bne September Crash or Crunch in CEE

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bne:infrastructure April 11, 2011 I No 18

Page 3

Top story

www.afi-development.ru

Real estate Infrastructure SinoCIS

AFI Development says reaches deal with City of Moscow about two major projects VTB Capital News: AFI Development announced that it has reached an agreement with the City of Moscow Government about its two major projects. The company is to: * transfer the development rights to Tverskaya Zastava Mall (its second largest project) to Moscow City, with full compensation for development costs which have been incurred; * purchase the city's 25% share in AFI Mall and the adjacent car park for USD 310mn.

Our View: Tverskaya Zastava was the most important long-term project in the company's portfolio, with a scheduled completion date of 2014. As of 3Q10, total capex incurred since the beginning of the construction was USD 75mn and had been financed

by Sberbank's project financing facilities. AFI Development will remain the owner of the projects surrounding Tverskaya (350,000sqm of commercial and residential space) but the concept has not been finalised and so we do not exclude the risk of similar governmental decisions.

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News, features and interviews with movers and shakers from the 30 countries of the region.

Inside this issue: Russia's Ponzi problems CEE factories go quiet Bulgaria's fiscal prudence pays off Astana la vista, baby September 2011 www.businessneweurope.eu

Special Report: Tatarstan

OR

in CEE?

bne September 2011 Editor-in-chief: Ben Aris (Moscow) editor@businessneweurope.eu

Contents

+7 9162903400

I3

12

Managing editor: Nicholas Watson (Prague) +42 0731582719 watson@businessneweurope.eu Eastern European editor: Tim Gosling (Moscow) +7 9031927966 gosling@businessneweurope.eu Eastern Europe: Graham Stack (Kyiv) stack@businessneweurope.eu

+7 9266052742

Central Europe: Robert Smyth (Budapest) +36 19995200 rsmyth_hu@yahoo.com Jan Cienski (Warsaw) +48 604994850 jancienski@ft.pl Mike Collier (Riga) +37 129473192 editor@balticfeatures.com Matthew Day (Warsaw) +48 607291187 mattday@businessneweurope.eu Tom Nicholson (Bratislava) +42 1907732736 tom.nicholson@sme.sk Kester Eddy (Budapest) +36 308665550 kester.eddy@gmail.com Steven Roman (Tallinn) +372 56665911 steven@online.ee Southeast Europe: Justin Vela (Istanbul) justinvela@bne.eu David O'Byrne (Istanbul) davidob@ttnet.net.tr Bernard Kennedy (Ankara) bkennedy@superonline.com Ian Bancroft (Belgrade) ian.bancroft@transconflict.com Bogdan Preda (Bucharest) bpreda@gmail.com Branimir Kondov (Sofia) br_kondov@yahoo.co.uk Guy Norton (Sofia) norton@bne.eu

22 COVER STORY 6

The Insiders

20

CEE factories go quiet

8

Crash or Crunch?

22

Swiss squeeze in Hungary

Perspective

23

Debt crimes and misdemeanours

24

Polish banking giant's share issue is no joke

11

+90 5393614470

EASTERN EUROPE

+90 5359210950 +90 535 7485120

12

Russia's Ponzi problems

26

Latvia prepares for three-way split

14

Bogolyubov shows steel in global pursuit of manganese

28

Estonia swims against the economic tide

+40 722580137

15

Russian steelmakers forge ahead

16

Dixy wins promotion to Russian retailer premier league

18

Trial and error in Ukraine

+38 513835929

Eurasia: Bureau Chief: Clare Nuttall (Almaty) +7 7073011495 nuttall@businessneweurope.eu Molly Corso (Tbilisi) molly_corso@yahoo.com Oliver Belfitt-Nash (Ulaanbaatar) +97688113149 oliver@businessneweurope.eu

CENTRAL EUROPE

Advertising & subscription: Elena Arbuzova +7 9160015510 Business Development Director arbuzova@businessneweurope.eu Alec Egan +44 2030516548 Business Development Director (International) egan@bne.eu Design: Olga Gusarova-Tchalenko +44 7738783240 o.gusarova@businessneweurope.eu

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bne September 2011

Contents

40

Feeling at home in Central and Eastern Europe starts right here.

36

58

SOUTHEAST EUROPE 30

Bulgaria's fiscal prudence pays off amid debt crisis

32

Turkey's new monetary policy – contradictory at best

EURASIA 40

Astana la vista, baby

41

Succeeding in Kazakhstan

42

IT in Tbilisi

33

Turkey looks to break import addiction

44

Corporate Statement: PASHA Bank

34

Kosovo – half a step forward, three steps back

46

Nomads in the global market

47

Making tracks to Astana

36

Bosnia's fiscal fragmentation

38

Slovenia tries to stop the Srot

SPECIAL REPORT 55

Tatarstan's agents of investment

58

Combining east and west to go global

59

Tatarstan building its future

60

Hi-tech Tatarstan

62

Alabuga or bust

63

Tatarstan puts faith in Islamic finance

64

Cleaning up in Tatarstan

66

Countdown to the 2013 Kazan Universiade

67

CLASSIFIED

70

UPCOMING EVENTS

SPECIAL FOCUS

39

15 million customers have selected us as their bank of choice.

Raiffeisen Bank International represents more than 20 years of experience in Central and Eastern Europe, covering 17 markets in the region with subsidiary banks, leasing companies and other financial service providers. International companies, local businesses of all sizes and private individuals rely on our network of around 3,000 branches.

Over 100 international banking awards validate the group‘s service quality. www.rbinternational.com

48

Fund Survey 2011: Grin and Bear it

Zagreb joins in Swiss franc fight

I5

6

I The Insiders

bne September 2011

The politics of economics

Marcus Svedberg of East Capital

T

he catalyst to the renewed turmoil in the global financial and economic system was the inadequate policy response from the US and the Eurozone. The market was dismayed to see how the infighting between American politicians almost shut down the government and yet failed to reach any significant agreement on the underlying budget and debt problems. Meanwhile in Europe, the leaders of the Eurozone call emergency session after emergency session without coming up with much of substance other than promising more summits, benchmarks and coordination.

It is, therefore, tempting to think that the economic and financial crisis is also a crisis for the Western liberal democratic model of economic governance. This is an especially appealing line of thought since the Chinese economy, which is the least democratic country in the G20, has outperformed throughout the crisis. Even if one has reservations about the long-term appeal and sustainability of non-democratic governments, is it possible to think that representative governments are great when things are going well but awful in times of crisis, and vice versa for authoritarian regimes? A friend posed that question recently and as appealing as it may be to answer affirmatively, I believe it would be a mistake to rush to that conclusion.

It is about economics…

First of all, not all undemocratic economies outperformed and not all democracies underperformed during and immediately after the crisis. Looking at the 2009-2011 period, India, which is considered a free economy by Freedom House, was the second fastest growing G20 economy, while Russia, which isn't reckoned to be free, was one of the worst economies. The level of economic development seems to have a stronger relevance, as the three fastest growing economies – China, India and Indonesia – also happen to be the three poorest in GDP/capita terms. Similarly, the three worst economies from a growth perspective – Japan, UK and Italy – are among the richest.

Second, growth is about economics, not politics. Although politicians often think that they can create or administer growth, they can merely create an environment conducive to growth. They can also, as has been crucial during this period,

stimulate the economy through extraordinary packages and bail out struggling enterprises (often banks) that are deemed crucial for maintaining the stability of the system. The Chinese received a lot of praise for the speed, size and implementation of the stimulus, while the Europeans and the Americans were criticised for being too late and moderate with their initiatives.

But at the end of the day, it is companies that create growth by increasing the capital or labour base, or their productivity. It is obviously easier to achieve this when moving from a low base, which has little to do with form of government, and implementation may be quicker in an authoritarian regime, but it is not necessarily better. … and transparency Third, and perhaps most importantly, having a multitude of actors with a high degree of independence is sometimes messy, but should be able to create a more favourable outcome over time.

Take the role of central banks. The European Central Bank, Bank of Japan and the US Federal Reserve have – through

"Although politicians often think that they can create or administer growth, they can merely create an environment conducive to growth" quantitative easing, dramatic rate cuts, bond purchases and provision of liquidity to the banks – played an enormously important role during the crisis. These institutions act independently from their governments and in a transparent way (although the minutes of the meetings are released with some delay). Central banks in non-democratic economies, on the other hand, tend to be less independent and less transparent,

bne September 2011

thus making it difficult to distinguish it from the regime and to analyse the reasoning behind the policies.

The rating agencies are another example. The downgrade of the US credit rating by Standard & Poor's in early August sent shockwaves through the global financial system. But just as it was possible (although heavily criticised) for an American firm to downgrade its own government, it was equally possible for the market to ignore the change and pile into US debt.

Meanwhile, neither governments nor the market cared that Dagong, the Chinese rating institute, downgraded the US credit rating days earlier. The biggest effect of the S&P downgrade may very well be that it puts pressure on the policymakers. Presidents, prime ministers and ministers of finance may decide the right things, but they may also make the wrong calls and they need independent and influential actors like the media, central banks and rating agencies to tell them so.

Fourth, the state of affairs may not be as good as they seem in non-transparent economies. That debt tends to be lower and growth higher in some of the authoritarian regimes has more to do with the level of economic development than with the form of government. It is emerging markets – democratic or not – that tend to have plenty of leverage and growth potential. Moreover, debt can be hidden and growth rates manipulated. Chinese growth is by any estimate very strong, but many economists suspect there is an element of manipulation, especially as some local governments have incentives to inflate the numbers. And while the official public debt in China is below 20% of GDP, some analysts argue that the correct ratio is closer to 80% if local government debt and non-performing loans of state banks and other pockets where some of the stimulus money ended up are included.

Lessons learned All of this doesn't mean that we should give Western politicians a break or suspect that all politicians in non-democratic economies cheat and lie by default. I am still convinced that representative governments with their network of independent institutions produce better results than authoritarian regimes even during times of stress. But it is of vital importance that we continue to scrutinise their work very thoroughly, especially during challenging times.

I am also convinced that the prospects for emerging economies are brighter than for their developed peers and that they ultimately will democratise. The fact that there are so few non-democratic countries (that are not commodity exporters) among the richest countries in the world, suggests that emerging economies either become democratic or get stuck in the middle-income trap.

And, finally, the government likely to produce the best response to a crisis is a government that has been in a crisis before. Many of the economies that are growing fast and have sound public finances went through a crisis where growth contracted and the economy deleveraged. Think about Latin

American economies in the 1980s, Asia in the late 1990s, or Eastern Europe in 20082009. The Swedish experience in the early 1990s is good example from the developed world, as it is one of the most prudent and fastest growing economies in the EU today.

So, the lesson here is that it is lessons that matter the most when it comes to crisis response and economics that matters most when it comes to economics. Combining liberal economics with authoritarian politics may seem like an increasingly attractive way forward for emerging markets that have not yet become fully-fledged democracies, but it would be a huge mistake to go down that road.

Marcus Svedberg is Chief Economist of East Capital

"The state of affairs may not be as good as they seem in non-transparent economies"

G20 ranking of growth, democracy and standard of living GDP Growth 2009-11

Democracy

GDP/Cap 2011 (USD)

China

32.0%

UK

1

India

1,382

India

27.5%

Germany

1

Indonesia

3,465

Indonesia

17.8%

France

1

China

4,833

Argentina

16.7%

US

1

South Africa

7,585

Saudi Arabia

12.2%

Canada

1

Mexico

10,638

Brazil

11.6%

Australia

1

Turkey

11,054

Korea

11.1%

Korea

1.5

Argentina

11,169

Turkey

7.9%

Italy

1.5

Brazil

12,423

Australia

7.2%

Japan

1.5

Russia

13,543

South Africa

4.6%

South Africa

2

Saudi Arabia

21,685

Mexico

3.7%

Argentina

2

Korea

22,961

Canada

3.3%

Brazil

2

Italy

35,985

US

2.9%

India

2.5

UK

39,459

Germany

1.2%

Indonesia

2.5

Germany

43,205

France

0.5%

Mexico

3

France

43,491

Russia

0.5%

Turkey

3

Japan

45,659

Japan

-1.2%

Russia

5.5

US

48,666

UK

-2.1%

China

6.5

Canada

50,265

Italy

-3.0%

Saudi Arabia

6.5

Australia

64,351

Sources: IMF, Freedom House

8

I Cover story

bne September 2011

Crash or Crunch in CEE?

manufacturing data for Germany, Hungary, Czech, Poland, Slovakia, Turkey, Romania and Russia appears to show is happening. "The real financial crisis only starts after the real shock of the slowing pace of the economy has done its damage; thus it serves as an amplifying mechanism rather than a trigger," the economists say in their book.

This physiology fed the US housing price bubble and the dot.com craze a decade earlier, as well as the intoxication that took over investors into Russia in 1997 and between 2004 and 2007 when they were both pulled into Russian equities by stellar returns and pushed out of the developed markets by the low rates of return.

Does this mean we are headed into a second wave of the 2008 financial crisis, a double-dip recession or just a soft patch from which the global economy will recover fairly soon? A crash in Central and Eastern Europe at any rate seems unlikely, as most of the other pre-

Too much cash in the system usually sends something through the roof during the early stage of the bonanza, but eventually reality reasserts itself and the market typically begins to sell off six to nine months prior to the ultimate collapse and crisis. "Equity prices tend to

"The real financial crisis only starts after the real shock of the slowing pace of the economic has done its damage " conditions that precede crises, identified

by Reinhart and Rogoff, are missing.

Ben Aris in Moscow

"I

was having fun until about three weeks ago," says Roland Nash, sitting in a café next to the new Hermitage theatre. One of Russia's best known analysts, Nash left his job as head of research at Russian investment bank Renaissance Capital earlier this year to join the up-and-coming Verno Capital, a fast growing fund that immediately took in $100m of Arab investment and quickly raised another $70m.

His move was illustrative of an optimistic and buoyant mood in Russia in the leadup to the summer, despite alarm bells sounding of a growing sovereign debt crisis in the West. Smoke from protests and rioting might have been rising over Athens, London and Dublin, but Moscow was calm and upbeat as both confidence and growth returned. The reason is that Russia has few of the problems that plague much of the EU and the US. Thanks to Alexei "Mr Prudence" Kudrin, deputy prime minister and minister of finance, Russia's economy is among the most robust on the planet with one of

the lowest debt/GDP ratios in the world, reserves that can cover 18 months of imports and better-than-expected growth.

The big question is what this means for Emerging Europe? Is it facing yet another crash or merely a painful economic crunch that will pass relatively quickly?

Now investors are looking into the abyss again as markets began tanking in August after the US suffered a rating downgrade, Eurozone leaders appeared unable to get to grips with the single currency crisis and Germany reported its economy grew by an anaemic 0.1% in the second quarter. In Russia, the RTS lost a quarter of its value in four weeks of continuous selling.

Early warning signs The August sell-off in global markets came as a shock, but investors should not have been so surprised, according to Carmen Reinhart and Kenneth Rogoff, who published the much talked-about book, "This Time is Different: Eight Centuries of Financial Folly", last year.

Stock market collapses are seen as "black swan" events, but the book, which studies crashes dating back Elizabethan times, concludes that they are both frequent and generally have several features in common.

Clearly the western world is facing a slowdown that may turn into a second wave of the financial crisis, a double-dip global recession or even a protracted depression. "Karl Marx, it seems, was partly right in arguing that globalisation, financial intermediation run amok, and redistribution of income and wealth from labour to capital could lead capitalism to self-destruct," Nouriel Roubini quipped in August.

The most important of these is that all of the last "big five" economic crises since 1990 (and most of the two dozen other smaller crashes) were preceded by a sharp and protracted slowdown in industrial production, say Reinhart and Rogoff, something that June and July

Cover Story I 9

bne September 2011

The root causes What actually causes a crisis? Annoyingly each time the trigger is something different, but Reinhart and Rogoff highlight several different factors that occur regularly.

One common trigger is a financial market liberalisation or the introduction of financial "innovations." And few would argue that the securitisation of mortgage-related financial products was the villain in this most recent riches-torags story.

Another culprit is what the authors dub a "capital inflow bonanza." In a boom, conditions conspire to attract significant inflows of money to some hot idea – be it a country, an asset class, or a product – that ramp up prices and make success a self-fulfilling prophecy. As Plamen Monovski, chief investment officer of Renaissance Asset Managers, pointed out recently in a paper, the human brain is set up to reward investment themes that lead to "irrational exuberance" and bubbles.

lead commodity prices, in oil as in other commodity prices: the reason why is clear – commodity prices reflect demand today, while equity prices seek to discount how they will be in the future. As investors realise the cycle is weakening, they sell cyclicals; only once demand is weaker do spot prices actually fall," says Kingsmill Bond, a strategist with Citigroup.

gains made this year and is back at the level it was in October 2010.

Another classic asset bubble caused by a capital inflow bonanza is housing. The Russian real estate market exploded after mortgages appeared in 2003 with prices quintupling. But here too, while the current sell-off has knocked the froth off the market, prices have already recovered and passed the pre-bubble trend line. Demand is still running significantly ahead of supply, argues property broker Richard Ellis.

Debts to society The other two important recurring causes of crisis are also muted in most of CEE: the build-up of debt (sovereign or private, external or domestic) and large current account deficits.

Reinhart and Rogoff found that once public debt reaches 58.9% of GDP (just below the 60% cap set by the euro's Maastricht criteria), the chances of a crisis increase significantly. All but three of the EU member states (and the US) have already breached this level, putting the whole of Western Europe squarely in crisis-prone territory, but none of the CEE countries are anywhere near this level of debt; indeed, Russia has one of the lowest debt levels in the world

Russia 1H08 vs. 1H11 1H08 1H11

Russia's stock market provided a textbook example of this in the run-up to the August 17, 1998 crisis. The RTS index peaked at about 500 in October 1997 before beginning a long descent that continued through the actual epicentre of the crisis before reaching a low of 36 in October the following year. The pattern was repeated in 2008, but the action went a bit faster: the RTS began selling off from its all-time high of 2488 on May 19, 2008, and was falling when Lehman Brothers collapsed, causing the massive global sell-off. The index reached a low of 500 in February 2009.

A fall of 25% is painful, but this current sell-off doesn't look like one of the early warning signals of an impending crash; all the RTS has done is give up all its

GDP growth, % y/y real

8.5%

3.9%

Inventories, %GDP

4.3%

2.3%

Nominal pension growth

24%

11%

Real disposable income growth

6.6%

-1.4%

CBR reserves, month of imports

23

18

Foreigh debt, % of CBR reserves

87%

93%

Reserve fund, $bn

130

27

Loan book growth, % y/y

46%

17%

NPLs as % of corporate loans

1%

5%

NPLs as % of retail loans

3%

6%

Budget breakeven**

$62

$118

...net of pension transfer**

$35

$75

Current account breakeven**

$59

$80

Source: Rosstat, CBR, Finance Ministry, Alfa Research * - 1Q11 data; **-full-year figure

10

I Cover story

thanks to Mr Prudence. "While government gross debt has increased over the last three years by $70bn, Russia's total level of debt is still only $160bn, or 9% of GDP… If one places these numbers in the international context, the Russian government looks to be one of the best placed in the world," says Citigroup's Bond.

Economists tend to focus on external borrowing when looking at the health of a country's finances, but one of Reinhart and Rogoff's insights is to take domestic debt into account too, which is a lot harder to measure. (And remember that

bne September 2011

putting in a strong performance for most of the other indicators. Both these countries are now crisis candidates.

Contagion The crash in stock markets around the world has spooked investors, as previous sell-offs have heralded nasty recessions.

But fund managers like Nash can take comfort in the fact the stock market is a very poor indicator of what is coming next. "The stock market has predicted nine of the last five recessions," the economist Paul Samuelson wryly observed in 1966.

"Karl Marx, it seems, was partly right in arguing that globalisation, financial intermediation run amok, and redistribution of income and wealth from labour to capital could lead capitalism to self-destruct" all of the US' debt is domestic – it has no external debt at all). But even on this score, most of CEE and Russia in particular look strong. "In the middle of 2008, Russian corporate debt from the banks and abroad was $800bn. It declined to $650bn during the global financial crisis (mainly because of the falling ruble, of course) and has now increased to $860bn. The split of foreign to domestic debt is 38%, similar to that pre-crisis," says Bond.

The picture for current accounts is mixed. Since oil prices recovered from a low of $40 per barrel in 2009 to around $100, Russia's current account has been positive to the point where the Ministry of Finance has started to replenish the reserve fund after expecting to exhaust it this year. But Belarus and Turkey are clearly in trouble. Belarus is teetering on the edge of a crisis as the International Monetary Fund estimates it needs some $6bn of cash in the second half of this year to avoid another forced devaluation. Turkey too has seen its current account deficit mushroom despite

Even so, the bottom line is that while only a few of the CEE countries remain vulnerable to another crash, most are unlikely to escape unscathed if the West endures another major crisis. "In general, the economies of Emerging Europe look most vulnerable, for four reasons.

First, they rely more heavily on exports to the troubled Eurozone. Second, they are more dependent on foreign capital to finance spending (particularly Turkey) and roll over external debt. Third, high budget deficits (if not debt) mean that there is limited scope for policy stimulus, if needed. And finally, the region's largest economy, Russia, will be hit hard if oil prices fall back, as we expect," argues Neil Shearing, head of research at Capital Economics.

How does a crisis in one country or region spread? Cross-border bank ownership is one of the main ways, as a bank in a crisis-struck country will not only curtail lending at home, but also in foreign-owned subsidiaries, even if they are located in healthy economies.

The Central European states could well

Perspective I 11

bne September 2011

rue their decision to sell off their entire banking sectors in the early 1990s to Austrian and German banks; countries like Russia, Ukraine, Belarus and Kazakhstan, where foreign capital makes up less than a quarter of the sector, will be much better insulated.

A curtailing of trade is another channel through which crises are transmitted. An obvious strategy to climb out of the postcrisis abyss is to export to those parts of the world unaffected. The reason why this past crisis was so nasty was that it was global. Yet currently countries like Russia can increase exports to other emerging markets like India and China, which are continuing to grow at a good clip. While a slowdown in the traditionally dominant developed markets will clearly be extremely painful, the medium-term effect will surely be to drive the emerging markets further into each others' arms.

Russia is also a special case here, as its economy is heavily dependent on oil exports. Citigroup released a report in August that drew up two scenarios with oil at $80 and another at $50, which seems to be the lower limit for forward looking forecasts with the consensus at the higher limit. The Kremlin currently needs oil at $120 a barrel for the budget to break even, against $62 oil in 2008 pre-crisis. However, if oil does fall to $50 would that really be so bad? In 2006, the government needed oil to be $24 to break even.

In the short term, the developed markets' failure to deal with their structural problems will mean pain for Emerging Europe, but a crash in the West does not necessarily translate into a crash further east, especially given that many of the early warning signals of an impending crash don't exist in CEE. So while 2008 may be remembered as a year of a bad, but relatively common, crisis, it might also be noted as a transformational year that marked the beginning of a seismic shift in the centre of global economic gravity to the east.

