Prime Minister Zoran Milanovic, leader of a centre-left coalition government, inferred that members of the HDZ were working in cahoots with the CDU to scupper Croatia's EU ambitions, a charge that has been fiercely rebutted by both Pack and the HDZ. "I was shocked to read in a Croatian daily an article accusing me of party political favoritism. I was even more appalled to learn that these accusations come from the Croatian government," said Pack, in reference to an article published in Jutarnji list.

"I have been following Croatia for many years. I followed it before its independence, through the war and throughout its European journey. In that entire time I was never afraid to be critical. May I remind the current government that 17 out of the last 21 years, the HDZ held power in Croatia.

If anything, I was more critical to HDZ governments because the task at hand, conducting and concluding accession negotiations, was too important to be taken lightly."

She added: "For Croatia, monitoring is a normal situation between the conclusion of negotiations and the

bne November 2012

Southeast Europe

date of accession. It is designed to help the government tie up any loose ends.

Croatia cannot be compared to other countries and it should not be paying for the sins of others. But it has to do its job before accession. It is as simple as that."

Meanwhile, on October 19, speaking in the Croatian parliament, former diplomat and HDZ MP Davor Stier, who is accused of encouraging German reservations about Croatia's readiness for EU membership, himself accused PM Milanovic of concocting conspiracy theories to mask the incompetence of his own government when handling accession negotiations with the EU. Making reference to the 1894 Dreyfus affair, when a French army officer Alfred Dreyfus was falsely accused of conspiring with Germany against the interests of France, Stier said: "Today, according to Jutarnji list, it looks like we have a new Dreyfus affair, but it's now called Operation Stier, and it has only one aim – to defame me and the HDZ, claiming that we have conspired with top German politicians against Croatia's accession to the EU. What a lie. I can only say, as in the Dreyfus affair, J'accuse – I accuse Mr Milanovic of failing to do his job properly and of seeking an alibi in a sick conspiracy theory. I accuse Mr Milanovic of fabricating internal and external enemies, following the old Communist recipe, instead of doing his job and of reading the European Commission's report and carrying out all the tasks so that Croatia may enter the EU on July 1, 2013."

Stirring stuff indeed, and typical of the growing nervousness that has seized Croatia in recent weeks regarding the progression of its bid to become the EU's 28th member state next year.

Photo: www.weblo.com

Montenegrins stick (a bit less) with what they know

B

The results of the October 14 election, the third since Montenegro gained independence from Serbia in 2006, the DPS alliance (which includes two other smaller parties) took 39 seats in the 81-seat parliament. It may therefore have to bring in former ally the Bosniak Party, which relies on Slavic Muslims for its support base and won three seats.

The new Democratic Front coalition won a respectable 23.8% votes (giving it a projected 20 seats); the Socialist People's Party (SNP), the traditional

The result takes the DPS up to a quarter century of ruling the former Yugoslav state. By some measures, in fact, the DPS has been in charge since 1943, since it is the direct descendant of the Montenegrin branch of the League of Communists of Yugoslavia. The party, and thus the country, has long been dominated by the controversial Djukanovic, who in the 21 years since 1991 has spent 12 years as prime minister and nearly five as president. Since 1998, Djukanovic has also been leader of the DPS, meaning that he has been an influential power player even when not in executive office including the last two years, when the PM has been "Milo" ally Igor Luksic.

party of opposition 10.6% (nine seats); and Positive Montenegro (PCG), another new political force, 8.9% (seven seats).

Once again, opposition divisions deprived voters of a clear alternative to Djukanovic.

Djukanovic has long been dogged with allegations of corruption and links to organised crime, but no charges against him have ever led to conviction. The most notorious claims are that Djukanovic was involved in tobacco smuggling in the 1990s, but all claims against him were dropped by Italian prosecutors in 2009, as well as those relating to the government's handling of Prva Banka, a bank controlled by the leader's family. The claim is that the Djukanovic family "treated the bank like an ATM machine" in the words of one investigative journalist, depositing state cash in the institution and then lending it out to businesses owned by family members and allies.

Deep roots Turnout was around 70% – not bad, given that the result was seen as something of a foregone conclusion, but also perhaps an indication of the

Djukanovic calls the charges "overblown" – and indeed they seem to have made little impact on his Montenegrin fan base, or on the DPS' support. The tall and dashing Djukanovic is seen by some

Andrew MacDowall in Belgrade ucking the trend of volatile politics in Europe, the dominant figure in Montenegrin politics, Milo Djukanovic, is set to continue his hold on power after his Democratic Party of Socialists (DPS) alliance convincingly won the October 14 election. However, the economic stagnation and corruption has taken its toll, and his alliance will have to form a coalition with lawmakers from ethnic minorities after voters denied it an absolute majority for the first time in 11 years.

I 43

"As the election results indicate, the opposition itself is divided" loyalty of the DPS' support. Djukanovic's opponents occasionally make dark allegations that this loyalty is secured by underhand means. While the vote was apparently free and fair – a prerequisite for this wannabe EU state to continue its accession talks – there is little doubt that the DPS has sunk its roots deep into Montenegrin society and the economy.

as the "father of the nation", having led it to independence from Serbia in 2006.

Despite the drop in support, the DPS remains a powerful force; according to Balkan Insight, it counts 100,000 members, around a fifth of the electorate. (For purposes of comparison, a British political party would need

44

I Southeast Europe

Bosnia's divisions revealed

Ian Bancroft in Belgrade Preliminary results from the October 7 local elections in BosniaHerzegovina once again demonstrate that ethno-nationalism remains the driving force of politics in the divided country. This doesn't bode well for the tone of political debate ahead of the general elections in 2014.

The Serb Democratic Party (SDS) – co-founded by Radovan Karadžic, who is currently on trial at The Hague on charges of genocide and crimes against humanity committed during the Balkan wars of the 1990s – scored a surprise success, taking 27 mayoral posts, up from 13 in 2008, and some 21.6% of the overall vote. The Alliance of Independent Social Democrats (SNSD), led by the president of Republika Srpska, Milorad Dodik – who has repeatedly called into question the very existence of the Bosnian state – lost some 26 mayoral posts (from 41 in 2008 down to 15) and took only 12% of the vote overall.

The re-emergence of the SDS as an electoral force will have profound ramifications on the political dynamics in the country, which is split into a Muslim-Croat Federation and a Serb-dominated Republika Srpska.

The SDS – benefiting from dissatisfaction with the socio-economic situation in Republika Srpska, particularly in its eastern parts – has taken a more assertive stance on issues of independence and accession to Nato, whose air power effectively ended the three-year war in Bosnia and led to the 1995 Dayton Agreement that gave rise to the current state structure. It was, however, the SDS's strong emphasis on local issues and decentralisation that struck a chord with many voters who've felt increasingly alienated by the SNSD. The prospect of the SDS's performance being repeated in general elections in two years' time will likely prompt a ratcheting-up of nationalistic rhetoric from Dodik and the SNSD, to the further detriment of politics at the national level. As Dražen Pehar, a university lecturer and political analyst, points out: "the election campaign was utterly misleading, but useful in a way: the focus was not on local issues (how to repair roads, build infrastructure etc.), but on ideological questions (whether Bosnia should be divided, ethnicnational issues etc.)… these issues should not be a basis for the election of local power-holders, but it tells you something concerning about the basis on which the voter population made the decision."

Pehar is particularly critical of the local media, "as they simply followed the election agenda as imposed by the parties and the candidates, rather than trying to steer it towards a proper set of issues."

bne November 2012

bne November 2012

Southeast Europe

I 45

about 9m members to say the same.)

It is still strongly linked to the cause of Montenegrin independence, with Djukanovic repeatedly pointing out that most of the opposition opposed sovereignty.

– valuable revenue for a financially strapped government. Notable examples include the French science fiction action film "Lockout" starring Guy Pearce, Ralph Fiennes' "Coriolanus", and "The Raven" starring John Cusack.

And Djukanovic is also playing heavily on Montenegro's progress towards the EU, which has indeed been a high point of his rule, as the country commenced membership negotiations in June.

What attracts foreign productions to Serbia is of course the relative cheapness, especially since the dinar fell to historic lows against the euro, coupled with the high-quality facilities and well-trained, English-speaking crews, not to mention the unspoilt locations. "Budgets that care about every penny tend to come to us, because we are 15-20% cheaper without incentives than either Prague and Budapest," says Angie Vlaisavljevic, a former US film producer who returned to Serbia and now owns the country's largest film production outfit Work in Progress.

Divided and weak As the election results indicate, the opposition itself is divided. The establishment of the Democratic Front was greeted with much fanfare, with hopes rising among the DPS' critics that Montenegro might at last have a united force for change. But the SNP's decision not to join and to expel members who joined the Front scuppered the new alliance's hopes of real power.

The opposition had thought voters would punish the government for its handling of the economy, which – being small, open and strongly linked to the Eurozone – has been hit by the current crisis. But they offered few solutions of their own.

Montenegro has done very well in recent years at cultivating its tourism industry, one of the world's fastest growing.

Projects such as Porto Montenegro, a luxury resort on the coast, are drawing in big investors as well as a smattering of the world's glitterati.

Tourists have continued to flock to the coast, but this cannot power the economy alone. After several good years, a sharp recession in 2009 saw GDP contract by 5.7%. The recovery was respectable, with two consecutive years of 2.5% thereafter, but this year, will slow to just 0.5%, according to Standard & Poor's, which downgraded Montenegro's long-term credit rating further into junk status in June. S&P drew particular attention to the country's fiscal crunch, which is pushing the government to implement austerity measures after public debt rose to 47% of GDP at end-2011, from 28% in 2007.

Take two in Serbia Nicholas Watson in Belgrade

E

merging Europe's luring of film and television productions away from traditional US or European locations has been one of the region's surprise success stories over the last two decades, and with one of the region's newest film studios Serbia is now competing head to head with the Czech Republic, Hungary and Romania. But industry players say it needs help from the government in the form of incentives if it wants to attract more big foreign features.

The film industry in Serbia, like most aspects of the country, was decimated by the wars during the break-up of Yugoslavia in the 1990s and the subsequent decade of isolation and sanctions that followed. Prior to then, Serbia had a thriving film industry centred on the now-bankrupt Avala Film studios, whose last major production was the 1989 television mini-series "Around the World in 80 days", starring Pierce Brosnan.

The previous government made some noises about reviving Avala, but the private sector has already stepped in with the opening in 2010 of PFI Studios,

part of the Pink Media Group owned

by Serbian tycoon Zeljko Mitrovic. So far, PFI Studios, located near Belgrade airport, has gone some way to putting Serbia back on the map for film and TV executives scouting in the region.

"It always used to be Prague, Budapest,

Those financial incentives are the controversial tax breaks that European countries began offering over the last decade in what the European Commission sniffs are little more than "subsidy races" that European countries use "to compete among themselves for prestigious Hollywood projects." The Commission claims these distort competition among European production locations, something that's perfectly illustrated by the example of Hungary, which had no film industry

"The former Yugoslavia may be many countries now, but culturally we're still one territory" then Romania or Bulgaria that people visited, but now we're in the loop over the last two years and people are pleasantly surprised when they come here," says Barbara Sandic Stetic, executive director of PFI Studios.

According to Ana Ilic of Film in Serbia, the country's film commission, the total number of projects shot in the past three years is 13 films and five television series and films, which has resulted in local budgets for Serbia of about €30m, of which 8-10% is spent on local permits

to speak of but with the introduction of 20% tax breaks managed to decimate the Czech film industry in a few years.

By 2008, the money spent by foreign film producers in the Czech Republic had dropped 85% from the $270m recorded in the peak year of 2003.

