Business New Europe September edition by Ben Aris

Inside this issue: Halliburton drawn into Ukraine scandal Warnings lights that are Amber Serbia's self-destructive defiance September 2012 www.businessneweurope.eu

Fighting for air in Georgia Special Report: Fund Survey 2012

STORM CLOUDS GATHER Who is ready for the next crisis?

How to invest in Eastern Europe and China

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bne September 2012

Contents

Editor-in-chief: Ben Aris (Moscow)

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Managing editor: Nicholas Watson (Prague)

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News editor: Tim Gosling (Prague)

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Eastern Europe: Graham Stack (Kyiv)

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

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27 COVER STORY

CENTRAL EUROPE

6 The Insiders

24 Slovakia's Mr Consensus

8 Storm clouds gather

25 Gorilla in Athens

12 Perspective

27 Warnings lights that are Amber

13 Chart of the month 29 Collective failure in Poland EASTERN EUROPE

31 Banking on Czech conservatism

14 Halliburton drawn into 17 Ukraine corruption scandal 19 Russia's capital market reforms take hold just in time

32 Czech central bank watches and waits, for now 33 Private banks eye panicky Hungarian rich 35 Lithuania's nuclear politics

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20 Russia's tyre market lays some rubber Please direct comments, letters, press releases and other editorial enquires to editor@bne.eu

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21 EBRD dismayed as Belarus stalls on privatisation 22 Bear-faced cheek Svyaznoy's transformation

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bne September 2012

Contents

We do it. 40

SOUTHEAST EUROPE 36

Basescu's back

Azeris put the "fraternal" in FDI of Turkey

Kazakhstan to decide on nuclear power plant in 2012

Turkey and Turkmenistan push mutual interests

Oil report puts troubled Tajikistan on the map

Ban's magical mystery-solution tour

Had enough of Babanov

Fighting for air in Georgia

Down and dirty in Georgia

Best Regional Bank in Central and Eastern Europe

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EURASIA

Serbia's self-destructive defiance

Hopes pinned on Serbia's industrial revival

Biting the Borovo rubber bullet

Croatia unveils tax roll of shame

Central Asia reaps poor harvest

SPECIAL REPORT Fund survey 2012 55

Beware of Greeks, but bonds are fine

UPCOMING EVENTS

I The Insiders

bne September 2012

Good news for capital market financing

Kvetoslav Krejci of White & Case

his summer brings some good news for companies in Central and Eastern Europe that are looking to raise finance in Europe's capital markets.

Traditionally, raising finance in the capital markets was often cumbersome and bank financing was accordingly often the preferred (or even the only) option for many companies. However, European institutions have finally completed their review of the Prospectus Directive regime and have published what are likely to be the final changes. The purpose of the Prospectus Directive is to harmonise requirements for the drawing up, approval and distribution of bond prospectuses, and to establish a series of requirements that issuers need to follow in terms of the content and format of the documentation given to investors. There are two basic scenarios where a prospectus is required: first, when securities are admitted to trading on a regulated market; and second, when an offer of securities is made to the public. When the Prospectus Directive was adopted back in 2003, its principal objectives were to enhance the protection of investors through the provision of high-quality, consistent information and to improve the efficiency of the single market. The key innovation brought about by the Prospectus Directive for companies at that time was that a prospectus approved in one member state of the EU is valid across the bloc, giving issuers a "passport" across the capital markets of the EU. With the new changes issuers should benefit from greater legal certainty, increasing market confidence in raising capital. Those that have already issued debt will need to bear the brunt of the amendments and are likely to face a somewhat painful process when updating their documentation in accordance with the new rules at their next update anniversary, as the market and the EU's regulators get to grips with the altered landscape.

For new bond issuers targeting sophisticated investors with their securities, however, there is better news. If an issuer does not target "the public" with its bond issue, but professional investors, things are much easier now. There have been a few changes to the exemptions from the obligation to publish a prospectus, such as no prospectus being required in the event a securities offer is addressed to investors who acquire securities for a total consideration of â&#x201A;Ź100,000 per investor and if a securities offer with a denomination per unit of at least â&#x201A;Ź100,000 is made. The market has already largely moved to use these bond denominations in practice, due to the changes in the Transparency Directive which were published in December 2010. We can be confident that market dynamics will adjust to the requirements of the new regime sooner rather than

"The changes are all in place now. But finding willing investors is something that not even the best legislation can do on its own"

later. The change may be slightly annoying for banks who buy blocks of securities in order to sell them on to multiple accounts, as it gives them less flexibility to spread their holdings over those accounts, but there has not been a huge market backlash about the change in practice. This private placement exemption was rarely used in primary market issuance due to the practical concerns that tend to arise when multiple managers are making offers on a transaction, as parties want to "count" investors through the gate to make certain that the threshold is not breached and

bne September 2012

the exemption lost. However, it is often helpful in liability management exercises where securities have found their way into the hands of "non-qualified investors" in the secondary market and an exchange offer needs to be undertaken. Being able to target now 150 people per member state rather than the previous number of 100 may assist in these exercises at the margins. Small business benefits If you are a small or medium-sized enterprise, then the socalled "proportionate" disclosure regimes have been established. This means that if such an issuer chooses to use the optional regime, it may include in its bond prospectus only one year of historical financial information (not the usual two years). One might question whether this regime will be used much in practice, as investors are likely to want more than simply a year's snapshot on a company's financial health and, obviously, if the transaction is being sold into the US pursuant to the respective applicable rule, investors will demand significantly more financial information than just one year's historical numbers.

extent cement existing market behaviour and we can expect that the impact will be rather intangible. However, it should provide increased market confidence in capital raising on the part of issuers. Professionals expect that the extension of some of the exemption thresholds in the Prospectus Directive will increase the number of fundraisings throughout the CEE region and the fact that unquoted companies do not require a full prospectus should be particularly of benefit for smaller companies wishing to reduce the associated expense and administration. Last but not least, more companies should be able to offer shares to their employees without triggering the requirement of issuing a prospectus. But finding willing investors is something that not even the best legislation can do on its own. Kvetoslav Krejci is a partner at White & Case in Prague

There is also good news for governments that need to issue debt: sovereign issuers in the European Economic Area (EEA) are now exempt from the obligation to produce a Prospectus Directive-compliant prospectus. The amendments now also exempt state guarantors from providing disclosure about themselves in circumstances where the member state's guarantee is not "unconditional and irrevocable," and the securities benefiting from such a guarantee would otherwise be within the scope of the Prospectus Directive. Any issuer, including an EEA sovereign who is exempt from the obligation to produce a prospectus, must however now include a sentence in any advertisement they issue regarding their offer of securities, stating that no prospectus is required to be prepared. The changes relating to offerings that involve a retail component are more far-reaching and will add time and pain to programme updates, but standalone wholesale debt issuers have come off remarkably well from the reforms. Current experience with listing authorities suggests they are still getting to grips with the regulatory changes and the initial deals that come in front of them are being very carefully examined and more heavily commented upon than usual. But no doubt as everyone becomes more familiar with the provisions, we will return to smoother running. Having said that, not content with leaving things as they are the European Commission is constantly looking to see how the regulations can be revised to improve disclosure to investors and have now turned their attention to the disclosure regime for convertible securities. We await to see what changes will be proposed here. Will the changes actually make life for companies easier? The current revisions to the Prospectus Directive to a large

"With the new changes issuers should benefit from greater legal certainty, increasing market confidence in raising capital"

I Cover story

bne September 2012

s the summer comes to an end and the fourth anniversary of the Lehman Brothers collapse approaches, the black clouds of another financial storm are gathering on the horizon. For most of the last four years, western governments have done little more than kick the giant debt can down the road, but now they are starting to run out of road. Markets were rallying mildly toward the end of August on the possibility of another round of quantitative easing, but its effectiveness has almost been exhausted.

Storm clouds gather Ben Aris in Moscow

More seriously, several of the ducks that contributed to the last crisis in 2008 have been lining up again. Specifically, industrial production has been slowing all year and poor harvests in the US and Russia threaten to cause an agricultural price shock this autumn, both of which were big contributing factors to unleashing the last storm. Many of the countries in Emerging Europe have not recovered from the last drenching; if there is another crisis, who is prepared and who will suffer more than before? Battening down the hatches "Normal" crises last between three and half to four years, according to a study made by Ukraine's leading investment bank Dragon Capital. But as this crisis' birthday approaches, clearly things are getting worse, not better. "History teaches us that the major ones like the crashes in the USA in 1837 and 1929 last seven to eight years, so we are only half way through this crisis. Russia and many other countries are clearly already preparing for the worst," says Charlie Robinson, chief economist at Renaissance Capital. The International Monetary Fund (IMF) warned ominously in its last economic report in July that the world has entered a new and critical stage due to the unresolved debt crisis in Western Europe. Robinson believes the next couple of years are crucial and while it is possible for governments to muddle through and reduce their levels of debt, the chance of a break-up of the Eurozone is still very much on the

Cover Story I 9

bne September 2012

cards: austerity measures have been put in place, but populations will only suffer these privations for a limited time, while countries like Greece are effectively bankrupt and could easily default on their debt. The possibility of serious civil unrest or another financial meltdown remains close to the surface. Governments in Emerging Europe are now actively preparing for another crash. Russia's central bank widened its ruble trading corridor against the dollar in July to provide more of a cushion should an external shock arrive. At the same time, the government will complete a crisis action plan that budgets for an oil price of $60 per barrel, to supplement the actual 2013 federal budget that assumes a downgraded $109 price. Likewise, Ukraine reintroduced a mandatory hard currency sale rule that allows the National Bank of Ukraine to force exporters (mainly steel producers) to sell half of their hard currency reserves to the central bank if needed. Widely used in the 1990s by all the cash-strapped governments of Emerging Europe, the rule is a drastic measure that was abandoned by Ukraine back in 2006. Other governments have likewise been scraping the barrel to shore up their fiscal position: the Hungarians even raided their private pension system for funds. The mood is black. The political agenda for the autumn is already full as prime ministers and presidents scurry around the world trying to thrash out a fix. German Chancellor Angela Merkel – the key player in any workable rescue plan – began the autumn season early, setting off a tour of Central and Eastern Europe (CEE) at the end of August. There is an important meeting of the European Central Bank on September 6 followed by a ruling on the legality of the currency bailout funds by the German Constitutional Court a week later that could block more bailout payments from existing facilities. The Netherlands has a general election the same week where the crisis will be a leading issue and the EU finance ministers meet two days later on September 14. Both Greece and Ukraine could run

out of money in the autumn thanks to debt redemptions, perhaps triggering another financial meltdown. Food and factory woes Another crisis is not a given – crises are inherently unpredictable – but there exist two serious causes of concern: a severe slowdown in industrial production across the continent began at the start of this year and is getting worse, and poor harvests amongst the world's biggest food producers could cause a spike in food prices this autumn. Agricultural price spikes are economic and social gelignite. The last one in 2008 not only contributed to setting off the financial crisis, but also led to food riots in 30 counties around the world. Indeed, the high cost of sugar was one of the contributory factors that set off the Arab Spring, according to Renaissance Capital. High food costs are especially painful for emerging markets where food purchases makes up at least a third of the average shopping basket. Droughts and floods in Russia, Kazakhstan and the US this year mean harvests are going to be poor and prices

month and corn prices are already over their 2008 peaks," notes Halligan. A severe drought will slash Kazakhstan's 2012 grain harvest to around half the record 26.9m tonnes gathered in 2011 and Russia has downgraded its forecast for this season from the 94m tonnes of grain that farmers brought in last year to between 75m and 85m tonnes this year. Even at the lower end of the forecast, Russia will still have enough to cover its domestic demand of about 60m tonnes, but will not have much left over to export. Falling industrial production is the second major cause for concern. While a slowdown in manufacturing doesn't necessarily cause a crisis, Carmen Reinhart and Kenneth Rogoff showed in their book, "This Time is Different," that there has never been a crisis where industrial production didn't slow first. Manufacturing data for August showed the Eurozone's business activity contracting for the seventh successive month, providing further evidence that the Eurozone is likely to stumble into technical recession in the third quarter

"Russia and many other countries are clearly already preparing for the worst" could well spike again this autumn. "Food price spikes are dangerous, not only because of potential social and political unrest, last year's Arab spring being a case in point. Rising food prices also drive inflation, of course, making it tougher for central banks to keep the economic show on the road," says Liam Halligan, chief economist at Prosperity Capital Management. Harvests are just coming in now, so it is not clear how bad the problem is, but the major producers have all slashed forecasts dramatically in the last few months. In the US, the downgrade was the biggest in 25 years. "Corn and wheat prices for end-of-year delivery have risen more than 40% in just the last

of the year – a worrying sign for the small open economies of Central Europe that are so heavily dependent on the single currency area for export demand. Weak manufacturing is already contributing to a slowdown in economic growth. Figures released on August 14 showed that German GDP grew in the second quarter but only by 0.3%. The rest of Western Europe is already on the verge of recession: France had no growth at all in the second quarter, Spain was minus 0.4% and Italy minus 0.7%. Capital Economics expects most of CEE to go into recession next year as a result, as many of these countries' manufacturing sectors are highly dependent on

I Cover story

bne September 2012

western demand, particularly Germany's. The economic consultancy says that since the end of 2011 economists have lopped 1 percentage point off the growth forecasts for the Czech Republic and Bulgaria, 0.6 point off Hungary’s and a milder 0.3 point off Romania's. Russia is still growing pretty strongly – it put in reasonably strong growth of 0.9% for the last three months thanks to high oil prices – but even here Morgan Stanley was only the latest to cut its forecast for next year from 5% to 3.7% for 2013. Out of all of CEE, only Slovakia and Poland have consensus growth forecasts higher now than they were at the end

Russia's failure to integrate more closely with Western Europe or sell much of anything else but natural resources leaves it relatively isolated from the fallout of another crisis. The losers are Romania, Hungary, Ukraine and Belarus – none of which has made much progress recovering from the last crash. The domestic banking sectors in Romania and Bulgaria are heavily exposed to Greece. Hungary hasn't seen any growth in over six years and is still running a big budget deficit even before this year's slowdown. Ukraine only has three months worth of import cover as hard currency reserves (the mini-

"There has never been a crisis where industrial production didn't slow first" of 2011, ie. 0.8% and 0.4% respectively, Prague-based Komercni Banka Bank says. Strong domestic demand supported the Polish economy and net exports helped by the start of new factories boosted the Slovak economy. "The bleaker global economic outlook is weighing on growth expectations for the Central and Eastern European countries and tight EU integration suggests that contagion risks remain high and will persist for longer," Komercni said in a note in August. Winners and losers The 2008 crisis was a shakeout for the countries of Emerging Europe. To paraphrase Leo Tolstoy: all healthy economies are alike; each country in crisis suffers in its own way. Those that had pressed their noses to the wheel of reform are reaping the benefits now, while many of the laggards were already facing the possibility of a crisis before the new problems appeared this year. Surveying the research, it is clear that the standout winners in the region are Poland, the only EU country to avoid recession in 2009, and the Czech Republic. Honourable mentions go to Slovakia, the Baltic states and Turkey, while

mum economists believe is needed to ensure the stability of the currency) and was already on the verge of a 10-15% devaluation as the year started. And the entire Belarusian economy was knocked sideways by the 2008 crash and is still unsteady on its feet. Perhaps the most remarkable recovery has been in the Baltic states. Locked into the Eurozone by currency pegs, the classic crisis response of devaluation was not available, so they reduced wages instead – politically impossible for western governments. Their economies quickly started to recover. "What the Baltics did was miraculous, but they were in a much easier position than the governments in Greece and Portugal," says Robinson. "Wages in Latvia have tripled in the last 10 years, so selling the idea of cutting per-capita income from $10,000 a year to $7,000 following the crisis when the people were only making $2,000 in 2000 is a lot easier than asking the Greeks to make a big cut income after their wages have only gone up some 40% in the last decade. Politically you can't do it." The greatest disappointment has been Ukraine. The administration of President Viktor Yanukovych squandered an

opportunity to re-launch badly needed reforms after taking over in 2010. An IMF team are due in Kyiv at the start of September, but they are talking about the same issues – pension reform and domestic gas tariff hikes – as they were four years ago. Turkey is probably in the most interesting position. The economy is growing strongly thanks to solid consumer demand and banking reforms introduced after the 2001 domestic banking crisis; Turkey was less affected by the 2008 crisis than most of its neighbours. Its Achilles' heel is the country's large current account deficit, largely funded by borrowing on the international capital markets. In theory this makes Turkey vulnerable to another crash. But as most of its current account deficit is due to commodity imports (especially energy), if there is a big crisis, commodity prices should fall, which would reduce the current account deficit. "Turkey has some built-in stabilising mechanisms, so it is not as vulnerable to a crisis as it seems at first glance," says Robinson. "In 2009, Turkey had its lowest current account deficit for years." Channels of contagion If a new crisis does break, how vulnerable are each of the countries in Emerging Europe? Ironically, in many cases each country's previous vulnerabilities have been turned into strengths, while the strong countries are more vulnerable. There are three main channels of contagion: banking, trade and dependence on international capital markets. Problems in the banking sector are the most obvious and immediate channel of contagion. In Central Europe, up to 90% of the banking sector's capital is owned by western banks, according to Capital Economics, and Romania and Bulgaria are especially exposed given the heavy investment from Greek banks. At the other end of the scale, Turkey and Russia's banking sectors are largely domestically owned and so in theory more insulated from a financial crash in the West. However, in addition to direct ownership of banks, the dependence on local banks

bne September 2012

Cover story

on international funding also plays a key role in transmitting a crisis, something Russian banks found to their cost in 2008. However, the Kremlin has successfully switched much of both state and private funding from international markets to domestic borrowing, and the local bond market has been flying as a result. The key number to look at is loan/deposit ratios, where Hungary does especially badly. "In Poland and the Czech Republic, we think interbank loans might be equivalent to around 10% of GDP. And in Hungary in Croatia they could be worth 20% of GDP or so. What's more, a significant chunk of this finance has a maturity of less than one year and therefore needs to be constantly renewed – adding to the risks of a sudden stop in funding," says Neil Shearing of Capital Economics. Export dependence on the West is another weakness that afflicts Central Europe, where most countries have built up their economies based on the export of low-cost manufactured goods. Countries to the east produce and export little other than raw materials, but the bigger economies of the Czech Republic, Hungary and Poland move almost in lock step with the German economy, which itself is closely tied to the global economy as the export Weltmeister. "Exports to the Eurozone as a share of GDP varies widely," says Shearing. "At one end of the scale, Turkish exports to the euro area are equivalent to just 5% of GDP. Likewise, Russia's dependence

Danger factors:

dependance on exports

Russia

low

Ukraine Turkey

openness of economy

on exports to the Eurozone is low and has actually fallen in recent years. But at the other end of the scale, in the Czech Republic, Slovakia and Hungary exports to the Eurozone are equivalent to 45% of GDP. And even in Poland, which is often said to benefit from a relatively large domestic market, exports to the euro area are equivalent to around 20% of GDP." Finally, much of CEE's growth has been financed by borrowing on the international capital markets – funding that has fallen dramatically since the 2008 crisis broke and will dry up completely if another crisis hits. Russia illustrates the problem: despite its extremely low external debt and over $600bn of hard currency reserves, many important Russian companies and banks were heavily exposed to international borrowing. When that lending was cut off in September 2008, their problems triggered a systemic meltdown that saw the economy go from 7% growth to a 7% contraction in a matter of months. Since then, Russian companies and banks have reduced their borrowing and significantly lengthened their debt maturity profiles, leaving the country a lot less vulnerable to a crash in Western Europe. For Russia, the 2008 crisis was a reality check and steps taken since have left the country in a lot stronger position.

foreign ownership of bank sector

And then there is the reliance on international capital markets for funding. Hungary is particularly badly off in this regard, with Romania in the second worst position. A financial crisis in Europe would wallop both these countries, while the Czech Republic is the standout winner in this respect and the least vulnerable in the region. Even if there is no crisis in Europe this autumn, next year is going to be tough and things are unlikely to start getting better until sometime after 2014. Hobbled by massive debt, Western Europe is unlikely to do anything more than recover slowly, but CEE is in a much better position thanks to its growing middle class and all the easy gains from improving productivity. If anything, the crisis will force local governments to concentrate on deepening and diversifying their economies to close the gap with their western peers. Every cloud has a silver lining, but that is little compensation when you are facing four years of standing in the rain.

NPLs in banking sector

depedance on inter Europe interbank lending

low

medium

high

low

medium

low

medium

low

Poland

medium

Czech

high

medium

Hungary

high

medium

Bulgaria

high

Romania

high

medium

high

Slovakia

high

medium

Slovenia

medium

high

Source: bne

only EU country to avoid going into a recession in 2009, Poland has enjoyed substantial portfolio inflows equivalent to 12% of GDP – more than four-times greater than its peers – over the last three years. If there is another crisis, then the Polish zloty could tank as this money flees again.

Ironically, Poland is at the other extreme and a victim of its own success. As the

low

Baltics

I 11

reversal of portfolio inflows

foreign debt exposure

poor economic growth

low

high

medium

low

medium

high

low

medium

low

medium

low

high

low

high

medium

low

high

medium

low

high

medium

low

medium

I Perspective

bne September 2012

state. The other is a squabble within the Schwarzenberg family, whose principal heir, Karel Schwarzenberg, is the current foreign minister. Elisabeth Pezold, daughter of Prince Adolf Schwarzenberg – whose vast property holdings, including the chateaux of Hluboka and Cesky Krumlov, were confiscated first by the Nazis and then the Czechoslovak state – claims her adopted brother Karel is blocking her attempts to inherit the property. On that issue, Elisabeth Pezold's son Adam says: "I feel we're making progress to an extent, but the legal process here robs you of any belief in the judicial system." Vladimir Dlouhy, a former economy minister and a candidate in next year's presidential election, says the coalition's church restitution bill is, in general, a step in the right direction. "22 years after the end of Communism, we should be able to sort out this issue," he says. "But as is usual in politics the devil is in the detail, and both government and churches should be better able to explain several sensitive issues."

