bne December 2011 poverty of nation

Inside this issue: Kyiv – the new Minsk Debt crisis stalks Hungary Mongolia's rising stock Terror on the steppe December 2011 www.businessneweurope.eu

Special Report: Eurasian bank survey

The Poverty of Nations Despair Index is rising in the west, but falling in the east

bne December 2011

Contents

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

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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

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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 (Zagreb) norton@bne.eu

30 COVER STORY 6

The Insiders

26

Debt crisis stalks Hungary

8

The poverty of nations

27

Czechs press nuclear tender button

9

The moving poverty line 28

A buyer's market for Latvian banks

30

Poland's retail therapy

32

No rest for AmRest

EASTERN EUROPE

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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

Russia's privatisation programme runs off the rails

15

Russia's Northern Sea Route trade soars

33

Franchising in the time of crisis

17

Kyiv – the new Minsk

34

Lithuania polishes family silver

19

Budget airline blues in Russia

21

Russia's invisible infrastructure boom

22

Throwing money at it

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CENTRAL EUROPE

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bne December 2011

Contents

40

47

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

62

SOUTHEAST EUROPE

EURASIA

SPECIAL REPORT

35

Gassing up Europe

44

Terror on the steppe

57

The dominant state of Russian banking

37

Still westward bound

45

Snap but predictable elections in Kazakhstan

60

38

The sun rises on Albanian tourism

The hunted become the hunters

47

On the block in Kyrgyzstan 62

39

Romanian holiday

48

The new man in Kyrgyzstan

Ukraine's banking disaster in the making

40

Down on the Romanian farm

49

Armenia resists calls to close nuclear plant

63

Kazakhstan's bad apple in banking barrel

42

Russia in Serbia – out from the cold or feeling the heat?

50

Georgia on my screen

64

VTB turns the super-tanker

66

SDM-Bank – rediscovering classic banking in Russia

68

CLASSIFIED

69

UPCOMING EVENTS

SPECIAL FOCUS

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52

Stepping out

54

Mongolia's rising stock

I5

6

I The Insiders

bne December 2011

Corporate governance matters

bne December 2011

zhstal and Sumy Frunze, to name just a few. Unsurprisingly, of the 114 companies we reviewed, we gave 25% of them our lowest rating, 'Poor'.

Ratings distribution as % of total ratings each year 45%

2007

40%

2008

2011

35% 30% 25% 20% 15% 10% 5%

Brad Wells of Concorde Capital

T

oday we are far, far removed from the heyday of the modern Ukrainian IPO. Those of us around in 2007 remember it as a year of plenty, with listing aspirants and bankers revelling in the spoils of this newfound capitalraising mechanism; the year saw an unprecedented (and never repeated) flood of more than 20 IPOs that raised over $1.77bn. But that spigot of fast and easy money closed. Now potential new market entrants face a dramatically different reality and the good news is that they are rising to the challenge.

0%

Debut ratings in 2011 survey Company

Myronivsky Hliboproduct Milkiland

What we have seen in 2010-11 and think will also be true going forward is that Ukrainian companies that want to list have to be an entirely different kind of animal. To even have a shot at raising money on equity capital markets they need to be much more fluent in investor-speak and demonstrate they have mechanisms in place to both respect the rights of minority shareholders and keep them informed.

The good news for international investors – Ukrainian companies seem to be getting the message.

Championing corporate governance Let me back that up with some numbers. We released a report in October that rated corporate governance practices in 114 listed Ukrainian companies. The nine new market entrants we rated for the first time this year had an average score of 8.8 (on a 10-point scale), well above our overall survey average of 5.2. Two-thirds of those nine received our highest rating, 'Quality'.

Venue

CG Score

CG Rating

May 2008

LSE

10

Q

December 2010

WSE

9

Q

June 2008

FSE

9

Q

Cadogan Petroleum

June 2008

LSE

9

Q

December 2010

WSE

9

Q

August 2008

FSE

9

Q

May 2010

LSE

8

AA

November 2010

WSE

8

AA

May 2008

FSE

8

AA

Sintal Agriculture Avangard

Back in 2007 and early 2008, the perception was that management looking to place a stake in their company simply had to follow a set list of expectations that included having financial reports, a placement prospectus, a road show and a pulse. Investors knew they were taking a big gamble on Ukraine, but at the same time nobody wanted to miss the big return bandwagon either. After all, Ukraine was the world’s second best performing equity market in 2007, returning an eye-popping 135%!

Listing Date

Mriya Agroholding

Sadovaya Group

Agroton United Media Holding

Quality

Above Average

Average

Below Average

Poor

Source: Concorde Capital research

Source: Concorde Capital research

What does this look like in practice? Well, the typical company we assigned a 'Quality' rating to publishes financial results according to International Financial Reporting Standards (IFRS), discloses its ownership and corporate structure, has low risk of dilution and strategic risks, and makes an effort in terms of investor relations. The sad reality is that while these are givens in other markets, they are still relatively rare in Ukraine.

Overall, we gave 13% of Ukrainian companies 'Quality' ratings this year (13%), which is twice as many as before the financial crisis, and at the same time we gave 23% companies a 'Poor' rating, which is nearly twice as few as in 2007.

The field of Ukrainian companies is still striking in terms of its diversity. On the one hand, there are these fresh faces that are truly setting the gold standard and adopting listing homes in Warsaw and London. But on the other hand, there is this unsettling number of bad apples typified by pocket oligarchcontrolled assets and companies unwittingly skupka-ed by investment banks into the market seemingly eons ago.

Ukraine’s reputation for poor corporate governance is in many ways well-earned. Recent years have seen investors burned by the owners of such now-infamous companies such as Zapori-

Assuming that the decline in 'Poor' ratings was due to upgrades in governance is incorrect and naive. Rather, the lion’s share of attrition can probably be chalked up to the global financial crisis – the vast majority of the 'Poor' companies in our 2007 report were excluded due to delisting, bankruptcy, mergers or reductions in liquidity such that we no longer deem those companies’ stock investible. As for the middle group ('Above Average', 'Average' and 'Below Average'), we assigned 34% of them the exact same rating as we did in 2007, another 34% moved up just one rating level, 24% of them were downgraded and only 8% moved up two levels. Quite underwhelming.

Are we entering a new age of accountability?

Clearly, the temptation to take advantage of a lax and malleable system of legal and judicial checks and balances, to push through decisions disadvantageous to minority shareholders, or to simply remain ambivalent is still present. A long listing history, in most cases, actually worked against the majority of companies we looked at.

While management and owners are keenly aware today that corporate governance is necessary to enter international equity markets, we still do not know whether those commitments will get relaxed or forgotten when it suits them. That these companies are listing in London or Warsaw, where compliance with corporate governance codes is mandatory or done on a comply-or-explain basis, should help. Only time will tell. But at least in the next few years the stream of quality issuers making offerings should continue to talk about and promote high corporate governance standards.

Our full corporate governance report is available in both English and Russian languages on the Concorde Capital website (http://rs.concorde.ua/research/corporate-governance).

Brad Wells is the Corporate Governance Analyst at Concorde Capital

"Going forward, Ukrainian companies that want to list have to be an entirely different kind of animal"

8

I Cover story

bne December 2011

of suffering is the “Misery Index": the simple addition of unemployment and inflation. Unsurprisingly, the Misery Index has been rising fast in the West as governments attempt (and fail) to tackle the twin debt and deficits that plague their economies.

But the Misery Index doesn’t fully capture the despair that many citizens are facing today. What does it matter if the prices of ipods are rising at 10% a year if you don’t have enough money to put food on the table? So, to better compare the wave of pain that is sweeping the globe, bne introduces a new index – the “Despair Index”: the simple sum of the rates of poverty, unemployment and inflation.

Calculating and comparing the Despair Index for western countries and those in CEE, the surprising result is that with poverty falling to near “normal” levels in the countries of Emerging Europe while rising fast in many developed markets, the Despair Index of several CEE countries has either already fallen below that of their developed peers or is about to do so.

The poverty of nations Ben Aris in Moscow

I

t can be miserable living in an economy in transition. Hyperinflation might destroy your life savings in a matter of months. Your job may be pointless and pay badly – until you lose it that is. And then you could be condemned to poverty because there's no social safety net to speak of.

However, much as changed over the past two decades. While the above is becoming less relevant to people living in the former communist transition economies of Central and Eastern Europe (CEE), as the sovereign debt crisis deepens in the West many of these worries are starting to affect those living in developed rich nations.

In October, the US Census Bureau announced that one in seven Americans, or 49m people, are now living in poverty, the highest number since records began 53 years ago. Two weeks later, the UK’s Office for National Statistics announced that the number of people out of work has hit its highest level in 17 years and youth unemployment is at an historic high, leading Jared Bernstein, who once ran the White House's task force on how to reverse the decline of the American middleclass, to warn that the British middle class is in danger of suffering a prolonged period of US-style wage stagnation. And Spain capped off the round of bad news with the announcement that

unemployment is currently 23% – its highest level ever and the highest in the EU. A catastrophe is unfolding among the nations of the developed world.

Compare that with the countries of CEE. The EU stats office Eurostat released a study last year that found the Czech Republic has the lowest poverty rate in all the EU: only 9% of Czechs live at or below the (relative) poverty line, compared with the Western European average of 17%. Almost all of the countries in CEE have poverty rates below 17%, with a few exceptions including Bulgaria, Romania and Ukraine.

The traditional shorthand measure

Cover Story I 9

bne December 2011

And the shocker is that thanks to record low poverty and unemployment levels, Russia's Despair Index fell below that of the US this year, to 25.5 and 28.1 respectively as of November. Given that Russia uses the US as a yardstick with which to compare itself, such a result is manna from heaven for a prickly nationalist like Vladimir Putin as he prepares to reassume the presidency.

Some caveats Comparing poverty in different countries is of course difficult, partly because western governments are not meticulous about measuring poverty in the general population and the benchmarks vary widely from country to country (see box). But as poverty is a relative concept, the comparison is still valid and the trends remain the same.

What is the lowest level the Despair Index could fall to? In an ideal world, inflation would be running at, say, 2% and residual unemployment at, say, 4%. As for poverty, it should be zero

The moving poverty line

bne A rich man in London is rich in New York, but is a poor man in New York still poor if he moves to Moscow? Comparing poverty rates across developed countries is not hard, as incomes are roughly the same for most of the EU countries and the US. But once you start looking at emerging markets, the poverty line varies widely.

"You're not poor if you own a car," scoffs Lilia Omelyanenko, a Moldovan housekeeper living in Moscow," referring to America's poor, many of whom have cars despite earning less than the minimum level of income deemed necessary to achieve an adequate standard of living. Omelyanenko earns ¤1,300 a month, about half as much again as the average salary in Russia, but if she moved to London this would be below the poverty threshold. Poverty has always been relative: if you are the only boy in the playground with 10 cakes when everyone else has one, you are rich.