The Commission earlier this year proposed caps on how much public subsidy money can be used to tempt foreign film production to the region, which some worry could see many productions stay at home in the US, where incentives

46

I Southeast Europe

bne November 2012

of up to 30% are still possible in some states. However, since Serbia is not part of the EU that shouldn't pose a problem – rather, the problem is the country's internal politics.

Gridlock In 2011, the previous government passed a law offering financial incentives specifically targeted to foreign productions filming in Serbia, but the law was never implemented and now there is a new coalition in power since July. "We really

"Now we're in the loop over the last two years and people are pleasantly surprised when they come here" hope the new government will implement this law by the end of the year, it will make all the difference to next year and gives credibility to the Serbian firm industry since it shows the government is fully behind it," says Ilic.

The industry could do with a boost. PFI’s Sandic Stetic says that after a "fantastic" 2010, the following year was slow, not helped by the lack of the promised tax incentives, though with PFI Studios being part of the Pink Media Group, one of the largest media corporations in Southeast Europe, the space can always be filled up with sister company productions. "2011 was a big disappointment with no international feature film productions, though we're never empty due to our facilities being filled by our sister companies' productions, and we had a lot of TV and foreign commercials from Greece, Austria, Russia, Spain and Scandinavia," she says.

Indeed, Serbia is becoming a centre for foreign television commercial shoots, especially since the country in 2008 joined the Commercial Film Producers of Europe (CFP Europe), an industry group, which helped to dispel much of the negative image of the country. "You need to understand how bad the image was here – you're having a good chat with some ad executives and then suddenly they ask, 'What about Mladic?'"

bne November 2012

Southeast Europe

says Vuk Marjanovic, producer for Cyber: Few Good Men, referring to the alleged war criminal on trial in The Hague. "By joining CFP Europe, we established Serbia as somewhere credible to do business and business really started coming in 2010."

Serbia's advantages are the same as those for film production, namely value for money at a time when budgets are tight. But Milos Djukelic, founder of Red Production, notes another that has enabled his outfit to double its revenues each year and reach the point where it can handle 70 commissions a year. "The former Yugoslavia may be many countries now, but culturally we're still one territory," says Djukelic, who now has opened offices in Croatia, Montenegro, Greece and, surprising given his Serb nationality, Albania.

Together with Russia and Greece, which also both have strong cultural and business ties to Serbia, Belgrade is proving to be the centre of television commercial production, where western companies like Nokia, Ikea, Procter & Gamble, and Santander choose to shoot commercials that can be rolled out over the region, according to Marjanovic.

In addition, there is also a budding post-production industry developing in Belgrade, which is growing on the back of knowledge from the industry on how to organise such projects to fit in with foreign feature film producers. "We're really comfortable with the work flow of western companies," says Petar Jovovic, founder of Crater Studio, which over the past two years has worked on films such as "Shark Night 3D", "One Fall" and "The Other Guys".

Jovovic adds that again Serbia's cost advantage is key for attracting work, something that would only be enhanced by the introduction of those tax incentives. "Serbia is priced very competitively – it's a good cost for the client but also it's a good cost for here."

I 47

for the fact that the ratings agencies refuse to upgrade the country's sovereign debt to investment grade.

Yet most pertinently right now, despite expectation that the Central Bank of Turkey (CBT) will ease rates later this week, it restrains the hand of the banking authority to offer deeper and long-term monetary easing help boost growth, due to the country's consequent exposure to the lira's strength.

Turkish forecast raised as monetary policy remains stuck bne

T

urkey's public finances continue to come under scrutiny as the government was forced to widen its budget deficit target for 2012 from 1.5% to 2.3% of GDP as the economy continues to slow. However, analysts point out that any stimulus via monetary policy remains limited by the current account deficit.

Finance Minister Mehmet Simsek announced on October 16 the deficit is set to widen sharply to TYR33.5bn ($18.5bn) this year, exceeding the original official forecast by more than half. The deficit is then expected to widen marginally to TRY33.893bn in 2013, Simsek told a news conference to detail budget forecasts outlined last week in the government's medium-term programme for 2012-2015.

In that programme, the government also cut its growth forecasts for this year and next, predicting growth of 3.2% in 2012 as the country heads for a soft landing

after surging 8.5% last year. "The soft landing process is very important to us," Simsek said. "Measures we have taken have been largely successful in bringing growth and the current account deficit down to reasonable levels."

However, Turkey is now caught in a vicious circle stemming from that

Taxed to the hilt With less opportunity to grow the economy to raise revenue, Ankara is left needing to find other ways to shore up its budget. That has led to a series of tax hikes, which have raised levies on vehicles, alcohol, and fuel, as well as raising gas and electricity tariffs.

However, Neil Shearing at Capital Economics doubts it will be enough.

"Despite the remedial action, we suspect that the government will still fall short of its budget deficit target for 2013.

Whereas it expects the economy to grow by 4% next year, we think growth will be a more modest 2%. This will keep a lid on revenue growth and mean that non-discretionary government expenditure (for example on social security) is higher. We have pencilled in a budget deficit of 3% of GDP in 2013."

Due to similar hikes in 2011, the analyst doesn't expect to see this year's tax increases provoke the inflation that the CBT has been so worried about.

"Instead, the tax changes mean that inflation will now fall at a slower rate

"We suspect that the government will still fall short of its budget deficit target for 2013" rapid growth's dependence on domestic demand. The current account deficit verged on 10% last year, and although the imbalance has narrowed to around 7.5%, it is still hitting Turkey hard.

The reliance on Europe's shaky banking sector to fund the gap is responsible

than would otherwise have been the case. We had previously expected headline inflation to end the year at just under 6%, but we now think it will end the year at around 7.5% (compared to 9.2% in September)," Shearing writes.

"What's more, assuming that there are no further tax measures, we think

48

I Southeast Europe

Ratings Xmas present for Turkey?

bne Turkey's slowing economy could be about to gift the government what it craves – an upgrade to investment grade – after a director at Fitch Ratings said on October 10 that the agency is set to review its 'BB+' rating on the sovereign before the end of the year.

Speaking at a conference in London, Paul Rawkins, head of emerging market European sovereigns, said Fitch is "quite close" to reviewing Turkey's rating.

While he offered no promise that the review would move the rating one notch higher needed to make investment grade, Fitch already said in August that it could offer an upgrade should inflation slow and the current account deficit narrow to a more sustainable level, moves that are slowly materializing.

Rawkins also stated that geopolitical tensions aren't currently a risk for the country, although he warned that the situation could affect Fitch's view if it deteriorates. "If Turkey got dragged in [to the Syrian conflict], that would have implications," Rawkins said.

Ankara has been at loggerheads with the rating agencies over their refusal to give the country an investment grade, with officials regularly accusing them of membership in a cartel of market players depressing Turkish assets for their own profit. However, the markets remain concerned because of – rather than despite – the galloping 8.5% GDP growth recorded in 2011.

bne November 2012

inflation is still on track to fall to the CBT's target of 5% by the end of next year."

The CBT's fretting over price rises should reduce throughout the rest of the year then, but the analyst insists that has never really been the major issue, despite ongoing fights between the government and CBT Governor Basci.

"We doubt that any of this has major implications for monetary policy," Shearing adds. "The key point is that monetary policy decisions remain governed by concerns over the lira against a backdrop of a large current account deficit. The summer rally in global risk appetite has allowed the CBT to let market interest rates fall to the bottom end of its "corridor". This represents a significant monetary stimulus. But keeping rates at these lows will be difficult if global risk appetite starts to sour once again (as we expect) and the lira comes under renewed pressure. The big picture remains that even though inflation should fall over the next year, the scope for a monetary policy response to revive growth is limited."

Much of that expansion was based on rampant domestic demand, leaving the economy dangerously out of whack. A current account deficit that hit double digits saw Turkey hugely exposed to the Eurozone crisis, with the vast bulk of funding to fill the hole sourced from Europe's precarious banking sector. The overheating last year also sent inflation soaring. This year, however, the economy is decelerating, which has pushed the current account deficit towards 7%, while inflation is also slowing.

bne November 2012

A sorry sell-off saga in Romania Andrew MacDowall in Belgrade

I

t's not been a great year for Romania.

It started as 2011 ended, with painful austerity measures biting. Since then, the country has been rocked by street protests against the cuts, corruption and the unpopular leadership; a prime minister resigned only for the administration that replaced him to be toppled in a vote of confidence; the third government of the year then attracted domestic and international opprobrium as it launched attacks on the constitutional court and other checks on its power, as well as an unsuccessful campaign to oust the president. A bitterly cold winter was followed by a blazingly hot and dry summer that adversely affected Romania's grain harvest. Meanwhile, progress on economic reform has stalled, and the country's privatisation programme, while it has moved forward in some areas, is beset by confusion in others.

The sale of Oltchim, a major chemicals firm specialising in PVC, is the latest sorry sell-off saga. On September 21, the government appeared to have sold its controlling 54.8% stake in Oltchim to the colourful and controversial media magnate Dan Diaconescu for RON203m, around €45m.

But within days, Prime Minister Victor Ponta was telling the press that the sale would not go through, as Diaconescu did not have the cash to seal the deal.

"The soft landing process is very important to us"

Southeast Europe

Diaconescu, a 44-year-old former journalist who now owns the OTV television station, had demanded new terms to the sale, including a guarantee that the state will cough up for unpaid salaries of Oltchim workers, and that it will not be forced into insolvency by public-sector creditors. The government decided otherwise, and on October 2 officially announced the sale had failed and pledged to complete the process in 2013.

No experience necessary There remain lingering questions about

how such a sale could go so wrong.

Diaconescu appears to have no experience of managing large chemicals companies, yet his bid trumped that of German chemical firm PCC SE, as well as local industrial companies Aisa and Chimcomplex Borzesti. Diaconescu's bid may have won because of the very high price it offered for the government's Oltchim shares – more than twice their market value, according to Andrei Chirileasa, capital markets editor of Ziarul Financiar, Romania's top business newspaper.

If the high offer by Diaconescu – a subject of several court cases – thickened the plot somewhat, it becomes thicker still when one takes into account his political ambitions and the looming general election on December 9. The mogul's modestlynamed People's Party-Dan Diaconescu

I 49

allies, or led to mass lay-offs. He asserted that his offer would be in the best interests of the workforce and the economy, and accused the authorities of deliberately undermining the deal by demanding payment so quickly. He made it clear that he saw PM Ponta as obstructing the sale.

Enjoyable as speculating about the winning bidder's motives are, the Oltchim debacle highlights pressing issues for the country. The sell-off was part of a package of swift privatisations agreed by Ponta's new government to shore up public finances and appease the International Monetary Fund (IMF). This is also meant to see rail freight operator CFR Marfa and airline Tarom opened to private investors.

Romania badly needs the IMF's cash and to divest itself of loss-making assets. But the confusion over Oltchim – as over previous privatisations, including the sale of the country's largest copper mine, abruptly cancelled in April, and the abortive sell-off of a stake in oil company Petrom – will not reassure investors.

Meanwhile, the future of Olchim, its 3,300 employees and the many people whose incomes depend on the plant in

"The winner did not show documents to prove he holds the sum. It is useless to continue negotiations" (PPDD) was founded in 2010 and has little current presence at national level, but has won a raft of local government seats.

Indeed, the widespread assumption among the local press is that the Oltchim bid was merely an attempt to raise his profile in the run-up to the polls. A generous interpretation of this theory is that his demands on Oltchim post-privatisation highlight the plight of workers in Romania's stalling publicly owned companies, and the likely harsh effects of sell-offs.

Diaconescu himself said that he wanted the Oltchim deal to mark a break from the privatisations of the past, which all too often saw assets sold to political

Ramnicu Valcea in central Romania, hang in the balance. The company is already in a mess, as production was suspended in August over €400m of debt to the state and power suppliers. On October 17, Minister of Economy Daniel Chitoiu said that Oltchim activity might resume at 65% of its capacity by early November, and the wages due for August for the employees would be paid before then.