The working renminbi Mark Emmerson of HSBC Europe

C

hina's economy grew at an average rate of 10% per year during the period 1990–2004, the highest growth rate in the world, and in that time it has gone from being a closed market to one of the key pillars of the global economy.

By 2050, 19 of the 30 largest economies will be the so called emerging economies, with HSBC predicting that China will be the world's largest economy by 2020.

For Europe, this change is having a real impact both in where order books are heading and also in how the new economies of Europe are emerging. Increased levels of investment and trade opportunities from China are influencing how countries such as Poland, Turkey and the Czech Republic are trading. As these countries look at how to capitalise on growth opportunities and identify where their best chances of economic success lie, they are not necessarily looking to the established European economies of Germany, France and the UK. China and India are identified as equally important as these established economies – in some cases they are believed to be more important, critical to countries' future growth and success.

Increasingly, CEOs no longer only see China as a foreign direct investment destination – according to the National Bureau of Statistics in China, it is now the 5th largest overseas direct investment origin.

Central to both these developments is the internationalisation of the Chinese currency, the renminbi, or more commonly called the yuan. HSBC forecasts that by 2015 over half of Chinese trade with emerging markets (approximately $2 trillion) will be settled in renminbi and it will become a top three international currency if it becomes fully convertible, with Asia and the emerging markets leading renminbi trade and investment.

The opening up of the Chinese economy offers a new, real alternative for currency settlements. Historically, with the renminbi as a restricted currency, companies would have to change renminbi back into US dollars or euros when settling trades outside of China. This extra bureaucracy increased complexity, cost and risk.

In identifying internationalisation of the renminbi as a key priority for the country's continued economic growth, China is enabling corporations in both China and its major trade partners to use renminbi instead of non-local currencies, such as the euro or dollar, for settling cross-border trade. Fewer currency changes, and a perceived strength of the renminbi as the Chinese economy continues to grow, make the renminbi a real option for traders and bankers, with little indication that it will lose its appeal as China continues to consolidate its prime position in global trade.

For businesses day to day, the deregulation of the renminbi also means companies can hold the proceeds of trade settlements in renminbi, achieving both a natural currency hedge for businesses that have existing receivables or payables already in renminbi and a diversification of offshore currency holdings.

Recent HSBC "Doing Business in China" events held in Poland and Turkey have highlighted how there is a real appetite from businesses of all sizes to adapt and exploit the renminbi as a working currency to drive growth opportunities. Indeed, HSBC has settled renminbi transactions – the first in each market – in Turkey, Poland and the Czech Republic. In everyday terms, working in renminbi will help strengthen importers' positions when negotiating contract terms and pricing, while exporters will also benefit, broadening their customer base by accepting renminbi as a settlement currency and reducing the risks of exchange rate fluctuations. Where both the vendor and purchaser settle in renminbi, both businesses will benefit from reduced costs and transaction times.

Renminbi settlements are a practical, accessible step to enhancing prospects for international growth, offering benefits to both customer and supplier while reducing risk and transaction costs. For businesses in the European emerging markets, the question is not whether the renminbi is worth considering, but whether you can afford not to.

Mark Emmerson is Head of Trade and Supply Chain at HSBC Europe.

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Eastern Europe I 13

bne September 2011

and the ruble has been appreciating against the other major currencies, investors are understandably incredulous. But if they start digging into why the fund went bust, they will quickly hit a brick wall.

“The investor can’t sue the Russian office, which it turns out has no legal connection with the club. The Russian end of the operation is acting as an ‘agent’ and reselling the services of the fund that is registered in Cyprus, British Virgin Islands or somewhere. It is noth-

What makes these scams so insidious is that the operators don’t defraud everyone. The bigger clubs make some real returns and pay back the bulk of their investors (with no reporting regulations, the investors have to simply trust the managers’ returns report), but they bolster the bottom line by simply stealing some of their investors money and using it to pay the rest.

Moreover, this practice of padding profits by simply helping yourself to a small proportion of investor’s money is

"Who are these repo men? Mostly they are not the sort you would want to bump into on a street corner at night"

Russia's Ponzi problems

ing more than a post box and is closed down when it has collected enough money,” says Kostikov, who established the Union Of Financial Services Consumers (better known by its Russian name of FinPotrebSoyuz) in February this year to help people who have been ripped off by unscrupulous investment fund scams.

Ben Aris in Moscow

“For most people, to pursue a claim against the company overseas is just too expensive and even if they did, the contract that they signed in Russia probably has no legal standing overseas.”

T

he more things change, the more they stay the same? Nearly two decades after Sergei Mavrodi swindled millions of Russians out of their life savings through his notorious MMM pyramid scheme, fraudsters continue to operate with relative impunity in the country.

That is according to Igor Kostikov, the former chairman of the stock market regulator, who says pyramid schemes masquerading as investment funds remain widespread in Russia.

“There are hundreds of FX clubs that are little more than pyramid schemes,” says

Kostikov. “Nothing can be done to stop them, as they are completely legal at the moment and there is no government regulation on cross-border trade.”

The way it works is this: an FX (foreign exchange) club advertises in the press promising handsome returns to small investors, who then get in touch with

the Russian office and sign a contract before investing their savings. When they come to withdraw their money, they are told, “Sorry, the investment club made some mistakes and has lost all your money.”

Given the Russian market has been among the best performing in the world

“There are hundreds of FX clubs that are little more than pyramid schemes”

No one is sure how much retail investors have in these funds, but Kostikov estimates the value of the total retail investment business in Russia at about $300m.

The scams are already generating tens of millions of dollars if not more, says Kostikov, but the state has done nothing to regulate the business; there is still no organ or laws to oversee or license FX investment clubs. In the meantime, the sharks are left to operate with impunity – and can even run high-profile advertising campaigns in the local media, as technically they are doing nothing wrong.

widespread, even among the established banks and funds, claims Kostikov, who named several well-known Russian high street banks as being guilty of the practice.

Slightly less egregious, but still unethical, are overly aggressive sales people in established banks selling more traditional products like mortgages and car loans. The absence of regulation and a supervisory body means salespeople push these products on customers even though they know many can’t afford them, simply to earn their bonus. Even the giant state-owned Sberbank is prone to this sort of problem.

“Sberbank has been one of the few banks that have fully cooperated with us [FinPotrebSoyuz]. The consumer complains to the regional branch, but if they don’t get anywhere, they come to us. We took these cases up with the head office here in Moscow. And in each instance, the consumer was refunded their money in a matter of days,” says Kostikov.

As the bank of last refuge, ironically it turns out that the state-owned Sberbank, with its famously atrocious customer service, is one of the few Russian

banks that really cares about its reputation for reliability.

Ignorance is not bliss The root of the problem is the average Russian's almost total ignorance of their rights when dealing with financial services. Companies prey on the punter and intimidate them when things go wrong.

Following the financial crisis in 2008, non-performing loans at Russian banks soared. The official level of the banking sector's bad debt stayed in single digits, but in smaller banks and in the regions it could top half of the bank's assets, according to anecdotal evidence.

Most of the established consumer credit banks have a well established routine for dealing with problem loans. The account is passed to a special department, which then offers to restructure the terms and pesters the clients with calls. As the average personal debt in Russia is on the order of $900 – equivalent to a bit more than one month's average salary – the recovery rate is fairly high, as most people can raise this sort of money from friends and family. However, if a loan is deemed "irrecoverable", the banks often sell them (at a deep discount) to a debt collection agency. That's where the problems start.

As you might imagine, Russian repo men are not fun people to deal with. "There is no such thing as a 'bailiff' in Russia and there are no licenses. There is no regulatory authority and there is nothing in the personal bankruptcy law that covers debt collectors. They are completely illegal," says Kostikov.

"Who are these people? Mostly they are not the sort you would want to bump into on a street corner at night. They turn up at 7am in the morning or a 1am during the night. The passing of your information to them is also a breach of the law on personal information. And they often hugely inflate the size of the debt immediately to cover a commission, interest and their costs – all of which is illegal. But almost everyone is unaware of this," says Kostikov.

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his prime minister Yulia Tymoshenko, which derailed the "Orange Revolution" that had brought them both to power at the beginning of the year.

Bogolyubov shows steel in global pursuit of manganese Graham Stack in Kyiv

M

anganese may not have the same ring to it as oil, gold or even iron ore, but Ukraine's banking and fuel magnate Gennady Bogolyubov, co-founder of Privat Bank and its associated industrial group, earmarked the metal over a decade ago as a way of getting exposure to China's addiction to steel.

Manganese is a non-substitutable ingredient in the steel production process, which accounts for around 90% of demand for the metal. And five years after Bogolyubov's first foray into the metal, it featured on a survey of objects worldwide that the US regards as crucial to its security, as revealed by a diplomatic cable published by the Wikileaks site. The list cited both the Australian and Ghana manganese ore assets now mined by Bogolyubov, as well as Ukrainian ferroalloy refining capacities that process ore.

Experts put Bogolyubov's market share of global manganese ore production at

10% and of ferroalloys – the step up in the refining process – at 20-30%. And Bogolyubov's Australia-listed Consolidated Minerals (Consmin) concern is now locked in a corporate struggle to set up the world's largest manganese ore

The winner was Privat group, who with Tymoshenko's support took the Nikopol Ferroalloy plant from Viktor Pinchuk, son-in-law of the previous president Leonid Kuchma. Then, as the Chinese boom went into overdrive, pushing up steel prices and raw materials, Bogolyubov went global in the pursuit of manganese assets. He first took control of Australia-listed manganese miner Consolidated Minerals in 2007 for $1.2bn after an epic 18-month buyout battle, and has since added assets in Romania and the US. Down under Most manganese ore mining is the preserve of the diversified global mining giants such as BHP Billiton and Xstrata.

Consmin and another Australia-listed miner OM Holdings are the dominant purely manganese plays. Given Privat group's reputation for hostile takeovers, there was no surprise when, within months of taking over Consmin, Bogoluybov built up a 11.7% stake in OM Holdings, which is headquartered in Singapore and owns a ferroalloy refinery in China in Qinzhou.

Bogolyubov's move was denounced as a hostile takeover by OM's board of

"Five years after Bogolyubov's first foray into manganese, the metal featured on a survey of objects worldwide that the US regards as crucial to its security" play, one that would be capable of setting prices on the market.

Privat group's manganese interests started as a domestic story. It was a dispute over ownership of Ukraine's manganese refining assets in August 2005 that split the alliance between the then president Viktor Yushchenko and

directors, which changed its articles to protect against Bogolyubov, who launched lawsuits in response. Peace then suddenly broke out in April 2010, with the sensational announcement of merger plans between Consmin and OM to create, "the world's second largest low-phosphorous siliceous high-grade manganese ore producer."

bne September 2011

But in October 2010, the two sides announced that talks had ended without agreement and hostilities quickly resumed. In April, OM announced a $400m share issue in Hong Kong, which Bogolyubov claimed was intended to dilute his stake and so tried to block with a court action in Australia. The Ukrainian was not the only minority fearing dilution it seems: since the announcement, the OM share price has plummeted by 30%, lending grist to Bogolyubov's mill.

On July 6, as a number of court proceedings and investigations in Australia and Hong Kong took their toll, OM called off the share issue, referring to adverse market conditions, and handing Bogolyubov a major victory.

Now the Ukrainian is leading the charge calling for an extraordinary general meeting (EGM) to make changes to the OM board. "The performance of OM in the midst of a global mining boom, and overall strong demand for manganese is unacceptable, and shareholders need to enact board change now," Bogolyubov said on August 2, according to Consmin's press service.

Bogolyubov's references to "the identity of key shareholders" are thought to refer to concerns that OM's key shareholders are in fact mainland Chinese interests, rather than the Singapor married couple Low Ngee Tong and wife Heng Siow Kwee, who claim they are the majorities.

OM responded by refuting the allegations, and pointing to technical non-compliance with stock exchange regulations for an EGM requisition, in particular because Bogoylubov exceeded a 1,000-word limit by 300 words.

Bogolyubov's representatives say this is only true if the word count includes the annexed biographies of two proposed new independent directors.

OM CEO Andreas Toth was quoted by Australian media as describing Bogolyubov's EGM move part of "an endless supply of legal and corporate antics to frustrate, slow down, undermine and de-stabilise the company from executing its strategic initiatives at a critical point in time."

Eastern Europe

Russian steelmakers forge ahead in modernisation drive Tim Gosling in Moscow The bid to develop nanotechnology and other high-tech gizmos may steal all the headlines in Russia's bid to modernise its economy, but the country is still heaving with natural resources that can't be ignored. The key is to move up the value chain, and Russian steelmakers are starting to do just that.

The options for Russia to turn its massive deposits of iron ore into downstream products are limited. On the one hand, the country can't compete with developed economies to turn out high-end products, or as independent investment advisor Eric Kraus puts it: "it's not going to compete by building Mercedes." On the other, Russia can't match the costs in China to turn out pots and pans.

What its steelmakers are increasingly doing, however, is turning out a wider array of specialist and high-quality steels to supply manufacturers on the domestic market. As Kraus puts it: "They have to move up the value chain where they have a competitive advantage."

Import substitution The likes of MMK and Severstal began the new century with open-hearth technology turning out basic slab steel. However, competition from more efficient steelmakers in lower cost environments around the world provoked an investment drive that continues today.

The strategy has also changed, points out Dmitry Smolin of Uralsib, with import substitution on the domestic market – "which currently offers a 10-15% premium over export markets" – the key goal. Barry Ehrlich at Alfa Bank agrees, saying: "We shouldn't expect, or want, to see these companies trying to export high-quality steels. They can't compete with Japan or the US on downstream products."

This is now reaping rewards, as Russian steelmakers are successfully wresting market share from foreign importers. Smolin points to MMK's $1.4bn Mill 5000, launched last year to turn out large-diameter pipes for a Russian energy industry previously supplied by Europe and Asia.

He also notes the same company's 2m tonne per annum Mill 2000, which recently began producing high-quality coil for the growing list of foreign carmakers in Russia, who currently buy from Europe.

Potential customers are reported to be inspecting the quality of output.

According to Steel Orbis, the company's test pressings have passed a technical audit with Renault, whilst it's producing test batches for Ford, GM and Volkswagen. Factories run by Samsung, Bosch and Siemens are further targets.

Nikolay Lyadov of MMK claimed last year: “Mill 5000 has strengthened MMK's foothold on the Russian market of rolled metal for pipemakers and secured [its] role in major oil and gas projects.”

I 15

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"Bogolyubov's EGM move is part of an endless supply of legal and corporate antics to frustrate, slow down, undermine and de-stabilise the company" Toth had some good second-quarter results to support him, with the company reporting a "record-smashing" output of 261,000 tonnes in the second quarter from its mainstay Bootu Creek mine in the Northern Territory, Australia – 14% ahead of any previous figure. But the results only brought a short respite to the share price fall.

The EGM has been scheduled for September 1. Bogolyubov is pushing for executive chairman Low Ngee Tong and an independent director, Tan Peng Chin, to be replaced by two upstanding and plausibly independent Australians as directors, with the risk that if his demands are denied, the share price will drop further.

Things thus seem topsy-turvy: down under Privat group is positioning itself as a fighter for transparency; in Ukraine the group has long been known for its opaque ability to control management and finances at the country's biggest oil producer Ukrtatnafta, despite the state being the majority shareholder.

However, one thing stays the same whether north or south hemisphere: Privat group's uncanny ability to get what they want.

Dixy wins promotion to Russian retailer premier league Ilya Yakubson, president of Dixy

B

However, he adds with a smile, while competitors in the discounter segment such as Magnit and Pyatrochka gained greatly from the most recent economic downturn, for Dixy it came a little early.

"Those that were already strong did best; Dixy was still restructuring. As the saying goes, you don't ever want to miss the crisis. Unfortunately, we did miss a little of that paradise."

Powered by an investment drive to build a new IT platform and logistics network, alongside a large marketing campaign, Dixy pushed into the Russian retailers' top five this year with the acquisition in June of the Victoria Group supermarket chain for RUB25.6bn ($915m), which added around 250 stores to swell the company's network to 944 overall.

With consumer confidence returning after the crisis, all the big Russian food retailers are chasing the same prize – the 87% of the market occupied by local chains, single store retailers, markets and kiosks. Magnit, for instance, is reported to be planning to open up to 1,000 new outlets this year.

Dixy hopes its rollout will help it grow sales at a rate of 30% a year to hit $5bn in 2012. That need for speed limits the options for growth. While you can find numerous grocery chains in any region of Russia, "there aren't many sizable targets," admits Yakubson. "Organic growth is also the cheapest option and offers higher quality."

Although there is some limited geographic expansion underway, the store expansion will look to deepen the retailer's presence in its current regions: the north-west around St Petersburg, Central Russia and the Urals.

Tim Gosling in Moscow

That's not cynicism talking, but pride.

Yakubson is gregarious and relaxed – he laments, for instance, that due to costs and incomes he can't offer his customers the tubs of blueberries he and his family tuck into when abroad – and clearly proud of the "remaking" of Dixy since Mercury Group bought a 50.96% stake in 2008.

be very fast and we have to know how to grow."

However, that doesn't mean the acquisitions team has been retired. "At the same time," he says, "to build a really big business you can't forget about M&A."

INTERVIEW:

orn in the wake of the 1998 financial collapse and undergoing a restructuring during the 2008 version, Russian grocery retailer Dixy Group knows all about turning crisis into opportunity. Ilya Yakubson, president of Dixy, says it has now gained promotion to "the premier league" of Russian retail.

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That's no small achievement: the barriers to building a national retailer in such a vast country with infrastructure limitations and a paucity of third-party service providers are significant. At the same time, because the market remains so fragmented, "the opportunities are huge, with the five biggest grocers still controlling no more than 13% or so of the market."

Need for speed "Organic growth is the main strategy for the next three or four years," Yakubson says. "With the infrastructure now in place, we're ready for a very fast store rollout. This year we plan to open 160 stores, next year more than 250. It's very aggressive, but in order to build a real market-driven business, we have to

That's also a reflection of a specific feature of the Russian market – how to expand through a country of such vast scale and low-population density. "In order to have logistics you need volume, and in order to have volume you need logistics," says Yakubson. "We've started to open stores in the Murmansk region, which is 1,000 kilometres from our existing network, but can't build a warehouse until we have 300 stores or more. But it’s the same for everyone, and just means prices are higher in the stores."

The long-term plan is "of course" to push Dixy across the whole of Russia, he says, but major competitors can be found in practically every new location, reflecting the assertion that, "the grocery sector is the most competitive in the Russian economy. We're all very aggressive on advertising and offering deep discounts to compete against each other."

Eastern Europe

Rising stock The expansion to the end of 2012 is set to cost up to $400m, and that will come from cash flow, explains Yakubson, pointing out that a listing in London or New York – as recently suggested by Igor Kesaev, head of Mercury – is not an immediate option. "We're quite comfortable with our debt/Ebitda ratio, but

I 17

foreign players, but now the market tends to think about how to compete with the major Russian names by improving efficiency."

That includes fighting the rapid inflation in global food prices, which Dixy attempts by cutting out Russian importers to buy directly from foreign

"Ten years ago we thought a lot about foreign players, but now the market tends to think about how to compete with the major Russian names by improving efficiency" to drive this growth we won't need any outside financing. Issues such as listing on foreign exchanges or raising further debt are best discussed when we've made further investment decisions."

That means investors will need to come to Russia for exposure to a stock that analysts have rushed to upgrade since it announced the deal to buy Victoria, forecasting the retailer is set to reduce the discount to its peers, which is currently around 40-65%. Alexandra Melnikova of Alfa Bank reckons that alongside an secondary share offering held in mid-June to raise the cash for the acquisition, "the increase in scale and better liquidity… should help Dixy to narrow the gap and lead to increased quotes."

While foreign investors have snapped up Russian retailers' shares in recent years, international grocery store operators have found it much tougher going.

France's Auchan and Germany's Metro arrived early and secured strong market share organically, but in the past two years both Carrefour and Walmart have given up in the face of the strength of Russian operators.

Without a giant M&A deal, Russian food retail will remain a mainly domestic affair for the meantime. "Quite frankly I don't care these days," laughs Yakubson.

"Ten years ago we thought a lot about

producers and wholesalers. Yakubson claims that with its expanded size, Dixy will be able to offer greater protection to the consumer. "It's not easy for our suppliers to raise prices," he claims. "For the most part, it takes a supplier several months at least to push a rise through."

Retailers have less control when it comes to government policy – which reverted to price caps in the wake of last year's devastating fires – he admits, before adding that the much criticised retail legislation introduced a year ago has accelerated the activity of the retailers lobby. "There's healthy dialogue with the government now," he says.

Meanwhile, he dismisses concerns that retailers risk getting caught in a pincer movement by food inflation and populist policy as Russia's election cycle cranks into life. "Pre-election years are great for retailers!" Yakubson declares.

"Social spending rises and the retailers get the bulk of that cash. It's not a risk, but a great opportunity. Russia is still the epitome of that cliché."

Still, the extra pennies in the purses of Russia's struggling pensioners are no longer his only priority. "We're now breaking our DNA. We were a discounter, so we thought only about prices – now we must concentrate on customer service and experience also," he insists.

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the ladder might be required, played correctly Yanukovych could even gain on the deal by promoting a scenario in which the courts are shown to be independent and the government's anti-corruption drive is free from political discrimination.

Allowing Tymoshenko to escape without a conviction would free her to challenge him politically, but that might not prove to be much of a problem given recent events.

KYIV BLOG:

Trial and error in Ukraine bne

W

ho hasn't wished they could turn back time at some point?

Viktor Yanukovych's dreams at the moment likely feature a time machine, as the trial of political foe Yulia Tymoshenko is continuing to give the Ukrainian president headaches both at home and abroad.

As the prosecution of the former prime minister on charges she abused her office by signing the January 2009 gas deal with Russia without going through the proper channels and at an inflated price drags on, the case is ruffling more feathers in the West, while at the same time accelerating the deterioration in relations with Moscow. The constant negative news flow is also doing nothing to help the country's investment image.

The government had twin goals in pressing the case: to do away with the political challenge of the country's most popular opposition leader, and to press Russia to renegotiate the terms of the gas contract. However, with the former starting to look superfluous and the latter increasingly unlikely, the president must surely be rethinking his strategy?

Home comforts The only positive for Yanukovych so far is on the domestic front, with the trial illustrating just how weak Ukraine's fractious opposition remains.

With the population clearly signaling a deep weariness with the self-interest of the political and business elite in general, it's possible that Yanukovych might cut his losses and allow Tymoshenko to

In the first place, the ruling Party of Regions made progress in its bid to reduce political competition in midAugust when it merged with Strong Ukraine, whose candidate came fourth in the 2010 presidential election. Rumours are now circulating that other popular minority parties such as Front for Change or Svoboda are next in line to throw in their lot with Regions.

