Page 1

Inside this issue: Russian aviation falls to earth Keeping LOT aloft Europe's soft underbelly of crime Rio Tinto trips up in Mongolia March 2013

Special Report: Retail Therapy in CEE/CIS

to Podgorica

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

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 March 2013


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





6 The Insiders

25 Cheers in the east

8 Passport to Podgorica

27 Eurozone means all or nothing at all in Latvia

14 Another pension grab 29 The Baltic banking bust 16 Perspective 31 Keeping LOT aloft 17 Chart of the month 32 Budapest Airport flies by seat of its pants EASTERN EUROPE 33 Hungary rides the wave 18 Russian aviation falls to earth with a bump

34 Buying some Czech security

20 Who will take over at Russia's central bank? +44 7738783240

21 Russians hanker for Soviet system Please direct comments, letters, press releases and other editorial enquires to 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

22 Flaring off Gazprom's monopoly 24 Ukraine's "serious challenges"

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

bne March 2013

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

We do them.









Europe's soft underbelly of crime


Second coming of Azerbaijan's Shah Deniz


Reaching out to the Russian consumer


Turkish coal faces a revival


Central Asia looks to oil shale


Keeping up with the Ivanovs


Taking stock in Turkey


Russia's growing food chain


Rio Tinto trips up in Mongolia


No rest for Amrest


Tavan Tolgoi risks burnout


Shifting fortunes in ex-Yugo retail


Georgia experiences perils of cohabitation


KFC soaks up Mongolia's middle-class gravy


Armenian PM wades into Carrefour row




Albania's oily opportunists


EU says Albania candidate status in reach


Serbia govt's anti-graft drive set to run


A commando performance in Serbia



Sargsyan a shoo-in


Kyrgyzstan's fight over gold

Falling ratings OPINION 56

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.


Zeman's supersonic view of Prague


I The Insiders

bne March 2013

Which way for Ukraine at Europe-Asia crossroads?


Russia is the big Slavic brother and has got used to bullying in its dealings with the more junior members of the family, becoming rigid and brutal in its negotiations, imposing conditions that are tougher than those of the IMF, which the Ukrainian government is currently considering. A new loan deal from the IMF is as indispensable as air for Ukraine today. External obligation payments by the state in 2013 will be about $9bn, and it's unlikely the government will be able to refinance its IMF debt (about $6bn this year alone) at low rates of around about 3% without a new IMF deal in place. And the country faces this debt at time when international hard currency reserves have been considerably depleted, the current account is negative and the population has lost faith in the national currency. But meeting the IMF's conditions – a sharp, almost double, increase of natural gas tariffs for the population, and transition to a floating exchange rate under conditions of almost 50% dollarization of the official segment of economy and almost 100% dollarization of its shadow component – is not a simple task and could lead to a further deepening of the crisis. Gas scams But the main problem that Ukraine faces is not the IMF's demands: at the end of the day, if Ukraine has a well-defined path it can defend in the negotiations, a deal can be struck. The larger issue is in the quality of state management, which missed the chance to create regenerative growth in 20092011 and the gradual transition to a floating exchange rate, as well as a smooth increase of tariffs with a transparent mechanism of subsidies to the poor. Instead, once again the necessary measures are only going to be implemented in a crisis and very few people in today's

If Ukraine chooses the Eurasian vector, it will not define the long-term economic strategy of the country: after the next gas row or trade war where the elite always loses both money and face, inevitably Ukraine will return to closer mutual cooperation with the EU. The government understands this. Consequently, it is searching for a compromise with the IMF and it has a few resources it can fall back on. Closing loopholes First is the search for additional sources of income for the budget. The government (despite fierce internal conflicts between representatives of various power factions) shows a willingness to strengthen its controls over the oligarchical capital, which for many years was "a sacred cow" for the authorities as their key sponsor.

Alexander Savchenko of the International Business Institute ven if the government of Ukraine cannot agree on a new deal with the International Monetary Fund (IMF), it will not save itself by throwing itself into Russia's embrace. More likely, it suffocate perish in Russia's arms from the lack of oxygen and hard economic realities.

bne March 2013

government are ready to take responsibility for them. Prime Minister Nikolay Azarov has diligently avoided engaging the IMF throughout the last two years. His official excuse was "full price tariffs are too expensive for Ukrainians." But this is only an excuse. The four-fold difference in retail and commercial gas tariffs has become a source of earnings for pro-government groups, which supervise gas distribution networks and regional gas distribution companies. The absence of a transparent system of accounting for gas consumption by the population creates the possibility for highly profitable scams with the blue fuel. This is the main barrier to reform of an energy sector that is non-transparent and riddled with corruption, out of which a lot of today's nouveaux riches have sprung. With its cheap gas and unlimited credit resources, Russia looks like a very attractive economic partner that, as many representatives of the ruling elite assure, can replace the IMF. Russia's key requirement in any deal is for Ukraine to enter the Customs Union, which would cut the country off from a

"Russia is the big Slavic brother and has got used to bullying in its dealings with the more junior members of the family" free trade zone (FTZ) deal with the EU. An FTZ with the EU could provide a powerful impetus to bring Ukraine out of the current crisis, by creating safe and predictable conditions for business and investment. Unlike Europe, which continues to speak to Kyiv in the language of diplomacy in spite all the problems in Ukraine with selective justice and a poor investment climate, Russia prefers to operate from a position of strength. And it will only push harder if the two countries continue to diverge.

It is necessary to say that following the formation of the new government, President Victor Yanukovych has essentially expanded the influence of his closest circles (the Ukrainian media often calls his representatives "The Family") over economic policy. He appointed the ex-head of National Bank of Ukraine, Sergey Arbuzov, as the first deputy PM; Yury Kolobov as the finance minister; and Oleksandr Klymenko, minister of incomes and fees. This group has managed what none of his predecessors could – tightening control over the operations of the largest Ukrainian financial and industrial groups. International experts estimate these groups have whisked some $100bn offshore in the last ten years. In a crisis, the profits of business fall and so the state budget becomes not only the main source of money (taking into account expenses of the pension fund, the level of state expenses in Ukraine comprises about 45% of official GDP), but also the sole resource for the country. Having concentrated almost 100% control over the key budgetary processes, the president and his closest circles decide who and how many get access to these resources. But how this redistribution of wealth functions remains a secret hidden behind seven seals. International standards of transparency and accountability remain a dream for Ukrainian society. But at the very end of last year a new law for tax "optimization" for both large and small businesses so capital transfers abroad using securities is now regulated. And another law halting the practice of transfer pricing is on the agenda. The purpose of this law is to limit the use of offshore intermediaries to prevent the real profit of the Ukrainian enterprises from leaving the country or escaping taxation. The job of developing and implementing both laws has been given to the youngest minister in the government – the 31-year-old head of the new created Ministry of Incomes and Fees, Oleksandr Klymenko. Among his ministry initiatives is the introduction of the general declaration of incomes and control over final expenses of, first of all, politicians, officials

and big businessmen. The ministry will also conduct full-scale audits of tax privileges that businessmen who are close to the authorities have gotten used to abusing. If these measures can be successfully implemented, the first winner would be the Ukrainian state budget. However, they are bound to face fierce resistance not only at an adoption stage in parliament, but also in their implementation by the bureaucracy, whose interests and incomes are based on the non-transparency and inefficiency of the system.

"Ukraine needs to make a deal with the IMF simply because it is safer and more profitable to do so" Other IMF demands will be equally difficult to meet, but these difficult and unpopular reforms have been put off for decades and any losses from implementing them will be smaller than the loss of influence and business that would follow caving in to Russia's demands. Ukraine needs to make a deal with the IMF, and thereby move in a Western direction, simply because it is safer and more profitable to do so. Alexander Savchenko is a former deputy finance minister of Ukraine (2009) and currently president of the International Business Institute.


I Cover story

bne March 2013

tions needed for investors from outside the EU to gain permanent residence, which involves having to spend at least €300,000 on a property, prove they have no criminal record and are in good financial standing, and agree to deposit €30,000 for a minimum of three years in a local bank account. Their permit will normally arrive in about 45 days, according to The Guardian.

to Podgorica

The wave of property ads in Chinese points to where Cypriots see a big potential market. The Land Registry claims that 2013 is on course to register an alltime low for property sales after January's figures showed a 53% drop from the year before, but Cyprus had received 590 applications from Chinese developers to build houses at the end of 2012, in a clear sign that such firms predict big demand from Chinese people looking for a holiday home and the accompanying residency permit that goes with it. As for Russia itself, it is moving in the opposite direction, where if anything it is getting harder to obtain a residency permit, let alone a passport, if you were not born Russian – or mates with the president.

Nicholas Watson in Prague


he EU may be under attack from all sides, but one thing from the bloc that is still highly prized are its passports. And in a sign of these straightened times, selling citizenship has become a big potential source of revenue for cash-strapped European governments. Case in point is Cyprus. A member of both the EU and the single currency, Cyprus is "exhibit A" for all that's gone wrong with many countries in Europe. Its flailing economy is back in recession. For too long, it tried to borrow its way out of trouble, and now its debts are predicted to reach 140% of GDP by 2016, an unsustainable level. Its banks were too closely tied to the country's main

sponsor Greece, whose meltdown meant that about 75% of their investments went down the drain, and it lent rashly. Facing bankruptcy, the government has requested an international bailout to the tune of €17.5bn. A bailout has been agreed in principle, but the European authorities want major changes before they agree to stump up the cash, particularly with the banks. Greedy and complacent, Cypriot banks have long been a haven for shady money, especially from Russia, and Mario Draghi, the European Central Bank chief, said February 19 that any final deal must include "close monitoring" of anti-money laundering mechanisms on the island.

The scale of the problem can be see in data from Russia's central bank, which showed that in 2011 Cyprus was the number-one destination for Russian money going abroad, with independent estimates of Russian deposits there ranging from €8bn to €35bn. Taking a leaf out of the banks' book, the Cypriot government is looking to monetize its attractiveness to outside depositors by offering residency to those who invest in the island, which will in turn provide EU-wide visa free travel and access to precious things like European schools. Since August 2012, the Cypriot government has set out the terms and condi-

Cover Story I 9

bne March 2013

Since the job of handing out visas was transferred from the foreign ministry to the interior ministry, getting a visa has become more difficult than ever. While the duration of business visas was increased from one to three years, you can only stay in the country a total of 180 days a year even with the long-term visa. If you actually want to live in, say Moscow, then you need to get a hardto-come-by work permit and also check in and out with the police every time you leave the city – even if you just go to Sochi for the weekend. There is even talk of ending the unrestricted entry rights for anyone holding the passport of one of the 15 former Soviet vassal states: Azeris and Tajiks are to Russia what Poles are to Brits in terms of a cheap source of labour. However, all this red tape can be avoided if you have the right friends. In January, French actor Gerard Depardieu was granted Russian citizenship by a

fiat of Russian President Vladimir Putin. Questions marks over what qualified the notorious actor to become Russian (other than escaping France's high taxes), were quickly dispelled when he arrived in traditional Mordovian attire to pick up his new passport in a ceremony in the Mordovian town of Saransk in the Volga basin. "The Russian opposition has no

says the proposed regulation is attractive for non-EU investors, because it provides for permanent residency at a significantly lower cost than other European countries offer, and without requiring prior continuous physical residence in Hungary. "There is an increasing number of enquiries from foreign nationals in relation to investment-based permanent residence

"Taking a leaf out of the banks' book, the Cypriot government is looking to monetize its attractiveness to outside depositors"

programme, nothing," Depardieu railed in an interview broadcast on the state television channel Rossia 1 just after turning down an offer to become the republic's culture minister. He went on to lambast the jailed punk rock group Pussy Riot, claiming that if band members had performed in a mosque, "they would not have come out alive," and that their behaviour would have caused outrage even in the Catholic world. Similar arguments have been made by Putin in the past. "If I say such things in France, I'm labeled an idiot," he concluded. Race to the bottom While the EU sets visa policy for the bloc as a whole, it leaves the question of residency to national governments. This has left Europe's governments free to compete to attract new, rich non-EU residents.

permits, in particular from China, the Middle East and Russia," says Varga. In the spirit of competition for wealthy new residents, the Bulgaria parliament on February 13 amended parts of a new law offering citizenship to foreign investors, significantly lowering the investment sums for several different categories of applicants. Instead of the initially intended BGN1m (€520,000) that a prospective new citizen of Bulgaria needed to pour into the country's ailing economy, permanent residency will now be granted to anyone who invests BGN600,000 in Bulgarian property, BGN500,000 in a company that creates at least 10 jobs, or BGN250,000 in a firm that creates five jobs in an economically depressed region.

Hungary, another bailed-out EU member stuck in recession with a government desperate to find alternative sources of funds, has a new law that took effect at the end of December which enables buyers of at least €250,000 worth of government residency bonds to obtain a permanent residency permit. Interest rates on the bonds will be lower than market rates to account for the residency advantage.

Less Riga-marole Offering to sell citizenship, even with a hefty price tag, would be more difficult in Latvia than in most EU countries. After all, this EU member state still contains around 100,000 people classed as "non-citizens." As the descendants of migrants who moved here in during the Soviet era, they are left in a legal limbo despite many being born and raised in the country, and repeated calls from international organisations such as the UN to resolve their status.

Janos Tamas Varga, managing partner at the Budapest law firm VJT & Partners,

So passports are a prickly issue, but that hasn't stopped Latvia's entrepreneurial


I Cover story

bne March 2013

spirit and the country has found several alternative ways to make a fast buck out of getting foreigners to live here – in theory at least. The most popular method involves buying real estate worth LVL100,000 (€142,000) in Riga and its surrounding region (including the popular resort town of Jurmala), or a mere LVL50,000 elsewhere in the country. With the property comes the right to apply for a Latvian residence permit. That may not

"The law will only attract tycoons and corrupt politicians on the run" sound like a huge prize for an international oligarch on the move, but with Latvia a member of the EU's border-free Schengen Zone, the right to reside in the country comes with the right to move freely around the rest of Europe – and includes family members. Sun yourself on the beaches of southern Spain or dine with investment bankers in Paris – it's all on tap to holders of Latvian residence permits, which makes buying a modest country house or flat seem like quite a bargain. Indeed, bne has even been told by estate agents that foreigners are willing to pay over the odds for property in order to get the right to apply for residence – so a country house worth LVL40k might actually sell for LVL50k. And since April 2012 instead of an oldfashioned passport insert, residence permit holders have been issued with a separate "EU national ID card". That's not all – alternative methods of getting a permit also exist and include investing LVL100,000 in a Latvian business or investing LVL200,000 in a five-year term deposit or bonds at a Latvian bank. Speaking of which, despite a population of just 2m, Latvia boasts 29 banks, the majority of them operating on a boutique basis primarily servicing well-heeled foreigners who may or may not have resident status.

The slickest provider of such services has been Rietumu banka (Western bank), whose homepage contains an enticing video titled, "Welcome to Latvia! Welcome to Europe!", along with the promise to "provide full advisory services and other support." According to official data from the Office of Citizenship and Migration Affairs, since the legislation came into force on July 1, 2010, a total of 4,744 foreign nationals have used it to obtain residence permits, bringing with them an investment of LVL318m to the economy. With 5,171 applications made in total, the rejection rate is so low that dubious characters - like those with lots of illicit money to launder - will hardly be discouraged from applying. Wannabe in my gang It's not just EU states that are trying to tempt wealthy residents; European countries that are still trying to join the bloc are also opening their doors to foreign investors looking for the chance to enjoy EU-wide travel, with the promise of an upgrade to an EU passport once they have successfully acceded to the union. Driving down the Montenegrin coast, it is immediately apparent which international investors this tiny country is courting. The roads are lined with billboards advertising glitzy-looking properties – almost all in Russian and English. Montenegro is Europe’s latest hotspot for holiday real estate, from summer homes to luxury resorts. Many people who have visited this beautiful country have considered – or at least dreamed of – buying a place in the sun, particularly those from frigid northern climes. But how many would seek to become Montenegrin? In 2010, Montenegro caused a stir when the government announced that it would grant citizenship to foreigners who invested €500,000 or more in the country. The move came under the 2008 "Montenegrin Citizenship Act", which already provided for citizenship to be offered to foreign nationals in some cases, if there was a compelling

bne March 2013

economic, scientific, cultural or sporting case. Other criteria also applied – including employing a certain number of local staff – but the figure of half a million euros for a passport made the headlines. Months before, Montenegro had controversially provided a passport to Thaksin Shinawatra, a self-exiled former prime minister of Thailand who was deposed in a coup and faced criminal charges relating to corruption in his home country. Pictures of a beaming Thaksin with his new passport brought citizenship policies in Montenegro – which had become independent from Serbia less than five years before – to international attention. The government made a strong case for its "economic citizenship programme," saying that it would encourage businesspeople to set up shop in the country and that it demonstrated Montenegro’s open-doors position on investment. As a country of just over 600,000 people without much in the way of natural resources, Montenegro's leaders felt that it needed a policy to stand out. However, economic citizenship was not universally popular. An opposition MP said that the law would "only attract tycoons and corrupt politicians on the run." He was doubtless thinking of Thaksin; others mentioned Oleg Deripaska, the Russian metals magnate who has a taste for mooring his yacht on the Montenegrin coast. Despite the government’s protestations that it would vet all citizenship applicants, criticism grew internationally. The Christian Social Union, part of Germany’s ruling coalition, even suggested that Montenegro’s EU visa waiver could be reversed over the law. Given Germany's clout in the EU, criticism from this quarter is not positive to EU membership hopes (Montenegro began accession talks in June). Thus perhaps not coincidentally, a few months after it was announced, the economic citizenship programme was put on hold. But while the scheme itself has been gathering dust, Montenegro has still

Cover story

been granting passports on a case-bycase basis, according to a November report by academic Jelena Dzankic for the EUDO Citizenship Observatory. And Petar Ivanovic, Montenegro’s agriculture minister and the outgoing head of the Montenegrin Investment Promotion Agency, tells bne that the cabinet is discussing reinstating the scheme, albeit potentially with different conditions. "This was an excellent programme as far as the government was concerned," he says. Other than being able to live yearround in a beautiful and relatively affordable country – something that is possible with temporary residency and thus does not necessarily entail taking up a new nationality – what does a Montenegrin passport offer? That visafree entry to the EU, certainly; and a passport that does not attract unwanted attention in most parts of the world. The government also trumpets its low and flat income and corporate tax – just 9%, lower than anywhere in the EU. There is also a suggestion – denied by the government of course – that the Montenegrin authorities are not as vigorous as they might be in tackling nefarious business activities. This perception partly explains why the economic citizenship programme came under such scrutiny. Another EU-wannabe state that is risking the wrath of Brussels is Albania. Visa-free travel to the EU took effect for Albania in December 2010, allowing Albanian citizens to travel easily to Europe’s borderless Schengen zone, but Tirana is putting that at risk with a draft law from the government that will grant citizenship to anyone who invests at least $200,000 in the country. With Albania boasting Europe's last undeveloped coastline, that $200k should ensure any prospective investor a prime beachfront location. As for the other pros and cons, bne looks in more depth at them in the following section…

I 11


I Cover story

bne March 2013

bne March 2013

Cover story


Montenegro Bulgaria Pros: • EU membership • Black Sea coast • Hot, dry summers • Still one of cheapest EU countries • 10% flat corporate and personal tax • Generally business-friendly environment Cons: • Not yet member of Schengen Zone • Cold, wet winters • Occasional gas cut-offs by Russia • Mob hits

Pros: • Lowest corporate/personal flat tax in Europe of 9% • Stunning mountain scenery and 295km Adriatic coastline • Venetian-influenced towns such as Kotor, Budva and Perast • Mediterranean climate: the temperature on coast rarely drops below freezing; Bar has 270 sunny days per year • Vranac wine and loza (grape brandy) • Property prices in coastal towns average less than ¤2000/sqm (CBRE) and have fallen in recent years. • New resorts such as Porto Montenegro attracting global glitterati • Uses the euro Cons: • Wet winter weather • Reputation for organised crime and corruption • Stagnant political scene dominated by one party for two decades (since WWII by some measures) • Income gap between coast and the mountainous interior • Flight connectivity could be better • Threat of overdevelopment along coast, potentially damaging natural beauty and property prices

Pros: • Lots of boutique banks with Russian-speaking staff • Will soon be in Eurozone • Residence permit with Schengen visa and ID card • Post-crash property prices still low: LVL50k (outside Riga region) or LVL100k (Riga region, including Jurmala resort) • Quick links to Russia and CIS • Business tax 15%; "microbusinesses" with fewer than 5 employees less at 9% of turnover (rather than of income) Cons: • Relatively high personal income tax rate of 24% • Banks have a habit of going bust • Connections to the elite hard to make • Could be the new Cyprus • Good luck learning Latvian • Baltic climate

Hungary Pros: • EU member of Schengen Zone • Flat personal tax rate of 16%, corporate 10-19% • Great local wine and goulash • Spas • Excellent time to snap up low post-crisis property: average Budapest price/sqm in 2011 was HUF239,000, or $100 per square foot Cons: • VAT at 27%, highest in EU • Growing anti-Semitism, racism in general • Democratic norms receding • Capricious government policy

Albania Pros: • 10% personal and corporate flat tax • Europe's last undeveloped coastline • A short hop across to Corfu • Mediterranean climate Cons: • Criminality on a grand scale • Political instability and corruption • EU membership a long way off • Decrepit or non-existent infrastructure, services

I 13


I Cover story

bne March 2013

Kazakh pension system crosses the Styx Kazakhstan's revanchement is maybe the most disappointing, as of all the countries in the former Soviet Union it was a standout success when it came to putting into place sensible and successful financial reforms.

Another pension grab Clare Nuttall in Astana, Ben Aris in Moscow


ash-strapped governments across Central and Eastern Europe and the Commonwealth of Independent States (CEE/CIS) are resorting to the desperate measure of raiding the pension piggy bank, which may plug budget deficits now but could leave their OAPs impoverished in a decade's time. Kazakhstan is the latest culprit, seizing the country's private pension funds at the start of this year. Previously considered to have one of the best organised and run pension systems in the former Soviet Union, the state has effectively nationalised the entire $20bn of assets under management and intends to hand them over the National Bank of Kazakhstan to spend "as it sees fit." Russia made a similar, if slightly less dramatic move in January, when the Kremlin order the contribution to the investable part of pensioned cut from 6% to 2% of the total, with the difference used to pay current pensions. Russia's private pension sector is still in its infancy after the initial attempts to reform the sector in 2002 were botched, but recently private pension funds have been growing quickly as the emerging middle class wake up to the need to provide for their old age themselves. Russian private pension fund managers were outraged by the decision, doubly

galling as the Kremlin has pushed capital reforms to the top of the political agenda and is making good progress on modernising the stock market. "It's a question of jam today, but gruel tomorrow," says one manager who didn't want to be named criticising the financial authorities. "This was a total short-sighted decision; if the government doesn't start building up resources now, it will not be able to cover its social obligations to retirees in the next couple of decades." And Hungary is well ahead of everyone else both in stupidity and bluntness. In 2010, the state issued its citizens an ultimatum: move your private pension to the state system or lose it. The grab saw some $14.6bn of privately managed money pour into state coffers that was used to plug a budget deficit hole or invested into public works. "This is effectively a nationalisation of private pension funds," David Nemeth, an economist at ING in Budapest, said in an interview at the time. "It's the nightmare scenario." In both Hungary and Kazakhstan the appropriations undo more than a decade of work to move citizens into private funds and so wind down the state's obligations to its elderly. In Russia, where the reforms have yet to really start, the Kremlin is strangling the goose while it is still a gosling.