Any future investor seems unlikely to preserve the employment set-up as it is, and will look on current debt levels with extreme wariness. Yet privatisation is the only hope, as the state cannot support the plant any longer.

50

I Southeast Europe

bne November 2012

Moldova, a topic that hasn't gone beyond allegations by politicians and a campaign used by business people to attack their competitors." Danu says the allegations "are simply part of a smear campaign originating in Moldova, and coordinated by a criminal group led by Mssrs Topa, two business people that have been convicted by a court of law, and who had been business associates of Mr Plahotniuc in the past."

Feeling the collar of a Moldovan oligarch bne

M

oldova's first deputy speaker, Vlad Plahotniuc, reputedly the country's richest man and a political kingmaker, could face criminal prosecution in UK on contempt of court charges, according to lawyer Patrick Boylan of Simmons & Simmons, "if a London court finds he is behind the transfer of shares frozen under court order."

According to Boylan, shares in UK company Tomdal Ltd. are believed to have been transferred to a Russian company, despite a London court having ordered an assets freeze during litigation. Plahotniuc features as the economic owner of the company, according to documents obtained by a court discovery order and seen by bne.

Tomdal is only one of several UK companies to which share packets in Moldovan banks and insurance companies were ultimately transferred without knowledge of their owners following apparently crooked court decisions in what is Europe's poorest country in 2010-2011.

Plahotniuc was revealed to be the beneficiary owner of all the UK companies, following the discovery order in England and Scotland. Lawyer Boylan is repre-

senting Moldovan businessmen Victor and Viorel Topa, who claim that the UK companies now own share packets rightly belonging to them and expropriated in 2010 and 2011 by Plahotniuc.

According to Boylan, Plahotniuc has already attempted to claim diplomatic immunity as deputy speaker of parliament in the framework of a Cyprus court case also relating to breach of a courtimposed asset freeze. "The claim was laughable, and the Cypriot court ruled that under international law he would not enjoy sovereign immunity," Boylan says, who warns that, "English courts take contempt of court very seriously."

In February 2012, a London high court judge handed down a 22-month prison sentence to the former owner of Kazakhstan's BTA bank, Mukhtar Ablyazov, on contempt of court charges relating to breach of an asset freeze.

Plahotniuc has vigorously denied all the Topas' allegations about his role in the Moldovan "raider attacks". According to his press secretary Diana Danu, "the topic of the raider attacks was made a subject of a political campaign in

Bank robbery The waves of dodgy asset transfers labelled "raider attacks" in Moldova started in 2010 and peaked in 2011.

"We had held a stake in Victoriabank since 2005 via companies," Victor Topa tells bne, "but when we attended the shareholders' meeting in July 2010, we suddenly found out that we no longer owned the shares."

The Topas then discovered a whole series of court decisions had been secretly set in motion in the preceding months that had transferred most of their stake to non-resident companies. And hardly they got their breath back than further court decisions in 2011 disappeared the remainder of their shares in Victoriabank, an 18% stake in Moldovan savings bank Banca de Economii, and a controlling stake in Moldova's second largest insurance company Asito. In all cases, the stakes were shifted to shell companies across the globe; ultimately they were parked with UK companies.

The Moldovan court decisions all involved alleged million-dollar debts owed by the Topas' ownership vehicles to previously unknown offshores, which it was claimed were collateralised by the bank shares. They also involved the same court and group of judges, and crudely tampered paperwork including judgments entered post hoc on the bottom lines of the court ledgers for those dates.

"On the one hand it was sophisticated, on the other hand it was unbelievably brutal and transparent, and easy to convince an English judge that these court decisions had been fraudulently obtained," lawyer Boylan says.

Bizarrely, for all the shenanigans in Moldova, court discovery orders obtained in

bne November 2012

England and Scotland as well as Cyprus revealed that Plahotniuc was down in black and white as economic owner of all the companies that now control the disputed share packets – without any smokescreen use of strawmen or relatives. Since Plahotniuc's outing as owner of the stakes, moves have apparently been made by at least one of the UK companies, Tomdal Ltd., to sell on the stakes despite the assets freeze. The moves could yet spell trouble for Plahotniuc if he is judged to be their initiator.

All change The Topas are not the only ones hurting.

Altogether the "raider waves" and linked transactions saw large stakes in Moldova's three largest banks, a controlling stake in a smaller bank, and controlling stakes in the two largest insurance companies mysteriously change hands 2010-2012, with no clarity over the new owners. The country's reformist prime minister, Vlad Filat, called the raiding spree "an attack not only on our banking system, but on our country itself."

Bogdan Tirdea, Moldova's leading oligarch watcher, says the amounts could be as much as $100m. "There has never been anything like this in Moldovan history."

For all of Filat's outrage, only in one case has the outcome of a raid been reversed: in August 2011, a Moldovan court transferred a blocking stake of just under 27% in Moldova's largest bank Agroindbank from ownership by a pool of Slovenian financial investors to two Seychelles companies, on the basis of a forged ruling from a Russian court.

Agroindbank took a €20m loan from the European Bank for Reconstruction and Development (EBRD) in 2009, with further funding under consideration. The panic among the European diplomatic community in Chisinau was great, and pressure piled on behind-thescenes. A quick Supreme Court decision in September 2011 resulted in the Agroindbank stake being returned to the Slovenian owners. The EBRD refused to comment on the situation in Moldova despite holding a blocking stake in Victoriabank and being the main creditor to Agroindbank.

Southeast Europe

Domestic investors have been less lucky than the quick response the EBRD got.

Russian banker German Gorbuntsov was worst hit – literally. His 80% stake in small Moldovan bank Universalbank was also transferred by Moldovan court order to a Seychelles company in August 2011. The bank had its license withdrawn in February 2012. Gorbuntsov, who has been accused of money-laundering in Russia, was then shot and badly wounded in London in April this year.

Gorbuntsov has said he believes Russian interests were behind the shooting.

The change of owners in Moldovan companies is still going on, although with less brutal methods. In July, five recently registered Moldovan companies bought 80% of the country's largest insurance company on the open market from Russia's Rosgosstrakh, for around $16m.

According to information obtained by the Topas, for which there is no independent confirmation, two of these companies raised funds for the acquisitions using as collateral the bank shares parked with the UK shell companies.

Another Moldovan company apparently raising funds by collateralizing the disputed stakes has taken a role in Payza, an e-payment company competing with Paypal that is the successor to Alertpay.

And following the transfer of the Topas' 18% stake in state-controlled savings bank Banca de Economii – slated for full privatisation by the government – war

I 51

tion replace a conservative Communist regime, stirred hope that Moldova could be a bridgehead for reform in the former Soviet Union. Some progress has been made, but it seems powerful businessmen such as Plahotniuc, behind the scenes during the Communist administration, adroitly jumped ships in 2009 to achieve direct power via democracy.

Plahotniuc, who made his money in fuel trading under Communist president Vladimir Voronin, is now first deputy president of Moldova's Democratic Party, a key member of a ruling Alliance for European Integration coalition that enjoys only a slim parliamentary majority vis-a-vis the Communist opposition. He is regarded as the party's main financial backer.

The "bank robberies" pose obvious questions about the rule of law in Moldova.

And, according to Victor and Viorel Topa, it is not just a question of bent judges at commercial courts, but of politicisation or commercialisation of the country's top legal offices.

Two weeks after the Topas went public in August 2010 with their accusations against Plahotniuc, Moldova's Prosecutor General, Valeriu Zubco, after consulting with the Anti-Corruption Prosecutor, duly launched criminal proceedings – against the Topas. In October 2011 Victor Topa was sentenced in absentia to 10 years in jail on blackmail charges; Viorel Topa was sentenced in absentia in January 2010 to eight years in jail on

"English courts take contempt of court very seriously" broke out between the new unidentified minorities and the state's interest in the bank, leading to two competing boards elected in April 2011, and an interim solution only reached in August, with the unknown minorities getting two representatives on the board – but still no clarity about their identity.

Democracy hijacked by oligarchs Moldova's democratic breakthrough of 2009, which saw a pro-European coali-

fraud charges. Both men, now resident in Germany, say the charges are politically motivated.

"None of this would have been possible without protection from the very top," says oligarch-watcher Tirdea. "Plahotniuc controls both the Prosecutor General and the Anti-Corruption Prosecutor, and this has been the root of all the evil."

52

I Eurasia

bne November 2012

parliament hall nor applauded when he concluded his speech.

Davit Usupashvili, a leader in the coalition and the newly elected parliamentary speaker, told journalists that members of parliament who committed crimes during the preelection period can expect to be punished. "We don’t want to act as per our mood or views. All issues should be legally grounded," he said. "It is not about just one certain MP. We are not going to forget what had happened before October 1."

With the mysterious death of former prime minister Zurab Zhvania, the murder of banker Sandro Girgvliani, and scores of disputed property and business deals, there are plenty of cases for the new government to reopen.

A parliamentary committee charged with investigating past misdeeds will be created – likely before the end of October, noted Tina Khidasheli, a lawmaker from the coalition and Usupashvili’s wife.

Photos: Mikheil Saakashvili's Photostream

Retribution in Georgia Molly Corso in Tbilisi

F

or years, the Georgian prosecutors’ office and court system trampled on property rights and human rights, leaving a tangled mess of allegedly politically motivated arrests and dubious court verdicts. With the Georgian Dream coalition now in power after winning the October 1 elections, people are eager for retribution, but Prime Minister Bidzina Ivanishvili is warning against acts of “revenge.”

Members of the defeated United National Movement (UNM), President Mikheil Saakashvili's party, are hoping the coalition is ready to forgive and forget, but they found little comfort at the first session of parliament on October 21. After months of a brutally aggressive campaign – and years of political animosity – the coalition’s reception for UNM was frosty: members of the Georgian Dream neither stood when the president entered the

Leaving the country Saakashvili’s allies are clearly taking heed. Reports of former ministers and high level appointments fleeing the country have increased since the election: Bacho Akhalaia, who had served as head of the prison ministry, defence minister and minister of interior affairs – Georgia’s national policing body – as well as Zurab Adeishvili, the powerful justice minister, both left Georgia soon after the elections. Dimitri Shashkin, who led the prison ministry, as well as being a past minister of education and defence, posted a brief goodbye to the country on his Facebook page on October 22. He did not indicate his future plans or if he plans on returning to the country.

Expectations that the new government will right eight years of perceived injustice are high, and the new authorities are under “enormous” pressure to act, notes Giorgi Gogia, South Caucasus senior researcher for Human Rights Watch. And controlling those expectations, Gogia warns, will be a huge task.

Eurasia I 53

bne November 2012

Tea Tsulukiani, Georgian Dream’s nominee for minister of justice and a former lawyer with the European Court of Human Rights, says the coalition is well aware what society expects from

stresses that while he does not know the circumstances for Tamazashvili and Sozar’s release, it is vital that cases are reviewed based on the law, not on relations with influential people. "We

"If there is a judiciary then the population has some feeling of justice, fairness – this has not been the case in Georgia"

them. But she reiterates that any action against anyone – from former ministers to judges charged with misusing their position – will be based on the law, not society’s thirst for revenge. "We need to create… a body that is in charge of reviewing cases," she says.

"First of all, we need to install some filtering mechanism because every family of every prisoner expects its own prisoner is an illegal one, so we will make some filtering mechanism.

Expectations from society are very high we need to introduce this mechanism quite speedily. By the end of November we should have the body that starts reviewing these cases."

There are already signs that judges are eager to fall into line, overturning decisions even without the Georgian Dream appointed ministers in power – and without a transparent use of due process. Relations and family friends close to the new government have already been released from prison: Tamaz Tamazashvili, minister of interior affairs nominee Irakli Garibashvili’s father-in-law, was free on bail just days after the election after serving just short of a year on his three and a half year sentence for illegally obtaining a firearm. Vakhtang Subari, jailed for "invoice fraud" in 2010, was freed after the coalition named his brother Sozar for minister over prisons and prohibition.