Secondly, the public response to Tymoshenko's arrest in August was muted despite calls for large-scale protest. As Brad Wells at Concorde Capital suggests, "the opposition movement does not look like it is in a position to build momentum right now. Tymoshenko remains a divisive figure domestically."

Falling out is easy to do Indeed, Yanukovych could now be realising that he's overplayed his hand Often forgotten in the hulabaloo is that Tymoshenko is actually facing three charges. A conviction in the two cases

"The ruling party is very sensitive to criticism from the West" walk away without the conviction that would bar her from taking part in the forthcoming elections in 2012.

Many commentators suggest the president can't stop the process without losing face, but with Tymoshenko's approval ratings low, Yanukovych appears to have a good opportunity to do just that.

Although a sacrifice or two lower down

accusing her of misuse of funds is likely to be more straightforward and would still rid Yanukovych of the turbulent "Orange princess."

However, the government was clearly unable to resist the temptation of dealing with a major economic obstacle at the same time as sidelining the president's main political rival. A ruling that

bne September 2011

Tymoshenko violated the law in signing the gas agreement with Russia would provide the government with a formal basis for demanding a revision of the contract both in domestic and foreign courts. However, many commentators argue Ukraine would have a decent chance in arbitration anyway.

With Ukraine facing many economic challenges, the price of gas imports is a crucial lever on which Moscow has kept a firm grip, replying to Kyiv's demands to renegotiate the contract with suggestions it should hand over control of its gas transportation network (a symbol of sovereignty to many in Ukraine), or join the Russia-Belarus-Kazakhstan Customs Union (which would scupper Ukraine's progress towards eventual EU membership).

No surprise then that Russia is riled at the Tymoshenko case. Moscow has called for a "fair trial," with Kremlin sources reported to have warned that Yanukovych could face "long-term consequences."

High-level contact between the two countries has dropped off considerably in recent months. Following a rare meeting between the two presidents on August 11, "the lingering stalemate in bilateral relations" was clear to see, says Lilit Gevorgyan at IHS Global Insight.

Gevorgyan suggests that even though talk of another gas war between the pair is likely wide of the mark – mainly because it would be catastrophic for both countries' reputations as reliable suppliers to Europe – the stand-off is likely to push Russia to revisit its plans of building alternative energy export routes. With 80% of Russian gas exports to the EU routed through Ukraine, that would hit the economy hard. "The fact that Moscow is having a hard time even with the relatively pro-Russian government in Ukraine strengthens the argument that it is perhaps better to invest in its own pipeline than in Ukraine's Gas Transporting System," says Gevorgyan. "Meanwhile, the freeze in relations with Russia may force the Ukrainian government to swallow the bitter pill and try to liberalise gas prices and reorient the country closer to the EU."

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I 19

Europe matters Yanukovych's top priority of joining the EU is also being impacted by the trial, which is raising plenty of hackles in Brussels.

Ivan Tchakarov of Renaissance Capital insists that the Party of Regions "is very sensitive to criticism from the West, and is therefore calibrating its policy accordingly."

On August 11, Minister for Social and Labour Policy Sergiy Tigipko acknowledged that the case is complicating negotiations on the free trade area with the EU. A tortuous process already, the FTA is a pre-requisite for sealing an association agreement with the 27-member bloc – both of which now have human rights clauses attached by Brussels and need the approval of each and every EU state. Wells is not the only analyst to suspect the trial makes "a lengthy-adoption scenario likely – with true [FTA] benefits for Ukraine delayed for the mid-term."

While the FTA is a two-edged sword for Ukrainian businesses, it would clearly be positive for the country's investment climate. A delay would only add to the damage already being done by the negative headlines, although, as Bilan notes, the immediate impact of Tymoshenko's jailing on August 5 on investor sentiment towards Ukraine, "is clearly being overshadowed by the ongoing global market sell-off."

Opportunity is practically a given in emerging markets; it's political stability, transparency and the rule of law that investors lust after in places like Ukraine.

The Tymoshenko trial is impacting on all three, especially as there are signs it's having knock-on effects in Ukraine's business world.

On July 12, Security Service of Ukraine (SBU) agents halted work at Rosava, part of Finance & Credit Group, which is controlled by Konstantin Zhevago, a member of Tymoshenko's eponymous party in parliament. On August 16, reports claimed that environmental inspectors were threatening to shut down Zhevago's iron pellet producer Ferroexpo.

"The government was unable to resist the temptation of dealing with a major economic obstacle at the same time as sidelining the president's main rival"

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Central Europe I 21

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June, with a 0.6% contraction in output on month and up just 1.0% on year.

"Our previous outlook for this year's 8.5% growth in the industry seems too optimistic after this release," says Zoltan Arokszallasi of Erste Bank. "[This]

in July, rising to 52.9, albeit from an 18-month low of 51.2 in June.

"A regional PMI – obtained by weighting together individual country PMIs by the size of their respective manufacturing

"While industry is still growing on a month-on-month basis, the pace of growth has slowed to a crawl over the past quarter" increases the risk that second-quarter GDP may be closer to 2.0% than to 2.5%."

Purchasing managers indices – which are based on private business surveys and so regarded as leading indicators of the overall situation in manufacturing – released earlier in August suggest this trend is going to pick up. Manufacturing PMIs for July fell in three of the four countries in the region that have reported such data.

CEE factories go quiet Nicholas Watson in Prague

J

une's industrial production numbers for Emerging Europe point to a weakening of the forces, mainly German demand, that have been driving the export-led recovery in the region.

With domestic demand and consumption in these countries also still weak, the economic slowdown is alarming and worries about a double-dip recession are growing.

"We expect the year-on-year industrial production growth rates to moderate in all of these countries as the euro area debt crisis and the slowing in activity in the US economy begin to slow the growth in exports from these areas,"

says Don Egginton of Daiwa Capital Markets Europe.

Indeed, on August 5 data showed that German industrial output fell a seasonally adjusted 1.1% in June from May, alongside falls in Italy and Spain. These weak numbers are consistent with the other evidence that the Eurozone economy is slowing, which in turn is hurting the exporters in Emerging Europe.

On August 8, the Czech stats office said annual growth in industrial production decelerated to 7.4% in June, while it actually declined 1.9% from May, when year-on-year growth came in at a huge

15.2%. "In accordance with the situation in Germany, the Czech Republic's biggest trade partner, the second quarter was weaker than the first," says Jan Vejmelek of Komercni Banka. "The risks for the future lie clearly in external demand development. Domestic demand cannot be relied on, as new domestic industrial orders even declined in June (down 5.2% on year). Foreign orders are rising so far (up 11.8% on year), although the situation in the global economy is becoming more and more blurry."

Russia showed the sharpest fall, with its PMI falling below the 50 mark - the point that in theory at least separates expansion from contraction – for the first time since December 2009. Elsewhere, the Czech Republic dropped to 53.4 (from 55.1 in June) and Turkey dropped marginally to 52.2. "Surveys in Turkey suggest that domestic and external orders are getting weaker, leading to a slowdown in industrial production," says Ozlem Derici of Erste Securities in Istanbul. "Industrial production growth is likely to further decline to low single-digit growth by the last quarter of the year."

In Slovakia, sentiment in industry has deteriorated quite substantially since June. "We expect Slovak industrial production to decline in June by some 1.5% on month. That would translate into a slowdown of annual production growth to around 6%, from the 10.7% year on year seen in May," says Maria Valachyova of Slovenska Sporitelna.

sectors – suggests that, while industry is still growing on a month-on-month basis, the pace of growth has slowed to a crawl over the past quarter," says Neil Shearing, senior emerging markets economist for Capital Economics.

The overall impact of this on the various economies will of course depend on

This leaves Poland as the only country in the region to report a rise in the PMI

On August 16, the depth of the economic slowdown became apparent as Germany reported that its second-quarter GDP growth slowed to 0.1% after rising 1.5% in the first three months.

The Czech and Hungarian economies slowed for the first time since they emerged from recession in the first quarter of 2010, Slovak GDP grew at the slowest pace since that same period and Romania's GDP decelerated after ending a two-year slump in the JanuaryMarch period.

"Manufacturing PMIs for July fell in three of the four countries in the region that have reported such data"

Weighted Regional Manufacturing PMIs 65

65

Headline Expansion

60

New Export Orders

60

55

55

50

50

45

45

40

40

Contraction

35

35

30

30

25

25 2006

Hungary also reported very disappointing industrial production numbers for

how much domestic demand can offset the fall in external demand. Turkey and Poland both have large domestic markets that should ensure industry doesn't collapse, though economists are more concerned about the potential impact of a slowdown in the Eurozone on Hungary and the Czech Republic, where domestic demand remains weak and exports have been the key driver of recent growth.

2007

Source: Markit, Capital Economics

2008

2009

2010

2011

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black holes – local councils in Hungary have some HUF1.2 trillion (€4.4bn) in debt, of which half is in Swiss francdenominated bonds – the mayor consulted the Hungarian Association of Local Governments and in early August appealed to the prime minister to back a request for a one-year moratorium on principal repayments the banks.

Swiss squeeze in Hungary Kester Eddy in Budapest

G

yorgy Gemesi, mayor of Godollo, is a worried man. His university town just to the east of Budapest, with a population approaching 33,000, decided in 2007-08 to utilise EU funds in order to finance development projects – specifically a school, kindergarten, urban renewal and restoration of the town's former Habsburg Palace, which hosted many of the more fancy meetings during Hungary's tenure of the EU's presidency earlier this year. To raise its own share of the required capital, the town borrowed and issued bonds.

Today, Godollo has total debt of around HUF3.8bn (€14m); at around €420 per man, woman and child, this might not seem excessive – except that the entire sum is denominated in Swiss francs.

When the loan was taken out, the city received around HUF160 in funding per franc, but with the inexorable rise of the Alpine currency, in early August the

mayor was looking at a rate of HUF260 per franc to pay back the principal – a 62% increase in forint-based repayments. "We've had a brutal increase in costs due to exchange rate movements.

The move – which the banks initially treated with scepticism though negotiations are continuing – raises the spectre of local councils unable to pay the bills for local services such as refuse collection and water supplies. However, it was downplayed by most economists in terms of the macro risks. "First of all, local government debt is included in the general government debt on an ESA basis, so it has no effect overall on the public debt level or the budget deficit figures. And it is not such a large sum, I calculate at around HUF30bn or so, even if the central government has to pay off this debt for one year. There are reserves to cover this," says Adam Keszeg of Raiffeisen Bank in Budapest.

Keszeg argues that the central government will automatically take over the debt burdens of any municipalities in default, thereby easing any concerns about the banks holding these municipal bonds, but others are less sure. "I don't think the state will automatically guarantee these loans," Janos Samu, economist with Concorde Securities, tells bne, adding that for banks more exposed to

"We've had a brutal increase in costs due to exchange rate movements"

We drew up our budget in February [when the exchange rate was around HUF210 to the franc], but now, in the middle of the year, we do not have the money for these repayments," Mr Gemesi tells bne.

Aware in July that many other municipalities were facing similar financial

municipal bonds, such as OTP Bank, a string of defaults could be "more than significant money."

But whatever the concerns over municipal bonds, it makes up only a minor portion of the total foreign-currency debt in Hungary, and it is the household borrowing that remains of most con-

bne September 2011

cern, says David Nemeth, chief economist at ING Bank Hungary. "The Swiss franc loan debt in Hungary comes to just under 30% of GDP. Of this, households accounts for 15% of GDP, municipalities about 3%, and the rest is corporate and [small business]. So households is definitely the biggest problem," he says.

The situation with households is all the more worrying because industrial production, which has underpinned the economic recovery (and stemmed job losses) since late 2009, suffered a sharp and unexpected decrease over the summer, indicating household incomes will stagnate. "Industrial production in June [at just 1.0% year-on-year growth in June] was much worse than we expected, and this does not seem to be a temporary effect. I have always been pessimistic about domestic consumption, because of the Swiss franc problem; now I have changed my forecast for GDP growth due to the global slowdown, from 2.7% to 2.4% this year," Nemeth said.

Hand-up, hand-out For the beleaguered homeowner struggling to pay the mortgage, some help is at hand – even if it is only of a temporary nature.

The government has designed a "fixed exchange rate" system to begin in September, whereby homeowners may make repayments on mortgages based on a fixed exchange rate of HUF180 to the Swiss franc (with the unpaid excess totted up on a separate account for later payment).

In addition, OTP Bank has also begun offering a similar fixed-rate mortgage repayment package, but with the exchange rate set at a more realistic HUF200 to the franc, and lower fees than the government scheme.

At the same time, there has been some respite in the market as the Swiss currency fell from a peak of HUF273 in early August to around HUF240 by the middle of the month – a move anxious borrowers are hoping will not be so temporary.

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I 23

Debt crimes and misdemeanours

Phil Cain in Graz, Austria Hungary's rightist Fidesz government is considering how to prosecute three former Socialist Party prime ministers for the "political crime" of running up the national debt, in the latest worrying sign that the new government is hell bent on abusing its two-thirds majority in parliament.

On July 31, the Fidesz members of a parliamentary committee voted to examine how to press charges against those it accuses of being responsible for increasing national debt from 53% of GDP to 80% between 2002 and 2010. The accused include three Socialist former prime ministers Peter Medgyessy (2002-04), Ferenc Gyurcsany (2004-09) and Gordon Bajnai (2009-2010).

The opposition Socialist and Politics Can Be Different parties boycotted the committee formed to apportion economic blame. Fidesz-controlled budget and constitutional committees will decide on the next step.

The threat of jail is "a pure PR show," says Tibor Szanyi, a leading member of the Socialist party, but adds that the consequences could be anything but.

Kristian Szabados, director of Political Capital, a political consultancy agrees.

"It is very serious," Szabados tells bne. "People can turn to the Constitutional Court, but that too is filled up with Fidesz politicians." Legal resolution, he adds, might only come from taking the case to the European Court of Human Rights in Strasbourg after a show trial lasting two to three years.

The Budapest three Having won a two-thirds majority of parliamentary seats in April 2010, Fidesz does not need support beyond party ranks to push through its agenda, described by Orban as "revolutionary". In April, the PM used his government's supermajority to amend the constitution without opposition participation.

The new constitution, passed on April 18 and coming into effect from January 1, makes it illegal for the government to allow debt to be increased to more than half of the GDP of the previous year. But under Hungarian law, and Article 7 of the European Convention on Human Rights, you cannot prosecute someone for breaking a law created retrospectively.

Deputy Prime Minister Tibor Navracsics, talking to pro-government HirTV in August, said laws already in place during the period of the Socialist government might be enough, "if sufficient evidence is available." The prosecution, he said, would be on the grounds of "providing false figures" or being "dishonest or negligent" in use of public money.

Prosecution may also be too indiscriminate to please Fidesz voters, reckons Szabados. "They are targeting Gyurcsany, one of the most hated former prime ministers in Hungary. But I don't think voters would support the criminalisation of Mr Medgyessy or Mr Bajnai - they are seen in a totally different way."

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But Ansip seemed in no hurry at all when a simple question from bne on a different subject sparked a 10-minute monologue on why Estonia was really, really happy to have joined the Eurozone on January 1 even with it experiencing more problems than a bull in a china shop. "Despite all the difficulties we have in some Eurozone member states, we are satisfied with the euro in Estonia," Ansip said repeatedly, starting to sound like a cuckold trying to convince himself his wife really does love him.

The art of economic renaissance Mike Collier in Riga

E

ven if a double-dip doomsday does do for the financial markets in the near future, traders can take some solace from the Baltic states of Latvia, Estonia and Lithuania – and not just because a region which suffered a cumulative real GDP contraction of 18% in 2008-09 has shown it is possible to bounce back in fairly short order.

August 28 saw the prime ministers of the three countries meeting in Latvia on the premises of the former Riga Bourse, freshly re-opened after a multi-million-euro restoration that has transformed it from the 1855 trading floor of the Baltic German and Imperial Russian mercantile classes into a rather impressive art museum. So if the worst happens and the London and New York stock exchanges do get wiped out for a century or so, at least they can take consolation from the fact that they could provide excellent exhibition space for collections of Chinese porcelain and Murano glass.

As if to stress the informal nature of their meeting, the three PMs arrived to meet the press in shirt sleeves and relaxed mood. All smart, centre-right politicians who have won the respect of their peers elsewhere for staving off total collapse by means of the sort of austerity measures that would get Greeks throwing plates in the Meissen pottery section, they are starting to get used to hearing the Baltics lauded as successes again after a few years as economic lepers.

Moving swiftly on Indeed, such is the level of acceptance of the Baltic turnaround that at times they seemed keen to just get on with the sightseeing. Following an introductory speech by host Valdis Dombrovskis – in Latvian – Estonia's Andrus Ansip said rather too quickly that he agreed with everything Dombrovskis had just said and that there was no need for a translation, until Dombrovskis pointed out that not everyone present spoke Latvian (including Ansip).

One thing all journalists on the Baltic beat look forward to is regular updates on Lithuanian PM Andrius Kubilius' bedside reading. A fan of the sort of self-help and motivational books usually given out at conferences of vacuum cleaner salesmen, he didn't disappoint in Riga. "Anyone who wants to understand the Baltic situation should read the book by Valdis Dombrovskis and Anders Aslund called... what's it called again?" he asked the author standing beside him.

"It's worth remembering our previous informal meetings," Kubilius said on the subject of the new lean Baltic economies. "Our topics for discussion have changed. In 2009, we talked about surviving the recession. In 2010, it was about getting a clearer picture, and this weekend we hardly talked about our economies at all. We overcame a very deep crisis. We have some worries about what can happen in the Eurozone, but we now have a recipe for national measures to account for any kind of global crisis."

It was left to Dombrovskis to rein in the mood by pointing out that the exportdriven nature of the recovery will depend on the region's main markets in Scandinavia, Germany, Poland and Russia also avoiding recession re-runs.

"There are some signs of alarm coming from Germany," he warned. "Second quarter growth was just 0.1%, which could mean the economy is slowing down, so we'll have to see how it impacts our export markets."

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I 25

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to split the centrist vote right down the middle, giving Harmony Centre a betterthan-even chance of finishing election day as the largest single party for the first time ever.

Latvia prepares for three-way split

© Zatlera Reformu Partija

Mike Collier in Riga

J

ust 11 months after Latvian voters won international plaudits for backing the austerity-driven leadership of Valdis Dombrovskis and his Unity electoral bloc, they have a chance to do so again on September 17. Only this time, they probably won't.

the spurned president, Valdis Zatlers, has formed his own party – the modestly-titled Zatlers Reform Party (ZRP) – and according to current polls is likely to be fighting with the Russian-flavoured Harmony Centre party for top spot come election day.

The reasons the election is taking place are too convoluted to recount in full, but involve raids on MPs' homes, a president who called a referendum to dissolve parliament over its links to oligarchs, and a parliament that returned the compliment by replacing that president – enjoying record-high approval ratings at the time – with a 66-year-old former banker known mainly for being on the country's biggest pension and using EU funds to build himself a very nice house.

Going it alone To the surprise of many, Zatlers rejected an unconditional offer to join Dombrovskis' now-unified Unity party as its number one candidate. It was a serious blow to Unity and one that threatens

Against that backdrop it's hardly surprising that the election itself promises to be an entertaining affair, not least because

Early signs from ZRP weren't promising.

Zatlers is no rabble rouser and his initial party meetings were shambolic affairs in which a selection of fruitcakes aired irrelevant opinions on random topics.

The selection of a red cross as his party logo (a nod to his former profession as a doctor) raised concerns from the Red Cross itself and it started to seem he had miscalculated badly. But in the last couple of weeks, ZRP has got its act together. Zatlers has roped in some of the country's brightest brains to work on his manifesto and they have added some much-needed original thinking to Latvia's political landscape.

Young, articulate economist Vyacheslav Dombrovsky has put together a smart financial package that seeks to co-ordinate economic policy with the business cycle. "This is a radical departure from the usual way programmes are presented," Dombrovsky tells bne. "What we do is offer a few things that will have the maximum effect on the economy in both the short and long term. It's very important to reduce the level of public debt, but we realise it's hard for politicians to do so because they want to spend money once it's there. So our solution is a socalled Fiscal Council – an institution that would make it harder for politicians to go into reckless spending.

Dombrovsky says the party's number two area is the need to reduce the huge tax burden on employees, which is currently about 45%. "That's one of the highest in the world with lots of nasty side effects such as tax evasion.

Our aim is to reduce it by 9% over three

"Zatlers is no rabble rouser and his initial party meetings were shambolic affairs in which a selection of fruitcakes aired irrelevant opinions on random topics"

bne September 2011

years. Part of it will come from real estate taxes and eliminating reduced rates of VAT," he says. "We also want to experiment with a new idea being advanced by Professor Danny Roderick at Harvard called the New Industrial Policy, which is an institutionalisation of the dialogue between business and the state."

Asked if he would like to be finance minister, Dombrovsky told bne he was "95% sure" he didn't – then became ZRP's nominee for the post a few days later.

But the answers ZRP is not providing are in some ways as important as their actual plans, according to another contributor to the programme, academic Roberts Kilis. "A politician thinking medium term in Latvia would be a definite public good," he says. "The public might welcome someone like Zatlers who is not a charismatic macho guy but an ordinary, decent person with good intentions who has shown some sort of ability to decide. The public may respect someone who openly says 'We may not always know what to do, so you have to come and help us'."

"Latvia has been acting like someone with bi-polar disorder - it's either extremely excited or extremely depressed," Kilis says. "What you usually do in terms of treatment is stabilise the mania to avoid deep depression. At the moment we are economically on the up, so we have to start treating possible mania that will be in place in 2013 and 2014."

Coalition controversies Whatever the outcome, the new President Andris Berzins – a former banker from the oligarch-influenced Greens and Farmers Alliance (ZZS) – will face a difficult choice when he has to nominate a prime ministerial candidate.

Asking a pro-Russian party like Harmony Centre to head a government 20 years after independence was restored would cause outrage and probable demonstrations from Latvian nationalists. Ignoring a victorious Harmony Centre would provoke a similar reaction from the other end of the political spectrum and Russia wouldn't be slow

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I 27

in pointing out Latvia's democratic deficiency.

of Russian as a possible second state language.

Asking Aivars Lembergs, the candidate of ZZS, to head the government would make Latvia an international laughing stock, as the mayor of the port of Ventspils is a bizarre individual fighting a never-ending series of corruption trials and recently had his offshore assets frozen by a UK court. He also believes financier George Soros is engaged in

What is clear is that two of the three main oligarchs will be making a longoverdue exit. Former Prime Minister Andris Skele has already disbanded his People's Party. It marks a remarkable decline in his political (if not financial) fortunes as a little over two years ago People's Party was the largest in parliament with 23 out of 100 seats.

"Latvia has been acting like someone with bi-polar disorder - it's either extremely excited or extremely depressed"

a shady conspiracy against himself and Latvia, by dastardly acts such as donating money for the construction of educational facilities and backing civil society groups.

