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Inside this issue: Rogers jumps on bearwagon Latvia's fanfare for the common currency Serbia's looming winter of discontent October 2012

Saakashvili becomes prisoner of scandal Special Report: Azerbaijan

A PARLIAMENTARY KLEPTOCRACY Ukraine elections to decide who stays free

How to invest in Eastern Europe and China

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bne October 2012


Editor-in-chief: Ben Aris (Moscow)

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6 The Insiders

26 Hungary's village of despair

8 A parliamentary kleptocracy

27 IMF chicken

10 Family affair

29 A glummer but still glimmering Poland

11 Bills that hark back to the bad old days

30 Building a survival plan

12 Perspective

31 Less driven in Poland

13 Chart of the month

33 Latvia's fanfare for the common currency

EASTERN EUROPE 14 Relaunching Russia's investment story

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34 Blowout threatens Lithuania LNG terminal 35 CEZ divestment plan said to fall short

16 Investing in the health of Russia Please direct comments, letters, press releases and other editorial enquires to

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18 Belarus looks to secure next part of EDB loan 19 Lost chance in Belarus 20 Rogers jumps on bearwagon 22 Russia’s “Beer Bank” toasts credit cards 23 Bribe inflation 24 Russia building bonds

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bne October 2012



We do it. 41



Romania on collision course with EU


Serbia's energy problems point to winter of discontent


Belgrade's tricky balancing act


New Serbian government, new anti-corruption drive


Gold under the mattress


A debut Sukuk that was no Turkey


Sun sets on Bulgaria renewables industry


More gloom and doom for Croatia


All aboard the ChinaKyrgyzstan-Uzbekistan railway


Undermined in Kyrgyzstan

51 52


The coming consolidation in Azerbaijan's banking sector


Azerbaijan prepares law to develop capital market

Wherefore art thou IPO?


Azerbaijan puts its foot on the gas

Saakashvili becomes prisoner of scandal


Promoting a chemical reaction in Sumgait

Mongolia's new government faces old problems


From black to white in Baku


Capital plans in Kazakhstan


PASHA Bank – from local leader to international player


Keeping the peace 68

Back to Baku with AZAL





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Lucas paradox


I The Insiders

bne October 2012

The most hated rally ever


The recent stimulus drive from the largest central banks is, however, fundamentally challenging this underlying pessimistic trend. Furthermore, there are more reasons to be optimistic, as the year as a whole has been pretty good in terms of equity market performance, which is perhaps why it has been described as "the most hated rally ever." Defensive or aggressive positioning? How should investors and managers position themselves going forward in this peculiar market situation? The dominant advice out there is that it is better to be safe than sorry, meaning that a defensive approach has been preferred over an aggressive one. Put differently, capital preservation has become more popular than capital management. It has simply been too costly to bet that things will be okay, as the downside risks have been perceived as too big. This approach has been quite understandable, especially as everyone remembers the sharp correction during the fall of 2008 and 2011 or even the second quarter of this year – except that it has been so widespread and seems to have turned out to be the wrong call performance wise. The recent rally turned the question on its head. Investors and managers that were defensive going into the summer may have missed the recent gains and can either stay defensive (hoping the fourth quarter will be as bad as the second quarter) or try to make up the relative underperformance by turning very aggressive. Either way, they will have to take a pretty big bet. Those that have been invested recently can either take profits

to increase the weight of equities to take advantage of the low valuations. The fund, which owns 1% of all ordinary shares in the world, is thus about to repeat the approach they took after the global financial crisis in 2008 (remember that equities outperformed in 2009 and 2010). Others are likely to follow suit. Fourth, the good news tends to be concentrated in the emerging world rather than in the developed world. The Norwegians acknowledge this and are increasing their exposure to emerging markets, while decreasing the weight of Western Europe. Many emerging markets are still growing and are not heavily indebted. Emerging markets have to some extent been taken hostage by the problems in the developed world for the past two years and should thus revalue once the focus is back on fundamentals. Also, emerging markets have only gained 4% so far this year, while developed markets are up more than 8%, which suggests there is room for the former to catch up.

Marcus Svedberg of East Capital he recent environment on financial markets has been difficult. Investors have been extraordinarily bearish and have stayed away from any asset that is deemed risky, while asset managers have been frustrated that their fundamental analysis matters less than politics and sentiment. This crisis mood, with sentiment moving in and out of risk appetite, has been going on for a long time already and there is reason to believe it will continue for some time.

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and an early vacation or bet on further gains. Both groups of investors and managers need to make a difficult decision based on their view of global macroeconomics and politics. We do think there is reason to be optimistic, at least for a while. Reasons to be optimistic! First of all, those that have been more bullish this year were rewarded handsomely, as most equity markets are in the black year to date, while the most bearish have lost money by staying in cash (due to the inflation effect) or lending at negative interest rates to the German or Danish governments. The broad global equity index is up around 10%, while the German stock market has rallied almost 25%. Now, previous gains are no guarantee for future gains. Sometimes it is the opposite, but valuations are still attractive and many investors have arguably missed out, so there should be room for further gains.

"Equity rallies should not be hated but rather embraced"

The fifth and final reason to be optimistic is monetary stimulus. The European Central Bank (ECB) announced the start of their new bond-buying programme in early September and the US Federal Reserve followed suit with another round of quantitative easing. The fact that both ECB President Mario Draghi and Fed Chairman Ben Bernanke managed to surprise the markets when action was so widely expected is a good indication of their determination to do whatever it takes to get their economies back on track. The Chinese have also shown that they are willing to stimulate when their economy slows more than expected, even though they have been somewhat more cautious this time compared to a few years ago. And when the central banks of the three largest economies in the world are standing ready to pump more money into the global financial system, there is reason to believe riskier assets will appreciate. It would simply be a very bold call to bet against the biggest printing presses in the world.

"It would be a very bold call to bet against the biggest printing presses in the world"

Embrace rallies This is not necessarily a call for investing in equities, but rather an encouragement to start questioning the predominantly negative view in the market. At the end of the day, equity rallies should not be hated but rather embraced. Marcus Svedberg is Chief Economist of East Capital

Second, the Eurozone crisis is far from being over, but we are slowly and incrementally moving towards a solution. It may not be an optimal solution and many things can still go wrong, but there is action and most likely more action if things deteriorate. There is very little pre-emptive effort, but lots of reactive policy responses, suggesting that there will be more rescues as needed, but not before it is really crucial. The Eurozone is slowly but steadily taking steps towards a more integrated monetary union with fiscal transfers, banking oversight and perhaps even joint debt at the end of the road.

United States, Volatility Indices, CBOE, S&P 500 Volatility Index (VIX), Close

Third, some large institutions are buying. One of the largest funds in the world, the Norwegian Pension Fund that manages $600bn, revealed in late August that they are planning

EM Eastern Europe, Equity Indices, MSCI, IMI (Large, Mid & Small Cap), Index, Total Return, USD


I Cover story

bne October 2012


ith crucial parliamentary elections looming in Ukraine, the election race is heating up – for fugitives from justice as much as for fighters for democracy. For all the razzmattaz and rhetoric, the October 28 elections to the Rada remain as much about who will enjoy the exorbitant privilege of immunity from criminal prosecution. Parliamentary immunity remains in Ukraine a last bulwark of political freedom. In the 21-year history of independent Ukraine, a grand total of five members of parliament (MP) have had their immunity lifted, one of whom was the notorious case of corrupt former 1990s prime minister Pavlo Lazarenko, currently the inmate of a Californian jail on major money-laundering charges. While parliamentary immunity protects opposition to the government – having surrendered their seats in parliament on joining the previous government, former prime minister Yulia Tymoshenko and former interior minister Yury Lutsenko were banged up almost as soon as they lost power in 2010 on what are widely seen as politically motivated charges – it also serves as a licence to commit crimes. In 2009, the situation got so out of hand that the then head of the Security Service of Ukraine (SBU) publicly denounced three MPs as "criminals" and pleaded for them to be stripped of immunity. Parliament, needless to say, ignored his pleas.

A parliamentary kleptocracy Graham Stack in Kyiv

In 2012, Ukraine's Rada is again ignoring the SBU's calls to strip an MP of his parliamentary immunity over allegedly serious acts of fraud. "Member of Parliament Oleksandr Shepelev is suspected of involvement in the theft of UAH220m ($27m) from Rodovid Bank. He is also possibly involved in the theft of UAH315.3uah ($39m) of National Bank of Ukraine refinancing funds in MarchMay 2009," the head of the SBU's investigative department, Ivan Derevyanko, told journalists on April 2. In statements to the press, Shepelev, a member of the Rada's finance committee and frequent commentator to the press on economy and banking issues,

Cover Story I 9

bne October 2012

denied he had anything to do with the schemes. Shepelev accused SBU officials in detail of having tried and failed to extract bribes from him, and taking punitive action as a result. The SBU then upped the ante. According to an SBU statement on April 10, "in the evening after he had been interrogated, one of the witnesses [in the Shepelev case] was found dead in his office, and an investigation has been opened into premeditated murder." In addition, according to the SBU, in 2011 another witness in the case fell to his death from a window, and a third survived a shooting. Despite this catalogue of crimes alleged by the SBU against a sitting MP, the Rada has not even discussed lifting Shepelev's immunity so that he can be questioned. Sitting pretty Shepelev may not be the only MP involved in an affair that is one of Ukraine's largest financial frauds, according to bne enquiries. The SBU allege that 40-year-old Shepelev acted together with his business partner, 36-year-old banker Pavlo Borulko. Borulko is additionally alleged to have stolen another UAH620m ($76m) from the Guaranteed Deposit Fund, which runs the national deposit insurance scheme for individual small deposit holders. To do this, he used three small regional banks he controlled, which were liquidated in 2009. According to the SBU, Borulko smurfed funds he borrowed from the banks into small deposits held by thousands of fictive individuals at his different banks – and when the banks were liquidated he duly cashed the payments from the Guaranteed Deposit Fund. According to bne enquiries, along with Borulko's three banks the SBU are investigating a fourth bank involved in the same fraud scheme, Dnipropetrovsk's Dialogbank, liquidated in 2011. In early 2010, the bank was readmitted to the deposit insurance scheme, within weeks new owners appeared, temporary administration was withdrawn, and within six months $120m of apparently

fictive individual deposits had appeared on its books.

of which Borulko and Shepelev would appear to be senior figures.

Who was behind the alleged fraud at Dialogbank? Court records show that in early 2010 five small firms took out loans totaling around $20m from Dialogbank and transferred them to fund the bank's acquisition. The loans were collateralised by property of a Donetsk company, Favorit 2002, owned by an MP from Donetsk of the governing Party of Regions, Nurulislam Arkallaev, and also by mining machinery produced by Yanuvatsky Engineering Plant, where another Donetsk Party of Regions MP Vitaly Bort runs the company's trading house. The owner on paper of the company that bought Dialogbank, Spetstroiprojekt-2007, is a certain Anatoly Aksyonov, CEO of Arkallaev's development company Voskhod. According to company records, one of the founding members of Voskhod in 2000 was the wife of MP Shepelev, Galina.

According to this theory, a conflict is brewing between the young upstarts headed by National bank of Ukraine head Serhiy Arbuzov and Finance Minister Oleksandr Kolobov, and government grandees such as First Deputy PM Valery Khoroshkovsky, who controls the country's largest TV channel Inter and who was head of the SBU when the investigation started, but was moved from the post two months after the SBU issued an arrest warrant for Borulko in November 2011.

Both MPs were contacted at their Rada offices, but were absent. Borulko's previ-

Sonya Koshkina, editor of Levyi Bereg, says that Arbuzov and Kolobov during a

Under the patronage of President Viktor Yanukovych's younger son Oleksandr, Arbuzov and Kolobov have filled positions in state-owned banks, the tax service and state treasury with their 40-something peers from Donetsk, effectively removing control of state finances from the hands of the oligarch grandees such as Khoroshkovsky.

"While parliamentary immunity protects opposition to the government, it also serves as a license to commit crimes" ous schemes used fraudulent collateral agreements to secure loans from banks, while it is unclear whether the same occurred with Dialogbank. Old guard vs young guns? Illustrating how impregnable parliamentary immunity is taken for granted, rather than asking who is protecting Shepelev from prosecution, pundits are asking what is behind the SBU's pursuit of well-connected figures such as Shepelov and Borulko – the latter an adviser to Viktor Yanukovych when the current president was prime minister in 2007. The Kyiv rumour mill smells a move by old-guard oligarchs against an upstart group of youngish Donetsk bankers,

late September visit to the US posed as "young reformers with a clear if undisclosed reform plan", according to their US interlocutors, and even acted "like people who have no doubt they will soon be at the very heights of power and don’t have any hesitation to say this. Soon meaning after the October 28 elections." Arbuzov and Kolobov have close historic links to the disgraced Borulko dating back to the late 1990s in Donetsk banks, where Arbuzov and Borulko were young colleagues at the same bank in the small Donetsk town of Konstantinovka, and then after 2003 at state-owned savings bank Oschadbank, where Kolobov was Borulko's boss in the treasury department. Borulko's prosecution, goes the


I Cover story

theory, would discredit Ukraine's two top finance officials and slow their meteoric rise. According to Koshkina, Borulko was also left exposed when his relative, former

bne October 2012

this group of Donetsk bankers (around Arbuzov and Oleksandr Yanukovych) until around 2005, but simply grew too criminal and was excluded," he says, adding that this looks more like "a purging of the ranks."

"The Kyiv rumour mill smells a move by old-guard oligarchs against an upstart group of youngish Donetsk bankers" general prosecutor Oleksandr Medvedko, was removed from his powerful post in 2010. Sergei Garmash, chief editor of Donetsk independent news resource Ostro, agrees. "Borulko was part of

Borulko has since fled the country for Belarus, which is now dragging its heels on an extradition request from Ukraine. But his Belarus exile did not discourage him from trying to gain some of that

precious parliamentary immunity: Borulko successfully registered his candidacy to run as a member of the marginal Cossack Ukrainian Party for a single-member constituency seat in the October 28 elections – though in a rare show of democratic sanity in the country his candidacy was struck down by a court. For his part, Oleksandr Shepelev has been thrown out of the governing Party of Regions parliamentary group, but is campaigning as an independent for a new seat in a single-member constituency in the Vinnitsiya region. But his chances of winning are seen as slim – so a date with justice or with exile could be looming.

CEO of a small Donetsk bank owned by his friend, President Viktor Yanuovych's son Aleksandr. Yanuovych Jr is a regional businessman with banking and real estate interests. Forbes Ukraine lists him in 2012 for the first time among Ukraine's richest persons, at 98th spot, with a fortune of $99m concentrated in his Mako real estate holding and a rapidly expanding bank All-Ukrainian Bank of Development, headed by Valentina Arbuzova. Arbuzov's appointment opened the floodgates for further appointments of Aleksandr Yanukovych's and Sergei Arbuzov's friends from Donetsk to key state finance posts in 2011 and 2012.

Family affair Graham Stack in Kyiv


he Ukrainian president's family influence is growing as they take a tighter grip on the state's finances. The 33-year-old Sergei Arbuzov's appointment to the post of head of the National Bank of Ukraine in December 2010 left many scratching their heads – Arbuzov was a complete unknown in

Ukraine's banking world, except for a sixmonth "internship" in 2010 as chairman of the board of state-owned bank Ukreksimank, followed by a three-month "internship" as deputy head of the central bank, which apparently qualified him for the top role in Ukrainian banking. Arbuzov's one redeeming virtue, it seemed, was that his mother was the

Most noticeably, on February 28, Yury Kolobov completed a meteoric rise in the footsteps of Arbuzov by becoming finance minister – Kolobov had previously served as deputy to Arbuzov at Ukreksimbank and then at the National Bank of Ukraine. Like both mother and son Arbuzov, Kolobov's career started in the 1990s in a regional section of Privatbank, Ukraine's largest private bank – although they are in no sense linked to the owners of Privatbank.

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Yanukovych appointed another unknown young Donetsk friend of his son as head of the state tax administration in November 2011: 31-year-old Aleksandr Klimenko. A low-level tax official, Klimenko shot up to become deputy head of the Donetsk regional tax administration following Viktor Yanukovych's victory in presidential elections in February 2010, where he worked for less than a year, before being named head of the Ukrainian national tax service. In an interview in Zerkalo Nedeli, Klimenko refused to comment on his friendship with Arbuzov and Yanukovych Jr, saying it had been "politicized" by the media. Instead, he simply called the two "wise men… who feel the state's pain (at corruption) as their own." Though presumably not nepotism. A particular cluster of appointments relate to former employees of the Donetsk office of Privatbank - which according to press reports was headed for several years in the 1990s by Valentina Arbuzova, mother of Sergei and CEO of Aleksandr Yanukovych's bank, and where Sergei Arbuzov himself started out. The new head of the Kyiv city tax administration, where the lion's share of the country's tax is paid, is 40-year-old Irina Nosacheva, who worked alongside the Arbuzovs at Privatbank in Donetsk, then in 2004-2008 she worked at Ukrbiznesbank, a small Donetsk bank of which Sergei Arbuzov was CEO. Another former employee of the Donetsk Privatbank office, 40-year-old Viktoria Kononykhina, succeeded now Finance Minister Koloba as first deputy head of Ukreximbank – Ukraine's largest bank by capital and key buyer of government bonds and lender to state companies such as gas monopoly Naftogaz Ukrainy. Kononykhina is regarded as the one pulling the strings at the bank. And finally in April, another former manager at the Privatbank Donetsk office, Roman Maguta, became head of Ukraine's state audit chamber – and promptly launched a campaign to expand the remit of the chamber to cover not only state expenditure, even aiming for changes to the constitution.

Cover story

Bills that hark back to the bad old days

bne Two new bills before the Ukrainian parliament have caused an international outcry and suggest the government is prepared to crack down on the opposition if it does badly in the October 28 elections. A draft bill on defamation passed its first reading in the Rada on September 18, but has been condemned by international press freedom groups as a return to Soviet-era controls. The bill seeks to make defamation a criminal, not civil, offence that is punishable by up to five years in prison – the same punishment that existed in Soviet times. Paris-based NGO Reporters Without Borders said the defamation bill could quash media freedoms completely in the run-up to the general elections and called on Rada deputies to reject it. The group said the bill would re-impose Soviet-era controls over the press and "threaten the very existence of independent journalism." Ironically, the draft law was introduced to the Rada just two weeks after Ukraine hosted the World Press conference where editors and publishers from around the world came to Kyiv to discuss the industry. Protestors held up signs during the event to protest the rapid erosion of press freedoms in the country. The law also follows the authorities' move earlier this year to investigate TVi, the only television channel reporting on government corruption; many regional cable operators have since dropped the channel. Alexander Akymenko, an editor at Forbes Ukraine, wrote on his Facebook page that journalists need to have "an already packed bag at home," a reference to the practice common among Russians during Stalin’s Terror in the 1930s. The other controversial bill imposes tight controls on public rallies, requiring organisers to apply for permission two days in advance and making them personally responsible for the conduct of the crowd. The law is vague about where sanctioned rallies can be held, allowing courts freedom to choose what is "appropriate". The government claims the bill will improve public safety, but Volodymyr Fesenko, a Kyiv-based political analyst, says the government is reacting because it has a "Maidan complex," referring to the square in central Kyiv that was the venue for mass protests during the Orange Revolution from late November 2004 to January 2005. Then, the current president, Viktor Yanukovych, had just won a disputed presidential election, but lost the subsequent re-held election to Viktor Yushchenko, who remained president from 2005-2010. Political tensions are rising as opinion polls show that President Yanukovych's Party of Regions is running neck-and-neck with the opposition Fatherland Party of jailed former PM Yulia Tymoshenko.

I 11


I Perspective

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of the hundreds of run-down cities east of the Urals, as it has done in Vladivostok. Nevertheless, the mood on the sidelines of the summit was positive, with businessmen who work in the region confident that the Russian government is taking the right steps to piggyback on Asian growth. "Russia is a big place and it's hard to get everything done at once, but the world doesn't wait," said John Faraci, chairman and CEO of International Paper, which has invested heavily in forestry projects in Eastern Siberia. "The world is growing and the opportunities are there."


Russia's Asian turn Natasha Doff in Vladivostok


rom the lavish preparations to the upbeat speeches, Russia's message at September's Asia-Pacific Economic Cooperation (Apec) summit in Vladivostok could not have been clearer: Asia, not the West, is the key to Russia's future. Usually a fairly uninspiring affair, this year's event – the first hosted by Russia in its 14-year membership – Russian readership tried to make this one to remember. Held in a swanky new university complex, perched atop an island off the coast of an expensively spruced-up Vladivostok, the summit far exceeded its aim of proving to the countries of the Asia-Pacific region that it means business. And just in case delegates weren't impressed enough with the 1,000-metre bridge built in their honour or the gifts left daily in their rooms, there was a gigantic fireworks display (rumoured to have cost $8.8m), a glamorous cocktail party aboard a ship on the final evening and the most lavish buffet the Russian press corps has ever seen.

Faraci and others pointed to the concrete steps already being taken, such as a new government ministry set up in Far Eastern city of Khabarovsk in May to promote the development of the region, railway capacity upgrades and measures to cut nightmarish customs procedures. The authorities have also opened up a shipping channel along Russia's northern coast and are lobbying Apec members to consider diversifying supply chain routes to include Russia. "The amount of trade between Europe and Asia exceeds $1 trillion and every percent of the cargo that is transported via Russian territory will bring our economy no less than $1bn," Ziyavudin Magomedov, chairman of the board of Summa Group, said at a panel session. Currently less than 1% of the cargo is transported via Russia. An industrial holding company with close links to the government, Summa looks set to emerge as a key player in the development of the Far East, having already invested in a raft of infrastructure projects in the region. The group is negotiating a deal to buy a 55.8% stake in the Far East Shipping Company and signed a memorandum of

"50% of Russian exports go to Europe, while just a quarter goes to the Asia-Pacific region" understanding during the Apec summit with Russia's state development bank, Vnesheconombank (VEB), to jointly develop a Far Eastern grain terminal.

Key to Russia's new geopolitical approach is trade, which the country hopes to capitalize on by using its strategic position as a land bridge between Europe and Asia. Currently some 50% of Russian exports go to Europe, while just a quarter goes to the Asia-Pacific region. The Russian authorities say they want to bump this up to at least half in the coming years.

Just as important as hard infrastructure, is further economic integration with the countries of the Asia-Pacific region. Joining the World Trade Organization (WTO) was a start, but Russia is also pushing for more free trade areas, a single Apec customs window and more lenient visa requirements.