Restitution on a wing and a prayer Nicholas Watson in Prague

opping up all over Prague in August have been billboards showing a right-wing politician's hand passing over a big bag of money to a hand in an unmistakably priestly pose and sleeved in a Catholic vestment. This is a graphic illustration of how the issue of whether the Czech state should return property seized by the Communists to the churches will be one of the defining campaign issues for this autumn's elections. The billboards are the work of the opposition Social Democrats (CSSD), who are bitterly fighting a bill being pushed through parliament by the centre-right Czech government to give back property and provide compensation worth a total of CZK134bn (about €5.4bn) to the country's churches, over half of that to the Roman Catholic Church. The amount is made up of CZK75bn worth of buildings, land and forests that can proven to have been owned in February 1948, and CZK59bn in financial compensation over the next 30 years for property that can't be returned. CSSD also plans to distribute flyers to Czech households in the run-up to the elections for the upper house in the form of a postal money order made out to the sum that the return of the churches' property would cost each of the 10.5m population, CZK12,755. Such figures tap into a rich vein of resentment among the largely secular population, who are struggling under this coalition's austerity measures to right the country's finances. A variety of polls show that up to 70% of Czechs are against the bill. The Catholic Church concedes that the timing is not ideal. "We totally understand that it is a difficult time for all citi-

zens," says Monika Vyvodova, spokesperson of the Czech Bishops' Conference, a grouping of bishops in the Czech Republic. Yet Vyvodova goes onto explain what many supporters of the bill say, that the issue is not, as CSSD claims, simply one of handing over a "gift" to the churches (the language in the poster uses the Czech word "darovat", which means "give" but usually in the sense of a birthday present). Rather, it is actually part a financing model designed to eliminate the national financing for churches by 2030, which currently amounts to around CZK1.4bn a year. "The annual range of compensa-

" As is usual in politics the devil is in the detail, and both government and churches should be better able to explain several sensitive issues" tion will be CZK2bn-3bn per year, depending on inflation, which is slightly more than what the state pays the churches now in accordance with the law adopted by the Communists. Although the state will initially pay both amounts, they will gradually decline to zero," says Vyvodova. A road that leads to the tidying up one of the last remaining issues left over from the country's Communist past is tempting for many, as the settling of disputes will open up land for development. This is one of two big remaining cases of restitution yet to be dealt with by the post-communist Czech

Perspective I 13

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Certainly, the debates within the parliament have been acrimonious, with CSSD deputy chairman Lubomir Zaoralek claiming the role of the Catholic Church is unclear during World War II, prompting the Catholic Church to respond that the left-wing opposition's anti-Semitic and anti-clerical stance is reminiscent of propaganda pumped out by the Third Reich and Communists. "The parliament has turned into a platform where churches and religious societies are blamed for various sinister motives and are suspected from dishonesty," church leaders harrumphed.

CHART:

The church position wasn't helped by Priest Tomas Halik appearing on television and claiming that more money has been stolen by corrupt politicians and businessmen than what's been agreed in the restitution bill It was no surprise, therefore, when the upper house, which is dominated by leftist parties, voted down the bill on August 15 and sent it back to the lower house, which had passed it on July 14. The three-party coalition government will need to muster a majority of 101 votes in the 200-seat lower house in September to overturn the Senate's veto, yet a series of defections and scandals has reduced its majority from 118 to nearer 100, meaning any new vote is too close to call. Even if the bill does pass, it has to be signed by the outgoing and mercurial president, Vaclav Klaus, who has been supportive of church restitution in general, but whose view on this particular bill is unclear. One persuasive argument against the bill for many like Klaus is the worry that the bill could open up claims for restitution before 1948, which might include certain German religious orders that lost land as part of post-war agreements. "All that came between that date [1948] and the end of communism in 1989 is fair game to be wiped from the law books, but no laws predating the Bolshevik takeover can be touched," says Ky Krauthamer, senior editor of the NGO Transitions Online.

Manufacturing boom and busts

With all eyes on manufacturing as worries about a fresh global crisis grows – Carmen Reinhart and Kenneth Rogoff showed in their book, "This Time is Different," that there has never been a crisis where industrial production didn't slow first – the chart here shows where the real problems lie. Purchasing Managers Index (PMI) flash data in the US was at 51.9 in August, above the contractionary reading of 50, meaning it has been above that level since early 2009. This led to Business Insider talking about "an American manufacturing renaissance." This boom is happening at a time when manufacturing is declining in some of the biggest economies in the world, notably China and Germany. China's flash PMI plunged to 47.5 and the Eurozone's PMI (which includes both the manufacturing and service sectors) was up marginally at 45.1 but still stuck well in negative territory. Eurozone business has now contracted for seven straight months, providing further evidence the single currency area is likely to stumble into technical recession in the third quarter of this year.

Global PMI Manufacturing PMI 60 55 50 45 40 U.S.51.9 China 47.8 Euro zone 45.3

35 30 '05

'06

'07

'08

'09

Source: Thomson Reuters Datastream, HSBC, Markit

'10

'11

'12

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Sweet home Alabama The Halliburton letter subsequently produced by Naftogaz is written in poor English and contains orthographical and factual errors, but Halliburton confirmed to bne it was authentic. The letter may not, however, fulfill the expectations placed on it by Naftogaz. It states that Halliburton in fact subcontracted rig appraisal work to a company called Marine Surveyors Incorporated, which deployed a team led by a certain Captain Michael Barrie. According to bne enquiries, the Halliburton letter is misleading in that there is no such company as Marine Surveyors Incorporated â&#x20AC;&#x201C; the company Halliburton hired is Captain Michael Barrie's own set-up: M. H. Barrie & Associates Marine Surveyors, Inc. According to Barrie, he travelled alone to a Turkish Black Sea port for the rig appraisal job, not with any team.

Halliburton gets drawn into Ukraine corruption scandal Graham Stack in Kyiv

krainian national energy company Naftogaz Ukrainy claims an appraisal provided by oilfield services giant Halliburton justifies the $400m price tag that it paid for an offshore rig in 2011. But a bne investigation finds the Halliburton appraisal is less than meets the eye, as the US firm subcontracted the rig appraisal work to a one-man band from Alabama.

election campaign for parliamentary elections set for October 28 got underway could be a key factor in determining the outcome.

In 2011, Ukraine's national energy company Naftogaz purchased an offshore drilling rig for just under $400m from a UK intermediary company, which previously had acquired the same rig for just $248.5m from Norway's offshore operator Seadrill. The discrepancy between the prices prompted widespread accusations of corruption on a grand scale, which coming just as Ukraine's

According to the Halliburton letter summarizing the preliminary appraisal results, seen by bne, the estimated value of the rig, outfitting and engineering work, and transport needed to move it from Singapore to the Black Sea almost exactly matches the sum of $400m paid by Naftogaz at the controversial procurement tender held in March 2011. The winner of the tender was a UK company called Highway Investment

In a fightback against the allegations, Naftogaz and energy minister officials are now claiming that a valuation of the rig performed by Halliburton confirms the $400m price tag, exonerating them from suspicion.

Processing, the beneficiaries and representatives of which have never been revealed. The bank account to which the funds were transferred was with Latvian bank Trasta Komercbanka. Naftogaz management and energy ministry officials are now brandishing the Halliburton appraisal letter as proof that the acquisition of the rig was above board. "The procedure of purchasing the drilling platform, its servicing and technological processes are all subject to an independent audit from Halliburton," Naftogaz deputy board chairman Vadim Chuprun declared. Ukraine's energy ministry claimed: "We believe further insinuations about the purchase of the drilling rigs are an instrument of competition for the development of the Black Sea shelf aimed at reducing Ukraine's energy security."

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According to bne enquiries, Captain Barrie's marine surveyor company is a small local affair based in the US southern port town of Mobile, Alabama, operating since 1994, with Barrie taking on some partners in 1998. Barrie operates from a four-room suite in a dockside office block, with total staff numbering under 10. According to his website, Captain Barrie offers "marine and terminal expertise" with "local knowledge of port operations." M. H. Barrie & Associates Marine Surveyors' role is to assess vessel and cargo condition mostly for insurance purposes and damage claims. Barrie's website does not mention any expertise in offshore energy. Barrie told bne that over the last two years he had indeed taken on some work with jack-up rigs and said that his website is seven years old and needs updating. Barrie acknowledged that his is a "small company" and that this was the first job he had done for Halliburton. Barrie said that Halliburton had refused him permission to comment to bne on any aspects of the appraisal, but indicated he was unacquainted with the appraisal letter's contents. Halliburton is the world's second largest oilfield services company, with

a market capitalization of $30bn and workforce of over 60,000, headed in the 1990s by the former US vice president Dick Cheney. The Halliburton press service intended to get back to bne with answers on the appraisal of the "West Juno" rig (now renamed "Petro Godovanets"), but failed to do so within a two week deadline. While the reasons for Barrie's hiring by Halliburton are unclear, the import of the appraisal letter so feted by Ukrainian officials is equally unclear: the bulk of the difference between the $248.5m sale price to Norway's Seadrill paid by the UK intermediary, and the $400m purchase price paid by Naftogaz to the UK intermediary, is explained in two lines, both of which refer to data supplied by Naftogaz itself. Thus, according to the letter, "based on the activities information provided by Naftogaz (sic) upgrades to the West Juno rig is (sic) estimated at $57,940,000." Secondly, "based on the work volume before rig dry tow requested by Naftogaz, auxiliary costs for engineering work such as cut and reinstall the legs, personnel and engineering is (sic) estimated at $71,380,000." This item refers to work

Interestingly, the original contract signed in March 2011 between Naftogaz and UK intermediary Highway Investment, as seen by bne, specified Singapore as place of delivery, not the Black Sea. Thus the price items connected to transit via the Bosporus â&#x20AC;&#x201C; $71,280,000 â&#x20AC;&#x201C; and also shipping costs of $15m were not included in the original deal between Naftogaz and Highway Investment of March 2011. The the place of delivery was shifted from Singapore to the Turkish Black Sea port of Giresun in amendments to the contract made in September 2011, seen by bne. The changes apparently at a stroke of the pen brought over $86m extra expense for Highway Investment, but without any change in the price paid by Naftogaz. September 2011 was also the month Halliburton signed a framework agreement with Naftogaz on construction, operating and maintaining of oil and gas wells, including an option for servicing the West Juno/ Petro Godovanets rig. This agreement sealed what had been a meteoric rise for Halliburton in Ukraine in 2011, with prior agreements in the course of the year signed on confidentiality and cooperation, and Halliburton opening a swanky new office in the

"Halliburton appreciates this opportunity to submit this preliminary report and looks forward to being Naftogaz's business partner in developing oil and gas assets in Ukraine" done on the rig necessary to move it through the Bosporus into the Black Sea. Notably, the Halliburton letter dated November 2011 was actually written before the engineering work was implemented in the winter 20112012, with Barrie visiting in April 2012. Naftogaz did not respond to bne queries about the extent to which the Halliburton appraisal was based on data supplied by Naftogaz itself.

prestigious heart of Kyiv. The November 2011 Halliburton appraisal letter thus finishes on a high note: "Halliburton appreciates this opportunity to submit this preliminary report and looks forward to being Naftogaz's business partner in developing oil and gas assets in Ukraine." Analysts surmise that Halliburton has now supplanted Schlumberger as Naftogaz's service partner of choice: as

I Eastern Europe

early as 2006, Schlumberger, the world's largest oilfield services company and Halliburton's traditional rival, signed a strategic cooperation agreement with Naftogaz, and as late as December 2010 Schlumberger won a Naftogaz tender for work on the Subbotinskoe offshore field. Schlumberger told bne, "we cannot confirm their [the previous agreements'] continuing validity." Rewriting history History is being rewritten not only in Ukraine with respect to the 2011 Naftogaz rig deals. The revenues from the sale of the West Juno rig to Naftogaz went through Highway Investment's account at Latvia's Trasta Komercbanka – a bank that appears to have links to Naftogaz Ukraine. Not the least of such links would be the fact that largest shareholder and chairman of the bank's council, Igor Buimisters, listed on his website biography that he is consultant to the supervisory boards of "Neftgas Ukraine" and also of a Naftogaz joint venture with Poland's PGNiG called Devon. Neftgas Ukraine is a russified version of Naftogaz Ukrainy. But Trasta has now removed the reference to the Ukrainian companies from Buimisters' bio. Following the deletion, the bank demanded that bne retract its previous statements linking Buimisters to Naftogaz. The bank also now claims in hindsight that the reference to "Neftgas Ukraine" never in fact referred to Naftogaz Ukrainy, but to an unspecified privately held company. Despite bne requests, the bank has not supplied the address or registration details of the "real" Neftgas Ukraine. Nor does the Interfax Spark database contain details of any such company. The bank is also silent on Buimisters' involvement with the undisputed Naftogaz joint

bne September 2012

venture Devon. But the website bio has generously retained reference to Buimisters' "doctorate" from Kennedy Western University – an unaccredited US distance-learning college that closed in 2009 after being named in a US government investigation into "diploma mills." The bank's apparent nervousness comes at a time when Latvian law enforcement agencies are finally making moves to investigate the 2011 Naftogaz tenders and the subsequent passage of money through Latvia. bne has obtained confirmation from the economic crime department of the Latvian state police that an investigation is ongoing, following transfer of materials earlier this year from the state prosecutor's anti-money laundering office. Sad end to tenders While there appears no end in sight to the controversy over the 2011 Naftogaz Black Sea tenders, in Ukraine an end has been made to the law on compulsory tenders for state companies, which has provided so much help to journalists and so much hindrance to bureaucrats. Without the law, the 2011 Naftogaz spending spree – which totalled roughly $1bn for two jack-up rigs and support vessels – would never have come to public attention. President Viktor Yanukovych, under whose watch the Naftogaz tenders took place in 2011, signed into law August 1 amendments to the procedure for state procurement, freeing state-owned companies such as Naftogaz from holding such mandatory procurement tenders – and thus effectively eliminating any form of public control over vast swathes of the state sector. The government argues that compulsory tenders slow the procurement process and

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Eastern Europe

is for this to have been completed by November. Therefore, the Russian local bond market might be fully liberalised for non-residents by late autumn 2012," VTB Capital said in a note.

impede state companies' international competitiveness. According to Oleksiy Shalaisky, founder of the Nashi Groshi website that monitors state tenders for signs of corruption – and who first flagged up the Naftogaz Black Sea tenders in 2011 – this will decimate the number of state tenders held. "State-owned companies account for around UAH300bn ($37bn) of a total UAH500bn ($62bn) state procurement orders," Shalaisky tells bne. "These will now be excluded from having to hold tenders, and we calculate that the level of minimum kickback will rise to 10%, meaning at least an extra UAH30bn ($3.7bn) will be stolen." According to Shalaisky, the Nashi Groshi website in little over a year's work achieved the cancellation of 25 tenders, resulting in over $700m being be returned to the exchequer. "All of these tenders were cancelled exclusively due to pressure from the media. There were no legal faults found in the tender procedure, but following media pressure, the tender winners themselves stepped back from the deals." The media pressure was heightened by independent critical TV station TVi, which runs a feature "Tender News" focusing on corruption suspicions, including the Naftogaz Black Sea tenders. In mid-July, authorities seemed to fire a warning shot across the bows of TVi, launching a criminal case against its CEO on tax evasion charges. The charges were officially declared dropped on August 2 – a day after the changes to the tender laws. Following the elimination of mandatory tenders, Shalaisky now expects a further surge in corruption: "The most corrupt deals were put on hold pending the recent amendments to the law."

I 17

Russia's capital market reforms take hold just in time bne

ith a new financial storm in the autumn looking increasingly likely, the Russian government's push to reform its capital markets should make a big difference to the economy's resilience. The crucial part of the government's changes is making it easier for foreigners to buy the OFZ – the main domestic bond used by the state to cover any budget deficits. Under the current regime, foreigners already own about 5.5% of all the outstanding OFZ, or RUB3.1 trillion, ($103bn). But to do so means these investors need to hire a local broker and negotiate the tax code. And because of certain regulations abroad, some gargantuan would-be investors, like US pension funds, can't buy OFZ even if they wanted to: under US rules, Russia would need to have a Central Securities Depository (CSD).

That is all changing. The centrepiece of the reforms has been to set up a CSD; in June, the biggest depository in the country, NSD, formally applied to take

Long-term horizons The OFZ bond has been developing since 2009 when bond market reforms began and is used by the state to cover the deficits that appeared after the last financial crash. For 2013-2014 the budget allowed the government to borrow RUB1 trillion ($33bn), though the actual borrowing by the government has been a lot less than in the plan thanks to the economic recovery and the rising tax take. This year the government has only borrowed the equivalent of 1.5% of GDP – far more than the 0.1% of GDP budget deficit the state is running, according to VTB. So the government has the money it needs to cover the deficit, right? Yes… but the problem with the bulk of the current breed of foreign and domestic investors – such as banks and hedge funds – is that they have short-term horizons. Most investors in the Russian capital markets are and always have been speculators. The real appeal of the new foreign investors is that they will have a longer-term perspective; pension and insurance funds tend to buy-andhold for decades, taking the bond

"The end result of the changes? Much more, much cheaper and much longer-term money for the Russian government"

over the job as CSD, a bit later than planned, meaning Russia is on course to have a CSD this autumn that will open the gates to a new pool of capital worth trillions of dollars. "The exact timing of the liberalisation depends on completing the standard process of approving and certifying the Central Depository. Our upbeat expectation

through to maturity, as their liabilities come due only when a worker retires or that rare catastrophe hits. This will give some crisis stability to the Russian markets that they so badly need and was so palpably missing in 2008. The reforms should make increased inflows a self-fulfilling prophecy. The

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changes mean the OFZ will have to be included in the indices (the GBOEM index family) that track emerging market bond funds, as they are now more readily investible. Hence most investors will be forced to re-balance their portfolios and buy some OFZ to match the benchmarks. VTB are predicting just this re-balancing process will see the foreign share in the OFZ jump from 5.5% now to 15% within only a few months of the changes being put in place. And this technical increase is before investors start thinking about how much more these bonds pay compared with the rock bottom yields currently offered by most developed countries (in Germany the returns are already negative.) "The relative attractiveness of OFZs compared with [emerging market] peers will likely push other classes of global investor (global pension funds, real money accounts) to include

"A 20-30% share of non-residents in the OFZ market looks achievable within 18 months following liberalisation" OFZs into their portfolios. Hence, a 20-30% share of non-residents in the OFZ market looks achievable within 18 months following liberalisation. In absolute terms, this translates into potential additional demand of RUB500bn-800bn from non-residents, which covers up to 70% of the total OFZ net issuance in 2010-11," says VTB. Will it be a success? All the ducks are lined up. Given the macroeconomic imbalances in the world today – you are locked into losing money on German bunds; you make a decent profit on Russia OFZ by any standard – everything points to the reform being a huge success. No withholding tax In addition to the creation of the CSD, the Kremlin has put several other key

changes in place. The 15% withholding tax that used to be charged on foreign OFZ holders will effectively disappear once the new rules are in place. More importantly, the Central Bank of Russia has more-or-less finished its transition to a floating exchange rate – in mid-July, the CBR widened the exchange-trading band against the dollar in anticipation of a meltdown in Europe. "Is the Russian local bond market fundamentally attractive for non-residents?" asks VTB. "Our answer is a firm 'YES'." VTB says Russia's fiscal position is one of the strongest among the G20 countries. It has a very conservative debt/GDP ratio, with the finance ministry forecasting 10-14% for 20122015, with a maximum sovereign external debt share of only 20% for the next three years. It has the third largest reserves in the world, more than $500bn. And a flexible exchange rate policy makes Russia's budget revenues less vulnerable to global shocks. The ability of the ruble to fall in value in a crisis is what provides the cushion for external shocks and the ruble exchange rate is now as flexible as it has ever been in the last two decades. VTB predicts that up to half of all the demand for new issues of OFZ from this autumn could come from international investors, which will have the effect of driving down yields by 100 basis points and making the cost of borrowing for the Russian government even cheaper. The end result of the changes? Much more, much cheaper and much longer-term money for the Russian government. Sounds like a good deal.

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The biggest foreign player on the market is Finland's Nokian Renkaat, which turned out some 11m tyres at its production plant in Vsevolzhsk near St Petersburg in 2011, according to Aton Capital, some 4m more than was produced at the firm's main plant in Finland.

Russia's tyre market lays some rubber Natasha Doff in Moscow

n a country where the ground is frozen solid for a good five months of the year and potholed roads are the norm, a good set of wheels in Russia is invaluable. This is good news for tyre producers, which over the past decade have been quietly reaping the rewards of a sector growing at around 6.4% a year, and have been joined by foreign manufacturers looking to take advantage of Russia's booming car industry. Last year some 55.5m tyres were sold in the country as new car sales soared close to pre-crisis levels, securing Russia's place as Europe's second biggest car market, according to a recent report by Moscow-based investment bank Aton.