In absolute terms, there are clearly big differences. Americans living at the poverty threshold are a bit better off than the average Russian: poverty in the US kicks in at an income of less than $11,139 a year for a single person, which is slightly more than Russia's average annual income of about $9,600. Still, in absolute terms just over 20m Americans are now living in "deep poverty" with an income of less than half the official poverty threshold and would be poor even by Russian standards.

As you move eastwards, the threshold starts to drop dramatically. The poverty line in the UK is a bit less than the American cut-off at £5,980 ($9,447) a year, but in Turkey it is only $1,460 a year. China and India give particular problems because their people are really poor by any standards. According to the Chinese state, poverty has fallen from 85% in 1981 to "only" 16% now. But the state uses a poverty line of $144, whereas everyone else follows the UN threshold of living on $1.25 a day or less to estimate the number of poor. No-one in the West lives on a dollar a day, but then neither does anyone in Russia or Turkey. However, 8% of Brazilians and a massive 42% of Indians do live on a dollar a day, according to the UN. That means 15.6m Brazilians, 176m Chinese and 546m Indians are currently living in a state beyond what our Despair Index can reasonably measure.

Against this deep poverty in the rural regions of some countries is the rapid growth in income that most of the emerging markets are enjoying. At the nadir of Russia's transition in 1998, per-capita income fell to $8,000. Over the following 12 years, per-capita income has nearly doubled to $15,700 now, about half the average US income. China and India have much further to go: China's per-capita income today is about $7,000 whereas India's is $3,000.

10

I Cover story

in a mature economy with a functioning social security system. That is what democracy is all about: society working together to provide a decent standard living for everyone, even for those who find it hard to get on in life.

bne December 2011

more than what most countries endure in a year). Unemployment was relatively mild at 5.7% in 1993, but the 27.9% of the population living in poverty gave a Despair Index of 2,367, which is off the scale when compared with any and all

"The shocker is that thanks to record low poverty and unemployment levels, Russia's Despair Index fell below that of the US this year, to 25.5 and 28.1 respectively as of November" However, the fracas over reforms to the US' healthcare system or the UK's National Health Service, plus the persistent poverty that exists in all developed countries, shows the system hasn't always worked properly. The lowest poverty level recorded by any country in the last 20 years was France’s 6.1% in 2001. As such, we can take a reading of 12 as the "residual despair" level that any country will feel.

other emerging markets, the worst of which saw their levels reach the lower hundreds at the worst.

Joseph Stiglitz, a Nobel laureate and former chief economist of the IMF, told an audience at the European Bank for Reconstruction and Development annual meeting a few years ago: “Subsequently, we have found that countries that didn’t go through shock therapy

Russia vs USA, misery & despair 120

Russia (despair) Russia (misery)

USA (despair) USA (misery)

100

80

60

40

20

0

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: bne

From despair to hope Life for Russians at the start of the 1990s was truly horrible. The International Monetary Fund-sponsored “shock therapy” introduced in 1992 freed state controls over prices overnight and sent the prices of staples to the moon: inflation reached a peak of 2,333% in December of the same year (that’s 6.4% a day,

have done better in the long term. That was a mistake,” he said with a little chuckle, blithely dismissing a blunder that condemned some 50m Russians to poverty and early death.

Still, it could have been worse. The legacy of the Soviet machine lumbered on and three out of four Russians still

had jobs, albeit useless ones: the lights didn’t go out, the heating wasn’t turned off and no-one starved.

After the initial blow, Russia's economy began to recover. By 1997, the ruble was stable against the dollar and poverty fell to a much more manageable 14.3%, although unemployment was creeping up steadily as those Soviet behemoths slowly died on their feet, to reach 10.8% in 1997. Overall, the Despair Index fell to a low of 45.3 in 1997, but still twice the level seen in the developed world.

The next crisis in 1998 delivered another body blow: inflation soared to 40%, unemployment jumped to 13% and poverty doubled overnight to hit 40%. The Despair Index was back at 89 by the end of 1999. But the big difference this time round was that the ruble crisis carried with it the seeds of recovery: the devaluation re-monetised the economy (which had lapsed into a kind barter system), but perhaps more importantly the jump in unemployment effectively pushed Russians out of their state jobs and into the private sector. Thanks to the tide of oil profits, new jobs were being created and there was cash to pay wages. By 2000, the economy was growing at 10% and the Despair Index began a continuous fall that has seen it reach a post-Soviet low of 25.5 this year.

BRICs and stars A very similar story has played out in most other emerging markets. China also booted workers out of state-owned factories in 1995 – except the Chinese planned their reforms. But unlike Russia, China is not an industrialised country and so there were few jobs for the newly unemployed to go. If Russia suffered its pain in the early 1990s, the Chinese suffered theirs in the first half of the naughties as unemployment soared to 13% by 2002 (according to unofficial academic estimates). It was only in the second half of the decade that the rapid economic expansion finally created new jobs and brought unemployment back down into single digits.

Today, China has the extremely low Despair Index rate of 14 – but here

bne December 2011

poverty is defined as living on less than $1.25 a day. If Russia’s poverty level is applied to China, then its Despair Index would jump to about 29 – one point worse than the US, but still one point better than the UK.

Cover story

I 11

sion, should be representative of Central Europe; surprisingly, Poland does poorly in terms of despair.

From a good base at the beginning of the 1990s with a relatively mild despair

Despair in New World 160

Russia Poland

140

Turkey China

120

100

80

60

40

20

0

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: bne

Turkey lies half way between China and Russia: like China, it has an extensive rural peasantry who have lived in poverty for decades; but like Russia, it is also has a well-developed manufacturing sector.

The Turkish poverty rate began the 1990s at around 30% according to the World Bank – twice that of the collapsing Russia – and it had big problems with both inflation and unemployment: inflation was a crippling 70% for most of the 1990s and unemployment was running at between 11% and 15%.

Taken together, Turkey was suffering an exceptionally bad despair rate of well over 100.

Following a nasty banking crisis in the early naughties, Turkey knuckled down to the task of enacting deep reforms, egged on by the prospect of EU accession. This year, its Despair Index level is down to an almost respectable 34.8, even if the country is still struggling with high inflation and joblessness.

Finally, Poland, the star of the 2008 crisis as the only EU country to avoid reces-

level of 78 in 1993, Poland’s proximity to Western Europe and economic reforms brought the Despair Index down to 37 by the time it joined the EU in 2003. Since then, though, the country has struggled. Inflation has been brought under control, but poverty and unemployment have remained stubbornly high for most of the last decade.

With a despair level of 42 this year, Poland was performing worse than Turkey’s 34.8 and Russia’s 28.

West moving in wrong direction The West went through most of this sort of pain decades ago, supposedly bringing to an end the scourges of hyperinflation, chronic unemployment

"Rising inflation, unemployment and poverty in all the developed markets is pushing them towards a despair rate of around 30, which is more typical of CEE countries"

12

I Cover story

and poverty. But now all three of these problems have reappeared – and most of them were visible even before the 2008 financial crisis broke.

The 1990s were a good time for most western countries. Economies boomed, driving down despair levels from around 40 at the start of the decade to exceptionally low levels of 20-25 for most of the leading powers; France even saw its Despair Index touch 15 in 2001 after unemployment and poverty hit record lows. But after the dot-com bubble burst, Despair Index levels began to rise again in France and Germany, and then jumped for everyone after the 2008 crisis struck.

It is easy to blame the increasing despair levels on the current crisis, but the US Census reports that poverty in the US had been rising during all of the last decade and incomes have not fallen this far or fast since the Great Depression.

American families in 2000 found themselves worse off than they were in 1990, say economists. The crisis just exacerbated that trend. The rate of poverty in the US hit 15.1% in October, higher than that of Russia at 12.3%.

All the major western countries have suffered similar problems. France’s Despair Index has worsened from that impressive 15 in 2001 to about 29 today, and the UK's has jumped from a low of 21 in 2007 to over 30.

bne December 2011

Rising inflation, unemployment and poverty in all the developed markets is pushing them towards a despair rate of around 30, which is more typical of CEE countries. Only Germany, the European economic powerhouse, has bucked the trend and maintained its Despair Index at a more-or-less constant level of about 25.

End of the monopoly To conclude, the evidence suggests that new and old Europe are moving in opposite directions. But isn’t this all just down to the hangover after the borrowing binge that western banks went on since the start of this century?

Celebrity historian Niall Ferguson argues that something more fundamental is happening: the monopoly that the West has enjoyed for the last 500 years over the most important factors that led to prosperity has been broken, and the feisty young economies of the emerging world are undermining the comfortable western way of life.

Ferguson identifies six of what he dubs “killer aps” that allowed the West to shoot ahead of the rest of the world: competition, science and the industrial revolution, representative government, medicine and healthcare, consumerism and the work ethic. “Westerners were the first people in the world to combine more extensive and intensive labour with higher saving rates, permitting sus-

Despair in Developed World 35 France Germany

United States United Kingdom

30

tained capital accumulation,” Ferguson said in a recent interview.

Emerging market governments have been buying, copying or simply stealing most of these "killer aps" and putting them to work in their low-cost, underleveraged economies to spectacular effect. The West, on the other hand, is labouring under the weight of overly generous health, pension and social care systems that were put in place when there was more money to spend and people didn’t live as long.

How will all this play out? Are the two conflicting trends permanent or only a temporary crisis-induced phenomenon?

A lot will depend on how politicians react – but so far they have not provided much evidence to be confident.

The process of convergence that began in 1991 has been catalysed and new and old Europe are moving rapidly together.

The West is facing the need for deep structural change if it is going to remain competitive, but is hamstrung by huge budget deficits and public debt levels that until recently were more typical of countries in the developing world.

Today, we are all living in "transition" economies, except things are moving in a better direction for one group of transition economies and in a worse direction for the other group of transition economies.

Every year we make over 1,200 company visits.

Every year we reward the three most outstanding companies. no index in the world offers an accurate view of an emerging market. that’s why we travel throughout eastern europe to find the right companies to include in our funds. east Capital Awards honors three of these companies each year – to highlight their outstanding achievements and to inspire others.

Important Information: investment in funds always involves some kind of risk. Past performance is no guarantee for future performance. Fund units may go up or down in value and may be affected by changes in exchange rates. investors may not get back the amount invested. the availability of east Capital’s funds may be limited or restricted in some countries. detailed information about where the funds are registered and what types of distribution are permitted can be obtained at east Capital.

Best Growth: Since 2003 Turkish Airlines, one of europe’s fastest growing airlines in recent years, has tripled its fleet size, grown the number of passengers by on average 18% per year and increased its revenues even during the worst of the global financial crisis in 2008–2009. As of September 2011, the company doubled its market share compared to 2005 and became the fourth largest carrier in europe. turkish Airlines is today a four star airline company with a fleet of 177 aircraft flying to 190 cities around the world.