But the new government will have to do more than release a few prisoners to make a difference, says human rights lawyer Kakha Kozhoridze. He

think it will be better to protect the procedure and protect the law than to release these people without [using the law]," he says. "A lot of people daily are coming in the Tbilisi office and they speak about severe violations about their rights – property rights and other rights. They say that they have

Expectations the new government will right eight years of perceived injustice are high

been imprisoned during several years unlawfully and they want to renew these cases now. And ask us how they can do this."

Referring to judges' attempts to "save face" and "rectify their own errors," Tsulukiani admits the trend will not help her ministry restore faith in due process. "Due process has not been followed in Georgia for nine years and the main guilt in this lies on judges, because every executive or every legislative body or families too close to the political team in power can commit some kind of errors or crimes, but if there is a judiciary then the population has some feeling of justice, fairness,” she says. "This has not been the case in Georgia."

54

I Eurasia

bne November 2012

economic integration led by Moscow in the post-Soviet space, most significantly with the creation of the Customs Union, which currently comprises Russia, Belarus and Kazakhstan, but is due to be expanded.

Photo ITAR-TASS / Mikhail Klimentyev

Russia's new role in Central Asia Clare Nuttall in Astana

R

ussia's recent striking of farreaching deals in the energy and security spheres with Kyrgyzstan and Tajikistan show Moscow's determination to regain ground in Central Asia. Russia has ensured its continued military presence in the region as the Nato withdrawal from Afghanistan approaches, offering in return support on key economic issues – hydropower in Kyrgyzstan and fuel in Tajikistan.

On his September 20 visit to Bishkek, Russian President Vladimir Putin succeeded in extending the lease on Russia's airbase at Kant in northern Kyrgyzstan until 2032, with provision for a further five-year extension.

Moscow agreed to settle Kyrgyzstan's debts of $489m as part of a package of deals that also included agreements on funding for two large-scale hydropower projects, Kambarata and the Upper Naryn cascade.

Two weeks later, Putin flew to Dushanbe for another round of talks. On October 5, it was announced that he had reached an agreement ensuring the continued

presence of Russia's 201st Motor Rifle Division in Tajikistan for 30 years. The amount that Russia will pay to lease its bases in Tajikistan has not been disclosed, but Putin aide Yury Ushakov told Russian journalists that it would be "almost free". Tajikistan, meanwhile, is set to

"Even before Putin came back to power, Russia has been trying to redefine a long-term role for itself in as many of the Central Asian countries as possible," Martha Brill Olcott, senior associate at the Carnegie Endowment for International Peace, tells bne. "What we see is Russia realising that if it doesn't define a new role, then it is going to be eclipsed in Central Asia. Russia feels the pressure of time if it wants to preserve a special role for itself in the economy and security of any of the five countries."

In less than two years, Nato-led forces are set to complete their withdrawal from Afghanistan, which borders three of the Central Asian republics.

There are concerns not just in Moscow but also in many of the Central Asian capitals that the Nato withdrawal is premature, and will leave the region more vulnerable to the dual threats of terrorism and drug trafficking. Tajikistan is particularly at risk because of its long and porous border with Afghanistan, a fact highlighted by the fighting between government forces and militants around

"What we see is Russia realising that if it doesn't define a new role, then it is going to be eclipsed in Central Asia" benefit from a new deal on cooperation in combatting drug trafficking, and a Russian concession on residency and work permits for Tajik migrant workers.

Back in the game With the Tajik agreements hard on the heels of those signed in Bishkek, this appears to be a concerted Russian effort to cement its relations with the Central Asian countries more than two decades after the break-up of the Soviet Union.

They follow several years of greater

bne November 2012

Asian region appears to be declining, especially from a security perspective, Russia is staking its long-term claim.

Its potential role as the protector of Kyrgyzstan and Tajikistan from future instability serves Moscow's ambition of re-establishing its dominant role in what it calls its "near abroad".

and security dimensions are very intertwined". While there are definite economic advantages to expanding the Customs Union, at the same time there is a perception on the part of many Russians that Putin has also made strategic gains in Moscow's traditional sphere of influence.

"From Russia's perspective it makes sense to take advantage of the common historic ties that it has with the Central Asian countries. Russia is aiming to become a global player and promoting its security and business interests in its neighbourhood is a logical move," says Lilit Gevorgyan, senior analyst of Russia/CIS at IHS Global Insight.

"The military and political clout in these countries can also serve as a risk mitigating factor for Russian businesses if they enter the difficult Kyrgyz and Tajik markets."

Within Central Asia, it has been easier for Russia to influence Kyrgyzstan and Tajikistan, which lack the oil and gas

Chinese whispers Countries from all sides – from Europe to Iran, and South Korea to India – have sought to take a piece of Central Asia's natural resources. However, the greatest change in recent years has been the emergence of China, which has established an economic presence in all five republics. In addition to the construction of new oil and gas pipelines to China, Chinese companies bought up assets in the oil and gas and mineral sectors across the region.

Chinese companies are also involved in infrastructure projects; Tajikistan's roadbuilding programme, for example, has been funded by soft loans from China, and carried out by Chinese construction companies.

According to Olcott, withdrawal from Afghanistan is at the forefront of everybody's minds. "It creates a potential security vacuum in the region," she says, "that could have the capacity to tip already unstable states into greater instability."

Bringing Kyrgyzstan and Tajikistan into the Customs Union will help to counter Beijing's growing economic influence. Kyrgyzstan is already on the way to becoming a member, and its accession would pave the way for Tajikistan – which does not share a border with any of the current members – to join. Expanding the Customs Union is expected to form the basis for deeper economic integration in the region.

At a time when the West's interest in Afghanistan and the wider Central

Olcott points out that when considering Russian motivation, "the economic

Khorog, a town on the Afghan border, in July and August this year.

Eurasia

I 55

Kazakhstan is already a close ally of Russia, but in the last two decades Moscow's level of influence in Ashgabat and Tashkent has fluctuated.

Relations with Turkmenistan reached a low point in 2009, when Gazprom suddenly suspended taking deliveries of Turkmen gas, causing an explosion that put the country's main export pipeline out of action for months. Relations have since improved, but Ashgabat is

"Nato's withdrawal from Afghanistan is at the forefront of everybody's minds. It creates a potential security vacuum in the region" resources and are therefore are highly dependent on Russia economically.

Russia is the main source of remittance payments from migrant workers from Tajikistan and Kyrgyzstan. In both countries these make up a substantial share of GDP; in Tajikistan, remittances from migrant workers account almost 50% of GDP, making it the most remittance-dependent country in the world.

The power that Moscow wields is already evident. This was demonstrated

by Dushanbe's brief show of independence in 2011, when a Tajik court jailed a Russian and an Estonian pilot for smuggling. Moscow's reaction was swift and decisive; the ensuing crackdown on Tajik migrant workers was followed by the speedy release of the two pilots. Moscow is also widely believed to have at least given its consent to the toppling of the former Kyrgyz president Kurmanbek Bakiyev in 2010. For the current president, Almazbek Atambaev, who presides over the still turbulent Kyrgyz political scene, Moscow's support, psychologically as much as economically, is crucial.

The remaining Central Asian republics have a greater degree of independence thanks to their oil and gas reserves and wider geographic spread of investors.

still looking away from Moscow toward European and Asian markets, especially China. Gevorgyan points out that Uzbekistan is "once again drifting away from Russia and wooing the West".

In 2012, Uzbekistan quit the Russianled CSTO in the economic sphere and forced a subsidiary of Russian mobile operator Mobile TeleSystems (MTS) out of business.

At the same time as sealing the deals with Kyrgyzstan, Putin also invited Kazakhstan and Uzbekistan to take part in planned hydropower projects in Kyrgyzstan. The proposal was intended to break the deadlock in Central Asia over the construction of new hydropower plants. This is fiercely opposed by Tashkent over fears they will restrict water supplies to Uzbekistan's cotton fields, and Putin's proposal got an unenthusiastic response.

Had the approach been successful, it would have further reinforced Russia's position not just as a source of funds and military might but as the region's diplomatic power broker. The deals already signed in September and October do, however, send out a strong signal to the whole Central Asian region about Moscow's intentions to remain the dominant power in the region.

56

I Eurasia

bne November 2012

oversight of the Kazakh authorities" at a time when other opposition forces have been marginalized.

The sentence drew a sharp response from human rights groups, less so from governments. A US Embassy statement talked about its "strategic partnership" with Kazakhstan before noting its "concern regarding the prosecution of Vladimir Kozlov and the apparent use of the criminal system to silence opposition voices."

Kazakh opposition leader jailed

However, Sizov insisted that despite the jailings, the party would continue to work for a more democratic system in Kazakhstan. "Vladimir Kozlov built up our organisation, but it is not like a presidential system, we can continue without him. He is a bright and strong leader, and will be a big loss, but we will continue our work."

Strike down All three charges against Kozlov were connected to his support for striking oil workers in Zhanaozen, an oil town around 150 kilometres from Aktau, where workers at the Uzen field started a seven-month strike in May 2011.

On December 16, 2011, Kazakhstan's independence day, fighting broke out between demonstrators and police who were trying to clear the central square so a concert could go ahead. Mass riots erupted and at least 14 people were shot dead by security forces.

Some aren't so sure. Rico Isaacs, a lecturer in International Studies at the UK's Oxford Brookes University specializing in Kazakh politics, told

Kozlov and his colleagues were accused of inciting social unrest in Zhanaozen and urging workers to resist the authorities. He was arrested on January

Clare Nuttall in Almaty

K

azakh opposition leader Vladimir Kozlov was sentenced to seven and a half years in prison on October 8 in connection with the December 2011 clashes in Zhanaozen.

As one of the strongest critics of President Nursultan Nazarbayev's regime, the sentence is a severe blow for Kazakhstan's already weakened opposition.

A court in Aktau, west Kazakhstan, found Kozlov, the leader of the unregistered Alga! DVK party, guilty of leading a criminal organisation (alongside fugitive banker Mukhtar Ablyazov), inciting social hatred and attempting to overthrow the government. Opposition activist Serik Sapargali and trade unionist Akzhanat Aminov were tried alongside Kozlov, but received suspended sentences.

Kozlov denied all three charges, which he called an attempt to destroy the opposition in Kazakhstan.

Speaking to bne in Almaty on October 5, the deputy leader of Alga!'s coordination committee, Mikheil Sizov, said: "Unfortunately the court system in Kazakhstan is not fair... The decision

Mihra Rittmann, Europe and Central Asia researcher at Human Rights Watch, was less circumspect. "Kozlov is paying a heavy price for publicly criticizing the Kazakh government,” she said in a statement. "By rendering a guilty verdict, the authorities are silencing an outspoken opponent and muzzling the Alga! party, one of Kazakhstan’s few alternative political voices."

has been made in the administration of the president. It's completely political."

"Kozlov is paying a heavy price for publicly criticizing the Kazakh government”

EurasiaNet.org that Alga! "will most likely cease to exist" – an unfortunate outcome, as Alga! is the only party which "provides regular scrutiny and

23, along with other Alga members, opposition activists and independent journalists detained as part of a clampdown on opposition activity.

bne November 2012

Kozlov's Alga! party is one of the most outspoken critics of President Nazarbayev's government, in a country where there are few dissenting voices.

Nazarbayev, who has ruled since Kazakhstan became independent in 1991, has a high level of popularity thanks to the country's steady economic growth and social and political stability.

However, the latter has come under threat since the Zhanaozen tragedy, and a series of bombings, attributed to terrorists, in the west of the country.

The authorities maintain a tight grip on the country's power structures, and no election has ever been recognised as free and fair by international observers.