The Kazakh government is planning to scrap the country's existing pensions system, considered the most advanced in the CIS region, and merge the 10 private and one state funds into a single state-controlled fund. This will allow Astana to tap the $20bn worth of pensions assets to maintain economic growth at its targeted 7% and finance infrastructure projects. But this could also be the kiss of death for the country's capital markets. The idea was first broached by President Nursultan Nazarbayev on January 25. Nazarbayev criticised the use of money from the National Fund, where windfall oil profits are accumulated, in Kazakhstan's recent anti-crisis programmes, saying that there had been "no pay-off" for the $10bn spent. "The pensions and insurance sectors combined hold $3.5bn. Why isn't the money put to use?" Nazarbayev told government officials. Deputy Prime Minister Kairat Kelimbetov confirmed on February 6 that all pensions savings accumulated in Kazakhstan should be merged into a single national pension fund by July 1, 2013. The fund will be set up on the basis of the existing State National Pension Fund (GNPF), which is owned by the central bank, and holds around 19.3% of Kazakhstan's total pensions assets. With just four months to go, government officials are still considering how to push through the merger. Kelimbetov indicated in an interview with Interfax in mid-February that the government may attempt to kill two birds with one stone by linking its pensions grab to offloading its holdings in BTA Bank and other commercial banks that are being put up for sale. Astana wants to start the process by getting the sovereign wealth fund

bne March 2013

Samruk-Kazyna to buy out the three largest pension funds – Ular Umit, which is owned by BTA, Kazkommertsbank's (KKB) Grantum Pension Fund and Halyk Bank Accumulative Pension Fund (Halyk APF). Astana is considering offering the state's shares in BTA and KKB to the banks in exchange for shares in the pension funds, Kelimbetov told Interfax. According to Kelimbetov, the government is "very close" to a decision on purchasing shares in the three funds, which together with the GNPF, account for 75% of pensions assets in Kazakhstan. Merging the GNPF and Ular Umit is an "internal matter" for the government since the GNPF is already under the control of the central bank, and following BTA's second round of debt restructuring in 2012, BTA is 97.26% owned by Samruk-Kazyna. Meanwhile, KKB's shareholders would be able to buy back the 21.26% stake in the bank owned by Samruk-Kazyna, in return for handing over Grantum shares, Kelimbetov told Interfax. The government might also propose to Halyk that the bank takes shares in struggling BTA in return for the Halyk APK pension fund – an idea that is unlikely to be welcomed by Halyk. Halyk responded to the reports on February 19 with a statement saying that no request had yet been received and it will consider selling or exchanging shares in its pension fund only in the event of a formal proposal. "Halyk Bank has always regarded Pension Fund as a strategic asset of Halyk Group," the statement added. Growth pains The decision to raid the pensions pot comes as Kazakhstan's GDP growth slipped to around 5% in 2012, well below the medium-term target of at least 7% a year set by Nazarbayev. With the National Fund strictly reserved for a rainy day (such as the previous crisis), the government has had to look for alternative financing sources. Astana has various ideas including plans for a KZT150bn ($996m) sovereign Eurobond – the first for 13 years – announced by Finance Minister Bolat Zhamishev on

Cover story

January 29. However, these are unlikely to be sufficient for all the government's ambitious investment plans. Kazakhstan's government and stateowned companies also have massive fund-raising needs for the coming years. Astana's existing infrastructure construction projects run into billions of dollars, and more are set to be announced when the government launches a new industrialisation programme after the 2010-14 programme is completed. State oil and gas company KazMunaiGas needs to finance projects including pipeline construction, and its needs will increase when the next phases of development at Kazakhstan's mega-fields Karaghaganak, Kashagan and Tengiz are agreed. But although the government is adamant the merger does not amount to nationalisation of Kazakhstani pensions, it appears to be a U-turn on the businessfriendly reforms of recent years. Almaty-based investment bank Visor Capital describes the merger as "a step backwards for Kazakhstan." The brokerage warns in a statement that, "we believe the pension funds reform will have a very negative impact on the development of capital markets in Kazakhstan. Most private pension funds will be closed or in a best case will lose most of their assets under management, and a large number of other professional participants in the market (ie. about 30 active brokerage and asset management companies) will shut down. And the remaining market participants will – we believe – reduce their staff significantly." Since the switch to a mainly funded system in 1998, Kazakhstan's pensions system has gained a reputation as the best in the former Soviet Union. Kazakhstan now has total pensions savings of $20.7bn, around 10% of GDP, putting the country well ahead of Turkey (2.3%), Russia (3.0%), and even the Czech Republic (6.3%), and only slightly behind Poland (on 15.6%). The impact of switching from a mainly private to a state pension system does not necessarily mean a worse outcome

I 15

for Kazakhstan's future pensioners, as it remains to be seen what the return on investment will be from the planned infrastructure investments. Workers will, however, lose the freedom they currently have to choose between 11 funds, which acted as an incentive for fund managers to perform. Renaissance Capital analyst Gennadiy Babenko says the new system may not represent as big a change as feared, since the funds already invest primarily into Kazakhstani government bonds. "The idea behind Kazakhstan's pensions system was perfect, but they ended up with pension funds mainly invested into state-issued bonds, which didn't yield much," Babenko tells bne. "In effect, the pension funds are already financing the local government and getting quite low returns." The biggest losers from the new regime are Kazakhstan's brokers. Since pension funds are the single largest investors on the local market, their merger into a single state fund is set to devastate the domestic capital market, and cut off one of the most attractive avenues for private Kazakhstani companies to raise finance. The process has already stated with the introduction of new rules banning pension funds from investing into all but a handful of instruments. Many brokers say this will force them to shut up shop even before the funds are merged. This is an apparent U-turn for Astana, where until 2012 officials were talking about broadening the range of instruments pension funds could invest into in an attempt to increase their potential returns and boost activity on the Kazakhstan Stock Exchange (KASE). "Pre-merger, the pension funds have already been instructed not to invest into any other instrument than government or quasi-government securities, which has already translated into missed opportunities for local companies," says Jean-Christophe Lermuisaux, head of research at Visor Capital. "Successful emerging markets countries usually have a powerful local stock exchange, but if non-Government related Kazakhstani companies want to raise money they will have to do it somewhere else."


I Perspective

bne March 2013

"I am sure a new Vulgaristan issue would do exceptionally well in this market, as would the Vulgaristan Absolutely Best Ever Credit Bank Honestly, and many others," he says. What worries people like Ash is that it seems as though credit risk is not being priced in at all at the moment.

CEE bond bonanza – too far, too low bne


ond investors appear to have lost their minds and this could all end in tears. Last year's rally in emerging market debt has spilled over into 2013 and it seems anyone with an economy is now issuing bonds at historically low yields, irrespective of their ability to pay back the money in full and on time. Since the beginning of the year, there's been a flurry of bond issues at relatively low yields just as many released weak GDP figures for last year that showed economic growth slowing. However, with yields slashed effectively to zero in the developed world, bond investors don't seem to care; ravenous for yield, they are willing to buy anything and everything at the moment if it pays a decent yield. Poland, the Czech Republic and Slovakia – all fairly strong creditors with sound public finances and low debt levels – got the ball rolling last year. With high global liquidity helping push yields in CEE to record lows, Poland's issuance of almost €12bn last year trailed only China's $30bn among emerging market peers, according to data compiled by Bloomberg. Yet the issuers jumping on the bond market bandwagon have reached the less creditworthy end of the spectrum. "I am tempted to say that almost any issuer, whatever the name and fundamentals, with a bit of carry could tap this overbaked and pretty ridiculous market," Tim Ash of Standard Bank wrote in a note, entitled "Vulgaristan prepares debut bond issue", in reference to a country he was close to adding to his regular sovereign weekly on April 1 last year.

Case in point: Ukraine. Its economy is going to the dogs, contracting 2.7% on year in the fourth quarter to leave 2012 growth at just 0.2%. Despite government protestations that the economy will grow 3% this year, most international financial institutions believe the very best it will manage is 1%, if not outright contraction. Hard currency reserves fell to just over $24bn as of February – less than the three months of import cover that most economists say is needed to support a currency – and the situation will only get worse thanks to a current account deficit of 8% of GDP in 2012 that is still deteriorating. Yet at the start of February Kyiv sold $1bn of 10-year Eurobonds that will yield of 7.625%, as well as another $930m of its newly introduced dollar-denominated domestic OVDP paper. The new money was just enough to pay off an International Monetary Fund (IMF) loan, but the state will have to come up with another $3bn this year to pay off its remaining obligations to the IMF this year. "For now the government is managing to cover its foreign debt repayments in real time, following the 'just in time' principle," says Dmitri Fedotkin, an analyst with VTB Capital. "However, this provides little flexibility and, given the intense debt repayment schedule in the months ahead… it leaves [the finance ministry and central bank] highly exposed to the risk of a deterioration in market conditions." In March and May, the finance ministry and central bank are jointly scheduled to repay another $1.9bn of foreign currency debt ($1.4bn to the IMF and $0.5bn of maturing domestic dollar-OVDPs), while in June a $1bn sovereign Eurobond matures. Kyiv's only chance to make these payments is to borrow more money from the markets or do a deal with the IMF to restart the $15bn stand-by agreement by at least April. The alternative is a nasty devaluation that would more than likely spark a financial crisis. While a sensible person would expect Kyiv to buckle into the IMF's demands if push came to shove in order to tap the fund's money, the government of Ukrainian President Viktor Yanukovych is becoming increasingly erratic, putting "stealing" over sense these days. Is 7.625% really enough to cover the risk of investing in a country that is increasingly looking like Russia circa 1997? And then there is Hungary. By comparison, Hungary makes Ukraine look like a model of fiscal prudence. Yet its government is guilty of capricious economic policies that include grabbing the country's pension assets and windfall taxes on banks and other foreign investors. And like Ukraine, Budapest needs cash to forestall a painful discipline-imposing

Perspective I 17

bne March 2013

deal with the IMF, as well give it some social spending money it can ill afford to spend ahead of elections in April 2014. So instead of giving in to the IMF's demands, in February Hungary's government sold its first sovereign foreign currency bond in nearly two years – a $3.25bn issue that included $2bn of a 10-year note priced at just 345 basis points above US Treasuries. This issue was four-times oversubscribed, implying bond investors happily bought into the idea there will be no more crises for another 10 years. And this year has seen two other high-profile deals from Emerging Europe's less creditworthy issuers: a $1.5bn, 10-year Eurobond from Romania priced to yield 4.625%, which was five-times oversubscribed. And another $1.5bn, seven-year Eurobond issue from Serbia yielding 5.15%. Both Romania and Serbia might be doing better than either Ukraine or Hungary, but still, both countries have been wracked by political problems over the past year and are clearly not out of the woods yet.

The Romanian parliament adopted a draft budget for 2013 the same week as its bond issue, targeting a budget deficit equivalent to 2.1% of GDP and an economic growth rate of 1.6%. Investors may have been impressed by Romania's better-than-expected GDP figures for 2012, which showed it emerging from recession in the fourth quarter with 0.3% annual growth, bringing growth for the full year to 0.2%. But Serbia looks a lot less appealing. The state plans to borrow about another at least another €3bn this year, but this will only add to a ballooning debt pile that has pushed the country's debt/GDP ratio above 60%, while the government is struggling to convince the IMF to agree a new stand-by loan deal. Either the economy will have to boom from now on or the country will be bankrupt within a year or two. "Maybe I am old fashioned but I kind of think that when investors are investing, particularly in bonds, they should think at the time that the issuer has some reasonable chance of paying back," says Ash.

Polish labour market deteriorated throughout 2012



aving performed well throughout the crisis, Poland is having its post-crisis hangover of late. While the rest of Emerging Europe looks like it will start building towards a full recovery this year, Poland was starting to go backwards at the end of the last year and the slowdown looks set to continue. The chart below shows that investment and consumption in Poland have both been slowing over the last 18 months, while unemployment is the highest in the region and on a par with many Western European countries. Poland's unemployment rate climbed to 13.4% in December, up from 12.9% the previous month.

Unemployment rate in selected developing countries at the end of 2012 Unemployment (%)

14. 0 12.9 12.0 10.7

10.0 9.1

Polish employment growth entered negative territory in November (-0.3% on year), for the first time since the 2010 recovery. The labour market is affected by the collapse in the construction sector and some big one-off lay-offs (ie. at the Fiat factory in Tychy).


In the near future, banks do not expect any improvement in the unemployment rate, which partly due to seasonal factors could even reach 14%, says Erste Bank. In fact, it says, the domestic labour market seems to be greatly inferior to other developing nations.




6.0 5.4

5.4 4.1


0.0 Poland


Turkey Czech Rep Hungary

Source: Bloomberg, Erste Group research





I Eastern Europe

bne March 2013

Eastern Europe I 19

bne March 2013

developing a high-tech industry that can compete internationally. Given the relatively high cost of labour in Russia, added to the effect of petrodollars pushing up the ruble, Russia has little choice in its bid to diversify the economy but to turn to high value added tech-related industries. But despite all the money being thrown at the problem – a new fund for "advanced

planes that are increasingly in demand around the world and compete with the likes of Boeing and Airbus should have been straightforward. Putin personally backed the establishment of UAC in early 2006. The holding consolidates Russian private and state-owned aircraft construction companies and assets engaged in the manufacture, design

"A flight from Astrakhan to Moscow saw the 'door open' alarm erroneously go off mid-flight"

Russian aviation falls to earth with a bump bne


ussia's attempt to build a hightech aviation sector on the rubble of the Soviet industry is looking more of a flop as national airline Aeroflot reveals that a full 40% of all reported equipment failures occur in the much trumpeted flagship of the drive, the Sukhoi SuperJet 100 (SSJ 100).

Now the complaints have become more public and more cutting. According to an Aeroflot report cited by the daily Kommersant, 40% of all reported equipment failures in the airline's entire fleet were found in the locallyproduced equipment on board the SSJ 100.

Aeroflot is clearly the biggest potential customer for the new mid-range passenger plane, which is produced by state aircraft manufacturing holding company United Aviation Corporation (UAC). However, the flag carrier has been complaining the SSJ 100 is not up to scratch. Last year the airline took delivery of four jets, but quietly sent them back again saying (publicy at least) that the "interior decor does not meet specifications."

Furthermore, Russian-made planes only make up 8% of Aeroflot's fleet, but are the main source of all problems. Aeroflot reported a total of 95 accidents in 2012, up from 60 in 2011, of which nine were classed as "critical" against only four critical accidents a year earlier. Of those incidents, the SSJ-100 accounted for just over a quarter – hugely disproportional given the small number of the new jets in the Aeroflot fleet.

On top of that, those figures only relate to planes in service, and there have been even more problems with trial and test flights. Kommersant reports on a flight from Astrakhan to Moscow where the "door open" alarm erroneously went off mid-flight. Aeroflot says that the conditioning and navigation systems cause the most problems, but the most dangerous failures involved six incidents that were caused by chassis-system failures. An unnamed Aeroflot source says that the company will send all its SSJ-100 aircraft to a Perm affiliate, but will not stop operating the planes. System failure The failure of the SSJ-100 thus far bodes ill for Moscow's hopes of

technologies" was set up by President Vladimir Putin just this year – unless something fundamentally changes in the way high-tech industries are promoted and pursued, it looks like the entire effort will be wasted.

and sale of military, civilian, transport and unmanned aircraft. The SSJ 100 is its flagship project in civilian aircraft, but it has experienced nothing but headaches ever since the first planes began rolling off the production lines.

Private sector innovation is the obvious solution, but all the Kremlin's efforts are going into state-backed entities like UAC – and these simply aren't working. Of all the Kremlin's plans to build a 21st-century economy and create the 25m new high-tech jobs that are central to the Ministry of Economic Development's long-term forecast for a bright economic future, setting up a modern aviation sector should have been the easiest.

The first commercial sale was to Armenia's national carrier Armavia in 2011, but the company declined to buy a second SSJ 100 as planned. In the summer, it announced it is to buy new planes from Boeing and Airbus instead.

Given that the only way of getting around a country as vast as Russia is to fly, it's little wonder that one of the few things country was good at during Soviet times was building planes. At its peak, the domestic aviation sector churned out 25,000 planes per year. Russia's warplanes remain some of the best in the world; the MiG fighter is the stuff of legend and the family of Sukhoi fighter planes is still in high demand by governments around the world. Russia is also the only country in the world to be producing a fifth-generation fighter, the T-50. Therefore, setting up a company to make cheap mid-range passenger

Real disaster struck in May when a SSJ100 crashed at an airshow in Indonesia killing everyone on board, including the representatives of the country's ministry of transport that were thinking of buying the plane. As it turned out, the crash was caused by pilot error, and Indonesia certified the plane in November and said the deal will go ahead. Additional customers appear thin on the ground.

"Aeroflot reported a total of 95 accidents in 2012 – of those incidents, the SSJ-100 accounted for just over a quarter"


I Eastern Europe

bne March 2013

Vnesheconombank (VEB) and now VTB, but is an old school-style banker. Big brother The other relevant event on the horizon is the creation of the mega-regulator that will take over the supervision of both the banking sector and the development of the domestic capital markets.

Who will take over at Russia's central bank? Ben Aris in Moscow


he Kremlin is calling for 5% economic growth, but the only way to achieve that is by turning on the spending spigots and reversing the Central Bank of Russia's (CBR) current tight monetary policy. The CBR has nailed its inflation-fighting colours to the mast, but with its chairman, Sergey Ignatiev, due to be replaced soon and a new financial mega-regulator in the works, the Kremlin's leverage over Russia's monetary policy and the central bank's vast cash reserves could change dramatically this year. The CBR has covered itself in glory over the last decade. The battle-hardened central bank has fought off a number of potentially financial sector-busting crises with aplomb. First it oversaw the recovery of the 1998 ruble crisis and managed to quickly put the banking sector back on its feet, which contributed to the 10% growth the economy posted in 2000. Then it dealt with the 2004 "mini-bank crisis" that threatened to bring the sector down, after the medium-sized Guta Bank went bust. And when Kit Finance went bust at the start of the 2008 meltdown on September 17, it found a white knight for the consumer lender by lunchtime the same day. Finally, it implanted a controlled 30% devaluation of the ruble in 2009 that

economists initially lambasted, only to change their minds completely a year later when it delivered a rapid economic recovery. Although it is not generally acknowledged, Russia has boasted one of the best-run central banks in the world. That all might change later this year. In January, the government drew up a list of potential replacements to replace Ignatiev as chairman – although it is not naming names yet. Amongst the candidates, according to press speculation, are: the CBR's public face, First Deputy Chairman Alexey Ulyukaev; liberal economist and Deputy Prime Minister Arkady Dvorkovich; former finance minister Alexei Kudrin; VTB Bank CEO Andrei Kostin; and VTB 24 CEO Mikhail Zadornov, who is a wunderkind of the retail banking world. Ulyukayev would be bne's favourite choice, as it would mean continuity with the current policies. Kostin would be our least favourite; he grew up as an economic attaché at the Soviet UK embassy where he served with his close personal friend and Gosbank representative Viktor Gerashchenko, the previous CBR head who led the banking sector into the 1998 crisis. Kostin cut his banking teeth working for Alexander Lebedev's National Reserve Bank before running the state banking giants, first

The State Duma adopted in a first reading a government bill to amend the Russian Federation's budget code and to set requirements for the staff of a specialised financial organisation on January 25. The bill will see the central bank absorb the stock market regulator, the Federal Service for Financial Markets, to create a mega-regulator. Russian President Vladimir Putin personally backs the move, which could happen by the end of this year. But the danger, say critics, is that doing so could undermine the independence of the central bank in the process. And there is also talk of setting up an open joint stock company to manage Russia's sovereign reserves that has also raised questions in some quarters. The company has the working name of the Russian Financial Agency (Rosfinagentstvo), which will be given the job of managing the state's financial reserves derived from mining and oil exports, currently held in the Reserve Fund and National Welfare Fund. The agency will also take over managing Russia's debt obligations and pension funds, which is currently the job of VEB. Rosfinagentstvo will completely change the relationship between the state and these large piles of money – some $300bn or a bit more than half of all of Russia's hard currency reserves. VEB is not actually a bank, but functions by dint of a special decree of the president that has to be renewed each year, whereas Rosfinagentstvo will work under contract with the Ministry of Finance. The motive driving this change is the Kremlin's growing awareness that the state's finances are in serious trouble, as the current system will not be able to cover the country's pension obligations in the future. Russia famously has a

bne March 2013

very low debt level, but Deutsche Bank argued in a report in February that if the state's promises of future payments are taken into account, then things don't look quite so rosy. "If the implicit debt stemming from the increase in pension- and healthexpenditure is taken into account (and adequately discounted), countries like China and Russia, the two countries with the lowest government debt levels, begin to compare much less favourably to countries with currently large public debt burdens but limited implicit pension and healthcare liabilities, such as India," says Markus Jaeger, an economist with Deutsche Bank. According to the International Monetary Fund (IMF), the difference between the present value of cash inflows and the future spending increases in 20112050 is 100-260% of GDP for China, Russia, South Korea and Turkey, but less than 100% of GDP for India, Mexico, Indonesia, South Africa and Poland. This massive increase in spending is the "Ghost of Christmas Future" for Russia – not necessarily its fate if the money it has now could be made to work a little harder. And that is the point of the new agency – it will have a mandate to "most actively" invest its funds. In 2008, the then-finance minister Alexei Kudrin initially floated the idea for Rosfinagentstvo. It now looks increasingly like it will become a reality. But the idea of taking funds that are under the direct control of the state and giving it to a semi-independent body scares the Bejasus out of some commentators. "Consolidating such huge state-owned reserves in the hands of a trading/commercial company should be seen as risky, given that Russian economy is inefficiently managed, bureaucratic and afflicted with pervasive corruption," wrote Ewa Fischer of the Centre of Eastern Studies (OSW), in a note on January 30. "The money earmarked for infrastructure projects may be directed to companies involved with the ruling team. This was the case in a number of projects funded from the state budget, such as the construction of facilities for the Winter Olympic Games in Sochi."

Eastern Europe

Russians hanker for Soviet system

bne Back to the future – that is the sentiment among many Russians who say they want to go back to the Soviet system. According to a recent poll, the number that support the Soviet political system has grown to 36% of Russians, who say the Soviet system is the best one for the country, compared with 29% in 2012. This is more than the number of Russians that support a western-style democracy, which is down from 29% to 22%, according to a survey published by the Russian independent pollster Levada Center. Russian President Vladimir Putin’s current system is the least popular, with only 17% saying they remain loyal to the existing political system, a 3-percentage-point drop from last year. The Soviet system has an enduring appeal. It is widely forgotten that in March 1991 Mikhail Gorbachev ordered a Soviet Union-wide poll that covered some 90% of the population. It found that 76% wanted to retain the Soviet Union – and this less than six months before Yeltsin ended it by fiat, according to a recent book by Professor Stephen Cohen. At the time, Gorby was negotiating with seven of the 15 republics on a new Soviet Union treaty that would have given greater autonomy to the members. It was a given that the Baltic states were going to leave the union – and Gorby didn’t have a problem with that. Georgia too was likely to leave and none of these new republics retain much love for Russia today. However, most of the other states – including Ukraine, Belarus and especially the five republics of Central Asia – were very keen to stay in the union. One of the quirks of the Soviet "empire" was that unlike other empires, the centre didn’t exploit the periphery; quite the opposite: especially in the case of the 'Stans, the centre invested heavily in the republics and lifted their quality of life at the cost of the more developed Russians. Had Gorby managed to complete his new union treaty, then it seems likely that Russia would have followed a path much more closely resembling China’s today. In the event, Russians miss the security of cradle-to-coffin social support that was one of the major appeals of the socialist system. While few would like to return entire to the old model, most want some sort of compromise. The survey also posed a question about the economic system. Poll results show that more than half of Russians (51%) support an economic model based on state planning (49% in 2012). Only 29% spoke in favour of private ownership and a free market system (36% in 2012).