Italy's Pirelli, after it ran into debts while trying to modernise its two plants. Competition is growing, however, from foreign players, attracted by growth potential in the country's unsaturated car market. Currently, there are only 257 cars for every 1,000 people in the country, compared with 540 in the EU. In the past several years, a raft of foreign companies have been setting up production facilities in Russia, focusing mainly

Aton analyst Mikhail Pak says foreign players have an advantage over domestic producers since the premium tyre segment is growing faster than the low-end segment, largely because Russians are investing in more expensive cars. "People are starting to trade up," Pak says. "The average car price in Russia has increased significantly over the past five years and generally, if you buy a more expensive car, you will be looking to put decent tyres on it." Companies working in the budget segment are also likely to be hit by an influx of imports, especially from China, when import duties on passenger tyres drop from 20% to 10% in the next five years due to Russia's entry to the World Trade Organization. Pak says this is unlikely to affect the premium segment, since most of the foreign players involved are already setting up production in the country. For them, the biggest risk is a slowdown in global economic growth. Russia's car market was hit hard by the 200809 crisis, with sales plummeting and many domestic producers having to be

"If you buy a more expensive car, you will be looking to put decent tyres on it"

As well as piggy-backing on growth in new car sales, the tyre market also benefits from the harsh Russian climate. Since new cars come equipped with only summer tyres, buyers inevitably have to splash out on a set of winter tyres, at prices around 15-30% higher than summer tyres.

on the premium segment, where Russian firms lack expertise. Italy's Pirelli bought two Russian tyre plants late last year in a joint venture with Russian Technologies for some €222m.

Currently the market is dominated by Russian players, with the biggest, Nizhnekamshina, holding a share of some 26% by production levels, closely followed by Cordiant (formerly SiburRussian Tyres.) A third major player, Amtel, was taken over by Sibur, and later

Carlo Costa, Pirelli's CEO for Russia, the former Soviet Union and Scandinavia, tells bne that the joint venture is aiming for sales of €250m this year, most of which will be reinvested in expanding capacity at the plants to 10.5m tyres from the current 8.5m by 2015.

propped up by government support programs to prevent them from going bust. Tyre producers, however, have an advantage over the sector whose growth they siphon: unlike cars, tyres constantly need to be replaced meaning they are therefore far less vulnerable to economic downturns. While car sales slumped almost by half between 2008 and 2009, tyre sales dropped by a comparatively less painful 36%. Someone then, at least, is benefiting from the icy roads and potholes.

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for privatisation. "If we really want to be effective, really want to help the country and its government, we should be more involved in privatisation, but this year we decided to discontinue pre-privatisation efforts in Belarus," he says. "We are not going to be involved in a situation where there is no key shift of management and ownership control to the private sector."

EBRD dismayed as Belarus stalls on privatisation Sergei Kuznetsov in Minsk

elarus is one of the most complicated countries for the European Bank for Reconstruction and Development (EBRD) to deal with and the multilateral lender has been forced to roll back its cooperation with the Belarusian authorities due to the significant deterioration in the human rights situation and the lack of progress in privatisation efforts. In April 2011, the EBRD board decided to recalibrate the bank's operational approach to Belarus following the disputed December 2010 presidential election and the continuing violations of democratic norms by the Belarusian authorities. This recalibration meant the EBRD will concentrate on developing the private sector and would not give any support – financial or technical – to the central authorities.

Paul-Henri Forestier, the EBRD's director for the Caucasus, Moldova and Belarus, tells bne that about 90% of the Belarusian economy remains in the public sector, so there should have been a lot of room for the EBRD to work in

Indeed, Belarus stalled all state-owned property privatisation efforts this year, even though the country had committed itself to selling off state assets as part of its $3bn bailout loan programme for 2011-2013 from the Eurasian Economic Community (EurAsEC). Specifically, in 2012 Belarus is supposed to privatise $2.5bn worth of state-run assets. Forestier adds that the "EBRD sees some small signs of improvement" in the situation in Belarus in the last few months, without elaborating. "Hopefully, we will see more of that, because our new strategy is a long process," he says. He expects the final approval of the EBRD's revised approach to cooperation with Belarus in January or February 2013. "So hopefully the things are evolving, and it will allow us to get an approval from our board of directors in order to be more open in Belarus, a bit more aggressive and, maybe, to get back to pre-privatisation," he says. IMF suspicions Meanwhile, the outlook for Belarus' cooperation with another multilateral finance institution, the International

"We are not going to be involved in a situation where there is no key shift of management and ownership control to the private sector" developing the private sector. However, earlier this year the EBRD was forced to halt its pre-privatisation efforts in Belarus, which envisaged helping to prepare Belarusian state-owned assets

Monetary Fund (IMF), also remains vague. Belarus applied in 2011 to the IMF for a new stand-by loan worth approximately $3.5bn, however the lender says that the new programme

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depends on the degree to which the Belarusian authorities are committed to structural reforms. The IMF has its suspicions. Fund officials have referred to President Alexander Lukashenko's repeated adjustments to the government's economic plans for 2012. Specifically, the president demanded that the government increase its original 1.5% GDP growth target for the year towards 5.0-5.5%. The IMF does not see the reasons for such an increase. That said, the economic situation in Belarus has certainly improved since a balance-of-payments crisis last year forced the currency to be devalued three times in the space of a year, inflation reached hyper levels, and bank runs drained the country of much of its hard currency reserves. In July, the EBRD, contrary to what's happening elsewhere in Emerging Europe, raised its 2012 growth forecast to 4.5% from the 2.5% it was predicting in May. There are also hopes that at least some assets could be sold this year to help further improve Belarus' finances, such as state-owned Paritetbank, a mediumsized bank that the central bank plans to auction in 2012. Forestier hails the intention of the Belarusian authorities to sell Paritetbank. "We were discussing its sale with the Belarusian authorities when we did pre-privatisation in Belarus. We were informed that the private sector was interested in acquiring this bank. We think it's a very good thing," he says. Forestier also wouldn't rule out the EBRD working with the bank once it becomes private. "But the process of privatisation has to be fair and open, and if we like the new management and new ownership, then we'll look at it."

Eastern Europe

Bear-faced cheek

bne Already strained relations between the EU and Belarus managed to take a turn for the worse in August as the fallout from the "teddy bear bombers" continued to grow. Belarus spent July denying the incident that saw Minsk and its surroundings on July 4 showered with hundreds of teddy bears clutching placards calling for human rights to be respected ever took place. The bears were part a stunt by Swedish public relations firm, Studio Total, which specializes in revolutionary advertisements. However, in August the government of President Alexander Lukashenko changed its tune. It first fired two high-ranking military officials for allowing the plane – which took off from Lithuania piloted by two Swedes – to penetrate the former Soviet air defences undetected. Lukashenko also told the incoming border guard chief not to hesitate to use weapons to prevent violations of Belarusian air space in future. The government then took strong diplomatic action against Sweden by expelling all its diplomats, and asked Lithuania and Sweden to help it apprehend the "teddy bear bombers" and put them on trial in Minsk for violating both Belarusian and Nato airspace. According to Belapan, the Belarusian KGB's PR chief Alexander Antanovich said that a request has been sent to Vilnius and Stockholm requesting assistance in the investigation of a violation of the Belarusian border by the airplane. Antanovich added that the Belarusian law enforcement agencies are asking the two countries for assistance to bring the perpetrators to Minsk so that an "objective investigation of the case" can take place. Apparently without irony, the KGB man added that Minsk is working on the grounds of international law and existing procedures, and on the understanding that the unauthorized flight violated Nato air space as well as that of Belarus. Asked whether the KGB might accept an investigation by the Swedish authorities into the identity of the pilots, Antanovich remarked "an identification parade on television is not possible." In response to Minsk's decision not to renew the Swedish ambassador's accreditation, Foreign Minister Carl Bildt accused the Lukashenko regime of having "seriously violated the standards of international relations" – a view backed by Brussels at an emergency meeting on August 10. "Everyone around the table were absolutely clear that this was not just a situation merely between Sweden and Belarus. It's a situation that... affects the EU's relations with Belarus,” Olof Skoog, a Swedish diplomat who chairs talks on foreign policy issues among EU states, was quoted by newswires as saying. "There is going to be a very clear message to all Belarusian ambassadors around Europe in the next few days expressing full solidarity with the Swedes on this."

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

bne September 2012

for the bank – a first for Svyaznoy, which has always had to use the cash-positive retailer as a backstop in past deals. Still, the borrowing doesn’t come cheap. While rates for loans in the West are of the order of 3%, in Russia the banks are charging closer to 9% even for wellknown and solid customers, and more for smaller companies, if they can get money at all.

www.svyaznoy.ru

Svyaznoy's transformation

While consumer lending was growing at about 28% in the first quarter – a rate that the Central Bank of Russia’s deputy chairman, Alexey Ulyukaev, says could lead to overheating – commercial lending remains the one part of the financial system yet to fully recover from the crisis and is growing at half the rate of consumer loans in the first quarter.

What you need to know

Ben Aris in Moscow

he strip of shops on Gruzinsky Val near Beloruskaya station in the heart of Moscow are typical of the downmarket retail outlets in the Russian capital. Gaudy signs above rundown premises that are little more than a single room. There are cheap eateries, small clothes shops decorated with sun-bleached posters of models in their knickers that sell imported Chinese-made underwear and the odd flower shop. Then you reach the new Svyaznoy store that juts out from the rest after its recent renovation. Clad in brown glossy stone with a slick and modern interior, it's a far cry from the glorified kiosks jammed onto a few square metres of pavement space at the corner of the road that for the last 20 years have been mostly mobile phone outlets. Svyaznoy used to be merely Russia's second biggest retailer of mobile phones, but is now transforming itself into one of the most successful banks-cum-shops in the country, leveraging its 3,000 outlets around the country. Retailing in Russia is developing fast, but the market is still wide open. What Svyaznoy has done is to leverage its existing retail platform and distribution network to expand into new areas of business; the company now offers a wide

range of goods from household appliances to consumer electronics and is growing by 30% a year despite the crisis. But it is the banking services that have been the most successful and the company recently raised $300m to fund its expansion. Initially, the holding group planned to sell a stake to raise money to fund the banking operations, but faced with the pall hanging over the stock markets it eventually went for debt. "We were looking at private equity deals as well as other options to raise money, among

However, apart from the difficulties of raising money, from Svyaznoy’s point of view the crisis has had little impact on its business. "In the worst of the crisis in 2009, mobile retail was down more than 10%, our sales remained almost unchanged. Now sales keep growing – in the first half they grew by 30% year on year and profits by even more," says Ludkovsky. Part of the reason is that Russians are switching over from regular phones, where sales were predicated on the type of package you bought from one of the

"We are still expanding – we opened more than 250 new branches over the first five months of this year, which is by 25% more than in the first five months of 2011" which we chose to finance our growth through debt in the end. Private equity is still open to us, and we consider it an option given the terms suit our expectations," says Dennis Ludkovsky, CEO of Svyaznoy. The phone retailer remains a cash cow, so the debt was taken on at the holding level

incumbent operators, to smart phones, where the add-on services like mobile internet are the money-makers. "And we are still expanding. We opened more than 250 new branches over the first five months of this year, which is by 25% more than in the first five months of 2011," says Ludkovsky.

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to the fiscal consolidation, bond investors will remain happy," he says. An agreeable fellow Fico is clearly looking to build a new image as consensus builder, Sindel says, even if sometimes that consensus is forced. "Compared with the expectations, Fico has been far less aggressive. I think he's looking to the next elections already, and he realizes his biggest potential opposition is himself." Sharon Fisher of IHS Global Insight stresses that Fico is no Orban, though warns there are still dangers ahead. "The catastrophic scenario [of Hungary] is not likely to play out [in Slovakia], but there are definitely risks for the business environment and foreign investment," she says. "Some are already upset about some of the issues, as you can see from the most recent confidence reports from Business Alliance Slovakia, with a sharp drop in the last quarter."

Slovakia's Mr Consensus Tim Gosling in Prague

nalysts met the news that Slovakia's first ever single-party government would be led by Robert Fico with dismay. Six months into the new administration, those fears have not been borne out, but what happens when the firefighting is over? Alarm calls went up in March when Fico's Smer party rode the so-called "Gorilla" corruption scandal to a landslide victory in parliamentary elections. The prime minister's earlier stint in office in 2006-2010 was marred by rampant corruption and populist policies, which prompted many to fret that Central Europe could have a "Viktor Orban mark II" on its hands. Yet in contrast to the combustible Hungarian PM, Fico has spent his current time in charge building a new image for himself as a fiscally responsible administrator and a consensus builder. His government's immediate commitment to the EU project and German-led calls for austerity on taking

office sent a positive signal. Together with the country's relatively robust economic growth, this has helped Slovakia avoid the sort of market collapse that Budapest suffered around the turn of the year. Investors appear happy enough with the Smer government so far. Slovak bond yields have slid sharply since January – the 2020 benchmark was 250 basis

July, and Slovakia has the time and space for pre-financing for 2013. At the same time, the ratings agencies and the International Monetary Fund have also offered their support in recent weeks. On August 3, Standard & Poor's affirmed its 'A' rating on Slovakia. Economist Jaromir Sindel at Citigroup laughs as he relates that he began covering Slovenia as well as Slovakia because

"This 'man of consensus' will likely persist as long as growth does, but that could change if Slovakia goes into recession" points (bps) below early year levels in late July – and Bratislava has managed to diversify its investor base with bond issues in Czech koruna, Swiss francs and US dollars. Analysts at Komercni Banka point out that the year's financing needs were already covered in

investors so regularly used to send him inquiries related to the small Balkan country, committing the same faux pas as former US president George W. Bush. "Investors not dedicated to [Central and Eastern Europe] are not so worried about the details – as long as Fico sticks

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While Fico's commitment to keep to the 2012 budget deficit target of 4.6% of GDP and follow that up by bringing the gap in below the magic 3% threshold cheered analysts, they worry that thus far the populist Smer is attempting the trick purely via revenue-raising measures. The previous 19% flat tax system has been scrapped, raising corporate taxes to 23% and creating an upper income tax band of 25%. Meanwhile, regulated companies will face a windfall tax. "Basing the entire fiscal consolidation programme on revenue is shaky, especially given the uncertainty in the Eurozone and likely impact on Slovak economic growth," points out Fisher. Indeed, Fico and his finance minister, Peter Kazimir, have already admitted that tax revenue is falling behind, and that they will have to freeze pensions and social benefits – a move Fico categorically ruled out in March – to help plug a gap of around €500m for 2013. That will rankle with Smer's core electorate. However, the previous centre-right government left a paucity of fat available to trim after inheriting a deficit of around 8% when it took over from Smer in 2010.

Gorilla in Athens

bne Events in the Eurozone often defy rationalisation, but having the disgraced former head of Slovakia's privatisation agency advising on the sell-off of Greek state assets even had the most hardened observers shaking their heads in disbelief. On August 10, Anna Bubenikova, the former head of the Slovak National Property Fund (FNM) who was dismissed for her involvement in the "Gorilla" corruption scandal, was forced to resign as a European Commission-appointed privatisation adviser to the Greek government after her role was highlighted by Slovak television channel TV Markíza. Although no formal charges of wrongdoing have yet been brought against her at home, Bubenikova came under pressure to resign after the new left-wing government, led by Prime Minister Robert Fico, said it would ask Eurozone finance ministers to call for her dismissal, because of doubts about her ethical standards. The former Slovak finance minister Ivan Miklos recommended Bubenikova for the EU post in July 2011, just months before the Gorilla tapes turned up, which allegedly featured a host of senior officials talking over cutprice privatisation deals with murky financial group Penta in 20052006. Bubenikova, who as head of the FNM was essentially Slovakia's privatisation chief, has been accused of facilitating the agreements. Bubeníková said her resignation would ensure that the EU and Greece's Asset Development Fund would not have "to judge and evaluate the disinformation and untrue assertions constantly made by some media and some Slovak politicians." The local Slovak daily SME wryly notes that in actual fact Bubenikova proved very efficient in her previous job as head of the FNM, with the tempo of privatisation in Slovakia twice that of Greece, benefiting a host of companies including that of her husband. Thus, the paper says, selling off ¤50bn of Greek assets by the deadline of 2015 "should be a cakewalk for her."

"Investors not dedicated to CEE are not so worried about the details – as long as Fico sticks to the fiscal consolidation, bond investors will remain happy"

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Meanwhile, the banks are unhappy over an increase in a special tax on the sector originally introduced by Fico's predecessor, Iveta Radicova. Analysts also worry about the government's rolling back of pension reform by cutting flows to the second pillar. However, Slovakia is not the first in the region tempted to bet against raised liabilities in the future to borrow that cash. Hungary decimated private pension funds, while Poland performed a similar trick to Smer. Nobody compares Donald Tusk with Orban, but that's because the Polish PM avoids Fico's occasional tubthumping. The one real red flag raised by "Smer version 2.0" so far was an announcement in late July that the government is preparing to expropriate

"Economic growth remains key for Fico's whole leadership outlook"

Slovakia's private health insurers, whose sins are apparently taking funds intended for medical care and locking them up as profit. "It's definitely a negative signal," says Fisher, suggesting it was probably just a way of getting rid of the private sector competition. When the firefighting is over Economic growth remains key for Fico's whole leadership outlook. Sindel says this "man of consensus" will likely persist as long as growth does, but that "could change if Slovakia goes into recession." In Slovakia, growth for now depends on large foreign manufacturers, particularly expansion by the country's giant carmakers, which have helped drive year-on-year GDP growth 3.0-3.4% since the last quarter of 2011. Smer needs to keep that up over the short term, and be ready to accelerate growth once the firefighting is finished. Fisher says foreign investors – hand in hand with coalition partners – quashed

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many of Fico's more controversial promises in his last administration. However, she also points out that investors don't have too many options right now either. For instance, struggling through the crisis, Peugeot-Citroen slashed hundreds of jobs at old plants in France producing flagship ranges, while expanding production at its modern Slovak factory, where small and cheap models are built to send to both underconfident European consumers and those with growing incomes in emerging markets. Longer term, however, Fico will need to curry favour with a wider range of investors, as the economy is clearly at risk from its heavy dependence on the auto and electronics sectors. "Economic diversification is badly needed, although it won't happen of course while companies go through the crisis," Sindel points out. Fisher worries that a forthcoming draft of a new labour code could hold back investment. Mooted changes include strengthening the unions; limits on freelance work, self-employment and temporary contracts; and raising the cost of firing staff. If they do arrive however, it's also important where within Slovakia investors head. Despite the strong recovery since 2009, unemployment remains a blight stuck at 13-15%, which in turn depresses domestic demand to leave the country with even greater exposure to export demand out of the EU. "Unemployment is huge in the east," points out Sindel. "They need to attract investors to those regions, but first of all they need to build roads so they can get there." Shelling out for expensive highways is clearly a step too far for the moment, however. So too is dealing with the chronic corruption that plagues the country and deters investors, suggests Fisher. "I don't think anyone thinks [Fico] is clean," she says. "It was the main reason he lost the election in 2010. The parliament has just voted down immunity for MPs, which is a good start, but I think there will be a few grand gestures, with little underlying change."

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70% of respondents. Tusk was a distant fourth with 40%, behind Foreign Minister Radosław Sikorski and Deputy PM Waldemar Pawlak. Tusk's already sinking popularity is expected to take another hit from the latest revelations that his son Michal Tusk worked simultaneously for the state-run Lech Walesa airport in Gdansk and for OLT, which was declared bankrupt in July, followed a month later by owner Amber Gold – a gold-derivatives business that Polish regulators accuse of being little more than a Ponzi scheme.

Warnings lights that are Amber bne

hen asked by a journalist what is most likely to blow governments off course, the former British prime minister Harold Macmillan replied, "Events, dear boy, events." Poland's premier, Donald Tusk, can only agree. Since winning power for an unprecedented second term last October with 39% of the vote, Tusk and his Civic Platform party have steadily lost public support, first with a raft of austerity measures to right the listing economy and then a series of scandals culminating in August with the revelation that the PM's son was involved in the debacle surrounding the collapse of the OLT Express budget air carrier and the murky investment company behind it, Amber Gold. In a July poll, Civic Platform's support had fallen to only 27% of respondents versus 32% at the start of July. One of the causes seen behind the fall was the

resignation of the agriculture minister, Marek Sawicki, following the release of transcripts of private conversations by daily newspaper Puls Biznesu that showed a former head of the Agricul-

Flyover Poland OLT Express burst onto the scene in April, providing long-suffering Poles sick of the awful roads and rail services the opportunity to fly around the country without having to rely on Lot Polish Airlines' regional subsidiary Eurolot. OLT came about after a mysterious investment company called Amber Gold, which made its money dabbling in gold and not airlines, bought OLT, then a failing German regional airline, and merged it with Jet Air, a small Polish flier. Although Amber Gold was on the blacklist of Poland's financial markets regulator (KNF) for acting without a banking licence, the company had outlets around Poland promising annual returns of 10% no matter what

"The opposition are questioning whether Tusk's son was involved in a conflict of interest in working for both a state-owned airport and a now-bankrupt low-cost airline" tural Market Agency, controlled by the agricultural ministry, talking about cronyism and misuse of public money by members of Sawicki's agrarian Peasants Party.

the gold price and, OLT CEO Jaroslaw Frankowski claimed, after several years of successful activity had gathered enough funds for it to plunge into the airline business.

Another July opinion poll found that President Bronisław Komorowski is Poland's most trusted politician, with

But after investing about PLN60m (€15m), Amber Gold pulled the plug at the end of July, forcing OLT to suspend

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Show me the money News that the Czech opposition Social Democrats (CSSD) plan to distribute flyers to households in the form of a postal money order with the sum the government bill on return of the churches' property would cost each person will remove any doubt the restitution issue will be a hot-button topic at the next parliamentary elections. Under the government restitution bill currently before parliament, churches are to be returned land and real estate seized by the communists worth CZK75bn (¤3bn) and given CZK59bn in financial compensation for unreturned property over the next 30 years. The largest sum, CZK47bn, will go to the Catholic Church. However, in this most secular of nations, the restitution issue is deeply unpopular with many Czechs, who are currently suffering under austerity measures being implemented by the same government in order to right the country's finances. Thus CSSD, which opposes the restitution and is in prime position to win the autumn elections, have decided to start sending out the "money orders" that will show the sum of CZK12,755 each of the country's 10.5m people will have to fork out. Past experience shows how effective such campaigning can be. The CSSD campaign resembles a similar one in the last 2010 elections by the TOP 09 party, a member of the current threeparty coalition, which sent out "postal orders" pointing out the state debt's level. A number of recipients were alarmed, believing they would have to cover the sum of CZK121,000 written on them, and called the police's emergency line.