The April 2011 presidential elections, which Nazarbayev won with 95% of the vote, was criticised by the Organization for Security and Co-operation in Europe for serious shortcomings. Alga! has been unable to take part in recent elections as it has been denied registration, instead leading a campaign calling on voters to boycott the polls.

Eurasia

Business as usual in Kazakhstan

Clare Nuttall in Astana A month on from the top-level Kazakhstan government reshuffle, there have been few changes in Astana’s economic course, and the new government under Serik Akhmetov has been quick to reassure investors that no drastic changes are planned.

The surprise resignation of Karim Massimov, Kazakhstan’s longest-serving prime minister, on September 24 was followed by some other high-level changes, but most of Massimov’s former cabinet retained their posts under newly appointed Prime Minister Akhmetov.

They include Sauat Mynbayev as minister of oil and gas, and Kairat Kelimbetov as deputy prime minister, while Akhmetov himself has been Massimov's deputy since January. He was previously minister of transport and communications from 2006 to 2012, while earlier positions included a term as the deputy mayor of Kazakhstan's capital Astana. "The main questions of investors are about continuity and stability. Since Mr Akhmetov was already first deputy PM and since Mr Massimov was appointed to a position which remains very close to the president of Kazakhstan, we believe that there is a clear message here: 'continuity is the key'," says an analyst note from Visor Capital.

Three days after his appointment, Akhemtov told his first government session as prime minister that his government would continue with existing economic policies including accession to the World Trade Organization and further integration within the common economic space.

Massimov, who had been Kazakhstan’s prime minister since January 2007, announced his resignation after nearly six years in office. He has been moved to chief of the presidential administration, a less high profile but still powerful position.

The reshuffle appears to be an attempt to balance rival groups within the top levels of government. Its main victim was Aslan Musin, the former head of the presidential administration, who was moved to chair the government's audit committee.

The new government has sought to reassure investors, who have benefitted from Massimov’s business-friendly regime. The former prime minister is widely credited with shepherding the economy through the international economic crisis. His government introduced a massive stimulus package for the economy in late 2008, followed by a large-scale industrialisation programme in 2010. Under his stewardship, Kazakhstan has shot up on the World Bank's "Doing Business" index – from 71st place on the 2008 index to 47th in 2012.

I 57

58

I Eurasia

bne November 2012

bne November 2012

Eurasia

Splash the cash Drivers for Kazakhstan's online retail market include the steady growth in incomes. By 2010, income per capita had reached $10,000, 15 times higher than in 1994, and Astana is targeting $15,000 by 2015, putting Kazakhstan among the world's high-income countries.

international airport, are unreasonably high. Baghdasarov, the airline’s majority shareholder since 2005, has several times said that Armavia might be forced to file for bankruptcy unless the charges are reduced.

Previously, rumours have surfaced that Zvartnots’ owner, Argentinian-Armenian businessman Eduard Eurnekian, had deliberately set high service charges for Armavia in an attempt to force the airline into bankruptcy and take it over.

When Armavia disclosed that an Italian company was among the potential buyers for Armavia, this gave rise to speculation that the would-be buyer could be Volare Air Company, which is owned by Eurnekian.

Armavia flies again Clare Nuttall in Astana

T

he Armenian airline Armavia has resumed services after striking a new debt-restructuring deal with its main creditor Zvartnots International Airport, but its majority shareholder, businessman Mikhail Baghdasarov, looks as though he intends to press on with trying to offload the unprofitable airline.

Plans to sell Armavia were announced by the airline management after the latest spat with Zvartnots in late September. A spokesperson for Armavia confirmed to bne on October 12 that negotiations on the sale of the airline were underway, but declined to give any further details.

Zvartnots' management announced on September 20 that it was suspending all Armavia flights until the airline had repaid $5.3m due in unpaid service charges. Armavia had been due to repay its debts to Zvartnots in full by September, under a previous deal struck between the two companies back in March.

The Armavia spokesperson tells bne that flights had resumed after a new deal was

agreed. "We have reached agreement and the issue between the airline and the airport has been resolved, so flights are operating again," she said.

However, the suspension in services in September was just the latest in a series of disputes between Armavia and Zvartnots, concerning the level of service charges set by the airport. Flights have been suspended several times in the last year – in November 2011, March and most recently September.

However, PanARMENIAN.Net reported on October 4 that Eurnekian said he had no intention of buying the airline. "I'm not planning to buy Armavia," Eurnekian told journalists at an agriculture forum in Yerevan.

Armavia has grown rapidly since it was launched in 2003, when it took over the international licence of the bankrupt Armenian Airlines. However, it has increasingly come under pressure as global fuel prices have increased. In April 2011, Armavia became the first commercial airline to put a Russianmade Sukhoi Superjet 100 into operation, but later cancelled its order for a second Superjet and tried to return the first. However, on October 5, Sukhoi announced that it had reached a new sixmonth leasing agreement with Armavia on the Superjet.

Too high Armavia argues that the service charges at Zvartnots, Armenia’s main

"Armavia argues that the service charges at Zvartnots, Armenia’s main international airport, are unreasonably high"

I 59

Kazakhstan's membership of the Customs Union (together with Russia and Belarus) is also helpful. "Since the launch of the Customs Union, we almost think of Russia and Kazakhstan as a single market," says Shaw. "We hope to turn the Kazakhstan market into a miniRussia for Lamoda."

E-tailing in Kazakhstan Clare Nuttall in Astana

A

s a country with steadily rising incomes and low population density, Kazakhstan is an obvious location for online retail. So far, the sector has been slow to develop, but a handful of early movers are investing, confident of the future growth potential.

Staking its claim in the Kazakh market, Russian online clothing retailer Lamoda, one of the Rocket Internet sites, entered Kazakhstan in March. Six months later, the company secured an investment – said to be between $50 and $80m – from JP Morgan, which will be used to grow its business in Kazakhstan and other Commonwealth of Independent States countries.

According to Lamoda's Kazakhstan country manager, Alexios Shaw, the company was looking to benefit from the lack of competition in Kazakhstan's online retail market and the appetite for international brands not yet available in the country. "Retail is waking up with international players such as Saks Fifth Avenue entering in the market, but internet retail is primitive. Low competition was an obvious reason why the market was attractive for us,"

Shaw tells bne. "E-commerce also has a natural advantage in a country like Kazakhstan, provided you have on the ground infrastructure or a good delivery partner."

Almaty-based Chocolife, which at present mainly offers discounts on events, is

Despite the crisis, the last five years have been a period of dramatic growth for Kazakhstani retail, with international mass-market brands including Zara, Monsoon and Gap entering the market. However, as Shaw points out, international retailers are mostly just active in Almaty and Astana, and many brands are still not available in Kazakhstan. Other regional centres including the western oil towns of Aktau and Atyrau and industrial towns such as Karaganda, have relatively high incomes, but are too far off the beaten track for foreign retailers.

"We hope to turn the Kazakhstan market into a mini-Russia for Lamoda" increasingly active in retail, with sales of goods now accounting for around 25% of transactions. Chocolife plans to transform itself into a fully-fledged online retailer and is set to launch an online store, ChocoMart, by the end of 2012. The company is also mulling expansion into Azerbaijan and Ukraine. "The market potential is significant. Now that internet penetration has passed the 50% threshold, we expect an e-commerce boom. We expect that by 2015, the volume of e-commerce transactions will reach 10-times their current level," Chocolife spokesperson Latina Satarova tells bne.

Internet penetration has advanced rapidly. Back in 2007, the country held the dubious honour of having the world's most expensive internet; today with a larger number of fixedline providers and the launch of mobile broadband, getting online is much more affordable. About 53% of the population are internet users.

According to Yandex, the operator of Russia's largest search engine, Kazakhstanis are increasingly active online. "In our view, the potential of e-commerce in Kazakhstan is great,

60

I Eurasia

bne November 2012

and it is gradually being realised – more and more people carry out everyday tasks through the internet, including purchases. Our data shows that around 1% of requests to Yandex from Almaty and Astana are associated with the desire to buy or sell something," Vladimir Isaev, manager of international media relations at Yandex, says.

However, the Kazakhstani online retail market is still tiny compared to that in Russia, which is worth over $10bn, according to East-West Digital News.

Chocolife's research shows that as of 2011, e-commerce transactions worth $133m were carried out in Kazakhstan.

"E-commerce also has a natural advantage in a country like Kazakhstan, provided you have on the ground infrastructure or a good delivery partner" The survey shows a steady increase in online trading volumes, with the number of transactions almost tripling from 115,952 in 2010 to 330,602 in 2011; this continued in the first half of 2012, when a total of 204,237 transactions were completed.

However, the lion's share of transactions in Kazakhstan, some $95m, were in the transport sector, in particular airline tickets, whose customers are mainly well-off Kazakhstanis and foreigners.

By contrast, Kazakhstan's railways are far less hi-tech; in 2009, when national railways operator Kazakhstan Temir Zholy launched its online ticket sales site, just 500 of approximately 12m tickets sold during the year were purchased online, Assylkhan Kaldykozov, executive director, strategic development and new technology implementation at KTZ, told the Digital Communications Kazakhstan conference in Astana. While there has been a steady increase since then, the government's target of bringing 40% of railway ticket sales online is looking over-optimistic.

According to Satarova, the main problem for the market is the lack of e-commerce entrepreneurs, with other barriers including service standards and the low level of credit card usage. Unlike Russia, which has spawned numerous domestic e-tailers – including the "Russian Amazon" Ozon. ru and KupiVIP, many of which have gown with venture capital backing – Kazakhstan has not yet seen a similar phenomenon.

Cash on delivery Kazakhstan, like Russia, requires a much higher level of investment than markets such as the US or Western Europe, due to a combination of the lack of courier services and the continuing preference for cash payments. Lamoda's Shaw says the company has had to invest in substantial on the ground infrastructure. "Entering the market properly requires a huge amount of effort and investment, and as a result we are easily the market leader," says Shaw. "Logistics – getting goods into Kazakhstan and around Kazakhstan – are a huge challenge for e-commerce, and in some ways it's as difficult for us as for an on-the-ground retailer. The big issue is online payment, which has not really taken off in the CIS because of low penetration of credit and debit cards, and high levels of credit card fraud. We therefore do cash on delivery."

But this investment is already yielding results, according to Shaw, who points out that while some Kazakhs buy from Russian and international retailers, the long delivery times (usually around three weeks for European retailers) and the inability of buyers to try and send back goods, make this problematic.

While the market is lagging behind that of Russia – and even further behind Europe – for early investors, it has the potential to pay off big time.

Opinion

bne November 2012

61

Azerbaijan – a new Gulf state Charlie Robertson of Renaissance Capital

T

he transformation of Baku (80% of Azeri GDP) in the past decade is stunning, and the city increasingly has the appearance of a 21st-century Gulf state city (à la Kuwait or Abu Dhabi), but with the attractive renovated Tsarist architecture of Europe’s first oil city. The scale of the investment makes a visitor wonder how Moscow might look if Russia chose to spend its oil wealth on investment, instead of US treasuries – but Azerbaijan has far more oil revenues than Russia on a per-capita basis, and can afford to both invest and save.

The Azeri economy expanded tenfold from $6bn in 2001 to $63bn in 2011, and it recorded the fourth-highest annual average growth rate in the world over 2000-2011, at 12.7%.

Only three demographically smaller (and also resource-rich) countries did better. The expected production of massive natural gas exports from 2016 should compensate for a decline in oil production that has already begun. In the meantime, the government is keen to develop the non-oil sector.

Debt ratios are, unsurprisingly, very low, with private sector debt at just 24% of GDP (2011), government debt at 10% of GDP (2011) and external debt at 13% of GDP (2010) – the three main rating agencies have 'BBB-' equivalent investment graderatings on the country, and we expect these to be upgraded. As with many of our favourite emerging markets, such good debt ratios make us bullish about asset prices. Having some of the best demographics in the CIS is encouraging too.