I 21


I Eastern Europe

bne March 2013

The upshot is that Gazprom has been forced to hand out billions of dollars of rebates to European countries (not Ukraine, though) in 2012 and will be forced to do the same again this year. No longer special Gazprom has long held a sacrosanct position in Russia's state-owned corporate firmament. Russian President Vladimir Putin said explicitly at the company's tenth birthday party several years ago that the company remains an "explicit tool of foreign policy." But as its economic clout wanes, so does its political usefulness.

Flaring off Gazprom's monopoly

With the economy stagnating, the Kremlin is on the hunt for revenues and increasingly it no longer feels it can afford to turn a blind eye to Gazprom's profligacy, corruption and below-par productivity. Accounting for 8% of GDP by itself, the company is simply becoming too expensive to ignore these problems.



013 has dealt further blows to Gazprom's hopes of keeping its long-held monopoly over Russia's gas business. Prime Minister Dmitry Medvedev began the offensive by telling reporters on his trip to the World Economic Forum in Davos that, "Gazprom’s monopoly on gas exports might potentially be removed." This was then followed by state-owned oil major Rosneft on February 13 calling for an end to Gazprom's export monopoly on liquefied natural gas (LNG). Rosneft chief Igor Sechin urged the Russian government to liberalise exports of LNG from offshore projects by ending Gazprom's monopoly of foreign gas sales. "Such volumes cannot be sold on the domestic market and so we are asking the government to consider liberalising gas exports, in particular liquefied gas," Sechin told the presidential commission for development of the fuel and energy sector. The government is clearly revving up to allow other companies to export

gas – albeit only as LNG for the time being. The government is to due to consider granting leading independent gas producer Novatek an LNG export licence this month. Gazprom has found itself in increasingly dire straits. The advent of shale gas and growing volumes of LNG trade on spot markets – which can be transported by

The Kremlin seems to be headed towards a policy already thrashed out in the banking sector: rather than outright privatisation (which is impossible both de jure and also in practice, as the company is simply too big to sell), the state is going to set up stateowned competitors to force Gazprom's management to focus more on the numbers. It's a hybrid model where competition between state-owned

"As Gazprom's economic clout wanes, so does its political usefulness"

bne March 2013

Eastern Europe

Forecasts for gas demand in key Asian states (figures in bcm)

All 2015 2025

companies provides the goad – in the bank sector Sberbank and VTB Bank – but the state retains control of the sector by owning the main players. In the longer term, the state will then gradually sell stakes to private investors, although whether this stake falls below a controlling or blocking stake will be decided on a case-by-case basis. The situation in the gas business is likely to be even more progressive than in

China LNG

180-260 17,5-60 270-440 35-130


India LNG

80-90 120-140

10-20 30

Japan* LNG All 115-130 115-130 140 140

South Korea* LNG All 55-60 60-80

55-60 60-80

Taiwan* LNG All 17,5-20 17,5-20 22,5-30 22,5-30

* Negligible domestic production, which means practically total dependence on imports Source: figures based on data from the Oxford Institute for Energy Studies

banking, as Novatek, a privately owned company, is set to win a leading role and is clearly being groomed to become Russia's LNG champion – an unusual willingness on the Kremlin's part to allow a private company to command such a crucial product as energy. At the same time, Rosneft is being prepped for a bigger role in the sector: to play VTB to Gazprom's Sberbank. It has been given gasfields and looks set to win a big chunk of the 40%odd of Gazprom's long-term domestic commercial supply contracts that come up for renewal this year. All of this might be a preliminary to breaking up Gazprom (although

no one has mentioned this yet) into GazVneshProm (Gazprom International) and GazRosProm (Gazprom Russia), which are clearly too different businesses anyway. But that is a long way out – if it comes at all. Under existing legislation, energy giant Gazprom has a monopoly on gas exports and other producer companies are obliged to sign export contracts with Gazprom structures. Sechin said LNG market liberalisation would not immediately affect Gazprom because Russian LNG exports in the near future are primarily destined for emerging markets (such as Asia Pacific nations), and not Gazprom's existing customers in Europe. Russia

and Japan signed a $7bn LNG deal in September 2012 for gas supplies from an LNG plant near the Pacific port of Vladivostok. But Gazprom is clearly in rearguard defence mode. It was already forced to concede a bigger share in a JV with Novatek to produce LNG in January. And last week it said it might allow greater access to the domestic gas transport system and give take-orpay rights that would allow domestic independent producers to collect money from their clients, as well as greater access to the pipeline network at home. The regulations underpinning these changes could be finalised in 2015, reports the Russian press.

Shtokman Pechora

ship so breaking the age-old dependence on geopolitical pipeline routes – means the cost of gas is tumbling. "Momentum toward North American energy independence accelerated last year well beyond the wildest dreams of any energy analyst and well above the forecast we made in our first Citi GPS report, 'Energy 2020: North America, the New Middle East?'," Citi said in a report this week.

I 23



Kamchatka Sakhalin

Black Sea


Legend: Existing LNG terminals

Projects under consideration

Projects in preparation

Projects suspended


I Eastern Europe

bne March 2013

this in a positive way, ie. to play the IMF game some more so as to keep investors sweet, but as Jarvis mentioned there are still significant policy differences between the two sides – likely gas prices, FX policy and macro assumptions underlying the budget," Ash says. "I would tend to think that there is a high risk of a delay – depending on market financing available. If the government has to go to the IMF for a programme, they will want to delay this until after the annual heating season ends in April, so that if they have to increase gas prices as a prior action for a new programme then at least the political hit can be delayed somewhat."

Ukraine's "serious challenges" bne


alks over a new stand-by loan arrangement for Ukraine could resume in March, the International Monetary Fund said on February 12 as it left Kyiv following initial negotiations. However, the Washington-based lender warned that the economy still faces "serious challenges". Christopher Jarvis, IMF mission chief for Ukraine, insisted in a statement that Kyiv's continued refusal to change key policies is loading further risk onto the economy by slowing growth and exposing it to potential shocks. "Large subsidies on gas and heating for households continue to undermine Ukraine's budget and its balance of payments," Jarvis says. "In the absence of corrective policies, our forecast for 2013 is growth of 0-1% and a high current account deficit that leaves Ukraine vulnerable to shocks." Ukraine's subsidised gas tariffs have been the key issue ever since the IMF froze the last stand-by programme in

2011, and Jarvis hinted that the lender will continue to insist Kyiv adjusts them before it makes any more money available to the country. "With better policies Ukraine can achieve better outcomes," he continued. "We expect the mission to return to Kyiv in March to continue the discussions." The forecast that the economy will remain sluggish through 2013 (the European Bank for Reconstruction and

By way of contrast to the warnings, officials in Kyiv painted a picture in which the IMF is heading back to Washington to dot the i's and cross the t's before putting its hand in its pocket. And they offered no clue as to what concessions Ukraine could offer to the lender. "The (IMF) mission will carry out technical work in Washington and prepare the next round of talks," Vitaly Lukyanenko, a spokesman for Prime Minister Mykola Azarov, said. "The mission is studying Ukraine's fiscal, exchange rate, monetary and energy policies." Asked whether a memorandum on a new loan deal had been drafted, Lukyanenko said: "We are not at that stage yet." Economy Minister Ihor Prasolov told reporters that he expects another "technical" IMF mission to visit Kyiv soon, followed by a third mission which

"With better policies Ukraine can achieve better outcomes" Development also recently downgraded its growth outlook for the country to 1%) is at odds with the 3% growth that the government says it expects – a prediction that Tim Ash of Standard Bank calls "pie in the sky" thinking. "The government is clearly eager to spin all

would be ready to finalise the loan talks. "The (third) mission will arrive… in late March, and we, on both sides, will be more prepared to move towards drafting a memorandum and we will prepare for its signing."

Central Europe I 25

bne March 2013

Cheers in the east Tim Gosling in Prague


verybody was claiming victory after marathon talks resulted in a deal over the EU's 2014-2020 budget being reached on February 8. But Polish Prime Minister Donald Tusk's remark that it was "one of the happiest days of my life" perhaps signals it was the eastern member states that probably have most to cheer about. The fight over the new budget pitched net contributors in the west of Europe against beneficiaries to the east and south. The big payers, led by the UK, insisted that while austerity reigns at state level, the EU budget should reflect that. And indeed, total spending over the next seven years has been set at €908.4bn, which represents a 3% drop on the last budget. "Commitments" – the maximum amount of money that can be allotted during the period – was pegged at €960bn, just below 1% of the bloc's annual GDP. The headline figure clearly represents a triumph for those large states pushing for a tighter budget. David Cameron,

the British prime minister, said the deal was good for Britain, good for Europe and "above all a good deal for all our taxpayers." Jose Manuel Barroso, president of the European Commission, was less effusive, saying that despite the levels agreed being below those the EU

2007-2013 budget. "Is this your dream budget? I would say if I were alone, no, it would have been different," French President Francois Hollande said after the summit. By way of contrast, the level of Cohesion Funds – the second major pillar in EU spending – actually

"Is this your dream budget? I would say if I were alone, no" executive considers desirable, the deal remains "an important catalyst for growth and jobs." France, a rare western proponent for an expanded budget due to high Common Agricultural Policy (CAP) payments to its farmers, was one of the largest losers, as the biggest ticket in the spending plan was cut to €373.2bn compared with €420.7bn in the

increased. Distributed among poorer member states like those in Emerging Europe to help improve things like infrastructure, its allocation in the budget rose to €325bn, an increase of €4.5bn from proposals laid out last year, even as the size of the overall pot decreased. Poland, a leader of the group of (mostly CEE) states that has been pushing


I Central Europe

against any cuts to the budget, will actually collect more funding over the next seven years, receiving a total of €105.8bn – €72bn in cohesion funds and €28.5bn under CAP. "This is one of the happiest days of my life," Tusk said after the summit broke up. "We received €102bn for the 2007-2013 period and now we are to get €106bn." Warsaw is pushing to continue the rapid development of infrastructure that started ahead of the Euro 2012 football championships, and has earmarked a new infrastructure fund as its flagship policy to help stimulate its flagging economy. This EU budget was particularly important for the country, as from 2020 it is expected to become a net payer to the EU budget – and not its largest recipient, as it is now – after its economy catches up with those of its EU peers. Moody's Investors Service said the EU budget deal will support the country's ratings. "The increase in EU financing is credit positive because it will support the Polish government's efforts to expand infrastructure investment in order to stimulate a slowing economy and boost long-term economic growth," Moody's wrote. As is the way with Romanian politicians, there was little agreement in Bucharest about the deal. President Traian Basescu hailed the fact Romania got an 18% increase for the period 2014-2020 from the previous period, and was one of the few countries that managed to get a budget increase at all. In total, Romania would get some €39.8bn.

bne March 2013

a big disappointment,” said Ponta, dismissing it is all as a PR stunt. Critics, however, say that arguments about the headline figure miss the point: Romania suffers a woeful record in actually taking up these cohesion funds because of its venal and incompetent politicians, bureaucrats and businesspeople. By the end of November last year, the country had absorbed less than 10% of the €19.6bn it is entitled to during the seven-year budget period had it put the correct procedures in place. Hungary's overall funding through the period will decrease by 10% from the 2006-2013 budget to €20.4bn. However, that's still a result for Budapest, which was facing a cut of up to 30% under earlier drafts of the plan. "The main question," according to analysts at Equilor Research, "is whether Hungary can utilize EU funds more effectively than it has in the current period." The Czech Republic, one of the few conservative members of the newer EU states, saw its funding fall by €6.2bn to give it €20.5bn in the period 2020. However, given the harsh austerity measures that the current government is inflicting on the country right now, Czech Prime Minister Petr Necas

However, Basescu's nemesis, Prime Minister Victor Ponta, said he was disappointed that the increase enjoyed by Poland was not matched by Romania. "However we want to spin the numbers, it is a very bad result, the worst we could have had,

"However we want to spin the numbers, it is a very bad result, the worst we could have had"

bne March 2013

Central Europe

This target date was part of Latvia's exit strategy form the crisis. From this point of view the Euro Commission has no issues with the target date," Dombrovskis maintains.

was at pains to try to paint the deal as a victory for both prudence and munificence. "The negotiations were very complicated and I do not deny that they were also very demanding," Necas said, claiming that his threats ahead of the summit to veto the budget package helped Prague raise its funding levels. "A cut has been made... It is really an austerity financial framework." Yet it's just this kind of ambivalence that is likely to cause further problems for the budget agreement. "This is a good budget for Poland, but not necessarily for Europe," EU Budget Commissioner Janusz Lewandowski said on Polish television, predicting tough negotiations in the European Parliament when it comes to ratifying the budget. "Everyone is eying their neighbours. The Lithuanians show envy about the farming subventions Poland is receiving, the Poles envy Germany. This political envy sometimes outweighs the fiscal vision."

Eurozone means all or nothing at all in Latvia Mike Collier in Riga

But in a warning to bolshy parliamentarians, European Council President Herman Van Rompuy said they have to think twice before rejecting this European budget, "because for the people, for the enterprises, for employment, for youth, for youth employment, for prosperity – the stakes are really high."

I 27


hen Estonia joined the Eurozone in 2011, antieuro campaigners famously compared the move to buying the last ticket aboard the Titanic. The European single currency has been shipping plenty of water since then, though it has yet to hit its fatal iceberg. In neighbouring Latvia, eurosceptics have been using the same analogy, though the parliament's narrow January 31 vote in favour of euro adoption could be better described as missing the boat, cobbling together a raft of austerity measures, paddling like stink to catch up and climbing aboard with arms aloft in true Leonardo di Caprio style. Speaking exclusively to bne minutes after he won the vote rubber-stamping Latvia's euro changeover plan by 52 votes to 40, Prime Minister Valdis Dombrovskis was in triumphant mood. "A year ago Latvia was the only country saying, 'We will stick with the target and we are willing to join'. Other countries were hesitating. Now the situation is changing – Lithuania has set a target

date of 2015, the Poles are thinking seriously about 2017 and so on," Dombrovskis says. Asked if there is any basis on which Brussels and the European Central Bank could refuse Latvia's application to start using the euro next year or suggest a delay while they consult their charts, he was unequvocal: "I wouldn't think so… we fulfill the [Maastricht] criteria and we approach the application with confidence." "There is no indication that the European Commission would say, 'Why

High stakes For government at least, the stakes are high. Having made euro adoption the major justification for swingeing austerity measures over the last three years, being holed by Brussels would have huge ramifications, as Dombrovskis himself admits. "If we don't reach this result [of euro adoption] it would have far reaching consequences not only for the government but for the country as a whole, for the economy, for interest rates, for financial stability, so I think it's in out best interests to join the Eurozone." Political analyst Ivars Ijabs of the University of Latvia is more specific. "[A refusal] would seriously undermine the credibility of Dombrovskis and would probably lead to serious losses in the parliamentary representation of [his party] Vienotība in 2014 elections. Most probably a new populist party would emerge, which would get their support from the failure of Dombrovskis." Ijabs also identifies an important fact that tends to get overlooked in an international media that assumes everyone in the country must be passionate about the pros and cons of euro membership. Polls show that support for Eurozone entry is at best lukewarm. A December 3 poll by DNB bank showed just 8% of people were in favour of joining the euro

"One shouldn't over-exaggerate the role of public opinion in joining the euro – unless we have a referendum, which we probably won't" hurry?' Indeed this euro adoption date of January 1, 2014 was agreed with the Commission when we had our [€7.5bn] international loan programme.

as soon as possible, 42% said Latvia should wait, and 41% were opposed to joining. 9% had no opinion either way. But the truth is that with most


I Central Europe

A run on diapers Southern Norway is in the midst of a diaper shortage after a supermarket price war lured enterprising bulk shoppers from Eastern Europe who have cleaned out the shelves, customs officials and retailers told Reuters. Norway is one of the world's most expensive countries, though supermarkets in the south try to lure local customers by undercutting rivals in the price of diapers so much that it made it profitable for residents of nearby countries to start trading in them. The Internet is heaving with Lithuanian sellers advertising Norwegian diapers. Norwegian diapers cost as little as $5.47 for 50, less than half of the prevailing price in the Baltic states. Some shoppers from as far afield as Poland and Lithuania have been stopped with diapers worth up to $9,100, roughly 80,000 diapers. "They told us that the only reason they came to Norway was to drive around and buy diapers to bring back home and resell," Helge Breilid, the chief of customs in Kristiansand on Norway's southern coast, told Reuters. "These people mainly come from Poland and Lithuania, and we have no reason to believe that they are part of any criminal gangs."

bne March 2013

mortgages and other consumer loans already denominated in euros and dualcurrency bank accounts the norm, euro adoption is no big deal. "One shouldn't over-exaggerate the role of public opinion in this – unless we are going to have a referendum, which we probably won't. Despite the rising anti-euro rhetoric of opposition politicians, most Latvians are used to be passive in these issues... the majority simply do not care much about it," says Ijabs.

Eurozone membership," chief financial officer Dainis Senbergs tells bne. "For customers in the USA and Asia, it is still not easy to understand what this place is called Latvia. It is different with the Eurozone, as that is strongly associated with Europe and it's much better known abroad," Senbergs says.

On the streets of Valmiera, an industrial town 110 kilometres north of Riga, the

The general assumption is that the country will indeed be admitted to the

On the other side of Valmiera's 13th century castle ruins at the cosy Liepziedi un Rozmarins trattoria, co-owner Atis Zentins expresses similar sentiments. "We let foreigners pay in euros if they don't have any lats," he says, speculating that the only impact on his business might be to make payments to Italian suppliers slightly faster. "It's more of a political game than anything else, but it would be a big change and it's important to be positive whenever you make a change." The mood is more positive at the town's major employer, the Valmieras Stikls glass fibre factory, a major exporter. "I think our business will benefit from

Central Europe

euro club. "Our base scenario assumes that Latvia will join the euro area in 2014, which will support confidence and thus promote growth somewhat," says a January 16 assessment by the country's largest bank, Swedbank. Opposition parties have repeatedly bluffed that they might call a referendum on euro adoption, but only Iveta Grigule of the oligarch-controlled Greens and Farmers' Union seems serious about it. Despite peddling a populist line based on fears that the central bank governor is about to drive Latvia's gold reserves to Frankfurt, Grigule should not be underestimated. Though President Andris Berzins has given his assent to the euro adoption law (ironically, Grigule was the sponsor of his controversial presidential bid and had hopes he would refuse it) she has sworn to collect enough signatures to force a referendum on the subject – provided she can find enough Latvians who actually care.

I 29

refused a banking licence in the UK and rebuffed from attempts to buy into struggling Swedish carmaker Saab, was stealing billions of euros from the bank. Antonov is currently in the UK fighting extradition to Lithuania, as well as a lawsuit from Snoras' administrators. Meanwhile Lithuanian authorities are racing Latvia in scouting the globe trying to track down millions in missing assets.

"Saying no to the Eurozone would damage the perception of Latvia among foreign investors," he adds.

"Saying no to the Eurozone would damage the perception of Latvia among foreign investors"

question of Latvia's Eurozone bid is of minimal interest. "I don't think about it," says Anete Kurpniece, manager of Dodam, a small office providing everything from translation services to souvenirs. "It will change nothing whether we join the Eurozone or not. In effect we already use the euro anyway – the exchange rate is fixed and we take euro payments from foreign clients."

bne March 2013

The Baltic banking bust bne


ong regarded as riven with criminality and appallingly supervised, the banking system in the Baltics received another blow to its already tarnished reputation in February when Ukio Bankas, Lithuania's sixth-biggest bank, was declared insolvent. On February 12, the Bank of Lithuania suspended Ukio Bankas' activities and appointed an administrator, saying the lender was a lost cause after it had crossed risk thresholds and was exposed to huge loans to parties related to majority shareholder Vladimir Romanov. Temporary administrator Adomas Audickas has said that Ukio's liabilities exceed its assets by approximately LTL1.1bn (€319m). "The Bank of Lithuania recognised Ukio Bankas as insolvent and permanently terminated its license. Taking into account the conclusion and proposals presented by the temporary administrator regarding the restoration of the stability and reliability of Ukio Bankas, the board... decided to transfer the assets, rights, transactions and liabilities to another bank."

Lithuanian regulators moved swiftly to announce on February 18 that the good assets of Ukio Bankas would be sold off to rival Siauliu Bankas, which is backed by the European Bank for Reconstruction and Development (EBRD). The speed and decisiveness of the central bank's actions suggests it has learnt valuable lessons from the last few troubled years. It was much criticised for its performance in dealing with Snoras the country's fifth-largest bank at the time of its collapse in November 2011.

Bank of Lithuania's governor Vitas Vasiliauskas told a press conference that a sale of Ukio Bankas to Siauliu Bankas would be the least costly and fastest way to resolve the problems posed by the insolvent lender, despite reporting earlier that at least four banks had expressed an interest in the assets. Vasiliauskas insisted that a swift and decisive approach "would better protect the confidence of the shareholders in the stability and reliability of the banking system, as well as other public interests, rather than liquidation." Under the terms of the deal released February 24, Siauliu Bankas will assume the insured deposits of insolvent Ukio Bankas, taking over LTL2.7bn ($1bn) of deposits and assets of the same value. The EBRD will grant Siauliu Bankas a €20m, 10-year subordinated loan to strengthen its capital base for the expansion. The contract obliges Siauliu Bankas, "to renew banking services for the customers of Ukio Bankas in the shortest time possible,” the Bank of Lithuania said in a statement. The deal will see Siauliu Bankas, which

"The Bank of Lithuania recognised Ukio Bankas as insolvent and permanently terminated its license" The Bank of Lithuania – as well as its peer in Latvia where Snoras subsidiary Krajbanka also went under – was widely derided for its failure to spot that owner Vladimir Antonov, who was

had assets of LTL2.9bn on December 31, double in size and overtake Danske Bank to become Lithuania’s fifthlargest lender by assets. “The achieved agreement will result in new and bigger


I Central Europe

bne March 2013

"There were worries over how much was available in the deposit-insurance fund so soon after the collapse of Snoras"

possibilities of growth for our bank’s clientele, staff and shareholders, while the entire banking system in Lithuania will become stronger and even more competitive,” Siauliu's chairman Algirdas Butkus said in a statement. The transaction will also reduce payouts from the Baltic nation’s deposit insurer to LTL800m compared with LTL2.7bn

Central Europe

Bankruptcy proceedings are planned to recover remaining the assets of Ukio Bankas, which include foreign assets that Ukio majority owner Vladimir Romanov had pledged to the bank as security on loans. Those include assets related to Edinburgh football club Heart of Midlothian, the Birac AD alumina producer in BosniaHerzegovina, real estate in Moscow and other things.