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flights. OLT’s sudden collapse inevitably put the spotlight on Amber Gold, which was already in trouble following a warning issued by the KNF that banks dealing with unregulated lenders faced a "reputational risk" prompting them to shut down Amber Gold’s bank accounts. Amber Gold officially went under on August 13. Amber Gold's 28-year-old founder, Marcin Plichta, called a news conference, saying that his companies had been brought down in a government conspiracy. While Amber Gold has promised it will pay investors back to the tune of €80m, few expect to see their cash again, according to internet forums. KNF now has the company under investigation, and questions are being asked about the role of PM Tusk's son in the whole affair. The opposition are questioning whether Tusk's son was involved in a conflict of interest in working for both a state-

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owned airport and a now-bankrupt lowcost airline. The fact that Amber Gold received permission from administrators to buy and operate an airline despite having been designated an illegal bank by the regulator KNF is another concern the opposition is raising.

regulators met in August and came out with a series of recommendations to tighten up the law on so-called "parabanks," to get government agencies to more closely investigate firms that find themselves on the KNF's watch-list for acting without a banking licence, to penalise companies that do not publish financial results, to limit the ability of companies on the KNF watch-list to advertise and to improve communication among government agencies.

Tusk the younger – presumably in a misguided bid to reduce the impact on the PM – said in a magazine interview published on August 13 that his father had warned him not to get involved with OLT Express and its owner, Plichta, who was convicted in 2005 of embezzlement. The opposition is now asking PM Tusk why he warned his son about OLT Express, but not the savers who were paying money into Amber Gold and may not have been aware of Plichta's conviction. They are also urging the PM to explain how both companies were cleared for operation by state regulators and justice authorities.

The trouble for Amber Gold's clients was that the company and its founder, Marcin Plichta, broke all of those recommendations, and suffered no consequences – until now.

Collective failure in Poland

mber Gold, the failed unregulated Polish investment firm, was difficult to avoid – one of its 60 branches was located just metres away from the headquarters of the Polish Financial Supervision Authority, the government's consumer watchdog agency, the National Bank of Poland and the Finance Ministry. Its advertisements, promising "guaranteed" investment returns of as much as 16.5% a year, graced the pages of the country's leading newspapers and magazines, while enormous billboards featuring a grizzled Clooneyesque man contemplating his golden future with Amber Gold adorned the buildings of Poland's largest cities. For those with a grain of financial sense, a company offering returns like that at a time when most banks were giving their best customers deposit rates of about 6% (which were then also hit with a 19% capital gains tax) seemed highly suspicious. But with the notable exception of the Financial Supervision

Plichta, whose original last name was Stefanski, is a 28-year-old with a knack for getting people to lend him money, but with a history of problems in paying them back.

Authority (KNF), government agencies did nothing.

He founded Amber Gold in 2009, after an earlier venture which was aimed at allowing people to pay utility bills at a lower cost than at a bank failed, leaving almost PLN200,000 of customers' money missing.

Now that Amber Gold has gone spectacularly bust, with at least PLN80m (€20m) of customers' money missing, Polish government agencies are scrambling to make up for years

Despite a suspended sentence for fraud, Amber Gold started promising customers fantastic returns by investing in gold – a metal that was in the midst of a massive leap in value. Yet the business

Jan Cienski in Warsaw

"The opposition is asking why the PM warned his son about OLT Express, but not the savers in Amber"

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"There is a task for all of us, that in the future so many people, so many institutions not fall prey to people who want to exploit their naivety" of neglect that allowed the firm to operate in apparent violation of a host of laws and regulations – but the whole operation has a bit of a close-the-barndoor-after-the-horse-has-bolted flavour. Pariah banks A special Financial Stability Committee involving most financial sector

plan was never quite clear, as Plichta promised to ensure customers' returns out of past profits if the price of gold fell – something that happened this year. Amber Gold never fulfilled minimal legal requirements of filing accounting results, and its investment strategy was murky at best.

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An inclement argument There is a well-worn adage that everyone complains about the weather, but no one does anything about it. Well, the tourist industry in Hungary has decided enough is enough, demanding that weather forecasters change their gloomy tone, which they claim is hurting business. "A cold wave is coming, the weather's about to turn bad, so holidaymakers or those planning outdoor activities have nothing good to look forward to:" this is the kind of language that the Hungarian tourism destination management association, or TDMSZ, says is too widespread in Hungary's weather reporting, according to The Wall Street Journal. Instead, the tourism lobby group suggests more optimistic language, such as "the refreshing cooler weather finally provides an excellent opportunity for touring the town without sweating" or "there are exciting museums, theatre and musical performances and affordable gastronomic experiences to try while its pouring down." Understandably, the Hungarian Meteorological Service is unimpressed. "I consider this whole thing to be a joke," Zoltan Dunkel, the service's president, was quoted as saying by the WSJ. "In most cases, it’s the television channel or radio station's editing staff that determine the actual forecasts."

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It became even more mysterious when Amber Gold jumped into the tricky airline business last year, buying OLT Jetair, an ailing German carrier, and setting it up as an airline serving Poland's national market. OLT Express launched in April, selling tickets for as little as PLN99 on flights between larger Polish cities. Just how much Amber Gold sank into the airline is unclear – estimates range from PLN30m to more than PLN200m– but in July the investment firm pulled the plug, forcing OLT Express to ground its airliners and declare bankruptcy. The KNF had placed Amber Gold and 15 other companies on a watch list for acting without a banking licence, but the prosecutor's office took only a desultory

Chequered past The press quickly found that Plichta had not one but nine past convictions for fraud and other financial offences, receiving suspended prison sentences for all of them. The past convictions should have made it impossible for Plichta to be the CEO of a registered company – however no one bothered to check his record when he founded Amber Gold. His criminal past also meant that he should have been unable to trade in gold and platinum, however neither he nor Amber Gold had applied for the required licence with the central bank, and again no one bothered to check. The central bank has tried to shift the blame onto the tax inspectorate and the customs department – who also did nothing to control Amber Gold.

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In a press conference held just before Amber Gold shut its doors for good on August 13, Plichta assured reporters that he had 110 kilograms of gold (worth about PLN20m) on hand, and that the total assets of his company were easily more than required to pay off the 7,000 unfortunates who still had funds deposited with the firm. However, no one had any proof of just what clients' money had been spent on, and the true state of Amber Gold's assets.

Overall, Erste’s non-performing loan (NPL) ratio increased to 9.2% as of June 30, compared with 8.5% at year-end 2011. That’s still low by regional standards – at the end of the first quarter, for example, Romania’s average NPL ratio was 16.3% and in Serbia it was 20.4%. However, the banking sector of the Czech Republic as a whole reported an NPL ratio of just 5.9% at the end of May, according to central bank data.

The prosecutor's office, which had not acted on the KNF's request to investigate Amber Gold, now has about 150 fraud claims filed by the company's clients.

SocGen also saw a big decline in its profits following write-downs on its Russian unit and US asset manager TCW Group, with its second-quarter profits falling 42% from the year-earlier period. However, its Czech unit Komercni Banka said that its net income for the same period almost doubled to CZK4.12bn from CZK2.1bn a year earlier, helped by a one-off gain from the sale of a stake in a development bank and higher banking income from lending.

Plichta's apartment was raided on August 17, and he has been charged with issuing illegal loans, violating banking

"It is unclear whether Amber Gold has any money left in its accounts" interest in Amber Gold despite pressure from the KNF. Other institutions did nothing. OLT's very public implosion finally stirred the media and the authorities to take a closer look at Plichta and Amber Gold.

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regulations and falsifying documents. Polish radio says that police found 60 kg of gold on the premises. However, it is unclear whether Amber Gold has any money left in its accounts. The Dziennik Gazeta Prawna newspaper reports that the accounts are empty, and the German gold merchant cited by Plichta as his source of precious metals denies having anything to do with him. "There is a task for all of us, that in the future so many people, so many institutions not fall prey to people who want to exploit their naivety, sand sometimes lack of care and sometimes the desire for gains, so that people cannot be fooled on such a scale," said Donald Tusk, the Polish premier, whose own son is in the firing line for having worked briefly at OLT Express.

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he average Czech’s financial conservatism is legendary – and earnings results from Erste Group Bank, Societe Generale and KBC Group announced in August perfectly illustrate this. Austrian bank Erste, France's SocGen and Belgium's KBC all released financial results that showed big declines in profits or losses, yet their Czech subsidiaries posted big increases in profits for the same periods. Erste, which together with Raiffeisen Bank International and UniCredit Group, make up the triumvirate of Emerging Europe’s largest lenders, reported first-half operating profit down 11% to €1.75bn as the bank was unable to cut costs at a fast enough rate to make up for the 6.7% decline in revenue. Reflecting the deteriorating operating conditions in Europe as the crisis there shows little sign of abating, Erste cut its 2012 operating profit outlook for the second time in three months, saying: “the full-year operating result

is expected to stay somewhat behind 2011.” Within Erste’s results, though, its Czech subsidiary Ceska Sporitelna reported net profit up 14% in the first half to CZK8.22bn (€324m), helped by bad loan provisions falling by 38%

And KBC even reported a first-half loss of €160m, down from a profit of €1.2m in the same period in 2011; its Czech unit CSOB, the Czech Republic's largest bank, on the other hand saw its profits surge 27% in the first half to CZK7.9bn, helped by rising loan growth and trading income, along with a steep drop in impairment charges after it wrote off its Greek debt holdings in 2011. Impairment costs fell 84% year on year.

“People ask me the difference between Czech banks and German banks – German banks invested everywhere, Czech banks only locally”

as the amount of bad loans declined to CZK2.25bn in the first half of the year from CZK3.64bn a year ago. Ceska Sporitelna is more efficiently run and profitable than the group as whole. The Czech bank’s cost/income ratio is around 40%, compared with the group’s cost/income ratio of 51.9% at the end of the first half.

Local loans The conservatism of Czech borrowers can also be seen in the country's foreigncurrency loan exposure, which is a mere 14.8% of total loans. The Polish, on the other hand, had a love affair with forex loans – largely those denominated in Swiss francs – because Swiss interest rates were much lower than those set by Poland’s National Bank. Although new

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Czech central bank watches and waits, for now

Nicholas Watson in Prague As widely expected, the Czech National Bank (CNB) on Thursday, August 2 kept its policy interest rate unchanged at a record low of 0.5%. But with the economy continuing to weaken, the odds are growing that the bank will make one further cut of 0.25 percentage points before the year is out. The CNB said there had been "a marked slowdown in external demand and subdued domestic demand against the background of fiscal consolidation". Indeed, purchasing managers indices for July showed that Czech manufacturing contracted again for the fourth consecutive month, with the new export orders sub-index remaining particularly weak at 47.9, reflecting poor economic conditions in the rest of Europe, particularly Germany. The CNB said it has lowered its outlook for GDP this year to a contraction of 0.9% compared with a previous prediction of zero growth. Next year, it sees growth of just 0.8%, down from a previous forecast of 1.9%. The worsening economy prompted the central bank to cut its rate by 0.25 percentage points on June 28. Miroslav Kalousek, finance minister, followed that on July 20 by saying he would ease up on the government's austerity drive to give the floundering economy a boost. Kalousek has been criticised for cutting spending too far, too fast and tipping the economy back into recession in the first quarter, when GDP shrank by 0.8% from the quarter before. The finance ministry now expects the economy to shrink by 0.5% this year, rather than grow 0.2% as it had been forecasting in April. With August's macroeconomic data all pointing to a further deterioration in the Czech economy – Komercni Banka sees month-on-month declines in industry, exports, construction and retail sales – and two of the six CNB board members voting on Thursday for an interest rate cut, many economists expect another rate cut this year, possibly as soon as September. "The growth outlook remains a serious concern, while fears about inflation have subsided in recent months," William Jackson, emerging markets economist for Capital Economics wrote in a note following the CNB decision. "We have now pencilled in one further 25 bp rate cut this year, bringing the benchmark rate to 0.25%."

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Together with rising bad loan provisions, the Hungarian banking sector suffered its first loss for 13 years in 2011. Erste's local unit contributed €567m to the sector's total loss of HUF92.5bn, and followed that up with a €72.7m loss in the first half of this year. Still struggling against a continued slowdown in the economy and a new financial transactions tax that will be levied on all commercial bank operations, Erste's Hungarian subsidiary says it does not expect to return to a profit before 2014.

forex loans in Poland are now rare, they still make up almost 60% of outstanding mortgages. Likewise, Czech banks made few forays into the kind of investments that so hurt banks elsewhere in Europe. “People ask me the difference between Czech banks and German banks – German banks invested everywhere, Czech banks only locally,” says one regional fund manager. He points out the general surprise among analysts when Komercni Banka, the third largest Czech bank by assets and the only publicly listed one, revealed that its dabbling in Greek bonds had forced it to take charges worth CZK5.36bn last year on its Greek bond holdings, writing them down to a quarter of their value. Miroslav Singer, the governor of the Czech National Bank (CNB), told bne earlier this year that the Czech Republic is rather exceptional within Europe for having a sound, very liquid and profitable banking system. He puts this down to the traditional conservative approach to banking that Czech bankers have pursued – taking in deposits, using that money to lend wisely to businesses and households – the kind of banking “which everyone would now like to do.” “We have one of the lowest loan/deposit ratios in Europe at around 70%, so banks have ample sources to finance credit growth,” he says. “The problem is the opposite: significant sections of the Czech public are too conservative to borrow from banks.” The back-drop to all this is a relatively stable economy. Though the shine may have come off the economy lately as it slips back into recession – Komercni Banka expects Czech GDP to decline by 0.5% this year – the fiscal position remains sound, with sovereign debt as a percentage of gross domestic product well within Maastrich criteria limits at just above 40%.

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Private banks eye panicky Hungarian rich Tim Gosling in Prague

he Hungarian government's "unorthodox" economic policies are hurting the economy and spreading worries about political risk among investors. That has private banks with international networks salivating. Shrugging off continued pressure from Hungary's government on the country's banks, Erste Group Bank's Hungarian unit increased its investment in the country with the acquisition of the local private banking arm of BNP Paribas on August 9. Erste said the acquisition was driven by the anticipation that Hungary's private banking market will undergo significant consolidation, but it's also likely the Austrian bank is one of several to note increasing interest from high net worth individuals keen to shift their assets out of the country. "We continue to believe in banking in Hungary, we're committed to grow here despite the hardships," Erste Hungary CEO Radovan Jelasity told a press conference. Erste did not disclose the cost of the acquisition, though revealed it would

increase its market share in Hungarian private banking from 9% to 12%, boost assets under management at Erste Bank's private banking division by HUF60bn (€217m) to HUF200bn, and increase its client list by around 400 to 2,200. Money fight Banks in Hungary have been fighting a concerted attack by the populist Fidesz government since it came to power in 2010. They have faced what Patrick Butler, a board member at Raiffeisen Bank International, claimed to bne is

Alongside the other foreign banks that dominate the market, Erste cut back on investment in commercial banking around the turn of the year, with branches closed and staff released. The sector has also reduced lending in response to the government pressure, and as the Hungarian economy has slowed. Money flight However, Budapest's "unorthodox" economic policies have hurt business across the spectrum – and frequent speculation about favouritism being shown to those companies close to the administration has only unnerved investors further. On top of that, the economy continues to slow, and slipped back into recession in the second quarter of 2012 after escaping by the skin of its teeth in the first three months of the year. While still awaiting a breakdown of the data, analysts from Erste's macroeconomics unit point out it is only exports that are likely to have offered

"Austrian banks on the border have seen a huge rise in clients coming across from Hungary to deposit assets" the "highest banking tax in the EU," as well as huge losses on foreign-currency mortgages incurred under a government scheme devised to relieve struggling borrowers.

any impetus to the economy, although with the vast majority of Hungarian exports headed to the Eurozone, that also looks shaky right now. They add that household consumption probably

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remained in negative territory during the quarter, and is expected to shrink 1.5% in 2012. "Moreover, investment activity is… poor and the outlook for investments is grim, partly due to the high uncertainty in the economy." Meanwhile, inflation continues to rise – it increased 0.2 percentage points on a monthly basis to 5.8% in July – and the forint remains vulnerable, which leaves the central bank in a tight spot regarding easing monetary policy to offer some stimulus to the economy. The big question for the markets is progress towards a new loan agreement with the International Monetary Fund and the EU. For now, they are betting it will appear eventually, but should capricious Prime Minister Viktor Orban and his cohorts knock that confidence, the fallout will be swift. As if that weren't enough to convince Hungarian investors they might be

better off shifting their assets outside the country, the government has also made it clear that anyone is fair game in its fight to assert its unorthodox policy. One of its first moves when it came to power was to effectively nationalise over €10bn in private pension assets by threatening savers that they would not receive a state payout unless they elected to move their accounts. The upshot of all this is that international private wealth managers note significant opportunity, eyeing increased client flows on the one hand, and acquisition opportunities on the other, as parent banks in the Eurozone face tough decisions in trying to shore up their balance sheets.

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recently, propelled by the political risk. On top of the lack of attractive investment opportunities offered by the economy right now, that's a compelling reason for the wealthy to look for an asset manager with an international network to deploy assets across Europe, he points out. "Austrian banks on the border have seen a huge rise in clients coming across from Hungary to deposit assets," he said. Following the announcement of its purchase, the head of Erste's Hungarian private banking arm, Andras Kallay, stated that the Austrian bank is one that is ready to take advantage. "Erste continues to seek further acquisition targets," he said, "as we expect more consolidation on the market."

Stephen Maxonus, CEE head for Austria's Schoellerbank – a private banking unit within the UniCredit Group – told bne in June that Hungary has shot up its list of target markets

supporter of Lithuania's accelerated drive for greater energy security in recent years. Still bickering At the same time, speculation persists that the Social Democrats' questioning of Visaginas is no more than political jockeying ahead of the elections. However, the likelihood that the referendum could show a significant majority of Lithuanians now oppose the nuclear plan would add grist to the mill of lobbyists for increased use of gas – 100% of which comes from Russia for the meantime – and other "capital groups," as the businesses that are involved in the energy trade are referred to in political debates and the media.

Lithuania's nuclear politics the vote on Visaginas complaining that details on the project remain too scarce after earlier supporting the plan to build the plant – are most likely to lead the next government.

In turn, increased uncertainty within Lithuania will create more problems for the Visaginas project, which has still yet to get off the ground despite years of talking. Like any large energy project in the Baltics, the nuclear plant is necessarily a regional scheme, and those regularly provoke bickering between the three Baltic states, with much encouragement from Russia. Latvia in particular, with its strong Russian minority, has regularly suggested it is adverse to the willingness in Vilnius to ruffle Muscovite feathers.

However, with no single party managing more than 17% in the latest polls, the current coalition leader Homeland Union has said it remains open to potential participation in the next government, which is likely to include three or four coalition members. The final composition of the government, and the distribution of posts, will also depend critically on President Dalia Grybauskaite, who has been a strong

Echoing the Lithuanian opposition, Riga continues to insist that it needs more details before committing to the project. Currently, Lithuania is set to own 38% of Visaginas, with Estonia to hold 22% and Latvia to split the remaining 40% with strategic investor Hitachi. However, those shares are anything but nailed down, while Poland is reportedly mulling a return to the project after leaving in 2011.

Tim Gosling in Prague

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

What you need to know

www.bne.eu

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ust under half of Lithuanians are set to vote against the construction of a new nuclear power plant, while less than 20% will offer support in a non-binding referendum in October, according to a recent survey. While a resounding rejection could make life very tricky for the troubled project, there's a lot of political horse trading ahead whatever the outcome. A total of 48% of Lithuanians are likely to vote against building a new regional nuclear facility at Visaginas to replace the old one that was decommissioned in 2009, while 19% support the construction, reports Bloomberg, referencing a survey by Prime Consulting. The poll, conducted in the country's largest cities among 500 people on July 16-17, provided no margin of error. Lithuania will hold the referendum on October 14 alongside a general election, in which the ruling centre-right coalition is widely expected to be ousted from office. The polls suggest that the Social Democrats – who originally called for

"A total of 48% of Lithuanians are likely to vote against building a new regional nuclear facility at Visaginas to replace the old one that was decommissioned in 2009"

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Less positively, the government gave clear signs that the power struggle is set to continue. Acting president and high-ranking USL official, Crin Antonescu, confirmed there will be no peace between Ponta and Basescu, who has now survived two impeachment referendums since becoming president in 2004. "We do respect the court

Raiffeisen Bank International said the markets’ reaction to the court decision was muted, as the decision was the most probable outcome. "In the very short term, we expect the intensity of political tensions to diminish, but only to return to levels witnessed before the [impeachment] vote. In the months ahead, taking into account

"I want to send a signal of stability to Romanians: the court decision will be respected and implemented"

www.presidency.ro

Basescu back in the hot seat Nicholas Watson in Prague

lus ça change, plus c'est la même chose. Romanians understand this not just because French is widely spoken in the country, but because the political fighting – which has already done so much harm to the economy – is set to continue after President Traian Basescu was reinstated by the country's top court. On August 21, the nine-member Constitutional Court, as had been expected, ruled that a July 29 referendum, called after Prime Minister Victor Ponta and his Social Liberal Union (USL) managed to get parliament to suspend Basescu, was invalid because the turnout fell short of the required 50% of the 18.3m electorate. In the referendum, 88% of those who voted wanted Basescu out. However, the turnout was only 46%, in no small part because Basescu had called for a boycott.