Having said that, there are, however, few assets to buy. There is no significant listed Azeri stock. Potential plans to IPO a government stake in International Bank of Azerbaijan (like Sberbank in Russia, but with higher non-performing loans), has been put on hold since June 2012. A number of companies do, however, issue external or local-currency debt instruments. The publicly owned energy giant, Socar, issued $500m of a debut five-year 5.45% coupon Eurobond in February 2012 that was eight-times oversubscribed, according to press reports. A smaller $200m Eurobond was issued by Azerbaijan State Railways in February 2011. We believe the state-owned electricity company, Azerenerji, may be next to issue a Eurobond. On the local market, Azerbaijani manat government three-year yields recently fell to around 3.5%, while corporate yields have fallen to around 8-9%, from 9-13%.

The sustained appreciation of the manat is what makes Azeri local debt interesting, aside from the obvious (a better yield than in the West). In contrast to Russia or Kazakhstan, the manat has appreciated steadily since 2003, with no volatility when oil prices plunged during the Western financial crisis

of 2008/2009. For a currency comparison, Azerbaijan is now more like a Gulf state than a CIS republic. With its current account surplus of 27% of GDP (2011) and sizeable rise in offshore assets held by the sovereign wealth fund ($33bn), and as we assume currency policy will not change before presidential elections in late-2013, stability or appreciation of the manat remains very likely, in our view. Therefore, we think manat corporate or bank bond yields should translate into dollar yields in the high single-digits.

Lacking information What are the problems for investors? A lack of research on the local names will be a constraint for investors – even macro data is harder to compile than in neighbouring Georgia – as will the effort required to find custodians and access to the market. The authorities do have reform plans to develop the financial markets, which we believe will help over time.

Politics appear stable, again making Azerbaijan resemble the Gulf states. Presidential elections are due around October 2013, but we think incumbent President Ilham Aliyev is very likely to run for a third term, and no one we spoke to suggest-

"Azerbaijan’s military budget is now larger than Armenia’s total budget, but conflict is impossible to imagine while Russia maintains its strong links with Armenia" ed any significant challenger was likely. We think it is possible that, over time, Aliyev could advance a more reformist agenda, which may face resistance from powerful ministers and their associated companies, but we do not think this is a serious issue over 2012-2013. We discussed Nagorno-Karabakh and heard that Azerbaijan’s military budget is now larger than Armenia’s total budget, but heard just as often that conflict is impossible to imagine while Russia maintains its strong links with Armenia. On every other issue, Azerbaijan has good relations with Russia, and indeed with Turkey and Georgia.

To conclude, Azerbaijan has decades of energy wealth to look forward to, and it represents a diversification play for international investors in local fixed income, in our view. However, equity investors will need to be patient.

62

I Special report

bne November 2012

Banking in the time of cholera

bne

I

t's a bad time to be a banker. The green shoots of recovery in 2011 didn't just wither, they were stomped on by the resurgence in the European debt crisis. Governments around the world began to panic as another financial meltdown looked increasingly likely, although the worst appears to have been averted for now. The "bne Eurasian Bank Survey 2012" shows banking asset growth in Eurasia has been lacklustre compared to the boom years – in some countries the whole sector has simply stood still, while several of the stars of the boom years have seen their assets shrink mildly.

Special Report: Eurasian bank survey 2012

Special report I 63

bne November 2012

Still, despite the obvious drag on growth from the ongoing uncertainty, the economies of the Eurasian region are all growing, which has benefited the market leaders in most of the region.

The names at the top of the list of bne's annual survey remain little changed from last year. The Russian banks still dominate, taking nine out of 10 of the top slots, and the first eight banks remained the same as last year. Collectively, these eight banks saw their assets increase by $186.5bn from $635.8bn in 2011 to $822.3bn, or a 29.3% increase – higher than the Russian sector's average growth of about 20%.

Steady as she goes Our survey also shows that the rise in asset growth of the top 100 banks in the region has been fairly uniform if you count Sberbank out. The assets of the top 99 banks (excluding Sberbank) increased by $140.2bn, compared with Sberbank’s increase of $115.1bn alone. This means that the increase in assets for banks all through the top 99 have on average been growing at 16-17%, which is a lacklustre performance when measured against Sberbank’s 39.6% increase.

Much of Sberbank’s growth is down to the merger with leading investment bank Troika Dialog at the start of this year. But at the same time, it is also starting to grow again relative to the

"The Russian banks still dominate, taking nine out of 10 of the top slots"

Top 200 Eurasian banks N

Bank

Country

Assets in $

Reporting date

1 2 3 4

Sberbank VTB Gazprombank Russian Agricultural Bank

Russia Russia Russia Russia

405902588210,73 132612529899,99 84996668396,44 50223263497,60

01.09.2012 01.09.2012 01.09.2012 01.09.2012

5

Bank of Moscow

Russia

44737478851,23

01.09.2012

6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

VTB 24 Alfa Bank UniCredit Bank Rosbank Privatbank Promsviazbank Raiffeisen Bank Nomos Bank Kazkommertsbank Transcreditbank HalykBank Belarusbank Uralsib MDM Bank Oschadbank AK BARS Bank St-Petersburg Ukreximbank BTA Bank CITI Bank Bank Rossia Moscow-Minsk Bank Nordea Bank Bank Russian Standard Svyaz Bank Bank of Khanty-Mansiysk Bank of Petrocommerce Home Credit Bank Bank Zenit Bank CenterCredit Belagroprombank ATF Bank IBAR Vozrozhdenie Globex Bank ING Bank Eurasia Orient Express Bank Raiffeisen Bank Aval Trust Bank Openbank Moscow Industrial Bank Prominvestbank Unicredit Bank TM BinBank MTS-Bank OTP Bank Sberbank National Bank for foreign economic activity VTB Bank National Clearing Centre UBRR SKB Bank DeltaBank Transcapital Bank PUMB SMP Bank Alliance Bank Tsesnabank Ukrsibbank Absolut Bank

Russia Russia Russia Russia Ukraine Russia Russia Russia Kazakhstan Russia Kazakhstan Belarus Russia Russia Ukraine Russia Russia Ukraine Kazakhstan Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Kazakhstan Belarus Kazakhstan Azerbaijan Russia Russia Russia Russia Ukraine Russia Russia Russia Ukraine Ukraine Russia Russia Russia Kazakhstan Uzbekistan Ukraine Russia Russia Russia Ukraine Russia Ukraine Russia Kazakhstan Kazakhstan Ukraine Russia

42485007783,98 34218270698,16 27149283474,94 20732584311,06 20610909545,85 19743788939,08 18717655042,39 16731558729,88 16158340155,11 15755107179,38 14857363381,69 13683392668,27 13616186987,40 11440358155,06 10539221819,09 10513957423,03 10471583110,46 9842862504,69 9699787444,01 9507413969,40 9393218267,63 8689313382,61 8331096911,28 8088396500,74 7797272690,98 7596854474,94 7532740297,66 7333273968,35 6967595933,29 6943578190,81 6630286548,10 6630286548,10 6549273167,01 6510291123,81 6326669102,68 6184346683,29 6107397388,15 5939822344,55 5880234225,55 5557544623,53 5304312046,89 5228199674,72 5025897660,45 4899698773,91 4633293313,15 4597275147,47 4578680056,16 4536507592,77 4370949580,88 4273019538,24 4133245718,81 4114023748,04 3962967596,65 3788386367,75 3756161641,44 3746196291,33 3665220197,90 3608139867,62 3584136119,10 3496924791,74

01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 >

Russia

Ukraine

Belarus

Azerbaijan

Kazakhstan

Georgia

Uzbekistan

Moldova

64

I Special report

rest of the Russian banking sector and saw its share in retail deposits climb back above 50% for the first time since losing market share steadily to the leading commercial banks during the boom years. In general since German Gref took over as CEO, Sberbank is emerging as not only the leading bank in all of the former Soviet Union, but is fast becoming a leading European bank that will challenge the more established names in Western Europe soon.

The importance of government ownership in Russia’s banking sector is highlighted, as all the top six banks in the list – Sberbank, VTB, Gazprombank, Russian Agricultural Bank, Bank of Moscow and VTB 24 – are at least partly state owned.

The highest ranked private bank is Alfa Bank, owned by oligarch Mikhail Fridman, who is also one of the partners in the Russian consortium that just cashed out of oil company TNK-BP in a deal with Rosneft. Alfa Bank is at the core of the diverse holdings controlled by his Alfa Group and saw its assets increase by over a quarter from $27.2bn as of September 2011 to $34.2bn a year later, which was enough to move it up one place from eighth to seventh place on the list. Alfa Bank’s increase in assets was enough to swap places with UniCredit Group, the leading foreign-owned bank in the region, which fell from seventh to eight place as its assets contracted mildly by $535m to a total of $27.1bn as of September.

Ukraine’s Privatbank overtook Belarusbank to become the largest non-Russian bank in the region, rising to 10th place with a impressive increase in assets from $17.6bn to $20.6bn, especially given that the entire Ukrainian banking sector has

Ukraine’s Privatbank overtook Belarusbank to become the largest non-Russian bank in the region been moribund and yet to recover from the blow it took in 2008. Belarusbank’s fall in assets from $14.1bn in 2011 to $13.7bn this year is more understandable, as the country has been through two devaluations in a year and the economy remains in intensive care.

Kazakh banks have also been experiencing a hard time recovering from one of the worst banking crises in the former Soviet region, despite the economy making something of a comeback.

The former leader, Kazkommertsbank, fell from ninth place in the table last year to 14th place this year as its assets fell from $17.5bn to $16.1bn from a year ago. It has now been overtaken by the ultra-conservative Halyk Bank as Kazakhstan’s top bank by assets, despite the fact the latter's assets have barely grown from the $14.8bn it had last year.

bne November 2012

N

Bank

66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133

Credit Europe Bank Rusfinance Bank Alfa Bank BPS-Bank Novikombank InvestradeBank Deutsche Bank Vneshprombank RosEvroBank Kaspi Bank ROSGOSSTRAKH BANK BNP Pariba Bank NadraBank Probusiness Bank MCP Bank Tatfondbank Bank of Georgia Avangard Bank Eurasian Bank Finance and Credit Bank ROSSIYSKY CAPITAL Uniastrum Bank Sberbank INTEZA Bank Bank Soyuz KIT Finance Bank OTP Bank Baltiyskiy Bank Evrofinance Mosnarbank Bank Renaissance Capital DeltaCredit Bank Sovkombank NKO MICEX GROUP ATB Bank Master Bank Zapsibkombank Brokbusinessbank Russian Regional Development Bank Peresvet bank Centrocredit Citibank Kazakhstan Sobinbank HSBC bank (RR) Uzpromstroybank TBC Bank Belinvestbank Loko bank Center-Invest Bank Svyaznoy bank FundServiceBank Nurbank Asaka BaltInvestBank Bank Credit Suisse (Moscow) Temirbank Zhilstroybank Kazakhstan InvestBank TKS Bank Surgutneftegasbank NotaBank Royal Bank of Scotland Metallinvestbank Pervoban Kreditprombank Kapital Bank Priorbank Bank BFA International Bank of Saint Petersburg

Country

Assets in $

Reporting date

Russia Russia Ukraine Belarus Russia Russia Russia Russia Russia Kazakhstan Russia Russia Ukraine Russia Russia Russia Georgia Russia Kazakhstan Ukraine Russia Russia Ukraine Russia Russia Russia Ukraine Russia Russia Russia Russia Russia Russia Russia Russia Russia Ukraine Russia Russia Russia Kazakhstan Russia Russia Uzbekistan Georgia Belarus Russia Russia Russia Russia Kazakhstan Uzbekistan Russia Russia Kazakhstan Kazakhstan Russia Russia Russia Russia Russia Russia Russia Ukraine Azerbaijan Belarus Russia Russia

3469535018,68 3442728660,08 3316401851,62 3308816466,35 3300160592,50 3289935486,64 3274428944,73 3234695350,19 3229628856,29 3204424229,46 3101308383,67 3080244051,48 3070686850,99 3018248589,83 3003755346,69 3003417580,43 2999826000,00 2932425253,86 2913352370,13 2841110972,10 2774964764,84 2752580073,63 2719254347,55 2681864101,28 2666787443,69 2663716841,33 2643312898,79 2631321986,43 2630769278,01 2551946915,43 2515836631,67 2475151150,40 2452459398,96 2431302948,70 2417485238,08 2352296349,97 2340172651,07 2306268020,60 2296012208,71 2288090054,63 2226345523,83 2221550101,48 2195112215,16 2111299241,78 2095949696,00 2014855288,46 2010722543,44 2003537333,92 2002124856,83 1980446404,17 1978700615,10 1977273487,80 1892013056,20 1831368659,59 1767884268,24 1753016828,24 1737684581,58 1723559810,73 1704368545,98 1657019857,59 1636201173,58 1630520559,22 1624747826,78 1619667208,81 1615771384,93 1563506971,15 1555290801,40 1555137271,28

01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.07.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.07.2012 01.09.2012 01.09.2012 >

Between them, Russia, Ukraine Belarus and Kazakhstan account for the lion’s share of assets in the Eurasian region, but there are a few outstanding banks from the other countries of the region.