Best IPO: DO&CO Restaurants & Catering AG is an international gourmet entertainment company. the company’s USd 90 million listing on the istanbul Stock exchange in 2010 was oversubscribed by more than 11 times by foreign investors and more than 8 times overall. on the first day of trading the stock shot up by 14%, recording a share price increase of 31% in the first three days. do&Co was up by 57% on 30 September 2011, outperforming its benchmark index by 74% since the iPo.

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25

20

15

10 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: bne

East Capital Awards Rewarding outstanding Eastern European companies

www.eastcapital.com

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I Eastern Europe

bne December 2011

Moreover, according to the business daily Kommersant, Timchenko's Transoil company board pre-approved spending up to RUB500bn ($16.7bn), while Lisin's companies put RUB300bn ($10bn) into his war chest ahead of the auction.

Russia's privatisation programme runs off the rails Ben Aris in Moscow

T

here were several big surprises at the privatisation auction of Russia's biggest rail cargo company First Cargo Company (FCC) on October 28, the biggest sell-off this year. The first was how fast the bidding was over.

The second was how small the premium paid was over the minimum starting price. The third was that Russia's richest man Vladimir Lisin won instead of Kremlin insider Gennady Timchenko, who had been widely tipped to walk away with the company.

FCC is a spin-off from state-owned monopolist Russian Railways (RZD) and is the country's biggest cargo rail company with more than 200,000 cars, or a fifth of the entire Russian fleet.

With the markets crashing and fears of a second crisis palpable, the auction of FCC is likely to be the only signifi-

cant sale this year in Russian President Dmitry Medvedev's much-vaunted privatisation programme, which aims to raise more than RUB1 trillion ($33bn) from the sale of state assets between 2012 and 2014. And with two of Rus-

bne's industry sources said prior to the sale that Timchenko was very keen to buy the company and it was assumed he would get it. However, Lisin was just as determined and went as far as registering two separate bids and paid two

"Medvedev's promise of transparency and accountability in Russia's privatisation programme was locked out of the room along with the press corps"

sia's biggest oligarchs facing off to take control of the company, the auction was expected to result in a bidding war.

separate deposits simply to make sure the minimum two-bidder condition for auctions to proceed was fulfilled.

Eastern Europe I 15

bne December 2011

But as the big day drew closer, the smell of fish started to waft. On October 13, the president of Russian Railways, Vladimir Yakunin, bizarrely started talking the price down, calling the sale "unwise under the current market conditions," but the company still planned to "fulfill its obligations" and go ahead with the sale. The company has no binding "obligation" to privatise itself and state-owned banking giant Sberbank postponed the sale of a 7.6% stake the same month, precisely because of those same market conditions. Yakunin followed up five days later announcing that the auction would be closed to the press. "The auction will be confidential, so journalists will learn about the results afterward," Yakunin said.

Medvedev's promise of transparency and accountability in Russia's privatisation programme was locked out of the room along with the press corps.

The end of the story is predictable. Lisin made a single bid that was the minimum RUB100m step over the starting price, or 0.8% of the total, to clinch the deal, ultimately paying RUB125.5bn ($4.1bn) for the company. Timchenko didn't move a muscle throughout the 10 seconds that the auction took to conduct.

Behind closed doors So what really happened? The first point to make is the government didn't get as badly burned as it did in the now notorious loans-for-shares deals during the mid-1990s: $4.1bn is not to be sniffed at, but it still values FCC at slightly less than Globaltrans, another rail cargo company that was sold via an IPO in April 2008. "The price could be higher, but not much," says Andrew Rozhkov, an analyst with Metropol.

"According to our calculations, with premium for control, it should be 15-20% higher than final price. How-

Russia's Northern Sea Route trade soars

bne Russia has opened up a new trade route that cuts the distance between Europe and Asia in half. The Northern Sea Route goes round the top of the Eurasian continent, rather than the traditional route via the Suez Canal, passing India and China.

The only problem is that the sea along Russia's Artic coastline freezes solid in the winter which has made the passage impractical for commercial traffic. However, as Russia expands its fleet of nuclear powered icebreakers, the volume of traffic through the icy northern waters has started to soar.

The Northern Passage was first conquered in 1879 by Finnish-Swedish explorer Adolf Erik Nordenskiรถld and making the journey was a perilous dice with death. But the same trip is becoming increasingly humdrum as Russia looks for ways to boost trade between the developed and developing worlds.

The number of ships using the route has already tripled this year to 33 from only 10 in all of 2010, and cargo shipments via the Russian part of the Northern Sea Route are expected to rocket to 800,000 tonnes in 2011 from 145,000 tonnes in 2010, Vladimir Mikhailichenko, executive director of the public partnership on coordination and operation of the route, said in October.

The explosion in traffic is partly due to the Kremlin's decision to slash transport duties, which were from four to six times higher than that of the Suez Canal last year.

Oddly one of the most important cargos is fish being shipped by the Northern Sea Route from Russia's Far East to the Russian city of St Petersburg, as "transporting fish by sea is more efficient than by railway," Mikhailichenko deadpanned.

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ever, I don't think RZD made a bad bargain. Considering the market situation, RUB125.5bn is close to market price."

Analysts speculate that as they were both interested in different parts of the company anyway, the two men reached a deal rather than waste billions of dol-

"I think there was a deal between Timchenko and Lisin to use FCC's fleet together in future" lars bidding against each other. "I think there was a deal between Timchenko and Lisin to use FCC's fleet together in future. Timchenko is more interested in tanks and Lisin in gondola cars. So I expect in a year we'll find that most of tanks are used for the benefit of Timchenko and most of gondolas for the benefit of Lisin's business. I don't think FCC will be divided between them - it's against the conditions of sale," says Ekaterina Andreyanova of Rye, Man & Gor Securities. "But if there was a backdoor deal, then Timchenko and Lisin agreed to split the fleet."

Lisin owns NLMK, a huge steel mine that needs gondola cars to move ore about, whereas Timchenko is an oil trader and needs tanker cars. Other analysts suggest that the Kremlin itself might have been behind keeping a lid on the bidding. The very same day that FCC was being sold, the investment company Dellawood Holdings, which is co-owned by Timchenko and Leonid Mikhelson, was reported to have closed a deal to secure a 95% stake in Sibur, Russia's largest petrochemical company, for an undisclosed sum.

Mikhelson bought a 50% stake in Sibur from Gazprombank last December and subsequently increased that to 57.5%. In the October deal, Timchenko separately bought another 37.2%, leaving Sibur's management holding the last 5%. "It is possible that Timchenko decided not to take part in the FCC auction when it became clear that he was about to secure a major stake in

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Sibur - a company whose core business complements his other major holdings no less than ownership of FCC would have done. At the same time, it cannot be ruled out that there was pressure from the top to prevent the oil trader from walking away with two major prizes on one day," says Christopher Granville, director of research house Trusted Sources.

If this is true, then the government rather perversely gypped itself out of several billion dollars for the sake of maintaining the balance of power amongst the oligarchic elite. But that is what the anti-trust laws are for. All in all, the auction was a sorry showing for the "new-look Russia" that the Kremlin has been trying to sell to international investors. It is also a providential indicator of the way Russia may be run after Putin's almost inevitable return to the post of president in the spring. Rather than getting government out of the economy, this privatisation showed the same old oligopoly from the naughties is in charge, with ZAO Kremlin overseeing deals and taking its cut.

Watch this space for the next instalment of the privatisation saga. Next up is a sale of 7.97% in Russia's hydropower holding RusHydro slated for July 1, 2012. The key here is that the state currently owns 57.97% and nominally this could be a very attractive asset.

The caveat is no-one knows who owns the free float except that oligarch Oleg Deripaska is a big shareholder.

Rumour has it that a share swap is being discussed. Deripaska owns EuroSibEnergo, Russia's second biggest hydropower company that controls Irkutskenergo, the most attractive hydropower asset in Russia. The deal would end up with Deripaska controlling RusHydro, which could sell cheap power to his aluminium production, in exchange for RusHydro obtaining a blocking stake in EuroSibEnergo – in other words another oligopolic deal between ZAO Kremlin and its client oligarchs.

I 17

bought $3bn worth of hard currency.

Analysts say the local currency is bound to devalue by about 5% in the new year and the government has already been forced to introduce administrative barriers on foreign exchange sales to slow the haemorrhaging. The banking sector remains sick and vulnerable to more shocks. "Perception is reality. The economy hasn't collapsed, but people are starting to take their money out of banks and are buying things like fridges," says Konstantin Golovynsky, head of communications at Renaissance Capital in Ukraine.

Kyiv – the new Minsk bne

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yiv used to look to cities like Warsaw, hoping to become a full-fledged member of the EU. Now it looks increasingly like Minsk as it turns in on itself. The ruling elite is carving up the country's wealth as the government careens from diplomatic gaffe to democratic debasement.

Ukrainian President Viktor Yanukovych's decision to jail former prime minister and opposition leader Yulia Tymoshenko in October killed the hopes of closer integration with the rest of Europe.

Relations with Brussels have become frosty and hopes of entering into a meaningful trade agreement with the bloc have been dashed.

Many recent column inches have been devoted to asking: if the doors to Brussels close, will Kyiv be driven into Moscow's open arms? But that's to give Yanukovych too much credit: Ukraine doesn't have a strategy. "No-one knows where we are going," complains Brad Wells of Concorde Capital. "Are we going to align with the EU or move closer to Russia? There is no direction at the moment, only confusion."

In the face of an inability to influence government, a sense of apathy has descended over the citizenry that brought us the Orange Revolution.

People are tired of politics of any shade.

Deputy Prime Minister Sergiy Tigipko presented an ambitious programme of reforms at the start of this year, but all of his promises have fallen on stony ground. The extent of the government's reform programme seems to be entirely

A new IMF team was in Kyiv in OctoberNovember to see whether next year's budget conforms to the fund's demands in order to revive the $15bn lending programme suspended at the beginning of this year. But on November 4, the IMF said any further talks would have to wait until Ukraine had reached a new gas agreement with Russia.

The IMF wants the government to hike domestic gas tariffs, but the government is living in la-la land by insisting in almost daily statements that hikes are unnecessary, because Kyiv is on the cusp of a deal with Russia to reduce gas prices. Following each of these statements, Gazprom replies that the existing and expensive deal is still in place.

"Ukraine has met the major requirements, but the considerable deficit of Naftogaz highlights the household gas rate raise as being a consistent and

"Are we going to align with the EU or move closer to Russia? There is no direction at the moment, only confusion" focused on meeting the International Monetary Fund's (IMF) demands in order to get the next tranche of cash on offer, which is essential to funding next year's deficit.

The uncertainty is also hitting the economy. The hryvna has been under pressure in October after the population

justified IMF requirement. The government's‌ verbal assurances are unlikely to hit home with IMF representatives," reckons Oleg Ivanets of Art Capital in Kyiv, adding that the government will have to cave in eventually because recent pressure on the hryvna and wobbly banking sector makes IMF funding indispensable.