But while the sentiment is attractive, it is clearly easier said than done. Transport between western Russia and the country's vast eastern hinterlands is served by a single railway, while red tape and corruption put a heavy strain on the transfer of goods and deter investment. Moreover, the Russian government does not have $21bn to invest in each

And Russian President Vladimir Putin's grand plans aren't limited to East Asia. His aim is to link up the region with most of the countries of the former Soviet Union via Russia's newly formed Customs Union with Belarus and Kazakhstan, and a wider project to create a European Union-style economic bloc with most of Central Asia, called the Eurasia Economic Union

Perspective I 13

bne October 2012

(EEU) that is supposed to appear by 2015. "If you look at the territory of the three countries, you will see that we do have something to offer," Putin told CEOs at the summit. Putin made clear that the main target of his new strategy is China, which has promised to open up its import markets and generate some $10 trillion in demand for global exports until 2015. It is notable that the Russian president repeatedly referred to trade and energy ties with Beijing during his speech, while barely mentioning the other major Apec economy, the US. Russia has also followed China's lead in shunning the TransPacific Partnership, a US-led trade group formed at last



year's Apec summit. Although Russia's trade with the US also has potential for a significant increase, investors said this strategy makes a lot of sense, given China's growth prospects and proximity to Russia (the country's eastern border lies less than 100 kilometres from Vladivostok). "If China is going to succeed, Russia will inevitably succeed too, because a lot of the growth in China will be dependent on access to resources that Russia has," David Gray, a managing partner at PricewaterhouseCoopers, said at the summit. "It doesn't make sense that everyone is optimistic about China but pessimistic about Russia. You'd have to have mismanagement on a Herculean scale for there not to be growth in Russia."

Despair Index revisited

n May, bne ran a story entitled, "The Poverty of Nations", where we compared our "Despair Index" of various countries, including Russia and the US.

In times of crisis, it has been traditional to measure the pain with the "Misery Index" (simply: unemployment plus inflation). But in order to better capture the impact on emerging markets, bne has added the poverty rate to the equation, which also captures what is going on in the bottom half of society. In an ideal world, the Despair Index of any developed country would be about 6 (4% residual unemployment, 2% inflation, 0% poverty), but in fact only France has managed to get their number under 20 in the last decade.

And things could be even worse than they seem. A discussion has started amongst economists over that obviously very sensitive unemployment number just ahead of the presidential election. It seems that the Obama administration has been massaging the figure: the number of people moved off the dole and on to disability payments has doubled since he took office, which would add another 2.9% to unemployment. Likewise, an unemployed American who had looked for work sometime in the last four years used to be counted in, but that period has been cut to one year, which is another 1%. Together the "true" level of unemployment in the US is probably closer to 12% (and that is not counting the 16% of "underemployed" or the 7.2% of "working poor" who earn so little they are living in poverty).

The findings of our investigation were that over the last two decades Russia had reduced its despair to the point where in 2011 it was actually slightly lower than that of the US, which was suffering with a sharp rise in poverty resulting from the economic crisis.

We have added these estimates into our chart below, which needs no further comment.

Four months on, we revisit the Despair Index. And brace yourself for bad news: the gap between Russia and the US has actually widened – although more recently the two lines have come back together, if official statistics are to be believed.

Despair index, Russia vs US

Russia has been putting in a sterling performance: poverty has fallen to between 12.5% and 13% of the population, while unemployment is at historic lows of 5.1% – below even pre-2008 levels. Inflation is higher than expected at 6.4%, but that is due to a poor harvest and "core" inflation is just 5.5% according to the Central Bank of Russia.

40 35 30 25 20 15

The situation in the US is, sadly, much worse. Inflation is only 1.4% (and there is even talk of deflation), but poverty has soared to 15.7% of the population and unemployment is stuck at about 8.1%, according to recent data.




Russian despair Russian despair (with inflation forecast) Source: bne






US despair US despair (inc disability) US despair (inc working poor)



I Eastern Europe

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Eastern Europe I 15

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months after Vladimir Putin retook office as president – which is pretty quick in political timing terms and that is very good news," says Chris Weafer, chief strategist at Sberbank CIB (formerly Troika Dialog). They're on the list Attention will now turn to the other big state names among the $100bn worth

international financial centres, and it comes only a week after Russia hosted the 24th Asia-Pacific Economic Summit (APEC) meeting in Vladivostok that was aimed at attracting investors from the east. These two events are only the most significant in a raft of smaller initiatives: Russia's energy ministry is taking $1 trillion of investment projects on a road show in London in

"For all of the bears on Russian reform, Sberbank's placement opens up the possibility the Russian government actually is more serious about reform that many would have believed"

Relaunching Russia's investment story Ben Aris


ussia's biggest bank, the stateowned Sberbank, successfully pulled off a much-delayed share issue on September 18 that was the tenth largest deal globally and by far the largest emerging market listing this year. The second public offering (SPO) was good news on several fronts. It means a window of opportunity has opened up for Russian would-be share issuers (helped in no small part to Federal Reserve Chairman Bernanke's latest round of quantitative easing) and several companies have already rushed to confirm their intention to carry out an IPO or SPO this year. It also officially restarts the Kremlin's stalled privatisation programme and, more importantly, reaffirms the government's commitment to reduce the state's role in the economy. Last of all, it suggests the Kremlin now sees a vital role for foreign investors in the remaking of Russia Inc, whereas only

a few years ago the hardliners were locking foreign investors out with the far-reaching Strategic Investment Law. Starting with the most obvious first: the sale of 7.6% of the bank's shares in a dual listing in London and Moscow was twice oversubscribed and priced in the middle of the range at RUB93 per share, raising for the government a handy $5.2bn but leaving the state still in majority control of the bank. Sberbank's management team worked the phones and met with the institutional big guns, forcing them to do their homework on Russia and refocusing everyone's atention on the Russia story for the first time in years. Russia's stock market has been performing relatively well this year and was up about 10% as of the middle of September, and the enthusiasm for Sberbank's SPO has encouraged a raft of other companies to launch IPO plans. Leading mobile phone operator

Megafon announced at the start of September its plans to list on thre stock market, and in the same week as the Sberbank sale Promsyvazbank and MD Medical Groups also announced another $1bn worth of IPOs between them slated for this year. Not to be outdone by its sister bank, statecontrolled VTB Bank also announced it will offer another 10% at the start of next year in another multi-billioneuro offer. "Sberbank's closing price was not quiet the RUB100 per share the government had been holding out for, but with that price they have to be very happy," said one banker close to the deal. More significantly, the sale of the Sberbank stake is the flagship deal in Russian Prime Minister Dmitry Medvedev's stalled privatisation programme, which is designed to get the state out of the economy. "The Kremlin has come back to relaunch the privatisation programme only four

of assets on the privatisation list, which include already-listed oil major Rosneft, power firm Inter RAO, hydropower holding RusHydro, diamond miner Alrosa, national carrier Aeroflot, the federal power grid and pipeline operator Transneft. First up will probably be shipper Sovkomflot and fixed-line operator Rostelecom; getting the rest of the companies to sell themselves off will be much hard work. "Hats off to Sberbank's CEO German Gref who has done a great job of turning the bank into one that looks like a western operation (albeit with a lot more to do)," says Weafer. "But the same isn't true for the other companies on the list that still look extremely Russian; the next stage of privatisation will be harder, but at least they have made a start." And there's the rub. Many Russiawatchers believe the government powers-that-be pay no more than lip service on the need to reform, while quietly lining their pockets. The Kremlin doesn't really do PR, but a quiet charm offensive seems to be building. Sberbank was a major advertisement for Russia and certainly caught the attention of the

October, the Russian capital market will be hooked into the international settlement system Euroclear in November (that will also force investors to do some homework after the indices are rebalanced as a result), and there are a host of top notch international sporting events in Russia each year from now until the World Cup in 2018. "For all of the bears on Russian reform, Sberbank's placement opens up the possibility that the Russian government actually is more serious about reform that many would have believed," says Milena Ivanova-Venturini, a bank

"The next stage of privatisation will be harder, but at least they have made a start"

analyst with Renaissance Capital. "Lots of skepticism is likely to remain (Russia, by definition, does not get the benefit of the doubt); however, the gates are now if not wide open, then ajar to the possibility of a somewhat-more-positive interpretation of the story in the eyes of investors."


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of opportunity seems to be opening for Russian would-be issuers and a string of companies have announced IPO plans in the last few months.


Investing in the health of Russia Ben Aris in Moscow


ussia's leading private healthcare company MD Medical Group is hoping to cash in on growing enthusiasm for Russian equity with an October IPO to raise more than $150m, which it will use to continue its rapid expansion. MDMG plans a London listing in October in two parts. A $150m primary issue of 30% of the company as global depositary receipts will be offered and used to fund the company's growth. There will also be a secondary issue of existing shares at the same time, the size of which has yet to be decided, but could be "significant," according to a source close to the deal. The Russian economy has been on sick leave for most of this year as industrial production declines, but not the private healthcare sector, which has seen almost uninterrupted growth since the crisis in 2008. Dr Mark Kurtser, chairman of MDMG's board and the driving force behind the group, tells bne in an exclusive

interview that his business was barely affected by the global economic collapse four years ago. "The government was quick to step in and prop up the economy," Dr Kurtser said during a short break, still dressed in his operating room smock that is his version of a work suit. "Incomes have continued to rise throughout the following years,

Rebirth MDMG specializes in reproductive and maternity services to the 38m people that are thought to make up Russia's emerging middle class. Russia's health service is good, says Dr Kurtser, who is one of the most famous doctors in the capital, but people come to the private clinic to jump the long queues for something like fertility treatment and also for the better service. "We offer IVF [in vitro fertilization] not just to deal with infertility, but also as a service for people that want to have children, who are suffering from other problems like cancer or are in their late reproductive years, but not covered by the government quotas for help," says Kurtser, who was also appointed chief obstetrician and gynaecologist for Moscow City in 2003. "MDMG is the Russian market leader in IVF, and we continue to develop this area of our business, as there is a significant deficit in the availability of IVF support in Russia." The business is also growing thanks to the reversal of a decades-long decline in the population. Russia's population shrank from 146m in 2000 to 142m in 2008, but since then birth rates have turned positive and last year Russia recorded its first population increase

"Couples that have already put off having a family for a decade are still having babies as a result"

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Eastern Europe

universal healthcare, but the state is still struggling to provide enough services on its own.

meeting on September 12, calling for new, "large-scale investments" in the medical sphere. "It is evident that huge injections in scientific research, technical re-equipment, and infrastructure are required. It is also necessary to integrate international industrial and scientific industries into the system. These and other key targets are provided in the development strategy of the medical sphere," Medvedev said at a government meeting. Fertile ground MDMG was founded in 2003 and in 2006 opened its flagship $100m private maternity hospital in Moscow with the help of a $70m loan from state-owned Sberbank. Some 18,000 patients a year now come through MDMG's doors, of which 2,000 are coming for IVF or other reproductive help. The business has grown fast and the company now operates 12 clinics and hospitals in Russia, plus one in Ukraine, that earned the company RUB851m ($28m) in the first six months of 2012, up 59% on year. The company estimates it will continue to grow at 35-45% a year and plans to open more clinics and hospitals in the regions. Medical service companies enjoy both corporate tax and VAT exemptions, and there is a tax rebate for Russians using private services of up to RUB120,000 ($3,530) a year. And there is currently a debate in the Duma that could allow private clinics access to the state's mandatory health insurance scheme by 2015; Russia's constitution guarantees

Still, the sector is relatively new: Russian spending on healthcare has been growing by 21.2% a year since 2006, much faster than incomes, which have grown by 13% a year over the same period. By 2011, Russians were spending an average $525 a year on healthcare (of which half goes on pharmaceuticals), a sixth of the OECD average of $3,698, and well behind the world leader, the US, which spends $8,362 per citizen in 2011, according to MDMG. The company specializes in gynaecology and obstretrics, which account for 58% of revenue, but it has built up a self-contained vertically integrated service that, unusually for a private Russian clinic, offers in-patient care in the company's 184 beds. In addition, the

hospitals cover everything from testing to outpatient treatment. The rest of the company's revenue is more-or-less evenly distributed between paediatrics, IVF and other support services such as stem cell storage. MDMG is the largest company in the sector, but already faces competition


MDMG's timing is excellent, announcing its plans to float around the same time that Russia's biggest bank Sberbank did a secondary public offering of a 7.6% stake, which successfully raised $5.4bn and turned global investor attention back Russia's way. A window

in two decades to 143m. The Kremlin concentrated its medical resources on halting the demographic decline several years ago when the current prime minister, Dmitry Medvedev, was still the first deputy prime minister. The IPO is also well-timed from a political perspective, as Medvedev relaunched the offensive to improve Russia's healthcare at a government

$4,668 $3,698





in this increasingly attractive sector. Amongst the other companies is Medicina (one hospital), GEMC that operates the European Medical Centre (with four clinics and two hospitals) and Medsi (30 clinics) – all of which offer general medical services. In addition, there are three smaller companies that offer women's services and IVF: Scandinvia (four clinics and eight beds), Bliznetsy (fewer than 10 beds) and Medlaif (six clinics and 17 beds). Investors are also waking up to the opportunities. Medsi is one of the biggest private healthcare providers in Russia. Owned by industrial conglomerate AFK Sistema, it has been opening clinics as fast as it can, and in April teamed up with the Moscow City government and private investors to raise capital to pay for more expansion. Medsi issued shares in April matched by the City with $205m worth of

"There is a significant deficit in the availability of IVF support in Russia"

Per capita healthcare expenditures (per annum), 2011

couples that have already put off having a family for a decade are still having babies as a result."

I 17


$525 Russia





property for a 24.98% stake, while the private investors contributed the same amount in cash for the same stake, leaving Sistema with majority control. The group wants use the money to expand its chain of clinics and build three in-patient hospitals across the country.


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Belarus looks to secure next part of EDB loan

and the bugbear here is the large current account deficit. However, some progress has been made here too: in the second half of 2011, the current account deficit began to fall from almost 16% of GDP in January-June 2011 to 4.5% in JulyDecember 2011. And it turned positive in the first quarter of 2012 when it was a surplus of 0.2% of GDP. At the same time, international reserves doubled and were equivalent to 2.1 months of imports (still below the three months of import cover most economists believe is necessary to maintain the stability of the domestic currency) as of the end of the first quarter.

elarus probably suffered more than any other country in Central and Eastern Europe during the 2008 crisis, but four years on how is it doing? And more importantly, will it qualify for the next tranche due this November from the Anti-Crisis Fund?

mainly driven by an almost 20% drop in investment. Although Belarusian exports have grown significantly, the prospects for the rest of the year don't look very rosy, as the positive effects of the real depreciation of the ruble are vanishing due to high inflation.

The republic has taken several shaky steps forward, but much remains to be done. "The success of stabilisation completely rests with the prudent monetary management and fiscal policy followed by the authorities of the Republic of Belarus with simultaneous maintenance of a flexible exchange rate. A further decline in inflation is a key condition of sustainable growth and external balance improvement in the medium-term perspective," Sergey Shatalov, the head of the ACF, says.

An expansionary monetary policy under a fixed-exchange rate combined with the deterioration of terms of trade and several external shocks hit Belarus hard. The government had to devalue the national currency twice and saw the economy come to a virtual standstill.

But despite the difficulties, the government acted more decisively than the likes of Greece: the National Bank of the Republic of Belarus (NBB) ended directed lending in June 2011 and adopted a unified exchange rate in October 2011, which resulted in a return to real positive interest rates by the end of 2011. Inflation has also been brought down

The government is also burdened with a relatively high level of debt (by CIS standards, but not by EU standards) that has risen to 28% of GDP in the last few years, which needs to be repaid to external creditors over the next three years. Still, this problem can be tackled thanks to the fact the government is running a budget surplus: the 2011 budget was



In order to keep its head above water, Belarus requested a financial loan from the Anti-Crisis Fund (ACF) set up by the members of the Eurasia Economic Community and administered by the Eurasian Development Bank (EDB). A third tranche of $440m was distributed in June and another tranche is due to be released in November. The republic has so far met 15 of the ACF’s 17 conditions for the release of the next tranche of money and the much-needed cash injections have stabilised the economy. In 2011, GDP grew 5.3%, following 7.7% in 2010, a sharp turnaround from 0.2% in 2009. In the first six months of 2012, Belarus’ GDP grew by 2.9%, dragged down by the collapse in internal demand

"Any attempts at artificial stimulation of the economy will reduce the competitiveness of the economy" from the hyperinflation levels: between January and June 2012, the average monthly inflation rate was below the 2% level and the end-of-year rate is forecast not to exceed 22%, against the rate of 108.7% in 2011.

implemented with a surplus of 2.3% of GDP against the initially planned deficit of 1.5% of GDP. The strong budget position was possible by cutting expenditure and surprisingly high revenue arising from inflationary income.

But to fully recover, the country needs to grow out of the trough it has fallen into

The gross external debt is still a relatively high 62.3% of GDP, of which a

bne October 2012

quarter is destabilising short-term debt and could put pressure on the currency market or deplete official reserves. Going forward, the NBB and government signed a new letter of intent with the AFC that lays out the conditions for managing the economy this year, clearing the way for the release of the next $440m tranche in November. Still, the government’s plans for this year are too ambitious, targeting growth of over 5% for 2012. Economists warn that if the state attempts to artificially stimulate the economy, this will accelerate inflation and quickly run down the country's hard currency reserves due to increases in domestic demand and real exchange rate appreciation. So the AFC has explicitly recommended Belarus goes more slowly. "Any attempts at artificial stimulation of the economy to attain GDP growth planned by the authorities on the level of 5% will exert high pressure on the international reserves level, the exchange rate and inflation, and through accumulation of structural disparities will reduce the competitiveness of the economy," says Shatalov. The AFC has called on the government to be a bit more modest in its plans and resist the temptation to return salaries to their pre-crisis levels, as well as keeping a tight rein on state-directed lending. At the same time, the European Bank for Reconstruction and Development is calling on the government to accelerate the privatisation programme. The AFC says that if the government can hold state lending to a total of BYR7bn and general lending increases to 15%, then inflation could be brought down to 20% by the end of this year, with growth running at between 2% and 3%. "The government needs to manage a tricky balancing act between keeping a tight rein on monetary policy and encouraging the recovery," says Shatalov. "Rising deposits, the state efforts at recapitalising banks and the reduction of state programmes at the end of 2011 have all contributed to excess liquidity at the banks.

Eastern Europe

Lost chance in Belarus

Sergei Kuznetsov in Minsk Belarus' parliamentary elections on September 23 had a predictable result – the opposition did not win one seat in the 110-seat lower chamber. It seems that the new parliament will be much like the present one that was elected in 2008 – an institution that will rubber-stamp any presidential initiative without discussion. According to Belarus' Central Election Committee, 109 MPs were elected on a turnout of 74.2%. This seems high, because the election campaign was listless and it appeared that the general public, especially in large cities, were not much interested. The only extraordinary move took place approximately a week prior to the election when Belarus' two main opposition parties – the United Civic Party and Belarusian People's Front – said they would boycott the elections and withdrew their candidates. The two parties said that the ballot could not be considered free and democratic, especially when many opposition activists remain political prisoners. President Alexander Lukashenko condemned this move by the opposition parties. "I am coming to the conclusion of their complete inability as politicians," he told reporters after voting at a Minsk polling station. Commenting on the possible reaction on the elections of the West, Lukashenko said that he "always hopes for the better," but the country was "conducting elections today not for the West, it is the Belarusian people that are front and centre during the elections." Except the people play little role in the process. Reports say that a number of Belarusian opposition websites were blocked after they reported the results of the turnout for the elections had been falsified. After the last presidential elections in December 2010, considered a sham by the West, and the subsequent mass arrests of opposition activists, the EU and the US imposed sanctions on Belarusian officials, businessmen and state-run enterprises. The US imposed sanctions against six large state-owned oil and chemical companies, including Naftan, one of the country’s two oil refineries, due to the deteriorating human rights situation. The EU has imposed sanctions against several tycoons suspected of being close to the regime, as well as against more than 30 companies controlled by them. According to a bne diplomatic source, the EU has taken a pause in the process of imposing sanctions until October. As such, the views of the election monitors sent by the OSCE will play a crucial role in deciding on further sanctions. Judging from the OSCE's findings issued September 24, there is little comfort for the government. "This election was not competitive from the start," said the OSCE. "A free election depends on people being free to speak, organize and run for office, and we didn’t see that in this campaign."

I 19


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of England, forcing the UK out of the Exchange Rate Mechanism in 1992, Rogers recently had an epiphany and said in an interview with CNBC in August: "I do not invest in Russia now, but for the first time in my life I have started considering it." Since it was founded in the aftermath of the 2008 crisis, VTB Capital has quickly grown to become Russia's leading investment bank, dominating the equity, fixed income, and mergers and acquisition business in terms of volumes of deals, according to Dealogic. The bank is also moving into private equity, which had been an ad-hoc business at the bank. The Russian government has targeted agriculture as a strategic sector and is pouring billions of dollars into its development. Rogers joins the agricultural division that is managed by VTB's private equity department, where he "will provide regular advice and insights into global commodity markets and investment trends," VTB said.

Rogers jumps on bearwagon Ben Aris in Moscow


egastar investor and notorious Russia bear Jim Rogers appears to have had a change of heart and taken a job as an advisor to the agricultural fund run by Russian stateowned banking giant VTB Capital. "Russia and the [Commonwealth of Independent States] region have all the ingredients needed to become the world's agriculture powerhouse. It seems

that everything may now be coming together under VTB Capital to make this happen, so I am keen to participate," Rogers, who is also chairman of Rogers Holdings and Beeland Interests, said in a statement, issued by the bank on Tuesday, September 19. Best known for co-founding the Quantum Fund with George Soros in the 1970s that "broke" the Bank

"VTB Capital sees high potential in the Russian agricultural market and plans to attract from $500mn to $1bn of the investments into the sector based on its phased development strategy. Russia and the broader CIS region is developing into a global agriculture superpower with its proximity to China, Middle East and North Africa resulting in it taking a leading role in the export of key agricultural commodities such as wheat, barley, corn and sunflower oil," the bank said. The move is quite a turnabout for Rogers, who is known for his bearish stance on Russia. He once famously told an audience at Harvard Business School that the country was a kleptocracy and that he would never invest there. His speech was so outspoken that one of the MBA students, a young Russian investment banker called Dmitry Alimov, stood up after the presentation to take issue with several of Rogers' more controversial statements. The exchange led to an emailed duel on the pros and cons of investing in

bne October 2012

Russia that epitomises the emotionally charged debate still dogging Russia's investment image today. Alimov cc'd his fellow students on Roger's replies, which were quickly forwarded to trading desks and investment bankers around the world before finally ending up as an article in the New Yorker. "Dear Mr. Rogers: I am the 'lad' who disputed your factual claims with regard to Russia today. First of all, I would like to thank you for speaking to us at the Harvard Business School. I think I speak for my fellow HBS students when I say that we enjoyed your original views and interesting stories today. However, I must address the unfortunate reality that your facts about Russia are plain wrong," wrote Alimov politely opening the exchange. Rogers' reply began: "Thank you for coming and for writing. I rarely suffer fools gladly and even more rarely bother with chauvinistic know nothings, but since you sent this ludicrous canard‌ ", before launching into a point-by-point dismissal of Alimov's arguments. The audience steadily grew as the exchange continued for several days. However, Alimov maintained the upper hand, countering each rebuttal with sourced facts and figures, often citing both the US government's own statistics as well as those of the World Bank and other international financial institutions.