But a rescue will involve juggling a lot of balls.

Keeping LOT aloft Jan Cienski in Warsaw


ir disasters are usually caused by a cascade of improbable failures that build to a catastrophic conclusion – the same is true for ailing airlines, as LOT Polish Airlines is finding out as it battles to stay aloft.

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

I 31

fuel supply contracts that were drowning the airline in red ink. He left after falling afoul of the airline's powerful unions, but was summoned back by an embattled treasury minister, Mikolaj Budzanowski, whose own job is in danger from a furious prime minister, and given a very broad licence to rescue the airline as quickly as possible. "I have [Donald Tusk's] blessing to do whatever is necessary. I am being permitted to do what was not possible two years ago," Mikosz told reporters just a few days after taking over the airline.

determined by auditor KPMG Baltic, could be revised in three months after a more detailed assessment, in which case the liabilities of the parties to the contract will also be revised, the central bank said.

in case of bankruptcy, a crucial development as there had been worries over how much funds were available so soon after the collapse of Snoras. The government was clearly eager to avoid another bankruptcy that would test the stretched deposit-insurance fund. The preliminary value of the assets transferred to Siauliu Bankas,

bne March 2013

LOT, owned by the state treasury, has been in trouble for more than a decade, but seemed to be finally turning a corner last year, with management predicting a PLN52m (€12.5m) profit for the year, boosted by the PR buzz of becoming the first European carrier to take possession of Boeing's new 787 Dreamliner. Instead, the flag carrier had to turn to the government for a PLN400m emergency injection of cash in December just to be able to keep flying, and now looks likely to post a net loss of about PLN200m for the year. That revelation ended up getting CEO Marcin Pirog fired. Added to the airline's woes, the Dreamliner was brought down to earth with suspected problems with its innovative batteries – leaving LOT unable to use it on lucrative long-haul routes. On February 14, the airline said that its two current Boeing 787 Dreamliners will remain grounded through the summer

season until November, forcing LOT to extend the lease on three Boeing 767s that it currently uses and look to lease two more 767s for the summer season. LOT of bad news LOT has also been savaged by fierce competition from low-cost carriers like Ryanair and Wizz Air, who are much cheaper and more nimble than the lumbering former national airline. At the top end of the market, big European carriers like Lufthansa, BA and

One is negotiating with the European Commission, which has to approve the December rescue package, as well as any further aid for restructuring the airline, which could come to an additional PLN600m. The rescue plan is supposed to be presented to the Commission by June 20, and its approval is likely contingent on LOT cutting capacity so as not to violate the EU's competition regulations. Another is figuring out what to do about the Dreamliners. Mikosz said by scratching them from LOT's line-up, he will have to rely instead on older 767s, which have fewer lucrative business and premium seats. Meanwhile, LOT has to continue making payments for airliners sitting uselessly on tarmacs in Warsaw and Chicago. "Dammit, the Dreamliners would have finally given

"I am being permitted to do what was not possible two years ago" Air France siphon off Polish passengers through their west European hubs to long-haul destinations. A new threat has also landed in the form of MiddleEast airlines Qatar and Emirates, who are offering rock-bottom fares to Asia through their Gulf hubs. The man riding to LOT's rescue is Sebastian Mikosz, who was its CEO in 2009-2010 and helped it extricate itself from the consequences of badly drafted

us a bit of a competitive edge," said an obviously frustrated Mikosz. He has written to Boeing asking for help in negotiating new leases for the fleet needed to make up for the lack of Dreamliners. Once the current crisis is over, LOT is also likely to ask Boeing for compensation. He is also preparing the airline for another round of layoffs, sending a


I Central Europe

request to local authorities for as many as 500 job cuts out of LOT's 2,300 staff. "If there are no group layoffs, the airline will not survive," said PM Tusk, who is keen to avoid a similar kind of political fallout from LOT going bankrupt that the Hungarian government faced when Malev went belly up in spectacular fashion in 2012. Mikosz is also tweaking the schedule, dropping four routes that were not making money while adding long-hauls to New York and Chicago, where LOT has a competitive advantage in offering direct flights to Poland for the large Polish diaspora that lives there.

bne March 2013

He is also pressing the government to move quickly to change a law that reserves a majority of voting shares for the state, a restriction that makes LOT an unpalatable potential takeover target. "I don't believe in a privatisation process that does not allow for a change of control," Mikosz said, noting that the law scared off potential buyers during his previous stint as CEO. "I am counting on the government to change the law, it is a litmus test of its intentions towards LOT." That is Mikosz's goal – to turn LOT around as quickly as possible and prepare it for sale before the end of this year.

Budapest Airport flies by seat of its pants Kester Eddy in Budapest


t may only have been a minor airline – 22 small and medium-sized jets hardly constitutes a major carrier in the global scheme of things – but for many Hungarians the collapse of Malev last year is one of those defining "What were you doing when....?" moments. On February 3, 2012, Hungary's flag carrier for 66 years was grounded overnight, leaving thousands of very worried passengers at Budapest's Liszt Ferenc airport frantically seeking alternative flights. Less frantic, but probably more worried, was Budapest Airport, the Germanowned operator of Liszt Ferenc, and thousands in the Hungarian hospitality sector. Malev was responsible for 40% of the 8.9m passengers that used the airport in 2011; the potential loss of this traffic would be devastating, certainly for the airport. Yet 12 months on – unemployed former Malev staff apart – it is almost a case of "crisis, what crisis?"

With low-cost airlines – notably Wizz Air and Ryanair – along with traditional carriers rushing to take up the slack, Budapest Airport boasted a footfall of 8.5m passengers last year, just 4.7% down on 2011. "I think this represents a pretty good recovery, particularly given the global economic troubles," Mihaly Hardy, communications director for Budapest Airport, tells bne. The airport also attracted a batch of new airlines, including Air Berlin, Aegean and Blue 1, and began offering 15 new (and so far successful) destinations, including Ekaterinburg, Lyons, Alicante, Warsaw, Modlin and London Stansted. However, along with Malev, a clutch of airlines, including American, Delta and regional carrier Carpatair, along with about 20 routes, were lost. Further, after the dramatic shake-up, the number of air traffic movements, ie. the takeoffs and landings, slumped by more than 20% to 87,560 – a level similar to when budget flights first began serving Budapest a decade ago.

The most obvious partner would be a European carrier, who would be able to take control of LOT and incorporate it into its own network. However, the big carriers have made it clear that they are not interested at the moment. Non-EU airlines are constrained by EU regulations from taking a majority stake in an EU carrier – one of the factors that dissuaded Turkish Airlines from making a bid last year, but Mikosz feels that a creative approach could make LOT interesting for a non-EU airline. "I am convinced and I believe that LOT can be privatised," he said. "That is my most important goal."

This decline – which will hit the airport's top line – was in part due to scheduled airlines increasing the size of airplanes (to make up for the lost Malev capacity) and in part due to the dramatic loss of feeder routes that used Budapest as a hub. The latter included Beirut, Damascus, Chisinau (Moldova) and capital cities in the successor states of Yugoslavia. "There are some 12-16 ex-Malev, low-density routes from [Budapest airport] that are not flown by anybody at all now,” says Hardy. While these did not account for large numbers of passengers, their loss is significant in terms of using Budapest as a regional centre. "For myself and others here, travelling from Budapest has become much more inconvenient," Roger Swinburn, a Budapest-based headhunter operating throughout the region, says. "Malev made Budapest a hub; now we are on the end of others' spokes, and this will surely put off some new investors." Moreover, in spite of the new destinations served by no-frills carriers, these often prove less than attractive to business travellers. "Budget airlines are not really budget when the all-up costs [including ticket flexibility] are considered. On top of that, one often ends up at some remote airport with further costs, and time, to get into the city centre,” Swinburn notes.

bne March 2013

Tourism professionals, however, acknowledge the swift response of airlines, particularly the low-cost carriers, has been a major factor in supporting visitor numbers to Hungary. "In the short run, the grounding of Malev has not affected incoming tourism significantly… From January to November last year, foreign guest nights in hotels in Hungary were up by 11%, and in Budapest by 14.6%," says Gergely Horvath, head of tourism at Hungarian Tourism. The result was that revenues in hotels were up by 10.3% in the 11 months of 2012. Yet these figures, though positive at first sight, also fail to give the whole story. In essence, tourism professionals seek high-spending clients, which translates to conference and corporate events, where spending is not merely on accommodation, but on food and drinks throughout the day. "The big problem with conference tourism is they don't really like the budget carriers or the changes [often involved with flying with carriers such as Lufthansa]. Our fourstar revenues are up, but we miss the big spending events. Especially our top hotels, like the [Castle] Hilton and SAS Beke are missing these [hospitality] revenues," Judit Liptai, sales director for Budapestbased Danubius Hotels, tells bne. In addition the weaker forint currency and the over-optimistic expansion of accommodation in the past decade in Hungary has led to a surfeit of rooms, and lower average room rates as hoteliers chase custom. "Everyone wants to keep a share. Five-star hotels are charging four-star prices, four-star are charging three star," Liptai says. Budapest Airport, meanwhile, says it's striving to attract new carriers and maintains that – despite cost-saving measures – confidential surveys reveal "passengers believe that security screening – politeness and helpfulness, thoroughness, waiting time, and general sense of security" has improved. Not every customer is satisfied, however. Ryanair, famous for its aggressive stance towards what it sees as laggard or greedy

Central Europe

I 33

Hungary rides the wave

bne Hungary finally sold its first issue of international debt in nearly two years on February 12 as it rode the emerging market wave of liquidity to raise $3.25bn from the sale of 5- and 10-year bonds. This, despite the breakdown of talks over a bailout with the International Monetary Fund (IMF) and continued vexation at the government's capricious economic policies. Budapest sold $2bn worth of 10-year paper at a yield 345 basis points (bp) above US Treasuries, while a $1.25bn tranche of five-year bonds were sold at a spread of 335bp. Both issues tightened 10bp below initial pricing, to offer spreads unimaginable six months ago. Back then, Hungary was locked in recession, struggling under the highest debt burden in Emerging Europe, at odds with banks and investors, legally challenged by the EU over constitutional changes, and failing to get the IMF to even talk to it over a bailout. None of that has changed much, but the hunt for yield around the globe has boosted Hungary's yields and the forint over the last few months. Long suspected of "doing a Turkey" – claiming to be after a loan programme from the IMF in order to keep the markets off its back until it could regain access to the international markets – Budapest grew more belligerent with the Washington-based lender in late 2012 as it watched its Visegrad peers selling debt at record low yields. With Hungary facing a huge repayment schedule of ¤5.1bn this year – much of it to the IMF under a 2008 loan – and dwindling international reserves, a tap of the first quarter emerging market rally has been on the cards for some time. However, the proof of the pudding is in the eating, and analysts welcomed that Budapest finally got the issue away successfully, as it covers 40% of its foreign-exchange refinancing needs this year, some $7.5bn in total. The IMF grudgingly congratulated Hungary, saying it has benefited "tremendously" from the "global tide" of liquidity and the government's fiscal commitment, Iryna Ivaschenko, the IMF's representative in Budapest said. However, she added, the country remains "susceptible to sudden changes in investor sentiment."

operators, complains of "excessively high landing fees, inefficient facilities", as well as a general unwillingness to cooperate to develop traffic. Robin Kiely, Ryanair spokesman, tells bne that Ryanair switched two aircraft from Budapest in late 2012 with the loss of 10 routes, reductions on nine others and the loss of 110 weekly

flights. "Sadly, 800,000 passengers per annum and over 800 jobs will be lost by Budapest to other airports elsewhere in Europe, where Ryanair will continue to grow," he says. The route to full recovery at Liszt Ferenc International will clearly be a turbulent ride.


I Central Europe

bne March 2013

Cognitive's technology first came to the attention of the US military, which was interested in its ability to monitor internet traffic for anomalies that could signal that a system was being hacked. "It's like we are acting as the immune system of a network that finds strange or non-typical things in the body and these are highlighted," Rehak, Cognitive's chief executive, told bne.

Buying some Czech security

At first only military or government institutions were interested in such technology because they were the only ones being hacked at such a level, explained Rehak, but industrial hacking has grown to a point where it has now become a problem at all levels. "This problem has become much more widespread and is now a standard issue for the networks of companies, both big and small," he said.

Nicholas Watson in Prague


ust weeks after Cisco Systems CEO John Chambers said he had written a blank cheque to beef up its security business, the US technology giant has tied up its first deal with the acquisition of the Czech Republic's little-known but highly promising Cognitive Security. The deal, say analysts and industry players, is further proof of Central and Eastern Europe's growing clout in the technology sphere, in particular cyber security. Cisco announced January 29 its intention to acquire for an undisclosed amount Cognitive, a Prague-based company specialising in technology for network behaviour analysis, which allows businesses to identify, and protect themselves against, sophisticated attacks on their networks. The selling shareholders include the founders Martin Rehak and Michal Pechoucek, Credo Ventures, several angel investors, and board members/ advisors including Richard Seewald, Vlado Jez and Karel Obluk. The deal is an important first step for Chris Young, Cisco's first executive for security appointed at a senior vice president level, who has been charged

with overhauling the US firm's security business over the next two to three years. Cisco is still the leader in the network security field, though it's struggling as its legacy products lose ground to smaller innovative rivals such as Juniper Networks and Palo Alto Networks. Acquisitions in this space don't come cheap, though, hence Cisco's move down the food chain to foreign, early-stage innovators like Cognitive. The founders of Cognitive, which was a commercial spin-off from Prague's venerable Czech Technical University

Until now, network security has primarily focused on securing the perimeters of networks, but "even if the door is locked, someone can get through the window and we can detect that," said Rehak. This opens up lucrative new possibilities for a $10bn-15bn industry that has, to some degree, become commoditized. "Cognitive Security is in an interesting space, as the evolution of malware and malicious threats go well beyond the perimeter (handsets and PCs) and now deeper into the network where valuable IP and specific disruption of business functions is

"Even if the door is locked, someone can get through the window and we can detect that" (CTU) in 2009, told bne at the end of last year that their company was in the process of hunting for a second round of financing. The first round came from local venture capitalists Credo Ventures in April 2011, which invested a reputed â‚Ź1m out of its Credo Stage I Fund that targets early-stage tech firms in the region, primarily from the Czech Republic and Slovakia.

targeted by hackers," the board member Seewald told bne at the end of last year. "Cognitive offers security as a service platform which is scalable and protects against these advanced variations of malware for large corporates, governments and small business where I believe vulnerability will be the greatest in the coming years."

Southeast Europe I 35

bne March 2013

Europe's soft underbelly of crime Andrew MacDowall in Belgrade


ith its mountainous landscape concealing remote valleys, indented coastline and position between Europe's east and west, the Balkan Peninsula has all the makings of a smugglers' paradise. Add to this widespread poverty, a history of conflict and, these days, weak institutions and rule of law in many parts, and it is easy to see why the region is plagued by organised crime. The problem was brought sharply into focus on January 29 as 1,200 Europol officers made simultaneous raids in ten countries, swooping to arrest 103 people in the biggest operation against a migrant smuggling network in EU history. The EU's law enforcement arm was acting against suspected members of a criminal network based in Kosovo, with strong links to Turkey's underworld.

The raids, in Croatia, the Czech Republic, France, Germany, Greece, Hungary, Poland, Slovakia, Turkey and Kosovo, involved 117 properties. More than â‚Ź176,500 in cash, as well as computers, mobile telephones and a rifle with ammunition were seized. Europol said that those arrested were suspected of involvement in smuggling illegal migrants into and within the EU from countries including Libya, Iraq and Syria, via Turkey and the Balkans. "They were often smuggled in inhuman and dangerous conditions, such as in very small hidden compartments in the floors of buses and trucks, in freight trains or in boats," the agency said. Officials said that the organisation had been "significantly disrupted", and that around 20 remaining unknown members would be tracked down.

Hidden problem The grim fate of many trafficked migrants is no secret. The deaths of 16 who drowned in the River Tisza while attempting to cross from Serbia into EU member Hungary in 2009 highlighted the issue; in 2000, 58 Chinese migrants were found suffocated in the back of a lorry at the British port of Dover. The majority who survive often work in dreadful conditions for miniscule wages, exploited by employers; some women are forced into the sex industry. There are also concerns that jidhadist terrorists could use the Balkans as a conduit to Europe, and there are allegations that training camps exist in some of the more remote areas, particularly in predominantly Muslim regions – though there is scant evidence of substantial operations. Last year, Russian media claimed that Syrian rebels were being trained in Kosovo.


I Southeast Europe

"It tells us that Turkey and the Western Balkans remain an important route for illegal migration into the EU as well as a sort of a soft underbelly of Europe," Dimitar Bechev, head of the European Council on Foreign Relations office in Sofia, tells bne. "The in-between position of Southeast Europe, halfway inside the EU but outside too (for example, Turkey

bne March 2013

becoming very rich in the process. Weak governments too often accommodated organised crime, sometimes with lucrative results for the politicians involved. While criminals do not operate with the same impunity now as they once did in the 1990s, there is little doubt that the

"It tells us that the Turkey and Western Balkans remain an important route for illegal migration into the EU as well as a sort of a soft underbelly of Europe" hasn't yet signed a migrant re-admission agreement), provides opportunities for cross-border criminal networks. In the Balkans, in particular, they are known for cooperating smoothly across ethnic lines and state boundaries. The other key point is that the Western Balkans and Turkey are now primarily transit countries, not countries of origin, as far as migrants are concerned." While people trafficking can be one of the most saddening aspects of organised crime in the Balkans, it is far from the only one. Drugs, contraband cigarettes and sometimes weapons cross borders with relative ease. The Balkan region's geographical position is of course a key factor – it lies between countries from which people want to emigrate due to poverty and instability and the wealthy, stable countries of Western Europe. It also lies between major narcotics producers and big European markets. But the volume of trafficking and other organised crime in the region is also attributable to other factors. In the power vacuum after the fall of Communism criminal networks, some linked to the old elites, were able to establish themselves. The wars in Yugoslavia created a nexus between organised crime and conflict, with some

Balkan region still has an undercurrent of crime and corruption. Governments have limited administrative capacity to deal with the issue, and officials are sometimes compromised, from senior politicians taking kickbacks to border police taking bribes. Anti-corruption purges have had some success – Romania's under Justice Minister Monica Macovei in the last decade, and Serbia's current drive led by Deputy Prime Minister Aleksandar Vucic have certainly proved popular – but have been incomplete and challenged by allegations of political bias. Allegations have just surfaced in Serbia of links between Prime Minister Ivica Dacic and a senior organised crime figure, though Dacic's Socialist Party claims these are politically motivated smears.

The scale of the Europol swoop indicates what a problem organised crime is in the Balkans, and the concerns that European authorities have about it. The fact that the large smuggling gang implicated in last week's bust was apparently based in Kosovo is perhaps no coincidence. The country is located at the heart of the Balkans, has weak institutional infrastructure, exists in an international legal limbo, is scarred by recent conflict, is relatively poor and has senior politicians who have been implicated in serious crimes. Most of the region is not in such a parlous state, but no countries therein have been able to shatter the criminal networks that stretch far beyond their borders. There is a silver lining to be found in all this, say some: the problem is pushing nations that have not traditionally cooperated into working more closely with each other. The latest raids are a case in point, but actually continue a growing trend of such cooperation. Europol on February 4 announced it had uncovered an extensive criminal network across 13 European countries, including several in the Balkan region, involved in football match-fixing that generated over €8m in betting profits Fighting Balkan gangs is now a collaborative continent-wide operation, in which the various actors work to their strengths. In Croatia, for example, the French and Italians have better connections than the British do, while the UK focuses on the Albanians and Serbia.

"The scale of the Europol swoop indicates what a problem organised crime is in the Balkans"

bne March 2013

Southeast Europe

I 37

Together this has spawned a surge of interest in new coal plant development, which promises eventually to help re-balance Turkey's power generating portfolio with 19 plants totalling close to 7 GW already licensed and under development and more projects set to follow.

Turkish coal faces a revival David O'Byrne in Istanbul


he recent announcement by Turkish economy minister Ali Babacan that Turkey's investment incentive scheme is to be expanded to include investment in power plant burning locally produced lignite has re-ignited interest, both foreign and domestic, in Turkey's sizeable but underused domestic coal reserves. Despite reserves of 11.8bn tonnes of lignite and 1.3bn tonnes of hard coal and new reserves still being discovered, the development of coal-fired power plants in Turkey has been slow with private developers opting to develop cheaper plants to build and operate that burn gas. Now with Turkey's gas demand expected to exceed its 51.8bn cubic metres a year (cm/y) import portfolio within the next couple of years, Turkey is keen to reverse the trend and make more use of its domestic reserves. Not just because dependence on gas for power generation last year reached a worrying 42%, but also because energy imports are the single biggest contributor to Turkey's increasingly problematic trade and current account deficits, the main issue which continues to hold down Turkey's international ratings. "We have no gas and no oil, so it makes sense to develop

the coal reserves we have," says Ankarabased energy analyst Haluk Direskeneli, explaining that while most of Turkey's coal is poor quality it is still cheaper to burn than imported alternatives. "The quality of Turkish coal is low," echoes Mustafa Karahan head of

Already announced is a plan to develop as much as 8 GW of new capacity burning lignite from the massive AfsinElbistan field in southeast Turkey. Abu Dhabi power giant Taqa and Turkey's state power generation company EUAS signed an memorandum of understadning in late December that will see the pair work together on projects to renovate an existing 1.4 GW plant burning coal from the Afsin field and build a new 1.4 GW plant alongside. A contract for this first phase is expected to be signed in the next few months, after which work will begin on detailed plans for the remaining 6.6 GW taking the total investment to close on $12bn. With reserves of 4.4bn tonnes, Afsin Elbistan holds a third of Turkey's known coal reserves, while the planned 8 GW development makes it the biggest power

"We have no gas and no oil, so it makes sense to develop the coal reserves we have" Turkey's Energy Traders Association. "But the incentives the government plans to issue will help cut investment costs." The black stuff The past year has seen a slate of new initiatives aimed at making the most of these reserves, with Babacan's announcement of new incentives following closely on the heels of new legislation allowing for the privatisation of the state-owned coalfields along with the 6.7 gigawatts (GW) of plant they supply, and a raft of new tenders for the development of unexploited coal reserves.

project in the country's history, dwarfing even the 5 GW nuclear plant being developed by Russia's Rosatom. Other state-owned coalfields are also up for development, with state lignite extractor TKI late last year opening tenders for the development of two fields and the construction and operation of two new coal-fired plant totalling 570 MW. More tenders are expected to follow with Energy Minister Taner Yildiz recently announcing the discovery of a 1.8bn tonne lignite field near Konya in central Turkey capable of supporting up to


I Southeast Europe

Taking stock in Turkey

bne What ails the once high-flying Turkish stock market? Since January 24, the Istanbul Stock Exchange's main index has fallen 10%, taking it down to its lowest level since a car bomb at the border with Syria killed 10 people on December 21. Part of the problem, say analysts, is Turkey is suffering from a more general gloom hanging over emerging market stock markets. The MSCI Emerging Markets Index by mid-February was down at its lowest level since January 1 as worries about global growth take their toll. However, there are more specific concerns about Turkey's stock market, which soared by more than 50% in 2012 to set a series of new record highs, in stark contrast to many other Emerging European markets. Turkish equities were lifted by rapid economic growth of 8.5% in 2011, and the following "soft landing" engineered by the government and central bank last year that resulted in Fitch Ratings awarding the country its first investment grade credit rating in October. However, concerns have been rising that new regulations over share trading in one of the world's hottest markets could be in the works, especially since it emerged that the owners and managers of Turkish food processor Mango Gida Sanayi & Ticaret had sold 34% of the company on the ISE between October 1 and a January 30 announcement that it is facing creditor demands against its assets, news which sent the stock plunging 47%. Those sales, reports Bloomberg, included 3.5m shares divested on January 28, just two days before the company said in its announcement to the stock exchange that it was seeking to sell assets, meet potential buyers, cut its workforce and stop packaging activities after creditors sent the company seizure and payment orders totaling TRY38.3m. Mango Gida Sanayi & Ticaret's chairman, Ayhan Karak, has claimed the shares were sold in order to loan the proceeds back to the company to help it through its difficulties. "There currently is no new development that we haven't announced through the Istanbul Stock Exchange," he told Bloomberg on February 5. "We were selling our shares, but then using the proceeds to lend to the company. Talks are ongoing" to resolve the company's financial difficulties. Karak and his vice chairman, Mehmet Yayla, are now owed TRY7m-8m by the company, he said, making them effectively "creditors". However, that will likely provide little solace to the buyers of the shares, who were not identified by Bloomberg. The case is unlikely to help Ankara's professed ambition to develop Istanbul into a global financial centre. Turkey's Capital Markets Board refused to comment on individual companies, but an insider trading scandal would do little to help keep the momentum going in the Turkish stock market, especially if renewed worries about the Eurozone crisis cause money to be pulled out of emerging markets, say analysts.

bne March 2013

bne March 2013

Southeast Europe

government to submit this "performance guarantee" of €170m. If Vetro was to be believed, coming up with that "performance guarantee" should not have been a problem, because Taci, Vetro's majority shareholder who enjoys close ties with Prime Minister Sali Berisha, said in a statement on November 22 that his group had, "finalised financing and investment of capital" for the €850m deal.