Current PM Dombrovskis is another option, but if his party is only the third or fourth largest in the new parliament as seems likely, his current authority will have been undermined even more than might be expected in what is effectively a mid-term election.

Ironically, Berzins' best escape route might be to ask his old adversary Valdis Zatlers to act as an honest broker between Unity and Harmony Centre in a ground-breaking three-party coalition. Even here though, Zatlers has done the unexpected by nominating political novice Edmunds Sprudzs, a 31-year-old entrepreneur, for the PM's chair.

Leading Unity politicians such as parliamentary speaker Solvita Aboltina have already aired the possibility of three-way split, while Harmony Centre leader Janis Urbanovics has made encouraging noises too, floating the idea of a three-year moratorium on the most divisive issues such as acknowledgment of Latvia's occupied status during the Soviet years and mention

Skele's former ally Ainars Slesers – the MP whose home anti-corruption officers were blocked from searching by fellow lawmakers – continues to believe in his own omnipotence. He took Latvian politics into the realms of farce on August 5 when he renamed his LPP/LC party the "Slesers Reform Party - LPP/LC" in a move even long-term allies such as Andris Berzins (not the current president, but a former prime minister) said was ridiculous.

Imitation may be the sincerest form of flattery, but in this case it is also an effective way of telling the electorate you think they are stupid.

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development. High praise indeed from a country that is normally all too happy to stick the knife into Estonia – viz Russian Foreign Minister Sergei Lavrov's latest allegation that the authorities in Tallinn have again indulged in the glorification of Nazism by hosting an exhibition devoted to Alfred Rosenberg, Hitler's ideologue in chief, at the Estonian History Museum.

Rated highly Putin's rare plaudit for Estonia followed a double-notch upgrade by S&P, which just days earlier had taken the momentous step of stripping the US of its prized triple-A rating. Granted Estonia's creditworthiness, which was raised from 'AA-' from 'A', still lags behind the US 'AA+' rating, but at a time when some of its Eurozone's peers are seeing their ratings slashed to so-called junk status, it's testament to Estonia's pragmatic economic approach that it is deemed worthy of an upgrade when others are being downgraded.

Estonia swims against the economic tide Guy Norton in Zagreb

A

mid the gloom and doom that currently clouds the outlook for the euro, Estonia stands out as a beacon of hope. While older, supposedly wiser members of the Eurozone are currently fighting for their financial lives as they try to avoid drowning in debt, the new kid on the euro bloc is confidently swimming against the economic tide.

Everybody it seems, whether it's US ratings agency Standard & Poor's, The Washington Post or Russian Prime Minister Vladimir Putin, has been lining up to praise the plucky performance of the economic leader of the Baltic pack.

Yes that's right, even Putin had a kind word to say about Estonia, pointing out the country was one of an exclusive troika of Eurozone members – Finland and Luxembourg being the other two – that had pursued prudent policies to ensure sustainable macroeconomic

Front and centre in S&P's positive analysis is the fact that the Estonian government, led by Andrus Ansip, showed the necessary political bravery when the country sank into recession in 2008-09 and GDP shrank by 20%. Eschewing easy options such as a devaluation of the europegged Estonian kroon, Ansip's government instead slashed public spending and raised taxes as part of an internal devaluation that laid the grounds for a strong economic recovery and its adoption of the euro at the start of this year.

As a result, Estonia currently sits atop the GDP growth league table for the Eurozone, with the country reporting on August 10 an increase of 8.4% on year in the second quarter. "The Estonian economy continues to grow at an impressive rate… [and] in general we expect to see a continuation of the high growth trend as exports remain very strong," says Vio-

"As for those who duck the tough decisions – well, let's just say that Congress' public approval rating is nowhere near Prime Minister Ansip's"

bne September 2011

leta Klyviene, senior Baltic economist for Danske Bank. "There is a certain upside risk to our forecasts and the GDP growth outcome might be significantly higher than 6% on average this year."

S&P is also looking positively into the future, saying that: "Should Estonia continue to post sustained growth without generating internal, primarily fiscal, or external imbalances, we could consider raising the rating over the next several

Central Europe

ness. On the back of the S&P upgrade, Estonian five-year CDS contracts were trading at 115 basis points, placing it among the top-10 safest EU economies.

To put that in context, just two years ago it was rated the third riskiest.

Furthermore, Ansip's government, which was reelected in March, is now looking to reduce economic risks even further by running balanced budgets and accumulating gold and foreign-

"Even Putin had a kind word to say about Estonia, pointing out the country was one of an exclusive troika of Eurozone members that had pursued prudent policies"

years." This holds out the possibility that the country could soon rank alongside economic superpowers such as the US in the not-too-distant future. Not too shabby for a nation of 1.3m people whose main economic claim to fame little more than 20 years ago was as a leading manufacturer of ladies underwear in the former Soviet Union.

Although S&P cautioned that any excess reliance on external debt or an unexpected widening of the country's fiscal gap would lead to a ratings cut, that seems an unlikely scenario given past performance and future economic policy. Estonia finished 2010 with the EU's only budget surplus and the bloc's lowest public debt – at just 6% of GDP. Indeed the Estonian state has no outstanding international bonds, with the credit-default swap (CDS) market the only avenue through which investors can speculate on Estonia's creditworthi-

I 29

Liesh, liesh and damned shtatistics Czechs drink much less alcohol than the EU statistics show, according to the Czech producers of alcoholic beverages, who harrumph that Czechs are not a nation of "boozers."

The Union of Producers and Importers of Spirits says the EU statistical data, according to which the alcohol consumption in the Czech Republic of 15.23 litres of 100% alcohol per capita is the second highest in the EU after Estonia (16.23 litres per capita), are misleading and inaccurate.

These figures are based on a project run by the Finnish Health and Social Care Institute, which is collecting data from various sources, such as the Eurostat EU statistical office, European agencies and the World Health Organisation.

currency reserves over the course of its four-year term in office.

According to the Czech Statistical Office, the average alcohol consumption in the 10.5m country is just 10.4 litres and the Czech producers say it is slightly under 10 litres, which would be the EU average, the daily Hospodarske noviny writes.

As a result, the country can now look forward with confidence given that public investment in the country in the coming years will be supported by aid from the EU, while increasing economic optimism at home should boost private consumption, which Danske's Klyviene warns still remains weak.

Nevertheless, Czechs are still "world champions" in beer drinking, with 144 litres of beer per capita in 2010, though beer consumption in the country has been decreasing in the past years. Czechs are drinking more wine than in the past, but with wine consumption at 19.1 litres per capita (2010), they are still below the EU average, according to the data of the Czech Wine Fund.

No wonder then that The Washington Post in a rare Estonia-focused editorial was singing the country's praises and contrasting Ansip's performance with that of the current US administration.

"Leaders willing to take tough measures to put national finances in order are more likely to be rewarded than punished by their constituents. As for those who duck the tough decisions - well, let's just say that Congress' public approval rating is nowhere near Ansip's."

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Southeast Europe I 31

bne September 2011

government will muster a qualified majority in parliament to adopt the third pillar of the Financial Stability Pact – an amendment to the constitution that calls for a majority of at least two-thirds in the 240-seat chamber for increasing the budget deficit above the 2% ceiling and for raising direct taxes. An attempt to pass the amendment at the end of July failed due to a lack of quorum. "It's time to make the next step in the right direc-

tral bank lending to the government.

The fixed exchange rate is enshrined in the BNB Law. The adopted budget deficit ceiling of 2% of GDP is lower than the 3% cap on the shortfall that is allowed under the Maastricht criteria for the adoption of the euro. Dyankov, however, told international news media in July that joining the euro's waiting room, or ERM-

"It's time to make the next step in the right direction – to change direct taxes through two-thirds majority in parliament only"

tion – to change direct taxes through two-thirds majority in parliament only.

This is the way in which our government and any other government after us will pursue a prudent fiscal policy," Finance Minister Simeon Dyankov told the chamber on July 28.

Bulgaria's fiscal prudence pays off Branimir Kondov in Sofia

W

hile the sovereign debt crisis laps at the shores of older and much bigger EU member states like Italy and Spain, and Greece, Ireland and Portugal catch a breath of air thanks to their bailout packages, newcomer Bulgaria has received an upgrade on its sovereign rating in recognition of its fiscal prudence, which the government is currently trying to enshrine into its constitution.

Having learned hard lessons from its own financial crisis in 1996-97 that closed a third of its banks and forced it to seek a bailout from the International Monetary Fund (IMF) and introduce a rigorous monetary policy arrangement to stabilise its currency, this poorest EU member plans to go a step further by trying to

make a cap on government spending part of the constitution – the second member of the bloc to do so after Germany, which in 2009 put into its constitution a provision allowing the federal government to increase its annual net borrowing by just 0.35% of the country's GDP after 2016 and banning the federal provinces from increasing their net borrowing after 2020.

In a bid to discourage politicians from spending beyond its means, Bulgaria's ruling centre-right GERB party, whose fiscal prudence won praise from Moody's Investor Service on July 22 when it raised the sovereign rating one notch to 'Baa2', pushed through parliament changes in the budget law in late June limiting the consolidated budget deficit to a maximum 2% of projected GDP and

capping government spending at 40% of GDP. Both changes, two pillars of the government's so-called Financial Stability Pact, were adopted by simple majority and are to take effect as of next year.

"We expect the general government financial balance to show a deficit below 3% of GDP in 2011, as evidenced by the results already achieved in the first half of the year," said Moody's in statement accompanying the upgrade. "Moreover, the implementation of the latest pension reforms and the new 'Financial Stability Pact' are likely to help keep the government finances close to balanced over the medium to long term."

Third pillar It is unclear yet, however, whether the

To amend the constitution, the cabinet will need the support of at least 160 members of parliament in which the GERB party has 117 seats, and the nationalist Ataka party, which usually sides with GERB, controls 16 seats. The opposition represented by the Socialists and mainly ethnic Turk DPS party control 75 seats. The right-wing Blue Coalition's 14 deputies and 18 independents hold the balance.

Dubbed locally a "fiscal board" in reference to the restrictive IMF-advised currency board system introduced in Bulgaria in 1997 to rein in triple-digit inflation and win back the trust of international financial institutions and investors, the Financial Stability Pact proposed by Dyankov also aims to back plans for the adoption of the euro in Bulgaria, which joined the EU in 2007.

The currency board pegs the Bulgarian lev currency at a fixed exchange rate to the euro, tying the amount of levs in circulation to the level of the Bulgarian National Bank's (BNB) foreign exchange reserves and restricting cen-

II, currently is not an immediate priority for Bulgaria in view of the debt crisis in the Eurozone.

The government plans to bring down its budget shortfall to 2.5% of GDP this year, or even to cut it to just above 2.0% as Dyankov said in July, from 3.9% in 2010. It reported a preliminary half-year fiscal gap equivalent of 0.9% of the GDP projected for 2011, compared with a budget deficit of 2.2% of GDP in the first half of last year.

Bulgaria's government cut its debt to €5.33bn, or 13.8% of the projected 2011 GDP, at the end of June from some 16% at the end of 2010, which was the second lowest in the EU27 after Estonia.

End-June external government debt was equivalent to 8.5% of the projected 2011 GDP, and domestic government debt was 5.3% of GDP, the Finance Ministry reported on its website in August.

Bond bonanza Confident that the government would honour its debt commitments, investors snapped up several issues of Treasury bonds in July and August, reflecting the perceptions of Bulgarian debt as low risk.

An offer of BGN30m worth of 3.5-year government paper at the end of July was 2.19 times oversubscribed, the highest coverage ratio in the last three auctions for this maturity, the Finance Ministry said. The average weighted annual yield achieved in the auction was 3.53%, below the yields on euro-denominated Eurobonds with similar residual maturity of Lithuania (3.57%), Turkey (3.84%), Croatia (4.01%), Hungary (4.62%) and Romania (4.88%). The spread compared with German federal bonds with similar residual maturity was 1.71 percentage points.

Added the Finance Ministry: "The yield level is below the current value of the index [five-year credit default swaps] of Bulgaria, which takes into account the assessment of international markets on the issuer default risk (about 220 basis points) and shows that market participants have not required any currency risk premium."

Yields on BGN50m of 10.5-year benchmark fixed-rate Treasury bonds fell to 5.31% in August, the lowest level in the five auctions of this maturity held since January 2011, as the amount on offer was 2.7 times oversubscribed. The average weighted annual yield on BGN40 million seven-year government securities also declined to 4.53% in August, the lowest ever since the issue was launched in February of 2010, as the coverage ratio in the auction 1.86.

"The latest pension reforms and the new 'Financial Stability Pact' are likely to help keep government finances close to balanced over the long term"

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Domestic vs. international concerns There is little argument that the Turkish economy needs to make adjustments to correct rampant growth. Having seen their GDP rise 11% on year in the first quarter of 2011, credit-happy Turks are spending wildly, feeding an unhealthy demand for imports as exports underperform. This is causing a widening of the current account deficit.

Turkey's new monetary policy – contradictory at best

However, the decision to cut interest rates was a surprise. For one, the central bank was not expected to make any changes to its already controversial policy of low interest rates anytime soon. The economy also needs to slow in order to dampen the overheating and narrow the current account deficit, which was singled out by Moody's Investors Service this month as one of the reasons why Turkey remains under investment-grade status. "It is important for the Turkish economy to slow down this year and next," says Emre Deliveli, a freelance consultant and economics columnist.

Justin Vela in Istanbul

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he results of an emergency meeting called by Turkey's central bank on August 4 increased concerns over the country's economic policies and pushed the already depreciating lira lower. Turkey's government will have to follow up with clear reforms to convince observers that its policies are aimed at more than pleasing an overspending public.

Central bank officials chose to reduce the benchmark interest rate to an all-time low of 5.75% from 6.25%. The move, which aims to increase domestic economic activity, highlights the central bank's worries that another global crisis will soon affect Turkey, despite claims from members of the ruling Justice and Development Party (AKP) that it won't. "The crisis in Europe will not even touch us and will pass this time," Turkish Prime Minister Recep Tayyip Erdogan was quoted as saying by Today's Zaman on July 27.

Citigroup's Ilker Domac said in an e-mailed note that, "Once again, the bank has caught the markets off guard by cutting its policy rate when such a

move was seen as difficult to justify."

Cutting rates when the lira is already falling and inflation increasing does not bode well for financial stability, nor was there a decline in domestic economic activity to support the cut, Domac said.

Aiming to counter the lira's fall, the central bank also raised its overnight borrowing rate to 5% from 1.5%, according to a statement, and will

Growth for this year is expected to be about 8%. Raising interest rates instead of cutting them would assist in slowing the economy more quickly. "[Hiking interest rates] would slow down demand, but will also be useful to attract capital into the country and make the lira appreciate if the foreign capital flows dry up," says Deliveli.

The current account deficit is now financed largely by short-term capital

"The increasing of interests rates is against the wishes of the prime minister" begin daily auctions of foreign currency to keep markets liquid. Yet immediately following the meeting, the lira fell about 2% to TRY1.74 against the dollar, according to Reuters. Since the beginning of the year, the currency has depreciated by about 12.6%, making it one of the worst performing emerging market currencies.

flows from portfolio investors, with net foreign direct investment covering only 15%.

Deliveli puts responsibility for the low interest rate policy squarely on the shoulders of PM Erdogan. "The increasing of interests rates is against the wishes of the prime minister," he claims.

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Crunch time The ruling AKP claims Turkey will stand among the world's top 10 economies by 2023, the centennial anniversary of the Turkish Republic. Over the past eight years, the party's management of the economy has turned Turkey into an economic powerhouse. But the government's obsession with high growth numbers as opposed to restructuring the economy puts Turkey in a precarious position, say experts.

Profits are currently high enough that most companies and individuals are satisfied with the status quo. But adjustments must be made to the structure of Turkey's economy or the country will continue to face long-term uncertainty regarding stability, remain below investment-grade status, and viewed as susceptible to outside instability. Hardly the place long-term foreign direct investment would like to settle in.

There is much that the government and the central bank, whose independence is increasingly being questioned, can do. In September, a new medium-term economic plan will be established.

According to analysts, the goal should be to slowly depreciate the lira to a suitable level and slow the economy for the next two years, narrowing the current account deficit and reducing the risk of overheating and asset bubbles. Then the economy will be brought back to what most economists believe is a sustainable growth rate of about 6-8% per year.

The plan must also focus on making the necessary micro-economic reforms.

Labour markets must be more flexible, there is a massive grey economy, women's labour force participation is very low and there's a need for a regional minimum wage similar to that in the US. Domestic production must be boosted.

Crucially, even Erdogan addressed one of the most important changes that must be made when he encouraged Turks to save money during a July press conference.

This makes the interest rate drop all the more curious. Is asking Turks to save while encouraging them to spend not contradictory policy in Turkey?

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Turkey looks to break import addiction

Justin Vela in Istanbul Research from the Turkish Exporters' Assembly showing that exports were up 23% in July from the year before is a healthy sign for Turkey's economy.

However, experts say to close the trade gap Turkey needs to foster more value-added domestic production and end the habit of assembling products that other countries make more cheaply. "[Turkey's] import dependency resembles a drug addiction," is how Zafer Caglayan, the new economy minister, recently described the situation.

Indeed, Turkish exports in June increased by 19.3% on the year to reach $11.4bn, but imports increased during the same month by 41.7% to reach $21.6bn. This resulted in the trade deficit rising 79.2% on the year to $10.2bn in June, the key factor behind forecasts that put Turkey's current account deficit at $83bn, about 10.8% of GDP, for the whole of the year.

The mushrooming current account deficit, along with 11% growth in the first quarter of the year, indicate Turkey's economy is overheating and critically unbalanced. Domestic production is rising – in the first quarter manufacturing and industry was up 10.9% on year, construction up 14.8% and retail trade up 17.2%. But with Turkey so heavily reliant on imports, how that production is being fostered makes a big difference. "When you look at domestic production, it is growing very fast," says Ozgur Altug, chief economist at BGC Partners, a global brokerage house. "The issue is that whenever Turkey increases its production, the current account deficit widens."

This is a structural problem that won't be solved in the short term, Altug says. The country imports the vast majority of its energy – Russia is the main supplier – and is largely focused on assembly line production that requires a large number of imported parts. What ends up being made is "medium-technology products" that can be bought on the global market from other countries at more competitive prices due to lower labour costs.

Many analysts believe that a current account deficit of about 5-6% of GDP for rapidly growing Turkey is a far more sustainable level. But to achieve that, deep labour market reforms are necessary, such as cost reductions, better education and training, and subsidies for research and development to not simply increase, but change the structure of domestic production in Turkey.

Experts say the government appears to understand the challenges posed by the current forms of domestic production. A government-sponsored analysis called the "Input Supply Strategy" is being conducted within sectors that are importing excessively. In a July meeting with the Association of Economy Reporters, Caglayan, who heads the newly formed economy ministry, which was created to deal with issues such as the current account deficit said that following the analysis, several subsidies and strategies will be established over the next months to increase competitive.

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Jarinje and Brnjak on July 26 prompted clashes that led to the death of a KPS officer and an arson attack on the Jarinje checkpoint by protesting Serbs, leaving the Kfor peacekeeping force to take over management the crossings.

All this comes at a bad time for Kosovo, which finds itself under increasing pressure from the international community that did so much bring an independent Kosovo into the world, but which is now becoming increasingly irritated with its wayward prodigy.

Kosovo – half a step forward, three steps back Alex Young in Belgrade

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alks between Serbia and the now independent province of Kosovo are never far from breakdown, and so a minor difference in opinion over state insignia quickly spiralled into a trade dispute, an abortive seizure of checkpoints on July 26 and deathly violence.

Despite reaching a tentative agreement in early-July on civil registry documents, the mutual recognition of academic diplomas and freedom of movement (which would see Serbia accept Kosovo ID cards), the latest round of talks between the two adversaries had to be postponed due to differences in opinion over the appearance of state insignia, in particular on Kosovo's customs stamps.

In apparent retaliation for the rejection of the "Republic of Kosovo" customs stamps, Kosovo government quickly moved to ban imports from Serbia and imposed a 10% tax on imports from Bosnia-Herzegovina.

With 12% of Kosovo's imports (roughly €300m) coming from Serbia, its secondlargest trading partner, the move hits the latter hard - particularly at a time when it is keen to demonstrate its credentials as a candidate for membership of the EU. Securing the aforementioned checkpoints in the Serb-dominated north of the country was deemed key to enforcing the decision, but prompted a stinging

Over the coming weeks, attention will again return to the alleged mismanagement of EU donor assistance and the controversial expropriation of public land to a private beneficiary without an open and transparent bidding process.

Audits The European Court of Auditors (ECA) – with the European Parliament watching closely – is set to proceed with an audit of all EU-funded projects in Kosovo since 2007. The Kosovo Electric Corporation (KEK) and Pristina International Airport will certainly be in the spotlight, having previously come under close scrutiny. As the largest donor in Kosovo – having provided over €2bn of assistance since 1999 – the findings will lead to stricter conditions on future aid from an ever more financially cautious EU and increasingly financially strapped Kosovo.

If previous investigations into fraud accusations are anything to go by, however, progress will be slow and arduous.

Numerous problems abound. Though the UN Mission in Kosovo (UNMIK) trans-

"The system of international supervision established in Kosovo is unable, or unwilling, to confront powerful interests" reaction by those opposed to Kosovo's independence.

The Kosovo Police Service's (KPS) heavy-handed attempts to seize control of the administrative line checkpoints at

ferred pending cases to the Kosovo Special Prosecution Office – which is run by the EU's rule-of-law mission (Eulex) – the vast majority have remained untouched; though Eulex did pursue several cases concerning Kosovo Post and Telecom (PTK).

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As Andrea Lorenzo Capussela, a former head of the Economics and Fiscal Affairs Unit of the International Civilian Office (ICO), Kosovo's main overseer, tells bne, "many EU-funded projects are implemented through the Kosovo budget and with the help of consultants, so the ECA might meet difficulties in gathering documents from the local authorities and interviewing consultants, who might have left for other assignments."

Capussela adds that, "the overall performance of the Kosovo Trust Agency [which manages Kosovo's socially-owned enterprises], and of the Privatisation Agency of Kosovo, was rather unsatisfactory, which might imply that they made inefficient use of the funds they received by the EU." Aside from such obstacles, which are further compounded by a lack of human resources, there is a distinct lack of political will – on the part of both the international community and domestic political elites – to investigate possible instances of mismanagement, let alone pursue possible indictments.

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Capussela has also vehemently criticised the expropriation of land from a publicly-owned company to allow the American University in Kosovo (AUK) to construct an educational complex, without a competitive bidding process and for compensation that is likely to be well below the plot's market value.

As Capussela explains, this deal was designed by the elite of Kosovo and involves powerful vested interests.

"The deal is manifestly unacceptable, but the supervisor of Kosovo, the ICO [International Civilian Office], chose not to object to it, and the EU rule of law mission, Eulex, decided that no investigation about it was warranted. This implies that the system of international supervision established in Kosovo is unable, or unwilling, to confront powerful interests."