Eastern Europe

After receiving his MBA, Alimov returned to Russia where he has enjoyed a successful career as a media entrepreneur. At the start of this year, he launched Frontier Ventures, a fund aimed at Russia's burgeoning e-commerce business that has already raised $50m. "We are looking to invest into five or ten projects and looking for ideas based on an established business model," Alimov told bne in an interview earlier this year. Rogers' apparent change of heart is part of wider reappraisal by investors about Russia. The sentiment pendulum has clearly been swinging back towards Russia over the last month or so and the secondary share offering by state-owned retail banking behemoth Sberbank was successfully closed on September 19, raising $5.4bn for the government. Perhaps Rogers may just be making another very good call. "Jim Rogers is a global icon and thought leader in commodity investment trends and understands the importance of this region in the global commodity supply dynamic. Jim sees the investment opportunity in regional agriculture resulting from its low-cost, highly fertile cropping land, potential productivity gains, abundant water supply and close proximity to the high demand regions of MENA and China via established shipping routes," said Tim Demchenko, global head of private equity and special situations at VTB Capital.

"It seems that everything may now be coming together under VTB Capital to make this happen, so I am keen to participate"

I 21

Spoof ad in Ukraine puts cat amongst pigeons It started as a joke, but a billboard sporting a Ukrainian babushka and her cat has gone viral and is seriously embarrassing the government of Ukrainian President Viktor Yanukovych. In August, the ad appeared on a billboard in the industrial town of Dniprodzerzhynsk, the heartland of political support for Yanukovych and his governing Party of Regions. Accompanying the picture of the old woman and her cat was the caption: "I learnt that my grandson voted for the Party of Regions, so I re-wrote my will to give my house to the cat." The image was shared on Facebook and quickly went viral, before spawning a raft of copycat posters picking up on the cat theme. The cat in the ad has now become a symbol of ridicule of the administration. The Dneprodzerzhinsk Online news portal, which broke the story, has identified Maksim Golosnoy as the creator of the original ad, a 30-year-old former head of the village council of Yelizavetovka in Dnipropetrovsk region, who is standing for election in October. An opposition politician, Golosnoy is the subject of a police investigation for the alleged theft of public funds, which he claims is politically motivated. He was formerly a member of the Party of Regions, but quit to stand as an independent in 2011. As it turns out, the old woman in the photo is actually a Russian, Anna Ivanovna Tretyakova, who lives in Russia's Kenozero region, near the border of Arkhangelsk Oblast and Karelia. She doesn't own a cat and has no connection to Ukraine. And the cat is actually American. Ukrainians have been having a field day with the cat jokes. The gaffe-prone Yanukovych has always made it easy to make fun of the administration. For example, during his failed presidential election bid in 2004 he became known as the "Proffesor" due to a spelling mistake he made on his official bio.


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Oliver Hughes, chairman of the management board of Tinkoff Credit Systems

Russia’s “Beer Bank” toasts credit cards Ben Aris in Moscow


ussia’s express consumer lending business was launched by the “Vodka Bank” in 2001, and now the country’s credit card business is being championed by what could be called the “Beer Bank.” Consumer lending in Russia exploded after the small start-up bank Russky Standart – better known for its premium vodka of the same name – introduced the concept of lending cash with no security at the point of sale. At the time the bank was thought to be a flash in the pan, but a decade later most of the incumbent banks in Russia are still struggling to catch up with Russky Standart. Oleg Tinkoff hopes to pull off the same trick with credit cards. Best known for opening a now legendary bar-cum-microbrewery in his hometown of St Petersburg in 1998, Tinkoff is a serial entrepreneur and a string of pubs quickly grew into the fourth largest independent brewery in Russia with 1% of the market. The company’s flagship brand Tinkoff Zolotoe (a light beer in the style of Mexico’s Corona) made Tinkoff a household name and he sold the

business to InBev for €167m in July 2005. Now he is hoping to do the same with finance, establishing Russia’s first “virtual” bank that has no branches and specializes in credit cards. Linking a bank to booze would be anathema in the West, but a study

Consumer loan growth was white hot over the first half of this year, up 43% on last year, according to the Central Bank of Russia (CBR) – but credit card growth is running even faster. Oliver Hughes, chairman of the management board of Tinkoff Credit Systems (TCS), tells bne in an interview that the company’s credit card portfolio has doubled in size every year for the last three years. “And the overall Russian credit card market has grown by between 25% and 40% a year for the last two years – with no sign of slowing down,” Hughes says. TCS is not alone in the credit card space and faces competition from not only Russky Standart, but also other up-andcomers like Renaissance Credit (the retail arm of the eponymous investment bank), Trust Bank, Alfa Bank, Citibank and mobile phone retailer turned bank Svyaznoy Bank. But surprisingly, Hughes doesn’t regard Sberbank, which recently started issuing cards and already accounts for one in five credit cards, as part of the competition yet. “Sberbank decided to launch credit cards about three years ago and now probably accounts for a fifth of credit cards in circulation. However, they have just built on their existing customer base. When it starts having to market to new customers, then its growth will slow down and we will be able to compete on

"Russians believe people will always drink regardless of the state of the economy and so an 'Alcobank' will never go bust" commissioned from consultants McKinsey by Russky Standart in its early days found that a bank tied to an alcoholic drink has a more stable image in Russia than those linked to oil or gas: energy prices are cyclical, but Russians believe people will always drink regardless of the state of the economy and so an “Alcobank” will never go bust. Rising incomes and a return to economic growth – albeit at a slower rate of 3.5-4% for this year versus 6-8% precrisis – have enabled consumers to start spending and borrowing again.

the basis of better service and product,” says Hughes. “Sberbank will become a major competitor – but not now as they are fishing in a different part of the pool.” Russia’s credit card market remains underpenetrated. Hughes estimates there are a total of 15m-16m credit cards in circulation out of a total economically active population of about 90m to 100m, and TCS already is the biggest issuer after Sberbank with 2.3m cards. From a similar start, Hungary’s credit card penetration after five years was

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20%, in Poland 30%, in Brazil 70% – all of which are still well off the mature market levels of penetration of 400 to 600% in Germany and the US respectively, says Hughes. Small town business TCS’ strategy is unusual for two reasons: first, its offers and services are entirely online; second, it has adopted a “Moscow last” policy when it comes to finding customers. Russia’s capital is the largest city in Europe and its population is more than that of most Central European countries, but this means a lot of competition. After that, most companies focus on the “millionki”, the 13 Russian regional capitals with populations of more than 1m people. However, TCS has explicitly ignored these markets and thanks to the internet has gone straight to the untilled markets of the smaller cities. “Some 61% of our customers are in towns of 200,000 people or less, and another 38% are in towns of less than 50,000 people,” says Hughes. “We have only moved into Moscow and St Petersburg relatively recently, which now account for 8-9% of customers.” Russia’s internet (known locally as RuNet) has exploded in recent years and at the start of September VTB Bank released a report saying that the broadband penetration rate has now reached 65% of the population. As a consequence, the volume of Russia’s e-commerce transactions is at least doubling every year, but “banks have only started to tumble to the power of the internet now,” says Hughes. After five years of operation, TCS is now branching out and offering its customers more services. Following the 2008 crisis, the bank started taking deposits amongst other services. The next stage is to double equity to $400m-450m and then exit, possibly via an IPO, says Hughes. Tinkoff owns some 62% of the bank, with minority investors that include Goldman Sachs and Russia’s biggest private equity investor Barings Vostok Capital Management holding the rest.

Eastern Europe

Bribe inflation

bne The size of the average bribe in Russia has increased 33-fold since Dmitry Medvedev launched his anti-corruption drive in 2008 following his election as president that year. Bad news? Not necessarily. While the campaign has not reduced the level of corruption, which is endemic, it has clearly raised the risk of taking a bribe and – ironically – market forces are at work: just how much the risks have increased is clear to be seen in the cost of a bribe now. "Corruption has permeated the country from top to bottom: From the highest public officials to the TSZh (homeowner's associations)," chairman of the Russian Association of Lawyers For Human Rights, Yevgeniy Arkhipov, summarized the results of the four-year struggle. Russia’s nationwide anti-corruption community outreach office, Clean Hands, which is part of the Russian Association of Lawyers For Human Rights, published its fifth report on corruption in the country at the start of September and found the average bribe has increased from RUB9,000 to RUB300,000 ($300 to $10,000) between 2008 and 2012, reports Kommersant. The average amount of a bribe differs from region to region: in the Moscow Oblast the indicator has increased five-fold to reach RUB395,000, while in Tatarstan it has been cut in half. Moscow City generates the most complaints for the Clean Hands office with Maritime Kray and Moscow Oblast in second and third place. Medvedev launched Russia's version of a Clean Hands anti-graft drive at the end of 2008, starting with a federal anti-corruption law that dramatically increased the punishments for bribe-taking. The next major reform came in 2010 when the Interior Ministry was shaken up. The police force has also been reorganised, although less has been done here, as the Kremlin wants to make sure the police remain loyal in the face of rising public protests. The size of the shadow economy has also increased, the report claims, from 35% of GDP in 2008 to 52.6% now, although part of this growth is connected to the economic slowdown: in difficult economic times small companies start cheating on their taxes as a survival mechanism. While this is a form of corruption and also involves bribe-paying, the root cause is external and in theory the trend will reverse during an economic pick-up without the government having to do more than enforce the current rules. However, the conclusion of the report was upbeat, with the authors talking about a "corruption bottom" in Russia. In the first phase of an anti-corruption drive, the level of corruption stays the same, but the costs go up. In the second phase, about to begin, the anti-corruption measures begin to bite and the level of corruption starts to fall.

I 23


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other emerging markets are chasing international investment into infrastructure, an infrastructure bond comes with the backing of the state. "We are talking about long-term, highyielding, guaranteed bonds that are backed by the state – who wouldn't want those in your portfolio?" says Monovski. Wider story The bond announcement seems to be part of a wider policy of upping Russia's game when it comes to both infrastructure and the capital markets.

Russia building bonds Ben Aris in Moscow


ussia's Economy Ministry has announced it will offer RUB1.5 trillion ($46bn) worth of bonds to finance the planned splurge in infrastructure projects. Given the recent appetite that global investors have shown for Russian assets, pundits expect to see good demand for these new bonds. Russia has massively ramped up investments into its crumbling infrastructure in recent years as part of a grand plan to invest at least RUB 1 trillion into modernising the country. A slew new spending has been announced in recent weeks that will add to the approximately $100bn a year the Kremlin has already been pumping into infrastructure since the start of 2008 (and will continue to spend until 2015) despite the global crisis. For comparison, the Kremlin spent just $7bn on infrastructure in 1999, according to Goldman Sachs. Russia will have to find RUB9.6 trillion over just the next three years for 48 major infrastructure projects of which RUB2.2 trillion will be borrowed, Deputy Minister Sergei Belyakov was quoted by Vedomosti as saying. Among the projects requiring finance are the

development of the massive Yamal gasfield and associated liquefied natural gas (LNG) plant, a central ring road around Moscow region, and Moscow's airports. "Infrastructure bonds could be transformational for Russia at multiple levels," argues Plamen Monovski, chief

The state has been spending about $30bn a year on upgrading the country's railway system, and more recently moved onto roads with a new road fund. Then at the start of September, Rosmorport, a state-owned company for development of maritime transport, released a new version of development plans through 2030 that sees cargo traffic rising from 540m tonnes in 2011 to nearly 900m tonnes by 2020. Likewise, the state poured $20bn into giving the far eastern capital of Vladivostok in a face lift ahead of this month's Asia-Pacific Economic Cooperation summit, but has already invested three-times that amount into the infrastructure of the surrounding

"Infrastructure bonds could be transformational for Russia at multiple levels" investment officer of Renaissance Asset Managers, which includes Russia's biggest infrastructure fund amongst its products. "At the most basic level Russia needs to fix its infrastructure, which will greatly enhance the growth of the economy and the productivity of the country. This is one of the most desirable kinds of investment the government can do." Monovski says he is also encouraged that the bonds suggest the government sees the need to get foreign investors involved and that while several

Primorye region as part of a plan to attract more foreign investment there. The same story is happening at a regional and city level too. Moscow announced in mid-September it will invest $5bn a year on improving the metro and all 13 of the cities due to host the 2018 World Cup in Russia.

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November, and its newly minted Central Securities Depository should become fully functional at the same time, opening up the Russian bond market to new pools of capital such as international institutional investors, who no longer need to open accounts with local brokers as a result. International investors have been able to buy Russian bonds over-the-counter since February and funds based in London report they have increased their Russian allocations as a result. Analysts at VTB Capital say the share of foreign investors in the Russian bond market could double or treble in just the first few months, owning up to 15% of outstanding sovereign ruble bonds after

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I 25

Renaissance Asset Manager's head of fixed income, Elena Kolchina, is recommending investors switch out of Russia's Eurobonds to ruble bonds on the back of falling inflation and returns on equity of over 20% amongst Russia's best infrastructure companies such as Globaltrans, Brunswick Rail and Etalon. Russia's leading companies have been taking advantage of the growing enthusiasm for ruble-denominated fixed-income with a growing volume of issues. At the same time, Russia's improved macroeconomic position has seen yields on sovereign bonds fall from double digits to around 6% now. The reforms to the capital market due in November could drive yields down

"This is one of the most desirable kinds of investment the government can do" the reforms as traders rebalance their portfolio to reflect Russia's increased weighting in the international indices. An infrastructure bond would also provide a good instrument to build up the domestic institutional investors that Russia's market is currency missing – a major source of the volatility that plagues Russia's capital market. Russian ruble bonds are very attractive in their own right. The Central Bank of Russia changed its priority from exchange rate stability to inflation targeting a few years ago and surprised economists last week by hiking rates to 8.25% after inflation crept above its 6% target to 6.4% on an annualised basis due to rising food prices. Economists in Moscow said the decision had more to do with cementing the CBR's reputation as an inflation-fighter than any economic necessity.

further. And with inflation also expected to fall back to between 4.5% and 5.5% next year, the outlook for Russian ruble bonds is good – always assuming global financial conditions don't suffer another turn for the worse.

Infrastructure Build-up in Russia 8%


Infrastructure investment, bn USD (right axis) Infrastructure investment, % of GDP (left axis)

7% 6%

However, with Russia sporting twodecade lows for inflation, real ruble bonds yields have turned positive for the first time since 1991 (see chart) and are becoming increasingly attractive.

100 80

5% 4%


70 60

3% 40


The bonds also fit in snugly with the state's efforts to develop its capital market. Russia will be hooked up to the Euroclear international settlement system, expected to happen in



1% 0%


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Rosstat, Morgan Stanley Research


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government of Prime Minister Victor Orban. Conspiracy of silence Devecser Mayor Tamas Toldi, a member of the ruling rightist Fidesz party, says he was deeply shocked by the speeches, yet was powerless to stop an event missold to him as a peace march and complains that he had no help from the central government, which often appears to tolerate such views. Orban eventually bowed to public pressure and condemned the anti-Semitic chanting of "dirty Jews" and "Buchenwald" at a Hungary-Israel football match on August 15, while his government is also trying rehabilitate some historical figures with fascist pasts.

Hungary's village of despair Phil Cain in Devecser, Hungary


he Hungarian village of Devecser was in the news again in August when it was invaded by a horde of neo-Nazi thugs baying for the blood of the local Roma, less than two years after being hit by a million cubic metres of caustic red sludge from a local aluminium plant. In its suffering, Devecser is symptomatic of the problems of economic stagnation and rising racism that Hungary is facing. On August 5, around a thousand rightwing extremists were bussed in to the village of 5,000 and whipped up into a murderous frenzy. "You are going to die here, Gypsies! You are going to die here!" they shouted, throwing water bottles and rocks at houses they thought were home to Roma families. Elderly Roma women whose homes they passed say they were "terrified." The marchers had first rallied outside the village church, many wearing combat boots and black shirts and flying the Arpad flag, the symbol of a Greater

Hungary. Non-Roma Hungarians had three options, they were told by Laszlo Toroczkai of the far-right Sixty-four Counties, "to emigrate, to become slaves of the Gypsies, or to fight." "All the trash must be swept out of the country," said Attila Laszlo of the paramilitary group For A Better Future Civil Guard. Later, Zsolt Tyirityan of the Outlaw Army, another paramilitary group, said: "The Gypsy is

said he wanted to see peace, order and safety in Devecser. This, he said, would come when "normal" Hungarians defended themselves against Gypsies. In case of trouble, he urged them to call on paramilitaries to resolve it. "This is the second disaster here and it is the worse of the two," sighs Alfred Kiraly, a Roma member of Better Chances After The Flood, a group set up to deal with the consequences of the caustic deluge of

"You are going to die here, Gypsies! You are going to die here!" genetically-coded for criminality" and that "genetically-encoded waste" must "disappear from public life."

October 2010. You could do something about the flood of mud, he says, but not about the neo-Nazis.

Gabor Ferenczi, an MP for Jobbik, a far-right party which won 16% of the vote at the last general election in 2010,

Indeed, a culture of silence exists in Hungary about the country's racial tensions, aided and abetted by the

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Kristof Szombati of the LMP, a small liberal Green party, says Fidesz's tactics are designed to avoid confronting their right-wing voters whom they worry will defect to Jobbik at the next general election in 2014; many of them are already unhappy at the government's incompetent handling of the economy, which is back in recession. "They do not comment on far-right actions in the national media, but ask the local Fidesz strongman to address the media," he says. By doing so, Fidesz hopes to prevent local crises becoming a national issue, as happened last year when the farright staged an anti-Roma invasion in Gyongyospata. "It also allows them to evade confronting right-wing voters sympathetic to Jobbik whom they hope to keep in their camp," Szombati says. Szombati explains that Devecser was chosen for the march not because of particular tensions between the two communities, but because a new electoral law favours the largest first two parties in each district, meaning Jobbik seats outside its eastern heartland will be vulnerable at the next elections set for 2014. Most of the village's thousand-or-so Roma have lived alongside their Magyar neighbours for generations. They may sometimes have a more bronzed complexion, but they speak the same

IMF chicken

Tim Gosling in Prague Showing his usual level of statesmanship, Hungarian Prime Minister Viktor Orban used his Facebook account in September to reject the conditions demanded by the International Monetary Fund (IMF) for a bailout as a "list of horrors", so restarting the tedious game of chicken between the pair that has being going on for almost a year. The Fidesz government asked back in November for a ¤15bn bailout loan as its economy struggled and its credit rating was cut to junk despite the government's much-heralded "unorthodox" economic measures. However, the loan has been delayed multiple times because of Orban's resistance to adhere to the legal and economic conditions set by the EU and the IMF, which said on September 13 that it has no date set for a return visit to Hungary following the previous talks held in July. Following the publication of a long list of IMF conditions for a loan programme, Orban claimed said in a video published on his Facebook page that Hungary would reject calls for a cut to pensions and a higher retirement age, reduced bureaucracy, a real estate tax, privatisation, lifting the extraordinary bank tax, scrapping the financial transactions tax, and raising the rate of personal income tax. "The list [of conditions] is long, it can be read in the press," Orban said. "The parliamentary group meeting [of the ruling Fidesz party] took the view, and I personally agree with it, that at this price, this will not work." Given the platform used, Orban's response is clearly one of his regular performances designed for a domestic audience, and is unlikely to derail the negotiations with the IMF and EU. The last thing Washington or Brussels needs is another EU member sliding into crisis, while for all its bluster Budapest will need a bailout sooner rather than later, as poor risk appetite is blocking access to international debt markets. Indeed, it was only on September 5 that Orban came out with the comment he still expects to secure a bailout loan this autumn, while chief aid negotiator Mihaly Varga said a week later the government could complete a deal by the end of this year. Ultimately, Neil Shearing at Capital Economics points out, the recent to-and-fro "underlines a point that we've been making since Hungary first announced that it would seek IMF assistance almost a year ago – namely that it is difficult to see both sides finding a mutually agreeable middle ground on the conditions attached to any loan. We suspect that market turbulence may ultimately force Mr Orban to cede ground."


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Hungarian and wear the same clothes as anyone else. Some grumble about noise and littering, but no-one complains of aggression or even minor theft. The biggest frustration everyone faces after the sludge disaster is that moving away is

Soon after, anonymous letters were published on the neo-Nazi web site appealing for help. "Hundreds of Gypsies attacked a handful of Magyars," they claimed. At the same time, the non-Roma family involved

"The mud did not discriminate between different races" nigh-on impossible because house prices collapsed. "The mud did not discriminate between different races," says Kiraly. The pretext for the march was a convoluted conflict between long-time neighbours. In late July, a Roma man honked his car horn in anger at being blocked by the vehicle of a visitor to the Magyar neighbour of his daughter. Two days later, this slanging match escalated into two bloody brawls involving makeshift weapons. Both sides claim they were the innocent victims.

keeps no fewer than nine Rottweilers, a group of which had previously escaped and killed their neighbour's German Shepherd. The family's lawyer talks darkly of a "civil war" if Roma do not conform to the norms of the majority. Mayor Toldi wants to organise forums for each street for people to meet and agree informal rules to iron out problems they have in their neighbourhood. "What should we talk about in these forums?" asks Alfred Király, the issues amounting to nothing

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Central Europe

European football championships. "That says a lot about the strength of the slowdown."

more than a little boy giving a cheeky answer or dropping a sweet wrapper on the street. They might easily be hijacked by Jobbik troublemakers.

Downgrading expectations The finance ministry has also been forced to recalibrate its assumptions for growth. New estimates now predict the Polish economy will grow by only 2.2% next year, down from earlier estimates of 2.9%. As such, Finance Minister Jacek Rostowski has also been forced to abandon his hopes of driving the budget deficit below 3.0% of GDP this year (compared with 5.6% in 2011) admitting that a 3.5% deficit is likelier; the government is again worried about public debt starting to rise beyond the legal threshold of 55% of GDP.

Jobbik is bolder than ever in fanning the flames of petty local disputes so it can cling on to its vulnerable foothold in the centre and west of the country. The party already suffered a serious blow in late July when one its leading lights, MEP Csanad Szegedi, was forced to resign after it was revealed he is Jewish. The Fidesz government, meanwhile, hopes to save itself from the flames by leaving the issue to its local representative, avoiding the need to draw a clear line between its right flank and Jobbik and its cohorts. But without clarity on where the farright really starts and the availability of the force necessary to prevent its most dangerous expression, Jobbik has little to stop it moving in and polarising once peaceful villages.