5 GW of coal fired plant, and that plans are underway to open a tender for the development of a separate 510m tonne field in Turkey's European province of Thrace. No less significant was the announcement in early February by Turkey's Hattat holding that it is talks with Chinese and South Korean companies to develop a 1.32 GW plant burning coal from the group's mines at Amasra in northern Turkey. Hattat plans to sign a deal on the $3.5bn investment by June with construction work slated to begin by the end of the year. International Coal Opportunity Turkey's dash for coal is not limited to domestic reserves. Despite no incentives being offered, interest in constructing plant burning imported coal is high thanks to falling international coal prices. "The discovery of shale gas in major coal exporting countries such as the US, Australia and South Africa means that international coal prices have fallen," explains Mustafa Karahan. A slate of license applications have been made for new plant including one from a consortium led by France's GDF-Suez for a 1.32 GW plant to be built at Yumurtalik on Turkey's East Mediterranean coast. Another consortium led by Turkey's Bilgin Enerji is planning to build a plant of similar size in the same area while Turkey's Alarko group is planning to build a 1.32 GW plant at Biga on the coast of the Sea of Marmara.

I 39

The stakes were high, because Albanian Deputy Energy Minister Sokol Dervishaj told reporters on December 10 that if Vetro failed to come up with the cash, the government would claim the 10% of its tender offer that under the rules was guaranteed by a reputable financial institution, in this case Chicago-based American Chartered Bank.

Albania's oily opportunists Nicholas Watson in Prague


he Albanian government said February 8 that it has invalidated the winning bid from a consortium headed by a local businessman in the tender for state oil firm Albpetrol after it failed for two months to come up with a down payment. The decision to annul the result of a clearly flawed tender brings to an end what was rapidly becoming a national embarrassment for the Albanian government, which is trying to convince the EU it is clamping down on corruption and cronyism in one of the poorest corners of Europe that desperately needs foreign investment. Nevertheless, serious questions remain about the conduct of the winner of the tender, local tycoon Rezart Taci's Vetro Energy, as well as that of the Albanian government and the adviser on the tender, US law firm Patton Boggs. Energy Minister Edmond Haxhinasto broke a two-month silence over the fate of the October 2012 tender for Albpetrol when he said on national television that the government had decided to, "consider the first offer invalid" after Vetro

failed to pay €170m, equal to 20% of its winning bid. The Chicago-based Vetro, bidding through the Singapore-registered Vetro Silk Road Equity consortium, offered a huge €850m for Albpetrol, which was more than twice the next-highest bid from the Chinese consortium Win Business Petroleum and three times the third-placed offer from Bankers

Except bne can reveal that American Chartered issued no such bank guarantee for the 10% of Vetro's bid. "American Chartered cannot discuss or disclose the specifics of its relationships with its customers, but I can confirm that American Chartered Bank was not involved in the transaction in question," American Chartered's legal counsel wrote in an email dated December 13, 2012. Doubts about the existence of the bank guarantee are also backed by Gary Kokalari, founder of Albanians for a Democratic Albania, which is involved in fighting corrupt practices in Albania, who tells bne that he contacted an official with the Chicago office of

"The questionable nature of the bank guarantee was only one of a number of dubious aspects surrounding the privatisation of Albpetrol"

Petroleum of Canada. "This decision has authorized the group of negotiators to continue evaluating the other offers," Haxhinasto said on Top Channel. The last public statement from Vetro was back in December, when it confirmed that it had been asked by the Albanian

the supervisory division of the Federal Deposit Insurance Corporation (FDIC), a US federal body that guarantees the safety of a depositor's accounts in member banks. The FDIC then conducted an audit of American Chartered and found no evidence that the bank had provided any such a guarantee for Vetro to buy


I Southeast Europe

EU says Albania candidate status "within reach"

bne EU Commissioner for Enlargement Stefan Fule was in Tirana in February, making encouraging noises about Albania's ambitions to join the EU. But is there really much appetite elsewhere in the EU to take in a country that so flagrantly disregards the norms of business? As well as the embarrassingly botched privatisation of its largest asset, Albpetrol, to a politically connected oligarch (see accompanying story), the government is also knee-deep in a dispute with CEZ after revoking the operating licence of the Czech utility's electricity distribution subsidiary in the Balkan country. In February, CEZ officially informed the Albanian government of its intention to initiate international arbitration. In the arbitration, CEZ said it would be seeking damages for its failed investment in the Albanian distribution network. Media have reported that CEZ's total losses amount to around ¤200m, which includes the initial investment, services to the subsidiary and invoices for electricity supplies from the parent company. The move was the latest twist in a long-running saga that has seen CEZ at loggerheads with the Albanian government since it bought, with World Bank backing, the country's electricity distribution company for EUR102m in 2009 as a way to help improve the sclerotic power sector there. The World Bank regards Albania's problems with brownouts as a major hindrance to the economy. But Albania claims as part of its attack on the Czech company that CEZ has failed to invest in order to limit electricity losses in the distribution system, and failed to import the required amount of power needed to meet the percentage of Albania's power deficit agreed in the licence. CEZ counters that it has been forced to run the company at a loss due to a hike in wholesale prices from the state-owned generator, while not being allowed to raise consumer tariffs. Furthermore, many households and businesses, both state and private sector, simply don't pay their electricity bills, CEZ says rightly. The unilateral decision by the Albanian regulator to revoke CEZ's licence on January 21 has already prompted Czech Prime Minister Petr Necas to wade into the row. He called Albania's move to revoke the licence a "very negative" signal for relations between the countries and raised questions about the Balkan country's commitment to EU entry. "The action taken by Albanian authorities towards CEZ is a big disappointment," Petr Necas said in a statement, in which he vowed to back the company's efforts to seek damages. Ahead of his meetings with Albania's president and prime minister, EU Commissioner Fule said that candidate status for Albania "is within reach". The Czechs and many others would beg to disagree.

bne March 2013

Albpetrol. Indeed, American Chartered is a local Illinois bank, with total assets at the end of 2011 amounting to $2.3bn – a guarantee of €85m would represent 5% of its total assets. The posting of such guarantees is crucial to any major privatisation, a failure to provide which should lead to instant disqualification. However, not only was Vetro not disqualified, its claim of a bank guarantee from American Chartered was unequivocally backed by statements from the government commission in charge of running the tender and the adviser to the tender Patton Boggs, a Washington-based law firm which also does advocacy work on behalf of the Albanian government in the US. The October 12, 2012 official bulletin of the Republic of Albania, states that Vetro submitted a bank guarantee, issued by American Chartered Bank, on August 23, 2012 in the amount of €85m. The bulletin goes on to say that the commission in charge of the tender carried out its own checks and also asked Patton Boggs to verify this at Amercian Chartered Bank. "In a letter dated September 25, 2012, a representative of Patton Boggs, Mr. David Farber, has confirmed carrying out checks at this bank and informed the committee that the guarantee is valid and covered by adequate collateral," the bulletin states. "Under these conditions, we estimate that the bid guarantee is valid and meets its goal of financial reliability of the bid submitted by the consortium."

bne March 2013

Southeast Europe

See, hear, speak no evil In fact, the questionable nature of the bank guarantee was only one of a number of dubious aspects surrounding the privatisation of Albpetrol, which is the country's most valuable asset. Bankers Petroleum, which offered just €106m in the tender, explained to bne in November that the large discrepancy in the size of the bids was down to the Albanian government extending Albpetrol’s gas transmission rights from five years to 30 years just days before the deadline to submit bids on September 7. His company, he complained, had no time to redraft its bid. Further, when Prime Minister Berisha announced the winner of the tender on October 3, it was presented as an international company that had won – the Chicago-based Vetro Energy bidding through the Singapore-registered Vetro Silk Road Equity consortium. It was only two days later it emerged that the winning consortium was actually 51%

owned by Taci, who told a October 5 press conference that he had kept his involvement in the bid secret from the public because he did not want it to have any influence on the bidding process. Nobody at Albania's Ministry of Economy, Trade and Energy was available to answer to bne whether it was also kept in the dark about Taci’s involvement. Further enquiries to the prime minister's office regarding the latest questions over the financial arrangements contained in Vetro's bid likewise have gone unanswered. Analysts speculate that the delay between asking Vetro for €170m and the February 8 announcement to invalidate the bid was down to the government giving Taci time to raise the financing. However, in the current economic climate and given the controversial nature of the tender and Taci himself, raising €850m was always going to be a hard act to pull off. So as pressure behind the scenes mounted from the EU

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

Vetro had not replied to a request to comment on these issues by the time bne went to press, nor did it issue a statement on the government's decision to invalidate its bid. However, a source close to Taci was quoted by Reuters as saying Vetro was "surprised by the decision because we were working to finalise the deal." Patton Boggs replied through a spokesman: "Patton Boggs categorically denies that there was any misrepresentation of any matter to our client, the Ministry of Economy and Energy, and any suggestion to the contrary is simply not supportable. We must defer all other inquiries to the Ministry."

and the US, amid increasing questions from the media, the government finally pulled the plug. Some question why it took so long. "It's been wilful blindness by the US and EU. If you do even a cursory examination of Vetro's website about their supposed abilities, and consider their apparent inability to finance the deal, you can tell that they were way out of their depth. And all this stuff was brought to the attention of the American embassy, the Albanian government and their consultants Patton Boggs, yet they decided to proceed with Vetro for reasons that I believe were not based on merit," says Kokalari. "Another part of this story is the damage that the Berisha government is doing by way of inhibiting foreign investment from looking at Albania – this might explain why Albpetrol attracted a rag tag group of bidders," he adds.

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

What you need to know

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

I 41


I Southeast Europe

bne March 2013

to introduce and run a new ticketing system for Belgrade public transport, called BusPlus, speculation has been growing that Belgrade mayor and the new leader of the opposition Democratic Party, Dragan Djilas, is in the government's sights. Taken for a ride In September 2010, Belgrade's mayor sold the rights to install a new ticketing system for Belgrade's public transport to Apex Solution Technology, a shady company with precious little history. The company is thought to be a phantom company, possibly orchestrated and run by the mayor himself, local media alleges.

Serbia govt's anti-graft drive set to run Dejan Kozul in Belgrade and Nicholas Watson in Prague


ince winning the election last year, the Serbian Progressive Party and its coalition partners have embarked on a wide-ranging anti-corruption drive that has already snared the country's richest man, Miroslav Miskovic. Will the leader of the main opposition party and the mayor of Belgrade, Dragan Djilas, be next? The new government's campaign taps into a rich vein of discontent among the population about the rampant corruption in the country and has boosted the Progressives' standing in the polls. Research by the Anti-corruption Agency of Serbia last year showed that almost 80% of the population considered corruption as the country's biggest problem. In its latest Corruption Perceptions Index, Transparency International ranked Serbia down at 80th out of 179 countries. According to the latest polls, Vucic and the Progressives right now would win more than 40% of votes in a new election, up from the 24% they won at the one in May, and allow them to dump their Socialist Party partner and govern on their own.

The anti-corruption drive is being spearheaded by the leader of the Progressives, Deputy PM Aleksandar Vucic, a former nationalist firebrand and today's most popular politician, who like his party has transformed himself into a pro-EU neoliberal intent on remaking Serbia into a modern,

According to a citizens group called "We are 99%", there were many irregularities surrounding the tender, as related in a fine investigative piece by the Centre for Investigative Journalism in Serbia (CINS) and the Balkan Investigative Reporting Network (BIRN). The group notes that when Apex took on the BusPlus project, it had only one employee and €500 in capital. The group says the tender was organised and run by Veljko Vlahovic, cousin of Aleksandar Vlahovic, a former minister in the Serbian government and a high-ranking person in the Democratic Party. As a board member of Erste Bank Serbia, the group claims that Aleksandar Vlahovic helped his cousin with a €2.5m

"The terms of the contract to run BusPlus are highly disadvantageous to Belgrade City" western democratic state. The anti-graft campaign is a key element in this, with the arrest of Miskovic, who together with his son and some associates, was remanded in custody on December 14. This, say analysts, is a bold statement by Vucic that no one is untouchable. That has the Serbian press abuzz with news about who will be next. With the Belgrade Police investigating the scandal over the awarding of an untransparent, legally flawed and questionable tender

bne March 2013

Not that many Belgraders got to hear of this. There was little fuss about the issue during the previous government of Djilas' Democratic Party, unsurprisingly. And even now the story is confined mostly to the tabloid Kurir, which was influenced by Djilas during the former government's time in office, but which since last year's elections has been backing Vucic and the Progressives, claiming now that Djilas had in fact really orchestrated this BusPlus business. Kurir is the place where Belgraders can find information about the next possible arrests, which usually then happen a few days after they were reported. Suspicions about Djilas don't end with BusPlus, and government sources say the simmering scandal and rising public anger over it offers a way for Vucic and the government to launch a wider investigation into Djilas' business interests without making it look too nakedly political. Djilas made his fortune as a player in the media market since the 1990s. During his time as Belgrade mayor, much of it while his party enjoyed both the presidency and the government, sources say he has enriched himself by funneling media contracts, especially advertising, to companies he owns, including Direct Media, a media firm that sells advertising space in various Serbian electronic media outlets.

loan from his bank even though Apex only had that €500 in capital.

The State Audit Institution has also filed criminal charges against Djilas's administration over the audited budget year of 2010 on suspicion that some activities conducted by the charged persons used budget funds for the purposes other than those that had been stipulated.

The terms of the contract to run BusPlus are also highly disadvantageous to Belgrade City. Apex gets the right to keep 8.53% of the total amount that passengers pay for tickets, which is a bad deal for the city. Collecting ticket fares currently generates around €4.6m a month, so the consortium can expect to earn just under €400,000 a month from ticket sales alone.

Together with the dodgy public transport tender, government sources say the Progressives believe they now have more than enough to engineer Djilas' downfall. And with the Democratic Party also set to suffer in the wake of that, sources say the likelihood is that the Progressives will strike while the iron is hot and hold a snap election before the year is out.

Southeast Europe

A commando performance in Serbia

bne It was a prank too far for Serbian PM Ivica Dacic, who has ordered an inquiry into how he ended up in a TV interview with a former Playboy model who at one point uncrosses her legs to reveal a lack of underwear a la Sharon Stone in the film "Basic Instinct". The video, which has been viewed on YouTube more than 3m times, shows the PM's eyes wandering downwards momentarily as the "presenter" makes her play, prompting a raised eyebrow and smile to play on the lips of the PM. However, the PM continues with the interview and displays a certain sangfroid not normally associated with the former spokesman for dictator Slobodan Milosevic. Dacic’s national security adviser was less phlegmatic. "The whole case will be fully investigated," Ivica Toncev told Blic. "This was Serbia being mocked, not the prime minister. The prime minister's office will not let this go unpunished." Serbs appear divided over the prank, but many have expressed similar outrage. Some commentators complain that it reflects the dubious mix of politics and lowbrow pop culture in Serbia, a phenomenon that emerged during the Balkan wars and sanctions of the 1990s as federal Yugoslavia collapsed. Women's groups say it's symptomatic of the media's relentless depiction of women as sexual objects for men to leer at while turning a blind eye to the violence and harassment they are subject to daily. Across much of the Balkans, women are marginalized in politics and discriminated against by employers. Worse, activists say, they are too-often victims of a culture that tacitly tolerates domestic violence. "Women are reduced to their body and looks," Sanja Sarnavka, head of the organization Be Active, Be Emancipated (BaBe) told dpa.

I 43


I Southeast Europe

bne March 2013

Falling ratings Nicholas Watson in Prague


lovenia and Croatia may be at loggerheads over a decade-long banking dispute that threatens to delay the latter's entry into the EU, but economically the two ex-Yugoslav states and neighbours are headed on the same dismal path.

In fact, with its finances so stretched, joining could actually make things worse for Croatia. The government said on December 19 that the budget deficit would widen this year to 3.1% of GDP as the country repays debt and begins contributing to the EU's coffers.

Take Croatia: on January 31, Moody's Investors Service cut Croatia's sovereign rating to junk status, downgrading it to 'Ba1' from 'Baa3', due to a stalled recovery, lack of budget discipline and the economy's vulnerability to external shocks. The only solace offered was that the rating agency changed its outlook to stable from negative, saying the risk that the government's fiscal position and debt will "materially deteriorate any further" is limited.

Moody's, which joined Standard & Poor's in removing Croatia's investment grade rating, noted the country is in its second recession in two years amid

Croatia is due to join the EU on July 1 – assuming, as seems increasingly likely, that the two sides manage to stitch together a deal over Slovenia's now-defunct Ljubljanska Banka, which closed its doors in 1991 as Yugoslavia collapsed without reimbursing its Croatian depositors. But Moody's said the benefits normally associated with such an event are unlikely to arise due to "the European environment and the government's reform inertia."

bne March 2013

to investment, forecasts the economy will grow 1.8% this year, as it hopes to see an expected €10bn in EU grants through 2020 boost investment. The International Monetary Fund forecast in November that the economy would grow 0.75% this year, after shrinking 1.5% in 2012.

needs to accelerate reforms to its labour market, pensions and banking system. But these reforms are further in doubt now that a second member of Slovenia's coalition announced its intention to leave the government over the corruption scandal engulfing Prime Minister Janez Jansa.

"The third driver informing Moody's decision to downgrade the rating is the weakness of its credit metrics relative to those of its peers, particularly its external vulnerability and fiscal position," Moody's added. "The government's fiscal metrics are also weaker, with general government debt exceeding those of Baa3-rated countries."

Jansa's conservative alliance had already lost its majority in parliament in January when Civic List and its two cabinet ministers quit. That left it with the support of just 36 MPs in the 90-seat parliament. Now the February decision by the pensioners' party Desus to leave the coalition deprives the PM of a further six seats, making it that much more difficult for him to remain in office.

Neighbours in hell Slovenia's ratings are also slipping. On February 12, Standard & Poor's cut its rating on the sovereign by one notch to 'A-' from 'A', citing the likelihood of the government wracking up bigger debts due to support of the state-owned banks and uncertain growth prospects. The rating outlook was revised to stable from CreditWatch negative. "We also observe rising policyimplementation risks to resolving economic and fiscal pressures," S&P said in a statement. "In our view, this confluence of factors constrains Slovenia's ability to further implement

The row centres on Jansa's refusal to resign or face a confidence vote following a report by the state anticorruption commission in January that said he could not explain the origin of assets worth €210,000. Jansa has denied wrongdoing. However, with the opposition still struggling to put a rival coalition together, and Jansa seemingly happy to tough it out in a minority capacity, Tim Ash of Standard Chartered predicts that, "this could all drag on for some time." Yet that would be disaster for a struggling economy in desperate need of strong leadership to put it back on track and avoid becoming the next Eurozone country to require a bailout.

Southeast Europe

Slovenia has been back in recession since 2011, with the country's mostly state-controlled banks crumbling under bad loans worth about 20% of annual GDP. Recent data showed the proportion of loans now considered non-performing (NPL) in the first nine months of 2012 grew to 14.2% of total loans, representing almost €7bn in bad debt. While the proportion of NPLs at foreign-owned banks is stable, it's rising at the state banks. According to S&P, government support for the state-controlled banks will increase its debt in 2013 by about €3bn-4bn. That is the amount S&P said it believes will likely be needed to fund the transfer of the banks' distressed assets to the government-owned Bank Asset Management Company. "In such a scenario, we forecast the net general government debt ratio will rise to 59% of GDP at end-2013 and exceed 60% thereafter – well above our previous forecast of 53% for 2013," S&P said. But any measures to try to halt the slide are now under threat from the political crisis. This has had analysts like Ash warning for some time that Slovenia faces credit rating downgrades, just as the country needs to mull issuing fresh debt on the international markets as its cash buffer erodes.

I 45


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.

Expect things in Slovenia, as in Croatia, to get worse before they get better.

"The political crisis in Slovenia – this could all drag on for some time" austerity measures and an investment drought sparked by Europe's debt crisis. "The second driver underpinning the downgrade are the headwinds to fiscal consolidation, namely the unfavourable economic environment and the government's lack of fiscal flexibility alongside a relatively high debt level," Moody's said.

policy responses to help boost its banking system, public finances, and growth prospects."

Prime Minister Zoran Milanovic's cabinet, which has vowed to reduce public spending and remove obstacles

The rating agencies have warned Slovenia repeatedly that in order to retain its rating, the government

The S&P rating matches that of Fitch Ratings, which has the Eurozone member at 'A-' with a negative outlook. Moody's has Slovenia at two notches lower at 'Baa2' with a negative outlook.

"This confluence of factors constrains Slovenia's ability to further implement policy responses"

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


I Eurasia

bne March 2013

On TAP After years of wrangling, the Shah Deniz consortium decided in 2012 to send the gas to the Georgian-Turkish border via an existing pipeline, from where it will hook up to the planned Trans Anatolia Natural Gas Pipeline (TANAP), which will transport the gas to the Turkish-European border. Construction of TANAP, estimated to cost $7bn, is scheduled to start in 2014 and will be completed by 2018.