That should have been an end to it, but this is Romania, where political fighting between the various actors is so ingrained that Ponta and his allies didn't know when to give up. The government then claimed that the size of the total electorate was lower in reality than on paper, and that the turnout threshold had therefore been met. It set about trying to push the Constitutional Court to agree. This resulted in complaints from the court to a judicial commission of the Council of Europe "about continuing pressure and threats against individual judges."

the court decision, the European Commission urged all political actors "to comply with the decision… and to respect European values, to act with responsibility and to work constructively in overcoming divisions, in Romania's best interests."

None of this has gone down well in the EU, which accuses Ponta and his government of trampling over democracy and undermining judges – massively counterproductive in a country where corruption is so rife and entrenched. In a statement following

In a positive sign, the government said it would accept the court's decision. "I want to send a signal of stability to Romanians: the court decision will be respected and implemented," Ponta told a news conference.

"The European Commission expects the Romanian authorities to abide by the rule of law and the decisions of the Constitutional Court," it said. "Accordingly, the legal procedure to reinstate President Basescu should be respected."

decision and Traian Basescu will again become a president. But he returns as an illegitimate president," Antonescu said. "The court refused to see that at least 2m Romanians shouldn't have been taken into account for the referendum quorum."

the tense relations between President Basescu and the current majority in the parliament led by the USL alliance, as well as the parliamentary elections which are due towards the end of the year, we expect uncertainty related to political developments to persist."

Elections ahoy! The battlefield will now move to the parliamentary elections set for November. Ponta's Social Democrats had been a shoo-in to win, but the PM is looking a bit ragged after losing the impeachment tussle and an academic panel finding that his doctoral thesis was based on plagiarism. His antidemocratic moves since coming to power in May, such as replacing the ombudsman – a check on parliamentary power – with an ex-party hack, trying to disband that academic panel, and now the failed impeachment, have caused consternation in the EU and frightened the markets.

Given Basescu's abrasive nature, there is no doubt he will make as much as hay possible out of this latest setback for Ponta and the USL, whose motivation for the attempted impeachment is thought to be an attempt to halt the president's anticorruption efforts.

The leu has fallen to record lows during the latest bout of political instability, an event which hurts not only Romanian pride, but hits hard because most public and private debt is euro denominated. A falling leu raises default rates and potentially destabilises the banking sector. "That is the last thing Romania needs right now," says Martin Prochazka, a independent analyst. Some €2bn left the country in May, according to a report published by the Romanian Academic Society (SAR).

That drive has targeted several USL deputies, while the recent convictions of ex-PM Adrian Nastase and other senior figures suggested that

"The court refused to see that at least 2m Romanians shouldn't have been taken into account for the referendum quorum" prosecutors are now willing to go to the very top. Basescu is now likely to step up these anti-corruption efforts, meaning he could be dodging impeachment bullets until his term expires in 2014.

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That purchase, together with the subsequent upgrade and expansion programmes for Petkim's petrochemical complex on the Aliaga peninsula on Turkey's Aegean coast, total $2.5bn. With $250m already spent, currently ongoing is a further $300m to expand capacity of the plant's ethylene cracker by 13% and production of two other products by 50%.

http://new.socar.az

Azeris put the 'fraternal' into Turkish FDI David O’Byrne in Istanbul

hen the Soviet Union collapsed in 1990, Turkish politicians and commentators alike hailed the historic opportunity for Ankara to become the leader of the newly emerged Turkic world and predicted a field day for Turkish companies moving into newly opened markets. In the event, the newly emerged Turkic republics showed no more appetite for being led by Ankara than they had for being ruled by Moscow and relations with some remain at best frosty, with one notable exception – Azerbaijan. Relations between Turkey and its eastern neighbour Azerbaijan have gone from strength to strength over the past decade on the back of a raft of oil and gas investments, the bulk of which are not by Turkish companies working in Azerbaijan, but rather by Azerbaijan's state oil and gas company Socar, either directly or acting as part of a consortium. These include the Baku-Tblisi-Ceyhan (BTC) oil line

that carries Azeri crude to Turkey's Ceyhan Mediterranean oil hub for export to global markets, and the South Caucasus Pipeline that runs parallel to BTC and carries Azeri gas to Turkey and on to Greece. And, most notably, Socar's purchase through privatisation

However, the bulk of slated new investment at Petkim's giant site will be for the planned 10m tonne/year (t/y) Star refinery, being constructed adjacent to the Petkim plant in partnership with Turkish energy group Turcas. "Currently, we're doing site preparation, and we expect to tender for the engineering design and construction by the end of the year, and to start construction in 2014," says Yavuz. Contrary to expectations, the plant will not just process the Azeri crude already arriving at Ceyhan, but will be configured to process all regional crudes. "Because of price fluctuations we want the flexibility to process all crudes produced in the regions," says Yavuz. Once completed in 2016, the plant will supply 1.6m t/y of Naphtha feedstock to the adjacent Petkim plant – not to mention a significant boost to margins. In addition, it will produce 6m t/yr of diesel and 500,000 t/yr of jet fuel

"At the end of the day, Socar and Azerbaijan will be the biggest single investor in Turkey" of Turkey's former state petrochemical company, Petkim – the focus for half of the ongoing and planned investment. "If we look at the whole picture of investments currently being made by Socar in Turkey, it will reach $17bn by 2018," says Kenan Yavuz, CEO of Socar's bourgeoning Turkish subsidiary Socar Turkey Enerji. "At the end of the day, Socar and Azerbaijan will be the biggest single investor in Turkey."

for sale to local and regional markets, as well as quantities of liquefied petroleum gas and aromatics that may be used locally or exported. Importantly, the plant will also produce 700,000 t/yr of pet coke, which will be used in another of Socar's investment projects – a 600-megawatt power plant, which will also be constructed adjacent to the Petkim plant. This $1.5bn power

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plant will provide power for both Petkim and the Star refinery, selling any excess production into the Turkish grid.

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Turkey and Turkmenistan push mutual interests

Other investments for the site include a wind power plant to take advantage of the peninsula's near constant winds and $400m set aside to upgrade and expand its existing port facilities.

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On Tanap Largest of Socar's planned investments in Turkey is the roughly $8bn it expects to spend on the planned Tanap gas pipeline, which will carry Azeri gas across Turkey to European markets.

Turkmen President Gurbanguli Berdymukhammedov embarked on a twoday state visit to Turkey on August 10 – his second of the year – as the two countries look to cement growing ties. Energy hungry Turkey is pushing to secure gas from the secretive producer to help it diversify its suppliers, while dangling the prospect of investing in the Turkmenistan-Afghanistan-PakistanIndia (TAPI) gas pipeline, for which Ashgabat is seeking to gather support.

The planned pipeline, for which Azerbaijan and Turkey inked three agreements back in June, finally guarantees that Azerbaijan will commit its Caspian gas reserves to European consumers, but details still remain vague. "The three agreements provide a framework for the structure of the operation, but the details have not been defined yet," says Yavuz, explaining that an ongoing feasibility study and a planned detailed engineering study will help finalise the capacity of the planned line and give a clearer idea of how much it will cost to build

With independent surveys showing that Turkmenistan has the fourth largest gas reserves in the world, Ankara is pushing to become a key importer of Turkmen gas, especially given the ongoing arguments with Russia – its largest supplier – over prices. Meanwhile, Turkey faces several challenges elsewhere in the region, with US sanctions suppressing trade with Iran, intraregional difficulties blighting Iraqi relations, and the Syrian crisis.

Current plans envisage a pipeline running 2,000 kilometres from the Azeri capital Baku to Turkey's European borders with a maximum capacity of upwards of 30bn cubic metres a year (cm/y). Initial throughput will be the 16bn cm/yr of output from Azerbaijan's Shah Deniz gas field, of which 6bn cm/yr will be supplied to Turkey at a discount and the remaining 10bn cm/yr will be exported to Europe. Plans for the remaining capacity are equally unclear, with the EU lobbying for the line to carry gas from Azerbaijan's Caspian neighbour Turkmenistan, while Azeri officials have indicated a preference for gas from Azerbaijan's other recently discovered gas fields. What is clear is that Socar plans for construction to start next year, with the first gas flow expected in 2018. "It's a difficult timeframe, but that's what we've been asked to do by the Turkish government," smiles Yavuz.

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At the same time, Turkmenistan is keen to diversify its export routes. Until 2009, it was totally reliant on Russian infrastructure, which saw it sell its gas at low prices to Gazprom, only for Moscow to pass it on to European customers at hugely increased prices. It is now also plugged into China via a Central Asian route, but still needs further options. The TAPI pipeline, which is planned to connect Turkmenistan with the energy hungry markets of Pakistan and India, is a key plank in Ashgabat's strategy to expand its export options, but with the precarious security situation in Afghanistan – through which it must pass – it has been struggling to whip up interest from investors. It is currently on a roadshow to sell the project. These mutual interests have seen the two countries try to put relations on a firmer footing. Turkish President Abdullah Gul has made four visits to Turkmenistan in the last several years, with his last official trip in May 2011, during which he discussed ways to improve cooperation in energy, construction, transportation and communications, as well as lavishing praise on Berdymukhammedov and his strict authoritarian regime. Turkish firms have also undertaken projects in Turkmenistan valued at more than $21bn in recent years, a total that accounts for 12% of such projects by Turkish companies. "Turkmenistan has achieved a distinguished and influential position in the international community with its neutrality policy. Taking into consideration its rich energy resources, Turkmenistan's role in regional development and stability is of critical importance," Gul said. Despite the two nations' determination to deepen relations, 2011 Turkmen-Turkish bilateral trade accounted for only $8.6bn, a mere 3% of Turkey's overall trade volume. In 2011, Turkey's imports from Turkmenistan totaled $392.7m, while its exports were worth $1.5bn. Turkmen exports to Turkey consist primarily of energy, textiles, chemicals and agricultural produce, while Turkish exports to Turkmenistan consist of metal manufactures, household goods, hardware, building materials, chemical and light industrial goods, food, vehicles, and medicine.

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Ban's magical mysterysolution tour Andrew MacDowall in Belgrade

he United Nations has a somewhat mixed record in the Balkans in recent decades. Most notoriously, UN-mandated troops stood by during the Srebrenica Massacre of 1995, which took place in a supposed "safe zone". In the same conflict, Bosnian Vice-President Hakija Turajlić was shot dead by a Serb soldier while theoretically under guard by a UN convoy. More recently, the UN's Interim Administration Mission in Kosovo has been regarded by many Serbs as violating their country's sovereignty and is unpopular even among the ethnic Albanian community, as the slogan "UNMIK go home" daubed on many a Kosovan wall indicates. And the organisation's Security Council remains at odds over Kosovo's independence. Thus the visit of UN Secretary General Ban Ki Moon to the Western Balkans in July was not greeted with a tremendous amount of excitement. No one was expecting Ban to deliver lasting solutions to the region's frozen conflicts and interand intra-national antagonisms. So in

this sense at least the South Korean's visit can be described as living up to expectations. There was the usual mood music about reconciliation and "lasting

in many cases, hampered by selfserving and corrupt elites. BosniaHerzegovina is divided on ethnic lines, leading to political deadlock, and is at risk of fragmenting further; Kosovo's sovereignty and the position of its Serb minority remain unresolved; violence flared between ethnic communities earlier this year in Macedonia, which is hamstrung at an international level by a petty row with Greece. Even Croatia and Slovenia, two of the more affluent, united and stable countries in the region, have restarted a squabble over Croatian savings salted away in a defunct Slovenian bank, with Ljubljana threatening to block Croatia's EU accession over the issue. Nonetheless, the secretary general's six-country tour (seven if one counts Kosovo, which the UN doesn't) does serve as a reminder that the region exists, that it faces serious challenges – and that it has made progress since the end of the Wars of Yugoslav Succession. History lessons One of the most significant aspects of the tour was Ban's visit to Srebrenica, the first by a UN Secretary-General since the 1995 massacre, in which around 8000 Bosnian Muslims were killed. The visit was largely of symbolic

"Ban left the Balkans pretty much as he arrived in them – troubled by ethnic divisions, economically sluggish and hampered by self-serving and corrupt elites"

stability," but rather less about how these might be achieved, other than through EU membership (a distant prospect for most countries in the region). Ban's statements could have been made by almost any figure in the international community. Ban left the Balkans pretty much as he arrived in them – troubled by ethnic divisions, economically sluggish and,

importance, but it was important nonetheless, not only from a Balkan perspective. As Kurt Bassuener, a Sarajevo-based policy analyst points out, his admission that "the international community was incapable of protecting those who in that moment needed our help, and they were killed" (Ban's words) isn't new, as the UN has already taken partial blame for the events. But the UN chief did indicate

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that the international community had taken on board the lessons learned, and had applied them in places such as Libya and the Ivory Coast – and that it should do so again in Syria.

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the need for increased interconnecting infrastructure and cooperation."

Ban also brought succour to Macedonia in its name dispute with Greece, saying that a "prompt resolution" was "imperative", and underlined the role of his personal envoy Matthew Nimetz to helping bring this about.

Ban's visit to Kosovo, the first by a UN secretary general since its declaration of independence in 2008, was rather more controversial, raising objections from Serbia. Inevitably, he urged Belgrade and Pristina to continue with negotiations and to normalise relations. As more than one person has pointed out, it's hard to normalise relations with a country while considering it a breakaway region and an inalienable part of one's own country. The fact that the UN doesn't recognise Kosovo itself also makes Ban's job rather harder.

Athens objects to the country being officially referred to as "Macedonia", claiming that it implies a territorial claim on the adjacent Greek region

In any case, the organisation has a minimal role in the day-to-day running of the country, having handed over its responsibilities to the EU; its staff

"Ban has been much stronger on Syria than his predecessors were on Bosnia, and I would look at his statements through that lens," Bassuener tells bne.

"The tour wasn't very special, nothing spectacularly new was said"

of the same name. As a result, it has blocked its neighbour's membership of Nato and its EU accession process, to the understandable frustration of the citizens of the Former Yugoslav Republic of Macedonia (as the country is officially referred to thanks to Greece). There are now real hopes that the issue can be unfrozen. "The visit was warmly welcomed and highly beneficial as it was first of its kind at this level in recent years," Aleksandar Dimishkovski, a Skopje-based business consultant, tells bne. "I think that it was designed and timed so that it can revive the negotiations between Macedonia and Greece. It seems that it was probably also an attempt to put the issue in the global public's focus and increase the pressure at both ends in order to finish the long lasting, ridiculous and tiresome dispute and enable the two countries (and the region as well) to focus on other important issues such as the economic crisis and its effect,

in Kosovo largely have an observeand-report role. "Ban repeated his previous and known positions, including that negotiations on Kosovo should continue, and that an improvement in relations would be welcome," Bratislav Grubacic, a Serbian analyst active in the Serbian Progressive Party of the new president, Tomislav Nikolic, tells bne. "The tour wasn't very special, nothing spectacularly new was said."

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bne:infrastructure

The economic crisis has hurt all the economies of the world, but now governments across the Central and Eastern European region are planning to spend trillions of dollars on infrastructure investment as the most effective form of economic stimulus to put their economies back on a sustainable growth path. This investment was badly needed even before the crisis hit 18 months ago. Decades of work lie ahead, which presents a unique opportunity for investors of all kinds. Every two weeks, bne will publish an online a round-up of the main investment projects, analysis, commentary, regulatory changes, investment plans, and funding news in bne:infrastructure.

In Grubacic's view, the UN has proved better at protecting peace in the region than the next step of bringing reconciliation. That, in the end, depends on the people of the Balkans and their recalcitrant governments.

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Serbia's self-destructive defiance Nicholas Watson in Prague

ing as a way out of the growing crisis, so it was no surprise that as soon as the coalition took office, it set about undermining the central bank in general with changes to the law governing its independence, and Soskic in particular, forcing his resignation on August 2. His replacement, Jorgovanka Tabakovic, is a senior member of the Progressive Party and will no doubt toe the coalition line.

sector pay – implying difficult budget talks ahead for the coalition – as well as introducing austerity measures such as raising VAT to no more than 20%, with the rate for food remaining at 8%.

The moves provoked howls of protest from the EU and international organisations, such as the International Monetary Fund (IMF), which prize central bank independence and liked Soskic's restrictive monetary policy that was aimed at holding down inflation.

Death by several cuts On August 7, Standard & Poor's announced it has lowered its longterm rating on Serbia to 'BB-' with a negative outlook, implying further cuts ahead. The downgrade, the agency said, reflected its view that Serbia's new government has failed to quickly adopt policies "that would promote confidence in its monetary regime and restore postelection fiscal stability," and expressed doubts that any new deal with the IMF will be possible.

IMF European Department Director Reza Moghadam warned that the changes to the central bank law that were rushed through parliament would create insecurity, tarnish credibility and raise doubts about the capacity of the government to run its macroeconomic policy properly. Coming from the IMF, this pointed criticism is particularly noteworthy given the new government desperately needs to unfreeze a $1.3bn IMF stand-by loan, which was put on hold as the previous government allowed the budget deficit to rise above the 4.5% of GDP target for 2011, and "the 2012 budget deviated from the agreed fiscal programme, in particular with regard to higher planned issuance of public debt (including government guarantees) and domesticallyfinanced projects," the IMF said.

he new Serbian government appears to be adhering to that cultural trait of inat – a Balkan attitude of proud defiance and stubbornness, often to the detriment of everyone, including oneself. In little over a month in office, it has proudly thumbed its nose at the EU and the other global institutions, forced out the central bank governor and crimped the bank's independence, for which it has suffered international condemnation and the ire of the rating agencies.

fell 1.3% and 0.6% in the first and second quarters of the year, with a 1% drop forecast overall for 2012 – were never likely to correspond with those of the former central bank governor, Dejan Soskic, a western-educated deficit and inflation hawk.

To be sure, the signs were there when the price that the Serbian Progressive Party, which narrowly won the May elections, had to pay to form a government was to team up with the Socialist Party of Serbia and make Ivica Dacic prime minister. Dacic has the dubious distinction of having been the spokesman for the late dictator Slobodan Milosevic during the Balkan wars in the 1990s, and though obervers say he has mellowed somewhat since those firebrand days, his outlook remains defiantly populist.

"PM Dacic's views on how to revive Serbia's ailing were never likely to correspond with those of the former central bank governor, Dejan Soskic, a western-educated deficit and inflation hawk"

Inevitably, therefore, his views on how to revive Serbia's ailing economy – GDP

Soskic told bne in April before the elections that to get the country's finances back on track, the way forward was

"relatively easy to comprehend." The government, he said, needs to take steps to grow the economy and put an immediate stop to further increases in public debt through spending cuts. Alas, Dacic sees spending and borrow-

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Finance Minister Mladjan Dinkic, leader of a small technocratic party within the three-party coalition, has pledged to start talks with the IMF over a new deal and to cut the budget deficit from some 7% of GDP to below 4% next year by limiting growth in pensions and public

However, that hasn't been enough for the ratings agencies who, alarmed by the coalition's moves so far, took action in August.

This was followed by Fitch Ratings' announcement on August 16 that it had

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revised the outlook on its 'BB-' rating to negative from stable, also citing the deterioration in the country's financing position and weak economic growth outlook. "Rather than focusing on correcting a rising fiscal deficit and public debt ratio, the new government has amended the central bank law in a manner which has dented investor confidence and might complicate the agreement of a new IMF deal," Fitch said. Still, there have been some welcome signs by the coalition. It quickly signalled its intention to tackle corruption and solve some of the numerous financial scandals of the years, with police arresting eight people on August 8 on suspicion of approving fraudulent loans of more than €200m from the failed Agrobanka, including the former general manager, Dusan Antonic, who had tried to flee the country. "According to the Serbian Progressive Party, further arrests are expected between now and September, as the new administration strives to fulfil campaign promises," says

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IHS Global Insight. "Minister for Defence Aleksandar Vucic, with responsibility for combating crime, stated that no one was beyond the reach of investigators, regardless of party political affiliation." In the other big issue for Serbs, Kosovo, Dacic announced August 16 that Belgrade was ready to discuss the normalisation of relations with Pristina – though hued to the line that it will never recognise the independence of its erstwhile province that unilaterally declared independence in 2008. Still, it's progress of sorts, even if it's still unclear when and in what format the talks are going to resume. "The agenda and format of talks haven't yet been outlined," Dacic told journalists, adding that those issues would be the subject of discussion at his meeting with senior EU officials in Brussels on September 4. It remains to be seen whether Dacic will be displaying much inat at those talks.

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grow in a more sustainable way. Vladimir Vuckovic, associate director, transactions and investments at Coreside Savills, recalls the rush to invest in Bulgaria. "Many of those buildings have been sitting empty for the last decade," he says. "I believe Serbia's path will be closer to that of the Czech Republic, as historically Serbia was a stronger economic power than either Romania or Bulgaria."

Hopes pinned on Serbia's industrial revival

He notes a similar pattern of industrial development in the Czech Republic and Serbia. "Volkswagen bought Skoda in Czech, and Fiat bought Zastava in Serbia. I expect most real estate projects here will be driven by industrial growth and rising salaries. There is a good market anywhere with large companies and privatisation of former state enterprises."