A glummer but still glimmering Poland Jan Cienski in Warsaw

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I 29


he annual economic summit in the Polish mountain resort town of Krynica held every September is usually an occasion for a lot of breastbeating as CEOs and economists boast about how well their companies and the country is doing. But this year the atmosphere was a lot glummer – one of a host of signs the Polish economy is slowing unexpectedly sharply as the sputtering Eurozone slows demand for Polish exports, while Polish consumers become more reluctant to spend out of fear of growing unemployment. "I'm going to have to start thinking of layoffs because the orders just aren't coming in," complained one executive to another over drinks at one of the boozy receptions that are a feature of the economic summit. While Poland has tended to outperform expectations in recent years – it was the only EU country to avoid recession in 2009 and has been one of the bloc's fastest growing economies since then – the latest data releases confirm that the

situation is getting worse. "We are working on the assumption that the next year will be more difficult," says Cezary Stypulkowski, CEO of Poland's Bre Bank, a unit of Germany's Commerzbank. Second-quarter GDP expanded at an annual rates of 2.4%, a sharp slowdown from the 3.5% in the first quarter and much worse than most economists were expecting. "Instead of a steady

At a news conference held to announce the bad news, Rostowski noted that the situation was similar to 2008-09, when Poland was buffeted by the storm coming from the implosion of the US economy, while now the challenge was coming from the crisis-ridden Eurozone. The prospect of a sharper-than-expected slowdown has sent Polish policymakers rushing to stimulate growth, partly backing away from their recent budget orthodoxy. The central bank, the only one in the EU to hike rates earlier this year on the back of what then seemed to be strong growth numbers and persistently high inflation, has markedly softened its tone. "Should the incoming data confirm further weakening of economic conditions, and should the risk of increase in inflationary pressure

"I'm going to have to start thinking of layoffs because the orders just aren't coming in" weakening of economic growth, we're seeing a no-holds barred fall," says Malgorzata Starczewska-Krzysztoszek, chief economist for Lewiatan, the Polish employers confederation, noting that the lacklustre growth came at a time when Poland was racing to finish large infrastructure projects ahead of June's

be limited, the Council will consider adjustment of monetary policy," said a statement from the central bank's interest rate setting Monetary Policy Council. Most economists expect the bank to start dropping rates from the current benchmark of 4.75% in the near future.


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Building a survival plan

bne Offering further support to the country's troubled construction group, the Polish government stepped in on September 21 to push through a stalled PLN6.3bn (¤1.52) contract for Polimex to build a giant coal-fired power plant for state-controlled utility Enea. This is the latest move by the government to shore up Polimex, and a further sign of the Polish government's determination to bail out its teetering construction industry, which is putting the wider economy – and especially the banks – at risk. The banks are reported to have loaned as much as PLN60bn to the sector, while investment funds are also facing huge losses on construction sector bonds. On September 19, state development agency ARP agreed to take a stake of up to 33% in Polimex, offering the company a likely boost of PLN150m250m. The company's creditors have already agreed to waive interest payments for four months to give it time to restructure its PLN2.5bn of debt. The company still needs to reach a wider agreement with its creditors that will likely include a debt-for-equity swap. Enea's contract for Polimex and Hitachi to build the 1,075-megawatt unit at the Kozienice power plant had been put at risk by the builder's creditors – led by the country's two biggest banks PKO and Pekao – which had held up bank guarantees. "No reaction to the unstable situation would mean a reduction in jobs, weakening of the country's energy security and, in the longer perspective, of the entire economy," Treasury Ministry Mikolaj Budzanowski said in a statement. The construction sector is reported to represent 7% of GDP, and employs around 700,000. The country's banks are heavily exposed to builders such as Polimex and PBG, which are struggling to survive after taking on state contracts on razor thin margins in the infrastructure push ahead of the Euro 2012 football championships, which Poland co-hosted with Ukraine in June. At the same time, the builders have a central role in the government's ambition to gain greater energy independence from Russia. Following the huge problems created by the Euro 2012 road and stadium building frenzy, Polish builders have set their sights on the government's ambitious plans to expand the country's power and shale gas capacities in a bid to raise energy independence to make up the shortfall in work. Warsaw is also concerned that those ambitions would suffer should it allow the country's major contractors to go to the wall. The case for government action was helped by horrendous first-half financial results announced by construction firms in early September. Polimex revealed a net loss of PLN370m, compared with net profit of PLN26m a year previously, while PBG – which entered bankruptcy protection in June – reported a loss of PLN1.7bn.

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The Polish Financial Supervision Authority also said it is prepared to revamp its regulations limiting easy access to credit for borrowers, another way of getting people to start spending again. "I'm happy that Polish regulators have taken another look and may loosen their policy," says Krzysztof Kalicki, head of Deutsche Bank's Polish operations.

steep fall in sales in Italy, its primary market, where new car sales fell by 20%. By contrast, the German market, where Volkswagen is dominant, shrank by only 0.6% over from January to August. Opel, still burdened by problems resulting from its near bankruptcy during the first wave of the economic crisis in 2008, saw sales fall by 15% in the first eight months of the year.

One of the biggest surprises is that markets barely reacted to the new and looser policy – a sign that the main preoccupation in Europe has swiftly shifted from fiscal austerity to ensuring that growth does not fall off a cliff and trap countries in a downward spiral of falling revenues, higher taxes and slower growth, something already seen in Greece and Spain and, to some extent, in the Czech Republic. Although the business atmosphere is fairly grim, Poland's plight still looks a lot better than almost everywhere else in the EU. Even with the finance ministry's recalculated estimates, Poland will be one the bloc's fastest growing economies both this year and in 2014. Just after the downbeat budget announcement in early September, Poland managed to place a $2bn dollar-denominated bond issue that was four times oversubscribed at a record low yield of 3.175%. Peter Attard Montalto, an economist with Nomura, the investment bank, finds that Poland is actually running what he calls a "Goldilocks economy", one that is neither too hot nor too cold, sustaining moderate growth and low inflation that allows a market-friendly monetary policy. "In a world of dying inflation targeting and much slower growth, Poland is as close as you can get to a stable goldilocks economy, in our view – downside risks are certainly present but contained and it is very difficult still to see how they could lead to a recession," he says. In the end, the Krynica forum businessmen may have been a bit down, but they were complaining at a flashy party funded by some of the country's largest companies, with alcohol flowing liberally and some of the country's top music acts hired to perform – not bad for a downturn.

I 31

Idling As demand for their production falls, the Opel and Fiat factories are planning worker furloughs. Opel estimates that its production this year will come to fewer than 140,000 cars, far below the 174,000 that rolled off the factory floor last year.

Less driven in Poland Jan Cienski in Warsaw


ne of the most visible signs of Poland's economic slowdown comes from two enormous factories in the south of the country – the Fiat plant in Tychy and an Opel factory in nearby Gliwice – where production is falling steeply due to a slump in demand from Western Europe. In the first eight months of this year, Poland produced 445,700 cars, a 22% fall from the same period last year and much of the blame rests with those Fiat and Opel factories. The country's third large car factory, a Volkswagen plant near Poznan in the centre of Poland, has production at almost the same level as last year, about 85,000 cars in the first half of the year. The reason for the slump is in large measure due to the reputational and market problems for Fiat and Opel, compared to Volkswagen, Europe's largest car maker which is doing better than most other European carmakers

despite the crisis, says Wojciech Drzewiecki, head of Samar, a Polish car industry research firm. Volkswagen, helped by its Skoda brand produced in the neighbouring Czech Republic and its recent acquisition of Porsche, managed to stay essentially flat in European sales for the first eight months of this year, according to new figures from the European Automobile Manufacturers Association – this at a time when the overall European market declined 7.1%. However, Fiat saw its European sales tumble by 17%, due in large part to the

Fiat is not releasing any production estimates for 2012 as spokesman Boguslaw Cieslar says that the turbulence in the rest of Europe makes it impossible to predict. Production at the factory was already down last year, when 468,000 cars were made, and this year is almost certain to be worse. Drzewiecki says that the "steepness of the fall in production is a surprise" adding that it does not bode well for the rest of the year. A further problem is that the carmakers based in Poland have almost no domestic sales to fall back on to buffer the fall in demand in Western Europe, as about 98% of production from the three factories is exported. Although Poland, with 38m people, is the sixth largest nation in the EU, the demand for new cars is negligible. In the first eight months of this year, only 188,000 new cars were registered, about the same level as Sweden, which has fewer than 10m people. "The fall in sales can be seen with the naked eye," writes Michal Hadys, an analyst at Samar. "The market

"The steepness of the fall in production is a surprise – it does not bode well for the rest of the year"


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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.

bne October 2012

is falling and dealers are wringing their hands as they look to the future." The reason is that Poles are among the keenest buyers of used cars in the EU thanks to relatively lax safety regulations that makes it easy to import beaters difficult to sell in richer countries. In the first six months of this year, Poland imported 323,000 used cars, significantly more than new car sales over the same period. Drzewiecki feels that the situation won't change until Poland brings in tougher regulations, although that is likely to prove politically very difficult in a country where many people are still too poor to be able to afford a new car. However, without changes that would significantly increase domestic demand, Poland's car factories are stuck with export sales.

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It is also bad luck that two of the largest auto investors in Poland are those with deep problems.

of front-loaded austerity programmes instead of gentler alternatives such as fiscal stimulus or quantitative easing.

In contrast, the Czech Republic and Slovakia are seeing steep rises in car production because Volkswagen (or its Skoda subsidiary) plays a much more important role in production there. Those two countries also benefit from having factories by Korea's Hyundai (which saw European sales rise by 10% from January to August) and Kia (whose sales soared by 23% over the same period). "Fiat and Opel are in trouble, which is what is hurting Poland's manufacturing numbers," says Drzewiecki. "The Czechs and Slovaks have been luckier in their manufacturers."

Certainly, any failure on Latvia's part to meet all the Maastricht criteria won't be for want of trying – in July a percentage point was even lopped off Latvian VAT, which fell from 22% to 21% as the Finance Ministry tries every trick in the book to satisfy the criteria with room to spare.

Latvia's fanfare for the common currency Mike Collier in Riga


nyone who wants to take a trip down memory lane and listen to the sort of giddy pro-euro rhetoric last heard in the run-up to the launch of the single currency should book a trip to Riga – preferably before the end of the year, to be on the safe side.

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.

"The fall in sales can be seen with the naked eye"

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

bne October 2012

While the euro may be unloved by many of the people using it at the moment, euro-enthusiasm remains undimmed in the Baltic states – in official circles, at least. The opening session of a Nato conference held in Riga on September 14-15 was a virtual fanfare for the euro, with leaders from Latvia, Lithuania and Estonia all predicting a great future for the coinage, Greece notwithstanding. "We don't really have a euro crisis... what we have is a debt crisis and an economic crisis in certain European countries," said Latvian Prime Minister Valdis Dombrovskis in what appeared suspiciously like an attempt at a soundbite. The exchange rate of the euro as a currency has remained relatively stable throughout the crisis period, Dombrovskis pointed out, claiming that

the main problem of Europe was that it was not compulsory to follow Eurozone rules. The euro, he said, is currently "at a turning point" with things set to improve after a "bumpy six months" while the Greek crisis is handled. His grand plan is to meet all the Maastricht criteria governing euro adoption by the end of this year in

But even if Latvia meets all the criteria so routinely flouted by most existing members of the Eurozone, there is still no guarantee it will be accepted into the club, as the European Commission and European Central Bank must both give their assent. The fact that neighbouring Estonia was admitted to the zone in 2011 under similar circumstances would make any refusal highly controversial, but an argument that Latvia's see-saw economy needs to prove its sustainability for a bit longer could easily be forthcoming from either if, as seems likely, the euro crisis will still be dragging on at year's end. Yet the possibility of being kept in the Eurozone waiting room is not one that Dombrovskis is even willing to consider. At a special briefing on the second day of the Nato conference, bne asked which countries had already said they would definitely back Latvia's candidacy and how he would react to a "non" from Brussels. The first part

"We don't really have a euro crisis – what we have is a debt crisis and an economic crisis in certain European countries" order to qualify for swapping the lat for the euro in January 2014. If he succeeds, it would put the cherry on top of the cake for Latvia's dramatic turnaround from economic basket case in 2008 – when it was forced into a €7.5bn euro bailout from the International Monetary Fund (IMF) and EU – to the pin-up of proponents

of the question was neatly ignored, while the second gained an admission that there is no plan B. "There should be no artificial obstacles. After all, it's the Commission itself which signed the memorandums of understanding during Latvia's bailout programme which forsees euro adoption on January 1, 2014, so in a sense the


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Commission has already signed up to this," Dombrovskis replied. Central support If anything, euro-enthusiasm is even stronger at the Latvian central bank than it is in government. On

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we get mostly negative news from Europe. Many people don't follow it that closely and don't understand all the issues but they see that something negative is coming from Europe and that affects their attitude towards the euro as well," he said.

"The euro is at a turning point, with things set to improve after a bumpy six months" September 5, the Bank of Latvia hosted a discussion of the subject that emphasised the expected benefits of Eurozone accession with little time given over to possible risks. According to the bank's predictions, euro adoption as planned would boost real GDP by 7.4%, investment by 15.9%, exports by 5% and would lower longterm interest rates by 0.5 percentage points (all by 2020). "We are now placed quite comfortably in terms of meeting the Maastricht criteria," Uldis Rutkaste, the bank's head of monetary policy, told bne on the sidelines of the event. But Rutkaste admitted public opinion remains equivocal at best. "Every day,

An August survey of more than 1,000 Latvians by the Latvijas Fakti pollster showed that just 35% supported euro adoption with 59% declaring themselves against and 6% undecided. A September poll was even more damning, estimating that just 14% of Latvia's 2m population was europhile. However, most analysts agree that what looks like a high degree of euroscepticism may not be as strong as it first seems. According to Ivars Ijabs, a political expert at the University of Latvia, the question of euro adoption in Latvia is not one that gets people particularly excited. "According to opinion polls, we

Blowout threatens Lithuania LNG terminal Jacy Meyer in Prague


s the developers of Lithuania's liquefied natural gas (LNG) terminal discussed possible supply deals in the US last week, the Baltic country's biggest gas users revealed they are considering mounting a legal challenge against the project. Lithuanian Minister of Energy Arvydas Sekmokas said he expects to have

agreements to supply the terminal with LNG in place before the end of this year, and confirmed that Rokas Masiulis, chief executive of project developer Klaipeda Nafta, met with US LNG major Cheniere on September 10 as part of supply negotiations. Masiulis has also met executives from other potential LNG suppliers, including Spain's Fenosa, BP, Shell and Norway's Statoil. "Our goal is

are rather euro-sceptic, but there has been no call for a referendum [on euro adoption] and even if there was, there would be a large campaign stressing security issues. Most probably, Latvia will enter the Eurozone as it entered the EU – without much debate, as it is more or less self-evident that Latvia has to be there," Ijabs says. Similar pragmatism comes from the business sector. Dainis Senbergs of the Valmieras Stikls fibreglass manufacturer, a major employer, says joining the Eurozone will place exporting companies such as his in a more efficient environment. "It will be easier to manage risks and will help in negotiations with other countries such as India and America who understand the euro, instead of having to explain about the lat," he says. "The euro question is really not so critical to ordinary people," Senbergs argues. "They don't like the idea of having to bail out people who are richer than them, and that will have to be answered, but it basically comes down to which side of the world we want to orientate ourselves – is it Europe or some other part?"

to sign gas supply contracts in the near future. That would be very important for the further implementation of the entire project, because supply contracts always go hand-in-hand with construction," Sekmokas said. But even as Sekmokas highlighted the rapid development of the terminal ahead of his country's October 14 general election, large industrial gas consumers were telling bne they are considering mounting a legal challenge against the project. The main issue for them is the Law on the LNG Terminal, passed by the country's parliament on June 12, that sets out the legal and financial basis for the LNG terminal, and requires large gas consum-

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ers to purchase a minimum of 25% of their supplies from the terminal. According to Joachim Hockertz, deputy CEO of Lietuvos Dujos, the country's main gas distributor, the law is merely designed to rescue the economics of the LNG project. "The law heavily distorts the gas market and could serve as a deterrent to competing gas infrastructure projects, like the GIPL (Gas interconnection PolandLithuania) project," he says. Hockertz claims that if the full costs of the LNG project are passed on to gas consumers, gas transmission tariffs could treble from current levels. "Klaipeda Nafta's business plan foresees that a major part of the LNG terminal costs will be socialized, by burdening all transmission system users," he says. One of the reasons that the costs of the LNG project are so high is the Lithuanian government moved ahead with plans to develop the terminal without garnering assistance from its Baltic neighbours, Estonia and Latvia. Another reason is Klaipeda Nafta's deal in March with Norway's Hoegh LNG to supply a floating LNG re-gasification unit to the project, he says. "The deal with Hoegh is paying LTL1.8bn (€521m) over 10 years, and that is just for rent, we don't end up owning the unit after that time. It was a very expensive deal for Lithuania... I understand they overpaid," he says. Petitioning the EU Lithuania's biggest consumers of gas, led by fertilizer producer Achema and the Lithuanian District Heating Association (LDHA), confirm that they have petitioned EU Energy Commissioner Gunther Oettinger, who arrived in Vilnius on September 14 for discussions with the government. According to Vytautas Stasiunas, president of the LDHA, a body representing 31 heating and power producers across the Baltic nation, the LNG law "distorts the market" and contravenes basic European laws on competition. In a letter to Brussels addressed to Oettinger and to Joaquin Almunia, the commissioner for competition, Stasiunas said the law also enables the government to "cross-subsidize" the activities of the

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CEZ divestment plan said to fall short

bne Following Brussels' invitation to third parties to submit their views on CEZ's plan to see off a competition investigation by divesting up to five Czech power plants, Prague-based advisory firm Candole Partners argues that "none of the divestments proposed reduce market concentration to an acceptable level; CEZ remains the pivotal generator in all scenarios." In a report published on August 29 and sent to the European Commission's competition authorities, Candole (which counts amongst its clients competitors to CEZ) starts by offering calculations it claims show the state-controlled utility's share of the Czech power market is "significantly above the threshold considered to be indicative of high concentration," with the company accounting for 63% of installed capacity or 78% of yearly generation. The report insists that none of the five plants that CEZ has suggested it could offload would reduce market concentration to levels acceptable under EU regulations, and that the utility will remain "the pivotal generator" in all scenarios presented by the company. Further, Candole claims that the figures in its analysis of CEZ's proposed divestment produces are on the optimistic side, as the calculations assume a new entrant purchasing the power plants for sale. "If one of the other incumbents, such as Energeticky a Prumyslovy Holding (EPH), Sokolovska uhelna, Alpiq or Dalkia were to purchase the power plants, the reduction in market concentration would be even lower." In addition, the analysts stress that the five plants actually produce far less power than their capacity suggests due to their age, costs and difficulties of fuel supply at several of them. Jan Oldrich, one of the authors of the report, told bne in July that the plants "belong in a museum." In fact, as the report flags up, CEZ has been planning to sell off the assets for some time anyway, facing as it does long-running disputes with their respective fuel suppliers. "In conclusion," write the analysts, "the plants can be divided into two categories: those which CEZ wants to sell because of lignite supply disputes: Pocerady, Melnik III, Tisová 1 & 2; and those which CEZ wants to sell because of their bad economics: Chvaletice, Detmarovice." The report points out that Pocerady is by far the largest, most productive and least costly of the five plants, and would have the greatest effect on CEZ's market share if sold. On September 4, mining group Czech Coal was reported by local media as having offered CZK14bn-16bn (€560m-plus) to buy the Pocerady power plant and CZK10bn for its Chvaletice plant. EPH, which has sometimes in the past appeared to be a subsidiary of CEZ, is also known to be interested in the plants. CEZ said it expects bids in September and October and would decide by year-end which plants and to whom to sell them to.


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terminal by passing on its costs to all Lithuanian gas consumers in the form of higher transmission tariffs. "The association expresses concern... on the distortion of competition, the equality of market participants, and the freedom to choose a supplier that this LNG Law

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monopoly supplier of gas in Lithuania," he told bne on the sidelines of the LATO conference in Riga on September 14. Storing up problems Lietuvos Dujos' Hockertz says the development of and access to gas

"We are exploring the legal options, we have held discussions with the government and European Commission about this very unfair law" raises," he wrote in the letter in August. The result, he said, would be significantly higher gas prices for the Lithuanian population.

transmission and storage infrastructure is also shaping up to be another stumbling block for the Klaipeda LNG project.

Lithuanian fertilizer group Achema, whose gas purchases account for around half of total gas consumption in the country, confirmed last week it had also petitioned the European Commission over the law. "We are exploring the legal options, we have held discussions with the government and we have contacted the European Commission about this very unfair law," said Valdemaras Vareika, general director of Achema.

He confirms that construction has started on a 138-kilometre pipeline with a diameter of 400 millimetres (mm) from Jurbarkas to Klaipeda, at an estimated cost of €50m. This new line, which will be operational in 2013, alongside an existing pipeline, would be used to transport gas from the LNG terminal into the Lithuanian transmission system. But he said the problem is if the government decides to build the largest of the various options on the LNG terminal a 4bn cubic metres a year (cm/y) facility, then this pipeline

He said he had projected that earnings at the fertilizer plant could collapse after 2016, if it is required to pay for a large share of the LNG's construction and operating costs through higher gas transmission tariffs. "This law is a very big problem. In the worse-case scenario, I estimated the additional costs could be over LTL100m," he said on September 14. "If they [the European Commission] do not do something about this, then we will consider action ourselves." In response to the criticism, Lithuanian Prime Minister Andrius Kubilius has defended his government's stance on the LNG law, saying the mandatory 25% purchase rule would make the project commercially stronger and provide a bulwark against Russian gas market dominance. "The reason for this mandatory purchase is to ensure the energy security of Lithuania. If there is no LNG terminal, we have only one

storage capacity of 170,000 cm, which will not be sufficient if a large-capacity LNG terminal is built, Hockertz says. A deal must be struck with the Latvians to make use of the 2.3bn cm-capacity Incukalns storage facility, he says. "I have asked Klaipeda Nafta, what they intend to do about storage, and they answer that they'll send the gas to Latvia. Then I ask them if they have spoken to the Latvians about this yet – and they don't have answers," Hockertz says. Latvia, which is still smarting from Lithuania's decision to bypass efforts to build a regional LNG terminal, is unlikely to greet any such request warmly. In a strongly worded letter sent in the summer to the Lithuanian government, and copied to the European Commission, Latvia's Minister of Economics, Daniels Pavluts, criticized Lithuania's "unilateral" approach to the LNG terminal. He also requested the Lithuanian government explain how the 25% mandatory purchase rule included in the LNG law "could not... be considered a severe market distortion." Daiga Grube, spokeswoman for Pavluts, tells bne that no reply had been received yet from the Lithuanian side. But the 25% mandatory purchase rule could only negatively influence other gas infrastructure projects in the Baltic region, she says, such as

"The law heavily distorts the gas market and could serve as a deterrent to competing gas infrastructure projects"

would be insufficient in terms of transmission capacity. "If they go with a 4bn cm/y terminal, then we need a 700-mm pipe, which costs €10m more, but it is already too late – we have bought the [400-mm] pipes already and we can't send them back," he says. Another problem is storage capacity. According to Klaipeda Nafta's published business plan, the terminal will include

Poland's plan to build an LNG terminal at Swinoujscie, or other projects, such as the GIPL consortium. "Restricting Lithuania's 25% market share for other suppliers raises concerns about the overall market liquidity and viability of large infrastructure objects," she says in an email.