Russia

Ukraine

Belarus

Azerbaijan

Kazakhstan

Georgia

Uzbekistan

Moldova

Special report

bne November 2012

Only 11 banks outside the dominant quartet make it into the list of the top-200 Eurasian banks. The largest is Azerbaijan’s state-owned International Bank of Azerbaijan (IBAR) in 38th spot with assets of $6.5bn. IBAR is followed by the stateowned National Bank of Uzbekistan with assets of $4.5bn in 53rd place. The celebrity bank of the Caucasus, Bank of Georgia, is in 82rd place with assets of $3.0bn and dominates that country's sector. And Moldova makes its debut into the list of top-200 banks in the region: Moldova-Agroindbank is ranked 194th in the list with assets of $835m.

Finally, there are several banks that lie outside the top 200, but are turning up the heat on their bigger competitors. TBC Bank in Georgia has been running an aggressive expansion plan and hopes to give Bank of Georgia a run for its money.

In Tajikistan, the banks Agroinvestbank, Tadjiksodirotbank and OrienBank are all pioneering the country's creation of a modern banking sector and growing fast. Moldova has made a lot of progress as its economy stabilizes, and Victoriabank and Moldinconbank are coming up fast behind Moldova-Agroindbank. Despite its autocratic regime, money is flowing into the Uzbek economy and Uzpromstroybank and Asaka bank are benefiting. And in Armenia, ACBA-Credit Agricole Bank and Ameriabank are amongst the ones to watch.

bne Eurasia Banking Survey 2012 awards * Sberbank Best Bank in Eurasia Promsvyazbank Most Innovative Bank Best Up-and-Coming Bank Moldova-Agroindbank Best Local Bank By Country Kazakhstan Belarus Azerbaijan Georgia Armenia Ukraine Tadjikistan Uzbekistan

Halyk Bank Belagroprombank Pasha BANK Bank of Georgia HSBC Bank Armenia Raiffeisen Bank Aval Agroinvestbank Kapitalbank

* bne awards are determined by an editorial committee in consultation with analysts, consultants and rating agencies in the region. bne would like to thank the following for contributing to the compilation of our rankings and awards: Russia - www.bankir.ru Ukraine - www.Minfin.com.ua Kazakhstan - www.afn.kz Belarus - www.nbrb.by Uzbekistan -www.ahbor.uz, "Ahbor" rating agency Moldova - www.infotag.md, www.bnn.md Armenia - www.arminfo.com Azerbaijan -www.apa.az, APA-Economics

N

Bank

134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200

SB Bank Belvnesheconombank Credi Agricol KIB International Finance Club Metkombank National Standard bank HSCB Bank Kazakhstan ING Bank Ukraine Moscomprivatbank WestLB Vostok (Portigon Financial services) National Reserve Bank Agrobank Tavricheskiy Bank Finansovaya Initiativa Pivdennyi Bank Express Volga Bank Intercommerz Bank Belgazprombank Toyota Bank Rodovid Bank Credit Dnepr Bank Mosoblbank Kuban Credit Bank Imexbank NarodnyBank Chelindbank Chelyabinskinvestbank Commerzbank Eurasia Xalq Bank GE Money Bank DVB Bank Dalnevostochy Metcombank Mezhtopenergobank JP Morgan Bank International Narodny Credit Bank Credit- Agrocole Bank Universal Bank Coltso Urala Russian International Bank Sarovbusinessbank Bank Standard NS Bank Fora Bank Kedr Bank SDM-Bank Krayinvestbank Ipoteka Bank Primsotzbank Severgazbank Gazbank First Republic Bank Stroycredit Bank Smolenskiy Bank Primorie Pushkino Natiksis Bank Lipetskcombank Mybank Dalcombank Levoberejny Bank Moldova-Agroindbank Avtovazbank MBA-Moscow Interprom Bank Morgan Stanly M2M Private Ban Bank of Tokio Mitsubishy UFG Eurasia

Country

Assets in $

Reporting date

Russia Belarus Russia Russia Russia Russia Kazakhstan Ukraine Russia Russia Russia Uzbekistan Russia Ukraine Ukraine Russia Russia Belarus Russia Ukraine Ukraine Russia Russia Ukraine Uzbekistan Russia Russia Russia Azerbaijan Russia Russia Russia Russia Russia Russia Ukraine Ukraine Russia Russia Russia Azerbaijan Russia Russia Russia Russia Russia Uzbekistan Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Russia Moldova Russia Russia Russia Russia Russia Russia

1546785232,86 1519910697,12 1455158458,43 1430869993,77 1424790201,09 1377226570,54 1375405529,18 1367071187,29 1361750734,64 1349959621,58 1336049792,89 1299391678,67 1264627581,99 1236957337,67 1232578506,19 1199131633,65 1198271864,99 1173238822,12 1157801325,89 1117602902,54 1117352683,60 1110360519,42 1109316514,62 1079194295,01 1056882942,22 1043421387,97 1042162441,01 1034516641,13 1018952393,08 1015571024,57 1014803373,98 1004086971,74 1002428846,47 1001231311,55 989378786,44 983985987,74 967221318,65 967209037,40 964599025,39 962480309,76 961547861,51 959839591,73 957137461,66 956646165,28 944670816,07 934875594,55 933426751,52 932173464,47 928734389,83 916789746,64 911784664,80 911047720,23 904353807,09 893115402,45 888877971,19 885561720,64 882030527,93 859123834,32 856943706,65 839379861,15 835214557,73 834866075,68 834344073,28 821386131,32 817240818,13 811406673,65 802440514,76

01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.07.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012 01.09.2012

Russia

Ukraine

Belarus

Azerbaijan

Kazakhstan

Georgia

Uzbekistan

Moldova

Source: bne, central banks in the regions

I 65

66

I Special report

bne November 2012

Industrial production is slowing and companies aren't investing in new production, preferring instead to sell off inventory and conserve cash in case of a second wave of the crisis coming out of Europe. This is one of the main reasons the labour market is so tight at the moment.

Euro crisis squeezes Russian banks Ben Aris in Moscow

R

ussia's banks are coming under increasing pressure from the global slowdown, which is destabilising the sector and has already made it more prone to shocks from the outside. Many of Russia's biggest banks will need recapitalisating soon and many of the smaller ones are probably sailing dangerously close to the wind.

At ground level, not only is the Russian economy recovering, but it has been enjoying a full-on consumer-driven boom. Wages have continued to rise throughout the last four years – even in the depths of the 2008 meltdown – and unemployment is at an all-time low, which, as President Vladimir Putin pointed out in the summer, means the economy is running at full capacity.

Spending is being driven by the recovery in consumer lending, which grew at a whopping 43%, according to the latest figures from the Central Bank of Russia (CBR) released at the start of October – well into "overheating" territory.

However, at the corporate level, things are very different. Overall, Russia's

economy grew at the relatively robust 4.4% over the first half of this year, which is its maximum potential if you remove the foreign lending. But most of those gains are from consumer lending; corporate borrowing grew by a much

The situation has been made worse by a Kremlin panic attack this summer: as the situation in Europe deteriorated, the government started actively preparing for a new crisis. It cut spending radically – federal budget spending growth was cut from 9% to 5%, or below the rate of inflation – which given the role of the state in the economy had the effect of pouring a bucket of cold water over it: GDP growth in August fell to 2.8%, which has recently been revised down further to 1.9%. Anything less than 4% is considered to be stagnation in Russia.

Lower budget spending in the second half of this year will shave off 1 percentage point from growth, Economic Development Minister Andrei Belousov said at the start of October. "Before the [2008] crisis, budget spending accounted for 12% of the gross domestic product, but now it almost reaches 22%. We have set a goal of reducing it to 19% by 2015," Belousov said, adding that GDP must grow at least 4.0-4.5% for the country to fulfill

"Funding growth remains an issue for most banks" more modest 16.9% in September, down from 22% a month earlier. "Divergence between retail and corporate lending has increased further. The loan growth trend became even more divergent in September than before. Retail loan growth stood at a strong 42% year on year in September, virtually unchanged from the 43% year on year in previous months. Meanwhile, corporate loan growth decelerated substantially from 22% year on year to 17% year on year in September, in line with slowing economic growth," Natalia Orlova, chief economist with Alfa Bank, said in a note in October.

its spending obligations and with 1.9% growth in August (in annualized terms), it is already running below this level.

This lopsided growth has hit bank capital adequacy as consumer lending outpaces deposit growth, which was up only 19% in September on year; cut off from international wholesale funding, local banks are struggling to fund their retail loan portfolios.

Borrowing on the domestic bond market is on fire, peaking in the first quarter of this year, with a record RUB179bn

Special report

bne November 2012

($5.8bn) raised in March, following on from the RUB123bn in February. The boom continued in August and September with RUB89.5bn and RUB98.9bn raised respectively. However, only a handful of Russian companies can borrow internationally, and as a result most banks are eating into their capital to fund all this lending. "Funding growth remains an issue for most banks. Both retail and corporate deposit growth slowed in September to 20% and 17%, respectively. The deceleration in retail deposit growth seems to reflect an increase in the inflation rate on retail markets. On the corporate side, the slower growth rate owes to tighter control over budget spending in second half of this year versus the second half of last year," says Alfa's Orlova.

Central bank to the rescue The CBR has been forced to take action and ramped up lending to banks as liquidity in the sector evaporated. As autumn set in, the CBR became the main source of funds in the banking sector – currently not a problem, as the state has built up considerable reserves and had equally considerable borrowing power held in reserve. "While the CBR managed to cut its exposure to banks by RUB50bn [in September], the Finance Ministry has boosted its deposits with banks by RUB100bn. As a result, total support to the banking system increased modestly to RUB3.5 trillion but remained at 7.5% of total assets," says Orlova.

State-owned VTB was the first notable bank to get into trouble after its crucial capital adequacy ratio fell to 9.8%, just below the mandatory minimum of 10%.

And the pressure banks are feeling is widespread. In the boom years, Russian banks enjoyed asset growth of 40-50% and capital adequacy ratios of over 18%; now asset growth has fallen to about 20-25% and the sector's average capital adequacy has fallen to around 13.3%, the CBR said in October. According to bne sources, this means that some banks are already operating with dangerously low, or even sub-mandatory, capital levels.

State-owned retail giant Sberbank may be the next major bank to raise subor-

I 67

dinated or perpetual debt or equity to shore up its capital base, say analysts.