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The government's strategy seems to be to try and link the gas issue to the onesided negotiations with the Kremlin: if Russia refuses to revise Ukraine's supply contract and the Rada is forced to hike tariffs by the IMF, then it can usefully pass the blame onto the Kremlin, thus minimising damage ahead of next year's elections. "The government's problem is the people don't understand the need for the IMF loan and so won't accept a hike in domestic tariffs," says Wells.

Yanukovych has also turned on the oligarchs that put him in power, who he now holds at arm's length. Many of these businessmen would love to see the country join the EU, as much of their exports are headed in that direction, but they are keeping a low profile and are unlikely to move against the government. What is left is a small circle close to the president that is attempting to grab what it can. As for Yanukovych: he is busy spending tens of millions of

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Yanukovych's rating has fallen to 16.7% against Tymoshenko's 13.3% as of October. The former PM should have received a sympathy bump since her jailing, but her low rating only highlights how disillusioned the voters are with everyone – orange or blue. And the government's rating is also tumbling. Yanukovych's Party of Regions has seen its popularity fall from 20.5% in January to 15.7% in October against 12.6% for Batkivshchyna, an opposition bloc that includes Tymoshenko's eponymous party. "The political situation has become more polarised. The attack on Tymoshenko looks like pure revenge. But because she has been jailed, the current team has to stay in power, as if the opposition takes over, then they will probably also take revenge," says one banker. "This will lead to trouble and the ruling elite need to make sure of the election result."

The trouble is that Ukraine is reverting to form and Yanukovych is following an old tradition of changing the election

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are often more expensive than those to European destinations. Avianova managed to transport 2.5m people in two years and climbed to an impressive sixth position among Russian domestic passenger carriers. But intense passenger traffic didn't translate into profits.

Avianova gave up the ghost on October 9 and began to pay compensation to more than 60,000 ticketholders booked on flights after this date.

of a tax reform that hikes taxes on small business and cuts it on big corporates, or are victims of "raiding": if an entrepreneur is unlucky enough to set up a successful business, then it doesn't take long for a representative of the local powers-that-be to show up and offer to buy the business at a massive discount. If the businessman refuses, tax police and secret service raids follow. "Earlier, the authorities built a coffin for entrepreneurs through their so-called 'reforms,' and now, through anti-national bill No. 8521 [on a simplified taxation system that hikes taxes on SMEs], they have already prepared a coffin lid and nails," says Andriy Panaetov, chief of staff of the Forward! Rally, which plans to demonstrate in Kyiv in early November.

The Rada is due to vote on the new election rules in the next few weeks and will almost certainly push them through. The expectation is that the Party of Regions will then sweep the single mandate seats in next year's election and will do what it needs to take much of the party list votes too.

Budget airline blues

www.skyexpress.ru

Anna Kravchenko in Moscow

"These guys at the top are the result of 15 years of violence and corruption"

dollars on the luxurious Mezhyhirya palace, the new presidential residence, complete with a boating lake, gazebo, a helipad and a $17m Agusta Westland 139 helicopter to go with it, known as the "Ferrari of the skies."

"These guys at the top are the result of 15 years of violence and corruption.

Some close to the president have survived multiple assassination attempts.

It is the survival of the fittest and they will never leave on their own," says one banker, who prefers to remain anonymous.

Polarised politics Still, Ukraine nominally remains the most democratic country in the CIS and, in theory, Yanukovych could be voted out of office if he continues to do a bad job.

laws ahead of a general election, which is due next year. Ukraine's current election legislation is a proportional system: voters vote for one party and those that get more than 3% get seats. However, the names on the party lists are not made public until after the results.

"Our president decided to change the election legislation to a mixed system: 225 deputies will be elected on party lists and the other 225 will be elected in single mandate districts," says Olesya Oleshko, an independent political analyst in Kyiv. "Those who will be running for election in single mandate districts only have a chance to win if they are on good terms with the corresponding regional governors – all of whom are appointed by the president."

What dissent there is has come from entrepreneurs who have borne the brunt

The investment climate has become so poor that companies are already pulling out. On November 1, Czech utility CEZ said it was closing down its operation and the Bank of Georgia's investment wing BG Capital, which scored successes with two Ukrainian IPOs on the Warsaw Stock Exchange earlier this year, closed its office. "I'm writing to inform you that in line with Bank of Georgia's strategy to focus more on its home market, and given the changing business and political climate in Ukraine, the Bank has decided to close BG Capital's Ukrainian office," Nick Piazza, CEO of BG Capital, wrote to customers on November 1. "As of today, the Kiev office is officially closed," he concluded in a sentiment that echoes many investors' attitude to the whole country.

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he bankruptcy of Russia's last two low cost carriers, Avianova and Sky Express, in the past month has brought an end to the short era of budget flights in Russia.

On November 1, federal air transport agency Rosaviatsia suspended Sky Express' licence, citing weak financial and operational results as the reason. Now the carrier is about to be taken over by oligarch Oleg Deripaska's Kuban Airlines. Talks between the two companies started last summer after Sky Express' debts to its home airport Vnukovo had topped nearly RUB2bn (â‚Ź47.5m) as of April.

Sky Express was set up in March 2006

by KrasAir CEO Boris Abramov, the European Bank for Reconstruction and Development (EBRD) and others as the first attempt to introduce a low-cost carrier that would cater to Russia's holiday-mad population. Its maiden flight was on January 29, 2007 from Moscow to the popular Black Sea resort of Sochi. But on October 29, just 20

days after its low-cost rival Avianova ceased operations, Sky Express also grounded its fleet for good. "It's really hard for a small, low-cost company with small capital to survive," says Sergei Babichenko, head of the press office of BasEl, the holding company that owns Kuban Air. "Sky Express started to sink

Monopoly in the making What mainly contributed to Avianova's demise was very high fuel prices. Kerosene supply is a monopoly market and the price continues to rise, but the issue has been ignored by Russia's Federal Antimonopoly Service (FAS). The other big reason for Avianova's failure was the impact of inefficient ground maintenance at airports, which reduced the number of miles a year the company's fleet could fly. Even the international hub of Moscow can't compete with western standards, let alone Russia's regional airports.

Avianova deputy CEO Konstantin Teterin blames existing legislation. "In Russia, the low-cost business model in its classic realisation, like Ryanair or Southwest, is impossible. Regional airports can't offer any special conditions for low-cost companies, there are no secondary hubs [and] taxes for planes with passenger capacity of 180 seats, which is ideal for a low-cost company, are very high.

"In Russia, the low-cost business model in its classic realisation, like Ryanair or Southwest, is impossible" in 2008 with the beginning of the global financial crisis. Company debts were growing, planes stayed idle. Our shareholders decided to save the business and staff, which was almost a charitable act. This company could not operate on its own."

Cheap tickets should have been a winner in Russia where domestic flights

Avianova's experience showed huge demand for cheap tickets. I think if the government admits low-cost companies are needed, new airlines with a hybrid business model, like AirBaltic, EasyJet, may appear."

The upshot is that the current conditions on the Russian aviation market make it impossible for low-cost airlines to oper-

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Runet Europe’s largest One-term wonder Russian President Dmitry Medvedev may go down in the history books as Russia’s least effectual ruler, but one thing he did right was to propagate internet use. His critics may say he did little else but surf the net during his four year stint as president, but research shows soaring numbers of Russians are on the same wavelength.

Russia squeezed past Germany in September to clock Europe’s largest number of internet users, according to market researcher Comscore. Russia boasted 50.8m unique users, leaving previous No.1 Germany in second place with 50.1m. European users total 374m.

Not only that, but Russian social network vkontakte is Europe's No.1 site in terms of time spent on it by visitors, with each vkontakte user spending on average 7.1 hours on the site in September, according to Comscore.

bne December 2011

ate without government support. Yet moves by the regulator make it clear that the government's strategy is to increase the monopolisation of the sector.

Moscow airports Sheremetyevo and Vnukovo are ready to merge, and the national carrier Aeroflot will get preferential treatment, while smaller companies will in effect be pushed out of the market. "The aviation sector does need consolidation to make it more profitable in general and also more safe," admits Alfa Bank analyst Yuly Matevosov.

"There is the same tendency in other sectors – government wants to clean them up from minor players and make them more transparent."

The real war against small airlines started in September after President Dmitry Medvedev said the nation's aging fleet was becoming unsafe and should be scrapped. As if to prove his point, Russia suffered from a string of catastrophic air crashes, culminating in the crash of a Yak-42 that went down in Yaroslavl in September, killing most of the much-loved Lokomotiv Yaroslavl ice hockey team.

The government reacted quickly, proposing changes in legislation to improve safety: from 2012, all planes must be equipped with the crash prevention system (which is absent on most airliners now) and companies with fleets of less than 10 airplanes are forbidden to offer regular flights. The transport ministry also announced it will suspend the company licence if the number of flights with two-hour delays exceed 10% of all flights in a season.

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I 21

However, a result of the new rules will be to reinforce Aeroflot's monopoly, as well as help second biggest Russian airline Transaero. Tellingly, both said they're not worried with the new legislation.

the amount of cash being spent may have decupled in the last decade, but as a share of GDP it has only doubled from 3.5% of GDP in 1999 to 7.0% in 2010 – still behind China's 11%, but ahead of India's 6% in 2010.

On October 26, Aeroflot deputy CEO Shamil Kurmashov claimed the company's market share would grow to 36.6% by the end of 2015. Considering many competitors will have to leave the market after the new regulations come into force, Aeroflot's ambition is well within its reach, says Investcafe analyst Kirill Markin.

However, the most telling change is that it isn't the federal government making the investments, but state-owned companies, many of which are now on the privatisation list. Over half of all infrastructure investment (3.7% of GDP) was made by just eight large stateowned companies, while federal budget spending accounted for only 1.8%, says Morgan Stanley.

Alfa's Matevosov reckons Russia won't see any new low-cost carrier for a couple of years; the aviation sector requires long-term investments and there is no big investor interested in creating an independent low-cost company right now. More likely, he says, one of the leading airlines will start its own low-cost daughter company. However, Kurmashov says Aeroflot has no plans to create a budget daughter company in the foreseeable future, explaining that under current conditions it's simply impossible. For example, he notes, airport taxes for low-cost airlines are the same as for "traditional" companies.

So the niche is empty now with no signs of any of the big domestic airlines ready to fill it, especially as they can now snap up the losers' local routes, pilots, planes and customers. Further, foreign companies are banned from the Russian market and that's not going to change anytime soon.

"The aviation sector does need consolidation to make it more profitable and also more safe"

Russia's invisible infrastructure boom Ben Aris in Moscow

A

n invisible infrastructure boom is underway in Russia as the state's trillion-dollar programme to remake or modernise the crumbling Soviet-era roads, railways, bridges and ports moves into full swing despite the crisis in Europe.

The Russian government is spending between $60bn and $65bn a year on a slew of major projects – not that you'd notice if you visit the country. Walking around Shanghai the state spending is obvious; nearly every regional capital sports a forest of sparkling glass-clad skyscrapers and freshly minted shopping malls. By contrast, Russia's regional capitals are just as drab and rundown as ever, bar a few brightly coloured billboards. That's because the Russian money is going not into real estate, but predominantly on the transport and power systems that are the lifeblood of this vast and largely empty country.