Capussela goes on to say that while the approach taken by ICO and Eulex might have been dictated by political realism given it involves interests linked to the US, such a choice merely further

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undermines the rule of law and aids the growing power of vested interests, which are constraints on economic growth and a serious obstacle to democratic development. "Accepting this deal undercuts the efforts to strengthen the rule of law," he says.

With Kosovo mired in accusations of corruption and struggling for international recognition – from states and foreign investors alike – the need to tackle the obstacles to democratic transition grow ever more acute. When quizzed on what the international community could do to strengthen the fight against corruption in Kosovo, Capussela insists that it should begin to demand action by the Kosovo authorities. "In three years, I have seen little more than lip service to the need of fighting corruption," he says.

Whilst the mantra about "improving the lives of all citizens" has underpinned negotiations between Pristina and Belgrade, the same does not seem to apply to international oversight of Kosovo.

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Indirect Taxation Authority (ITA) and the opening of separate accounts for the collection of revenues. Effective from 2006, the ITA administers the collection of VAT revenues from throughout Bosnia, providing the largest single source of government revenue. The two parts of Bosnia receive any surplus left over after state expenses have been covered, in accordance with their respective collection of VAT receipts. Given its significance, the ITA is likely to provide the next battleground in the heated dispute over Bosnia's future shape and form.

Bosnia's fiscal fragmentation Alex Young in Belgrade

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ithout a state-level government for almost a year, the extent of Bosnia-Herzegovina's economic woes continues to become ever more apparent.

Widespread protests by farmers' associations from the Federation of BosniaHerzegovina, the country's BosniakCroat entity, over changes to agricultural subsidies recently led to the blocking of four border crossings and the Federation government building. Workers from one of the country's oldest factories, meanwhile – the furniture manufacturer Konjuh – have descended on Sarajevo, requesting both financial assistance and investigations into alleged mismanagement. Though Bosnia's economy has returned to (marginal) growth, job creation and the position of domestic producers remain extremely weak.

Fiscal matters are increasingly proving to be one of the main sources – and

manifestations – of inter-ethnic tension.

The Republika Srpska, the country's other Serbian entity, is to pursue two lawsuits against the Federation – one relating to €35m of unpaid indirect

In addition, the Republika Srpska's Ministry of Finance has proposed amendments to the Law on the Central Bank of Bosnia-Herzegovina, arguing that – as a co-founder of the bank, having contributed a third of the initial loan – it should be entitled to one-third of the bank's revenues. At present, 60% the bank's revenues are paid to the budget of Bosnia's state institutions, with the remainder transferred to the bank's general reserves.

Budget battle Once a government is established, approving a budget for Bosnia's statelevel institutions for 2011 and 2012 will be a first priority.

The Republika Srpska has clearly indicated that it will reject any proposed increases, arguing that its budget cuts – particularly of government salaries –

"Fiscal matters are increasingly proving to be one of the main sources of inter-ethnic tension"

taxation revenues; the other concerning some 25,000 pensioners, whose obligations the Federation should have assumed. In sum, the outstanding debts to the Republika Srpska amount to approximately €300m – roughly a third of the Federation's annual budget.

The Republika Srpska government has also called for reform of the state-level

should be mirrored at the state level and in-line with austerity measures passed by other European countries. Even if the budget for 2011 were to remain the same as 2010 (at BAM1.028bn, which is approximately €514m), the share derived from indirect taxation revenues would increase by approximately €59m due to losses of other revenues. Such an arrangement is seen as detrimental

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to the entity's financial interests and is likely to spark heavy resistance that will threaten the sustainability of state institutions, which currently rely upon temporary financing.

Meanwhile, the governing coalition in the Federation – led by the much-vaunted Social Democratic Party (SDP) of Zlatko Lagumdzija – has been accused of nepotism in appointing hundreds of close associates to positions in public companies. Audit reports have revealed a distinct lack of transparency in the spending of almost all the Federation's institutions and ministries, particularly the Ministry of Agriculture, Water Management and Forestry, which apparently paid agricultural incentives to a manufacturer of ammunition and explosives. The same institutions have also been criticized for their excessive levels of spending on salaries and allowances, and travel expenses. Several state companies, such as BH Telecom and Elektroprivreda Bosnia-Herzegovina, which produces and distributes electricity, have also been accused of hiding some €500m in commercial banks that could instead be used for investment purposes.

Standard and Poor's has already warned that Bosnia's credit rating may be downgraded from 'stable' to 'negative' due to, in particular, political stalemate and public sector corruption. In addition, Bosnia could lose some €96m of support allocated for 2011 under the EU's Instrument for Pre-Accession Assistance (IPA), due to a failure to reach agreement on which projects to support. With the EU pushing stronger conditionality as part of its bid to play a more assertive role in the country, such disputes are likely to intensify; particularly with the Republika Srpska largely opposed to projects designed to strengthen state-level institutions, such as the High Judicial and Prosecutorial Council and the Statistics Agency. Continued delays in the formation of the Council of Ministers may also deprive Bosnia of further international assistance – including the IMF's StandBy Arrangement, World Bank credits and the EU's Macro-Financial Assistance – amounting to some €500m.

The shifting regional context, mean-

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while, is creating new dilemmas.

Kosovo's decision to impose a 10% customs duty on goods from Bosnia (which amounted to some €80m in the first six months of 2011) has further impacted its trade balance, with competitors from Macedonia and Montenegro taking over lucrative markets. Croatia's seemingly imminent membership of the EU, however, may open up new possibilities.

Once it joins, Croatian manufacturers will no longer benefit from duty-free exports provided by the Central Euro-

"Audit reports have revealed a distinct lack of transparency in the spending of almost all the Federation's institutions and ministries" pean Free Trade Agreement (CEFTA), but will instead have to pay a 15% levy to export to its most significant non-EU markets in the region. As such, many are considering relocating factories to Bosnia. Pre-empting such a move, the Croatian government has threatened to allow exports to pass through only two border crossings (Gradiska and Bijaca), thereby adding to the costs facing Bosnia's exporters.

If functionality is to be the key driver of constitutional reform, then the country's political elites, as well as the international community, may have to consider the creation of a third – and invariably predominantly Croat – entity within Bosnia as a replacement for the cumbersome and expensive cantonal system of government in the Federation. Indeed, given the contentiousness of constitutional reform issues at present, it makes a great deal of sense to shift the focus to economic development programmes at the entity and cantonal levels.

In the absence of consensus, however, Bosnia-Herzegovina's accelerating economic and fiscal fragmentation continues to pose the biggest threat to its future viability.

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But in a classic example of nemesis following hubris, Srot tried unsuccessfully to turn his financial wealth into political influence and raised the ire of the powers that be in the Slovenian capital Ljubljana, who launched an anti-tycoon drive in response.

Slovenia tries to stop the Srot Guy Norton in Zagreb

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ow the mighty are fallen. Slowly but surely, the business empires built up by a number of Slovenian entrepreneurs over the course of the past two decades of independence are being dismantled piece by piece. A toxic cocktail of over-ambition and overleverage, combined with a bitter dash of sharp practice and political shenanigans, mean that a number of wheeler-dealers that were once hailed as heroes in Slovenia are now regarded as zeros.

Chief among them is Bosko Srot, who at one time was lauded as one of Slovenia's most successful citizens with a net worth of over €2bn, but is now generally viewed with contempt and loathing.

A lawyer by training, Srot at one point effectively controlled the country's two biggest brewers, the country's biggest supermarket and three out of the four leading daily newspapers through a

Having lost the support of politicians in Slovenia, he then lost the support of bankers in the country after they realised – far too late argue many in Slovenia – that the foundations of his business empire were built on the financial equivalent of quicksand. When Srot failed to keep pace on the repayments of the loans he took out to fund his over-weaning ambitions, they seized whole chunks of his empire or made him promise to sell off parts of it to repay them. The net result is that like many one-time Slovenian national champions, the "House of Srot" is now being dismantled brick by brick and sold off to the highest bidder.

In many instances, this involves companies being offloaded to foreign buyers – a controversial process in a country of barely 2m people who fear that just 20 years after the country gained independence, it will effectively become a vassal state of global capitalism.

Juicy bits The latest Srot holding to go under the hammer is juice maker Fructal, which has been auctioned off to Serbia's Nectar in a deal worth the best part of €50m by brewer Pivovarno Lasko, formerly the jewel in Srot's crown that is reported to have debts totalling €400m which it's struggling to repay.

Whereas formerly Slovenian companies were acquirers in Serbia – some 1,400 firms from Slovenia have invested over

"In a classic example of nemesis following hubris, Srot tried unsuccessfully to turn his financial wealth into political influence" labyrinthine legal maze of dummy corporations, friendly companies and share-parking schemes.

€1.8bn in the country to date – the financial misfortunes of Srot et al mean that that process is now being reversed, albeit

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on a much smaller scale. Nectar joins a select band of Serbian firms that have broken into the Slovenian market in recent years. These include technology firm ComTrade, which took over Slovenian software company Hermes SoftLab for around €40m in 2008, and detergent manufacturer Beohemija, which in the same year bought its Slovenian peer Sampionka for €6m.

The next part of the Srot empire to be put on the block is Slovenia's leading daily Delo, for which Pivovarna Lasko is seeking around €45m. Swiss-German publisher Ringier-Axel Springer and Sweden's Bonnier are among the international media groups which are reported to be interested in acquiring the newspaper. Having previously submitted separate bids, the two companies are now acting in unison.

Meanwhile, later this year Pivovarna Lasko and a number of Slovenian and international banks that jointly hold 50.03% in Mercator, Slovenia's leading supermarket are to conduct an international tender for their controlling stake.

Earlier this year Pivovarna Lasko had tried to offload its 23.34% share of Mercator to Croatia's Agrokor, but the Slovenian competition watchdog slapped a ban on the disposal because Pivovarna Lasko had not sought its approval.

Agrokor's owner Ivica Todoric, meanwhile, has taken advantage of the travails of another financially embattled Slovenian tycoon, Mirko Tus, by buying a chain of supermarkets in Serbia from him for €50m. Tus, like Srot, is now being forced by his creditors to offload assets to repay a reported €450m debt burden. Recent enforced sales by Tus include petrol service station arm, Tus Oil, which was bought by Hungary's Mol for an undisclosed sum in May.

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A murky interior in Slovenia

bne The pervasive problem of corruption in the Balkans is now tainting Slovenian politics as the country's interior minister was forced to resign on August 10 amid corruption allegations, which has led to renewed opposition calls for a fresh election.

The 38-year-old Katarina Kresal's decision to leave was not a sign of guilt, but "due respect for the authority of law," she said, after the Commission for the Prevention of Corruption concluded it had detected "elements of corruption" in the rental of a building by her ministry.

The Court of Audit, initially called in by the anti-corruption commission, had said the day before that the company letting the building was not selected by a public tender, that bidders were treated unequally and that the ministry's dealings were wasteful. Social Democrat Prime Minister Borut Pahor refused Kresal's resignation on this first occasion, but "understood" a day later.

Pahor's government had already lost its parliamentary majority with the departure of DeSUS, a pensioners' party, in May and the left-liberal Zares in late June. Kresal's Liberal Democrats of Slovenia (LDS) party is now the only coalition partner left and has indicated that retaining the interior ministry will be the price of continuing in the coalition. The Pahor government is already reeling from three defeats in plebiscites in June, among them one on increasing the retirement age, a move which might have helped slow the rising level of debt. The idea was rejected by 72%. The budget deficit, meanwhile, is forecast to end the year at 5.8%, almost twice the level laid down by Brussels for those in the euro.

Building problems Kresal's downfall stemmed from her ministry renting the national headquarters of the NPU, the Slovenian version of the FBI, from Igor Jurij Pogacar, a controversial real estate dealer who counts among the friends of her lifepartner Miro Senica, a lawyer. Pogacar's Ram Invest company, in turn, leased the building from Hypo Alpe Adria Group, a bank nationalised by the Austrian government in December 2009 to save it from collapse in murky circumstances. The Democrat opposition claims the rental on the 10,400 square metre premises of ¤1.6m a year is excessive when compared to alternative arrangements made by Kresal's Democrat predecessor, Dragutin Mate.

Kresal, a commercial lawyer, won her seat in parliament after the elections of September 2008, having entered politics a year earlier by being elected chairmen of the LDS. Having initially been a tabloid favourite, Kresal soon faced a barrage of scandals. Kresal has faced two confidence votes in parliament, winning the first in April 2009 when the opposition Democrats wanted to oust her for restoring permanent resident status to people deleted from the register in 1992. Last year came the second, when the opposition queried her role in the leasing of the NBU building together with the return of a Bull mastiff dog to a well-known doctor in Ljubljana. It proved to be the NBU building that had the more powerful bite.

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unsecured creditors to agree to previous terms. Creditors were not happy with the second proposal from Astana Finance, but the third is even worse," he tells bne.

Unlike BTA, Astana Finance is not considered to be a bank of systemic importance, so the Kazakh government and Samruk-Kazyna have less incentive to prop up the institution. "The outcome of the Astana Finance restructuring may create bad feelings within certain institutions, but provided BTA and Alliance perform on their debt and there is no further restructuring, I think Astana Finance will be forgotten relatively quickly," Andrijanovs says.

Astana la vista, baby Clare Nuttall in Almaty

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stana Finance is struggling to reach a debt restructuring deal with creditors after Kazakhstan's sovereign wealth fund Samruk-Kazyna pulled the plug on extra financing for the troubled firm. This is more bad news for the country's banks, which are making little headway in dealing with troubled loans as government help fails to materialise.

Astana Finance was Kazakhstan's third financial institution to default, suspending debt repayments in May 2009, three months after BTA Bank and Alliance Bank were nationalised.

Under Astana Finance's latest proposal to creditors, made in July, export credit agencies would receive 100% of the nominal amount of their outstanding claims, while all other creditors would receive new zero coupon notes representing 20% of the nominal amount of

their outstanding claims and recovery notes to capture potential future upside.

The proposal is currently being considered by the creditors' committee. Astana Finance's timescale for the restructuring envisages that a term sheet will be drawn up by the end of September, with

on August 4 that a $190m subordinated loan from Samruk-Kazyna on which it was based was no longer on the table.

Astana Finance "understands that Samruk-Kazyna is no longer willing to consider making any such loan," the statement said.

"Creditors were not happy with the second proposal from Astana Finance, but the third is even worse" the restructuring due to finish by the end of December. However, a source close to the negotiations says that timescale is looking increasingly optimistic.

The previous proposal to creditors collapsed when Astana Finance confirmed

According to Andre Andrijanovs, director and corporate strategist at emerging markets investment bank Exotix, the new offer is "definitely unsatisfactory" from the point of view of unsecured debt holders. "The latest proposal may be being used to put pressure on

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Reshuffles and resentment Meanwhile, BTA, which completed its $10bn debt restructuring last year, announced a top management reshuffle on August 15. A statement from the bank said that the chairman of the board of directors, Arman Dunaev, had resigned. Ex-Nurbank chairman Marat Zairov has been appointed chairman of BTA's management board, replacing Anvar Saidenov, who has in turn replaced Dunaev on the board. "I am sure that the appointment of Mr Marat Zairov as a chairman of the management board, who is well known in the Kazakh financial market, will contribute to the qualitative solutions for new tactical tasks of the bank," Saidenov said in a statement.

The reshuffle is understood to have come after Samruk-Kazyna, BTA's majority shareholder since it was nationalised in February 2009, became dissatisfied with the bank's performance.

While Kazakhstan's economy as a whole is doing well – GDP grew by 7.1% in the first half of this year – most banks are still struggling with their burden of nonperforming loans (NPLs), a legacy from the crisis period that shows no signs of disappearing. Government action to help the banks to deal with this legacy has so far not materialised, despite pressure from the sector.

Speaking at the press conference to announce the bank's first-half results,

Succeeding in Kazakhstan

Clare Nuttall in Almaty When Nursultan Nazarbayev won April's Kazakh presidential election with a resounding majority, the issue of who would suceed the septuagenarian appeared to have been put on the backburner for the time being.

But three months later, Nazarbayev's visit to Germany for medical treatment has put it firmly back on the agenda.

In July, the German press reported that Nazarbayev was receiving treatment at a Hamburg hospital. Bild reported that the then 71-year-old president had had a prostate operation after checking into the hospital on July 10. It's not unusual for wealthy Kazakhs to seek medical treatment outside the country, especially in Germany. But the operation followed shortly after repeated assurances from Nazarbayev's spokesman that he planned to serve out the full term after winning the election.

Nazarbayev has ruled Kazakhstan since the country gained its independence in 1991. He has been re-elected three times, most recently in April when he took an implausible 95.5% of the vote on a turnout of 89%, according to official figures.

Democratic shortcomings notwithstanding, Nazarbayev is credited with building the Kazakh nation state, and maintaining peaceful relations among the country's many ethnic groups. Under his 20-year rule, Kazakhstan also pulled away from its Central Asian neighbours economically, and income per capita has increased from $700 a year in 1994 to almost $10,000 in 2010, although corruption remains a problem.

Foreign investors prize Kazakhstan's political stability almost as much as its oil and mineral wealth, but have become increasingly troubled about the future, especially since Nazarbayev has always avoided appointing a successor. "Succession has been the gazillion-dollar question for a very long time and remains one without an answer to date," said Milena Ivanova-Venturini, head of research in Central Asia at Renaissance Capital.

Candidates Those believed to be jostling for position include the president's son-in-law Timur Kulibayev, Astana mayor Imangaldi Tasmagambetov, former prime minister Kassym-Zhomart Tokayev and Karim Massimov, independent Kazakhstan's longest-serving PM. There have been rumours this year of an intense power struggle between the elites of west and south Kazakhstan.

Recently, Kulibayev seemed to have pulled ahead of his rivals. He was promoted to head up Kazakhstan's sovereign wealth fund SamrukKazyna in the post-election reshuffle, and voted onto Gazprom's supervisory board on June 30. According to Ivanova-Venturini, these events "are pointers in some more public convergence of power going his way," but she adds that "my personal view would be that also in the private domain, the question of succession remains just that – a question."

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the chairwoman of Halyk Bank's management board, Umut Shayakhmetova, voiced the industry's impatience. "There is still a large pool of NPLs in the banking sector. The government has not yet made significant progress on creating a Distressed Asset Fund for these assets," Shayakhmetova told journalists on August 17. "There is also a need for changes to the tax law and banking regulation that would allow bad loans to be written off. We are already only

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four months from the end of this year, and need the legislative changes to happen soon in order for them to be effective from January 1, 2012."

There has, though, apparently been progress at Alliance Bank, the second largest Kazakh financial institution to default during the crisis, which on August 14 announced it had reached agreement on a sale of a portfolio of problem retail loans worth $1.25bn. A

research note from Visor Capital says, "We believe Alliance Bank is well on track to deliver its 11-12% loan growth target, as its loan book has already increased by 7.6% in the first half of 2011."

Within the sector as a whole, however, NPLs remain high. According to the latest data from Kazakhstan's financial regulator, overall loan quality continued to deteriorate in June, with NPLs increasing by 2.6%.

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Another US investor, Open Revolution, chose Georgia over 50 other potential countries to headquarter its mobile payment platform, Mobipay. Allen Gilstrap, chief executive officer at MobiPay, says Georgia's pro-business environment and the absence of corruption helped convince the company to come here.

"The complete absence of business corruption, fervency of the government to promote foreign investment – Georgia has a fantastic future in front of it," he says, adding that the country's strong mobile phone network coverage and pool of good programmers helped Open Revolution choose Georgia.

Today, two years after its initial investment, Mobipay is using its Tbilisi offices – and Tbilisi programming staff – to expand operations to countries around the region, including Ukraine and Poland. "We are a poster child for what we think they [the government] wanted to do," Gilstap says.

www.president.gov.ge

IT in Tbilisi Molly Corso in Tbilisi

G

eorgian-made computers, mobile programmes and Apple applications are feeding Tbilisi's ambitions to turn the country into a regional IT hub. Georgia's limited pool of programmers could stifle the sector's growth, however.

Georgian President Mikheil Saakashvili – never one to shy away from the latest fads – is enthralled with the idea of Georgia becoming a regional IT capital.

During the July 25 opening of a new computer factory built by local company Algorithm in cooperation with Intel, Saakashvili predicted future generations of Georgian programmers and inventors would learn computer skills on locally produced computers. "We are attending a historic process indeed, because it is

a high-technology and modern production in Georgia," he said. "A generation will be raised in Georgia that will think in an absolutely different way and will invent absolutely different product…

In several years, we will reach such a level when Georgians will invent such products by their own sources and will even export them abroad."

With Latin letters and Georgian programmes, the small netbooks that will be assembled at the plant are a radical departure from the Russian language computers and software that Georgians have grown accustomed to. "For the region, this is a good issue politically – that in the Caucasus region, Georgia will be the first to produce these netbooks," Algorithm director Givi Korakhashvili said.

The computer factory, set to produce 60 thousand netbooks for the country's first-graders, was a GEL32m (approximately €13.5m) investment for Algorithm. An estimated 60 workers will produce the computers with Intel processors. Korakhashvili, a 58-year-old engineer who has built his career – and business – on the Georgian computer market, says Georgia is ready to produce technology, not just consume it.

"Over the past five years, Georgia has been developing very quickly," he says.

"This is also part of the development.

This is needed, I think."

CEE expansion base The new computer factory in Tbilisi is the latest in a wave of recent investments to create IT products in Georgia.

Eurasia

"The government is really trying to find potential investors in IT [and] there are definitely some very positive movements," he says. "The biggest challenge right now is the cost of labour for IT in Georgia. Costs for labour are very high and until there will not be a bigger supply of IT trained professionals, it will be very hard for the bigger, larger companies to see a competitive advantage to investing here rather than investing somewhere else."

Chirakadze notes that there are countries like Bangledesh and India where you can hire an IT specialist for a third of the cost of the equivalent worker in Georgia.

But while Gilstrap was encouraged by the programmers and IT specialists who applied for jobs at Mobipay, other industry insiders warn the shortage of skilled workers – and strong IT programmes – could stifle Georgia's potential as an IT hub.

New investment, however, could change that. In July, Cisco Networking Academy partnered with the United Nations Development Program (UNDP) to open an academy in Batumi – its first in the country. The academy, an international education programme with over a million students in 165 countries, will teach students at Batumi Professional College how to design, build and troubleshoot computer systems. The government is also planning to build a university for IT and technical skills in Batumi.

Giorgi Chirakadze, head of Georgia's largest IT provider UGT, says the government is "really trying" to push the sector and find investors – Vera Kobalia, the minister of sustainable economic development, made Silicon Valley the focus of her trip to California last year, talking to Cisco, HP and other big industry players – but the lack of affordable IT specialists is an obstacle for the sector's development.

Chirakadze stresses that the main question is how fast the government's plans will produce IT specialists. "There are pretty positive moves from the government, from the Ministry of Education, from the universities…there is more interest in IT which is very important," he says. "But how much more is needed to create that critical mass that bigger companies will be interested in? It is a question of time."