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Romania on collision course with EU Nicholas Watson in Prague


omania, a chief member of the EU's awkward squad, appears on another collision course with Brussels as it approved a plan September 27 to buy F-16 fighter jets in a direct deal rather than hold an open tender for the procurement, something the EU has specifically warned against. The European Commission has confirmed to bne that it sent letters to the governments of Romania, Bulgaria and the Czech Republic to highlight EU laws concerning procurement, after it became concerned about possible moves by those member states to conclude major defence deals to buy supersonic fighter jets without holding an open tender. All three countries are looking to buy fighter jets, part of a wider procurement programme in Emerging Europe over the

next decade that the defence industry estimates could generate sales of over 200 jets. With the economic downturn squeezing defence budgets across the world, these tenders are regarded as crucial for an industry suffering from cost cutting and job losses, hence the fierce competition amongst manufacturers such as the US' Lockheed Martin, the Eurofighter consortium (made up of EADS Deutschland, Spain's EADS Casa, BAE Systems and Italy's Alenia Aeronautica), Sweden's Saab and France's Dassault, among others.

EU Commissioner for Internal Market and Services Michel Barnier, who oversees public procurement in the 27-member bloc, wrote the letter, dated May 15, 2012, to the defence ministers of Bulgaria, Romania, Slovakia and the Czech Republic to remind them about EU directives concerning tenders for public procurement and the need for transparency in such procurement. "The decision to acquire combat aircraft is a sovereign decision of your country. However, since combat aircraft are military equipment in the meaning

"We would hope that all the competitors be invited to provide an offer, to be considered seriously"


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of Directive 2009/81/EC, Member States have to abide to the rules of this Directive when they purchase such aircraft," Barnier wrote in the letter, a copy of which has been obtained by bne. "This means in particular that they have to publish a contract notice in the Official Journal of the European Union and open the procurement procedure must be open to all potential suppliers in the EU." In confirming the existence of the letter, Stefaan de Tynck, spokesperson for Barnier's office, tells bne that while such government-to-government contracts (G2G) are excluded from the EU directive that covers defence and

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was quoted as saying. "We start paying for them next year and until 2016 when we get them." The decision is a clear snub to the EU by Romania, which has just emerged from a different battle with Brussels over its attempted (but failed) impeachment of President Traian Basescu. EU Commission President Jose Manuel Barroso said those events in Romanian politics had "shaken our trust" in the country's democratic values. Inevitably, Lockheed Martin's European competitors are not happy. Richard Smith, Saab's Gripen director for Europe, which as the maker of the

"The procurement procedure must be open to all potential suppliers in the EU"

security contracts, "there is a general statement in the Directive that no exclusion (including G2G) should be used for the purpose of circumventing the provisions of the Directive... [and] used as a means to avoid EU-wide competition and in particular discriminate against potential EU suppliers." "The letter was sent to clarify obligations under EU law," he adds. Romania's lack of reply De Tynck says the Commission has received replies from Bulgaria and the Czech Republic that he described as positive, though pointedly omitted to mention Romania. Romania's silence was explained on September 27 when Defence Minister Corneliu Dobritoiu told the news site that the Romania's Supreme Defence Council (CSAT, in Romanian initials) had approved a plan to buy up to 12 secondhand F-16s made by Lockheed Martin between now and 2016 from Portugal in a deal he had said could be worth up to $600m. "We have found money in the budget to acquire these F-16 jets," he

Gripen fighter jet expects to be part of any tender held in Romania told bne: "We have no doubt that we are able to offer a New Generation Gripen fighter through innovative procurement methods that would undoubtedly be more cost effective in terms of procurement and also the costs of operation, when compared to second hand fighters. We would hope that in order to ensure the best product, the best total package and the best industrial package, that all the competitors be invited to provide an offer, to be considered seriously." Worryingly, this is the second time in two years that Romania has tried to shoehorn a deal through for the American jets. In March 2010, the Romanian president's office announced that after a meeting of the Supreme Defence Council – an unelected advisory board that has no executive powers but is very influential by dint of its appointment by the country's president – it had been decided to send a proposal to acquire 24 used F-16 fighters from the US Air Force to parliament for a vote. President

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The coalition government, led by the Progressive and Socialist parties, has already taken some steps toward this since it came to power in late July.

Basescu in subsequent interviews said it was purely an economic decision, yet that didn't stand up to much scrutiny once Saab had released its proposal showing it would offer the same number of planes, 24 new Gripen C/D multirole jets, for the same price of around €1bn. Furthermore, Saab also offered a number of sweeteners, such as offsetting (a kind of industrial compensation that the US has said it won't provide) 100% of the value of the contract with Romanian companies. That was enough to convince the Romanian parliament and the media, and the president's plan was shelved. There are also worries about Bulgaria's commitment to an open tender. In October 2011, Bulgaria's Defence Ministry announced it would not, as had been expected, launch a tender for the purchase of fighter jets for the Bulgarian Air Force in 2012, to be completed by 2015. Bulgarian Prime Minister Boyko Borisov the following month reiterated to his Swedish counterpart Fredrick Reinfeldt at a press conference that this was because of budgetary issues, though there are suspicions, through the release of diplomatic cables by Wikileaks and other reports, that Sofia is looking to buy used F-16s, including perhaps some of those belonging to Portugal. A spokesman for Eurofighter, which is targeting Bulgaria as a potential market, said of Commissioner Barnier's letter: "Eurofighter welcomes initiatives which support an open, fair and transparent competition."

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Serbia's energy problems point to winter of discontent Nicholas Watson in Belgrade


erbia in September signed a multi-billion-euro energy deal with Germany's RWE, part of the new government's drive to kick start investment in the sector and head off a looming energy crisis. However, a drought-stricken summer that cut electricity production by about a third means it has the more immediate problem of dealing with a severe energy shortfall this coming winter. On September 10, the new head of stateowned Elektroprivreda Srbije (EPS), Aleksandar Obradovic, accompanied by Deputy Premier Aleksandar Vucic and Minister of Energy Zorana Mihajlovic, travelled to Berlin to sign a memorandum of understanding and strategic partnership with RWE, the projects for which could add as much as 3,000 megawatts (MW) of hydroelectric power capacity in the Balkan country and, the government hopes, "ensure stable and continued growth of the energy sector in Serbia." RWE's total investment through the joint venture with EPS could amount to €2.2bn, which will include €1.2bn to add a third unit to the 1.240-MW lignite-fired Termoelektrana Nikola Tesla B plant, and about €1bn in hydropower plants on

the rivers Drina and Danube, including the construction of the Djerdap 3 hydro plant on the Danube River. Mihajlovic tells bne such deals are crucial for Serbia because for 27 years the country hasn't built any significant new energy infrastructure to add to the 8,359 MW of installed capacity, most of it ageing communist-era coal-fired plants, even though consumption of electricity has risen by an average 2-3% per year. "This is a problem for us, because we now have a deficit of electricity of about 25-30%, so we are in an energy crisis I think," says Mihajlovic. "By building Tesla B and other smaller hydropower plants on the river Drina we could solve our problems in five to eight years." A river runs through it The RWE deal is an acknowledgement of the huge, untapped potential that the country's renewable energy sector has. Rene Jensen, an independent expert on Balkan affairs, has told bne that its potential is around 4.3m tonnes of oil equivalent a year, of which more than half is biomass from agriculture and forestry, while hydroelectric, wind and photovoltaic all have good potential, at least theoretically.

In moves it hopes will stimulate the country's renewable energy sector, the government has said it intends to bring in public tenders for renewable energy permits, while also establishing rules on a time limit within which the investor will have to finish the project, or at least build it to a certain level. If the investor fails to do so, the permit will be revoked. "This way we shall make sure that we do not have the same persons extending the permit every two years, or investors who after eight years still have not finished the power plants they began constructing," Mihajlovic says. The government also wants to cut red tape, which it believes is fostering corruption and stifling investment. Today, to build a small hydropower plant an investor must get 27 permits from a variety of ministries. "This is a problem because it opens the way for corruption and an investor hasn't two or three years to get all of these permits. From 27 permits, I think we should bring it down to three or four and the investor will get all of them from the energy ministry," Mihajlovic says. "There have been a lot of investors who came to Serbia over the years, but the result is we don’t have any big investment in the energy sector, so something is wrong – I think what's wrong is corruption," she says. Elephant in the room Crucial to turning around Serbia's energy sector will be the restructuring of the lumbering, loss-making EPS – the vertically integrated state utility that in 2010 generated 35,855 gigawatt hours (GWh) of electricity and produced 37m tonnes of lignite. The new general manager, Aleksandar Obradovic, has been tasked by the government with preparing the company for the liberalised energy market along EU lines that Serbia will develop over the next few years. A key part of this will be the "unbundling" of


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Belgrade's tricky balancing act

bne At the same time as an assortment of high-profile Serbian government officials were in Berlin trying to add to the already $1.2bn Serbia has received from Germany since 2000, the country's president was in Moscow cosying up to the country's favourite Slavic brothers, the Russians. In a financial fix, Serbia is clearly trying to pull off the difficult trick of playing the West off against Russia, though both appear to be playing hardball with Belgrade at the moment. From the Russian side, the confusion over whether it will help tide Serbia over for the year with a $1bn loan exemplifies this. Numerous officials on both sides have given conflicting statements; the latest from Serbian newspaper Politika is that sources have said that Russia will approve a $1bn loan to support Serbia's budget in a deal agreed at the September 11 meeting in Sochi between President Tomislav Nikolic and President Vladimir Putin. Instead of the previously agreed $800m that was supposed to be used for infrastructure projects, the paper says, the entire $1bn will be redirected into the state treasury. The first instalment of $300m will be approved this year and the second instalment of $700m will be approved next year. Russia is also a crucial energy partner for Serbia. Gazprom Neft is majority owner of the former state oil and gas firm Naftna Industrija Srbije (Nis), and the Russian state-controlled gas giant has also agreed to run its planned South Stream gas pipeline through Serbia. Nikolic said construction would begin in early December on the Serb section of the pipeline, which will transport up to 63bn cubic metres of Russian gas a year under the Black Sea to Bulgaria and then on to Greece, Italy and Austria, and he has invited Putin to attend the launch. "The only thing I love more than Russia is Serbia," the Serbian president was quoted by broadcaster B92 as saying at the summit. Still, South Stream highlights much that's wrong with the Serb-Russian relationship too. The Serbs, particularly the current nationalist lot in power at the moment, are happy to play up their close Slav-Orthodox ties, but constantly harbour doubts about Russian follow-through. "We want to have South Stream, but when will it really start? President Putin said South Stream would start 2009, but today it is 2012 and still we don’t have a beginning," a clearly exasperated Minister of Energy Zorana Mihajlovic tells bne. Likewise, the Serbs always welcome Russian support on the question of the legality of its erstwhile province Kosovo's unilateral declaration of independence, yet moan about Russia's recognition of the breakaway Georgian region of South Ossetia, which implies that Russian support is not based on a principle, rather it's a convenient way to needle the West. Brussels, meanwhile, appears to be making a normalisation of relations with Kosovo a make-or-break issue for Serbia's EU accession hopes. On September 13, a bigwig of Germany's ruling party, the Christian Democratic Union (CDU), revealed a list of seven conditions that Serbia must meet in order for accession talks to begin, including several regarding Kosovo.

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Delegation of the European Union to the Republic of Serbia tells bne, "we have no views of our own on these cases. The list was drawn up by the Anti-Corruption Council which has raised a number of suspicions on 24 privatisation cases and we have asked the authorities to inform us regarding the follow-up undertaken by law enforcement agencies."

EPS, splitting off the distribution from the generating bits of the business. The first step is stabilising the financial situation of the company, which was loss-making in the four years to 2010 (the 2011 figures appear to show a profit though have not been analysed sufficiently by the company for public release). "We have to make sure our liquidity and financial stability is there, so I'm now working on renegotiating some financial packages," says Obradovic. This is particularly crucial in regards to this upcoming winter when demand traditionally surges, because the terrible drought suffered this summer reduced production of hydropower, which accounts for about a third of EPS' production, by around 30%. "All missing electricity we need to import, but if we're not financial stable, then we could have a problem" says Obradovic. "I'm confident in our technical ability to handle this winter, but I want to be sure we are financially stable to cover all the needs that may arise from importing electricity." This view is backed by Mihajlovic. "Our biggest problem is to get through this winter and how to have enough energy, electricity and gas, for households and industry in November, December and January – it is the biggest problem right now," she says. Returning the utility to profitability, which will also involve rooting out corruption (several EPS officials were arrested last year in connection with the misuse of funds in procurement) and raising electricity prices for households and industry to nearer market prices, will allow the state to eventually privatise the country's biggest employer. "We don’t want to privatise EPS yet – we need to make EPS like a modern European company first," says Mihajlovic. That will take time, as Obradovic sums up. "I took this responsibility at a very difficult time. We have a lot of shortterm, medium-term and long-term issues that I have to work on resolving at the same time."

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New Serbian government, new anti-corruption drive Ian Bancroft in Belgrade


ith a new government now firmly in place, Serbia has embarked upon its latest anti-corruption drive, with some 24 privatisations to be investigated – over a year on from the original EU demand that was largely ignored by the previous administration of Boris Tadic. The list of those under suspicion includes prominent companies such as Mobtel, Jugoremedija, C-Market, Sinvoz, Novosti and the Port of Belgrade, involving some of the country's most renowned businessmen, such as Milan Beko and Miroslav Miskovic. Politics, however, is certain to play a key role in determining which investigations are pursued in earnest. The first main investigation is likely to centre upon the privatisation of the Smederevo-based steel plant, Sartid and its subsidiaries – which was originally sold to US Steel Kosice, a part of US Steel group, back in 2003 for some $33m, before being re-purchased

by the Serbian government this February for the nominal sum of $1. The Anti-Corruption Council – established by the government back in 2001 to oversee anti-corruption activities – argued that the company was sold for less than it was originally worth, and that the buyer was

The Croatian example of tackling corruption – namely, the prosecution of high-profile political figures, such as former prime minister, Ivo Sanader, and former deputy prime minister, Damir Polancec – has long been slated for replication elsewhere in the region, particularly in Serbia and Montenegro. By offering up several sacrificial lambs, aspirant EU members hope to demonstrate their commitment to establishing the rule of law, whilst at the same time avoiding the need for more challenging, deep-seated reforms required to fully stamp-out endemic corruption. The untouchables Though Serbian Deputy PM Aleksandar Vucic – who was expected to request German assistance in tackling systemic corruption during a recent visit to Berlin – has declared that nobody is untouchable, there are doubts as to how much progress will be made on this front. As Vladimir Radomirovic, editor-inchief of the Serbian anti-corruption

"Tackling corruption and establishing the rule of law will – aside from the question of Kosovo – prove the most challenging condition" exempted from assuming all the company's debt arrears, which were believed to amount to some $1.7bn. Though the move to investigate can be explained to a large extent by EU pressure, the emphasis is firmly upon local ownership of the process. As the

website Pistaljka (The Whistle), tells bne, "I expect some progress in investigation of suspicious privatisation cases will be made. However, I doubt that big privatisations involving tycoons with close links to high-ranking politicians will be investigated to the full extent."


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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.

bne October 2012

The investigations will ultimately have profound political ramifications. As Radomirovic cautioned, some cases where former officials, especially from former president Boris Tadic's Democratic Party, were involved will be sanctioned, as Vucic has to make good on his promise to effectively fight corruption. "If Vucic does nothing, his Serbian Progressive Party (SNS) stands to lose in the next elections," he says. Serbia's prime minister, Ivica Dacic – who promised an "uncompromising fight against corruption and organised crime" – has stressed that his Socialist Party of Serbia (SPS) was "not involved in contentious privatisations", despite his party being part of the previous administration. Such jockeying is already fuelling public accusations that the investigations are politically motivated. There is much speculation as to whom the so-called "Serbian Sanader" may ultimately prove to be, if indeed such a course is pursed. The man Dacic replaced, Mirko Cvetkovic, has already been forced to strenuously refute allegations that he was involved in the privatisation of Montenegro's Crnogorski Telekom. Cvetković has also denied being the owner of CES Mecon, which has apparently acted as a consultant on a number of high-profile

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I 43

privatisation cases, including those of Telekom Serbia, Knjaz Milos, Frikom, Zmaj, Somoboled and Mlekara Sabac.

more recently to 25% while at the same time allowing them to take "under the pillow" gold direct from customers.

With the Democratic Party currently being torn apart by internal rifts after losing both the presidential and parliamentary elections this summer – Tadic is being challenged for the leadership by the current mayor of Belgrade, Dragan Djilas – those cast into the wilderness will not only be made scapegoats for Serbia's current plight, but may find themselves without the necessary political cover to prevent targeted corruption investigations.

Gold offerings The new policy has seen banks launch special gold promotion days when customers can deposit physical gold in the bank in exchange for investments in a range of gold-based banking products: including gold deposits, gold funds and gold-linked capital-protected funds.

The legacies of Serbia's hasty and largely unregulated privatisation process continue to weigh heavily over the country's development. Whilst some justice may finally be delivered, and some dubious privatisations reversed, the move will prove too little, too late, to undo much of the damage caused to the Serbian state – damage which is estimated to amount to billions of euros in lost revenues, asset values and jobs. For the country to continue its path towards EU membership, however, tackling corruption and establishing the rule of law will – aside from the question of Kosovo – prove the most challenging condition.

Gold under the mattress David O'Byrne in Istanbul


ews that Turkey's banking regulator BDDK has drafted regulations that will allow banks to sell all kinds of gold has been greeted with anger by Turkey's jewellers, who have until now held a near monopoly on the trade, and with surprise by those unfamiliar with the "unorthodox" monetary policy being implemented by the Turkish central bank. While the draft regulation allowing banks to sell gold is new, it is a natural extension of existing regulations brought in last year that allow banks to buy gold. This sudden move to allow Turkish banks to trade in what many would regard as a luxury item having no relation to the business of banking reflects the twin realities of Turkey's still developing financial services sector and the central bank's ongoing "unorthodox" monetary policy.

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"The Anti-Corruption Council has raised a number of suspicions on 24 privatisation cases"

On the one hand, it recognises that despite legal changes obliging employers to pay employees salaries into bank accounts, the irregular nature of much of the Turkish economy means that many are still paid in cash – leaving Turkey as a country that those within the industry readily describe

as "under banked". And, thanks in no small part to Turkey's recent history of runaway inflation, many Turks who are financially secure prefer to save their money in "under the pillow" physical gold, rather than trust it to interest

The success of these promotions has been unprecedented with around 170 tonnes of physical gold collected in little over a year, causing the value of gold deposits held collectively in Turkish banks to jump by over 500% over the same period from TRY2.4bn ($1.3bn) to around TL14.4bn. With many of those holding substantial amounts of physical gold belonging to the conservative segments of Turkish society, Turkey's participation banks – ie. banks which operate on strict Islamic principles and don't charge or pay interest – have been reporting particular success in attracting gold investments. Two of these, Kuveyt Turk

"Estimates put the amount of gold held by Turkish households at as much as 5,000 tonnes, worth around $240bn"

bearing savings accounts, even though inflation has been brought below 10%. On the other, it reflects the central bank's monetary policy, which has seen it seeking to control inflation, stabilise the Turkish lira and stem inflows of "hot money" by means of an unorthodox mix of variable interest rates and strict controls on the reserve requirement ratios (RRR) of Turkish banks. More specifically, in the central bank's decision last year to increase the level of RRR banks can hold in gold from 10% to 20% and then again

and Bank Asya both collected around 2.5 tonnes of gold over the first half of this year alone. The benefits of such schemes are clear. On the one hand, they offer the owners of the gold the opportunity to keep their investments in a safer location than "under the pillow," while at the same time earning a return on the investment which is not based solely on fluctuating gold prices. On the other, they offer the banks an easy route to making a substantial part of their RRR without having to dip into


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A debut Sukuk that was no Turkey

bne Turkey's first sovereign Sukuk bond issue completed on September 18 attracted an orderbook that was nearly five times the actual size of $1.5bn, reflecting huge demand from Middle Eastern accounts, which bought 58% of the issue. Demand for Sukuk from cash-rich Islamic investors has been unsatisfied this year. Ernst & Young estimates global outstanding demand for Sukuk is around $300bn, yet new issuance this year of these bonds, which are structured to comply with Sharia law by not paying interest to investors but giving them a share of the revenues from certain assets that are placed in a special-purpose vehicle, may not total much more than $100bn. Such high demand, which also came from Europe, Asia, the US and local sources, helped the pricing. The five and a half year Sukuk was priced to yield 2.803%, which is roughly on a par with Turkey's sovereign Eurobond due 2018, which traded at around 2.76% on the same day the Islamic bond was issued. Normally, Sukuk pay a premium of as much as 1 percentage point. Speaking on the sidelines of the Global Islamic Finance Forum 2012 in Kuala Lumpur in September, Ali Babacan, Turkey's deputy prime minister responsible for the Economy, told newswires that he believes the issue will act as a benchmark for other Sukuk from Turkish borrowers. "We believe there is good room for growth in this sector, and I believe it will definitely be utilised by our private sector counterparts," he said. Indeed, Turkey was expected to issue another Sukuk, a lira-denominated one, by the end of September, demand for which was also predicted to be high, the Turkish unit of Bahraini lender Al Baraka said. And this issue should open the way for a splurge of issuance from "participation banks", as Islamic banks are called in Turkey, which currently hold a 5.6% share of Turkey's banking market and have been growing rapidly over the last five years, with assets growing almost five-fold. Babacan has also said that deepening the Sukuk market is important for Istanbul's ambition to become an international financial centre. "We think it will not be only a national market, but a regional and global market. These certificates will be traded on the Istanbul Stock Exchange every day," he claimed. Despite espousing Islamic values, Turkish Prime Minister Tayyip Erdogan's government has shied away from launching a Sukuk issue, fearing that it would offer ammunition to critics who accuse his ruling AK Party of seeking to roll back state secularism by stealth. However, tight liquidity and lending conditions, and the current risk aversion in Western markets has made Islamic financing increasingly tempting.