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Zivkovic tells bne. "Several foreign companies have purchased land in prime spots, but have not started construction. Since the crisis, most construction has been by local developers." However, he notes that in an encouraging sign, since 2009 the situation has improved. "Throughout 2011, we saw a stabilisation of all segments of the market. Rents went down and are now bottoming out, while demand has remained fairly constant." Retail trade Even though Serbia is back in recession after GDP growth was 2.1% in 2011, retail remains the most resilient part of the real estate market, again because of unfulfilled demand. Belgrade, with a

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population of 1.7m, has just two modern malls, while Zagreb in Croatia, which is less than half the size, has seven. Delta Holding, one of Serbia's largest domestic real estate investors, plans to start construction of a third mall in the capital, Delta Planet, in spring 2013. At 200,000 square metres, the €200m mall will be the largest in Serbia. According to the company's vice-president Jelena Krstovic, international high street brands started to enter the Serbian market four or five years ago. "This process paused when the crisis started but now they are very interested. In the last six months companies have been calling us to ask about new retail space in Belgrade," Krstovic says. However, she believes future growth is

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not limited to retail. "The future for the sector is also in office and residential property, and hotels," she says. "We have plans for all these segments, and we have selected our locations while we wait for the market to revive. There is more potential in Belgrade now than in Croatia or Serbia, both because of the catch-up factor and because Belgrade is a big city and the centre of the region." Given that Serbia lacks all sorts of real estate – from modern malls to warehouse space, class-A and class-B offices to housing for its growing and increasingly prosperous population – the market has some serious catching up to do and scope for investment. The question is when significant volumes of investment will come back.

BRICKS & MORTAR:

Clare Nuttall in Belgrade

ack of funds has caused many of Serbia's planned construction works to stall, but domestic companies are persevering with projects to fulfill the growing need for all types of real estate, especially in the industrial cities that have escaped the worst of the crisis so far. Serbia's fourth-largest city Kragujevac, formerly the centre of the Yugoslavian auto-making industry, has seen a remarkable revival. With Fiat's decision to start up production at the old Zastava car plant, the city hopes to attract autocomponent manufacturers supplying other CEE-based carmakers. It also had the knock-on effects of bringing down unemployment, boosting spending power and creating demand for real estate from residential to retail to warehouse space. Plaza Centers Group, a subsidiary of Israel's lbit Imaging, chose Kragujevac as the location for the first of four planned investments into Serbia, the €50m Kragujevac Plaza which opened in March. Other firms interested in Kragujevac include Yu Kapital, which describes

the city as "the most favorable investment destination in central Serbia". Goran Zivkovic, deputy managing director of CB Richard Ellis Belgrade,

For historical reasons Serbia lags a decade or so behind other Emerging European markets and has a high level of pent-up demand for real estate, as the country only started to open up to international investors with the democratic changes after 2000. For a short period, Vuckovic says, Serbia was the fastest growing real estate market in the world with "cranes everywhere" in New Belgrade, the capital's commercial centre. But the boom was limited to the

"I believe Serbia's path will be closer to that of the Czech Republic, as historically Serbia was a stronger economic power than either Romania or Bulgaria" describes Kragujevac as alive again after the arrival of Fiat and other international investors. "Demand for residential and retail property has quickly followed the initial need for industrial and logistic space," he says. "The situation in Novi Sad, Nis and smaller towns with successful industries is similar." Pre-accession bubbles The growth of cities with a solid industrial base has raised hopes that Serbia's real estate market will escape the pre-EU bubble seen in Bulgaria and Romania, and

post-democratic, pre-crisis window and came to an abrupt end in 2008, meaning Serbia did not have enough time to catch up with the rest of the region.

With the break-up of Yugoslavia, however, the company's financial fortunes went into what many fear might ultimately be a terminal decline, not least because the company's manufacturing facilities were totally destroyed when Vukovar became the centre of Croatia's bloody fight for independence in the first half of the 1990s. Ultimately, Borovo is estimated to have suffered €300m worth of damage during the 1991-1995 conflict and it was only in 1998 that it was able to resume production in Vukovar, where it is one of the major employers.

Biting the Borovo rubber bullet Guy Norton in Zagreb

Now foreign investors are stalling, as they need time to raise finance and are not ready to commit to new markets, especially one that is facing a fresh economic crisis as a new, untested government tries to fix the country's deteriorating finances. "Most foreign investors are a bit inactive at the moment and hesitant to make new investments,"

n the former Yugoslavia, Borovo was a true industrial giant, with the footwear and rubber goods manufacturer boasting more than 23,000 employees, many of which were housed in a purpose-built residential area on the outskirts of the Slavonian town of Vukovar in eastern Croatia.

At one point in the 1980s Borovo was the second largest company in Yugoslavia, producing 23m pairs of shoes, 580,000 tyres and 12,500 tonnes of rubber goods a year, which were exported around the globe. Its retail network comprised over 600 stores spread across the length and breadth of Yugoslavia.

Now Borovo, which was established back in 1931, is a shadow of its former self, having just 1,100 employees – roughly half of them based in Vukovar – and is facing stiff competition for customers from imported products made in lowcost labour destinations such as China. Mismanagement In recent years, the company has become notorious for racking up losses – it last made a profit in 2004 – and the feckless behaviour of its former management. One-time chief executive Mirko Cavara, for example, attracted widespread opprobrium in 2009 when it was reported that he had purchased a Volkswagen Phaeton with a list price of HRK500,000 (€70,000) despite the

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Croatia unveils tax roll of shame

bne Until recently, the fact that in Southeast European countries such as Croatia tax evasion had become something of a national sport – and a very professional one at that – was widely conceded, but ultimately unproven. No longer. As part of its pledge to uphold greater levels of financial transparency than its predecessors – not a difficult act by any means – the centre-left coalition government that came to power in Croatia in late 2011 unveiled on July 31 an extensive list of 130,000 individuals and firms that, according to the country's tax office at least, had reneged on up to HRK52bn (¤6.9bn) of payments. That's some going in a country given that this year's government budget is HRK118bn. The list of debtors comprised companies that owe at least HRK300,000, sole traders that owe at least HRK100,000 and private individuals that owe at least HRK10,000. The hotly anticipated list of shame includes many of the great and not so good of the Croatian corporate and social world, and shone a long overdue spotlight on the financial shenanigans in the country that have caused widespread concerns about Croatia's accession to the EU, which is due to happen on July 1, 2013. Top of the corporate list of tax debtors was construction company Tempo, which owes a not so grand total of over HRK292m to the cash-strapped Croatian state, which faces the unwelcome prospect of turning to the International Monetary Fund if it cannot shore up its own finances in the next few months. Tempo can safely be said to be a perfect template for the whole Croatian construction industry whose fortunes have nosedived since the country entered into recession in 2008, leading to a sharp decline in spending by both the public and private sectors. While one-time private sector heavyweights such as Industrogradnja and Konstruktor can arguably claim to be victims of the global credit crunch and associated economic downturn, which has choked off the hitherto plentiful supply of cheap credit and construction projects in Croatia, the same cannot be said for state firms such as broadcaster HRT. Not only does it levy a subscription from hard-pressed Croatian taxpayers at a monthly rate of HRK60, it is also able to attract advertising and sponsorship revenue, much to the chagrin of commercial broadcasters against which it competes. HRT ranks number two on the country's tax pillory, having amassed a debt of almost HRK223m. Whether the Croatian government will ever see any of the taxes owed by corporate debtors is a moot point. A number of the companies that owe the largest amount of unpaid taxes have already been declared bankrupt, meaning that there's effectively no chance that the government will ever be able to recover any money from them.

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100% state-owned company being strapped for cash after it registered a loss of HRK11m in that year. Cavara claimed that as boss of a major stateowned company it was only right that he should drive a luxury car. Cavara's limousine has now been sold to fund his severance package after he refused to accept a lower paid, more junior post at the firm. Cavara also had workers at the firm build a yacht for his open personal use, although he claimed that he paid for the construction of the 10-metre craft out of his own pocket and wanted to see if the company could diversify into shipbuilding. Finally, the former management burdened the company with a series of expensive short-term loans, which they used to pay day-today expenses rather than fund future development. Small wonder then that Borovo has often been tipped to join other one-time major industrial enterprises from Yugoslav-era Croatia such as engineering firm Jugoturbina and components company Jugoplastika in bankruptcy. However, Hrvoje Merki, who was appointed as the firm's new chief executive at the end of March, is determined to disprove the Cassandra-like predictions of Borovo's demise with a root-and-branch restructuring of the company that he hopes will return the firm to profitability and secure a sustainable future for Borovo's remaining employees. "Borovo has the capacities, the know-how and the logistics to be the market leader in the shoe business in Croatia. Its highquality products need to be recognised by the market and the market needs to be expanded through new sales channels. The only thing that has to be done is to manage all these resources effectively and wisely." However, the 38-year-old Merki, who has extensive experience of working for major private sector companies in Croatia, is under no illusions about the size of the task that lies ahead of him, given the years of mismanagement that preceded his appointment this spring: "I was very shocked by the unreasonable management decisions of my predecessors, which led to the situation that Borovo finds itself in today."

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He cites Borovo's own footwear stores as an example of past irrational management decisions. "It's strange that only 22% of the shoes and boots in our own shops are from Borovo, while 64% are from China and 14% from Croatia, most of them from Borovo’s direct competitors." And that's not because of a lack of product. "We have huge amounts of finished products in our warehouses that have remained unsold for years, in fact for almost a decade." Market driven One of Merki's first moves when he took the helm at Borovo was to commission a full scale audit of the eight companies that form the Borovo group to gain a proper insight into the true extent of the firm's operational and financial problems so that the new management team can formulate a comprehensive recovery plan to help turn Borovo's financial fortunes around. Merki expects to receive the results of the audit by mid-August, after which an in-depth restructuring programme will be submitted to Borovo's owner, Audio, the government agency which manages state-owned assets in Croatia. "The vision is to transform Borovo from a manufacturing company into a marketing-driven company, producing only what the market demands, while at the same time opening up new markets and market niches." For example, Borovo is preparing to launch a range of specialty protective footwear for use in the oil and gas industry, which Merki believes will have global appeal. Moreover, while Borovo's recent financial performance give plenty of grounds for concern – in 2011 the group racked up HRK21.5m of losses, a 363% increase on those for 2010 – Merki also believes there are plentiful reasons for optimism about Borovo's future. Among the reasons for his upbeat view on the firm's perspective is the fact that the company has an estimated €40m worth of confiscated real estate in other former Yugoslav republics, principally Serbia and Macedonia, which it is seeking to reclaim or seek compensation for with the active assistance of Croatia's

Southeast Europe

ministry of foreign affairs and the office of Croatian President Ivo Josipovic. Recent press reports indicate that after years of wrangling, the Croatian and Serbian authorities may announce a landmark settlement relating to such issues as Borovo's stores later this year. Meanwhile, at home Merki is determined to strengthen an already extensive sales network of Borovo stores. Currently, the firm boasts 105 stores throughout Croatia and is looking to add at least a further 25 outlets as part of an effort to expand the sales and marketing side of the firm in support of its manufacturing activities. Despite the company's recent financial woes, Borovo remains a major footwear manufacturer, producing 850,000 pairs of shoes in 2011 alone. In order to capitalise on that strong manufacturing base, Merki has also introduced a motivational training programme for all its existing store managers in Croatia in order to increase its domestic revenues, while it is also looking to boost its overseas sales, with an increased focus on high-growth markets such as Russia and the Middle East. As a result, Merki expects the Borovo group to report "a modest profit" as early as next year. While he declines to comment on the likely outcome of Borovo's restructuring plan in terms of how many of the current

"We have huge amounts of finished products in our warehouses that have remained unsold for years, in fact for almost a decade" 1,100 employees will remain with the firm, he says many of the older workers will be encouraged to seek early retirement, while younger employees will be hired to fill an increased number of sales and marketing, and production positions. "We do not think that there will be a need for drastic lay-offs," says Merki. So while it may longer be the industrial giant it once was, a much smaller, perfectly reformed Borovo does at least look to have a viable future.

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is to sell 1.3m tonnes of stockpiled grain to local milling companies in an effort to keep bread prices at a reasonable level. This grain will be provided at a fixed price of KZT28,000 ($186) per tonne, the agriculture ministry says. Regional governors are also working with Food Contract and the KazAgro state holding company to maintain supplies and keep prices at an acceptable level. Feast and famine Droughts are not unusual in Kazakhstan, where the harsh weather conditions in the grain producing areas result in widely fluctuating yields from year to year. 2010 saw an even worse harvest than is expected in 2012, with just 12.2m tonnes of grain produced.

Central Asia reaps poor harvest Clare Nuttall in Astana

severe drought will reduce Kazakhstan's 2012 grain harvest to around half the record 26.9m tonnes gathered in 2011, slashing agricultural revenues at a time when the economy is already anticipating a hit from the global economic downturn. The news is especially worrying for the smaller Central Asian republics, which rely on Kazakh grain imports and have already seen an increase in food prices. Kazakhstan expects to harvest just 12.8m tonnes of grain – well below the average of the last decade – this year after drought damaged crops in the northern grain belt. Worst affected is the northeastern Kostanai region, where just 18% of crops are in good condition, according to the Ministry of Agriculture, although the other main grain producing regions have also seen a high level of crop damage.

Kazakhstan does, however, expect to be able to maintain exports at around 12m tonnes in the 2012-13 marketing year, thanks to a surplus left over from the record 2011 harvest. "About 12m tonnes – this is our export potential for this marketing year," agriculture ministry official Yevgeny Aman told an online conference on August 16. This is slightly above the 10m-tonne forecast from Agriculture Minister Assylzhan Mamytbekov in July. Although Mamytbekov also announced on July 25 that Kazakhstan would scrap grain export subsidies from August 1, saying they were not "economically expedient," there are currently no plans to introduce a cap in exports. The ability to maintain exports is important for Kazakhstan, which is starting to see a slowdown in growth due to worsening conditions in the global economy. Although the economy is in much better shape than when it entered the previous

crisis in 2007, Kazakhstan has already experienced a four-month slowdown in industrial production because of a fall off in global demand. "Kazakhstan's Ministry of Agriculture expects the country's 2012 crop harvest to be well below the record-high 2011 number of 26m tonnes... For us, this indicates that the 7.5% GDP increase previously forecast by President Nursultan Nazarbaev for 2012 will be hard to achieve," says a research report from Renaissance Capital. "We... see potential for a GDP growth downgrade in the coming months, on the back of a low harvest [versus 2011] and declining [industrial production]." As it became apparent that the 2012 harvest would be a poor one, President Nursultan Nazarbayev announced on June 23 that it would be "important to control grain prices on the domestic market." Kazakhstan's state grain trading company Food Contract Corporation

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This year's problem is part of a wider drought that's affecting large swathes of the globe, such as Russia, the US and other countries in Central and Eastern Europe. In July, the International Grain Council cut its forecast for global wheat production in 2012-13 to 665m tonnes because of drought in major food producing countries. The Food and Agriculture Organisation (FAO) Food Price Index rose by 6% to an average of 215 points in July after three months of decline, though it is still well below the February 2011 peak of 238 points. According to the FAO, the increase was mainly driven by a surge in grain and sugar prices. This is already resulting in food price inflation in Kyrgyzstan and Tajikistan, which depend on grain imports from Kazakhstan to make up their domestic shortfall. Anger over rising food prices could even lead to further unrest in the two volatile countries; Kyrgyzstan's

government is on the brink of collapse, and Tajikistan is dealing with the aftermath of the July insurgency in Gorno Badakhshan. Flour prices in north Kyrgyzstan, which borders Kazakhstan, increased by almost 43% in July, according to the Ministry of Economy and Antimonopoly Policy. Drought has affected Kyrgyzstan's own harvest, and traders have raised prices in anticipation of higher prices on world markets. Autumn in Kyrgyzstan is expected to be difficult due to the increase in grain prices on the world market, Economy and Antitrust Policy Minister Temir Sariyev told a government meeting on July 24. In Tajikistan, food prices, and consequently inflation, have fallen steadily since an alarming peak in mid-2011. By May, wheat flour prices were 16% lower than a year before, and Tajikistan also expects to increase its grain harvest by around one-third in 2012 to 1.5m tonnes, after farmers switched from cotton to grain. However, the World Food Programme (WFP) reports that wheat flour prices started to increase in July and notes that the Kazakh harvest may lead to price pressure in Tajikistan, which is an importer of Kazakh wheat. The "reduced harvest this year may well put upward pressure on prices of exported wheat and wheat products, including for Tajikistan, which imports 95% of its external wheat requirements from Kazakhstan," says a WFP report. Anticipating future shortages, on August 14 Tajik government officials visited Pakistan and secured a deal to import wheat, rice, sugar and other foodstuffs.

"Worst affected is the northeastern Kostanai region, where just 18% of crops are in good condition"

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population is growing and becoming more affluent, so consumer demand is also increasing. Kazakhstan has abundant oil and gas, but Astana prefers to use these for export, while investing in other forms of power generation for domestic use. The Ekibastuz power plants near the northern coal basin are being expanded, and a new thermal power plant will be built at Balkhash to serve the south and centre of the country, but the country's main coal deposits are thousands of kilometres from the western oil towns.

Kazakhstan to decide on nuclear power plant in 2012 Clare Nuttall in Astana

azakhstan's government is to decide by the end of this year whether to build a nuclear power plant, according to the head of state nuclear company Kazatomprom, Vladimir Shkolnik. Construction of the plant will fill a growing energy deficit in the rapidly industrialising west of the country, but it is a controversial decision given Kazakhstan's legacy as the main Soviet nuclear testing ground. For several years Kazatomprom has been in talks with its Russian counterpart Rosatom over plans to build a nuclear reactor in the remote western town of Aktau. The two companies have already set up a joint venture, initially to carry out a feasibility study on the construction of a VBER-300 reactor. Speaking to journalists in Astana on August 15, Shkolnik said the final decision will be the Kazakh government's, and it should be made before the end of 2012. "My opinion as an expert with more than 40 years in this industry is that Kazakhstan has the right to operate a nuclear power plant.

We have no less experience than any other country in the world in the safe operation of nuclear power plants," Shkolnik said. Although Aktau is the capital of Kazakhstan's Mangystau region, in the heart of the Caspian oil basin, the region faces an energy deficit as

Nuclear legacy The country's previous experience of nuclear power generation was also in Aktau, where a BN-350 fast reactor was built during the Soviet era. It was used mainly for heating and desalination before it was shut down in 1999. Today, Kazakhstan has no nuclear power stations, despite being the world's largest producer of uranium. However, nuclear power generation is increasingly seen as an obvious step for Kazakhstan, which produced over 19,000 tonnes of uranium in 2011, and aims to exceed 21,000 tonnes in 2012. Shkolnik acknowledged that while Kazakhstan "could manage without nuclear power," it would be more economically viable to turn to nuclear energy than to transport coal over huge distances. This is reflected globally, as nuclear power is enjoying a resurgence in

"We have no less experience than any other country in the world in the safe operation of nuclear power plants" obsolete power plants will soon have to be decommissioned at the same time as industrial activity is increasing. Western Kazakhstan's electricity needs have risen as new industries, most centred around the oil and gas sector, are launched, and the government's 2010-14 industrialisation programme progresses. As in other parts of the country, the

numerous countries, despite the Fukushima disaster in Japan in 2011. Around 417 new reactors are either being built or are at the planning stage, according to the International Energy Agency, with countries looking to boost nuclear energy generation including China, India, Russia and South Korea.

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Kazakhstan is, however, in a special situation because of its history as the main Soviet testing ground. More than 450 nuclear weapons were set off at the Semipalatinsk Polygon between 1949 and 1989. After independence, Kazakh President Nursultan Nazarbayev agreed with the leaders of the other Central Asian republics to make the region a nuclear weapon free zone. This makes the construction of a power plant a controversial decision. "I believe that society has yet to make a decision and vote â&#x20AC;&#x201C; there should be a referendum,

Eurasia

and people have to say what they need or want," Shkolnik told journalists, but added that the dangers of nuclear energy can be overestimated by those who have never worked in the industry. Progress on the nuclear power plant has been further delayed because of disputes between Russia and Kazakhstan over funding and ownership of the intellectual property rights for the reactor. Construction of the Aktau reactor was due to start in 2011, but planning was put on hold

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for several years, until talks resumed in 2009. Recently, Kazakhstan and Russia have increased cooperation in the civil nuclear sector, signing a new cooperation deal in June. However, the Aktau reactor is not the only option for Kazakhstan, which has also been in early stage talks with Japanese companies over the potential construction of a second reactor near Lake Balkhash.

the company is pursuing in Tajikistan have ''super-giant'' potential. Bokhtar is part of the Amu Darya basin, the location of some of the world's largest gasfields. "Geological and geophysical work undertaken has shown that Tethys is operating in a world-class basin with enormous and untapped potential," Robson said in a statement.