"The complete absence of business corruption, fervency of the government to promote foreign investment – Georgia has a fantastic future in front of it"

I 43

Karimov The Brave Like other former Soviet republics, Uzbekistan is preparing to mark 20 years of independence and the sycophantic media are going into overdrive in a desperate attempt to bring to light the role that autocratic President Islam Karimov allegedly played in securing the country's freedom.

According to Radio Free Europe/Radio Liberty, Uzbek television has been airing a series of programmes devoted to Karimov and the leadership he showed before, during and after those critical days in August 1991 that preceded the fall of the USSR. One that aired in August is titled "On The Eve Of Independence, Or The Last Agony Of The Soviets" and is mostly based on Karimov's recently published book, "On The Threshold Of Independence." In this programme, which highlights the hopelessness and poverty of Soviet rule, the president keeps popping up to soothe ethnic tensions between the various tribes of Uzbekistan at great risk to his own saftey – incidences which until now have apparently not been recorded.

What the programme fails to mention, however, is that in March 1991 Karimov led the campaign to maintain the Soviet Union. Then, RFE/RL says, he told the people of the Uzbek Soviet Socialist Republic that, "our rivers will run with milk if we stay within the Soviet Union," but "if we leave it, our rivers will fill with blood."

If the programmes are to be believed, it was fortunate he was around to make sure that didn't happen.

44

I Eurasia

bne September 2011

CORPORATE STATEMENT:

PASHA Bank – a strong partner in a dynamic economy Azerbaijan’s economy took off in 2003 after its oilfields were connected to western markets by a pipeline to Turkey and it quickly rose to become the fastest growing economy in the world.

T

oday, work has turned to building a modern and diversified economy that is not dependent on the vagaries of the international commodity markets. PASHA Bank is your strong local partner to capitalise on the opportunities in one of the world’s most dynamic markets.

PASHA Bank was set up in June 2007, receiving its banking license that November, and has gone on to become the leading non-state commercial bank in the country with a strong focus on the corporate sector and private banking. Working with most of the largest companies and servicing private accounts, the bank also pays special attention to small and mediumsized enterprises (SMEs) that are becoming increasingly important in the economy and is the fastest growing segment of PASHA Bank’s businesses.

The bank’s assets and profit have been growing strongly in recent years as the economy gets back on its feet. Despite the recent crisis, the bank's profits grew by 50% in 2009 and the bank’s assets increased by 67% in 2010.

“The crisis has hurt everyone, but Azerbaijan was relatively sheltered from the worst of the storm,” says Farid Akhundov, chairman of the board of PASHA Bank, “Although growth has slowed somewhat, the country was still the fastest growing in the world in 2010 and we saw our assets increase strongly that year too. This year has also been more difficult for everyone, but we are still on track to meet our targets at the end of this year.”

In terms of its paid-in capital, PASHA Bank is Azerbaijan’s largest commercial banking institution, providing the bank with the financial clout needed to take on large projects. But the key to PASHA Bank’s success has been its emphasis on quality and adhering to international best practices. From the outset, PASHA Bank has concentrated on sticking to international corporate governance and risk management standards.

PASHA Bank is already recognised as an innovator and was one of the first local banks to set up a compliance department, headed by the country's first compliance officer accredited by the internationally recognized ALCO (Association Luxembourgeoise des Compliance Officers du Secteur

Farid Akhundov Chairman of the Executive Board

Financier). Furthermore, the bank is audited by the "Big Four" accountancy Ernst & Young and its IFRS accounts are reviewed twice a year.

“Our reputation is all we have,” says Akhundov. “We are very careful with our reputation, and will not compromise it just for the sake of getting additional money or clients.”

Behind any strong business are strong employees, says Akhundov, which is why the bank considers one of its most important investment destinations is its own staff. Employee training and professional development are a major part of PASHA Bank’s internal growth strategy, financing the studies of staff at a number of respected universities in the United Kingdom.

Although Azerbaijan currently earns most of its money from oil production, the government has made a strong commitment to diversifying the economy, which is also at the core of PASHA Bank’s growth strategy.

“Our three-year strategy comes to an end this year and the development of the non-oil sectors of the economy is key for the country and key for PASHA Bank's ongoing growth for the next three years,” says Akhundov. “As the economy grows, there are opportunities across the board for investment to participate in creating a new market-based economy in Azerbaijan.

At PASHA Bank we intend to play a central role in this process.”

In the next stage, PASHA Bank will obtain a credit rating from one of the international credit rating agencies and establish a benchmark borrowing rate. It is also playing a leading role in developing the nascent banking sector in Azerbaijan, which is expected to consolidate over the years to come.

“Increasing our competitiveness is a priority for us,” Akhundov says. “We want to be an able competitor, both against local banks and the foreign banks that we expect to enter the market.”

PASHA Bank should be your first port of call when arriving in Baku. Come and work with the locals who have an international perspective.

bne September 2011

Eurasia

I 45

46

I Eurasia

bne September 2011

Nomads in the global market Oliver Belfitt-Nash in Ulaanbaatar

S

igns of how Mongolia is in its capitalist infancy are everywhere in Ulaanbaatar, but a flood of investment in the country's natural resources over the next few years promises to pit engrained cultural attitudes against the demands of modern business. Can Mongolians' "nomadic mentality" adapt quickly enough to this new environment?

In Mongolia, cleanliness of shoes is the best indicator of a person's status and personality. Given dirty shoes means dirty businessman, you'd expect the shoe-shining business on the mucky streets of Ulaanbaatar to be thriving, but you'd be wrong: the lonely shoeshiner on the corner of the central Sukhbaatar Square scoffs at the dusty shoes walking past him in an attempt to get business, but only rarely does it result in a customer.

This correspondent agreed a price of MNT2,00 for a shine, thinking that £1 was expensive but a fair enough price for status to be restored, and after a few minutes my left shoe was as good as

new. "Next foot, MNT10,000," the shoeshiner said.

Not a very sophisticated trick, but notable for its rarity. Scams and haggling are commonplace on the streets of developing markets around the world, yet Ulaanbaatar remains largely devoid of such practices 20 years since Soviet rule and far fewer under the glare of global investors. Rather than engaging in the haggling game, vendors will look confused and say, "no, you must have misheard, it's…" and restate the original price.

Herd mentality Some attribute Mongolians' innocence of the rough-and-tumble ways of the

marketplace to deeper cultural reasons.

With a traditionally nomadic population and small communities of herders, there was no need to undercut your competitors when you were the only source in town. Your word was your bond and each individual customer was a friend. "Doing business in Mongolia is always interesting," says Harris Kupperman, CEO of Mongolian Growth Group, a Canadianlisted company active in Mongolia since the beginning of this year. "You never really know what will happen when it comes to closing a property transaction.

Every deal has its nuance. You would be surprised at how often a little old lady wants to be paid in cash, and walks out of the bank with hundreds of millions of tugriks in a shopping bag. In America, you couldn't even get that much money out of a bank – nor would you want to walk home with it in a shopping bag."

This "nomadic mentality" tends to limit plans beyond the immediate needs of friends and family, the herd and the environment. However, the country is now widely discussing subways for 2016 and nuclear plans for 2017, washing plants and thermal power plants are announced on a regular basis, and there's an industrial city in the works. Mongolia's ambition is growing, and its business methods are having to rapidly adapt to this huge international interest.

Howard Lambert, head of investment banking for ING in Mongolia, has been proposing deals to Mongolian companies since 2010. "Doing business in Mongolia has been like pulling on a cotton thread from a sleeve. To begin with, it was just thread, but now we're getting the full sleeve and shirt. People are coming back to us asking about financing, and things are taking off," he says.

However, the shortage of experienced managers promises to be a bottleneck.

"You would be surprised at how often a little old lady wants to be paid in cash, and walks out of the bank with hundreds of millions of tugriks in a shopping bag"

bne September 2011

"The quality of top management is amazing," Lambert states, "but at some point there will be a [human resources] crisis."

People might be "hungry for education," as Lambert says, but the education sector has a long way to go if Mongolia wants to fulfil its HR needs domestically. Although statistics boast a 98% literacy rate in Mongolia, the educational needs of the 2.8m Mongolians lie in technical training to support the mining boom. The information that drives students to study is still outdated, and statistics are not readily available to those wishing to alter the system.

However, with the added international scrutiny comes a general awareness of what foreign investors are looking for and a push for data-gathering. "At the moment, data comes from personalised views, there is so much contradiction," says Lambert. "Every tugrik spent on improving the data stream will be for the core development of Mongolia."

The Mongolian press, too, needs to raise its standards. The press is rife with inaccuracies, with an unsubstantiated rumour from one source quickly amplified by others, until the next day when a reported "denial" will circulate. This is especially important given the susceptibility of Mongolians to negative reports about foreign investors "stealing" the country's natural wealth.

However, with improved transparency, tighter data collection and more reliable information sources, confidence in the market among ordinary Mongolians should grow and good practices will become the norm. Coupled with a culture of innate honesty and the ambition to develop into an Asian powerhouse, there is a bright future ahead for these descendents of nomads.

Eurasia

Making tracks to Astana

bne Astana is becoming the centre of a rail manufacturing industry as the Kazakh government's lavish spending on the country's railways draws in international firms Alstom, GE and Talgo.

National rail operator Kazakhstan Temir Zholy (KTZ) plans to spend around $37bn to build a modern rail network and slash travelling times in this vast country. Part of this money has already been allocated to buying new locomotives and rolling stock, which will increasingly be assembled within Kazakhstan itself. As such, in the last three years, KTZ has signed joint venture agreements with several international companies.

The agreement with GE Transportation has already seen the opening of a locomotive assembly plant in Astana. By end of 2010, the plant had produced 30 GE Evolution series locomotives adapted for the Kazakhstan market. According to Rene de la Pena, plant leader at GE Transportation Kazakhstan, the factory is expected to produce 78 locomotives in 2011, of which 69 will be for the domestic market and the rest to be sold to other CIS countries, which operate on the same wide gauge as Kazakhstan.

"Future production will depend on demand. We expect to produce 94 units in 2012. Total capacity is 150 units a year," de la Pena tells bne. "We have had a lot of interest from Mongolia, and companies from Russia, Estonia and Latvia – all in the 1520 gauge area – are interested."

In addition to the joint venture with GE, KTZ is working with a number of other companies to build factories to produce locomotives, freight and passenger cars, rails, large car casting, crossing pieces and wheelsets.

"These projects are being carried out on the basis of technology transfer from the world's leading manufacturers of railway equipment and machinery, but also organising production of a significant proportion of components within Kazakhstan," KTZ vice president Yermek Kizatov tells bne.

Tulpar Talgo, a joint venture between KTZ and Spain's Talgo, started building a plant to produce railway carriages in Astana earlier this year.

The Madrid-based company already supplies high-speed trains for the Almaty-Astana route, which KTZ plans to introduce on other key lines. In November 2010, Talgo and KTZ signed an agreement under which Talgo will gradually replace the 3,000 passenger coaches in Kazakhstan with modern intercity coaches. The initial batch of 420 coaches, to be delivered over a three-year period, will cost over ¤300m.

A third agreement, with France's Alstom and Russia's Transhmashholding, will see the construction of another factory to produce electric locomotives, with annual capacity of 50 units, some of which may be exported. Alstom said in a statement that the locomotives will include components from the French-Russian consortium and from Alstom's factory in Belfort, but that "production of components will gradually be delocalised to Kazakhstan."

I 47

By contrast, emerging market bond funds were cementing their "safe haven" status in August. In the week ended August 2, when US equity and bond funds posted their biggest outflows since last year, emerging market bond funds took in over $1bn, with those focusing on local currency debt enjoying their best week in over a year. "The positioning of our [ESPA Bond Danubia] fund is for the moment cautious, especially in light of the risk of external factors, with a focus on countries with no major imbalances and good local demand, like Poland and Russia," says Christian Gaier, senior fund manager for Erste-Sparinvest.

Special focus: Fund survey 2011 48

bne September 2011

Nicholas Watson in Prague

As the debt crises in the US and Eurozone began to take their toll on economic growth and investor sentiment in the latter half of the period that this survey covers, the performance of the funds invested in Central and Eastern Europe and the Commonwealth of Independent States (CEE/CIS) consequently dropped off.

The rekindling of the crisis in the first half of this year forms the mirror image of the 2009 fund survey, when the financial meltdown in the autumn of 2008 caused markets to tank, before they began a comeback in the first half of 2009. "In the first half of this year, it's been all about the euro, the US debt and the global situation – it's much more focused on external factors," says Alexandre Dimitrov, who heads up Erste-Sparinvest's CEE equities team. "Last year in the second half, we were much more bullish, with financial results and earnings very good."

bne 2011 Best Fixed-Income Fund: Troika Dialog - High-Yield bonds with a 26.3% return bne 2011 Best Balanced Fund: VTB Balanced Fund with a 37.3% return bne 2011 Best Real Estate Fund: Renaissance - Zemelny fund with a 28.3% return

The other major trend has been that Russia-focused funds have outshone other regional funds; all four winners in this year's survey are Russian fund management firms with local funds (see below). The reasons for this aren't hard to find: Russia's economy is still heavily influenced by the oil price rather than the exports to Germany that Central Europe relies on, and the oil price has been very much part of the commodity boom; its banks are not to the same extent owned by or exposed to the creaking western banks; its economic fundamentals are more robust. "The expected government debt/GDP ratio is 9% in 2011; the international reserves are above $530bn, which is more than 3x coverage of all government debt; the expected budget deficit for this year is 1.3% of GDP, far below the level of the US and many countries in Europe; growth of consumption is robust at 5.3% on year for the first half of 2011," lists Vladimir Tsuprov, chief investment officer at BNP Paribas Investment Partners in Moscow.

Grin and Bear it Like bne's 2009 fund survey, the performance of funds investing in our region this past year was, to borrow footballing terminology, a game of two halves. The difference this time was that the second half of the year (which runs June 30, 2010 to June 30, 2011) was much worse, not better, than the first.

bne 2011 Best Equity Fund: VTB Equity Fund with a 47.0% return

Looking at some of the reversals in fund performances, Troika Dialog's "Potential" equity fund grew 41.3% for the whole of the June 2010-June 2011 period, but actually fell 2.6% between January and June this year; Prosperity Capital's flagship "Quest" equity fund grew 43.9% for the year period, but only 7.7% between January and June this year; Erste-Sparinvest's Ringturm Osteuropa fund returned 22.8% over the year period, but just 2.2% between January and June this year; and Deutsche UFG's "OFG Invest – Balanced" fund rose 10.5% for the year period, but fell 2.0% between January and June this year.

These global fears have, needless to say, been reflected in the huge flows of money out of funds – a reversal of the huge inflows that were seen in 2010. For the year, investors have taken out about $14bn from emerging market stock funds (compared with the $45bn that left the EM stock fund world during the 2008 crisis). By the end of August, Emerging Europe equity funds had extended their current outflow streak to 15 straight weeks, with the week ended August 10 described by the fund tracker EPFR Global as a "brutal week" that "conjured up memories of 2008".

It was a tough year for real estate funds, though bright spots included Russia, which hosted the winning fund for this year's real estate category, and Hungary, whose

"It was a brutal week for fund flows that conjured up memories of 2008"

office market is proving to be an attractive place to invest money for many funds. "The yield we see in the Hungarian office market is about 7.5-8%, depending on the length of lease and the tenant – it's quite a stable rate in Hungary right now, but still only few transactions on the market," says Balazs Pazmany, portfolio manager of the Erste Open-ended Real Estate Fund, which had a return of 6.5% for the period surveyed.

And this year's winners are…

Special focus: Fund survey 2011

bne September 2011

49

bne September 2011

bne September 2011

CEE and CIS funds

Fund manager

Name of fund

Type of fund

Geographic allocation

Size

Return 1 year (to June 30)

Return YTD (June 30)

Return since Inception

Total expense ratio

ATON Group

ATON Bond Fund

bonds

Moscow, Russia

RUB91.67m

6.51%

3.76%

35.25%

4.46%

ATON Group

ATON Savings Fund

mixed

Moscow, Russia

RUB316.26m

32.91%

-4.42%

159.97%

0.03%

ATON Group

ATON Pension Fund

mixed

Moscow, Russia

RUB16.84m

19.50%

-3.14%

8.61%

0.02%

ATON Group

Moscow Small Business Interval Fund

mixed

Moscow, Russia

RUB5.055bn

7.76%

4.26%

25.39%

0.00%

ATON Group

ATON Equity Fund

stocks

Moscow, Russia

RUB694.86m

32.38%

-5.45%

299.13%

0.04%

Berenberg

Berenberg Funds II - East European Equity Selection

Equity Fund

Eastern Europe

¤31.9m

12.18%

-3.12%

14.93%

1.45%

BNP Paribas

BNP PARIBAS L1 EQUITY RUSSIA

Equity

Russia/CIS

$1.89bn

38.80%

3.10%

25.70%

1.00% as of 31.12.10

BNP Paribas

PARVEST EQUITY RUSSIA

Equity

Russia/CIS

$119.53m

35.90%

0.50%

minus 3.8%

0.07% as of 09-10 financial yr

Citadele Asset Management

Citadele Eastern European Bond Fund

Open-end investment fund

Eastern Europe/CIS

$23.16m

13.37%

5.77%

7.56%

1.75%

Citadele Asset Management

Citadele Eastern European Balanced Fund

Open-end investment fund

Eastern Europe/CIS

¤14.00m

9.10%

minus 1.95%

5.91%

1.72%

Citadele Asset Management

Citadele Russian Equity Fund

Open-end investment fund

Russia

$14.93m

30.06%

minus 1.06%

14.06%

2.25%

DWS Investment

DWS Osteurope

Equity

CEE

¤560.5m

11.20%

3.30%

491.20%

1.75%

DWS Investment

DWS Russia

Equity

Russia

¤681.8m

22.20%

1.40%

137.20%

2.05%

DWS Investment

DWS Europe Convergence Bonds

Bond

CEE

¤70.21m

minus 0.36%

n/p

102.45%

1.40%

Deutsche UFG

"Petr Stolipyn"

Open-end Equity Fund

Russia

$167.97m

25.03%

minus 5.21%

2217.34%

3.46%

Deutsche UFG

"Russian Bonds"

Open-end Bond Fund

Russia

$43.69m

7.08%

3.67%

801.22%

2.03%

Deutsche UFG

"OFG INVEST - Balanced"

Open-end Balanced Fund

Russia

$11.26m

10.51%

minus 2.05%

14.48%

3.63%

Deutsche UFG

"FUND 2025"

Open-end Equity Fund

Russia

$19.91m

20.22%

minus 8.68%

47.37%

3.71%

Deutsche UFG

"INFRASTRUCTURE"

Open-end Equity Fund

Russia

$15.18m

15.46%

minus 12.68%

minus 9.07%

3.71%

East Capital Alternative Investments

Bering New Europe

Equity (USD)

Central Europe/Baltics

$31m

35.77%

3.95%

7.80%

2.00%

East Capital Asset Management AB

Baltic Fund

Equity (SEK)

Baltics/Poland

SEK1.146bn

16.08%

minus 4.23%

436.52%

2.50%

East Capital Asset Management AB

Eastern European Fund

Equity (SEK)

Eastern Europe

SEK7.055bn

8.71%

minus 4.49%

315.57%

2.50%

East Capital Asset Management AB

Russian Fund

Equity (SEK)

Russia/CIS

SEK14.693bn

10.94%

minus 5.03%

1322.86%

2.50%

East Capital Alternative Investments

Bering Central Asian Fund

Equity (USD)

CIS/Central Asia

$71m

16.56%

minus 9.21%

minus 45.8%

2.00%

ELANA Fund Management

ELANA Money Market Fund

money market

Eastern Europe

¤5.8m

7.54%

3.35%

7.17%

0.49%

ELANA Fund Management

ELANA Eurofund

bond fund

Eastern Europe

¤ 651,652

5.87%

2.98%

5.46%

0.55%

ELANA Fund Management

ELANA Balanced EUR Fund

balanced strategy

Eastern Europe

¤4.35m

1.48%

1.63%

0.18%

1.33%

ELANA Fund Management

ELANA Balanced USD Fund

balanced strategy

Eastern Europe

$7.954m

minus 2.35%

minus 0.2%

0.64%

1.31%

ELANA Fund Management

ELANA High Yield Fund

equity fund

Eastern Europe

¤2.39m

1.44%

1.78%

minus 1.35%

1.91%

Erste Sparinvest

Ringturm Osteuropa

Equities

CEE

¤48.81m

22.76%

2.22%

17.83%

2.25%

Erste Sparinvest

Espa Stock Russia

Equities

Russia

¤32.12m

18.81%

minus 5.81%

minus 13.62%

1.82%

Erste Sparinvest

ESPA BOND DANUBIA

Fixed Income (incl. FX)

CEE/SEE/CIS

¤645m

6.82%

1.72%

151.20%

0.83%

Erste Sparinvest

Erste Open-ended Real Estate Fund (Erste Nyíltvégű Ingatlan Alap)

Real Estate

Hungary

¤713.31m

6.50%

3.26%

78.81%

1.30%

Pioneer Investments

Pioneer Funds - Emerging Europe and Mediterranean Equity

Equity

CEEMENA

¤913.6m

6.60%

minus 7.4%

174.01% (=10,04% p.a.; since 18.12.00)

n.a.

Pioneer Investments

Pioneer Funds Austria - Russia Stock

Equity

Russia

¤70.2m

16.45%

minus 7%

297.23% (=17,35% p.a.; since 18.12.00)

2.21% (as per 30.10.10)

Pioneer Investments

Pioneer Funds Austria - Eastern Europe Stock

Equity

CEE

¤123.1m

17.96%

minus 4.66%

168.01% (=5,77% p.a.; since 01.12.93)

2.22% (as per 31.05.10)

Pioneer Investments

Pioneer Funds Austria - Central and Eastern Europe Bond

Bonds

CEE

¤148.0m

5.40%

0.80%

132.13% (=7,48% p.a.; since 28.10.99)

1.11% (as per 28.02.10)

Prosperity Capital

Russian Prosperity Fund

Long-only, Fundamental-Value, Equity Russia/CIS

$1.646bn

40.86%

8.12%

2501.64%

2.63%

Prosperity Capital

Russian Prosperity Fund Euro

Long-only, Fundamental-Value,

¤172m

14.29%

minus 4.23%

841.44%

1.54%

50

(Cayman) Ltd.

(Cayman) Ltd.