Infrastructure investment in Russia in 2010 reached $111bn, according to a report by Morgan Stanley, a 10-fold increase from the pathetic $7bn spent in

1999. Moreover, after the government launched its trillion-dollar makeover for Russian roads and railways in 2008, it continued to spend over $100bn throughout the crisis, which has gone a long way to ameliorate the external shock that hit the economy when the global debt market froze in 2008.

Tip of the iceberg The real boom in infrastructure spending is only now getting underway. A host of mega-projects are currently being prepared that will come online over the next couple of years, which will push the spending even higher.

Amongst the biggest are: development of the Vancor oil and gas field, the biggest find made in Russia in the last 25 years; the development of the Ust-Luga port in the Gulf of Finland that will become the biggest warm water port in Russia; the reconstruction of the Black Sea resort town of Sochi ahead of the 2014 Winter Olympics; and the construction of the East Siberia Pacific Ocean (ESPO) oil pipeline from Siberia to Russia's Pacific coast.

"What is odd is that much of this work has gone unnoticed" Commentators regularly lambast the Kremlin's spending frenzy that has driven up the level of the oil price required to balance the budget to over $125 today from just $21 in 2007, according to Citigroup. But what they fail to release is that a big chunk of this money is going into infrastructure projects rather than propping up struggling factories or paying public servants. And the splurge in spending is not that much when set against the rapidly expanding economy:

Morgan Stanley estimates there is a total of $500bn worth of infrastructure projects already underway or about to start. "Based on our major projects database, we see a steady $60bn-65bn [per year] flow of infrastructure capex on major projects, and a new generation of mega-projects under development, including high speed rail, new federal highways, the Moscow transport hub and further development of the Yamal oil and gas province," says Jacob Nell,

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"Russia inherited significant elements of a modern industrial infrastructure from the Soviet Union" chief economist of Morgan Stanley and author of the report.

To sustain this high level of development, Nell estimates that the state-owned companies will have to raise another $28bn a year to finance the work – about as much as Russia currently attracts as foreign direct investment.

What is odd is that much of this work has gone unnoticed. Part of the reason is that the spending has failed to have

much impact on either growth or overall investment – both are now actually lower than prior to the onslaught of the crisis.

In addition, because the more opaque state-owned companies are in the frontline of this, their spending is less easy to see than federal budget spending or privately funded investment.

But perhaps the biggest factor is that unlike China and India, which were both largely agrarian economies, Russia inherited a lot of infrastructure

from communism that is still serviceable; during the Soviet boom years in the 1970s when the workers' paradise looked like it might actually happen, Kremlin spending on infrastructure was averaging 40% of GDP per year. It was only in the 1990s that it dropped off to next to nothing after most of the heavy lifting was already finished.

"Russia inherited significant elements of a modern industrial infrastructure from the Soviet Union, including an oil and gas industry, a mining industry, a railway network, a power network, and urban transport and municipal services.

However, the infrastructure was often inefficient, and there were notable gaps, particularly in telecommunications and transport," says Nell.

this summer. On the face of it, there is little to complain about. The fund will co-invest in interesting sectors with leading foreign funds and take a minority role. It is run by Kirill Dmitriev, a sharp, young manager who cut his teeth at the US-backed private equity fund Delta Capital before going on to run his own highly successful $1bn fund Icon. In short, Dmitriev "gets it" when it comes to creating the kind of investment opportunities that will appeal to western investors. His focus on strong returns and squeaky clean corporate governance will be music to foreign fund managers' ears.

The chances are that the RDIF will work: it should bring in billions of dollars of foreign capital.

given the scale of the job at hand is actually just a drop in the bucket.

The second big addition to this initiative is the International Financial Corporation-run Russian banking fund, which complements the RDIF that can invest into everything except banks. Both funds are backed by the state development bank-cum-debt agency Vnesheconombank (VEB), which has committed $10bn to the RDIF and $250m to the IFC fund.

The most high profile initiative was the creation of the $10bn Russian Direct Investment Fund (RDIF) that was launched at the Kremlin's annual investment jamboree in St Petersburg

The bank fund's manager, the IFC's Timothy Krause, is now on the road pitching the fund to sovereign wealth funds and other big investors. And as an old Russia hand with several very successful bank

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ussia needs investment – a lot of it – but it's not arriving, so the Kremlin has launched a raft of initiatives to attract more capital. The trouble is, rather than fixing the fundamental issues that are keeping investors away, the Kremlin is throwing a huge amount of money at the problem, which

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investments under his belt, the chances are Krause will manage to raise the extra $500m that he's looking for.

However, critics argue that there is a fundamental contradiction at the heart of these funds. "Look at the logic of these funds," says one senior fund manager who didn't wanted to be quoted criticising the Kremlin. "What they are saying is if you invest together with the Kremlin, then you are safe. But flip

Eastern Europe

productivity is a third of the US' and a World Bank study found that 60-80% of the gap is simply due to bad management. Russia doesn't need one elite $1bn business school; it needs a hundred to train a generation of managers how to run a business efficiently.

And this is not to mention all the national champions the state has set up such as the United Aviation Company, VTB group in banking, Sovkomflot in

"What they are saying is if you invest together with the Kremlin, then you are safe. But flip that around: if you don't invest with the Kremlin, you are not safe" that around: if you don't invest with the Kremlin, you are not safe. Is that what you want to be telling investors? So will these funds improve the investment climate? After all, that is ultimately what they are there for."

And these two funds are only the latest addition to a slew of Kremlin-backed initiatives designed to kick start investment. In 2008, the then president Vladimir Putin personally backed the creation of the Russian Venture Company (RVC), which was supposed to unleash Russia's intellectual talent by providing it with access to about $1bn of capital. (As the former chairman of Russia's Venture Capital Association, Dmitriev was also involved in creating this.) But the company has been a failure and is yet to produce a single marketable product.

The same is true of Nanotech, the statebacked technology company. Heavy hitting Russian politician Anatoly Chubais was hired to run the company, which is supposed to finance the development of technology that will put Russian science at the leading edge modern science. But it too has yet to produce a single sellable product.

Or Skolkovo, the business school and technology park, which is rapidly turning into another white elephant; Russia's

shipping, Avtovaz at the centre of the automotive sector, to name a few – although some of these champions have made some real progress and produced real products and services.

The Kremlin correctly identifies the problems, but its knee-jerk solution is to throw money at them. It is an expensive way to go about remaking Russia and despite the tens of billions spent on these programmes, they pale into insignificance in comparison to Russia's investment needs, which run into the trillions of dollars. But thanks to oil and gas, Russia has buckets of money to spare and so it doesn't matter if these plans are wasteful; they allow those in power to point at these structures and say they are doing something about Russia's problems.

So while Dmitriev might "get it" when it comes to structuring a fund and a deal to make it attractive for foreign investors, he is just one bright, young manager (from a growing cadre of real professionals that are gradually moving

I 23

into positions of power in the Russian government). His bosses in the Kremlin, however, don't get it.

Better uses Far more effective would be to take all this energy and put it into fixing the underlying system, so that investors don't need the backing of the Kremlin to plough through the corruption, bureaucracy and economic volatility to make successful investments.

So is real Russian reform condemned to wait until the current ruling elite retire or die? "The Russian [stock] market is worth about a trillion dollars, which means that companies could use it to raise about half a trillion," says Alexander Ikonnikov, chairman of Russia's Independent Directors Association. "But if you double the value of the market to 2 trillion, then companies could raise 1 trillion – there you have it: the money the government needs to pay for all the investment that it wants to do. The new direct investment fund has $10bn, but in the grand scheme of things, it is only a drop in the ocean."

To be fair, the Kremlin has started on this more difficult task with the International Financial Centre (IFC) project headed up by the Micex stock exchange chairman Ruben Aganbegyan (who at 39 years old is another one of Russia's Young Turks). But as the former head of the stock market regulator Igor Kostikov pointed out in an interview with bne, even this reform is being done top-down and ignores the broad problems facing small investors who are the key to making this reform work. "The trouble is, we don't have the experts in government to develop the market," says Ikonnikov.

"They focus on the strategic sectors that will generate money and then use that to push the economy forward. In the USA they are very good at attracting capital and do everything to promote their markets. That is what we need to do."

"The new direct investment fund has $10bn, but in the grand scheme of things, it is only a drop in the ocean"

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GeoProMining brings hi-tech to Soviet-era assets

bigger problem is the lack of infrastructure, but the government is paying a lot of attention to Eastern Siberia and the Far East, and infrastructure has visibly improved in the last few years."

INTERVIEW:

Ben Aris in Moscow Siman Povarenkin

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he Russian government talks a lot about modernisation, but the privately owned diversified mining company GeoProMining (GPM) is actually doing it – simply because it makes them more money.

Siman Povarenkin spent five years as chairman of the hugely successful Vladivostok-based Fesco shipping company, arguably the best run company in Russia's wild Far East. In 2001, he set up GPM with his partner Sergei Generalov, Fesco's president, to invest in gold and copper mining in the Commonwealth of Independent States (CIS). "GPM started more as a hedge fund than anything else, but in 2005 we bought some gold and copper mining assets in Georgia and have successfully developed the company from there," says Povarenkin, seated in his designer office in the heart of Moscow.

In the corner of the room is a giant meat cleaver standing in a Zen sand garden – an artwork by one of Indonesia's leading contemporary artists. Povarenkin explains that ingraining the company with an international culture is a key part of the company's philosophy, which is why he recently stepped aside as chairman and promoted Australian-born Russell King from independent director to chairman to inject a little more of the Anglo-Saxon business culture into management.

GPM has built up its business over the last six years largely through acquisi-

tions and today the company has six main assets. The company's first two purchases took place in 2005 when GPM successfully competed in one of the first public privatisations of mining assets in the tiny Caucasus republic of Georgia, shortly after President Mikheil Saakashvili came to power. It bought Madneuli in a hotly contested open auction, one of the largest mining companies in Georgia, which develops the Madneuli gold-copper deposit. GPM followed this up with the acquisition of Quartzite, a

invested heavily in them to create worldclass mining facilities using the best technology on offer. "When we took over the assets in Yakutia they were basically stationary. It took two years of investment and extreme efforts of the management team to get the plants back on their feet," says Povarenkin.

And with dramatic results: for its gold plant in Armenia, GPM bought technology from the Austrian specialist company Exstrata and combined it with Russian

"Some of the Soviet-era infrastructure was obsolete or of poor quality, but in mining the Soviets were pretty efficient" producer of gold and silver the same year. Then in 2007, GPM bought several assets in Armenia: the Agarak CopperMolybdenum Mine and GPM Gold, which develops the Sotk gold deposit and manages the Ararat Gold Extraction Plant. Finally, at the end of 2008, GPM acquired the Russian antimony and gold mining assets and processing plant Sarylakh-Surma and Zvezda, which exploits the Sentachan antimony gold deposit in the snow-bitten autonomous republic of Yakutia – the coldest place on Earth.