Oil report puts troubled Tajikistan on the map Clare Nuttall in Astana

ajikistan's oil and gas reserves, until now assumed to be insignificant, could in fact be greater than those in the British sector of the North Sea, according to new research. Resources on this scale would have far-reaching implications for Tajikistan's economy and relations with its neighbours, though an outbreak of violence in July illustrates the difficulties of operating in the CIS' poorest country. Tethys Petroleum announced on July 19 that it had received an independent resource report, carried out by US-based

Gustavson Associates, on its Tajikistan assets, which cover an area of around 35,000 sq km. The estimated gross unrisked mean recoverable resources of those assets are 27.5bn barrels of oil equivalent (boe), the company said. London-listed Tethys is now continuing with its seismic programme in Tajikistan, with initial results expected in the last quarter of 2012. The company then plans to build its first deep well in Tajikistan. Tethys' then chairman and CEO David Robson said the deep prospects that

He forecast that any exploration success at Bokhtar would be "transformational" for Tethys. It would have a similar impact on Tajikistan, which is seen as one of Central Asia's losers in terms of hydrocarbons resources. Now it may be on a par with countries like Kazakhstan or Russia in terms of oil and gas reserves per capita, and is potentially a major exporter. Tethys is not the only frontier investor active in Tajikistan. In another sign of interest in the country, on August 8 Santos International Ventures said it has exercised its option to acquire a stake in Tajikistan's Somon Oil. A Santos affiliate and an unnamed third party are in "advanced stages of negotiations" on the acquisition of a 70% holding in the Tajik company, and the deal is expected to be signed by September 6. Poor relations Tajikistan's main exports today are aluminium and cotton, and it remains the poorest state in the former Soviet Union, with up to 1m of its population leaving to seek work abroad. It also relies on its neighbour Uzbekistan for gas imports during the cold winter months. The two countries' troubled

I Eurasia

Had enough of Babanov

Clare Nuttall in Astana Deputies from several parties within Kyrgyzstan's ruling coalition are once again pushing for a vote of no confidence in the government. The move is just the latest in a campaign to oust Prime Minister Omurbek Babanov that began virtually on day one of his administration in December 2011, and has prevented the government from dealing with the shattered economy. Two months after their previous attempt to oust the PM failed, MPs from three of the four parties making up Kyrgyzstan's fragile coalition are again holding meetings on whether to continue backing the government. If they succeed in bringing down the administration, it would mark the start of another lengthy period of negotiations to form a new government and another period of uncertainty for investors. The Ata-Meken and Ar-Namys parties both voted to support a proposed parliamentary motion of no-confidence at their respective extraordinary meetings on August 13. The Social Democratic Party of Kyrgyzstan (SDPK) – the fourth member of the coalition alongside Babanov's Respublika – is also planning to hold a meeting on the issue. Ata-Meken MPs have accused Babanov of accepting an expensive racehorse as a bribe. Zhoomart Saparbayev claimed that a company carrying out building work at Bishkek's Manas International Airport imported the horse without paying import duties. According to Saparbayev, the horse, which is valued at up to $1.5m, is now in Babanov's possession, AP reported. The party's leader Omurbek Tekebayev has also called for a criminal investigation. However, Babanov's office has dismissed the claims as lies, saying without a hint of irony that the horse is worth less than $20,000. Meanwhile, Ar-Namys MPs criticised Babanov on a variety of issues, with his management of the economy coming under particular scrutiny. Felix Kulov said economic performance had deteriorated since Babanov came to power in December 2011. The IMF cut its 2012 GDP growth forecast from 5% to just 1% in July 2012, although the reduction was mainly due to technical issues at the Kumtor gold field, resulting in a dramatic fall in export revenues. The numerous deputies lining up to take pot shots at the PM are clearly hoping to apply enough pressure to push the motion through this time. In June, MPs tried to force Babanov to resign but failed to gather enough signatures in a single petition for a vote of no confidence to go ahead. With the summer recess now drawing to an end, they are again trying to topple the government. Once again, the attempt to bring down the administration is most likely being backed by Ata-Zhurt, the only one of the five parties in the parliament excluded from the current coalition. However, it is not yet clear whether enough signatures can be gathered from among members of the four parties within the coalition.

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relationship – and cash flow problems at power company Barki Tojik – have resulted in supplies frequently being cut off. In April, gas supplies were suspended for a month, resulting in serious damage to the Tajik economy. To increase energy security, Dushanbe has focused on hydropower. With the lion's share of Central Asia's water resources, Tajikistan is estimated to have potential hydropower generation capacity of more than 500bn kilowatt hours (kWh) of electricity a year. However, attempts to develop the sector, especially with plans to build the massive Roghun dam, have further damaged relations with Uzbekistan. Tashkent objects to the construction of new dams on tributaries of the Amu-Darya, which is

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been sent to the region, which borders Afghanistan, to bring the insurgency under control. The government was successful, with rebels starting to surrender on July 29. The last time an operation of this scale was launched in Tajikistan was in 2010, when a mass prison break from a high-security facility near Dushanbe was followed by a series of bombings and other incidents. Government forces fought for several months to regain control of the Rakhsh Valley, which like GBAO was an opposition stronghold in the 1992-97 civil war.

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Opposition activists have claimed that Nazarov's murder was the pretext for the government to increase its hold on the region, while the Strategic Research Centre under the President of Tajikistan, a think-tank linked to President Emomalii Rakhmon, says the government took action after reports of up to 1,000 militants massing on the Afghan side of the border. Tensions have persisted in Tajikistan despite the power-sharing agreements between the government and opposition at the end of the civil war in 1997, and the continuing threat of instability

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is the main factor deterring higher levels of investment in the mineral-rich country, although corruption and lack of infrastructure are also factors. "The events in the GBAO demonstrate the farreaching weaknesses of the Tajik states structures. This is the second incident in recent years where the government has had difficulty enforcing control over part of its territory," writes Marek Matusiak of the Centre for Eastern Studies (OSW) in a report. With presidential elections due to take place in November 2013, there is a danger of further eruptions of violence in the coming year.

bureaux across the country, promoting the station as a Georgian version of the 24-hour news channels run by the likes of CNN, according to CEO Kakha Bekauri.

"This is the second incident in recent years where the government has had difficulty enforcing control over part of its territory"

Fighting for air in Georgia

However, they soon learned that in Georgian politics nothing is quite that easy, and despite owning a channel, the opposition is still having trouble getting the word out. Since Channel 9 – now known as TV9 – announced its plans to go on the air, it has repeatedly faced problems finding carriers for its broadcast signal, which struggles to make it out of Tbilisi.

The news does, however, come at a difficult time for Tajikistan, as an outbreak of violence in the eastern Gorno Badakhshan autonomous region (GBAO) has raised questions once again over the country's stability.

ith just three months to go before the Georgian parliamentary elections, the race for media influence is heating up. As in most countries, in Georgia, where 88% of the population depends on television for news, media wars mean a fight for coverage on the box.

Unlike previous elections, when the opposition was forced to storm the public television building in a desperate bid for media attention, this year they are fighting fire with fire: they have created their own TV station, Channel 9, a station financed by billionaire opposition leader Bidzina Ivanishvili.

Khvedelidze tapped her brother-in-law’s cable/satellite, Global TV, to carry the station. Soon after, however, Global TV lost its contracts to carry other, pro-government television stations – prompting a mass exodus of subscribers since they would not be able to watch popular Georgian language shows. Global TV also lost a fight with the government over a scheme to expand its client base by providing free satellite dishes – a plan the state alleges was in violation of the campaign finance law.

Fighting broke out in and around the regional capital Khorog on July 24, as government forces took on a militant group believed to have been behind the assassination of regional security chief Major-General Abdullo Nazarov. Over 3,000 additional troops supported by helicopter gunships are reported to have

A newly passed "must carry" provision means every cable and satellite provider has to provide subscribers with every channel available. But stations associated with the opposition charge that the regulation will do little to diversify Georgia’s polarised media landscape in the long run.

Georgia’s three national broadcasters are, as usual, firmly in the pro-government camp, so in April Ivanishvili revived Channel 9, a station owned before the Rose Revolution by his wife Ekaterine Khvedelidze and her business partners. They invested $7m to build a new studio, hire foreign consultants, and create

TV9 then turned to another proopposition channel, Maestro, which has its own satellite signal. In July, however, Maestro was also charged with violating the campaign finance law when it too announced plans to provide free satellite dishes. Now, with no major satellites carrying the signal, TV9 has resorted to

used to irrigate Uzbekistan's cotton crops. Finding substantial oil and gas reserves, however, could prompt Dushanbe to rethink its energy policy, which could lead to a seachange in its relations with Uzbekistan.

Molly Corso in Tbilisi

I Eurasia

Down and dirty in Georgia

Michael Cecire in Tbilisi Campaigning for Georgia’s October parliamentary elections, pitting the ruling United National Movement (UNM) against the billionaire-led, upstart opposition Georgian Dream coalition, have become so ugly that the country's carefully crafted image as a beacon of democracy and safe investment destination is being shattered. The latest example of heavy-handed government action against the opposition is the apparent raiding by the authorities of the bank accounts of four political parties in the six-party Georgian Dream election bloc, led by tycoon Bidzina Ivanishvili, in order to collect a fine imposed on the coalition in late June, Civil Georgia reported on August 18. The authorities had earlier fined all six parties within the coalition GEL2.38m (¤1.2m) for allegedly receiving illegal non-monetary corporate donations from an Ivanishviliaffiliated company in the form of renovation works of the coalition's regional branch offices. According to Nodar Khaduri of Ivanishvili's party Georgian Dream-Democratic Georgia, over GEL100,000 was diverted from the Georgian Dream parties' bank accounts to the state budget after these accounts had been seized. This is the latest in a series of moves taken against the opposition since October 2011, when Georgia’s political landscape was turned on its head with the arrival on the political scene of billionaire Ivanishvili, Georgia’s richest man and a well-known philanthropist, who announced his intention to challenge the entrenched UNM of President Mikheil Saakashvili, which was then expected to coast through the 2012 parliamentary and 2013 presidential elections. Almost immediately, Ivanishvili, who earned his fortune in Russia, was stripped of his Georgian citizenship on a rarely used technicality and branded a Kremlin proxy. In late June, following a lengthy string of unprecedented financial penalties imposed on Ivanishvili and his political allies over numerous – and oftentimes creative – allegations of party funding violations, Georgia’s National Bureau of Enforcement at the Ministry of Justice impounded 100% of Ivanishvili’s shares in Cartu Bank and 21.7% in Progress Bank. The impounded assets were put up for sale but, after finding no takers, the state took control of Cartu and installed new management. Yet by using such a heavy hand against its political opponents, Georgia could be undermining its own brand as a hands-off technocratic state, ripe with investment opportunities. "It doesn’t look good," says Michael Taylor, a senior Eastern Europe analyst with Oxford Analytica, a political risk consultancy. "It sends a message that one needs good friends in Georgia to do business there." But Taylor believes the Cartu Bank seizures, while bad for the Georgian government’s image, are mostly a distraction from a more serious problem. “A small group of people in Saakashvili’s circle control most major private enterprise in the country,” he says. This means "you can invest in Georgia only if you make friends with those people."

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live streaming via the internet, which provides a maximum of around 1,500 viewers per news slot, in addition to the estimated 11,000 viewers in the capital who can pick up the signal. Media constraints Sean Griffis, an American communications consultant hired by TV9 to help navigate its public relations strategy, says the problem accessing cable coverage is just one of "a basket" of issues facing the station as it attempts to expand. It has also met trouble leasing office space in the regions, he notes. Journalists working for the station have been targeted at protest rallies, he claims, verbally attacked and obstructed from working by pro-government supporters. In July, Amnesty International admonished the government for "failing to protect opposition supporters and journalists from what appears to be politically targeted violence." The government has taken some steps to help level the media playing field, passing the country’s first "must-carry" regulation in June. The law requires all cable and satellite companies to offer every channel available for the two months proceeding to the elections. The requirement expires, however, right before election day. While the "must-carry" provision was intended to help depolarize the media landscape prior to the elections, Bekauri claims that it falls short of offering real guarantees to stations like TV9, since it only provides access for two months – and there is no provision that assures equal quality broadcast for all stations. "The government’s primary goal is to block the spread of truth and reality among the population of the country," he insists. The ruling party is refusing to buckle to pressure to extend "must carry" beyond the elections, saying it constitutes "meddling" in private business. However, Speaker of Parliament Davit Bakradze has noted that the parliament will "promote and encourage all the cable operators and TV channels to keep cooperation which they build during the pre-election period."

Special Report: Fund Survey 2012

56 Central Europe report 56 II Special

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big difference," says Andreas Nurscher, spokesman for Pioneer Investments. "This is one of the reasons why investors in emerging markets should have a longterm time horizon." The backdrop for the bond funds' performance is of course the solid fundamentals in much of CEE – or at least better fundamentals than in much of Europe and the US. Sovereign debt as a percentage of GDP, for example, in all the countries except for Hungary is comfortably below the 60% threshold stipulated by the rules governing the euro. And even Hungary's debt burden is only around 75% of GDP, far below the levels of 165% in Greece, 121% of Italy, 110% of Ireland or 107% in Portugal.

FUND SURVEY 2012:

Beware of Greeks, but bonds are fine Nicholas Watson in Prague

his has been the year of the bond in Central and Eastern Europe and the Commonwealth of Independent States. While debt and equity markets struggled in the second half of 2011 as worries about Greece caused investors to lose their appetite for risky investments, they have piled back into bond funds so far this year, leaving regional equity funds in the dust. "Everyone is talking about the euro debt crisis, but everyone is buying Eastern Europe debt," Heinz Bednar, CEO of Erste Asset Management, tells bne. "Even Hungary has had a very nice performance this year." Looking at bne's table of funds, the winner of the "bne Best Fixed-Income Fund 2012" is Erste Asset Management's "ESPA Bond Emerging Markets Corporate" fund with a return of 8.01% for our surveyed year (July 1, 2011 to June 30, 2012) and a 6.98% return for the first half of the year. In the weeks since the end of the surveyed period,

the fund has continued to outperform. "The absolute performance is above 10% year to date," Peter Varga, senior portfolio manager at Erste Asset Management, told bne at the end of July. "It's a purely hard currency fund and it's quite remarkable actually to have that type of performance, so that shows we have had quite a nice run in this asset

and 4.83% respectively; Erste's "ESPA Bond Danubia" fund returned 4.01%; Aton Capital's "ATON Bond Fund" returned 3.05%; and Raiffeisen Asset Management's "Raiffeisen Eastern European Bonds" fund returned 2.43%. Pioneer Investments' "PIA Central & Eastern Europe Bond" fund also per-

"Everyone is talking about the euro debt crisis, but everyone is buying Eastern Europe debt" class from the desperation of investors to have higher yielding assets in their portfolios." Erste's winnning fund topped a group of such bond funds that have performed well over the year. ELANA Fund Management's "ELANA Money Market Fund" and "ELANA Eurofund" returned 5.85%

formed well, but shows another feature of the market this year – its volatility. Over bne's yearly period to June 30, Pioneer's bond fund returned 1.99%, and 9.20% in the first six months of 2012. However, extending those periods to the end of July would see returns boosted to 6.9% and 14.6% respectively. "In a volatile market, one month can make a

Special report I 57

bne 2012 bne September May 2008

Likewise, most budget deficit positions in the region are also looking likely to come in below the 3% of GDP stipulated in the Maastrich criteria. While the Czech Republic, Hungary, Lithuania, Croatia and Ukraine will probably report imbalances marginally above the ceiling this year, their deficits will be nothing like the situations in Ireland, the US and UK, which will be closer to 7% of GDP. "Central European EU countries are better positioned than most of the southern EU countries in terms of sovereign debt to GDP. Except for Hungary, all countries' debt/GDP ratios are below 60%," says Margarete Strasser, portfolio manager at Pioneer. "That means the annual budget deficits are much lower than in other developed markets, not only European. Most of them will be at or under the 3% level in 2013." In addition, growth has been – and will likely continue to be – greater in the CEE/CIS region than elsewhere in Europe. Latest estimates by the European Bank for Reconstruction and Development (EBRD) released in July show that although average growth in the transition region is expected to drop from 4.6% in 2011 to 2.7% in 2012, before modestly picking up to 3.2% in 2013, that's still much better than the Eurozone. The International Monetary Fund said in April it expects the Eurozone economy to contract 0.3% this year, after growing just 1.4% in 2011. "Growth won't come from developed

markets, but from emerging markets, and this is one of the drivers of investing in this area," says Strasser.

"We've had some quite huge inflows as people continue to switch from Western Europe into Eastern Europe."

These solid economic fundamentals, together with the tame inflation, higher interest rates, rising local currencies and tightening spreads on the hard currency side, have pulled in bond investors this year. According to the fund flow data provider EPFR, in the year to August 1 global bond funds took in $223bn, while equity funds surrendered $31bn. That compares with an inflow of $115bn and an outflow of $4bn respectively during the same period last year. "Money is still coming in, some of it institutional," says Anton Hauser, portfolio manager for Erste's "ESPA Bond Danubia" fund.

This has been especially true on the corporate side. "The [CEE] corporate bond market has seen tremendous inflows, more than $200m so far this year, as people have discovered this asset class. Five years ago it was basically nonexistent, globally it was worth $250bn, and now it is approaching $800bn," says Varga. It is likely to get much larger too. All bond fund mangers are talking about the Russian government's capital market reforms that will make it much easier for foreign investors to buy ruble-denom-

Vladimir Potapov Global Head of Portfolio Management Business VTB Capital Investment Management

Russian equities lost 18.3% for the period in local currency measured by the performance of the Micex Index. We think the result was driven by increased global risk aversion due to the unfolding European debt crisis and lack of appetite for emerging markets in general from global investors. Local factors such as pre-election uncertainty and lack of visible progress with structural reforms also made some contribution to the decline. Only five out of 30 Micex Index members managed to show a positive return for the period. Dividend stories looked far better than the market on average as investors sought the relative safety of tangible cash flows and support from yields during turbulent times. Surgutneftegas preferred shares gained almost 32% underpinned by 10%+ yield based on 2011 results. MTS local shares were down 2.5%, but the 7% yield helped to make the stock’s total return decisively positive. Russian oil and gas stocks were core outperformers thanks to their attractive dividend yields and relative defensiveness of earnings stream compared to other sectors present on the Russian stock market. At the same time high-beta, low-quality, less liquid names went through a heavy sell-off. Steel and coal names lost 50-70% for the period on the back of multiples reverting to cycle averages and earnings expectations coming back to earth. Electric utilities were among underperformers due to a protracted period of regulatory uncertainty stemming from preelection pressure on tariffs. Federal Grid Company’s shares lost 49%, while RusHydro lost 41% for the period.

58 58

II Special Central report Europe

inated sovereign, quasi-sovereign and corporate debt, the centrepiece being the establishment of a Central Securities Depository. "The Russian local bond market might be fully liberalised for non-residents by late autumn 2012," analysts at VTB Capital say, adding that

bnebne September 2012 May 2008

Elam Håkansson, chairman and head of portfolio management at East Capital. "The country is not very dependent on exports, and this is a good thing when the economic climate is as uncertain as it is today. Long term, the country benefits from a young and growing population,

"The CEE corporate bond market has seen tremendous inflows, more than $200m so far this year, as people have discovered this asset class" the potential additional demand from non-residents for just the state's OFZ bonds could be as much RUB500bn800bn (€12.6bn-20.2bn) within 18 months following liberalisation, as global bond investors look to rebalance their portfolios. Share the pain Equity fund managers are hoping that some of this shine will rub off on equities, which had a terrible 2011 – not one of the equity funds surveyed had a positive return during the year – but enjoyed a much better first half of this year. "Look at corporate bonds, they have done very well because corporates are earning and balance sheets clean," says Alexandre Dimitrov of Erste. "So maybe some of this will transfer into equities." The winner of the "bne Best Equity Fund 2012" shows how tough this past year has been for equity funds, but also where most agree the best opportunities lie: Turkey. The winner was Erste's "ESPA Stock Istanbul" fund, which had a negative return of 0.21% in the yearlong period surveyed, though returned a huge 30.48% in the first six months of this year. East Capital's "Turkish Fund" likewise had a negative return of -6.60% for the survey period, but returned a whopping 26.39% in the first half of 2012. "Turkey stands out as a strong market year to date due to a combination of long-term good fundamentals and short-term low volatility in the country," says Peter

improvements in efficiency and sound public finances." Russia too is benefiting from this trend among investors toward investing in the bigger emerging markets, and away from frontier markets like Kazakhstan and Ukraine, though it hasn't seen anything like the run-up that Turkey has. The best performing Russian equity fund in the first half of 2012 was JPMorgan Asset Management's "Russia

other markets, and it tends to outperform on the way up," says Javier Garcia, portfolio manager at Swiss & Global Asset Management. "We had a very good start to 2011, then it started to correct and underperform in November and December with the disputed elections and the associated demonstrations. We had a strong and sharp recovery at the beginning of the year, as people became more optimistic at the start of the year and Russia outperformed the rest of the emerging markets until March-April when we had troubles coming out of Europe and fears of a slowdown in China." Russia proved once again to be the standout performer in the real estate category, with Renaissance Real Estate Company's "Renaissance - Business Nedvizhimost" fund winning the "bne Best Real Estate Fund 2012" with a return of 22.0% Outside of Russia, East Capital's "Baltic Property Fund" returned 1.57% over the year period, implying that the Baltic real estate market is bottoming out after several tough years. "Our fund has

"You have a growing, young population that wants to consume, that has more disposable income, that has no debt – this creates an interesting consumption story" Fund", which had a negative return of -28.61% over the surveyed year, but saw a turnaround for a 10.46% return in the first six months of this year. Swiss & Global Asset Management's "Julius Baer Multistock - Russia Fund" had a negative return of -25.19% over the year period, while the first six months of this year saw a negative return of only -3.60%. "Russia is a high beta market - it has more volatility for being highly correlated with commodities and because of corporate governance issues. If we have a risk-off period, then Russia suffers more than

performed well this year as a result of years of good and consistent asset and property management, but also hard work in these very challenging markets," says Biljana Pehrsson, CEO of East Capital Real Estate. "Starting from early 2011, the market has demonstrated a noticeable improvement in the general dynamics of the office and retail real estate segment." In May, East Capital launched its second property fund, the "East Capital Baltic Property Fund II", whose primary focus will be Tallinn, followed by Vilnius and Riga. "In order to benefit from the Baltic

bne 2012 bne September May 2008

real estate market and its bottoming out, the low property prices as a result of halved rents and higher yields, as well as low financing costs, we launched our second property fund in May and almost at the same time closed our first acquisition, the logistic park VGP, at a total purchase price of €24m reflecting a yield in excess of 9%," says Pehrsson. Looking ahead The biggest determinant of how CEE/ CIS funds will perform over the next 12 months is the unfolding European debt crisis, which could see major developments this autumn – perhaps an exit by Greece followed by other countries, or a major step forward in resolving the crisis. Many fund managers, like Hauser of Erste, are doubtful about the latter. "Economies are clearly slowing and the bond markets are trading down. If there's a big resolution to the euro crisis, there will be a big run-up again. But my feeling is we will continue to muddle through – there's no big solution in sight," he says. For equity investors, it's the very cheapness of Emerging European stocks that give fund managers hope. "Emerging Europe equities are trading at only sixtimes [price/earnings], which is a 40% discount to other emerging markets. Even Poland is trading at a discount, while Turkey is trading at the same valuation as global emerging markets even after its huge run-up. The room to grow is enormous," says Erste's Dimitrov. Swiss & Global Asset Management's Garcia says his "Julius Baer EF Black Sea" fund looks to take advantage of what he sees as the attractive factors behind investing in Emerging Europe: the consumer is underleveraged, the corporate sector is underleveraged, and the governments are underleveraged. "You have a growing, young population that wants to consume, that has more disposable income, that has no debt – this creates an interesting consumption story," he says. "In this region you also find a lot of companies with a global competitive advantage and this competitive advantage won't change in the next 5-10 years."