Nabucco International

Second coming of Azerbaijan's Shah Deniz Nicholas Watson in Prague


013 promises to be a key year for the second phase of Azerbaijan's giant Shah Deniz gasfield, with final decisions to be made on investment for the multi-billion-dollar project expansion as well as the pipeline that will carry the gas the final leg into the EU markets. BP, which is the operator of the consortium developing the field, and its partners (Azeri state oil and gas firm Socar, Statoil, Total and ENI) are targeting 2018 for the first gas from the second phase of Azerbaijan's Shah Deniz gas project, whose 16bn cubic metres a year (cm/y) of gas is crucial to the EU's plans to reduce the continent's reliance on Russia for its energy supplies. The first phase of the gasfield, estimated to hold total reserves of 1.2 trillion cm of gas and 240 million tonnes of condensate, has been pumping gas since 2006 at a rate of 8bn cm/y. Al Cook, BP Azerbaijan's vice-president for Shah Deniz, told a news conference in the Azeri capital Baku on January 23 that a final investment decision (FID) on the expansion is due later this

year, provided the consortium can put in place all the necessary agreements. Costs of the second phase have been put in the region of $28bn–30bn. "We will target 2018 for first gas [from Shah Deniz 2]… and that means BP, Socar and our partners have to prepare not just Shah Deniz, we have to prepare the wells, offshore facilities, we have to prepare the South Caucasus Pipeline Expansion, the Trans-Anatolian pipeline system and the European pipeline system – all this has to be ready in 2013 for a final investment decision," Cook said. So far the signs are encouraging. Cook noted that the December 18 meeting between BP's chief executive Bob Dudley and Azerbaijani President Ilham Aliyev resulted in a series of agreements being signed that will underpin the economics of Shah Deniz 2. This was followed on January 27 by the news that the Azeri government had agreed to extend the production-sharing agreement (PSA) for the Shah Deniz gas project from 2031 to 2036, which Elshad Nasirov, vice-president of Socar, called a "green light" for proceeding with the second

phase of the field and accompanying construction of a pipeline to transport the gas exports. Analysts say the extension of the PSA by five years gives BP and its partners ample time to recoup their multi-billiondollar investments in the field, as well as signalling a major improvement in relations between BP and the Azerbaijan government following criticism last October by Aliyev over a steady decline in oil production from the BP-operated Azeri-Chirag-Guneshli (ACG) project. An extension to the PSA covering ACG – which expires in 2024 – is still up in the air. In a year that Cook describes as one with "many targets and many milestones," he picked out the selection between two competing pipelines that will carry the gas from the second phase of Shah Deniz from the border of Turkey into the EU as one of the most crucial. "One of the most important milestones is the selection between the Trans Adriatic Pipeline and the Nabucco West pipeline to be made in June for our gas sales to Europe," Cook said.

Eurasia I 47

bne March 2013

BP's Cook believes that TANAP is one of the most strategic pipelines in the world, carrying as it will initially 16bn cm/y of Shah Deniz gas to Turkey and beyond, but eventually as much 60bn cm/y of Azeri and other Central Asian gas. This would give Europe huge leverage in its negotiations with Russia's Gazprom, which dominates the export of gas to Europe, and is looking to extend that influence with the construction of the giant South Stream pipeline, which from 2016 will transport up to 63bn cm/y of Russian gas through Bulgaria, Serbia, Hungary, Slovenia, Austria and Italy, with offshoots to Greece and Croatia. The key decision for Azerbaijan and the Shah Deniz consortium will be to pick which pipeline will carry the 10bn cm/y earmarked for Europe (6bn cm/y will be kept for Turkey's domestic use) from the Turkish border to the EU markets. Ahead of this decision, the Shah Deniz partners have been finalising agreements with the rival pipeline builders that would allow them to take a 50% stake in each should it be picked. On January 22, the shareholders building the Trans Adriatic Pipeline (TAP), which will run from the TurkeyGreece border via Greece and Albania and onward across the Adriatic Sea to southern Italy, agreed an option for some key Shah Deniz consortium members including BP, Socar and Total, to take up to a combined 50% of the project should it be picked. TAP's current shareholder structure includes Axpo of Switzerland (42.5%), Norway’s Statoil (42.5%), and Germany’s E.ON Ruhrgas (15%). This followed a similar agreement on January 10 with the partners building

the rival Nabucco West to take up to a 50% stake in that pipeline (BP said January 31 it would take a 14% stake), which is a vastly scaled-back EU project that was initially intended to take gas all the way from the Shah Deniz field to Austria. The shorter version of 1,300 km will pick up from TANAP at the Turkish-Bulgarian border and run to the gas hub at Baumgarten near Vienna, via Romania and Hungary. At present, the six equal shareholders in Nabucco West are Austria's OMV, Hungary's Mol, Romania's Transgaz, Bulgarian Energy Holding, Turkey's Botas and Germany's RWE. With BP in advanced talks to take a stake in the Azeri-Turkish TANAP project, that would give the British firm equity stakes in all four of the pipeline projects associated with Shah Deniz 2 – the South Caucasus Pipeline Expansion, TANAP, Nabucco West and TAP. On the face of it, TAP looks a better bet, say analysts, since it offers a shorter route with fewer transit countries and fewer partners to complicate matters, though Cook told delegates at the Vienna European gas Conference on January 31 that, "there are a number of factors other than length which will dictate which pipeline." One major factor will be political support. "We genuinely do not know which pipeline will have the more compelling offer… what we need to see on TAP is a

Nabucco shareholders, and Exxon Mobil discovered huge gas reserves in offshore fields in the Black Sea. As such, some experts believe that both pipelines could end up getting built – a view given some weight by comments from BP and Socar over the past few weeks. Socar's deputy vice-president, Vitaly Beylarbayov, was quoted by newswires as saying at the end of January that Nabucco West and TAP "are definitely not mutually exclusive". While Cook told that conference BP had received buyer interest totalling 20bn cm/y for each of the two proposed routes and, asked whether both pipelines will be built, replied: "We would not rule it out in the long term." Analysts at IHS Energy says these comments suggest Socar and BP are signalling that both Nabucco West and TAP will be built, with the long-awaited announcement in June likely to reveal which will come first. Andrew Neff, senior energy analyst at IHS Energy, says the fact that TANAP is open to having two exit routes, to Bulgaria and to Greece, seems to suggest that both Nabucco West and TAP could be built in the end. "There is a growing expectation now that Nabucco West versus TAP is not an 'either-or' proposition so much as a 'which comes first?' decision – with the June decision on which route will be built first and will carry Shah Deniz 2

"2013 will have many targets and many milestones" similar level of political support through an inter-governmental agreement that we have seen on the Nabucco pipeline." Tomasz Daborowski, an energy expert at the Centre for Eastern Studies, a Warsaw think-tank, says he does not share the widespread opinion that Nabucco is dead, given the project's still solid political backing, desire by Azerbaijan to diversify its export routes as much as possible, plus new gas discoveries that could potentially supply the pipeline; for example, last year OMV, one of the

gas, while the ‘loser’ option could yet be built one to two years behind, carrying additional Azeri gas supplies from Umid, Absheron, and future output from ShafagAsiman, deepwater ACG," says Neff. But the June decision is still crucial, since obviously it would better to be chosen as the first option. "The second option/loser has a bit more problem to overcome with regard to getting to a [final investment decision] in the context of what happens with South Stream's progress on construction," he says.


I Eurasia

bne March 2013

products from Kazakhstan, which has its own shortages and relies on imports from Russia," Shaw tells bne .

Central Asia looks to oil shale Clare Nuttall in Astana


zbekistan could become the first Central Asian country to start developing oil shale as early as 2013 as part of plans by the government to address dwindling oil production and domestic fuel shortages. However, Tashkent is exploring other options too, including construction of a $4bn gas-to-liquids plant and smaller scale investments into renewables. Preliminary studies on mining oil shale – rock that contains a solid organic compound known as kerogen, which is something between crude oil and bitumen – have already been carried out by companies from Japan, Russia and South Korea. State oil and gas company Uzbekneftegaz is now planning a $600m oil shale project with the aim of launching production. If the project goes ahead, it will be the first attempt to produce non-conventional hydrocarbons in oil and gas rich Central Asia. Back in 2010, Uzbekistan's Uzbekneftegas and Uzbek government agencies signed several agreements with Japanese companies to develop the country's oil shale reserves estimated at around 47 billion tonnes.

The Japan Oil, Gas & Metals National Corp (JOGMEC) signed an agreement with Uzbekneftegaz and Uzbek government agencies to explore two oil shale deposits. Two other Japanese companies, JGS and Technopian, announced plans to evaluate the feasibility of shale deposits. Matthew Shaw, analyst at consultancy Wood Mackenzie, points out that the industry has known about the existence

Decline and fall Uzbekistan's oil production has been in steady decline for more than a decade, falling from 171,000 barrels per day (b/d) in 2001, to 125,000 b/d in 2006 and dropping to just 86,000 b/d by 2011, according to the "BP Statistical Review of World Energy, 2012". Meanwhile, oil consumption was up by 0.7% in 2011 to 91,000 b/d. Natural gas production has fluctuated between 52bn and 63bn cubic metres (cm) for the last decade, with 57bn cm produced in 2011, of which 49.1bn cm was consumed domestically.

bne March 2013

countries of southern Central Asia. While Central Asia has a large amount of oil and gas, the region's processing capacity is low, and many of the refined products consumed are imported from Russia via Kazakhstan, which suffers its own shortages. While planning oil shale investments, Tashkent is also looking at other options, the most ambitious of which is the planned $4bn gas-to-liquids (GTL) plant to covert some of Uzbekistan's gas into liquid fuels. State-owned Uzbekneftegaz has set up a joint venture with Malaysia's Petronas and Sasol, which has built similar facilities in Qatar and Nigeria. The three companies are currently in the final planning stages for the plant, and a


final decision is expected in the second half of 2013. If the project goes ahead, the plant will resolve many of Uzbekistan's fuel shortages. It is expected to have processing capacity of 38,000 b/d, and produce diesel, naphtha and kerosene. However, Sasol points out in a 2012 statement that, "Uzbekistan is one of only two double-landlocked countries in the world and was not an obvious prospect for an industry which held the belief that GTL projects were only commercially viable with export access to the sea." Wood Mackenzie's Shaw says construction of the GTL plant would require a bigger upfront investment than mining oil

A 2011 report from Tashkent-based think-tank the Center for Economic Research (CER) forecast that at current consumption rates, Uzbekistan's oil is expected to run out in just over a decade unless significant new finds are made. Uzbekistan will have enough gas for the next 28-30 years – less if exports to China increase as planned. There are concerns that the Uzbek government is prioritising gas exports, a source of hard currency, over the needs of the population – a fear that has grown since Uzbekistan started exporting gas to China in mid-2012. In addition to dwindling reserves, Uzbekistan also lacks refining capacity and has seen periodic shortages of gasoline and other oil products, with

"Production of oil shale would reduce Uzbek dependence on imports of oil products from Kazakhstan" drivers forced to queue for several hours at petrol stations, and occasional cutbacks to public transport services. Tashkent jealously guards its foreign currency reserves, and the authorities are not keen to use them to pay for increases in the imports of oil products. Oil products can also be difficult to obtain for Uzbekistan and the other

shale, but could be transformational if it goes ahead. "However, there are a lot of challenges to overcome, including the high cost of bringing equipment into Uzbekistan," he says. Meanwhile, Tashkent has not lost hope of reviving conventional oil production with a new find, and both Uzbekneftegas and international oil companies have announced plans to step up exploration work. Companies expected to carry out drilling work in 2013 comprise Petronas, Petrovietnam, South Korea's KNOC and KOGAS, and the Aral Sea consortium, which includes Uzbekneftegaz, CNPC, LUKOIL, KNOC and POSCO. Lukoil alone is planning to invest $678.5m in Uzbekistan in 2013.

Rio Tinto is increasingly facing the prospect of losing the right to exploit the deposit to local companies – as has already happened to other unlucky multinationals hoping to profit from Mongolia’s cornucopia of natural resources. Fears were heightened by remarks from President Tsakhia Elbegdorj on February 1 that Mongolia should have more control of the mine, which is 34% owned by Mongolia’s government, with the other 66% owned by Rio Tinto unit Turquoise Hill Resources.

Rio Tinto trips up in Mongolia Terrence Edwards in Ulaanbaatar

of oil shale in Uzbekistan for many years, but little was done to develop the resource "because this is a country where nothing happens quickly", rather than any doubts about the strengthen of the fundamentals of investing into oil shale. "There is some oil production, but the volume is falling quite rapidly. Production of oil shale would reduce their dependence on imports of oil

I 49


hen things get too heated, sometimes it's best to take a step back and let cooler heads prevail. Perhaps that's what the world's second-largest miner Rio Tinto is hoping after talks on the future of the prized Oyu Tolgoi copper/gold mine with the Mongolian government were put on hold until after the country's lunar new year celebrations.

The latest heated talks took place in Ulaanbaatar on February 7 and centred on issues relating to the soaring cost of the gold and copper venture, furthering Mongolian participation in its management, and increasing the number of local companies that can benefit from the project, including the use of a Mongolian bank, the government said in a statement.

The upsurge in tensions is primarily down to costs for the project ballooning, which means Mongolia will have to wait for its dividends that are paid out after the private investors recuperate their initial investment. On February 5, Rio Tinto admitted that the first phase of developing Oyu Tolgoi would be 16% higher than originally planned at $6.6bn. According to an e-mailed statement from the government to Bloomberg, the total cost of the Rio Tinto-operated development in southern Mongolia has jumped to $24.4bn, versus the company's earlier estimate for a total cost of $14.6bn. A lot is at stake. The mine will account for about a third of Mongolia's economy by itself after it becomes fully


I Eurasia

Tavan Tolgoi risks burnout

Terrence Edwards in Ulaanbaatar Mongolia's enormous Tavan Tolgoi coking coalmine, a vital organ that has kept the Mongolian economy vibrant and healthy, is failing due to poor market conditions and a government intent on taking away the operating capital needed to keep pumping out coal to China. "E-TT is facing... financial difficulties," Yachil Batsuuri, chief executive of the state-owned company that operates at the mine, tells bne, referring to Erdenes Tavan Tolgoi, the operator of the mine. "That's why we stopped our coal transportation and export." The Tavan Tolgoi deposit, which holds 7.5bn-tonne of coal reserves, helped propel coal into the becoming Mongolia's largest export, most of which ended up in resource-hungry China. The Tavan Tolgoi coalfields lie just some 200 kilometres away from the Chinese-Mongolian border. And "financial difficulties" may be an understatement, as the Mongolian government has been taking away most of its operating capital in order to restock its Human Development Fund. Though this fund was introduced as a means to drive the development of Mongolia's human resources, in practice it has been used as a cash pool to distribute to the general populace. The 2008 parliamentary election in Mongolia was characterised by politicians trying to outdo each other over how much money they planned to give citizens. Batsuuri's predecessor, recently retired Baasangombo Enebish, said in August last year that the Mongolian government had taken from the company MNT937bn ($669m). Then in January, it was announced that the transport company responsible for the export of Tavan Tolgoi's coal would discontinue its services, as the state-owned miner had fallen behind on its payments. "We asked for $500m to bail out our debts and finance our operations before we start our infrastructure, wash plant structure, water-supply project," says Batsuuri, later adding that Mongolian Prime Minister Norov Altankhuyag had agreed to provide $350m. Other debts incurred include the $350m advance payment made by Aluminum Corporation of China, or Chalco as it's commonly called, for coal. The government has since said it wants to renegotiate that payment and end the contract in an attempt to diversify its customer base, even though Prime Minister Altankhuyag admitted that would incur a $50m penalty. Batsuuri says that Tavan Tolgoi has already delivered $170m worth of coal to Chalco, but now would like to pay the remaining $180m of the contract in cash. "The government has also said that it will have multiple buyers, not only a single buyer. It decided to sell its coal at the world market price," says Batsuuri. Such a move will do little to soothe already strained relations with China, to whom Mongolia sells over 90% of its mineral resources to.

bne March 2013

operational, says Rio Tinto. Naturally, the government is extremely interested in the project and the Mongolian parliament was already pushing for a bigger slice of the Oyu Tolgoi pie at the end of 2011 and again in 2012. "Although it is hard to see how Rio would benefit from overspending on this project, discrediting the [investment agreement] could work in the government’s favour in their intention of increasing the state’s share of the mine," reckons Vidur Jain, an analyst at Ulaanbaatar-based Monet Capital. Government intrusions Projects on an economy-sized scale are always intensely political and prone to cost-related problems. On the one hand, the government wants to grab as much revenue as they can out of what lies in the ground; on the other, foreign investors tend to play down the costs initially in order to win the right to exploit the deposits in the first place. Shell fell into the same trap with the Sakhalin-2 field in Russia’s Far East. The Kremlin was incensed after Shell announced in 2006 that development costs were going to come in at double the original estimate, meaning that the state would have to wait a lot longer for its first payout. The Russian government promptly suspended Shell’s licence and arranged for stateowned Gazprom to buy a majority stake in the project – about half of Shell's 55% stake and half of Japan Mitsui & Co's – for a paltry $7.5bn. To add injury to insult, Shell also got itself into trouble on environmental grounds by disturbing the important local fishing industry. The partners developing the giant Kashagan oilfield in Kazakhstan also found themselves facing environmental impact allegations after the operator presided over long delays and cost overruns. Instead of 2005, delays now mean that Kashagan won't see first oil until later this year, while costs have soared from the initially envisaged $57bn to $136bn. A long drawn-out dispute with the Kazakh government was finally resolved in

bne March 2013


late 2008 when the shareholders in the project – Eni, Shell, Total, Exxon Mobil, ConocoPhillips and Inpex – agreed to give up part of their shares in the project to allow the state-owned KazMunaiGas to raise its stake to 16.81% from 8.33%. Further, a new operating company called the North Caspian Operating Company replaced the previous operator, Eni subsidiary Agip KCO. Rio Tinto has got into similar trouble by disrupting the centuries-old herding patterns of Mongolia's nomadic population in the Gobi desert. Indeed, the environmental problems could come back to haunt Rio Tinto. Oyu Tolgoi Watch, an NGO dedicated to monitoring the mining activities at Oyu Tolgoi, in cooperation with the Bank Information Center and London Mining Network, sent out a press release last year criticizing the International Financial Corporation (IFC), the World Bank's financing arm, for even considering a loan for the project. It described the environmental and social

impacts assessment (ESIA) as "an elaborate and costly hoax” that only concentrated on the construction phase of the mine while ignoring the impacts once commercial production began. Rio Tinto has also done little to uphold the "social contract" that was part of the package, argue its legion of critics. The company has earmarked only $1.5m to set up vocational training

I 51

unconvinced of Rio’s sincerity. "They're just making show – it's show business. They pay some wages and give the odd scholarship to some young people or create an official training centre, and make a show for TV," said Ganbaatar in an interview last August. Speaking on the growing number of unemployed youth in Mongolia, he added: "They spend a lot of money

"Discrediting the investment agreement could work in the government’s favour" programmes and the renovation of four schools. Mongolian MPs have become increasingly vocal about these shortcomings. Sainkhuu Ganbaatar – Mongolia’s second most popular political figure according to the Sant Maral Foundation, a local pollster – remains

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

on media, but they don't give any guarantee to get them employed." Rio Tinto in January forced out its CEO Tom Albanese in January following $14bn in write-downs. With so much riding on Oyu Tolgoi, a disaster at this project could spell disaster for Albanese's successor, Sam Walsh.

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

What you need to know

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


I Eurasia

bne March 2013

other guests to flee the building before the speech. Tbilisi Mayor Gigi Ugulava, National Security Chief Giga Bokeria, and MP Chiora Taktakishvili were among the high-ranking UNM figures caught up in the melee. Taktakishvili suffered a bloody nose, and her attempts to get out of the crowd were broadcast on live television.

Georgia experiences perils of cohabitation Molly Corso in Tbilisi


bloody scuffle between progovernment protestors and supporters of President Mikheil Saakashvili is threatening to turn Georgia's festering political turmoil into open conflict. While both sides have made an effort to tone down the rhetoric and return to power-sharing since the incident on February 8, the distrust and dislike simmering between the government and the president's camp could continue to undermine efforts at cohabitation. Georgia has been enmeshed in a messy experiment with political cohabitation for the past four months, since Saakashvili's United National Movement (UNM) party lost the October 1 parliamentary elections to Bidzina Ivanishvili's Georgian Dream coalition. Over the past few weeks, tensions have grown as the new government grapples with proposed constitutional reforms and consolidating its power base. Political tension turned to physical blows – and at least one bloodied MP – on February 8 when protestors blocked Saakashvili supporters and members of his UNM party from entering the Parliamentary National Library to hear the president's State of the Union address.

The speech, traditionally given in the parliament building, was moved to the National Library after the Georgian Dream-controlled parliament objected to Saakashvili speaking in front of the legislature before MPs have determined which powers will remain with the president under the new constitutional reforms. Catherine Ashton, the EU's head of foreign affairs, and EU Enlargement Commissioner Stefan Fule issued a warning to Georgia over the incident, underscoring the need for both sides "to act in a responsible way, and to refrain from any violence." The statement asked political parties to avoid using "processes or institutions of the state for partisan or for party political purposes", and emphasised the "paramount importance" of respect and "European values" in building democracy in Georgia. Bloodied but not bowed There was little sign of European values or respect on February 8, however, when police did little to stop protestors, including angry former prisoners and other pro-government supporters, from filling the street outside of the library in the hour before Saakashvili was scheduled to make his speech. The mob forced diplomats, MPs, officials and

Recriminations and accusations soon followed, with each side eager to prove to a shocked public the other side was to blame for the chaos and violence. Irakli Gharibashvili, a close ally of Prime Minster Ivanishvili who holds the police portfolio as minister of internal affairs, blamed the UNM for inciting the crowd. Citing an existing police corridor and private entrance to the library designated for guests, Gharibashvili charged that the UNM officials made a path for the protestors to incite a clash. Saakashvili and other UNM officials, however, maintain that the police made no effort to control the mob or provide sufficient security. But while both Saakashvili and Ivanishvili appeared eager to project an image of statesmanship, their public statements have been peppered with animosity, underscoring the partisan rhetoric that has characterised their power-sharing efforts since October. On February 9, both the president and prime minister issued statements condemning the incident and calling for renewed talks between the two sides. Saakashvili gingerly offered the first olive branch, issuing a public invitation to Ivanishvili to discuss their political differences. "What happened on February 8 should never happen again in our country… We need to start a real cohabitation as prescribed by our constitution and as wished by our people," Saakashvili wrote. "I hope that the shameful event of February 8 will serve as a lesson and put an end to the cycle of harassment and hatred that started recently in our beloved Georgia." Ivanishvili "denounced" the protest and violence, and promised a full investigation into the police response; three men were arrested for disturbing

bne March 2013

the peace and the police have asked Ugulava to answer questions relating to charges that he incited violence during the protest. But while the prime minister agreed to enter talks with Saakashvili and the UNM over the contentious issues – including plans to reduce presidential powers and create a legally binding pledge to maintain Georgia's EU/ Nato aspirations – he took offence at Saakashvili's "moralising" over the coalition's handling of the incident. He also warned that the coalition would not be dragged into "futile and lengthy negotiations" if the UNM is just trying to "buy time" for political gain and not engage in constructive dialogue. Keeping UNM and Saakashvili's hopes up for an October presidential election are signs of growing tensions between members of the Georgian Dream coalition. Media speculation about a possible split in the six-party Georgian Dream coalition has been high since Minister of Defense Irakli Alasania lost his role as vice prime minister on January 23, the reasons for which remain still unclear, although include an odd allegation that Alasania might have taken a trip abroad with the wife of Tbilisi Mayor Gigi Ugulava. But political scientist Koba Turmanidze notes that Ivanishvili's tone – and the very fact that he discussed the issue with journalists – sent a very public signal about the hierarchy in the coalition. "I am speculating, but there could be a message that 'I [Ivanishvili] am the boss here and these are minor partners for convenience and if they don't behave or if they don't coordinate their actions with me, they will pay for that and the price will be kind of high'," he says. "It doesn't matter that much how serious it [the argument] is between the two guys, between the two political forces. What matters I think is how the electorate perceives it and I think it was perceived as the leader telling off [another] one of the leaders – to demonstrate that Ivanishvili is… high above all the other [leaders in the coalition]."