Tech in the tundra The company's strategy is simple. It has taken rundown Soviet-era assets and

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The use of the new technology has changed the mining game in Russia. In Soviet days, the cut-off for developing a gold mine was a gold density of 5g/ tonne of ore, but today – especially after gold price soared to just under $2000/ oz this summer – concentrations as low as 0.6g/tonne of ore have become attractive. This means simply working the tailings of rich mines abandoned by the Soviets can be used as the basis of profitable gold production in some cases. "Gold has become a financial asset for investors fleeing things like the US T-bills, but even so sales of physical gold have risen 10% faster than the volume sold on the London Metals Exchange in the last year," says Povarenkin.

GPM keeps applying the same model to all the plants and mines it takes over.

Today, the company is the third largest Russian investor in Armenia. When it bought GPM Gold from the Indian company Vedanta Resources in 2007, the plant was at a standstill. GPM started investing heavily in the midst of the financial crisis and breathed new life into the plant. The Agarak mine was in

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"GPM started more as a hedge fund than anything else, but in 2005 we bought some gold and copper mining assets in Georgia"

a similar state, but this year both mines are producing again and in profit. The Armenian plants are also the "greenest and most efficient in the world," boasts Povarenkin.

Gold and copper account for most of the production, but GPM is also a world player in antimony production, which is used in tyre production and increasingly in touch screens for products like Apple's iPod. "We have the richest antimony resource in the world and we are the biggest player on the market outside of China with around 5% of the world's proven antimony reserves," says Povarenkin.

Gold remains the company's most important product, which accounted for over 50% of its revenue, while antimony contributed just over 10% in 2010. Last year, the company produced 290,000 oz of gold equivalent, but estimates that it has over 9m oz of reserves and 24m oz of resources still to work.

technology from the well-known (in Russia) St Petersburg-based firm Mekhanobr Engineering and production soared. The plant is expected to produce 150,000 ounces (oz) of gold annually starting from 2014 compared with the 24,000 oz it produced in 2010.

Russian technology is typically portrayed as an almost medieval, clunky affair, but GPM didn't have as much work to do as you'd expect: the gap with the best from the West is surprisingly small, claims Povarenkin. "Some of the Soviet-era infrastructure was obsolete or of poor quality, but in mining the Soviets were pretty efficient," says Povarenkin. "The

www.geopromining.com

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growth of just 1.5% this year and only 0.5% in 2012.

The liquidity situation in Hungary is not yet dire. At the end of September, there was still liquidity of some HUF1000bn held in cash at the central bank. Furthermore, some HUF500bn remains of the privately-held pension fund assets that the government effectively nationalised last year to fill the funding gap left by the withdrawal of the IMF. But what was becoming increasingly clear to even the Hungarian government was that its 15-month experiment in what it calls "unorthodox economic policy" – in practice doing without the IMF – was running into difficulties.

Debt crisis stalks Hungary bne

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ne was already warning that a debt crisis was stalking Hungary as it faced increasing difficulty finding buyers for its government debt, when the government shocked the market on November 17 that it's back in talks with the International Monetary Fund.

Typical for the weirdly populist-nationalistic government of Viktor Orban, the announcement to restart talks with the IMF (which it abandoned in 2010 after soon coming to office) was grudging and accompanied by a fair degree of griping about how foreign investors were seeking "revenge" for the government's "unorthodox" fiscal policies, and doesn't reflect a true picture of the economy.

Hungary had made "far greater strides than the world recognized," Laszlo Parragh, chairman of the Hungarian Chamber of Commerce and Industry, moaned to the Magyar Hirlap daily a few days before. "Those who have been the losers of the past year-and-a-half of the government's decisions – certain banks, financial investors, retail chains, energy multinationals – now see us as being in trouble."

However, the writing was on the wall a week before on November 10, when the country's debt management agency was

able to find buyers for only HUF23bn (€73m) of one-year treasury bills, compared with the HUF40bn it had been seeking to place. More worryingly still, the government was only able to sell the bills at a price that implied an average yield of 6.79%, a full 24 basis points (bps) above the level at which the bills were trading on the secondary market: institutional investors clearly felt they were taking on substantial risk in lending to the Hungarian state, and wanted substantial compensation.

This left the funding situation looking almost as tight as it did in 2008, when investors were similarly spooked by the Lehman Brothers collapse, driving Hungary, along with much of the rest of Central and Eastern Europe, to the IMF. But while Romania and Ukraine continue to stick to their IMF programmes (more or less), one of the first acts of Hungary's government when it took power some 18 months ago was to break with the IMF, which it said was demanding unacceptable levels of austerity.

Nor was this the first sign that Hungary was having difficulty raising funds. At an auction two weeks previous, even before concerns about the indebtedness of the Eurozone periphery set the forint on a

Just a precaution Admittedly, Hungary had a good start to the year, with strong export demand from the Eurozone bringing about a return to growth in the country after a

"The IMF move was necessary to assure risk-free growth for the country" renewed downward path through the psychological barrier of 300 to the euro, an auction had to be cancelled when no investors were interested in buying at the yield on offer. On November 17, the debt management agency thought better of calling investors' bluff.

painful recession. But as early expectations of continued strong demand from Germany were dashed, growth forecasts have been revised sharply down: in the spring, the European Commission forecast growth well above 2% for 2011 and 2012; in its latest outlook, it expects

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With growing speculation that the credit rating agencies, all three of which rate Hungary at the lowest investment grade rank, were preparing a disastrous downgrade to junk status, the government swallowed its pride and announced, somewhat vaguely, that it had begun discussing a "new type" of cooperation with the IMF in order to, as Economy Minister Gyorgy Matolcsy told Parliament on November 21, "assure risk-free growth for the country."

Whilst the wording of the statement left some analysts cynical that it is a real attempt to reinvigorate cooperation and is merely trying to put off any rating downgrade, analysts say the announcement does represent a starkly different attitude from the government's usual strongly negative attitude to international help.

On November 22, the European Commission confirmed it had received a formal request from Hungary to receive financial assistance from the EU and IMF, whose Managing Director Christine Lagarde also said it has "received a request from the Hungarian authorities for possible financial assistance." Neither put a figure on the amount of this precautionary backstop, though analysts say it is likely to be between €6bn and €12bn.

The Hungarian government is also blustering that it doesn't expect to have any strings attached to this money, but that's unlikely to impress the EU and IMF.

Czechs press nuclear tender button

bne The Czech Republic's giant nuclear tender took an important step forward October 31 when the country's utility CEZ invited the qualified candidates – France's Areva, the Toshiba subsidiary Westinghouse Electric and a RussoCzech consortium led by Atomstroyexport – to submit bids by July 2, 2012, with the winning bidder expected to be announced in late 2013.

In a statement, CEZ said it has provided the bidders with the official documents outlining the parameters of the tender to build two new nuclear units at its 2-gigawatt Temelin nuclear power plant.

CEZ has earlier said the tender, which was first announced in 2009, includes an option for it to order another three more reactors at sites inside and outside the Czech Republic under the same terms and conditions that apply to the one at Temelin, which analysts say could mean the total investment reaches over ¤20bn.

The tender documentation includes the relevant evaluation criteria and the overall bid assessment procedure. "Criteria to evaluate the bids is…

50% centred on technical specifications including safety and licensing, and the remaining 50% include the economics of the offers, namely the price, commercial terms such as guarantees, payment terms or conditions in the supply of nuclear fuel," CEZ said.

With the global economy and nuclear industry in uncertain times, the importance of this tender to the three bidders has been evident by the PR battle being conducted through the press in the lead-up to the announcement.

The previous week, the head of Russian state nuclear holding Rosatom, Sergei Kirienko, was in town for several days, during which he met with journalists and spoke at the Atomex Europe 2011 international forum.

Kirienko was keen to stress how the bid of Atomstroyexport and Gidropress, which are both controlled by Rosatom, and its Czech partner JS Skoda (which is actually owned by Russian engineering firm OMZ) will help over 300 Czech suppliers with billions of crowns in orders.

This is the line the French and the Americans are also keen to stress.

"We are ready to commit to local suppliers – we have identified more than 150 that we can work with, and we are already working with many of them and want to work with them even stronger on this project," said Ruben Lazo, Areva's chief commercial officer, who added that Areva is the only company with a third-generation nuclear reactor design which is already licensed in Europe with two currently under construction in Finland and France.

Westinghouse described a win by the US firm as, "A huge opportunity for Czech companies to participate in manufacture and construction of the plant – based on our 'We Buy Where We Build' philosophy – which could see up to 70% of the project delivered by local Czech firms."

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to realise as many bad assets as possible as it continues its duties as a resolution bank, it's definitely a buyer's market in Latvia at the moment.

Neither one nor the other At present Hipoteku, founded in 1993, is in a curious half-in, half-out position in which it performs commercial operations while also receiving government money and cash from the EU's European Investment Bank to give development loans. The situation has unsurprisingly attracted the attention of the European Commission and the new impetus given to the process may be in part to try to head off an Commission probe into the bank's inner workings that might uncover some nasty secrets.

A buyer's market for Latvian banks Mike Collier in Riga

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nyone on the lookout for Latvian banking assets will soon be spoilt for choice after the confirmation on November 11 that the Latvian government has submitted a plan to the European Commission to sell off the commercial wing of state-owned Hipoteku un Zemes Banka (Mortgage and Land Bank).

"We can confirm that the Ministry of Finance has submitted the sales strategy of Hipoteku un Zemes Banka to the European Commission. We have started to form the advisory committee and... it is planned that the advisory council will be composed of the members from ministries of Finance, Economy, Agriculture, Environmental Protection and Regional Development, the State Treasury, as well as the Association of the Commercial Banks of Latvia, Venture Capital Association of Latvia, Confederation of Employers of Latvia and Latvian Chamber of Commerce and Industry," a finance ministry spokesman tells bne.

The finance ministry – which is the actual owner of the bank – was given until November 15 to put together an advisory board "to coordinate state aid

According to Prime Minister Dombrovskis, two alternative scenarios exist as far as Hipoteku's sale is concerned: the best-case scenario sees the state losing about LVL28m (€32m), whereas the worst-case scenario sees more than LVL110m (€156m) going down the plughole.

Despite local media reports to the contrary, the Commission's local office told bne that no investigation had yet been launched, though annoyance is clearly mounting over delays with divesting the state of its commercial interests.

"What is known is that Hipoteku has some very influential clients" mechanisms." "Since the development bank/institution plays mainly a complementary role and it does not have to compete with other players in the market, the part of the Mortgage Bank which is not directly linked with the performance of development functions, namely the commercial part, will be provided a possibility to develop in the private sector," the ministry said earlier.