Special report

I 59

Peter Elam Håkansson Chairman and Head of Portfolio Management, East Capital

The all-consuming issue in the past year is of course the crisis in the Eurozone and the market has largely developed in line with the sentiment there. As a consequence, the autumn of last year was poor, whereas the first quarter this year was good on the back of ECB stimulus. With the renewed concerns in the Eurozone in the second quarter, the Eastern European markets took a hit once again. In Russia, the trends have received extra fuel by domestic political developments that have been both positive and negative. Turkey is one of the best markets this year, with fluctuations amplified by domestic economic development. The economic development in the Baltics has been relatively strong as expected. There has not been much focus on the frontier markets. Our funds have lagged in relation to our competitors a bit in the second quarter after having had a very strong performance in the first quarter of the year. However, it is the long-term perspective that is important, and with a longer view we are also well ahead of our benchmark. Our long term approach means that our performance will differ from the benchmark and over time we have seen that this has been positive for our investors.”

Javier Garcia Fund manager, Swiss & Global Asset Management

Russia had a very good start to 2011, then it started to correct and underperform in November and December with the disputed elections and the associated demonstrations. We had a strong and sharp recovery at the beginning of the year, as people became more optimistic at the start of the year and Russia outperformed the rest of emerging markets until March/ April when we had troubles coming out of Europe and fears of a slowdown in China. Reforming Russia is going to be a very difficult task and the market is very sceptical about it. This cynicism is the reason why Russia is trading at such a huge discount to the rest of the emerging markets. People tend to play Russia as a value play, but I think best value lies within quality. I focus on earnings, focus on stock picking – it's 100% bottom-up driven. I pick the best stock in the worst sector to build up a diversified portfolio. The only sector I would highlight would be the consumer sector – Russia shows positive momentum mainly driven by higher consumer spending. It's very difficult to generate alpha at the moment, be better than your benchmark, because everything is so highly correlated. We need a more normal situation, then I hope that my picks will outperform as they did in past.

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bnebne September 2012 May 2008

bne 2012 bne September May 2008

Special report

CEE and CIS funds

Return since inception (Total unless otherwise stated)

Total expense ratio

Fund manager

Name of fund

Type of fund

Geographic allocation

Size

ATON Group

ATON Bond Fund

Bonds

Russia

RUB161.81m

3.05%

3.25%

39.38%

n.p.

ATON Group

ATON Equity Fund

Stocks

Russia

RUB522.30m

-21.21%

-3.21%

214.48%

n.p.

ATON Group

ATON Active Strategy Fund

Mixed

Russia

RUB136.18m

-28.87%

-5.68%

84.91%

n.p.

ATON Group

Moscow Small Business Interval Fund

Mixed

Russia

RUB5.510bn

-1.40%

2.40%

23.63%

n.p.

Citadele Asset Management

Citadele Russian Equity Fund

Equity

Russia

$8.3 m

-27.41%

-1.46%

89.40%

2.28%

Return 1 year (to June 30)

Return YTD (June 30)

World Investment Opportunities Funds Citadele Asset Management

Russia and CIS Performance Fund

Equity

CIS

$9.0m

-34.61%

-6.38%

-21.03%

4.95%

Citadele Asset Management

Citadele Eastern Europe Bond Fund - USD

Fixed income

CEE/CIS

$18.2m

1.42%

7.84%

85.80%

1.75%

Citadele Asset Management

Nestor Osteuropa Bond Fund

Fixed income

CEE/CIS

¤3.4m

-1.24%

7.15%

18.15%

1.34%

DWS Investments

DWS Osteuropa

Equity

CEE

¤332.7m

-15.9%

5.00%

390.40%

1.75%

DWS Investments

DWS Russia

Equity

Russia

¤551.1m

-19.8%

0.30%

82.90%

2.05%

DWS Investments

DWS Europe Convergence Bonds

Bond

CEE

¤58.2m

-1.0%

10.70%

107.50%

1.40%

East Capital

East Capital Russian Fund

Equity

Russia

SEK9,717m

-21.83%

0.61%

1012.21%

2.46%

East Capital

East Capital Eastern European Fund

Equity

Eastern Europe

SEK3,851m

-23.87%

2.89%

216.38%

2.47%

East Capital

East Capital Turkish Fund

Equity

Turkey

SEK1,434m

-6.60%

26.39%

East Capital

East Capital Baltic Fund

Equity

Baltics

SEK756m

-12.18%

8.77%

East Capital

East Capital Baltic Property Fund

Closed-end

Baltics

¤55m

1.57%

-1.24%

-36.18%

2.50%

ELANA Fund Management

ELANA Money Market Fund

Money market

Eastern Europe

¤8.136m

5.85%

2.70%

6.89%

0.49%

ELANA Fund Management

ELANA Eurofund

Bond

Eastern Europe

¤760,328

4.83%

2.27%

5.25%

0.58%

Erste Asset Management

ESPA BOND DANUBIA

Bond

CEE

¤523.782m

4.01

9.12

6.56%

0.82%

Erste Asset Management

ESPA BOND EMERGING MARKETS CORPORATE

Bond

¤325.066m

8.01

6.98

7.41%

1.38%

Erste Asset Management

ESPA STOCK ADRIATIC

Equity

South-Eastern Europe

¤1.134m

-32.74

-9.37

-22.87%

2.88%

Erste Asset Management

ESPA STOCK EUROPE-EMERGING

Equity

CEE

¤106.307m

-17.42

4.01

2.64%

2.03%

Erste Asset Management

ESPA STOCK ISTANBUL

Equity

Turkey

¤42.545m

-0.21

30.48

12.83

2.11

Erste Asset Management

ESPA STOCK RUSSIA

Equity

Russia/CIS

¤19.598m

-27.51

-2.68

-9.09

2.29

-13.66% 371.18%

2.50% 2.50%

I 61

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Special report

I 63

Return since inception Fund manager

Name of fund

Type of fund

Geographic allocation

Size

Return 1 year (to June 30)

Return YTD (June 30)

(Total unless otherwise stated)

Total expense ratio

Erste Asset Management

ESPA VINIS STOCK EUROPE EMERING

Equity

Central & Eastern Europe

¤8.064m

-15.06

7.11

-0.3

2.24

Franklin Templeton Investments

Templeton Eastern Europe Fund

Equity

CEE/CIS

¤467m

-28.43%

7.04%

135.29%

n.p.

ING Investment Management

ING (L) Invest Emerging Europe Equity

Equity

CEE

¤114.3m

-13.99%

10.66%

-30.84% (past 5 years cumulative)

n.p.

ING Investment Management

ING Czech Equity

Equity

CEE

¤7.4m

-21.97%

1.96%

-44.24% (past 5 years cumulative)

n.p.

JPMorgan Asset Management

Eastern Europe Equity

Equity

CEE

¤724.5m

-22.01%

n.p.

-23.61%

1.95%

JPMorgan Asset Management

Russia Fund

Equity

Russia

$7.85m

-28.61%

10.46%

-6.76%

n.p.

Pioneer Investments

Pioneer Funds Austria - Eastern Europe Stock

Equity

CEE

¤108.7m

-18.24%

8.85%

119.3% (since 2 Dec 1993)

2.33% (as per May 2011)

Pioneer Investments

Pioneer Funds Austria - Central and Eastern Europe Bond

Fixed Income

CEE

¤124.6m

1.99%

9.20%

136.65% (since 18 Oct 1999)

1.14% (as per Feb 2012)

Pioneer Investments

Pioneer Funds Austria - Russia Stock

Equity

Russia

¤44.6m

-21.22%

1.27%

212.93% (since 18 Nov 2002)

2.33% (as per Oct 2011)

Pioneer Investments

Pioneer Funds - Emerging Europe & Mediterranean Equity

Equity

CEE

¤523.9m

-13.53%

9.70%

136.93% (since 18 Dec 2000)

2.14% (as per July 2012)

Prosperity Capital Management

Russian Prosperity Fund (A)

Equity

Russia/FSU

$1.21bn

-19.30%

6.50%

Total: 2000.2%; CAGR: 21%

2.5% mgmt fee

Prosperity Capital Management

Prosperity Quest Fund

Alternative

Russia/FSU

$377.84m

-22.10%

3.80%

Total: 4867.3%; CAGR: 37%

n.p.

Prosperity Capital Management

Central Asian Prosperity Fund

Alternative

Central Asia

$18.16m

-8.10%

12.30%

Total: -18.6%; CAGR: -5%

n.p.

Raiffeisen Capital Management

Raiffeisen Russia Equities

Equity

Russia/CIS

¤39.4m

-20.38%

n.p.

Raiffeisen Capital Management

Raiffeisen Eastern European Bonds

Fixed Income

CEE

¤194.2m

2.43%

Raiffeisen Capital Management

Raiffeisen Eastern European Equities

Equity

CEE

¤487m

Renaissance Asset Managers

Renaissance Ottoman Fund

Equity

Turkey

Renaissance Asset Managers

Renaissance Russia Debt Fund

Fixed Income

Renaissance Asset Managers

Renaissance Cautious Managed Fund*

-8.80%

n.p.

9.46%

7.29%

n.p.

-16.25%

4.81%

8.14%

n.p.

¤46.49m

-3.39%

21.48%

17.73%

0.21%

Russia

¤31.31m

-2.92%

5.77%

80.51%

2.67%

Balanced

Global/EM

¤9.32m

-6.61%

2.15%

-6.61%

1.88%

Real Estate

Russia

$52.7m

15.2%**

9.6%

59.8%*

2.7%

Real Estate

Russia

$72.9m

22.0%**

6.1%

164.7%*

3.0%

Real Estate

Russia

$260.2m

8.5%

0.3%

-21.9%

0.6%

Real Estate

Russia

$44.9m

-4.2%**

5.6%

16.1%*

0.5%

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

"Renaissance - Nedvizhimost" Closed-end investment rental fund

Renaissance Real Estate Company Ltd.

"Renaissance - Business - Nedvizhimost"

Renaissance Capital

Closed-end investment rental fund

Asset Management Company Ltd.

"Renaissance - Zemelny"

Renaissance Real Estate Holding Ltd (Bermuda) Renaissance Real Estate Fund Swedbank Investeerimisfondid

Swedbank Central Asia Equity Fund

Equity

CIS

¤5.86m

-21.1%

-2.2%

-62.2%

n.p.

Swedbank Investeerimisfondid

Swedbank Eastern Europe Equity Fund

Equity

CEE

¤24.28m

-17.8%

18.70%

-26.3%

n.p.

Swedbank Investeerimisfondid

Swedbank Eastern Europe Real Estate Equity Fund

Real Estate

CEE

¤7.27m

-20.2%

12.70%

-70.6%

n.p.

Swedbank Investeerimisfondid

Swedbank Russian Equity Fund

Equity

Russia/CIS

¤52.06m

-15.2%

6.70%

Swiss & Global Asset Management AG

Julius Baer Multistock - Russia Fund

Equity

Russia/CIS

$25.42m

-25.19%

-3.60%

18.20%

n.p.

13.89% (annual past 3 years)

2.30%

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bne 2012 bne September May 2008

Special report

I 65

Return since inception Total expense ratio

Fund manager

Name of fund

Type of fund

Geographic allocation

Size

Return 1 year (to June 30)

UFG Advisors

UFG Russia Select Fund

Equity Hedge Fund

Russia/CIS

$153.21m

-13.1%

2.3%

208.5%

N/A

UFG Advisors

UFG Russia Alternative Fund

Equity Hedge Fund

Russia/CIS

$85.152m

-20.7%

8.9%

0.3%

N/A

UFG Advisors

UFG Debt Fund

Fixed Income Hedge Fund

Russia/CIS

$95.158m

-0.5%

2.4%

9.0%

N/A

VTB Capital

VTB Treasury Fund

Fixed Income

Russia

$21.2m

-9.57%

2.00%

12.32%

1.75%

VTB Capital

VTB Equity Fund

Equity

Russia

$8.0m

-18.18%

-1.55%

-4.42%

3.95%

VTB Capital

VTB Balanced Fund

Balanced

Russia

$8.4m

-14.38%

0.00%

-0.17%

3.35%

Wermuth Asset Manager GmbH

Wermuth Quant Eastern Europe Strategy IC

Equity

Russia

$4.031m

-2.09%

2.13%

171.44%

1.49%

Wermuth Asset Manager GmbH

Wermuth Leveraged Quant Eastern Europe Strategy IC

Equity

Russia

$869,673

-6.03%

-3.64%

618.65%

6.90%

Greater Europe Funds Management Limited

Greater Europe Fund Limited

Equity

Russia

$12.877m

-20.68%

-1.94%

120.83%

2.83%

* The Renaissance Cautious Managed Fund is invested circa 10% of its value in Russia / CIS / CEE. This fund was launched on 25/07/2012, as it does not have a full year performance an extra column has been created for performance up to July 2012.

And the winners areâ&#x20AC;Ś bne Best Equity Fund 2012

ESPA Stock Istanbul

bne Best FixedIncome Fund 2012 ESPA Bond Emerging Markets Corporate

bne Best Real Estate Fund 2012 Renaissance-Business-Nedvizhimost

"Throughout its history, Turkey has been the link between Europe and the Middle East due to its excellent geographic location. In contrast to previous years, when the economy was suffering from hyperinflation and an unstable political situation, the founding Nato member has in the meantime gone through a process of political stabilisation with a booming economy. The Istanbul stock exchange has not been a one-way street in the past 10 years, with sharp increases and massive corrections taking turns. On aggregate, investors have benefited from holding out for the long term. The impressive performance since our fund's launch, +288%, translates into an average annual performance of +13.2. In spite of the big rise in Turkish equities this year, the current price/earnings ratio of 10x is still low." Amalia Ripfl, fund manager.

"The level of government debt in the emerging countries is very low, whereas in Europe and the US it is on the brink of blowing up. The gearing in the corporate sector is minimal as well. The still relatively young asset class of emerging market corporate bonds has been gaining in importance. The issue volume in this segment has almost tripled over the past five years from about $260bn to $735bn (sources: Bank of America, Merrill Lynch). In recent years, the issue volume has even outgrown that of emerging market government bonds. The drastic increase in issue volume is absorbed by investor demand that has been soaring at an equally dramatic rate. As a result, overall liquidity has improved." Peter Varga, fund manager.

"We are very proud that we have been able to classes within the next three-five years, and that investments into carefully selected income-generating properties with attractive investment characteristics located in Russia will continue to produce strong returns and serve as an excellent hedge against inflation." Ekaterina Konstantinova, CEO of Renaissance Real Estate.

Return YTD (June 30)

(Total unless otherwise stated)

** Pro forma performance shows investor's theoretical total return defined as a change in value of the NAV per share assuming dividends paid to shareholders were reinvested in the NAV on the last trading day of the month the shares were quoted ex-dividend. Pro forma performance is calculated internally and is given for indication purposes only. Reported performance is calculated by the Administrator and does not take the dividends into account.

bne Best Balanced Fund 2012

ATON Small Business Fund

bne Best Alternative Fund 2012

Wermuth Quant Eastern Europe Strategy IC

"Our fund is an interval mutual investment fund incorporated in Russia. The principal investor of the Fund is the Moscow Government Foundation for Small Business Financing that tendered the management of its assets in 2006. The fund aims for long-term capital growth and stable performance through investing its assets in a diversified portfolio of highly liquid debt securities and equities of Russian companies. The investment strategy of the fund is considered to be conservative. The markets were very turbulent throughout 2011 due to rising concerns about the sovereign debt crisis in Europe, which was the reason we focused primarily on investing in high-profile fixed-income instruments while keeping the equity share of the portfolio at a minimum." Evgeniy Malykhin, head of investment department and portfolio manager.

"This systematic trading fund is focused on Russiaâ&#x20AC;&#x2122;s most-liquid securities. A fusion of an unemotional statistical approach and fundamental inputs is rather unique for a Russia-focused fund. The team of mathematicians and economists with a seven-year experience in quantitative trading continues to achieve superior results, beating their peers. The clue to success is in providing downside protection for the clients due to a trend-following approach and an automated execution process. The fund aims to achieve a return of 20% p.a. Historically it has beaten the RTS$ index two times in terms of compounded annual returns, with just half the volatility. The team aims to reach $50m AUM until the end of 2012 and $100m by 2013." Wermuth Asset Management.

I Events

bne September 2012

Events

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Upcoming events 2012

Private Client Russia and CIS Conference (2 - 4 October) Adam Smith Conferences, +44 20 7017 7444 London, UK www.adamsmithconferences.com/xr45bnew

FMCG in Russia (15 - 17 October) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia www.adamsmithconferences.com/arc14bahpe

Pharma Excellence in the CEE, CIS, SEE & Turkey (4 - 5 October) Fleming Europe Budapest, Hungary http://pharma.flemingeurope.com

Ukrainian Pharmaceutical Forum (15 – 17 October) Adam Smith Conferences, +44 20 7017 7444 Kyiv, Ukraine www.adamsmithconferences.com/hu5bnew

Russian Power: Investment & Finance 2012 (9 - 11 October) Adam Smith Conferences, +44 20 7017 7444 Radisson Royal Hotel, Moscow, Russia www.adamsmithconferences.com/ERC16BNEa

5th CFO Summit Emerging Europe & CIS (17 - 18 October) CFO Insight Vienna www.cfo-summit-ee.com

cee-summit-2012-85x116mm-4c_cee-summit-2012-85x116-4c 03.04.2012

Get 16 CPD Points Get a Certificate accredited by ACCA

CFO Forum

n Senior level Speaker Panel & Expert Advisors n Pre-conference masterclass n 2 streams: Protect & Improve n Favourite CFO coffee spot n Roundtable discussions n Networking Cocktail Reception n Dedicated staff and friendly atmoshpere of 5-star castle hotel

5th 17-18 OCTOBER 2012 • HOFBURG, VIENNA CONGRESS • GRAND EVENING EVENT: CFO INSIGHT AWARD “CFO OF THE YEAR”

Don´t miss it! The top event for CFOs in emerging Europe and the CIS – Attendance limited to executive financial decision-makers –

Speakers include Slawomir Jedrzejczyk, CFO, PKN Orlen, Poland

Top 10 Reasons You Should Attend:

n Increase capital via smart choices and new trends n Hear the latest strategies for shared services excellence n Discuss the value of corporate responsibility n Improve your working capital management n Learn the trends of forecasting amid economic swings n Review the requirements for financing from different sources n Find out how a new EC proposal can impact audit and consulting realities n Rethink the outsourcing strategy for finance n Expand your insights into emerging markets n Discover how to make the best of new IT trends

FAX: +4212 3220 2222 ONLINE: www.ebcg.biz PHONE: +4212 3220 2200 EMAIL: register@ebcg.biz

Russian & CIS Machine-Building & Engineering Forum (13 - 15 November) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

Russian CFO Summit (22 – 25 October) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia www.adamsmithconferences.com/brc19ban

Innovative Drug R&D in Russia Forum (21 – 23 November) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com

2nd Annual CFO Forum (24 - 26 October) EBCG, +421 2 3220 2200 Prague, Czech Republic event@ebcg.biz

Russian Banking Forum (26 - 29 November) Adam Smith Conferences, +44 20 7017 7444 London, United Kingdom events@adamsmithconferences.com www.adamsmithconferences.com

AutoRetail Russia Forum (29 - 31 October) Adam Smith Conferences, +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com www.adamsmithconferences.com EuroFinance’s 21st conference on

2nd Annual

24th - 26th October 2012, PRAGUE Became a part of the CFO Community and enjoy networking with your counterparts. Event is based on interactive information sharing and will provide you with a great return on investment.

26th BACEE Country and Bank Conference (18 - 19 October) Banking Association for Central and Eastern Europe (BACEE) Budapest www.bacee.hu

Gürhan Kartal, CFO, Hattat Group, Turkey

Alexey Kornya, CFO, Mobile TeleSystems, Russia

Further information and registration:

International Cash and Treasury Management 26 – 28 September 2012, Monaco

MEDIA PARTNERS

The leading event for international treasurers Discover what’s really going on with the global economy and how it affects your business. Plus unique perspectives on how to overcome risk.

The 12th Annual SuperInvestor 2012 (6 - 9 November) ICBI, +44 (0) 20 7017 7200 The Westin Paris - Vendome, Paris, France info@icbi.co.uk www.informaglobalevents.com

20% Discount

for Business New Europe readers

Ukrainian Banking Forum 2012 (13 - 15 November) Adam Smith Conferences, +44 20 7017 7444 InterContinental Hotel, Kiev, Ukraine events@adamsmithconferences.com www.adamsmithconferences.com

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