Alfa reckons that Sberbank's capital adequacy fell to 12.1% in September from 12.9% in August and 15.5% at the start of this year. The bank may have to issue new shares by the middle of next year if not sooner, having only just successfully sold a 7.6% stake to raise $5.2bn in September after much dithering.

The CBR is well aware of the problem and Deputy Governor Alexei Ulyukaev said at a conference in September that

"The situation has been made worse by a Kremlin panic attack this summer" the gross debt of Russia's banking sector to the central bank is likely to double over the next three of years to RUB6 trillion-7 trillion ($192bn-224bn) to support the sector during the current difficulties.

At the same time, the CBR has taken a number of regulatory steps to shore up the health of the system and to better prepare it for any external shock, like a break-up of the Eurozone.

In September, the CBR announced it would hike reserve requirements for unsecured loans, because the speed of the consumer lending this year has raised worried the quality of new loans is deteriorating. The CBR is also accelerating its move to Basel III norms for calculating capital and wants to introduce these within the next two years, to inevitable howls of protest from the leading banks.

And the icing on the cake, probably the most effective measure the CBR can take to bolster confidence in the banking sector, was to announce an increase in the retail deposit insurance limit to RUB1m ($32,258) from the current RUB700,000. The increase in the amount covered by the insurance is one of the most effective tools the state has to improve the resilience to a shock to the system.

68

I Special report

bne November 2012

Special report

bne November 2012

I 69

EDB – monitoring mutual investments

CORPORATE STATEMENT:

EDB on course to fulfil its goals

bne

T

he Eurasian Development Bank (EDB) is on track to meet its investment goals after raising a key Eurobond in September at record low interest rates.

The bank also issued its debut rubledenominated Eurobond two weeks later on September 28, raising RUB5bn of 5-year bonds with a yield of 8%.

In doing so, it closed out its financing needs for this year, adding to the RUB20bn the bank has issued this year on the domestic market.

The highly successful international 10-year Eurobond worth $500m, which was so popular that the orderbook was 12-times oversubscribed, was issued at a yield of only 4.767%.

“We were very pleased with our bond issues, as they underline the confidence investors take in the strength of the bank and the long-term value that EDB investments add to our member countries,” says Igor Finogenov, Chairman of the Management Board of EDB. “The yields we received are lower than most of the biggest Russian state-owned blue-chip banks, but the most important thing for us is the tenors of the bonds that match the long-term perspective of our projects.”

The EDB is a regional development bank with a specific focus on integration projects, including promotion of mutual trade and mutual investments between the member countries. The Bank was established by Russia and Kazakhstan in 2006, since when Armenia, Belarus, Tajikistan and Kyrgyz Republic have joined. The Bank’s investment portfolio includes the integration projects that

Igor Finogenov, Chairman of the Management Board of EDB

enjoy the benefits of the Customs Union of Belarus, Kazakhstan and Russia, which came into effect in 2011.

The bank is also the administrator of the Anti-Crisis Fund of the Eurasian Economic Community (EurAsEC), which was set up to help member governments that were struggling with the international financial crisis.

The recent bond issues help to build out the bank’s yield curve and play an integral part in meeting the bank’s goal to provide affordable long-term financing for projects that would otherwise struggle to find funding over such long periods.

The bank may come back to the capital markets next year, while it’s 2012 funding programme has been fulfilled. "We've met the targets, and will be tapping the market no earlier than 2013. We don't want to borrow funds that we won't be able to employ on the spot. However, we have

will also be able to connect to the power system of Northern Kazakhstan.

"The EBD member states have their attention focused on building interregional and cross-border power bridges," notes Finogenov. "I have no doubt that our cooperation with En+ Group, one of Russia's power industry and infrastructure leaders, will help implement this kind of long-term investment project that will deepen economic integration in the region.”

The power bridge is one of the EDB’s mega-projects, but the EDB also invests into smaller companies that will benefit from the creation of the Common Economic Space (CES), which could generate up to $1 trillion of added value for the participating states, says Finogenov.

"The total cumulative effect from the creation of the CES and Ukraine's

"The highly successful 10-year Eurobond worth $500m was so popular the orderbook was 12-times oversubscribed" several large projects that will take a long time to develop and we are constantly renewing our portfolio," says Finogenov.

A typical project is the deal signed with the EN+ Group and the EDB during the St Petersburg Forum this summer to develop the power industry in Russia and Kazakhstan.The EDB has agreed to finance the group’s plans, which include an extra-high-voltage power bridge between Siberia and Central Russia that

possible subsequent participation can reach $1 trillion for the four countries before 2030,” says Finogenov. “Working together will benefit each country and produce an additional growth in Belarusian GDP of 14%, Ukrainian 6%, Kazakh 3.5%, and Russian the least with 2%.

Belarus, Ukraine and Kazakhstan are expected to benefit from this integration the most in terms of rising per capita, while Russia will benefit the most in absolute terms. Everyone wins.”

T

he Eurasian Development Bank (EDB) is an international financial organization established by Russia and Kazakhstan in January 2006 to promote mutually beneficial investment that will bring the economies of member states closer together. So after half a dozen years of work, how is it going?

Since the EDB was founded, several other countries have joined: the Republic of Armenia, the Republic of Belarus, The Republic of Tajikistan and the Republic of Kyrgyzstan all became full-fledged members of the Bank between 2009 and 2011.

Most outsiders are surprised to find that Russia has been a net exporter of capital for most of the last two decades – most of it going to its neighbours. With similar markets, similar problems and similar cultures, intra-Commonwealth of Independent States (CIS) investments make a lot of sense to local businessmen, who are only now beginning to branch out to Western Europe, Africa and further afield. However, the bulk of their investment is going to countries next door.

“We are working to promote partnership amongst our members and doing this by investing long-term money into key projects from a variety of sectors,” says Dmitry Zhurba, Deputy Chairman of the Management Board of the EDB, who is responsible for coordinating the Bank’s investment activities. “The most important projects are infrastructure development for the real economy – things like energy, transport, municipal infrastructure and so on,” says Zhurba.

Zhurba highlights the example of the renovation of the Pulkovo airport in Russia’s northern capital of St Petersburg and the construction of the Western Speed Diameteraround the city.

“This is being done on a private-public partnership-like basis and involves a huge consortium of banks. When it is finished, it should make a huge difference to transport in the northwest of Russia.”

The importance of foreign direct investment (FDI) to the region is widely recognized, but the assumption is that the capital will come from the developed markets of the West; however, in practice investment from the other countries of the CIS has also played a significant role. In September, the EDB released the first comprehensive database of mutual investment, which differs significantly from the FDI numbers recorded in official statistics. One of the things that immediately jumps out the research is that Ukraine is a highly

attractive market for Russian FDI due the combination of its proximity, large population and close cultural ties.

The major investment ties without Russian participation are all predicated on purely economic factors: neighbours tend to invest in each other (for example, the overwhelming FDI from Azerbaijan flows into Georgia) and the leading local companies tend to push aggressively into markets where neither Russian or western companies are established.

The statistics also show that while there was little mutual FDI in the 1990s, there has been a veritable boom of cross-border investment in the CIS during the following decade.

“Despite the global downturn since 2008, investor companies from the CIS have continued to be active and the number of projects – while not back at its pre-crisis peak – is recovering,” says Zhurba.

Russia still plays a leading role in these mutual investments: of the 25 largest deals, only three didn't involve a Russian transnational corporation; between them Gazprom, MTS, VimpelCom, Lukoil and steel company Evraz have invested a total $15.75bn in the other countries of the CIS. Geographic structure of accumulated Russian investments by country (% total) Ukraine Kazakhstan Belarus Uzbekistan Armenia Azerbaijan Tajikistan Kyrgyzstan Moldova Georgia Turkmenistan

38 25.3 15.6 6.8 5.9 2.7 2 1.3 1.1 1.1 0

Source: IMEMO & EDB Centre for Integration studies (CIS MIM)

Investment projects by country of origin, size and value Russia Kazakhstan Azerbaijan Ukraine Georgia Belarus Other TOTAL

Number of Projects 391 42 9 23 8 41 14 526

Projects ›$100m 76 13 2 5 1 0 0 96

Projects ‹$3m

Source: IMEMO & EDB Centre for Integration studies (CIS MIM)

127 3 0 6 2 36 11 185

total volume FDI ($bn) 47.94 4.89 1.38 1.15 0.41 0.18 0.05 55.97

70

I Events

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

bne November 2012

Upcoming events 2012

What you need to know The 12th Annual SuperInvestor 2012 (6 - 9 November) ICBI, +44 (0) 20 7017 7200 The Westin Paris - Vendome, Paris, France info@icbi.co.uk www.informaglobalevents.com

IV Annual Economic Forum of big Business (7 November) +7 (727) 3441 1212 Astana, Kazakhstan expert100@raexpert.kz www.raexpert.kz Sustainable development of the national business, key factor in modernization of Kazakhstan.

German Equity Forum 2012 ''Entrepreneurs meet investors'' (12 - 14 November) komments GmbH +49 (0)69 2 11-1 88 88 Frankfurt/Main, Germany eigenkapitalforum@deutsche-boerse.com www.eigenkapitalforum.com

Ukrainian Banking Forum 2012 (13 - 15 November) Adam Smith Conferences, +44 20 7017 7444 InterContinental Hotel, Kiev, Ukraine events@adamsmithconferences.com www.adamsmithconferences.com

Russian & CIS Machine-Building & Engineering Forum (13 - 15 November) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

Atlantic Council Energy & Economic Summit (15 - 16 November) Antlantic Council Istanbul, Turkey www.antlanticcouncilsummit.org New Opportunities in a dynamic Region

Innovative Drug R&D in Russia Forum (21 – 23 November) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

Russian Banking Forum (26 - 29 November) Adam Smith Conferences, +44 20 7017 7444 London, United Kingdom events@adamsmithconferences.com www.adamsmithconferences.com

Russian & CIS Precious Metals Summit 2013 (12 - 14 February) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com/AS222XBNEb The only strategic conference for Russia's Industrial and precious metals executives bne’s veteran team of journalists have more than 100 years of collective experience of reporting on this dynamically growing region and can explain the “why” of “what” is going on.

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

Sign up today for a free month trial of all our services www.bne.eu

Partnership knows no boundaries From Almaty to Zagreb: we provide powerful solutions for your crossborder business via one of the largest networks of any German bank.

Professional solutions for cross-border business are an essential success factor for every company and every bank. With decades of experience, a profound knowledge of the markets and a comprehensive range of services, Commerzbank is your natural strategic partner.

Our services include everything from the efficient processing of your payment transactions or optimising your cash and treasury management, to documentary business or structured foreign trade financing. With Commerzbank, you will benefit from one of the largest global networks of any German bank, with 7,000 correspondent banks worldwide and 20 locations in Central and Eastern Europe, Turkey and Central Asia alone.

Subsidiaries and branches Bratislava Budapest: Commerzbank Zrt. Kiev: JSC Bank Forum Moscow: Commerzbank (Eurasija) SAO Prague Warsaw: BRE Bank SA

Representative offices +421 2 57103 110 +36 1 3748 176

Almaty

+7 7272 588 106

Minsk

Ashgabat

+993 12 456 037

Moscow

+7 495 7974 848 +7 383 2119 092

Baku

+994 12 4373 318

Novosibirsk

+7 495 7974 809

Belgrade

+381 11 3018 520

Riga

+420 221 193 223

Bucharest

+380 44 2002 451

+48 22 8291 570

+375 17 2101 119

+371 67 830 405

Tashkent

+998 71 1403 706

Istanbul

+90 212 2794 248

Tbilisi

+995 59 9569 966

Kiev

+380 44 3039 530

Zagreb

+385 1 4551 565

+40 21 3104 120

Achieving more together