With Bank Citadele (the "good" bit of the former Parex bank) already up for sale and the rump Parex bank looking

"The elaboration and implementation of [Hipoteku] restructuring and the sales process of the bank's commercial part is included in the specific conditions of [Latvia's €7.5bn bailout] programme," said a spokesman.

"In the most recent (4th) addendum to Memorandum of Understanding between Latvia and the EU, it is mentioned that transformation plan was finally approved by Cabinet of Ministers on April 12, 2011. It was envisaged that the government will submit to the

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EC a sales strategy for the commercial part of [Hipoteku] by end-June, 2011, so that the actual sales process could start in July and be completed by midDecember 2011," said the Commission spokesman.

The International Monetary Fund – the other major contributor to Latvia's bailout – has also bemoaned the "long delays" and "lack of political consensus" in dealing with Hipoteku.

But according to the finance ministry, negotiations will be launched with potential buyers in order to "start evaluation of their offers by end-2011". The transformation itself "should be finalized by end-2013."

The sales plan – devised by SEB Enskilda, part of the same Swedish banking group that tried to buy Hipoteku in 2006 – envisages selling off the bank's commercial assets in six "packages" containing pre-wrapped delights: the "universal" banking operations, loans to small businesses, loans to big businesses, real estate loans, leasing, and funds.

At end-2010, 59% of the bank's loans were classed as commercial in nature.

The precise reasons for the delays in offloading the bank are unclear, but might be attributed to any or all of a number of curiosities. If ever there was a case of "caveat emptor," it is Hipoteku.

For a start, the state parked its shares in Parex at Hipoteku in 2009 while it decided what to do with them, as part of its dramatic and expensive nationalisation of what was then the second-biggest bank in the land. Ownership was later transferred to the Financial and Capital Markets Commission before Parex was split in two. There have been rumours (but it must be stressed no real evidence) ever since about precisely what happened during Parex's holiday at Hipoteku, mainly concerning whether assets or liabilities of one bank were transferred to the other. The phrase "second Parex" is occasionally whispered in dark corridors when discussing Hipoteku.

Described as "profitable" in official blurb (on the basis of earnings of LVL3m

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during the first 6 months of 2011), the bank actually lost LVL63m in 2010 (even more than in the crisis year of 2009 when it dropped LVL53m). Gross assets declined by LVL158m or 16% last year to stand at LVL808m. During the first six months of 2011, assets shrank by another LVL59m, though the bank did also manage to pay off the last of its syndicated loans to the tune of LVL39m.

Moody's Investors Service puts the bank's long-term foreign deposit currency rating at 'Baa3'.

Such figures may not seem huge by international standards, but in a Latvian context they are significant when the government and its lenders are deadlocked over how to save LVL122m from the 2012 budget. As Bloomberg has perceptively pointed out, the bank's 2010 loss was equivalent to 0.5% of Latvia's total GDP – and that from a bank with market share of less than 4%.

What is known is that Hipoteku has some very influential clients. If Parex became a boutique bank for Russian oligarchs, Hipoteku during the boom years cultivated a different line as the bank of the Latvian political elite. The wife of current Prime Minister Valdis Dombrovskis, the central bank governor Ilmars Rimsevics (who says the sale should not go ahead until market conditions improve) and some of the most notorious mixers of business and politics such as former prime ministers Andris Skele and Valdis Birkavs are either clients or involved via linked companies, with rumours abounding of better-than-market rates charged on loans to the great and the good.

Investors looking for Baltic banking assets should always consider employing the services of a decent due diligence investigator. But perhaps the best evidence that things went a bit wrong in this case lies in the simple fact that despite its name, it is currently impossible for an ordinary Latvian citizen to obtain a mortgage or buy land with money from the Mortgage and Land Bank bank.

"Described as 'profitable' in official blurb, the bank actually lost LVL63m in 2010"

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of their available retail space vacant, while Gdansk, Gdynia and Sopot closed out the list with a 3% score.

BRICKS & MORTAR:

Poland's retail therapy Jaroslaw Adamowski in Warsaw

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oland's retail property market is experiencing a boom, just as the euro crisis threatens to dint Poland's economic growth and consumer confidence.

According to a recent report from Colliers International, a global consultancy, Poland's total retail space is forecast to expand by 550,000 square metres (sqm) in 2011, up 15% from last year, as the sector recovers from a weak 2010. Local developers could complete a further 700,000 sqm of retail space next year, Colliers International predicts in its report. "In the third quarter of 2011, developers added nearly 90,000 square meters of modern retail space to the Polish market, which represents an increase of 47% compared with the same period last year," the report says. By the end of this year, Poland's total retail space is slated to reach 8.6m sqm.

These new retail projects are driving the Polish construction industry,

confirms data from Jones Lang LaSalle, a real estate services and management firm. In the first 10 months of 2011, investments in the segment totalled â‚Ź885m, which represents roughly 49% of the aggregate â‚Ź1.8bn spent on new investments in the office, industrial, retail and hotel construction segments.

But despite the increasing market saturation, Colliers suggests that retail property developers in Poland have little to complain about. In the third quarter of this year, vacant retail space in the country's eight biggest cities rep-

Between January and September, six new shopping centre projects were completed in Poland, adding some 251,900 sqm of retail space to the local market, according to Colliers.

Moreover, analysts say the continuing expansion of US and European brands to Poland is spurring new investments in the retail construction segment.

"Internationally recognised brands such as GAP, Cinnabon and Toys R Us, which are currently opening their first stores in Poland, will very likely increase the attractiveness of many shopping malls," says Anna Radecka, a senior associate at Colliers International's Retail Agency. "But what is most important to potential investors is the general market optimism and the availability of credit to both developers and tenants."

Pricking the bubble That optimism may be soon tested.

In its draft budget for 2012, Poland's Ministry of Finance said the country's GDP will expand by 4% next year, but few expect this to be borne out. "It would be unreasonable to expect this 4% to happen next year," Jan Krzysztof Bielecki, chairman of the economic council to the Polish prime minister, said in an interview with local news channel TVN CNBC. On November 10, the European Commission cut its growth forecasts across Europe, predicting growth in Poland at 2.5% and 2.8% for 2012 and 2013 respectively. "Turbulence in financial markets have begun to weigh on consumer and producer confidence, ultimately limiting private investment

"New retail projects are driving the Polish construction industry" resented only 1.8% of the total, it said.

Warsaw and Szczecin outranked all other Polish cities, with less than 1%

expenditure, employment growth and the expansion of private consumption," the Commission said.

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"Even if consumer spending will drop in 2012, the store chains which were skilful in negotiating long-term leases will most likely manage to keep all their retail surface."

Banks too are reducing their growth forecasts, with Swiss banking giant UBS recently downgrading its forecast from 3.3% to 2.9% in 2012. This still exceeds the estimates for the Czech Republic at 1%, and Hungary at a mere 0.5%, but further financial turmoil in the Eurozone could signal another round of growth downgrades in the CEE region.

This could spell trouble for retailers. "A scenario with a weaker consumption outlook and a further tightening of the belt by Poland could have an impact on the retailers' revenues," admits Malgorzata Kobziakowska, an associate at Colliers International's Retail Agency.

"But most of them have learned their lesson from the first phase of the downturn in the years 2009 to 2010, which is reflected in the improved strategies of lease negotiations," she says. "Even if consumer spending will drop in 2012, the store chains which were skilful in negotiating long-term leases will most likely manage to keep all their retail surface."

To date, consumer spending in Poland has not taken a hit from the turmoil in the Eurozone. In the third quarter of 2011, Polish retail sales were up 7.1% over the same period a year earlier, according to figures from the Central Statistical Office (GUS).

Local analysts believe the Polish market is in better shape than most other retail property markets in the region.

"When comparing Poland to the Czech Republic and Hungary, we have to keep in mind that the Polish market has a total retail space of 8.6m sqm, while the Czech market has 3m sqm and the Hungarian only 1.3m sqm, but also that this market is much more diversified in Poland," explains Radecka. "The results of our analysis show that the market situation in Poland is stable, developers launch new projects and new store chains are lining up to expand their businesses here."

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A banker torn by greed A former Czech National Bank (CNB) employee has been charged with fraud after a scam over torn bank notes was uncovered, according to the Prague Post.

A recent shift in Czech central bank policy enables holders of damaged crown notes to more easily replace the money. The new rule allows any damaged note containing more than 50% of the original to be exchanged at any commercial bank for a new note of the full value. In the past, holders would only receive a fraction of the value of the bank note corresponding with the percentage of the note they held, and banks would often limit how much damaged money could be exchanged, or even charge a fee.

Ahead of this rule change, this enterprising (and unnamed) employee got a gang together and tore CZK440,000 (¤17,600) worth of bank notes before the law changed, then exchanged the smaller parts of the torn notes for their percentage worth.

After the law changed, members of the group then also returned the remaining portion of the bank notes for the original's full face value, profiting about 125% on each bank note, or CZK110,000.

If found guilty of fraud, the gang's ringleader faces up to one year in prison.

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Stock Exchange in April 2005 saw their investment before the 2008 financial crisis reach a peak of PLN158 (€36), up almost 560% from the issue price of PLN24 and giving the company a market capitalisation of PLN3.3bn (€760m). Though the shares are now trading around PLN70, they have never fallen below their IPO price – not bad for a company that is, in McGovern's words, "in the disposable income business" at a time when household budgets are being squeezed. "Still, we're the last one into problems, and the first one out."

No rest for AmRest as it looks to expand into BRICS Nicholas Watson in Prague

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mRest Holdings is an archetypal Central and Eastern European company. Forged in the postcommunist fires by a young American abroad, this restaurant operator that brought pizza, burgers and fried chicken to western-starved eastern Europeans has outgrown its region and is now turning its attention to the fast growing BRIC markets.

AmRest – which at the end of 2010 had 360 outlets of KFC, Pizza Hut, Burger King, Applebee's and Starbucks spread across six CEE markets, including Russia – is now looking to expand into India and Brazil over the next 12 months, the company's founder and chairman of the board, Henry McGovern, tells bne.

"Of course, we'd also like to be in China.

Our shareholders would like us to be

there, and so I expect us to do it, but it's too early to say where, when or how," says McGovern, an affable, causally dressed American with an appetite for the restaurant business that shows no

"Of course, we'd also like to be in China" sign of abating, even though AmRest's success would allow him to give it all up anytime.

Those shareholders are likely to trust management's instincts. Investors prescient enough to buy into the company when it listed on the Warsaw

Convergence at the dinner table At its most basic, AmRest is a leveraged play on the growth of the middle class in CEE, who are expected to flock in increasing numbers to its "quick service and casual dining restaurants." And despite the global crisis of 2008 and now the sovereign debt crisis in the Eurozone, that's just what they have continued doing.

In the first half of 2011, AmRest reported a net profit of PLN24.8m, compared with PLN23.9 m in the yearearlier period, while cash flow (Ebitda) was 55% higher at PLN62.4m. That followed a profit in 2010 of PLN2.8m, a turnaround from the loss of PLN4.1m the previous year.