Equity, UCITS-III Compliant

Russia/CIS

Special focus: Fund survey 2011

Special focus: Fund survey 2011

(Total unless otherwise stated)

51

bne September 2011

bne September 2011

Fund manager

Name of fund

Type of fund

Geographic allocation

Size

Return 1 year (to June 30)

Return YTD (June 30)

Return since Inception

Total expense ratio

Prosperity Capital

Prosperity Quest Fund

Long-only, Special Situations, Equity

Russia/CIS

$548.38m

43.89%

7.66%

6279.61%

2.31%

Raiffeisen Capital Management

Raiffeisen Eastern European Bonds

Bond

CEE

¤285m

7.29%

n/p

7.74% (annualised return)

1.11%

Raiffeisen Capital Management

Raiffeisen Eastern European Equities

Equity

CEE

¤657m

14.90%

n/p

9.75% (annualised return)

2.20%

Renaissance Capital

Renaissance - Nedvizhimost

Real Estate (Closed-end investment rental fund)

Russia

$57.3m

5.80%

9.60%

19.40%

2.0%

Renaissance - Business - Nedvizhimost

Real Estate (Closed-end investment rental fund)

Russia

$75.3m

minus 1.1%

3.70%

68.10%

1.2%

Renaissance - Zemelny

Real Estate (Closed-end investment rental fund)

Russia

$281.5m

28.3%

16.80%

minus 28%

0.6%

Renaissance Real Estate Fund

Real Estate

Russia

$49.5m

15.50%

16.50%

8.10%

0.5%

Renaissance Business Real Estate Fund

Real Estate

Russia

$27. m

7.20%

minus 2.0%

minus 14.0%

0.7%

Swedbank Investeerimisfondid

Swedbank Central Asia Equity Fund

Equity

CIS

¤7.5m

5.50%

minus 14.9%

minus 50.1%

n/p

Swedbank Investeerimisfondid

Swedbank Eastern Europe Equity Fund

Equity

CEE

¤32m

1.20%

minus 5.8%

minus 14.6%

n/p

Swedbank Investeerimisfondid

Swedbank Eastern Europe Real Estate Equity Fund

Real Estate

CEE

¤10m

minus 13.2%

minus 17.8%

minus 65.1%

n/p

Swedbank Investeerimisfondid

Swedbank Russian Equity Fund

Equity

Russia/CIS

¤62m

17.00%

minus 2.0%

45.60%

n/p

Sturgeon Capital LLP

Sturgeon Central Asia Fund

Offshore

Caucasus/Central Asia

$32m

5.40%

0.77%

37.09%

0.69%

Troika Dialog AM

Troika Dialog - Dobrynia Nikitich

Equity - Diversified

Russia

$230.18m

39.62%

3.56%

146.50%

3.98%

Troika Dialog AM

Troika Dialog - Potential

Equity - Second Tier

Russia

$53.59m

41.35%

minus 2.64%

524.40%

4.36%

Troika Dialog AM

Troika Dialog - Ilia Muromets

Bonds - Diversified

Russia

$202.60m

24.92%

15.72%

250.12%

1.38%

Troika Dialog AM

Troika Dialog - High-Yield bonds

Bonds - High yield

Russia

$23.21m

26.32%

15.58%

89.40%

2.36%

VTB Capital

VTB Treasury Fund

Fixed Income

Russia

$26m

23.62%

30.03%

15.29%

1.60%

VTB Capital

VTB Equity Fund

Equity

Russia

$8m

47.02%

21.89%

minus 0.29%

4.00%

VTB Capital

VTB Balanced Fund

Balanced

Russia

$6m

37.30%

23.61%

4.10%

3.00%

(Total unless otherwise stated)

Asset Management Company Renaissance Capital Asset Management Company Ltd. Renaissance Capital

Special focus: Fund survey 2011

Renaissance Capital

52

Investment Management Ltd. (BVI) Renaissance Capital Investment Management Ltd. (BVI)

bne 2011 Best Equity Fund

bne 2011 Best Fixed-Income Fund

bne 2011 Best Real Estate Fund

bne 2011 Best Balanced Fund

The winner of this year's best equity fund is VTB Capital Asset Management's VTB Equity Fund, which returned 47.02% over the year period. This open-ended investment fund is incorporated in Russia, and its aim is to seek long-term capital appreciation through investing in a diversified portfolio of Russian companies with high growth potential, according to Vladimir Potapov, head of Portfolio Management Business at VTB Capital Asset Management. "We are pleased that VTB Equity Fund and VTB Balanced Fund have been named '2011 Best Equity Fund' and '2011 Best Balanced Fund' respectively. We would like to thank Business New Europe for the high appraisal and recognition of VTB Capital's activities in asset management," says Potapov.

The winner of the fixed-income category is Troika Dialog AM's Troika Dialog - High-Yield bonds fund with a 26.32% return. "Despite the challenging market conditions presently facing investment managers, we are pleased that our funds continue to outperform the benchmarks and deliver exceptional returns for our investors. We continue to see solid fundamental value in the emerging markets and are absolutely convinced in the compelling investment case of our investment universe. As a leading local investment house, we will continue offering our best on-the-ground expertise and offer best and most up-to-date investment solutions in Russia and the CIS space," says Anton Rakhmanov, managing director at Troika Dialog AM.

The winner in the real estate category is Renaissance Group's Renaissance - Zemelny fund with a return over the period of 28.3%, quite exceptional given the difficult market conditions in this area. "We are very proud that, for the third time in a row, one of our real estate funds has been recognised as the '2011 Best Real Estate Fund'. This year, the recognition was received by Renaissance Land fund, which demonstrated a return of 28.3% for the evaluated period. Such an excellent result has been achieved through the superior efforts of dedicated professionals, careful selection of investment opportunities whose value appreciated significantly with the recovery of Russian real estate market, active management of the fund's assets, and absence of leverage. We are confident that the shift in investor focus to emerging markets represents a major opportunity in the Russian real estate sector, and the funds that perform will be enormously successful," says Ekaterina Konstantinova, CEO of Renaissance Real Estate.

VTB Capital Asset Management's VTB Balanced Fund is this year's winner in the balanced fund category with a 37.30% return for the year. According to VTB, the fund is an open-ended investment fund incorporated in Russia.

The fund's investment objective is to achieve long-term capital growth and stable income stream from investing its assets in a balanced portfolio of highly liquid debt securities of Russian companies as well as equity securities to diversify the investment risk for investors.

Special focus: Fund survey 2011

Asset Management Company Ltd.

53

54

I Special report

bne September 2011

bne September 2011

INTERVIEW:

Sponsored by Tatarstan Investment Development Agency

I Special report I 55

Tatarstan's agents of investment

Linar Yakupov, Chief Executive of Tatarstan Investment Development Agency (TIDA), talks to bne about how Tatarstan has been so much more successful in attracting foreign investment than many other regions of Russia and what more it can do to make the republic attractive to investors. bne

Q:

Russia's leadership has picked Tatarstan as a successful example of how to attract foreign investment. What makes your repub­ lic different from other regions of Russia?

A: Special Report: Tatarstan

The most important factor is a long-term commitment to improving the investment climate on the part of the government, and particularly the president of Tatarstan. [President] Rustam Minnikhanov takes a very personal approach to practically every major project.

The economic infrastructure that's been built over the last several years – indus­ trial parks, special economic zones [SEZ] and several joint ventures – is also significant. In order to continue developing this foundation, our agency – completely unique in the history of the republic – was founded. We guide inves­ tors from start to finish on all of their projects and are the only state represen­ tatives that they ever have to talk to – the 'one-stop centre' system.

Q: A:

What else does your Agency do?

We have two primary functions – to attract foreign investment and improve overall business climate; to develop the small and middle-sized businesses; they are related, of course.

In addition to promoting Tatarstan as an attractive destination for foreign capital and helping investors who come here, we also lobby business-friendly legislation to be adopted. We have all the tools

to do this, as we report directly to the president and prime minister.

We're currently working on the creation of a regional investment fund in Tatar­ stan that would hedge part of the risk faced by investors. This is very important because, unfortunately, despite all our rhetoric, Russia is not the most attrac­ tive destination for investment yet. Tax breaks could be great, but poor governance and the perceived high level of so called political risk still scare off a lot of capital. And many changes have to be implemented at the federal level, as the investment climate in Tatarstan depends also on the country as a whole. We hope the legal framework for the fund will be in place by January 2012.

ing capital. On a positive note, there's a strong feel­ing that Russian authorities have come to understand the importance of attracting foreign investment and are taking the necessary steps to improve the business climate.

Last few years we've been putting a lot of efforts into attracting investment from the Middle East to Tatarstan and Russia.

This morning I read news that one of the emirates of the UAE had decided to invest in CIS country which someone would think has a low level of stability, but this example – and many others in Azer­baijan, Kazakhstan and even Ukraine – proves many of our neighbors do a good job of attract-

Linar Yakupov, Chief Executive of Tatarstan Investment Development Agency (TIDA)

56

I Special report I Sponsored by Tatarstan Investment Development Agency

Q:

You mentioned the impor­ tance of federal policy. What would you like to see the federal gov­ ernment do to improve the business climate in Russia?

A:

Tatarstan in particular and Russia in general are in very lucrative geographic positions between Europe and Asia. In addition to improving overall business climate we need

that they feel this is a region where we will talk to them in a language they understand. There are entire sectors of the economy that can­not simply be privatized; hopefully PPPs will provide a logical solution to improving efficien­cy in these areas.

Q:

What are your best success stories so far?

"Tatarstan in particular and Russia in general are in very lucrative geographic positions between Europe and Asia" to build roads across the breadth of the country to take advantage of it.

To demonstrate the seriousness of our intentions to investors, we need to show we are able to provide such basic infrastructure.

I lived in Malaysia in the 90s. They were able to build a network of high-quality roads in a very short period of time and open up previously isolated parts of their country to an influx of industrial parks. China did the same thing and has attained very high levels of economic growth as a result. The Russian government needs to announce such a plan; we've had 'national proj­ects' in healthcare, housing and education to improve these areas. I believe the same approach has to be taken for road construction as well. We are doing a lot to improve road quality in Tatarstan but that not enough if it will not be done on the country level as a whole.

Q:

Your Agency recently suc­ cessfully lobbied the local government to adopt the Law on PublicPrivate Partnerships (PPPs). What will this law change?

A:

We needed this law to show investors a legal framework for this type of partnerships, so they would know their rights, opportuni­ties and obligations – and those of the state. We feel this is an important and transparent signal to investors, and since its passage on August 1, I've had the impression

A:

The Alabuga SEZ has attracted scores of Russian and foreign investors to the point that its board is constantly considering increasingly large projects. I'm also thinking of [truck maker] Kamaz's joint ventures with Daimler and other companies, [Russian passenger car manufacturer] Sollers' launching assembly lines of FIAT and ISUZU and now going for new JVA with Ford.

Another good example is ICL KPO VC which is a joint venture company with Fujitsu-Siemens that makes hard­ware and software here and has seen explosive growth for last few years. Now their clients include some of the world's largest corporations like Volvo, Mercedes, Electrolux and Siemens. They have created serious competition for similar ventures in India.

We are actively working on developing aviation industry, since major aviation and helicopter facto­ries have been here for decades and offer enormous poten­ tial for generating value-added products and developing the local scientific base.

That is why we call on investors not to see us only as a source of chemicals and raw materials, but also as a hi-tech and manufacturing hub with a highly skilled workforce.

Q:

How long does it take for most investment projects to become profitable? Which sectors offer the highest profit margins?

bne September 2011

A:

If we're talking about small and medium-sized businesses, this is somewhere between one and five years. Larger projects – like those in the Alabuga SEZ – usually take from 5 to 12 years.

I think while profit margins are about the same in all Russian regions, the differences occur in the ease of doing business and the level of risk. These two factors impact the timeframe we're discussing.

Projects in petrochemical and chemical industry are probably most profitable ones for this moment. Industrial zones like Kamskie Polyani and Technopark Khimgrad are offering good opportunities for that. The services sector, IT industry, food processing, auto components production also offer good profits.

Q:

The biggest impediments for­ eign investors have cited to do business in Russia include corruption and red tape. Does Tatarstan score better or worse than the average Rus­ sian region in this regard?

A:

According to the independent survey made by PwC Rus­ sia among the main benefits of doing business in Tatarstan around 90 % of investors described relatively little red tape (compared to other regions of Russia), no significant problems with registering a business or gaining licences, permissions and approvals from local authorities. Also number of investors emphasized on open dialogue with the government and some investors commented on how well e-government works.

Q:

What are the main misconcep­ tions foreign businesspeople have about Russia?

A:

Unfortunately, there is a major lack of information on the oppor­tunities for investment. Foreigners know very little about the massive privati­zation going on at the federal level, which offers stakes in some of the most profit­able companies in Russia.

Some efforts are done now to show the current situation in Russia and its

bne September 2011

regions to the world, but seems like it is still not enough and more creative approaches have to be taken. As a matter of fact I should say that most of the investors completely change their understanding about our country and opportunities that are available here after visiting us.

Q:

Kaluga Region Governor Anatoly Artamonov has been known to give out his personal mobile number to businessmen who work in his region. Can investors expect a similar level of support in Tatarstan?

A:

I've seen nothing but complete personal dedication from the president of Tatarstan. He doesn't just wait for complaints, but frequently visits various projects and asks the investors about the problems they're having.

However I would argue that while from a PR perspective giving out the gov­ ernor's cell phone is probably a wise move, effective governance on the part of regional investment agencies like ours would eliminate the need for such an approach.

Q:

A number of globally signifi­ cant sporting events – the 2013 Universiade Games, 2015 Swimming Championship and 2018 World Cup – will take place in Kazan in the com­ing years. How will they affect your Agency's work and the investment climate overall?

Sponsored by Tatarstan Investment Development Agency

I Special report I 57

A:

Certainly these events help Kazan and Tatarstan to become a globally recognised brand. Sports have become something like an ambassador for our region.

compete with each other to improve the overall investment climate. For Rus­sia this will likely mean among others improving our tax policy; some of the taxes are twice as low in some CIS countries as here.

They have also created a huge demand for all kinds of infrastructure: not just stadiums, but also roads, hotels, restau­ rants and other service-oriented facili­ ties. This demand creates a stimulus for investors to come and build many of these objects. I hope we won't miss this golden opportunity to become popular among international investors.

Q:

Finally, this infrastructure will increase the likelihood that we will continue to regularly host sporting events of international level and will become an important part of the service economy.

How will Tatarstan look in 2015 from the point of view of an investor?

A:

I hope by then all investors – foreign and Russian – will have a clear understanding of what opportunities we offer and a transpar­ent and easy passage through all legal requirements for conducting business here. I also hope by then we will have accumulated a whole series of 'success stories' from satisfied businessmen that will constitute the best evidence that Tatarstan is a good destination for investment.

Q:

How will Russia's entry into the Customs Union along with Belarus and Kazakhstan, and the World Trade Organization affect Tatarstan?

A:

It's an opportunity and a chal­ lenge at the same time. The access of our goods to Belarus and Kazakhstan is a great opportunity, but the increased competition from those countries is a major challenge. If we do not court investors as effectively as Belarus and Kazakhstan, investors will go there instead of Russia and Tatarstan.

The example of other trade blocs has shown that countries usually successful­ly

Tatarstan Investment Development Agency (TIDA) 50 Peterburgskaya Str. 420107, Kazan, Republic of Tatarstan, Russia Phone: +7 (843) 570-40-01, 570-40-02 Fax: +7 (843) 570-40-03, 570-40-05 http://tida.tatarstan.ru

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I Special report I Sponsored by Tatarstan Investment Development Agency

Combining east and west to go global Rachel Morarjee in Kazan

T

atarstan’s 1.1m-strong capital, Kazan, rose to fame nationally in 2005 when massive construction projects marked its 1000th anniversary: the Kremlin was completely restored, a new mosque was unveiled inside next to the Orthodox Church (symbolizing the peaceful co-existence of two rival religions), Kazan State University’s campus (at present Kazan Volga Region Federal University) was rebuilt and the country’s first metro system since the fall of the Soviet Union began operation.

“Tatarstan is one of Russia’s most developed regions,” explained Midkhat Shagiakhmetov, the regional Economy Minister and former tax inspector. “We’re located in the middle of a major industrial area with vital transportation arteries – highways, railroads and rivers – with the rest of the country.” The region currently ranks fifth in economy size and is a major transportation hub on the Volga River. It is also home to Russia’s sixth-largest oil company, Tatneft, and enjoys among the country’s highest incomes.

Now Kazan hopes to attain world fame via a series of upcoming events: the Universiade Games in 2013, World Swimming Championships in 2015 and World Cup in 2018. “International cooperation has always been one of our top priorities,” explained Shagiakhmetov. “All of

these events will bring tourists, investors, jobs and infrastructure. It will also bring the global media’s attention to the investment opportunities Tatarstan offers.”

Already Diversified Despite its considerable wealth in natural resources, Tatarstan has already achieved results in diversifying its economy away from raw materials.

bne September 2011

In 2005, the Alabuga Special Economic Zone – the largest and most successful of its type in Russia – was set up 200 kilometres east of Kazan to take advantage of an already developed industrial base.

The SEZ offers residents an advantageous location at a major transportation artery, freedom from land and property taxes, reduced profit and transportation taxes and a free customs area for the importation of hi-tech assembly equipment. The latter was enough incentive for major Russian automobile producer Sollers to set up Fiat automobile and Isuzu truck assembly lines with the capacity to produce 120,000 units a year.

“Alabuga was formed after our application won a tender conducted by the Ministry of Economic Development of Russia,” explained Shagiakhmetov.

“RUB14.7bn of state money has been invested into the SEZ since 2005. So far it has attracted RUB16.3bn of private investment.”

“We’ve created a particularly favourable and stable economic and legal atmosphere for foreign and domestic investors,” continued Shagiakhmetov.

Tatarstan is different from other Russian regions thanks to “comfortable legislation, developed production, transporta-

Locked between Europe and Asia, Tatarstan wants to use a series of upcoming international sporting events to catch investors' eyes and become a global economic hub.

“Raw materials accounted for 23% of our Gross Regional Product (GRP) in 2010, followed by manufacturing (18%), trade (13%), construction (10%), transportation and communication (8%) and agriculture (5%),” said Shagiakhmetov.

Tatarstan’s manufacturing base was developed in Soviet times, when major truck (Kamaz – 11% owned by Daimler) and airplane (Kazan Aircraft Production Factory, which produces the Tu-160 strategic bomber) manufacturing was set up around Kazan.

tion and logistics infrastructure, and minimal political risk.”

In an independent survey conducted

by PwC, 90% of investors indentified low administrative barriers and support from local authorities as the major advantage of doing business in Tatarstan. 60% indentified state support for major investment projects as their top reason for choosing the region. Ernst & Young’s 2011 report found Tatarstan to be the most attractive Russian region for conducting business.

bne September 2011

Sponsored by Tatarstan Investment Development Agency

A Future in Innovation Thanks largely to the conditions mentioned above, Shagiakhmetov claims Tatarstan no longer suffers the brain drain that has plagued much of Russia since the demise of the Soviet Union.

“The brain drain – which presented a major challenge in the 1990s – is no longer acute. We’re creating all the necessary conditions to entice young people to remain here: our universities are setting up companies and businessincubators to get their students earning money from their ideas early on.”

Shagiakhmetov is proud of the Khimgrad industrial cluster (see Page 63), whose hi-tech products are purchased “by the country’s largest companies, including Gazprom, Rosneft, Lukoil and Nestle Russia.”

“Forming a competitive and innovative economy is one of the most important long-term priorities in Tatarstan’s development,” he went on. Plans through 2015 include 6% annual GRP growth and attaining an average monthly wage of RUB40,000. Shagiakhmetov hopes a new IT village planned outside Kazan, set to attract 20,000 specialists, will help Tatarstan achieve “a new model of economic growth, founded on dynamic innovation and the development of human capital, by 2020.”

And with the upcoming major sporting events, “services will play an increasingly important role in achieving a comfortable standard of living for our population,” said Shagiakhmetov.

TATARSTAN GRP GROWTH, % 2000

7

2001

11

2002

3.6

2003

7.4

2004

5.3

2005

5.5

2006

8.5

2007

10.7

2008

7.7

2009

-3.4

Source: Russian State Statistics Service

I Special report I 59

Tatarstan building its future

bne In contrast to air travellers arriving at Kazan's aging international airport, visitors by road enjoy a remarkably smooth and efficiently-managed highway to the centre of the city. Hardly anyone speeds, as most of the route is monitored by automatic cameras, and the route passes through no fewer than four two-storey interchanges being built (there are 12 total currently being built in the city) ahead of the upcoming triad of international sporting events coming here.

"All of the upcoming events will stimulate the development of transportation infrastructure," Tatarstan Economy Minister Midkhat Shagiakhmetov explains.

But while the 2013 Kazan Universiade, 2015 World Swimming Championships and 2018 World Cup are catalysts for developing the republic's transport infrastructure, Tatarstan's government has bigger ambitions. "Our priorities are rebuilding Kazan and Begishevo airports, organising inter-modal transportation from Kazan station to the airport, developing the fleets of Tatarstan-based airlines, improving port and railway infrastructure - especially in the Kamsky economic region - and developing bus and automobile terminals," says Shagiakhmetov.

A few kilometres to the west of Kazan, the scale of the minister's ambitions becomes clear: at the mouth of the Sviyaga River, a 1,200-hectare empty plot of land is being developed to become the largest transportation hub in the Volga region. Russia's deputy transportation minister, Victor Olersky, called it "the first such logistics centre in Russia."

At a cost of RUB11.6bn, split 50/50 between private investors and the state, the Svijashsk Interregional Multimodal Logistical Center will include warehouses to store various cargo types, a port, railway terminal, truck depot, hotels and restaurants. With Russia's impending membership of the World Trade Organization, officials hope this will become the major import/export hub for cargo headed to and from the entire Volga region, a major centre of manufacturing. There are also hopes of a Europe-Western China transportation corridor forming over the next decade, for which Svijashsk would be an ideal link. Last year, a 40-km road linking the M5 and M7 federal highways - allowing traffic travelling east or west to bypass Kazan altogether - was unveiled by Tatarstan President Rustam Minnikhanov and formed an important link in the corridor.

The Svijashsk project is slated to be complete by 2013 and become profitable within seven years. Shagiakhmetov hopes that Tatarstan's location along the Volga River - which connects it with automobile-producing hubs Nizhny Novgorod and Togliatti, and industrial giants Samara and Volgograd (all over 1m people) - and along the M7 federal highway (which comes from Moscow and eventually heads into Siberia) will generate the traffic necessary to make Svijashsk a success. "Tatarstan is at the intersection of the country's most important highways that connect north and south, east and west," says Shagiakhmetov.

60

I Special report I Sponsored by Tatarstan Investment Development Agency

bne September 2011

years and a day hasn't gone by that I haven't felt the complete backing of local authorities," he says.

Hi-tech Tatarstan Clare Nuttall in Kazan

"S

ome23% of all traffic fines in Tatarstan are paid electronically," the grinning 29-yearold regional Minister of IT and Communications Nikolai Nikiforov explains in his office atop the glitzy glass skyscraper that forms the "IT Park" in downtown Kazan.

Nikiforov is exuberant about his eGov programme, which allows access to 25 types of government services – including paying taxes, scheduling weddings and obtaining a passport – via the internet.