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Some investors shifted to solar projects instead, and the segment began to attract attention from further afield. In July, Saudi Arabia's ACWA power announced that it was taking a 42% stake in a €155m, 60-megawatt (MW) plant in central Bulgaria.

the Turkish lira reserves they need to maintain their loan books. It also aids the slowing Turkish economy by making liquid a huge reserve of moribund capital, putting it to work in the economy. Current estimates put the amount of gold held "under the pillow" by Turkish households at as much as 5,000 tonnes, which valued at around $240bn at current prices is not far off two and a half times Turkey's total foreign exchange reserves. And with less than 300,000 of Turkey's estimated 75m population thought to have opened gold accounts, clearly there still exists both huge potential for getting more liquidity back into the Turkish economy and righting one of its long-term imbalances, namely the low level of bank savings which has left Turkey's banks disproportionately dependent on foreign loans to fund their domestic loan books. According to World Bank data, the level of bank savings held by Turks fell from around 23.5% of GDP in the mid-1990s to around 12.7% by 2010, way below that of other high growth countries such as China where savings peaked at 46% of GDP in 2008. Ironically, this fall has come about as a direct result of the country's strong economic performance over the past decade. While younger earners have preferred to spend and enjoy higher lifestyles, older and more conservative Turks with money to save have preferred traditional "under the pillow" gold. Attracting more of that gold back into the real economy will benefit both the economy and the banks – providing domestic resources for funding loan growth, not to say benefit consumers guaranteeing them an income on investments beyond possible growth in the gold price.

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Sun sets on Bulgaria renewables industry Andrew MacDowall in Belgrade


ulgaria is imposing swingeing retroactive cuts to the price the government pays renewable energy producers in a move that has angered the industry and could disconcert other investors. Others argue that the reductions are a reflection of economic reality. From September 18, energy regulator DKVER will impose cuts of between 10% and 39% on network access fees for all existing renewable projects. Network fees are tariffs paid to the power plant owner by the network operator – also known as a distribution company or disco – for electricity produced. Following a meeting on September 14, DKVER (also known by its English abbreviation, SEWRC) announced it was cutting tariffs on all wind projects by 10%, and those on solar projects launched before this year by 20%. The biggest cuts are for solar projects launched in the first half of 2012, which will lose 39% of their income. Renewable energy has become a huge growth sector in Bulgaria in recent

years, partly due to the favourable terms offered to investors in the sector. Some of the institutional investors who put money into Bulgaria's then-burgeoning real estate sector in the mid-2000s

Becalmed Now, however, the outlook for Bulgaria's entire renewables industry looks shakier. According to the Bulgarian Wind Energy Association (BGWEA), DKVER's fee changes are "illegal" as they contradict the country's renewable energy law, which guaranteed investors fixed prices for 12 to 20 years. According to BGWEA executive director Sebastian Noethlichs, the changes to network fees are effectively retroactive cuts in feed-in tariffs – long-term prices that the state pledges to investors in renewables projects. In a very strongly-worded statement, BGWEA warned that the changes imperilled not only the renewable sector, but the broader economy, given the scale of renewable energy investments in the country. "Several billion leva worth of domestic and foreign investment along with hundreds of newly created jobs have been destroyed overnight," the statement, issued on Monday, said. "The ultimate consequence will be that the Bulgarian banking system, which has so

"The government had to find a scapegoat to blame for the electricity price increases" switched to renewables as the country pushed towards its target of generating 16% of its energy from green sources by 2020. Now, the proportion is around 12% -not bad by European standards. However, a distinct cooling of government opinion towards the sector has been apparent for some time now, given its cost to the budget and use of agricultural land. A law passed in April 2011 established that producer prices for wind projects would only be set after they were completed, obviously making projecting profitability difficult.

far been stable and insulated from the financial crisis all around the region, will end up with a massive amount of bad loans on its books." Noethlichs warns that the message to any investor in any sector in Bulgaria is clear: what the law promises you today, can be retroactively revoked tomorrow. "Investing in Bulgaria no longer means investing in a stable, reliable European market, but in a wild, chaotic market where every investor is at the mercy of an untransparent, secretive government."


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DKVER has said that the cuts are necessary to account for the cost to the discos of purchasing an increasing amount of renewable power. The regulator states that capital expenditures for renewables companies have fallen considerably since network fees were set, making their projects considerably more profitable; it asserts that generators' return on investment will still exceed 7%. Like last April's changes to wind farm legislation, the tariff reductions are also likely to reflect a waning enthusiasm from the Bulgarian government and among consumers to foot the bill for more costly renewable energy at a time of fiscal austerity and straitened circumstances for households. But Noethlichs says that the changes are a partly political move following the unpopular decision to increase power

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prices by 13% this summer, and are a maladroit attempt to tackle the serious funding issues faced by NEK, the stateowned national electricity company. "The government has a problem," he tells bne. "NEK constantly runs at a deficit because it buys electricity at market prices and then sells to the general population well below those prices. Power prices in Bulgaria need to go up. That's a fact. But power prices going up are political poison, that's also a fact. So the government had to find a scapegoat to blame for the price increases. Now it appears that they actually believe that by lashing out at renewables alone they can solve the problems of NEK, which is very misguided indeed." Ruslan Stefanov, director of the economic programme at the Centre for the Study of Democracy, a Sofia think-tank, agrees with Noethlichs that the abruptness of the fee changes, and their retroac-

More gloom and doom for the Croatian economy Guy Norton in Zagreb


t's been a glorious summer in Croatia, with many parts of the country enjoying months of unbroken sunshine – a blessing for the country's tourism industry, but a curse on its agricultural sector. With the peak holiday season now over, Croatians are now steeling themselves for what could be a winter of discontent, given the parlous state of the country's economy. According to the Central Bureau of Statistics, the country is still firmly stuck in recession, with preliminary figures for the second quarter showing that GDP shrank by 2.1% on an annual basis – the biggest fall in the last two years after GDP fell 2.5% in the second quarter of 2010. The second quarter fall in economic activity indicates an acceleration in the

decline in Croatia's financial fortunes compared with the first three months of the year when GDP fell by 1.3%. Although it's probably cold comfort to the vast majority of Croatians, the fall in

tive nature, bodes poorly for investor confidence in Bulgaria – but argues that the renewable sector has been in need of a haircut for some time. "I have to say there is some rationale to lower feed-in tariffs on two grounds," he tells bne. "Firstly, they have been misaligned with improvements in technology and with falling costs, which has resulted in huge profit margins. Secondly, their level is unsustainable for the average income level of Bulgarian households. However, changing them retroactively is a very bad signal for investors, not only in this sector but in others too. The need to trim tariffs was already obvious in 2008-2009, when the housing boom collapsed and money from there went into renewables. The government should have acted then. All in all, the changes are reasonable, but were done in a very, very cumbersome way."

Nevertheless it confirms that the country is still struggling to find its way out of a recession that hit at the start of 2009. Since then the economy has only registered three quarters of positive growth, in the third quarter of 2010 and the second and third quarters of 2011. Commenting on the latest GDP number, Zdeslav Santic, chief economist at Splitska Banka, says that although a detailed breakdown of second-quarter GDP won't be available until late September, recent indicators point to an across-the-board fall in economic

"Maybe the government is not crying because of the difficult situation and the fall in GDP, but the Croatian people are crying" GDP was actually lower than most local analysts had predicted. In a survey conducted by state news agency Hina, eight Croatian macroeconomists had predicted a 2.3% fall in economic activity on a consensus basis.

activity: "Most likely all categories of GDP recorded a decline on an annual basis. Retail trade was 5.6% lower in real terms, while industrial production contracted by 6.7%."

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Santic adds that the country's trade balance also deteriorated in the second quarter, with a 7.7% increase in the trade deficit on the back of falling exports to the EU, the country's main trading partner. Looking ahead to the rest of the year, there is unlikely to be a major turnaround in the economy in the near term, argues Erste Bank's chief economist, Alen Kovac. "I still see a negative GDP figure for the third quarter, less pronounced, but still negative." Santic at Splitska Banka says that while foreign tourism revenues from the peak holiday season of July and August may mitigate some of the decline in economic activity in the third quarter, that positive effect will be absent in last three months of the year. "In the fourth quarter, GDP might again contract at a somewhat stronger pace as economic activity at the end of year relies mostly on domestic growth factors, such as household consumption and capital investments." Commenting on the weak GDP data, Prime Minister Zoran Milanovic admitted that it was clear that Croatia would not achieve the 0.8% growth in GDP the government had forecast at the start of the year when it came to power, but that he firmly believed that Croatia would emerge from recession in 2013 when it is due to join the EU. Asked by reporters if he was thinking about resigning because of the poor state of the economy, Milanovic said the government was not asking for sympathy or mercy but a little patience and that after half a year in office, it was perfectly clear that miracles were not possible in six months. "If there is headway next year, that will not be a miracle but the result of this government's work, because good measures and laws are being adopted, he said. "The government is not crying because of the difficult situation." That prompted a bitter response from Dragutin Lesar, leader of the leftwing Hrvatska Laburista (Croatian Labour) party, who told Hina: "Maybe the government is not crying because of the difficult situation and the fall in GDP,

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but the Croatian people are crying. We can not just expect a further decline in GDP… but also a decline in production, higher prices, declining incomes, rising unemployment... It is an never-ending spiral. I can not believe that they [the government] cannot see the spiral and that they do not see that their actions are only deepening the crisis." Meanwhile, Goran Maric, an economic strategist for the HDZ, the main opposition party in Croatia, said that the weak GDP data was no surprise given the tax hikes implemented by the centre-left government. "In such a recession, you cannot impose such high taxes and expect economic growth. With such a tax burden the government has pushed Croatia from recession into depression."

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On the international front all eyes will now be on the credit rating agencies, which at the start of the year were widely seen as giving the newly installed government the chance to prove its economic credentials when they retained their 'BBB' investment grade ratings for Croatia, albeit with a negative outlook. Santic at Splitska Banka says that the government will now quickly need to convince the rating agencies it is able to rein in public spending and push through long overdue economic reforms if the country is to avoid being relegated to so-called junk status. "In comparison with the start of the year we expect that the rating agencies might be less willing to provide a grace period for the government to tackle these two issues."


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exporter of gas, uranium and other commodities. Kyrgyzstan, which inherited minimal railway infrastructure from the Soviet Union, has been keen to see the line built for the last decade. Both President Almazbek Atambaev and his two predecessors wanted to improve transport links across the mountainous country to give a much-needed boost to the economy – especially if China was footing the bill.

All aboard the China-KyrgyzstanUzbekistan railway Clare Nuttall in Astana


he latest change of government in Kyrgyzstan has not resulted in any delays to plans for the ChinaKyrgyzstan-Uzbekistan railway, which after years of fruitless discussions are now going full steam ahead. Just days after his election, Kyrgyzstan's new prime minister, Zhantoro Satybaldiyev, met with Chinese officials on the railway, and indicated that talks on the $2bn project could be wrapped up by the end of 2012. Progress on the railway is, however, a setback for Iran and Tajikistan, which both had hoped to get backing for a rival line that would run from western China to Iran, via Kyrgyzstan, Tajikistan and Afghanistan. Although an Iranianfunded feasibility is due to be finalised in September, the scheme may already be dead in the water, as interest from Bishkek – and more importantly Beijing – has steadily waned.

Both lines were proposed to link China to the resource-rich markets of Central Asia, which are also hungry for Chinese consumer goods. The first would run from the Chinese market town of

across Afghanistan into Tajikistan, then through Tajikistan's Rakhsh Valley and Kyrgyzstan's Alai Valley, finally through the Irkeshtam Pass into China, where it would also terminate at Kashgar.

"The Iran-China line doesn't interest us much at this time; the China-Kyrgyzstan railway is more important economically and strategically" Kashagar across Kyrgyzstan, and enter Uzbekistan near Kara-Suu, Kyrgyzstan's second largest bazaar. It would connect to the main Uzbek rail network at Andijan. Meanwhile, the other line would run from the Iranian rail network to Herat,

Despite initial interest in both lines, Beijing has increasing favoured the China-Kyrgyzstan-Uzbekistan route, which would provide a rail link to KaraSuu bazaar, a regional distribution hub for consumer goods. At the same time, it would build upon China's already good relationship with Uzbekistan, an

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Balancing act After his appointment on September 5, Satybaldiyev quickly dispelled fears that the change of government would delay decision-making. One of his first actions on assuming office was to meet Chinese Vice Premier Hui Liangyu on September 10. Hui is reported to have told Satybaldiev that the process of securing finance for the railway needed to be accelerated. Negotiations on the railway could be completed by the end of this year, state news agency Kabar reports. The government-level agreement was quickly followed up by discussions between officials at Kyrgyzstan’s Ministry of Transport and Communications and the China Road corporation. According to a statement from the Ministry, talks focussed on technical details, with Kyrgyz officials proposing a cheaper route for the line, as well as asking for it to be routed near the Kara Keche coal deposits. Policymakers in Bishkek are, however, having to balance the benefits of the railway against the increased influence of Beijing – an unpopular move in Kyrgyzstan's increasingly nationalist political scene. In June, Kyrgyzstan's then transport and communications minister Kalybek Sultanov announced that Bishkek was not interested in the Iran-China line, which would mainly cross the remote Alai Valley. "It doesn't interest us much at this time, because there's another project, the China-Kyrgyzstan railway – that's more important economically and strategically," quoted Sultanov as saying.

Despite Kyrgyzstan's lack of interest, Iran has been stepping up its efforts to persuade the Central Asian countries to join the China-Iran project. The idea has been around for a while, but Teheran has only put real weight behind it recently, spurred by the need to find new allies in Asia as western sanctions bite. It also has enthusiastic backing from Tajikistan, which was excluded from the China-KyrgyzstanUzbekistan project. Teheran has offered to fund feasibility studies of the Tajik and Kyrgyz sections of the line. Iranian and Tajik officials are currently waiting for the results of the first feasibility study, which is being

behind the project, a spat over Metra's work has already erupted. Tajik officials have complained about Metra's slow progress on the feasibility study, while Metra says the delays were caused by the Tajik government's reluctance to hand over maps deemed too secret to share with the Iranian company. For Tajikistan, however there is a firm case for going ahead with the railway, since access through its only existing international rail route, to Uzbekistan, has been plagued by political problems. The two countries have an often troubled relationship, and Dushanbe has several times accused the Uzbek government of holding

"A technical issue is that China, Iran and the former Soviet republics of Central Asia all use different rail gauges" carried out by Iranian engineering company Metra and is due to be completed in autumn 2012. A clearer idea of the cost of this section of the line will be key to determining whether the line, which will pass through some of Central Asia' highest mountain regions, is economically viable. The Tajik section is expected to be most technically difficult, and it will also pass through the volatile Rakhsh Valley. Another technical issue is that China, Iran and the former Soviet republics of Central Asia all use different rail gauges. After an initial report highlighted the difficulties, however, Tajik Transport Minister Nizom Khakimov told journalists that he believed that they were surmountable, although he also pointed out that, "The problem is that in our territory the railway will run through a number of important facilities, in particular the Roghun hydropower plant." While Teheran and Dushanbe are united

up freight wagons to exert political pressure on its neighbour. As a result, the Tajik government is exploring its options for international transit routes, but assuming that Beijing and Bishkek continue their support for the China-Kyrgyzstan-Uzbekistan railway, Tajikistan will be left scrabbling for alternatives.


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Tashbayev told Reuters: "We must not deviate from this path." Code for investment The failed auction took place four months after the government approved a new mining code aimed at making the process for issuing licences more transparent. Under Bakiyev, licences to develop many mineral deposits were allegedly handed out to cronies of government officials for nominal payments. Many holders of the deposits did nothing to develop them, instead holding onto their licences for several years in the hope of selling them for a higher price to a genuine developer. As a result, work in the sector stalled.

Undermined in Kyrgyzstan Clare Nuttall in Astana


he unrest in Kyrgyzstan's mining sector shows no signs of abating as the adoption of a new mining code earlier this year, with the aim of encouraging investment, is being overshadowed by a wave of protests targeting the industry. The most dramatic of these was the attack on the Kyrgyz state broadcaster on August 28, just as the first televised auction of mining licences was about to begin. This was followed by protests targeting miners in the Naryn and Jalal-Abad regions as local residents demanded a better deal from the companies developing deposits in their regions. Bishkek has started using live broadcasts after the April 2010 revolution as a means to demonstrate transparency. Candidates for the 2011 presidential elections, for example, had to sit televised Kyrgyz-language exams. They have now been extended to the allocation of mining licences, which post-revolutionary leaders say was a hotbed of corruption under former president Kurmanbek Bakiyev. But the attempt backfired on August 28, when the very first set of auctions was broken up by an invading mob.

Around 50 men forced their way into the studio as the auction was about to begin. The demonstrators are reported to have been mainly young men from several organisations, including the New Kyrgyz Opposition. Many were wearing

Since then, first Kyrgyzstan's interim government, then later governments under prime ministers Almazbek Atambaev and Omurbek Babanov, have tried to make the sector more transparent, but the process has thrown up new problems. Initially, the interim government introduced a moratorium on licences, including renewals of existing rights. While the intentions were believed to be good, this created problems for companies, including

"The motherland is not for sale!" traditional Kyrgyz "kolpak" hats, and chanted: "We won't allow our beloved lands to be sold!" and "The motherland is not for sale!", according to reports in the Kyrgyz press. Security guards failed to prevent them from entering the studio, and as fighting broke out employees of the television station fled the building. On the auction block were the licences for 11 gold deposits and one coal deposit, most of which are just at the exploration stage. Prospective bidders included companies from Azerbaijan, Turkey, China and Russia, as well as domestic investors. The auctions for the 12 mining licences are now due to be rescheduled, according to Kyrgyzstan's State Agency of Geology and Mineral Resources, whose director Uchkunbek

Kyrgyzstan's handful of foreign investors active in the sector, who were unable to continue with their investment plans. A new mining code was then adopted in April 2012, under which even licences for relatively small deposits have to be auctioned in a transparent bidding process. However, there are still questions over the way the new regime is being implemented. Feelings for home Kyrgyzstan has also seen an upsurge in resource nationalism since April 2010. Respect for property rights was severely damaged when the revolution unleashed a wave of illegal squatting and violence against businesses, especially those owned by foreigners and ethnic

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minorities. Both these factors have been bad news for companies still keen to exploit Kyrgyzstan's mineral wealth. In one recent incident, a construction company rebuilding a road to a mine operated by Chaarat Gold in the Jalalabad region was raided by local villagers on September 10. Around 100 people seized bulldozers from the construction company, Spektr, which they said was too slow in repairing the road that serves two villages as well as the mine. Demonstrators threatened to block roads in the nearby town of Zhany-Bazaar unless action was taken against Spektr. A week later, residents near the Kara Keche coal deposit in the mountainous Naryn region demanded that Sharbon, which is developing the deposit, cut coal prices, employ only locals and mend roads in the region. A delegation first approached the local authorities, threatening action against Sharbon unless officials agreed to "nationalise" the mine. Kyrgyzstan's new Prime Minister Zhantoro Satybaldiyev visited the region on September 18 to try and resolve the situation peacefully. The most serious recent incident took place in October 2011, when armed horsemen attacked Anglo-South African joint venture Talas Copper Gold's mining camp. Several buildings were torched, and an attempt made to kill the security manager. Talas Copper Gold suspended operations for several months. All these incidents have led to growing instability in Kyrgyzstan's beleaguered mining sector, worsened by the latest change of government. Babanov's government was brought down by a corruption scandal after less than eight months, although in a more positive sign, three of Kyrgyzstan's parliamentary parties were quick to form a new coalition. However, Aktilek Tungatarov, executive director of the International Business Council in Bishkek, points out that Satybaldiyev is the 23rd prime minister that Kyrgyzstan has had in its 21 years of independence. "Political instability is one of the main constraints for our economic growth," he tells bne.


Wherefore art thou IPO?

Clare Nuttall in Astana Kazakhstan is edging closer to the first of the planned series of "People's IPOs". But with the date for the IPO of oil transportation company KazTransOil still unclear as of late September, further delays beyond the promised October launch date look likely. Under the programme, minority stakes of around 5-10% in 10 major stateowned or partially state-owned companies will be issued at a discount to the Kazakh population and pension funds. The programme is intended to stimulate activity on the Kazakhstan Stock Exchange (KASE) – whose development has been held back by a lack of liquidity and low level of retail investment – and foster an investment culture in Kazakhstan. First announced by the Kazakh government in early 2011, it has taken over 18 months to reach the stage when the first company is nearly ready to list. The first IPOs were initially due to take place in 2011, but the process has been postponed several times – first because of the need to prepare the companies for IPO, and later due to uncertain conditions in the global economy. Back in March, Kazakh Economic Development and Trade Minister Bakytzhan Sagintayev told a government meeting that both KazTransOil and electricity grid operator Kegoc were ready to issue shares, but that the IPOs were being delayed due to the turmoil in international financial markets at that time. Since then, Kazakhstan has remained relatively immune to the latest wave of the crisis. However, the worsening global situation is bringing down demand for its main commodity exports, and the country's grain harvest has also been hit by drought. Renaissance Capital said in August that it expected GDP growth of just 5.5% in 2012, due to low agriculture output and falling industrial production. This being the case, it may be that Astana will postpone the KazTransOil IPO beyond October. An official at KazTransOil told bne in mid-September that no announcement about the timing for the IPO would be made until early or midOctober. Nor has information on the pricing of the IPO – previously expected in August – yet been disclosed. A source close to the process tells bne that the preparations to float KazTransOil are continuing and, while the October date is not set in stone, an IPO is likely by the end of the year at least. Following the KazTransOil IPO in 2012, IPOs of nine other companies will take place in the following three years, starting in 2013 with the IPOs of Kegoc, national carrier Air Astana, electricity generation company Samruk-Energo, KazTransGas and Kazmortransflot, Samruk-Kazyna has said. National railway operator Kazakhstan Temir Zholy and its cargo transportation subsidiary Kaztemirtrans may be floated by 2014, with oil and gas company National Company KazMunaiGas and state atomic energy company Kazatomprom possibly due to follow in 2015.

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using his vast wealth to overwhelm the UNM's resources. The contest for parliament has given a political charge to nearly every aspect of life in Georgia over the past several months, creating an increasingly divided society split between the two camps. The videos, however, could change all that.