Sargsyan a shoo-in

bne President Serzh Sargsyan has secured a second term after taking a majority of votes in the first round of Armenia's February 18 presidential elections. Predictably, the incumbent's victory has been accompanied by accusations of fraud. Sargsyan took around 59% of the vote, enabling him to avoid a second round. Heritage Party leader and former finance minister Raffi Hovannisian came in second with 37% of the vote. Former prime minister Hrant Bagratyan was in third place with 2%, and National Self-Determination Party leader Paruyr Hayrikyan, who survived an assassination attempt on January 31, took 1% of votes. Hovhannisyan accused Sargsyan's supporters of numerous violations of the voting process, including ballot stuffing and the removal of stamps from voters' passports. Hovhannisyan's spokesman Hovsep Khurshudyan demonstrated to journalists on February 18 that the stamps used to show a person has already voted could be easily removed with a wet tissue. International observers said Sargsyan’s party had made some inappropriate use of government resources to promote his candidacy, but the overall political climate has improved, with opposition candidates enjoying better access to coverage by the news media. Although dogged by accusations of election fraud, the incumbent Sargsyan always looked the odds-on favourite from the start of the campaigning on January 21. A poll carried out by Gallup International on February 2-5 had predicted that 68% of respondents would vote for Sargsyan. The resulting lacklustre competition was notable only for an assassination attempt on candidate Paruyr Hayrikyan. Another of the runners, Andrias Gukasian, spent the campaign on hunger strike in support of his accusations against Sargsyan of widespread vote-buying. Claims of election fraud against the president are nothing new. The start of Sargsyan's first term in February 2008 was marred by mass protest as opposition leaders claimed that the vote was rigged. Violent clashes between demonstrators and police resulted in 10 deaths, and a monthlong state of emergency followed. Sargsyan also came under pressure when the international economic crisis hit Armenia in 2009. Heavily dependent on metals exports and remittance payments, the economy contracted by almost 15% during the year. Since then, it has recovered gradually, with GDP growing by 3.9% in 2012, according to the International Monetary Fund. It forecasts a slight increase to 4% growth in 2013. Foreign policy initiatives are likely to be front and centre, according to Richard Giragosian, director of the Yerevan-based Regional Studies Center.

I 53


I Eurasia

bne March 2013

bne March 2013

the issuing of licences has since been adopted. The officials responsible for drawing up and signing the 2009 Kumtor agreement may also be called to account. Members of the ruling coalition voted in favour of a recommendation that Kyrgyzstan's Prosecutor General's Office "consider the responsibility" of those involved, according to reports in the Kyrgyz press.

Kyrgyzstan's fight over gold Clare Nuttall in Astana


he Kyrgyz government plans to scrap its investment agreement with Centerra Gold for Kumtor, the largest privately owned gold mine in the former Soviet Union, unless new terms can be agreed within the next three months. With Toronto-listed Centerra's management saying they are prepared to fight through the international courts if need be, the spat is set to be a further blow to investor confidence in Kyrgyzstan and will hinder Bishkek's efforts to find an investor for another of the country's largest gold deposits. On February 21, the Kyrgyzstani parliament adopted a decree, under which the government will carry out negotiations over the next three months with Centerra to revise a 2009 deal signed regarding Kumtor. The decree also states that Kumtor should continue to operate without interruptions within this period. Should the two sides fail to reach a new deal within three months, the parliament decree authorises the government to take steps to invalidate the 2009 legislation approving the Kumtor Project Agreements.

Centerra responded later on February 21 with a statement saying that: "While Centerra has not yet reviewed an official version of the Decree, it continues to believe that the Kumtor Project Agreements are legal, valid and enforceable obligations." Centerra says it plans to continue discussions with the Kyrgyz government and regulatory officials. "However, there can be no assurances that the Company will be able to successfully resolve any of these matters currently affecting the Kumtor Project." Centerra says. Bad for business The parliament's decision follows the release in January of a report from the State Commission on Kumtor that calls for the 2009 deal with Centerra to be amended. Prime Minister Zhantoro Satybaldiyev has told MPs that the existing agreement "is not in the interests of the country". The PM has, however, indicated the government is not looking to nationalise Kumtor, an option that was rejected by MPs in a vote in June 2012. The Kumtor Operating Company, a subsidiary of Centerra, has also been hit by a $315m claim from Kyrgyzstan's

State Agency for Environmental Protection and Forestry for alleged environmental damage. The claim follows five smaller claims issued in December 2012 totaling $152m. Both opposition parties represented in the parliament are also in favour of revising the agreement, with the main disagreement on February 21 being over how far to go against Centerra. Omurbek Tekebayev, leader of coalition member Ata-Meken, is understood to have already drawn up draft legislation repealing the ratification of the Kumtor agreement. The existing agreements were signed between the Kyrgyz government under former president Kurmanbek Bakiyev and Centerra, and gave the Kyrgyz state a 33% in the Toronto-listed company. However, Bakiyev has been in exile in Belarus since the April 2010 revolution ousted him, and he was sentenced in absentia by a Kyrgyzstani military court on February 12 to 24 years in a high-security prison for abuse of office. The interim regime that took over in April 2010 launched a thorough review of the mining licences issued under Bakiyev's rule and new legislation on

Despite the enthusiasm for ending the agreement, Economy Minister Temir Sariyev has acknowledged that Kyrgyzstan could be unsuccessful if Centerra decides to fight it in the international courts. "Our stand is very weak. We need very skilled lawyers who require to be paid good money," Sariyev told MPs, reported. The brokerage Visor Capital says the worst-case scenario for Centerra is the ripping up of the Kumtor agreement, but reckons that is unlikely to due to the threat of international arbitration.


and the nationalisation of Kumtor, in what the authorities say was an attempt to overthrow the government. While most MPs are against the nationalisation of Kumtor, there is both political will and strong public support for the 2009 agreement with Centerra to be revised in a way that grants more favourable terms to Kyrgyzstan. However, President Almazbek Atambaev is understood to be against plans to change the agreement, saying in 2012 that it would damage Kyrgyzstan's reputation among investors. In particular, some worry that any revision could stymie Bishkek's plans to find an investor to develop Jerooy, the country's second largest gold deposit. Economy Minister Sariev announced in mid-January that the government was planning to put the rights to develop Jerooy, which has an estimated value of around $5bn, up for tender within weeks.

"Our stand is very weak – we need very skilled lawyers who require to be paid good money" Political project Kumtor is a highly political issue in Kyrgyzstan, where the mine's output accounts for around 12% of annual GDP. With resource nationalism on the increase in Kyrgyzstan and other parts of the for Soviet Union, popular opposition to foreign ownership of the country's largest gold mine is growing. The opposition Ata-Zhurt party, which was founded by Bakiyev, is now one of the fiercest critics of the Kumtor agreement. Three of the party's leaders are awaiting trial after their attempt to invade the White House in October 2012 during a demonstration partly motivated by anger over the situation at Kumtor. Around 1,000 of their supporters demanded the government's resignation

I 55



bne March 2013

Zeman's supersonic view of Prague James de Candole of Candole Partners


etween 1998-2004, the campaign to sell the JAS-39 Gripen supersonic fighter to the Czech Republic, led by BAE Systems, was orchestrated from an office located on a street leading to Prague castle called Loretanska. For the last few months, the same building at number 13 was used as the headquarters of Milos Zeman's presidential campaign. This is an unhappy coincidence given that relations between Milos Zeman, the president-elect, and Gripen go back a long way. Between 1998-2002, Zeman was the leader of a minority Social Democrat (CSSD) government, secured with the support of its sworn ideological enemy, the Civic Democrats (ODS), then led by outgoing president Vaclav Klaus, in a blissfully happy arrangement that came to called, without a hint of irony, "The Opposition Agreement". Zeman's premiership was dominated, at least in the realm of defence, by the decision to procure supersonic fighter jets. In May 2001, four of the five bidders to supply the Czech Republic with supersonic fighters, including two US bidders, Boeing and Lockheed Martin, pulled out on the grounds that the process was being rigged in favour of BAE Systems/Saab and their JAS-39 Gripen. Most of us assumed at the time that such a resounding vote of no-confidence in the selection process would kill the project off for ever. We were wrong. The fact that there was only one bidder now left, far from deterring the government, actually emboldened it. A year later, on April 22, 2002, the Zeman government approved the purchase of 24 shiny, new Gripen fighters. All that now remained between Richard Hava, the middleman on the deal, and his multi-million-dollar success fee, was a vote in parliament on the funding of the acquisition. Without parliamentary approval of a state-guaranteed bank loan, the deal would collapse. The pressure on the government – and on BAE Systems – to secure 101 votes in the 200-seat lower house of parliament was intense. The campaign to persuade Czech MPs to vote in favour of the state guarantee was run from a lovely office overlooking

the Petrin orchards. It was masterminded by an Englishman called Steve Mead, the country manager for BAE Systems. Mead had a large white board on the wall of his office with the name of every member of the lower house of the Czech parliament, colour coded according to their voting intentions. All CSSD MPs were coloured green, of course. But perhaps more surprising, so were many ODS MPs, including their leader, Vaclav Klaus, who was chairman of the lower house at the time, a position he secured as part of the blissfully happy arrangement mentioned earlier. One of the more regular visitors to the Gripen campaign HQ on Loretanska was Egon Lansky, who served as a deputy prime minister (1998-1999) in Milos Zeman's government, responsible for coordinating the foreign affairs, interior and defence ministries. Jan Kavan was another deputy prime minister and minister of foreign affairs in the same government. Both gentlemen were enthusiastic supporters of the Gripen – as was Vaclav Klaus. Allegations that BAE Systems funded bribes paid to Czech politicians in the build-up to the critical parliamentary vote in June 2002 remain unproven in a court of law. This may be because the allegations are unfounded or because BAE Systems settled out of court with the British and US fraud authorities at a cost of hundreds of millions of dollars to the firm, thereby removing the need for any further legal action – at least in the two jurisdictions that matter to BAE Systems. Bribes or no bribes, the Zeman government lost the loan vote by just one vote in June 2002. And the deal to buy 24 new jets collapsed. And two years later, the Czech government decided instead to lease 14 Gripens for 10 years, at which point BAE Systems moved out of Loretanska 13, its mission accomplished. And who would have imagined at the time, that a decade later, the man who made it all possible would be orchestrating his return to power from the very same building? Milos Zeman will move out soon as well, his mission too most skillfully accomplished.

Special report I 57

bne March 2013

Special Report: Retail Therapy in CEE/CIS

I Special report

bne March 2013

But the trend is clearly helping consumers, and this in itself is a powerful economic incentive to stay the course. "So even though the EU trade commissioner is right to pressure Russia on its WTO commitments, the truth is that European exporters have been, along with the Chinese, the main beneficiaries of the rise in Russian consumption and investment demand," says Francois-Xavier Chauchat, an analyst with GaveKal. "EU goods exports to Russia have doubled since the trough of 2009, mainly thanks to capital goods, cars, chemicals, pharmaceuticals and food products. Russia is also, with China, the most important emerging market for EU exporters of business services." Some of this is simply post-crisis catchup, but the official statistics show that the recovery in inbound goods from the EU had already regained their pre-crisis levels in 2011 and have been powering ahead since then. Imports should reach 30% of annual GDP next year.

Reaching out to the Russian consumer Ben Aris in Moscow


fter waiting for more than 19 years, Russia finally joined the World Trade Organization (WTO) in August 2012. The effect has been immediate and dramatic: imports into Russia have soared and nowhere have they grown faster than in consumer products. Russian President Vladimir Putin has taken a big gamble. Joining the WTO exposes Russia's young companies to unfettered competition from the best businesses in the world. And thanks to lackadaisical growth in their home markets, these multinationals have charged into Russia. In the last two years, just the foreign fast-moving consumer goods companies have committed some $10bn to entering Russia or expanding their operations there. Of course, the most "strategic sectors" (and ones where the government is heavily present) continue to receive

tariff protection, which will be phased out over eight years for the most sensitive products like agriculture and cars. Russia has alreday been criticised for dragging its heels on meeting its WTO obligations: the recent Russian decision to ban US meat imports on medical grounds (its meat contains a stimulant called ractopamine that is banned in Russia and the EU) is indicative of the

Russia more easily and at a lower cost. According to data from the International Monetary Fund, Russian imports of goods exceeded $300bn in 2012 (versus total retail sales of $670bn), a new record and up 15% from 2011. Imports as a percentage of GDP have been, in real terms, on an upward trend since the ruble crisis in 1998, according

"By the end of the decade, Russia could become the biggest retail market in Europe" growing pains that Russia's full integration into the global economy will have to go through. But on the whole, the world's multinationals have clapped their hands in glee at being able to export their goods to

to independent researchers GaveKal. More recently, WTO entry has had a strong impact on food imports, as tariffs on pork and dairy products were cut heavily, which has provoked a revolt by local producers.

Special report I 59

bne March 2013

Government relations with the EU are maybe at their nadir since Russia ostentatiously turned its back on the west and opened up towards its new friend China in November last year at the ASEAN summit. But that is not true for western companies, which are welcome and new superstores are opening on a weekly basis around the entire country. McDonald's will launch operations in Siberia this summer and Burger King now has over 70 restaurants in Russia after only entering the market in 2011, to name just two examples. Chauchat says this underlying trend of a rising middle class was well anticipated by many European and US multinationals producing consumer goods in the food, retailing, car or medical drugs sectors, which have been investing massively in Russia since the beginning of the 2000s. "By the end of the decade, Russia could become the biggest retail market in Europe, with real consumer spending rising 3 to 5% per year," says Chauchat. "As soon as this year, car sales should match German levels at about 3m vehicles. If the optimists are right, Russia will become the economic giant of Europe by the end of this decade and this is certainly not priced in to the listed retail companies."

Since 2000, real Russian imports have been rising much faster than GDP 27.5 In real terms, OECD annual data and forecasts


Real imports as % of real GDP


22.5 20.0 17.5 15.0

In real terms, quaterly national accounts

12.5 10.0 Source: GaveKal Data

7.5 1997









Tariffs under WTO (MFN = most-favored nation treatment) % Simple average MFN applied Weighted average MFN applied Bound MFN tariff rate




7.8 5.8 8.6

10.9 9.3 12.4

11.5 13

Applied MFN by industry Agriculture and forestry Food industry Electric industry Oil extraction Oil processing Gas Coal mining Other fuel industries Ferrous metallurgy Non-ferrous metallurgy Chemicals and petrochemicals Mechanical engineering and metal working Timber wood, pulp and paper Construction materials Light industry Other industries Other goods-processing sectors

2020 5.7 13.6 0 1 4.9 5 4.4 5 5.9 10 5.2 5.7 8.2 9.9 8.2 7.4 10.7

2012 7.8 17 0 1 5.1 5 4.4 5 8.1 9.8 7.2 8.3 14.1 12.9 12.3 10.8 14.6

2011 7.7 18.2 0 1.7 5.1 4.7 4.4 5 8.6 7.4 7.4 8.9 14.3 12.7 12.3 10.4 14.2

Openings in services Financial services

Retailers Telecom Others Agriculture Automotive

Foreign banks and insurance firms can own up to 50% of market cap (previously 15%); banks have to be regulated and registered by the Central Bank; full access for non-core activities Full access for retailers, wholesalers and franchise operators Gradual removal of 49% foreign market share cap until 2016

End of fertilizer and fuel discounts to farmers; $4.4bn cap on subsidies by 2018 ($9bn in 2013) Tariffs on vehicles to drop from an average 33.2% to 9.7% by 2018


I Special report

bne March 2013

cally, Russia's demographics works to its advantage in that the wealth will be concentrated in fewer hands, which in turn will drive the consumer sector faster.

Keeping up with the Ivanovs Ben Aris in Moscow


berbank CIB held a press conference on February 5 to announce something that (without wanting to be facetious) many knew already: Russian consumer stocks have not only outperformed the rest of the market, but outperformed all emerging market indices for most of the last decade. The difference is that the guys at Sberbank have done their homework – a lot of homework – and put some real meat on the conceptual bones of investing into the Russian consumer story. Plus they have developed an index based on the 24 best names with major exposure to Russia's consumer story called the "Ivanov Index", which will be listed on Bloomberg under the ticker "IvanovCIB" so fund managers can measure just how well this story is playing out. "The Russian story is not one about oil, gas and metals, but it is a consumer story," argues Andy Smith, Sberbank's head of research. "The consumer companies have been outperforming yet two-thirds of the companies listed on the exchange are raw materials producers." The index is not made up exclusively of companies belonging to the consumer sector, as there are not enough Russian listed companies directly catering to the

Here the research kicks in, as Sberbank shows that oil and gas actually contributed little materially to Russia's superstrong growth before the crisis hit in 2008, with almost all the gains coming from retail and services since about 2000. Oil obviously does play a role, as it accounts for two-thirds of exports and a bit less than half of the government's tax revenue. "It's the fuel," says Smith. "But the producers, retailers and processors are the engine of this growth." The index is investable and will be updated and rebalanced bi-monthly, based on the bank's ongoing consumer research as well as its partner Euromonitor's surveys.

consumer, like supermarkets. Instead, the index includes some names that benefit from the growth of consumer demand with two degrees of separation, like fertilizer company Uralkali, which is growing because Russian agriculture is growing, which in turn is growing because Russians are buying more and better food. Likewise, financial services are usually classed as "financial," but in this case are lumped into the consumer bracket. Indeed there are even a few names in there that are not even Russian, like Ukrainian chicken farmer MHP.

Kings of retail The report, entitled "Consumer Speed Kings: Team Russia Leads the World" (that includes a cartoon on the cover – the trademark image of Troika Dialog, which was merged into Sberbank last year), compares Russia with other emerging markets, including Brazil, India, China, South Africa and Turkey, as well as the Eurozone and the US. It combines a top-down domestic consumption growth mega-theme analysis with a bottom-up assessment of individual equity investment opportunities.

Still, let's not quibble, as the basic idea is solid. Russia's emerging middle class has already emerged a fair way and now accounts for 55% of the population (defined as Russians with an income of between $6,000 and $15,000 a year). Their spending has taken over from oil and gas as the main driver of the economy.

"Domestic consumption (not the extractive industries) has delivered 80% of Russia's economic growth since 2004: the consumer-linked industries have driven almost all of this growth," the report claims. "Russia is set to become the biggest consumer market in Europe and the world's fourth largest by 2020; Russia's annual total consumer sector activity may climb to $3 trillion by 2025," up from $670bn in 2012.

One of the more controversial claims that Sberbank is making is that the increase in per-capita GDP won't slow any time soon. Currently, Russia is clearly the fastest growing of all the BRICs in this regard, and Smith predicts that Russia will go from 45th in the world in terms of per-capita GDP to 4th or 5th by 2050. Although countries like China and India are growing faster economi-

"All of Russia's retail companies are hugely undervalued," Smith tells bne. "Even [supermarket chain] Magnit, if you compare it with its peers in the West. There, companies are expensive, but they are priced for growth that they are clearly not going to achieve. CEOs at

Special report

bne March 2013

multinationals will be forced to look at Russia, which is growing at above trend, yet the valuations are still very cheap." As bne has consistently argued for several years now, Russia comes out very favourably from most BRIC comparisons and already has by far the biggest proportion of middle class among the BRIC countries with a GDP per capita level that will take more than 10 years for Brazil, India and China to achieve, according to Smith. Indeed, while some experts believe that many of Russia's retail companies are reaching maturity, Sberbank's research suggests that actually, "the Russian consumer market is still early-cycle relative to the other BRIC economies and continues to benefit from pricing resilience and low levels of penetration." For example, Magnit trades at a price/ earnings multiple of around 30-times, which is extremely high for a Russian

versus Brazil, India, China, Turkey and South Africa, while expanding its aggregate earnings materially faster. We forecast Russia's listed retail sector revenues will grow by circa 23% in 2013." This growth should attract more investment and feed an expansion of mergers and acquisitions. Sberbank expects mergers and strategic alliances across the wider Russian consumer sectors to pick up and lists the most likely candidates in their report. But perhaps the most useful part of the index and its associated research will be the surveys done to predict where the retail trends are headed. The inaugural survey threw up some interesting indicators: • While 2012 was challenging in terms of personal income and concerns over the direction of the Russian economy, most consumers are now more optimistic and expect an improvement in their personal situation in 2013;

"The Russian story is not one about oil, gas and metals, but it is a consumer story" company. However, it still commands less than 10% of the market and is planning to roll out 1,000 new stories this year alone. That's Smith's point: the multiple tells the investor little, as over the next few years the sizes of companies like Magnit and its supermarket cousins are going to increase by orders of magnitude and valuations that make little sense of current metrics.

• While optimistic, the majority of Russians are still not yet confident enough to make major purchases. Most people are holding back from big-ticket purchases, while waiting for evidence of better economic growth; • Within the big-ticket category, a surprising 42% of people still plan to

I 61

change their car within the next two years; • A majority of people own their existing home (only 11% rent), but approximately half plan to upgrade to a newer home in the near term; • Customers are increasingly price sensitive: 37% of respondents consider price attractiveness as a key factor in whether, and where, they buy; • In selecting a supermarket, price and the quality of goods are significantly greater considerations for food shoppers than interior layout or service; • Inflation and unemployment are key areas of concern for most of the population, although there is healthy optimism: 44% say they expect an improvement in their personal wealth in 2013 compared with 2012; • Most people see the high level of corruption as one of the main reasons holding back economic development in Russia. They see the fight against corruption as one of the government's key priorities; • The number of people who say they would be prepared to emigrate, considering economic and lifestyle prospects to be better elsewhere, is still extremely high at 38%; • Stock-specific findings reinforce its positive stance on multiple Russian equities, including Magnit, Dixy Group, Yandex, MegaFon, MTS, LSR Group, Etalon Group, Sollers and Aeroflot.