"We lose hundreds of millions of manhours a year on bureaucracy," he tells bne. "Our portal saved RUB90m in salary costs for our citizens in June alone."

Down the hallway, a bustling call centre filled with young women wearing headsets is dealing with complaints and questions from users of the system. In June, Tatarstan's eGov provided a million services online, a four-fold increase from January. For the 48% of households without access to internet, touch-screen terminals across the city offer easy access to the system. "The beauty of the system is that it offers complete transparency. While the line of parents trying to get their children into overcrowded state daycare centres used to be held in some officials' safe, it's now available for everyone to see online [but initials and dates of birth only]. My own child is on that list, and there's nothing I can do to

move him higher up without everyone else finding out," he explains.

Home grown There's further good news for Tatarstan – and Russia as a whole. "We could have offered the contract for developing eGov to pricey foreign software engineers, but chose locals instead," Nikiforov says. "80% of the system was developed right here, and now the companies are marketing their products in other parts of Russia."

IT curently accounts for 3.5% of Tatarstan's economy, but Nikiforov says the republic is aiming to get to 7-10%, like its peers in the developed world, by 2016. "The tools we have for this – tech-

The technopark Idea was founded on the territory of an abandoned defence plant in 2004 with the aim of creating jobs in hi-tech sectors of the economy. By providing two key services to local start-ups – cheap rent and sound business advice – the technopark had "graduated" enough firms within three years to become selfsustainable; by 2007, its companies were paying enough taxes into the local budget to repay the start-up capital. "For the last four years, we've been independent of the regional budget, and this is important.

We receive some federal grants, but face a high level of competition for those monies. Our experience proves technoparks are a viable model for economic development in Russia," says Yushko.

The halls of Idea's Innovative Technology Centre (see box) resound with the voices of cartoon artists, software engineers and web designers. Igor Zilberg, 24, founded a firm called SmartHead after graduating from Kazan Technological University. "We offer outsourcing services to major advertising agencies who, in turn, represent global giants like Danone and L'Oreal," he explains. "We work mostly with the technical aspect of digital marketing platforms: programming, domains, technical support, moderation, layout, animation and work with servers."

"After three months, I moved the company to Idea for the cheap rent and good contacts. The atmosphere is very

"When we asked investors five years ago what we needed to do for them to come, they said 'build a new airport!'" noparks, venture funds and universities – are nothing individually, they are part of a single ecosystem we must develop systematically," says Nikiforov.

supportive and the only thing they ask of us is quarterly reports. Smarthead began paying dividends last year and we currently employ 17 people," says Zilberg.

Sergei Yushko, general director of the neighbouring Innovative Technopark "Idea", agrees. "We've existed for seven

Yushko explains most of the companies located there provide engineering services, software design or web design.

bne September 2011

Sponsored by Tatarstan Investment Development Agency

Innovative Technopark Idea The Idea technopark in downtown Kazan consists of three separate buildings sharing a common courtyard: the business incubator (for incoming start-ups), the Innovative Technology Centre (for companies already engaged in research and/or production) and the business park (office space for "graduates" and foreign investors keen to tap local talent). In total, Idea houses 102 companies. Between 2004-10, it contributed RUB720m to the local budget. The average wage at Idea is 24% higher than in the rest of Tatarstan, while the average age of employees is 26-28.

A company called GKS develops products to measure liquid and gas depletion for Gazprom. "When I'm shown examples of hi-tech production in Russia, they're often simply local duplicates of technology developed elsewhere. I'm proud that all of our residents develop genuinely unique and marketable products," he says.

After three years, "graduates" of Idea have the option of leaving the territory of the technopark altogether (usually securing bank loans independently to acquire office space) or moving into its business park (where rent is no longer subsidised). There, neighbours will include the local R&D branches of international behemoths like GE, Honeywell and Siemens. "The foreign companies come first and foremost for the qualified personnel," explains Yushko. "If they just want office space in a prime location, I send them to another business park."

Brain Power "I'm a believer in the unpopular notion that we don't need factories in Russia," explains Yushko. "Production will eventually be moved to where you have cheap labour, like China. Look at Israel's example: they develop lots of hi-tech products and then sell the technology for production elsewhere. A lot of Russian scientists and developers work there. Our competitive advantage is people and their ideas, and that's where we should focus."

Yet that's also one of the greatest challenges to hi-tech companies in Tatarstan. "We want to build an 'IT Village' outside Kazan based on the Skolkovo model in Moscow," says Nikifirov, referring to Russia's equivalent of Silicon Valley located in a village near the capital. "By our best estimates, we'll need to

house 20 ,000 IT specialists there to get this sector of the economy as large as we want it. We’ll have to attract 15,000 from other regions of Russia."

Tatarstan is home to two national research universities (higher education institutions that successfully competed for additional federal funding to conduct independent research), one federal university and over 200,000 Russian and international students. The IT & Communications Ministry has partnered with Kazan State University (at present Kazan Volga Region Federal University, incidentally, Vladimir Lenin's alma mater) to set up a special Higher School of IT and Technologies. But it won't be enough.

"We'll have to attract IT specialists from other regions of Russia," says Nikiforov.

Thinking locally In another part of Kazan, an industrial park called Khimgrad became the first such project in Russia to be internationally certified by representatives of Ernst & Young and Knight Frank.

Khimgrad (see box) focuses on polymer and chemical production and, unlike the

I Special report I 61

technoparks, it seeks to take advantage of underdeveloped raw materials in Tatarstan. "We produce a plethora of polymers in Tatarstan, but these are typically exported and then re-imported with much added value," explains the park's manager, Airat Gizzatullin. "At Khimgrad, we don't work with technologies of global or even national significance; we're just focused on modernising the local economy and establishing efficient supply chains here in Tatarstan."

Khimgrad offers fully-equipped facilities, business solutions and tax breaks to investors – both Russian and foreign – willing to set up production. A relative newcomer is Danaflex, a major Russian flexible packaging firm supported by state nanotechnology giant Rosnano.

Danaflex has its sights set on increasing its share of the Russian polymer film market by 10-20% and to begin exports to the EU in the next few years. "Only a complete ecosystem can structurally change Russia's economy on the scale that our country's leadership talks about," posits Nikiforov. "That's what we're trying to do in Tatarstan, and we began this process earlier than other regions of Russia."

But a lot of work remains to be done.

"When we asked investors five years ago what we needed to do for them to come, they said 'build a new airport!' It was a funny response, but carried a lot of truth."

So much so, that Tatarstan's government has moved in its typically quick fashion – a sign currently hangs over the shoddy building that services both domestic and international flights to Kazan: "New terminal to be completed in 4th quarter of 2011."

Khimgrad industrial park The Khimgrad industrial park was founded in 2008 and occupies an area of 131 hectares in Kazan. The park offers residents willing to invest in chemicals, polymers or manufacturing tax breaks, business services and infrastructure. After an initial investment of RUB1.2bn (¤28.8m), the park has already attracted RUB3.6bn of private investment. Some RUB6.9bn worth of goods were produced in 2010, meaning that "the phase of state involvement is over," according to manager Airat Gizzatullin. Projects are expected to take an average of seven to nine years to become profitable, and the first international residents are expected to join Khimgrad in the near future.

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headaches and soaring costs of doing business in Moscow.

Gridlocked traffic and sky-high wages have driven many firms out of Moscow and St Petersburg, both foreign and domestic, in search of better places to do business. Tatarstan is proving an attractive alternative, with Forbes magazine ranking the region number one in terms of doing business, while Ernst & Young and Penny Lane Realty named Tatarstan as one of the country's easiest places to work and live.

Alabuga or bust Rachel Morarjee in Moscow

O

ne of the biggest headaches investors in Russia face is navigating the country's labyrinthine bureaucracy; setting up a business can mean months of trekking from one government office to another in search of the correct stamp on the right document. Not so in Alabuga, a special economic zone (SEZ) in the central Russian Republic of Tatarstan.

Investing in Alabuga is a much simpler task, claims Renat Khalimov, deputy general director of the Alabuga Special Economic Zone. "A one-stop-shop system operates in the Alabuga SEZ and therefore the amount of bureaucratic red tape is significantly diminished, because residents are able to interact with government authorities without leaving the SEZ," says Khalimov.

SEZs are a tried-and-tested method of bringing new streams of foreign investment into a post-Soviet economy and boosting economic growth in a controlled manner. In the late 1970s, China used such zones to lure foreign inves-

tors to the country and created millions of new jobs in the process. Shenzhen, the most famous of China's SEZs, was transformed in two decades from a

Over the last five years, the Tatarstan government has invested $480m in the Alabuga SEZ, attracting over $2bn from private investors over the same period.

So far, 16 companies are resident in the zone, but authorities expect more than 30 companies to set up shop there by end-2015 and predict the new arrivals will bring in $3bn.

Russia began setting up SEZs in 2005, and the largest and most successful is Tatarstan's Alabuga. Located 200 kilometres from Kazan, the capital of Tatarstan, and about 1,000 km from Moscow, Alabuga offers access to the Russian capital as well as regional Russian markets without the transport

obtain the SEZ residential status till 2012 will be able to import raw material and components for processing in the SEZ and export finished products with no customs duties and taxes (VAT) if they are sold in Russia, Belarus and Kazakhstan – the three countries that make up the Customs Union.

But tax breaks are not the only incentive to invest in Alabuga. The SEZ has well-developed industrial infrastructure – gas, water, heating, sewerage, roads, railway branch, rain sewerage – which was all provided by the government and residents are connected to them free of charge.

Sponsored by Tatarstan Investment Development Agency

Alabuga has built on Tatarstan's Soviet industrial heritage to become an investment hub for various industries. So far, car manufacturing, petrochemical and construction materials manufacturing have driven the development of the Alabuga SEZ, says Khalimov, adding that "the fields of potential activity are virtually unlimited.

Carmaker JSC Sollers began making Fiat Ducato cars at Alabuga in 2006 and this year announced it would launch a 50-50 joint-venture with US motor giant Ford to make Ford Transit vans for the entire Russian market at Alabuga. Ford-Sollers will also make engines, operate a stamp-

es, including a profit tax rate of 15.5%, some 2 percentage points lower than the federal rate and 13.5 points less than the regional tax rate.

The SEZ is a customs-free zone, with any foreign equipment and construction materials being imported and used within it being exempt from customs duty and VAT. Additionally, manufactured goods, exported from the zone, are exempt from customs duties and a customs zone speeds up processing time for imports and exports. Companies that

I Special report I 63

ing facility that will provide a higher level of local parts content for Ford vehicles built in Russia, and establish research and development activities.

Ford-Sollers' presence has drawn other auto-parts suppliers making parts from gear boxes and diesel engines to seats and brake systems to Alabuga. Global producers Daimler, Fiat, Isuzu Motors, auto design company Magneti Marelli, diesel engine maker Cummins, breaking systems manufacturer Knorr-Bremse, tyre-maker Continental, car part specialist Zahnrad Fabrik, insulation company Rockwool and Scheider Electric have all set up shop in the SEZ.

ties with Middle Eastern investors earlier than any other region in Russia. "We have spiritual ties, so there is a natural affinity, and we aim to become a gateway and a platform for Islamic investment into the whole of Russia," he says.

Not taxing times Investors at Alabuga can benefit from a range of impressive tax breaks. Resident companies are exempt from property tax for 10 years from the moment their property is registered, from land tax when the company obtains title to its plots, and from the regional transport tax. Residents enjoy other tax privileg-

"A one-stop-shop system operates in the Alabuga SEZ and so the amount of bureaucratic red tape is significantly diminished" sleepy fishing village on the coast opposite Hong Kong to a boomtown of over 8m people with its own stock exchange and the greatest number of Phds per capita of any Chinese city.

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Tatarstan puts faith in Islamic finance Rachel Morarjee in Moscow

T

he global Islamic finance industry has boomed in recent years, but until recently Russia hasn't featured much in this development. But now the Republic of Tatarstan is capitalising on its Muslim faith and industrial heritage to attract capital from Islamic investment companies from places as diverse as Yemen and Malaysia, has already established an Islamic technol-

ogy investment fund, and is planning to issue a Sukuk bond later this year.

Linar Yakupov, Chief Executive of Tatarstan Investment Development Agency and one of the brains behind the bid to turn Tatarstan into a hub for Islamic finance, claims that this central Russian republic identified the potential of Islamic investment and began building

In the 1990s, most foreign investors headed straight for Moscow. With a population of about 15m people, Moscow is the largest city in Europe and bigger than most Central European countries. However, over the last decade Russia's regions have become more attractive to foreign investors who want to avoid the gridlock of Moscow traffic and its stratospheric wages. The Tatarstan capital of Kazan, one of Russia's largest and most prosperous cities, offers lower property and labour costs than both Moscow and St Petersburg.

And Tatarstan lies at the heart of the Volga region, with 11 of the 13 Russian cities with more than 1m population less than 1,000 kilometres away.

And the word is getting out. Moscow's New Economic School and Ernst & Young listed 15 obstacles to business in a March survey and asked respondents to rank their significance. The survey found that Kazan was the easiest place to do business in Russia and Moscow the most hostile. Meanwhile, Penny Lane Realty ranked the city as the second best place in the country to invest in property based on eight criteria ranging from the city government's development plans, the

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environment and the strategic significance of the companies operating there.

Local partner The business environment has been a big draw for Islamic investors and the local government has set up the Tartastan International Investment Company (TIIC) to act as local partner for Islamic investors.

TIIC's first foray is a $50m technology fund, which was launched in June in cooperation with Foras International Investment Company, which represents Saudi interests. The $50m fund will focus on the region's strengths in biotechnology, nanotechnology and IT, and counts among its founding investors the Islamic Development Bank (20%), the Republic of Tatarstan (20%), Foras International Investment (15%) and some smaller investors from Saudi Arabia, Malaysia and Yemen. The tech fund has already garnered $10m from the founding investors and is in the process of raising the rest, with the ultimate aim of building up the fund to $100m, says Emil Gasimov, general director of TIIC.

Gasimov says TIIC aims to be a bridge between Islamic investment companies and Russian financial institutions, such as GazpromBank and VTB Capital, which are actively exploring the Islamic investment market. It is currently looking at 10-15 projects in areas as varied as pharmaceuticals, biotechnology and aircraft engineering, and will likely invest in established projects that are looking for second phase financing. "There is no need for investors to put money into untested projects," says Yakupov.

Indeed, Kazan was known in Soviet times as a centre of learning and its universities still churn out many of Russia's best engineers. It is also home to a flourishing aviation industry (Kazan Helicopter is a leader in the market and its order book is full for the next three years), as well as a burgeoning automotive sector (home to the Russian Kamaz heavy truck maker, as well as Ford and Chevrolet's Russian production). "We are focused on the Volga region and the attractive investment climate the government has created here with tax breaks and incubators," says Amizan

Cleaning up in Tatarstan

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bin Mohd Nor, head of Foras International Investment. "One of the most attractive elements in this region is the high level of science and engineering, especially in things like civil aviation."

"The companies here are advanced and the level of technology is as good as anything I have seen in Europe," he adds. "The trouble with Europe is it is a highly saturated market and very expensive to do deals; in Russia, we can easily find companies where we can really increase the value, with willing buyers in the Middle East and beyond."

Other Islamic investment projects on the horizon include plans by the Tatarstan regional government to issue a $100m-200m Sukuk bond this autumn, the proceeds from which will be used to fund a new exhibition and convention centre in Kazan. "More people are coming to Kazan, so we want the facilities to host world class sporting events; the centre will have hotels and sporting facilities as well as meeting halls," says Yakupov.

the country, Wermuth Asset Management knows the Russian regions better than most. However, even they were stunned at how receptive the Republic of Tatarstan government was when they approached them with the idea of establishing Russia's first clean tech fund. "We were very pleasantly surprised by how ready the Tatarstan authorities were to accept such a new idea," says Wermuth CEO Maarten van den Belt. "Everyone knows that it's one of the most progressive regions in Russia, but the speed with which we've been able to set up the Tatarstan Clean Tech Fund (TCTF) has been amazing.

We'd normally expect it to take six to 12 months, but it's taken just three."

Tim Gosling in Moscow

R

ussia's modernisation drive is beset by obstacles, not least those blocking the capital that's needed to turn the country's scientific knowledge-base into innovation. The launch of the country's first clean technology

fund, arm in arm with one of the most progressive regional governments in the country, is set to help overcome this.

With over 13 years' experience and $1bn of assets under management in

Saving energy The opportunities for clean tech in Russia are clearly huge. The country's economy is one of the most inefficient in the world in terms of energy use. According to the International Energy Agency, the energy intensity of Russia’s GDP

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is 11 times higher than in Germany; 6 times higher than in Canada; and 4 times higher than in Poland. President Dmitry Medvedev has insisted that the country's goal is to improve the energy efficiency of the economy by 40% over the next 20 years.

However, while clean technology has grown rapidly in developed markets – US company Clean Tech claims the segment accounted for $2.6bn in venture capital, $2.1bn in IPOs and $15.3bn in M&A in just the first quarter of the year – Wermuth claims its TCTF will be the first of its kind in Russia.

With €100m provided by the Tatarstan government, and another €10m from Wermuth, TCTF is just embarking on a campaign to raise a further €90m from investors, which will be used to power innovation both originating in Tatarstan and international technology that can be imported by the region's large industrial operators. "In the regional rankings, Tatarstan is always amongst the top places for attractive investment destinations," points out van den Belt.

Meanwhile, for projects that aim to help industry improve efficiency and environmental impact, the region has plenty of potential targets, including oil company Tatneft, petrochemicals producer Kazanorgintez, truck maker Kamaz and the Kazan Helicopter Plant, Nizhnekamsk Neftehim.

Van den Belt says the fund has several projects earmarked already: development of a renewable jet fuel; nextgeneration batteries for electric cars; technology to help make oil extraction more environmentally friendly; and a CO2-negative chemical production process. "There are two main potentials for Tatarstan," van den Belt suggests.

"Firstly, its oil extraction industry could save ten's of billions of dollars with more efficient operations."

In terms of new technologies, he claims, the mandate of the fund to invest internationally means the region's industry will also gain access to global best practice and development.

"The regional government understands

Sponsored by Tatarstan Investment Development Agency

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that if the fund were just to focus on local innovative development, then there's the danger that they end up reinventing the wheel," he says.

Obstacles to modernisation At a national level, although Wermuth hasn't spoken with the Russian federal authorities, van den Belt points out that the deal was signed in the presence of Medvedev at a recent summit with German Chancellor Angela Merkel, so the launch of Russia's first clean tech fund is clearly in line with the modernisation agenda coming out of the president's office. "Clean tech will become a much bigger topic as energy prices continue to rise – it's a natural stimulus."

Nevertheless, it may not cheer up the Kremlin to hear that Wermuth felt the country's major financial centres were out of bounds when setting up the fund. Although van den Belt claims that investors have no qualms that the TCTF is outside the country's biggest cities, his justification is that they're impressed with Wermuth's track record in the regions. There aren't that many international investment managers with the same profile, however, which means such projects will need to move to harness the might of Moscow eventually. It's another potential roadblock that the Kremlin's modernisation drive doesn't need.

The obstacles to attracting capital to innovation in Russia remain serious – outside the IT sector anyway – with venture capitalists complaining about a lack of business acumen in innovative projects and a lack of business infrastructure to help launch them commercially. On top of that, the weakness of Russian institutions that are meant to drive the policy and deep-seated corruption do little to help either. "We never thought of trying to set up this fund in Moscow or St Petersburg," says van den Belt. "It can be very difficult in those cities, much more complex. In a place like Tatarstan, the decision-making process is so much simpler – and of course they work that much harder to attract investors."

"Everyone knows that it's one of the most progressive regions in Russia, but the speed with which we've been able to set up the Tatarstan Clean Tech Fund (TCTF) has been amazing"

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are already using the facilities prepared for the Kazan Universiade.

The population is also set to benefit from the high level of infrastructure investment being carried out in preparation for the games. “Transport infrastructure modernisation is one of the major parts of the preparations for the 2013 Games,” says the Kazan Universiade press service.

Countdown to the 2013 Kazan Universiade Clare Nuttall in Kazan

W

ith under two years ago until the 2013 Kazan Universiade, investments into world class facilities and infrastructure are already underway as the city prepares to host some 100,000 visitors.

The 27th World University Summer Games, or Universiade, is due to open in Tatarstan on July 6, 2013. Competitions will take place across 26 sporting categories at 64 different venues.

Of the 36 facilities being newly built for the event, as of July, 27 had already been commissioned. According to the media department of the Kazan Universiade, the city is already prepared to host the event, even though some major new facilities still have to be completed.

Chief among these is the 45,000-seater stadium that will be the venue for the opening and closing ceremonies. The stadium, which will also host the Universiade football matches, was started in May 2010, and is due to open in 2012.

Two other key venues, the Gymnastics Centre and Aquatics Palace, are on schedule to open later this year. The

Aquatics Palace will play host to the swimming, diving and synchronised swimming events, and has capacity for 4,200 spectators.

Those facilities to have already been completed include the KAI-Olimp Sports Complex, one of Kazan’s largest sporting facilities. The complex, which opened in August 2010, includes a football stadium and an indoor swimming pool. Russian Prime Minister Vladimir Putin visited Tatarstan in May 2010 to formally open seven other facilities, including the Bustan Multifunctional Complex, which has a multi-functional sports complex, a swimming pool and fitness centre. The Tatneft Arena, which opened in 2005, is one of Russia’s largest ice arenas, with a total capacity of 10,000 people.

Long-term benefits In addition to the event itself, it is hoped the Universiade will have longterm benefits for Kazan, creating a launch pad for future generations of athletes and encouraging a healthy way of life for the region’s citizens, especially its children. More than 12,500 people, including 5,500 schoolchildren,

For road transport, large-scale reconstruction and construction of local roads and traffic intersections is planned in order to reduce the volume of traffic. Kazan International Airport is also being reconstructed to allow it to raise the quality of flight services and to offer world class air services to both Russian and international airlines. An inter-modal transport system between the airport and the local railway network is also being organised. The Kazan underground system will be upgraded, with five new stations to be opened to connect the main Universiade venues.

Another element of the preparation is testing all the new sporting facilities, as required under the International University Sports Federation (Fisu) regulations. This means there will be a series of events in the run-up to the 2013 Universiade. “Kazan has already hosted largescale events like the 4th European Table Tennis Championship, the 7th European Beach Volleyball Championship and the 2011 European Weightlifting Championships,” says the Kazan Universiade press service. “Both athletes involved in the competitions, and spectators, gave a high appraisal to the events and wished to come and re-visit Kazan soon.”

Some 2,000 volunteers have signed up for the Universiade, and are already taking part in sporting events in the run-up to 2013 - more than 100 sporting and cultural events have been scheduled for 2010 and 2011 alone. To prepare for the games, Kazan volunteer teams are doing internships at other events including the 25th World University Summer Games in Serbia in 2009, and this year the Winter Universiade in Turkey, the 7th Asian Winter Games in Kazakhstan and the 2011 Summer Universiade in Shenzhen, China.

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