Saakashvili becomes prisoner of scandal Molly Corso in Tbilisi


eeling from graphic evidence of widespread prisoner abuse just 10 days before the parliamentary elections, Georgian President Mikheil Saakashvili and his party are bracing themselves for a major fight to stay in power. The scandal broke on September 18 after a series of violently explicit videos showing prisoners being sodomized with brooms and beaten were broadcast on Georgian television. Public reaction was swift, threatening to upset the ruling party's hold on the October 1 elections. Large-scale protests against the president as well as several ministers have been held in Tbilisi and other cities around the country, and civil society groups have publicly called for the resignation of several key members of government. In response, Saakashvili has appointed the country's ombudsman, Giorgi Tugushi – a longtime advocate of prisoners' rights – to lead the prison ministry, and called on Prime Minister Vano Merabishvili to oversee a crackdown against those responsible for torturing inmates. But analysts like Dr Alexander Rondeli, head of the Georgian Foundation for Strategic and International Studies

(GFSIS), note there might not be enough time for the ruling party to recover before the elections. Polarised Prior to the leaked video, opposition parties were trailing Saakashvili's team, the United National Movement (UNM), for months based on surveys commissioned by the National Democratic Institution, the International Republican Institute and the party itself. For his main rival, billionaire-turnedopposition financier Bidzina Ivanishvili, the scandal has been a short reprieve in a dirty political battle. The opposition has spent months fighting off allegations

The footage, which showed violent abuse of prisoners including graphic scenes of inmates weeping while guards sodomized them with broom handles, has cast doubt on the UNM's ability to win a majority of seats in parliament. "It will have, I think, quite a serious effect on the election results and it will make the ruling party situation worse, no doubt about it," Rondeli tells bne. "It also depends on how things develop on these days before elections. [There is not too] much time for repairing damage. The steps which the government is taking are right, but the problem now is time."

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tried to draw a clear line between the shock of the tapes and the campaign. "I understand very well that this is the political war of compromising materials, but I am less worried about politics now," Saakashvili was quoted as saying on

recriminations. It is too soon, however, to judge how much impact this has had.

"We thought that we changed many things and we did, but major nasty things turned out to be still remaining [in the penitentiary]," he said. "We have zero tolerance towards these crimes… we also should have similar zero tolerance towards human rights infringement, because we are building a civilized country and not just discipline built on violence."

"It will have quite a serious effect on the election results and it will make the ruling party situation worse, no doubt about it"

After months of aggressive campaigning, Saakashvili has pointedly curtailed his cross-country speeches and town hall-style meetings, staying in the capital to issue strong statements and

Hundreds of protestors – many wearing Ivanishvili's Georgian Dream t-shirts – have closed streets in Tbilisi in the days

since the videos were broadcast, burning brooms and accusing the government of recreating a Georgian version of Abu Ghraib, the jail in Baghdad made infamous for footage of US soldiers abusing prisoners. Calling the protests a "healthy reaction" to the broadcasts, Ivanishvili warned

For the ruling party, the stakes are high. The parliamentary vote sets the stage for who will control the country following the presidential election in 2013, the date when Georgia will go from a strong presidential form of government to a parliamentary-style state ruled by a prime minister. The prime minister will be elected from the sitting parliament, making the October 1 vote essentially a fight for future control of the country. Now, with just 10 days before the election, the ruling party is scrambling to appease shocked voters.

"For billionaire-turned-opposition financier Ivanishvili, the scandal has been a short reprieve in a dirty political battle"

Mongolia's new government faces old problems Oliver Belfitt-Nash in Ulaabaatar

Ivanishvili, who finances many of them under his umbrella coalition the "Georgian Dream", is tied to Russian President Vladimir Putin, and wrestling with a long litany of fines as the ruling party fought to stop the billionaire from

Protests While the ruling party initially insinuated that the video was the work of the opposition trying to destabilize the elections, since the seriousness of the issue became clear the president has

I 53


he term "Dutch Disease" may have originally been coined in relation to a gasfield in The Netherlands, but Mongolia is finding out that it can just as well apply to coal. This "black gold" that propelled Mongolia's economic

growth to a record 17.3% in 2011 is now in a sudden glut and Chinese demand has dropped off a cliff, and the country's new government is learning the hard way about how reliance on a few commodities can endanger the economy.

supporters that large rallies prior to the vote could backfire in the current politically charged atmosphere. "The Georgian population had a very healthy reaction… but I want to call on them not to start unplanned rallies and not

to do what the Georgian authorities are expecting from the very first day after I came into politics," he said in a statement September 19. "We should manage to reach the elections in an organized manner, without much emotion and to change these authorities through the elections."

Mongolia shipped 21.1m tonnes of coking coal to China in 2011 worth $2.25bn, up 26% in volume and a staggering 155% in terms of value from the previous year. The coal excitement reached its peak exactly a year ago in September 2011, when 2m tonnes were sent across the country's southern border to rake in $380m for those in on the deal. The country overtook Australia as China's main coal supplier and the previous government's coffers began to swell with royalty and tax revenue, which it swiftly dealt out to its citizens in preparation for the elections in June this year. But the handouts didn't work, and now a new government has taken the reins. Uphill battle The Democratic Party has an uphill battle to keep the economy on track. It takes office at a time when coal export prices have fallen to their lowest level in 10 months and volumes have been cut sharply since June to around 1m tonnes for August. The global slowdown has dulled investors' appetite for risk, the country's biggest project is under fire from resource nationalist fragments of the party, and China's hand has been slapped away from acquiring a mine in the Gobi


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bne October 2012

desert. "This country needs foreign direct investment now more than ever," says Jargalsaikhan Dambadarjaa, a Mongolian economist and political commentator. "We need to use the mining revenues to diversify away from mining." Dambadarjaa warns that "Dutch Disease" – where an increase in the exploitation of natural resources is accompanied by a decline in the manufacturing sector – is taking hold. "We are still fully dependent on coal and copper – these two commodity prices are behind everything."

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

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

To add fuel to the fire, parliament passed a new resource-nationalist "Foreign Investment Law" in May in order to veto a bid by the Aluminum Corporation of China (Chalco) for a Canadian-owned coal miner based in Mongolia, SouthGobi Resources. The law's intention was

The new government has promised measures to deal with the slowdown. A fouryear plan was released mid-September outlining the policies that will drive its term of office. Many of the clauses are encouraging, highlighting the importance of "cooperat[ing] with foreign direct investors on a mutually beneficial basis," as well as an entire section on economic diversification. "The key economic policy objective of the government is the reduction of dependency on the mining sector, achievement of a


Plans have been drawn up to encourage industrialisation, wool and cashmere production, livestock and meat, tourism, technology, import replacements and services. Projects such as the Sainshand Industrial Park, which aims to add value to export commodities before shipping them on to China, will be pushed hard. Alongside these bold plans it's mandated that inflation will be kept in single digits and the state deficit will remain under 2%, yet August figures showed annual inflation at 16.6% and the deficit already at 4.4% of 2011 GDP. "What will be the government's role in these efforts?" asks Jargalsaikhan, referring to the Sainshand project. "I

don't believe the government can do it. All state-owned enterprises are losing. CEOs are picked politically, not on merit. It will not be competitive – this was the whole reason for our transition." Indeed, government-funded companies operating in the cashmere sector show how hard this will be to pull off. Loans were made to the sector at reduced rates, hoping to spur growth, but while cashmere exports rose 20% in the first eight months of this year, they still only account for 4.7% of the total exports in dollar terms. "If you think one reform will solve everything, you're fooling yourself," Dr James Riordan, former director of Chemonics International, said at a recent economic development conference. "You have to focus on the buyers. Diversification will come slowly, little by little." Unfortunately, commodity crashes do not come slowly, and despite all the naysayers Mongolia's new government is promising a much brighter future than the past left by their predecessors. As their world crumbles, the band keeps on playing.

I 55

the city. It has the further advantage of being in the north of the country, much closer to fellow Customs Union founder Russia than Almaty.

long-term sustainable development and creation of a competitive and diversified economy," the document states.

"Any rational-minded Mongolian would oppose this law" evident, but its consequences have reached far beyond the single deal. The legislation states that any investment over $75m designed to own over 49% of a Mongolian company will be subject to approval by a government panel. Many investors have seen this as a red light and reversed, leaving the new government short of cash. "Any rational-minded Mongolian would oppose this law," says Jargalsaikhan. "We wanted them to cut the hair, not the head! We need technology and know-how, but this will be a backwards step from diversification."

bne October 2012

The volume of investment into Astana has steadily increased in recent years. In the first seven months of 2012, Astana received KZT295.1bn worth of investment, a 16.2% increase compared with the same period of 2011. According to the official forecast for 2012, total investment of up to KZT600bn is expected this year.

Capital plans in Kazakhstan Clare Nuttall in Astana


azakhstan's capital Astana is increasingly becoming an industrial centre as well as the country's seat of government. Government support in the form of tax breaks and other incentives has brought in a growing number of international manufacturing companies to the capital, which has seen a subsequent steady rise in investment. When the Kazakh government decided to move the capital from cosmopolitan, temperate Almaty to Tselinograd, a small city in the northern steppe, it seemed the main claim to fame for the new capital – renamed Astana in 1998 – would be as a contender alongside Ottawa and Ulaanbaatar for the title as the world's coldest capital. Instead, it has become known for its exotic architecture, as billions of dollars were poured into construction works that has earned it the nickname "Dubai of the steppe", as an icy version of the Middle Eastern city. Indeed, investors from the Gulf are among the largest in Astana, where the Abu Dhabi Plaza is set to become Central Asia's tallest building when it is completed in 2014, and the 14th highest in the world.

The KZT165bn ($1.1bn) development is set to become another Astana landmark alongside the Ministry of Transport and Communications Ministry (dubbed "the lighter"), the egg-shaped national archives, and the giant tent housing the Khan Shatyr shopping centre. But while Astana started out as Kazakhstan's administrative capital, with the former capital Almaty remaining

The Astana New City Special Economic Zone (SEZ) has been working with investors since its launch in 2011, managing both the new business and administrative centre on the left bank of the Esil river, and an industrial zone. The SEZ was set up under a presidential decree covering the period until 2027, with a mandate to manage investment into new housing, offices, retail and trade centres, industrial space and the infrastructure underpinning construction of the new city. To encourage businesses and construction companies to set up in Astana, investors at the SEZ receive a variety of tax and customs preferences, including exemptions from corporate profit tax, land tax and VAT on building materials. A "single window" centre was set up to provide support and information services for investors, according to

"We will be actively working to attract international companies to these areas" the business centre, the national and municipal government have been pushing to turn the city into an industrial hub for northern Kazakhstan. Makings of the future The establishment of the Astana New City special economic zone (SEZ), and a package of government tax and financial incentives has brought a growing number of international companies to set up manufacturing operations in

Meder Maselov, head of the Astana akimat (city authorities) department for administration of the SEZ. "At present there are 41 projects in development in the industrial zone, with total investments of over KZT150m. Seven investors in the manufacturing sector have already launched projects worth a total of KZT55.1bn," Maselov tells bne. Two of the first investors were in the rail sector, where Kazakhstan's


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Keeping the peace

Clare Nuttall in Aktau Nearly a year after the deaths of 16 oil workers in the western town of Zhanaozen, Kazakhstan's government is planning to launch a range of support measures for the oil-rich region as it tries to ensure the tragedy doesn't happen again. At an international investment forum in the western town of Aktau, Lyazzat Kiinov, the chairman of Kazakhstan's state oil and gas company KazMunaiGas, announced on September 24 that a series of investment deals will shortly be signed to channel more development funds into the region. Although western Kazakhstan is responsible for over 30% of the country's GDP and has less than 15% of its population, living standards in many regional towns are well below those in the country's main cities Astana and Almaty. The trigger for the strikes that preceded the December 2011 shootings in Zhanaozen was the perception by oil workers that profits from the country's vast oil and gas resources were going only to the elite, while their living conditions remained low. On December 16, Kazakhstan's independence day, the strike erupted into violence when police tried to evict sacked oil workers and their supporters from Zhanaozen's main square so that a celebratory concert could go ahead. When clashes broke out, security forces opened fire, killing 16 people. Oil company offices, shops and banks were attacked in violent riots in Zhanaozen and in nearby Shepte. The events shattered Kazakhstan's carefully nurtured reputation for internal stability, and Astana quickly realised the need to placate workers, announcing investment plans for Zhanaozen and a new programme to support mono-industry towns in general. "The main idea of this event is to prevent last year's tragic events at Zhanaozen from being repeated," Kiinov told the West Kazakhstan investment forum. "We believe one of the main reasons was the high level of unemployment, because when a person has no job, he has no life and no prospects, so we are discussing how to create new jobs." Plans include setting up an industrial park in Zhanaozen in a bid to diversify the local economy. Summer 2012 saw two brief strikes in Zhanaozen, but this time managers quickly opened talks with workers. On a Sunday afternoon in late September, the town was quiet and calm, although there was a considerable military presence around the UzenMunaiGas offices and local administration. There were no traces of the buildings burned down during the riots, and teams of women were picking up litter and sweeping the sandy verges in the town centre. However, behind the freshly painted facades on the well-kept main streets, lie dirt tracks and shabby apartment blocks. While the situation in the region is currently calm, feelings are still running high and Kazakhstan's opposition is being pressured by the authorities. On the day the investment forum opened, across town at the regional court house the trial of opposition leader Vladmir Kozlov resumed. The Alga! party leader was arrested as part of a security clampdown in January on his return from discussions with EU officials on Zhanaozen.

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national rail operator Kazakhstan Temir Zholy is carrying out a multi-billiondollar investment programme. GE Transportation opened a locomotive assembly plant in the city under a joint venture agreement with KTZ in late 2010, which was followed by Tulpar Talgo, a joint venture between KTZ and Spain's Talgo to produce railway carriages. By the end of 2012, a third factory is due to be set up under an agreement with France's Alstom. Investments are also being made into other sectors. "Under the plan for further development of the Astana New City SEZ, we have a new set of priorities for the industrial park, including production of machines, electronics and instruments, chemicals and pharmaceuticals, and in the energy and [nformation, communications and technology] spheres," says Maselov. "We will be actively working to attract international companies to these areas." The industrial park is now being expanded, and a new innovation park added. In total, the SEZ is being expanded from 7,093 hectares to 7,562. This will require extending infrastructure for roads and utilities to new areas as Astana – whose population has more than doubled from around 300,000 in 1997 to 775,000 in June 2012 – expands out onto the steppe. While the new city does not yet have the transport problems of Kazakhstan's congested former capital Almaty, the city planners are also investing into a high-speed light railway for the city; along with the Abu Dhabi Plaza, this is the largest ongoing investment in the city. The light railway will cost a total of KZT355.8bn to build. Construction of the first stage of the 42.1-kilometrelong railway started this year, and will connect the airport to the Abu Dhabi Plaza, with additional lines planned between the plaza and the railway station. To fund the second and third stages, there are plans to approach international financial organisations, Maselov says.


bne October 2012


Lucas paradox Ben Aris in Moscow


he markets are not rational. Classical economics says that capital should flow to those investments that pay the highest returns, but according to Nobel laureate Professor Robert Lucas of the University of Chicago, capital actually flows the other way in times of crisis – a phenomenon dubbed “the Lucas paradox.”

The same sort of mismatch is apparent in the number of stories on top companies. The internet is a hot sector again, yet a search of the Financial Times archive for “Google” returns 13,698 results and 504 for “Groupon”, yet a mere 94 for “Yandex”, which is not only Russia’s biggest online business, but the biggest online business in all of Continental Europe.

Bond investors have fled emerging markets and rushed into US Treasuries and even loss-making German bunds in the last two years as tensions in the Eurozone increased.

Yandex and Groupon are about the same size (Groupon IPO’d in November 2011 with a valuation of $17.8bn, which has fallen to $2.77bn now; Yandex IPO’d in May 2011 with a valuation of $11.2bn, which is $6.9bn now), but Yandex commands only about a fifth of the attention of the international press.

Why would investors lock themselves into guaranteed losses when they could buy assets like the Russian state-issued OFZ that are paying at least 5% interest and are backed by the most robust fundamentals of any country in Europe? In the boom years, yields on OFZ tightened against US Treasuries to such a degree that the spreads threatened to turn negative, only to soar when the financial firestorm struck. Now the spreads bear little relation to the progress – both social and economic – that Russia and other emerging markets have made over the last decade. Traditionally, the pain of a crisis can be measured by the Misery Index, the addition of inflation and unemployment. But to better capture how life feels to populations in emerging markets, bne adds poverty to create the Despair Index. As the chart shows, Russia (and most emerging markets) have lower levels of despair than the US. (Differences in the quality of life are reflected in the higher cut-off for poverty in developed markets.) There is a tremendous mismatch between the economic realities of the global economy and the allocation of assets. Emerging markets currently account for about 40% of global GDP and 80% of global growth, according to Sweden’s Swedbank, yet their allocation in total global assets under management is only 8%. Professor Lucas told this correspondent he can’t fully explain his paradox, but suspects that lack of information and the relatively poor quality of institutions in emerging markets are the main causes.

And Yandex is the most famous internet company in Russia by a long chalk: Groupon’s main rival in Russia, Kupikupon, has seen revenues go from $400,000 to $30m in just over two years, yet it has had only two stories in the FT (both of which are only available on the website) against the dozens on start-ups in the

"The paradox springs from globalisation being still at an early stage" UK and US. Given that Russia is growing strongly and well on its way to becoming the largest consumer market on the Continent by around 2018, surely it warrants more coverage. The bottom line is the Lucas paradox springs from the fact that the much-vaunted globalisation of the world’s economy is still at an early stage. Investors in the global financial capitals still have a very parochial view, concentrating on their own backyard and largely ignoring the fast growing emerging markets that offer the best returns.

US / Russian sovereign bond "despair" US / Russian sovereign bondspread spread vsvs "despair" indexindex 50









According to the old saw “invest in what you know”, the low allocations make sense simply because there is so little reporting on what is happening in emerging markets. The US press corps currently numbers about 60,000, according to the US Bureau of Labour Statistics, or one writer per 5,300 citizens. By contrast, the entire English-speaking press corps in Russia numbers about 300, according to bne’s estimates, or one journalist per 834,000 people.










5 0 2003

0 2004



Russian despair


US despair

Source: Thomson Reuters Datastream, bne




US T bills vs OFZ spread (RHS)




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Special Report: Azerbaijan

Special report I 59

bne October 2012

The coming consolidation in Azerbaijan's banking sector Clare Nuttall in Astana


igher capital requirements for Azeri banks are set to force consolidation and reduce risks in a sector currently expanding rapidly along with the growth of the country's non-oil sector. Larger banks will, Baku hopes, mean larger loans to support development of the economy, but for the 72% of banks that fall below the new threshold the next 15 months will be a scramble to find new partners or risk losing their licences. Banks have already started to look for new partners after the Central Bank of the Republic of Azerbaijan announced on August 3 that it was raising the minimum aggregate capital requirements. The new requirements will be quintupled from AZN10m ($12.7m) to AZN50m ($63.7m), with banks having until January 1, 2014 to increase their capital or find another solution such as merging with another bank. Azerbaijan has 44 commercial banks – a large number given the country's

population of just over 9m. As of April 1, only 12 of those banks met the new requirements, according to data from APA-Economics. "The central bank raised capital requirements for banks to strengthen the banking sector and increase its sustainability. The bank's

investors. Azeri bankers say that while the country has a relatively low level of foreign ownership right now, this is not for lack of potential acquisition targets, and M&A is expected among local players. "We have seen the same process across Europe. It will make banks

"Consolidation will make banks improve, encourage banks to be more competitive" aim is to take the sector to a new stage of development, [with] larger banks that can benefit from economies of scale," says Elchin Gadimov, vice chairman of the board at Rabitabank. This consolidation process has already occurred in other countries. Kazakhstan, for example, raised equity capital requirements to KZT5bn ($33.2m) in 2009, a move that led to several acquisitions of smaller banks by international

improve, encourage banks to be more competitive. Unibank already meets the capital requirements, but we expect M&A among some other banks," says Yevgeniy Soltanov, marketing manager of Unibank. Within Azerbaijan, banks have already started to react. NBC Bank was quick off the mark, raising its capital from AZN20m to AZN50m just five days after the central bank's announcement. And


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Gadimov says Rabita is considering how to comply. "We are looking at our options, which include an alliance with an institutional partner, consolidation or raising capital on the local market. We would consider a merger with or acquire another bank if both parties

"The central bank's aim is to take the sector to a new stage of development; larger banks can benefit from economies of scale" had the same market focus and vision for the future – the right mix is essential." AccessBank Azerbaijan's CEO Michael Hoffmann notes that there are still questions about how the ruling will be enforced. "The new legislation should have a significant impact on the banking sector, as some banks are well below the threshold... It is not yet clear what will happen to banks who fail to meet the deadline, or whether there will be extensions," he tells bne.

Azerbaijan prepares law to develop capital market

Diversification Strengthening the banking sector is part of the government's strategy of growing Azerbaijan's non-oil sector. After more than a decade of lopsided development, with Azerbaijan's booming economy almost solely reliant on its oil and gas sector, in recent years the government has made a concerted effort to diversify the economy. Realising that the energy boom cannot last forever, Baku has started using its hydrocarbons revenues to grow the non-oil sector, and launched anti-corruption efforts in a bid to stop small businesses being stifled. In 2011, Azerbaijan's GDP growth dropped to just 0.1%, but the non-oil sector expanded by 9.4% during the year, government data shows. This is positive for Azerbaijan's banks, which are very active in the non-oil sector. "Azerbaijan's banks are a very important contributor to growth of the nonoil sector, but at present the banking sector is very fragmented and the banks are limited by their size and consequent ability to efficiently meet financing needs available on the market," says Gadimov. "The decision to increase capital requirements will create larger and stronger banks, making it possible

leader at PwC Azerbaijan, says it is important that the law specifically provides for strengthened protection of investor rights. "This is a very crucial pillar for successful modernisation of the capital markets and the overall economy of the country. This effort also entails facilitating establishment of corporate entities," Feder tells bne.

Clare Nuttall in Astana Azerbaijan is working on a new law governing the country's capital market in an effort to create a modern financial system capable of supporting the country's economic development.

"Setting ground rules for market participants shall then gradually lead to the next step, which is the strengthening of the regulatory environment to enforce reforms. Currently, there are a number of bodies participating in the regulation of the capital market," says his colleague, Elchin Ibadov, director and PwC Academy leader.

Azerbaijan launched a decade-long programme on development of the securities market in 2011. Government and stock exchange officials are working alongside international organisations including the EU and the World Bank, which has provided a $12m loan to support the project.

At present, Azerbaijan's capital market has a low level of capitalisation and turnover. Confidence in the market is also relatively low, and an increase in financial literacy – among both the population and financial institutions – is essential for it to fully develop.