Sberbank CIB Ivanov Index versus MICEX Index On the flip side, even the current valuations are depressed due to Russia's poor investment image and perceived "oil risk image". "Russia's implied equity risk premium is trading at a near 10-year high," says Smith. As such, the Russian equity market has largely missed out in the recent return of fund flows to the emerging markets as normalcy slowly reasserts itself. "The aggregate Russian consumer sector is trading at a 25-50% valuation discount

Sberbank CIB Ivanov Index


MICEX Index (rhs)









500 Source: Bloomberg, Sberbank Investment Research

0 2007









I Special report

bne March 2013

Russia's growing food chain Ben Aris in Moscow


ussian supermarkets have been the standout winners since the 2008 crisis struck, but Magnit – now arguably the country's most successful company – outdid even its own high standards in 2012. The discount supermarket chain concentrated its efforts on Russia's fast evolving regions and has grown throughout the crisis years – even in 2009, a year when Russia's economy contracted by more than 7%. Rather than chase other retailers – both Russian and foreign – in the increasingly competitive mega-cities of Moscow and St Petersburg, its regions strategy resulted in a solid 32.6% of revenue growth last year, well ahead of analyst expectations, while profits almost doubled to reach $803m as the company became more efficient. And it is expanding fast. Despite being the clear leader in its sector, Magnit still only controls less than 10% of Russia's organised retail – but it's rolling out new stores as fast as it can. In 2010 it opened 300 new stores; this year it

plans 800-1,000 new stores, as well as 60 new hypermarkets. It has also been branched out into cosmetics (500 new stores planned this year alone) as well as power distribution for retail customers with MagnitEnergo. The company had a total of 6,921 stores as of the end of January and is rolling out about 37 new stores a month. This is no flash in the pan, as almost all Russia's other supermarket chains such as X5 and Dixy, also did well, reporting

on the sale of tobacco and hard spirits. It is not only the Russian firms that are growing lickity split. French retailer Auchan is the biggest foreign supermarket chain and also plans to roll out at least 10 new mega-malls and buy another 16 from competitors this year, to bring its total of large format malls in Russia to 56.

60-70 new restaurants across the former Soviet Union, but mostly in Russia. The company already opened 35 last year and aims to increase this to about 80 a year until 2015, according to CEO Oleg Pisklov. The company is not disclosing its 2012 revenue, but said revenue rose by 46% last year and forecasts revenue will hit $1bn in 2015.

And like Magnit, Auchan is also starting to branch out into new business lines. The big event for the company this year will be to break into the consumer electronics market. Auchan plans to launch the Elektrodiskont chain of discount white goods, with the first store already open in Moscow since September. Auchan will take a year to observe the first store and if the format succeeds, the company will look to open such stores near each Auchan in Russia, Elektrodiskont CEO Ludovic Hasquette told reporters at the opening, but ultimately the plan is to open a similar store next to each of the company's existing supermarkets throughout Russia. An online retail effort will be run in parallel, which is currently only available in the Moscow region.

In general, food is driving retail sales, as it remains a big part of most Russians' shopping baskets. Retail sales decelerated at the end of last year, falling from 7% year-on-year growth at the end of 2011 to 5.9% in December 2012. But food sales continue to grow more quickly, according to VTB Capital.

Fast competition Fast food in Russia is emerging as an equally frenetic and competitive market. McDonalds opened its first flagship store on Pushkin Square way back in 1990 and had 345 restaurants as of the end of 2012, with plans to move into new regions in Siberia this year. But a slew of its international competitors have entered the market over the last two years.

"Despite being the clear leader in its sector, Magnit still only controls less than 10% of Russia's organised retail" around 20% rise in revenues and equally strong profits. Analysts expect another successful year for the food retailers due to strong consumer demand and regulatory changes, although growth may be knocked a bit by new tough restrictions

YUM! Restaurants International Russia & CIS, which owns KFC, is one of the most aggressive. It bought out its joint venture partners Rostiks (a KFC clone) in 2010 for an undisclosed sum and says that this year it plans to open

Special report

bne March 2013

For all the talk of the government's big role in the economy (and no one is denying this is true), household spending has become a bigger force in recent years. In 2012, household spending made up 48% of Russia's GDP in terms of expenditure. The state accounted for another 19%, with exports accounting for another 7%, according to Rosstat. All this shopping is driven by the government's socially oriented budget policies: the economy may have tanked in 2009, but thanks to the government's rescue and massive spending from the Reserve Fund wages have continued to rise over the last four years in both nominal and real terms. Real salaries were up 7.8% in 2012 and shopping was supplemented by a veritable boom in retail lending, up a whopping 39% in 2012. Still, analysts are expecting things to cool down this year. "The key risk for consumption will be the substantial deceleration of budget spending from 18% year-on-year last year to 2% yearon-year in 2013. This will likely reduce real income growth to only 1.5% yearon-year this year," says Natalia Orlova, chief economist with Alfa Bank. "In the banking sector, the new provisioning rules effective from March 2013 have already started to lift lending rates and will trigger a slowdown in retail loan growth this year."

GDP breakdown by expenditure, 2012



Gross capital formation



48% Final consumption expenditures


Households Non-profit institutions Change in business inventories

Government Gross fixed capital formation Net exports

Spending on goods and services 20

15 10





-5 -10

Retail sales, %YoY Services, %YoY

-15 2004




Source: Rosstat, VTB Capital Research






I 63


I Special report

bne March 2013

The move into China fits snugly into AmRest's strategy, which at its most basic is a leveraged play on the growth of the middle class in CEE and other emerging markets – after China, McGovern expects to follow shortly with a move into India – who are expected to flock in increasing numbers to its quick service and casual dining restaurants. And despite the global crisis of 2008 and now the sovereign debt crisis in the Eurozone, that's just what they have continued doing.

No rest for Amrest Nicholas Watson in Prague


mRest Holdings is an archetypal Central and Eastern European company. Forged in the postcommunist fires by a young American abroad, this restaurant operator that brought pizza, burgers and fried chicken to western-starved eastern Europeans has outgrown its region and is now turning its attention to the fast growing BRIC markets. AmRest – which at the end of 2012 had almost 700 outlets of KFC, Pizza Hut, Burger King, Applebee's, Starbucks and La Tagliatella spread across ten countries, most in CEE – on October 15 opened its first La Tagliatella restaurant in China, Shanghai. Currently, AmRest operates 136 La Tagliatella restaurants in Spain and France, which are designed to offer quality Italian food with prices at the casual dining level and the speed of service of a quick service restaurant.

“I am delighted to be opening the first La Tagliatella restaurant in China, which will be known as Chun Yi Tang or ‘Pure Italian Heaven’," says Henry McGovern, the company's founder and chairman of the board, an affable, causally dressed American with an appetite for the restaurant business that shows no sign of abating, even though AmRest's success would allow him to give it all up anytime. "This is an extremely significant event for AmRest, as it gives us a great opportunity to expand our own brand with its unique and successfully proven economic model into a huge market with a fast-growing middle class population." The company then followed this up with an announcement on December 14 that it had acquired a majority stake in Blue Horizon, an owner and operator of the casual dining restaurant brands in China, Blue Frog and KABB.

In its latest set of results, AmRest reported that third-quarter 2012 sales rose 13% on year to PLN603m (€143m), generating a net profit 7.9% higher at PLN24.3m. New openings were the biggest driver of sales growth, the company said, with 87 new stores added to the portfolio in the past year. AmRest attributes the business' ability to hold up well in difficult times to its diversification across not only geographical lines, but also across business lines (though McGovern admits it's hard to get all four divisions – CEE , Russia and new markets, the La Tagliatella chain, and the US – moving at the same time). In addition, he says the company grew up in emerging markets, so is used to the wild swings that are part and parcel of operating in this part of the world. Many of the best opportunities are in the large, fast-growing emerging markets, and it's the company's geographical diversification that will allow it to efficiently access these new markets. McGovern says it would be hard to run a business in Brazil out of its headquarters in the provincial Polish town of Wrocław, so it will do so from its Atlanta regional HQ in the US. Likewise, the Indian operations will be run out of its Spanish office. McGovern won't say which restaurant chains AmRest is looking to open up in these new markets, but its US business is Applebee's, while its Spanish business is La Tagliatella and KFC (and KFC already exists in India). The company said for 2013 it expects to open more 80 new restaurants, with more than 60 of those in CEE and

Special report

bne March 2013

Russia. Growing at such a pace at a time like this takes guts, yet McGovern says AmRest throughout its existence "has been bolder than one would suspect" as it strives toward becoming one of the world's top-10 restaurant companies in the world by 2020. If it achieves that goal, AmRest will have come a long way from its humble beginnings as a single pizzeria on a Wrocław square.

Investors too will have been amply rewarded for their patience. Those prescient enough to buy into the company when it listed on the Warsaw Stock Exchange in April 2005 saw their investment before the 2008 financial crisis reach a peak of PLN158 (€36), up almost 560% from the issue price of PLN24 and giving the company a market capitalisation of PLN3.3bn (€760m).

I 65

Though the shares are now trading around PLN87.60, they have never fallen below their IPO price – not bad for a company that is, in McGovern's words, "in the disposable income business" at a time when household budgets are being squeezed. "Still, we're the last one into problems, and the first one out."

to be a very promising region in terms of economic and consumer spending growth, both supporting the roll-out of modern retailing," adding that in the coming years he expected Delta Maxi's markets would likely support growth of 5-7% a year, more than double the levels predicted for Western Europe. Consolidation At almost a billion euros, the Delhaize acquisition was not only one of the largest ever instances of foreign direct investment in Serbia, but also served to illustrate the scope for consolidation in the supermarket sector in the former Yugoslavia.

Shifting fortunes in ex-Yugo retail Guy Norton in Zagreb


ntil fairly recently, the supermarket scene in the former Yugoslavia was almost boringly predictable, with each of the successor states having their own national champions, supplemented by a smattering of smaller domestic outfits and larger foreign players that had established small-scale operations in the region. That all changed in March 2011 when Belgian retailer Delhaize shelled out a whopping €932.5m to acquire the supermarket chain Delta Maxi from Serbia's leading tycoon Miroslav Miskovic. The

deal saw Delhaize take control of a total of 450 stores, some 350 of them in Serbia, but also including operations in Bulgaria, Bosnia-Herzegovina, Montenegro and Albania. At a stroke, Delhaize became the leading foreign food retailer in Southeast Europe. With the Delta Maxi purchase complementing the group's existing supermarket chains in Greece and Romania, it now had more than 800 stores in the region. Commenting on the investment rationale behind the transaction, Delhaize’s president Pierre-Olivier Beckers, said: "The southeast of Europe continues

Delhaize's purchase instantly changed the rules of the game in the food retail markets in Serbia, with the Belgian retailer threatening to undermine its rival’s market shares through a combination of expanding Delta Maxi's network by around a hundred stores by 2015 and implementing aggressive price-cutting on hundreds of basic grocery items. As a result, some cashstrapped firms such as Slovenia's Tus Holding immediately threw in the towel in Serbia, with Tus selling off all six of its Serbian stores in April 2011 to supermarket chain Idea, owned by Croatian food and retailing group Agrokor. Delhaize’s entry into Serbia has also piqued the interest of other major European retailers in the country. In mid-February, for example, it was announced that France's Carrefour, the second biggest grocery chain in the world, had signed a lease on a 10,000-square-metre plot in a new


I Special report

bne March 2013

shopping centre in Belgrade, which should be opened by 2015. The planned store will be Carrefour's first in Serbia and follows in the wake of the opening of a hypermarket in Macedonia last October, which is operated by Greece's Marinopoulos Group under a franchise arrangement. Meanwhile, Croatia's Agrokor, which has been beefing up its operations in Serbia to cope with the challenge posed by the entry of Delhaize to the country, has also been looking, so far unsuccessfully, to further extend its overseas operations with the potential acquisition of Slovenia's leading food retailer, Mercator. To date, Mercator has been put up for sale no less than nine times and Agrokor has made no less than five attempts to acquire its regional rival. Last year, it

"To date, Mercator has been put up for sale no less than nine times and Agrokor has made no less than five attempts to acquire it" seemed that it was poised to finally land its prized catch, having offered €220 per share for a 53.18% stake in Mercator, which a consortium of shareholders, including Slovenian brewer Pivovarno Lasko and a group of Slovenian and foreign banks operating in the country, had put up for sale. Having offered much more money than a number of private equity funds, Agrokor seemed poised to finally achieve its long-cherished goal of acquiring Mercator, only to see its bid scuppered by fierce resistance from Mercator's then management and local politicians who claimed that a takeover of the firm by Agrokor would harm the interests of local agricultural producers for whom Mercator was the principal buyer of their goods. A year on and Agrokor is once again favourite to buy Mercator, which has once again been put up for sale by the same consortium. This time around though, Agrokor's chances of acquiring Mercator look far rosier.

As the Slovenian economy has once again sunk into recession, local feeling against foreign takeovers of household names such as Mercator has considerably mellowed. Furthermore, Mercator's faltering financial fortunes means that Agrokor is likely to be able to snap up its prey at a much lower price than in 2012. According to Slovenian press reports, Agrokor has offered between €115 and €130 per share this time around, much lower than in 2012 but still apparently topping the bids submitted by private equity firms such as including KKR, Mid Europa, CVC Capital Partners, Bain Capital and Advent International. The lower purchase price reflects last year's downturn in Mercator's business, with the firm reporting an unaudited loss of €104m in 2012 on the back of falling sales and growing write-offs. The loss has sparked fierce criticisms of the former Mercator management team led by chief executive officer Ziga Debeljak, who resigned last year after falling foul of the firm's shareholders who objected to his resistance to the sale of the firm. Current Mercator chief Toni Balazic has accused Debeljak of not implementing a focused strategy when it comes to overseas expansion, claiming that in countries such as Albania and Bulgaria, Mercator was misadvised by foreign consultants and as a result has ended up paying over the odds to acquire what have proved to be underperforming assets. The current management has announced that Mercator is to withdraw from Albania and Bulgaria, while it will seek to turn around the financial fortunes of its struggling Croatian subsidiary of Getro, which it bought in 2009. Additionally, at home Mercator has been criticized for spending much-needed cash reserves on buying land plots in Slovenia at heightened valuations and then failing to build stores on them. The net result is that Agrokor now looks odds on to finally acquire its rival and firmly establish itself as the leading locally owned supermarket group in the former Yugoslavia.

Special report

bne March 2013

I 67

Jones says his firm has looked to partner with franchises such as Papa John's and Domino's to tap into that prized demographic.

KFC soaks up Mongolia's middle-class gravy

Meat in the middle Mongolian diets are heavy in meat, with beef and mutton being two particular favourites of the locals. Though people in the countryside live more traditional lives centered around the five customary meats from cows, goats, sheep, and even horse and camel, chicken imported from China is now easily available and consumed widely in the city. As Western culture continues to spread and the middle class grows, Tavan Bogd and Yum! are betting that this fast-food chain will perform as strongly here as it has done in China where the company experienced 3% same-stores growth in the fourth quarter despite an 8% decline following bad press on the company's chicken supply, and 15% growth in sales over the five-year period between 2007 and 2011.

Terrence Edwards in Ulaanbaatar


here's nothing so tired as the chicken-or-the-egg argument, but if next year a slew of foreign restaurants begin opening in Mongolia's capital, investors might be asking whether it was the economy or the chicken restaurant. Mongolia is falling in the footsteps of the nation that is also its largest trading partner, China, whose first western food chain was Yum! Brands' KFC in 1987. Now Tavan Bogd Group, one of Mongolia's largest holding companies, has attained the rights to develop and operate the restaurant famed for its buckets o' chicken. Last year it announced four would open up in the Mongolian capital Ulaanbaatar, with the first to open in mid-2013. The chicken franchise will try to tap into Mongolia's emerging middle class that has grown out of a blossoming mining industry. The remote north Central Asian country saw the launch of one of the world's largest coal mines in 2011 and the continued development of one of the world's largest mines for copper. The latter, the Oyu Tolgoi copper-gold project, is due to begin

operations in June this year and its output is projected to comprise a third of the economy. Oyu Tolgoi in particular has driven up Mongolian wages, giving people the ability to spend more on food, clothing and housing. According to the World Bank, the country's per-capita GDP grew 61% from $2,250 in 2010 to

Drawing in US franchises to Mongolia such as KFC or McDonald's has long been a goal for companies. Though its rapidly growing youth demographic is interested in western brands and products, multinationals have been hesitant to open up shop. US franchises have opened in Mongolia before, but with varying degrees of success. Though bd's Mongolian Grill still

"I'm very sceptical that chain restaurants will be able to provide the same proportionate low cost service they can in the US"

$3,623 in October 2012. Matt Jones, an analyst at Mongolian Investment Capital Corporation (MICC), says: "Bullet points would be the large youth population – youth are generally more knowledgeable and disposed towards import goods like imported clothing, Western foods, and the like. And there's the high growth rate and all the wealth that comes from the mining sector."

caters heavily to the tourist crowd during summer months, Kenny Roger's Roasters' – who would have been KFC's main competitor – has long been closed. The fact that KFC is willing to take this risk now is acknowledgement of the rapid transformation taking place in the country. The crux for franchises in Mongolia has been the ability to deliver the consisten-


I Special report

cy one expects from these restaurants and ensuring quality control in such a far-flung and isolated destination. The challenges of dealing with only a single rail line from China that leads to

bne March 2013

Though Mongolia has 14 heads of cattle for every person, meat producer Just Agro is the only one that has facilities that comply with standards for export. Russia put a ban on Mongolian meats

"Though its rapidly growing youth demographic is interested in western brands and products, multinationals have been hesitant to open up shop" Ulaanbaatar and the absence of other logistical infrastructure raises the cost of necessary ingredients and drives the price away from the low costs that western consumers are familiar with.

due to outbreaks of animal illnesses such as foot and mouth disease. That ban was lifted in November 2011 and the Mongolian government is interested in seeking out ways to sell its meat as a

high-quality specialty project. "I'm very sceptical that chain restaurants will be able to provide the same proportionate low cost service they can in the US in these developing markets due to ingredient scarcity," says Jones, whose company has still yet to find a franchise interested in coming to Mongolia. "In order to obtain high-quality and consistent products, you have to pay a higher price relative to the rest of the market." Jones says the biggest obstacle is finding the right partner who is willing to take the plunge and invest in a country that is still unproven and with demographics that nobody knows very much about. In this instance, KFC is the "first-mover" that stands to either lose and pack up or lead a trend and have the best chance of dominating the market for some time.

Special report

bne March 2013

wants to open in Yerevan. I used to shop there in Brussels. Would be good for competition here. Hope it happens," Heffen wrote.

man and MP Samvel Alexanyan, who is also the owner of Fleetfood, Armenia's largest importer of wheat, sugar, alcohol and cooking oil.

However, Carrefour's plans are rumoured to have alarmed the owners of some local chains, which currently dominate the formal retail sector. Because of its larger purchasing power and proprietary supplier network, retailers fear Carrfour will be able to undercut them, potentially putting the handful of local chains that have so far had the market to themselves out of business – or at least slash their fat profit margins.

Opening day Carrefour's arrival in Armenia has been anticipated for more than a year, and the first store was expected to open in late October 2012 – a month after Majid Al Futtaim Holding, the operator of the Carrefour brand in the Middle East and Central Asia, launched the first Carrefour in neighbouring Georgia. Carrefour executives have reportedly been trying for several months to meet with top government officials in an attempt to break the impasse.

Earlier in February, Armenian newspaper Zhamanak cited sources as saying that the owner of Dalma Garden Mall, oligarch Samvel Karapetyan, had suspended the agreement to lease space in the mall to Carrefour. There are also reports that the space may be leased instead to Yerevan City, a chain of supermarkets owned by Armenian business-

In an emailed statement, Carrefour's press office told bne that, "in line with its strategy of developing the Carrefour brand, the Majid Al Futtaim group continues to analyze the Armenian market and aims to open its first store in the next 12 months."

Armenia's small retail sector is relatively underdeveloped, and still populated by local players, among them Star, SAS, Galaxy and Yerevan City – all of which have emerged in the last decade. The supermarket and grocery chains have gradually replaced open-air bazaars and street vendors, as Armenia, like other post-Soviet countries, makes its transition to a formal retail sector. However, as of 2012, the level of formal retail was only around 12%. Retailers also face logistical problems because of the country's geo-political isolation. Hostile relations with Azerbaijan and Turkey mean that two of Armenia's international borders are closed, and Iran is under international sanctions, meaning that around 80% of Armenia's international trade is through Georgia. Combined with relatively low spending power, this has held the international chains out until now.

come out in favour of the French retailer, which could pave the way for Carrefour to open its first store in Yerevan this year. On February 7, Sargsyan told journalists that, "Carrefour must be opened in Armenia for sure. I had a meeting with Carrefour representatives, and we discussed all the issues related to the entrance of the network to Armenia and its normal operation here. Armenia is quite interested in providing people with Carrefour's services," Sargsyan told journalists, Arka reported.

Armenian PM wades into Carrefour row Clare Nuttall in Astana


he Armenian government says it's set to help Carrefour resolve a dispute that has delayed the French hypermarket giant's entrance to the country, in a bid to prevent the country's investment climate being harmed further by the affair.

As the first international supermarket chain to try to crack the Armenian market, Carrefour is running up against the power of local oligarchs who want to keep control of the lucrative food retail market, say reports. However, Armenian Prime Minister Tigran Sargsyan has

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

Sargsyan said that the company's delayed entrance to Armenia was due to disagreements between "private companies" and that his government had offered to help the company enter the market.

| 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

Carrefour's arrival is expected to boost competition, raise demand for agricultural products and help create new infrastructure, Sargsyan said. Carrefour has another supporter in the form of US ambassador to Armenia, John Heffern, who made his views known over Twitter. "Hear Carrefour

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

I 69


I Events

bne March 2013

bne March 2013


Upcoming events 2013

Agribusiness in Ukraine Forum (12 - 14 March) Adam Smith Conferences, +44 20 7017 7444 Kiev, Ukraine

The European Azerbaijan Society Business Forum Paris 2013 (14 March) TEAS, +44 (0) 2007 808 1921 Paris, France

VIII Kazakhstan Financial Forum (14 March) Cbonds, +7 (812) 336-97-21 ext. 124 Almaty, Kazakhstan

Russian Retail Forum (18 - 21 March) Adam Smith Conferences , +44 20 7017 7444 Moscow, Russia

9th Private Equity and Venture Capital Russia and CIS (19 - 20 March) C5, +44 (0)20 7878 6888 Moscow, Russia

Russian Wood and Timber 2013 (19- 21 March) Adam Smith Conferences , +44 20 7017 7444 Moscow, Russia

HSE In OIL and GAS. Russia and CIS (19- 21 March) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia

The 16th annual Russian Automotive Forum (9 - 11 April) Adam Smith Conferences, +44 20 7017 7444 World Trade Centre Moscow, Russia

Wealth Management and Private Banking Conference (9 - 11 April) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia

3rd Annual Conference Russian Arctic Oil and Gas (15 - 17 April) Adam Smith Conferences, +44 20 7017 7444 Marriott Grand Hotel, Moscow, Russia

Russian CFO Awards & Dinner (25 April) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia

The 3rd annual International Forum Airport Development: Russia & CIS (15 - 17 May) Adam Smith Conferences, +44 20 7017 7444 World Trade Centre Moscow, Russia

KAZANSUMMIT 2013 (15-17 May) Organized by IBFD Fondation Kazan, Russia

Treasury, Risk and Cash Management in Russia (25 – 26 June) Organized by EuroFinance Moscow, Russia

Cbonds Fixed Income Conference: Russia, CIS & CEE (13 September) Organized by CBONDS CONGRESS London, United Kingdom

International Cash and Treasury Management (16 – 18 October) Barcelona, Spain

II International Investfunds Forum. Russia and CIS Institutional Investors Conference (8—9 November) Organized by CBONDS CONGRESS Istanbul, Turkey

I 71

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

What you need to know

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

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

Business New Europe March 2013 edition  

The only English-language magazine that covers CEE/CIS.