The planned legislation includes several EU recommendations. Dan Feder, partner and assurance

Feder stresses the importance of increasing financial transparency in Azerbaijan. "Here, the roles of indepen-

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Special report

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for banks more confidently to pursue investment opportunities and also invest into larger projects." Overall, banks have been growing rapidly, helped by the government to overcome the first wave of the 2008 crisis, with the central bank giving additional liquidity to banks that needed it. The crisis also forced a switch in focus from the corporate to the retail and small and medium-sized enterprise (SME) market segments. "After the crisis, some banks changed their strategies to put more focus on retail banking. Currently, Unibank is more focused towards the retail segment. We plan to expand further in the retail market," says Soltanov. As economic activity in Azerbaijan becomes more diversified, banks are increasingly expanding into previously neglected areas of the economy – both geographically and in terms of sector focus. "We have seen a lot of growth in the regions, in agriculture and other parts of the non-oil sector. This is not only major towns outside Baku, but also regional towns with populations of 100,000-200,000, many of which are exhibiting growth in the high double digits," says Hoffmann.

dent auditors and the Ministry of Finance, as the regulator of financial reporting matters, are crucial to achieve the required level of financial transparency," he says. While the capital market modernisation programme addresses the main areas of importance specific to the market, according to Feder and Ibadov, other areas including fundamental issues such as investor protection also need to be addressed. As an oil and gas rich country that was one of the fastest growing economies in the world in the mid2000s, Azerbaijan has no shortage of cash for economic development. Expanding the non-oil sector has become a government priority, and development of the capital market would increase the options for growing companies outside the natural resources sector. Therefore, a strong effort to develop the capital market, coupled with wider-reaching economic reforms, would be a vital step to supporting businesses. "Azerbaijan receives substantial amounts of oil and gas revenues, which creates a significant pool of investment capital

for many businesses that are not able to expand globally due to lack of efficient funding," says Feder. That said, Ibadov says resilient infrastructure, strong human capital and overall confidence in the economy are key factors to facilitate the optimum circulation of these funds. "The future of the capital market in Azerbaijan will heavily depend on the success of the coordinated effort of the Azerbaijani government with global institutions on one hand, and with local businesses and consumers on the other." In the longer term, it should also be possible for Azerbaijani companies to tap international capital markets as their peers from Russia and Kazakhstan have done. This, however, is some way off, given that there are few local companies with the necessary corporate governance, transparent financial reporting and financial sophistication needed to IPO internationally.


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Azerbaijan puts its foot on the gas

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bne October 2012

sortium are also still in the process of choosing a winner from the final two competing projects for onward delivery of the gas from the Turkish border to Europe, with the Nabucco West option targeting Central Europe and the TransAdriatic Pipeline (TAP) project targeting Southern Europe.

Priding themselves on the availability of highly skilled staff, SCIP plans to open a specialist technical school within the park to offer intensive training in dedicated subjects and will, if necessary, sponsor students to study at European universities to comply with investors' requirements of specialist skills. "Sumgait is full of chemical specialists and we intend to utilise their knowledge and experience," says Mammadov.

Nicholas Watson in Prague


ith Azerbaijan's energy ministry now expecting that the second stage of the giant Shah Deniz offshore gasfield could produce significantly more gas than thought, plans to deliver that gas into the heart of Europe gather pace. On September 18, Industry and Energy Minister Natik Aliyev told reporters on the sidelines of the "Oil, Gas and Media Conference" in Baku that Shah Deniz 2, as the BP-led expansion project is called, should be able to produce more than the currently targeted output of 16bn cubic metres of gas per year (cm/y). "In my mind it will be maybe 20bn-25bn [cm/y]," he was quoted as saying. The Shah Deniz field, which is already producing gas from its first stage, has more than 1 trillion cm of gas in place, according to BP. The British operator of the project holds a 25.5% stake, as does Norway's Statoil. Other shareholders include Azeri state oil and gas company Socar, Russia's Lukoil, Iran's NICO and France's Total. Plans to get that gas to customers centre on the Trans-Anatolia gas pipeline (Tanap), which will run from Shah Deniz across Turkey, from where a second pipeline will carry gas from the field to Europe. Thus it is well on the way to establishing itself as a lynchpin in the EU's coveted "southern energy corridor," which is intended to reduce Europe's dependence on Russian gas. The inter-governmental agreement signed between Turkey and Azerbaijan in June has paved the way for the Tanap project, with Azerbaijan set to provide 10bn cm/y of gas for transit via the pipeline to European consumers, while another 6bn cm/y is to be supplied for Turkey itself. Currently, Socar owns 80%

of Tanap, with Turkish partners Botas and TPAO, holding the remaining 20%. But in September it became clear that Socar would like to offer up to a 29% stake in the planned pipeline to its partners in Shah Deniz. "Socar will leave for itself 51% of the share capital, 29% will be sold to other companies, thus the controlling stake will remain with Socar," the Azeri firm's president, Rovang Abdullayev, said. IHS Global Insight says Abdullayev's comments indicate that, "Azerbaijan is keen to bring in other members of the

There are growing hopes that Azerbaijan's gas production could be such that it can fill both of those pipelines. On September 20, Abdullayev announced that Socar had begun the first gas production from its offshore Umid field. Umid is the second largest gas structure in Azerbaijan's sector of the Caspian Sea, with reserves estimated at 200bn cm of gas and 30m tonnes of condensate. Commercial production from Umid will commence by the start of 2013, with output from the field eventually providing Azerbaijan with another 6bn cm/y to export for 30 years.

"Rather than choosing between TAP to Italy via Greece and the Nabucco West pipeline to Central Europe, Azerbaijan could supply sufficient gas to fill both routes" Shah Deniz consortium to the pipeline equation in order to share the financial cost of the multi-billion-dollar project… as well as to ensure their support for exporting gas via this route." Abdullayev also went on to confirm that construction of Tanap, which has an estimated price tag of $7bn, is due to begin in 2013. The pipeline will initially have a capacity of 16bn cm/y, which may later be increased to 32bn cm/y or even 60bn cm/y. Turkey, which will take 6bn cm/y from the first stage capacity for itself before sending the remainder onwards, said it is also working on a potential deal to fill the potential expanded capacity with gas from Turkmenistan, assuming that the gas can be carried across the Caspian Sea. Pipe plans Azerbaijan and the Shah Deniz con-

Development of the Umid field, together with other offshore fields operated by Socar, is expected to enable Azerbaijan to more than double its gas production to around 40bn cm/y by 2025. "Gas production from these fields, as well as from Total’s Absheron discovery, is boosting the Azerbaijani government’s confidence that it can increase its gas production enough to support exports through both of the two remaining gas pipeline proposals seeking to carry Azerbaijani gas to Europe from the phase-two development of the Shah Deniz field," says IHS Global Insight. "Rather than choosing between the TAP to Italy via Greece and the Nabucco West pipeline to Central Europe, Azerbaijan could argue that it can supply sufficient gas from Shah Deniz phase two and future output from Umid, Babek, and Absheron to fill both routes."

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Promoting a chemical reaction in Sumgait Jahan Hoggarth in Sumgait


ith the non-oil sectors of Azerbaijan's economy growing rapidly thanks to government subsidies, the frenzied diversification of the economy is filling up Azerbaijan's run-down industries like a swollen river regenerating the dried-up streams. Beating the drum of Azerbaijan's diversification policy is Azpromo, the state promotion agency, which is hard at work fostering non-oil industries and encouraging investors. And no job is too big or too small; from restoring the production of old favourite sweets at the Guba sugar factory, to pioneering opportunities in solar energy, to reviving in an environmentally and economically sustainable way Azerbaijan's industrial hub Sumgait, located about 30 kilometres from Baku, by turning it into a free economic zone. Once an industrial centre of the Soviet Union during World War II, Sumgait was a grim example of neglect and environmental degradation resulting from the Soviet-era chemical plants, many of which have been closed down since the 1990s. Yet Sumgait as an industrial centre is the basis of the Absheron economic region, where nearly 90% of the industrial potential of the country was centered, including large petrochemical plants. It's not surprising, therefore, that the city's restoration and industrial revival is high on Azpromo's list. Recently formed,

the Sumgait Chemical Industrial Park (SCIP) is a good example of the government's efforts to create new opportunities and a favourable environment to encourage businesses to invest. Located on a land plot of 163 hectares, SCIP is a one-stop-shop entity created solely to develop Azerbaijan's chemical and petrochemical industry through private investments and foreign knowhow. With a minimum investment capital of €1m, investors will be offered zero customs duty, VAT and income tax. SCIP also plans to offer to co-finance projects up to 30% of total costs. Acting as a "buffer" zone between the government and private companies, SCIP will ensure fast licensing and registration, as well as relief from bureaucratic complications. "We offer access to a wide range of international markets and export opportunities," says Samir Mammadov, business support manager at SCIP. "Russia, Iran, Turkey, Georgia and Europe via Georgian sea ports – all are within easy reach from Sumgait. We can also access Kazakhstan and Uzbekistan via the Caspian sea."

Employment opportunities With the demolition of the old Soviet factories in full swing, SCIP estimates that the park will be open for business in six months' time. SCIP's new infrastructure will include railways; the Azerbaijan-Russia motorway; and an industrial seaport. They also plan to develop the park into a living complex with shops, playgrounds, sports centres, and financial services. According to SCIP's estimates, the capacity of new working places could be up to 10,000 people. With so much on offer, the heads of SCIP are also clear on what they're looking for in a potential investor. "Attracting foreign know-how and latest technology is very important to us. Companies that are unable to bring in new technologies with them will not be able to invest, independent of their investment amount," says Mammadov. The main investors to be targeted are those involved in the production of plastic materials, the food industry and medical supplies. SCIP is already in talks on a variety of production opportunities, such as compound ink for printer cartridges, plastic door frames and hosepipes. "There isn't much around yet, as we're busy demolishing the old Soviet factories for the time being, but the interest from abroad is huge already. We offer cheap resources, access to oil and gas products, and small investment capital. There are no equivalents to what we're offering in the radius of 1,000 km from Sumgait.

"Russia, Iran, Turkey, Georgia and Europe via Georgian sea ports – all are within easy reach from Sumgait"


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residential buildings, designed for different incomes, the project hopes to achieve social diversity in a vibrant community. Planned housing of a large number of offices and even separate banking district will bring a range of economic opportunities, supporting the project’s idea of economic sustainability.

From black to white in Baku Jahan Hoggarth in Baku


or regular observers of Azerbaijan's economic development, the sight of computer-generated images of soaring skyscrapers and buildings in the shape of flying saucers has become an all-too familiar one. Chances are that if you Google any construction project in Baku, the search result will turn up lots of YouTube videos of futuristic architectural designs that are intended to reshape the face of Baku. At first glance, the Baku White City project – the latest state-sponsored project designed to modernise Azerbaijan's capital – looks more of the same. But beyond the glitzy images is a government-driven initiative to improve Baku’s polluted environment with sustainability as its core value and land reclamation as the main goal. Phenomenal architecture is a bonus. There's irony in the project's name. When the first oil boom swamped the city with heavy oil production, an industrial oil-belt, known as Black City, appeared on the eastern side of Baku at the turn of the 20th century. Shifted from the centre of Baku, the oil refineries spread out across the Black City, pol-

luting the environment and blackening the buildings with soot and smoke. Years later, after the oil production has moved to the other parts of the country and most of the old refineries shut down, the Black City has been left looking derelict and in desperate need of modernisation and regeneration. And that's where the story of Baku White City begins. A Monaco-sized complex

As expected, the world's best architectural and engineering experts were invited to design what is Azerbaijan's most ambitious urban development to date. The masterplan was created by the global engineering and architectural design firm Atkins (UK), which is famous for its Burj-AlArab project, the tallest hotel in the world built on water. The internationally renowned Foster+Partners and F+A

"Baku White City will create a new modern centre for the capital city" that will contain an array of residential and office buildings, the region’s largest shopping mall, hotels, entertainment and sports centre, Baku White City will create a new modern centre for the capital city. Architects arrive Propelled by the government's action plan to improve Azerbaijan's ecological condition, the 221-hectare site has become one of the most attractive investment opportunities in Azerbaijan.

Architects, US experts in the planning and design of retail stores and shopping malls, have also been invited to join the Baku White City project. Driven by the idea of building something progressive on the reclaimed land, the project team took sustainability beyond the idea of solar panels. Social and economic sustainability are among the core values of this ambitious project. By providing mixed-scale

The government is overseeing the supply and implementation of new uitilities and transport infrastructure, subsidising new road and pipeline works, and the development of a range of public transport options, including new subway stations and a waterfront tram link. But project developers are determined to utilize the existing infrastructure to reduce the need for development on environmentally sensitive land outside of the city. Baku White City will benefit from the close proximity of shops, offices and residential buildings to encourage walking and reduce the use of cars. The development will also contain at least six parks, as well as tree-lined streets and avenues throughout the complex. Environmental sustainability is paramount to Baku White City. The buildings, such as the Baku White City Office, are made using environmentally friendly materials, along with the use of alternative energy solutions, such as Solar Energy Harvesting Photo-voltaic cells. All new infrastructure, transport and utility units will comply with European and International standards. By creating new investment opportunities, bringing in new infrastructure, and housing many retail, financial, commercial and leisure companies, the developers are also hoping to rejuvenate the local community through creating new employment opportunities, estimated at up to 48,000. The project is keen to attract both local and foreign investment, offering investors a variety of residential and commercial buildings, from small villas to large-scale urban projects. Other investment opportunities include hotels, private schools, clinics, sports and spa centres. Independent of the size of the investment, the project will also provide legal and organizational support to all investors.

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Baku White City Office Building is soon to become one of the iconic buildings of Baku. The building is envisioned as one of the signature buildings of Baku White City project. Situated in the East of the city centre, on the Nobel Avenue one of the main traffic arteries of Baku, it shapes a spectacular entrance to the site from the West and has excellent views, including a broad panorama of the Caspian Sea. It’s a striking modern architecture mixed-use development featuring high-end offices, with residential boutique apartments on the West side, convenient retail and commercial areas on the ground and first floors with the total surface area of 27000 sqm. Landscape with water features and expansive pedestrian areas facing Nobel avenue create a feeling of a large urban plaza. The building's elegantly curved silhouette is formed by modern environmentally friendly materials, along with use of alternative energy solutions. The ultimate objective of the design was to create a landmark building framing an entrance to the new development from the city centre as a gateway feature; a working sculpture, which will be an enduring signature not only for the Baku White City project but for Baku as a whole. In sharp contrast to the surrounding buildings which are heavily influenced by period Parisian architecture, the form of the Baku White City Office building is a fluid, sensuous modern form. A grand arch at the base lifts the building off the surface of the site, visually linking the pedestrian plazas to the North and South, and further enhancing the notion of a portal into the site. Baku White City Office Building was designed to integrate Solar Energy Harvesting Photo-voltaic cells in building canopy. This solution is to provide the building with clean energy in the form of electricity. The entrance canopy alone has an area of 362.7 sqm, which would generate a daily average energy yield of 144.1 KW. Integration of LED technology was also an integral part of electrical design.


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PASHA Bank – from local leader to international player


ASHA Bank, the leading corporate bank in Azerbaijan, has launched the third phase of its long-term growth strategy and is moving from being a leading player on the Azeri market to becoming an international bank. In September, Standard & Poor’s granted the bank its first international rating, awarding it a 'BB-' long-term and 'B' short-term counterparty credit ratings – the highest of any commercial bank in the country. Fitch Ratings followed two weeks later, granting the bank a 'B+' rating with a stable outlook, highlighting the bank’s “sizable capital buffer, considerable liquidity cushion and reasonable performance.” The two ratings confirm PASHA Bank’s reputation as a leading innovator in the Azeri market and international outlook. “The ratings come as the result of five years of hard work, but they remain constrained by the sovereign rating and the debt of the banking sector as a whole. However, we were very pleased with our rating and look forward to working on further improving it,” says PASHA Bank’s chairman, Farid Akhundov. The ratings open up new opportunities to diversify the bank’s funding base; PASHA Bank is currently negotiating the country’s first syndicated loan with international partners in a deal that should be completed this autumn. “We are keen to diversify our funding base and this is an obvious next step,” says Akhundov. “We want to issue a syndication or club loan before the end of the year.” The deal will be the first international borrowing by an Azeri bank, but PASHA

Bank is already playing a leading role on the emerging domestic capital market. In June, it co-managed with French bank BNP Paribas a $150m Eurobond by Baghlan Group, which is developing the Bahar and Qum Deniz offshore oil deposits. It was the first time an Azeri bank lead managed an international bond issue, which had a 14.75% coupon and is due for repayment after three years. The bond was one of four PASHA Bank has participated in organizing, raising a total of $90m for domestic issuers from a variety of industries, including a domestic commercial bank and a telecommunications company. The bank also launched market-making services for mortgage-backed bonds in July, and took one step closer to providing such services for a new issuer whose name as well as the parameters of the bonds will be disclosed in the near future. “There is a lot more interest in the topic of bonds than before, as local businesses are starting to look at new ways to finance their growth,” says Akhundov. PASHA Bank’s ratings and Eurobond are confirmation of the bank’s international perspective, and this autumn it will open its first branch outside the country with one in the Republic of Georgia. “We decided to set up a branch in Georgia, as our clients are increasing their business, trading and investments there,” says Akhundov. “We wanted to set up a branch to be able to serve them better, and the tax and legislative regime in Georgia is very friendly so we can open a branch relatively quickly and easily.” Georgia is amongst the most progressive countries in the former Soviet Union and already several international banks from

Farid Akhundov, Chairman of the Executive Board

both Russia and Western Europe have expanded there, something which PASHA Bank sees as a challenge, not a problem. “Eventually, these banks will come to Azerbaijan too. We thought that we could learn from them, from the competition, in Georgia so that we will be better prepared when they come to our home market,” says Akhundov, who was the head of HSBC in Azerbaijan in the 1990s, before it pulled out during the 1998 crisis. PASHA Bank has been able to build on its existing business in Georgia, where it is already directly financing projects and has various interbank loans and money market transactions as the two economies become more closely integrated. A bit further down the road, PASHA Bank also intends to open another foreign bank in Switzerland to offer services to its private banking clients. In the meantime, the bank continues to expand its domestic business and plans to open two more branches in Azerbaijan’s regions this autumn to capitalise on growth in its home market. The global economic debt crisis impacted Azerbaijan, but it was amongst those least affected by the crash; Azerbaijan’s economy continues the process of transition to a market economy unabated. “You can see growth in our market,” says Akhundov. “The government is working hard to diversify the economy away from oil production and while the oil sector grew by 2% in 2011, the non-oil sector is growing much faster – up to 8% in 2011. This creates more opportunity and more companies that need our banking services. It is a trend that will only accelerate in 2013.”

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Back to Baku with AZAL INTERVIEW:

Jahan Hoggarth in Baku


n 1991, when Azerbaijan split from the collapsing Soviet Union and central government subsidies dried up, its economy was in tatters and its infrastructure almost non-existent. Left without funds, the Azerbaijani government had to scramble to find ways to survive the new and alien market economy – Azerbaijan Airlines (AZAL), which had been carved out of Aeroflot, was no exception. Aeroflot bequeathed AZAL a huge fleet, including more than 20 Soviet-made Tupolev airliners, but little else. So to secure its long-term future, AZAL's management decided to go down the privatisation route, which involved reorganizing the company into five units – the airline, airports, air traffic control, inflight catering and cargo – and then bringing in the private sector to manage parts of it. In 2005, Silk Way Holding, an Azeri private aviation company, took over some parts of the business, while other strategically important parts, such as air traffic control, staff training and fuel supply to airports, remained in the control of AZAL. "If we hand it over to a private company, they'll jack up the fuel prices," says Sabir Ilyasov, AZAL's first vice-president. "We have a unique amalgamation of private and government sectors here at AZAL." Collaboration with Silk Way has helped AZAL to increase the number of flights to the regional cities of Azerbaijan, and for some of these cities this opportunity is vital. "With up to six flights per day, 70% of communication with the Nachichevan region of Azerbaijan [enclosed within Armenian territory] is done via airways, as the region is in blockade." Hubbub According to Kamran Gasimov, CEO

of Silk Way Airlines (part of Silk Way Holding), the volume of cargo flights is falling rapidly around the world due to the global slowdown and the opening of international land borders that is making ground transportation cheaper and more accessible. "On average, we currently lose one out of three cargo flights a week, but we have to keep flying to keep our air space with our destination countries,” Gasimov says. As a solution, AZAL and Silk Way plan to turn Baku into a hub of international transits and cargo flights. "We are working together with AZAL to secure the state the reputation as a key regional hub," says Gasimov. The new Air Traffic Control Tower will allow AZAL to increase the number of chargeable flights over Azerbaijani territory, whilst a new cargo terminal will offer technical assessment, support and refueling to more airplanes using Baku as an interchange between Europe, the Middle East and Southeast Asia. "This will also allow us to pay off the loans taken to purchase the new airplanes," explains Ilyasov, referring to the airline's new fleet. That will include two new aircraft from the Boeing 787 Dreamliner series in 2014, which would make AZAL the first airline in the CIS region to operate such planes. The ambitious plan is to use these on a Baku-New York route. "We have already done a trial flight to New York and it was just under 12 hours," Ilyasov says. The "hub" idea is very much a desired outcome for AZAL. If plans to add Peking as a new destination materialize, it would increase the number of passengers, albeit business tourists, travelling to China via Azerbaijan.

Cost of improvement Monitored by an assertive government, AZAL is constantly under pressure to improve its service. The latest push was the purchase of special equipment for scanning passengers' shoes without having to take them off. "It's a rather unpleasant procedure when you have to take your shoes off in front of other people," Ilyasov sniffs.

What you need to know

Once very affordable, AZAL's ticket prices have rocketed over the last five years as a result. "With the latest technology available and the most modern airplanes in our fleet, our costs have increased," Ilyasov admits. "Improving the quality of our service, even the on-flight food, costs a lot of money and that is, unfortunately, reflected in the price of the tickets." Key to AZAL's success will be the government's attempts to put Azerbaijan on the tourist map; the country can offer not only beach resorts, but also skiing holidays in the Caucasian mountains, with some of them covered in snow all year round. Measures are being taken by the Ministry of Tourism and Leisure to develop infrastructure and to keep costs affordable to encourage a sustainable level of tourism. "The Azerbaijani government recognizes the fact that it's cheaper and less hassle for international tourists to travel to Turkey, for example, than come to Azerbaijan. I can say that measures are being taken to improve the situation and encourage mid-range tourism to our country," Ilyasov says. Ilyasov says the tourism push has been helped by Baku hosting this year's Eurovision Song Context. "It was the biggest advertising campaign we could've hoped for."

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