AmRest attributes the business' ability to hold up well in difficult times to its diversification across not only geographical lines, but also across business lines (though McGovern admits it's hard to get all four divisions – CEE , Russia and new markets, the La Tagliatella chain, and the US – moving at the same time). In addition, he says the company grew up in emerging markets, so is used to the wild swings that are part and parcel of operating in this part of the world.

The recent half of the year, for example, was boosted by strong KFC and Pizza Hut sales in Russia, while it added PLN74m to its top line by consolidating sales from of its new Spanish division of 105 Italian casual dining restaurants under the La Tagliatella brand as well as 30 KFCs, which it acquired through its

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purchase of Restauravia Grupo Empresarial for around €200m in April.

While businesses all around it retrench and hunker down as the debt crisis takes its toll, AmRest has opened 48 new restaurants so far this year (35 in CEE) and plans to have a total of 80 new outlets by the end of this year. "The way we structured the business is as a multi-brand business and so we are quite comfortable with segmented mar-

"We're the last one into problems, and the first one out"

kets," says McGovern. "We have scale, points of attack, good industry margins and lots of cash flow – we see a lot of opportunity today."

Many of those opportunities are in the large, fast-growing emerging markets, and it's the company's geographical diversification that will allow it to efficiently access these new markets.

McGovern says it would be hard to run a business in Brazil out of its headquarters in the provincial Polish town of Wrocław, so it will do so from its Atlanta regional HQ in the US. Likewise, the Indian operations will be run out of its Spanish office. McGovern won't say which restaurant chains AmRest is looking to open up in these new markets, but its US business is Applebee's, while its Spanish business is La Tagliatella and KFC (and KFC already exists in India).

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

Central Europe

Franchising in the time of crisis

Jacy Meyer in Prague With a euro collapse and recession looming, entrepreneurs are treading carefully. Starting a new business seems reckless and even expanding might be a bit foolhardy. Franchising, however, is one option that, at least in the Czech Republic, has weathered the economic storm and shows excellent potential.

"Franchises, at this time, are a good formula for success; it is low-risk, highly profitable and offers quick success," says Dr Jaroslav Tamchyna, managing partner of the Czech Franchise Institute (CFI). "We saw more interest in franchising during the economic crisis; entrepreneurs wanted more clients and money, but less risk."

Tamchyna adds that franchisees have five or six times less risk than individual business owners; after five years, only 15% of new independent businesses are still operating compared with 92% of franchises.

Tamchyna believes the Czech market is a good one for franchises for a number of reasons, including a business-oriented population who not only are interested in owning businesses, but like the idea of a "proven concept."

There are no barriers to franchises legally, and in fact the CFI is attempting to insert a small article in the Czech business code stating that franchisors must provide full disclosure documents to their potential franchisees. They are also trying to get banks to offer special financing for franchises and the government to support small business through franchising, offering bank guarantees and access to EU funds. "There are really no obstacles, especially acquiring a brand which is established in EU. But let me just say this – the Czech Republic as a country definitively does not support small business," says Jana Mařicová, co-owner of Selective, which operates the franchise Crabtree & Evelyn in the Czech Republic.

Dan Benton, director of International Development for the Global Franchise Group (GFG), who is looking for master licensees for three of their brands – Pretzelmaker, Great American Cookies and Marble Slab Creamery – believes the Czech Republic, and Central and Eastern Europe as a whole, offer conditions right for his brands. "The CEE nations in general and the Czech Republic specifically have a growing middle-class consumer population," he says.

Franchising isn't a solely imported enterprise. Tamchyna points out the first Czech franchise after the revolution was AAA Radio Taxi. Since then, other companies have used the model, often to grow their business. "The franchise model is a perfect expansion model," he says. "For example, one year ago UniCredit Bank began a pilot franchise project and now there are 20 new UniCredit franchise branches in the Czech Republic."

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Lithuania polishes family silver Mike Collier in Riga

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t should probably come as no surprise that in a topsy-turvy world in which global capitalism is rescued by means of wholesale nationalisations, one of Europe's more open economies is planning to show just how dynamic and business-oriented it is by deciding not to privatise its inefficient state-owned enterprises (SOEs).

Despite ranking 27th out of 183 countries in the World Bank's latest "Doing Business" report (and 9th in the EU having overtaken Belgium, France, Portugal, the Netherlands and Austria), Lithuania has scotched hopes of any imminent IPOs or strategic sales of state assets. Instead, the Lithuanian government of Andrius Kubilius has unveiled plans to streamline and modernise the SOEs in an effort to make them contribute greater revenues to state coffers and help bring the budget deficit down to 2.8% of GDP. If successful, the move could even prompt other post-Soviet states with key industries in state hands to keep their "for sale" signs firmly locked in the garage while they instead start polishing the family silver.

Economy Minister Rimantas Zylius tells bne that the SOE shake-up came from a July 2010 review of state-owned assets. Remarkably, it was the first such review of its kind: the first time a comprehensive list of assets had been drawn up since Lithuania regained its independence in 1991. "It revealed that the national government owns around €5bn of commercial assets, which provided extremely low returns and income to the budget," Zylius says, adding that in 2010 these companies paid just LTL42m (€12.2m) to the budget.

"The government considered that better management of state-owned enterprises was possible as a third measure

for fiscal balance – besides the alreadyimplemented measures of austerity and tax rises. The potential of getting returns from SOEs seems very attractive, as SOE reform does not inhibit the economy in the way that both austerity and tax rises do. Also, it looked rather more efficient than trying to privatise these companies during an economic slowdown," he reasons.

Modest expectations If Lithuania's move seems strangely familiar, it's not surprising as Zylius freely admits that it is based on Organisation for Economic Co-operation and Development corporate governance principles and "Norwegian, Swedish and Israeli models."

Following its economic crisis of the early 1990s, Sweden embarked on its own renovation programme to inject

From the LTL42m (€12m) in dividends in 2010, the government expects this amount to double to LTL86m this year and in 2012 to soar as high as LTL540m.

"We have learned that the major element for success in securing considerable dividends for 2012 is the fact that the government has the capability and expertise to analyse SOEs," says Zylius.

"Experts in the ministry of economy, with backgrounds in investment banking and private equity, have established professional relationships with the managers of SOEs. Now the managers know and understand that they cannot play with figures. Thus, they are more honest when talking about the potential contribution to the state budget."

That all makes it sound as if the major reform was telling managers they wouldn't be able to get away with cooking the books any more rather than universal application of idealistic principles involving improved transparency, "setting ambitious and unequivocal targets" and separating commercial and non-commerical activities.

There is also probably a political element to the government's strategy for the SOEs. Despite the success of companies that have been privatised (most notably

"Now the managers know and understand that they cannot play with figures" some dynamism into its SOEs and has reaped the benefits: in 2010, the 60 largest state-owned companies contributed more than €4bn in dividends to the economy, equivalent to around half the total budget surplus.

telecommunications company TEO), with a general election due in 2012 the sight of state assets being sold off by Kubilius' centre-right government would make an easy target for opposition Social Democrats and the populist parties.

The expectations for Lithuania are more modest, but still ambitious and already showing results. "Lithuania's strategy is still under implementation, however the first results show that significant returns from state-owned enterprises are achievable within a 12-18 months' time frame," says Zylius.

And Zylius insists that the SOE revamp is long-term rather than a holding strategy to increase asset value ahead of some future sale. "Reforms of SOEs take a long time to implement fully, so the initiative is targeted for the long run.

The reform is not aimed at privatisation of SOEs, it is aimed to ensure that SOEs are governed professionally," he says.

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Gassing up Europe David O'Byrne in Istanbul

A

t first glance, a new gas deal between two countries on the south-east fringes of Europe should have little bearing on the energy security of the continent as a whole.

However, a deal struck between Turkey and Azerbaijan could well lay the foundations for the energy security of the EU for some decades to come.

Briefly, the deal signed at the end of October commits Azerbaijan to send 16bn cubic metres a year (cm/yr) of gas from the second phase of development of its Shah Deniz gasfield to Turkey, from where it can be exported to European market. Crucially, it includes a commitment on the part of Turkey and Azerbaijan to ensure that the gas reaches European markets by 2018 even if the companies and consortia that are

backing three rival pipeline projects vying to carry the Azeri gas to Europe fail to finalise their plans. Indeed, on November 2 newswires reported that Boru Hatlari Ile Petrol Tasima, an Istanbul-based government pipeline company, and Azerbaijan's state energy company Socar will set up a space that will look into building a pipeline across Turkey. "With this agreement,

all obstacles to transiting the gas have been removed," said Turkish Energy Minister Taner Yildiz, announcing the deal. "If they [the pipeline consortia] are unable to reach an agreement on this issue, then Turkey will take steps to ensure it happens."

That's quite a commitment, given that for much of the past decade Turkey has

"The southern gas corridor is a pipeline route through Turkey for gas coming from the ample reserves of the Caspian region, Iran and the Middle east, which would offer competition to Russia"

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been accused of dragging its feet over facilitating agreements that would help realise the EU's own pet pipeline project, Nabucco, which is the largest of the three planned pipelines vying to take this Azeri gas into the heart of Europe.

Nabucco has long been a major part of the EU's plans to create a "southern gas corridor" into Europe to help diversify its gas supplies. With its own gas reserves rapidly depleting, the EU is already dependent on imports from outside the union to meet 60% of its gas needs. Currently, those imports arrive both as liquefied natural gas (LNG) and by pipeline from three sources – Norway, North Africa and Russia. The largest supplier by far is Russia, which already supplies about 25% of all the EU's gas needs, a figure expected to grow to as much as 40% over the coming decades. This is a worrying prospect, given that gas production in Russia is overwhelmingly dominated by the state-controlled Gazprom – a company which just announced profits for the first half of 2011 up 56% on year to $25bn.

Hence the EU plans for the southern gas corridor – a pipeline route through Turkey for gas from the ample reserves of the Caspian region, Iran and the Middle east, which would offer competition to Russia, and a route which could be expanded as new Caspian and Middle East gasfields come on stream.

"The new agreement with Turkey makes it easier for the Shah Deniz consortium to supply its gas to either ITGI or TAP"

And hence too the importance of the commitment by Turkey to deliver this Azeri gas to Europe, even if the three commercial consortia planning to carry the gas fail to finalise their plans.

Whether or not that promise will need to be realised won't become clear until after the BP-led consortium developing the Shah Deniz field has announced its decision on which of the three it will offer the gas to.

And then there were three Of the three planned pipeline projects, the most ambitious is Nabucco – a planned 2,000-km pipeline from eastern Turkey to Austria, expected to cost an eye-watering $12bn-15bn.

With a planned capacity of 31bn cm/

yr, Nabucco, which is sponsored by a consortium of gas companies led by Austria's OMV, will also need to find other sources of gas to be economically viable.

Its rivals are two projects aiming to use Turkey's existing east-west transit lines to carry gas to Greece, from where new pipelines will carry the gas across the Adriatic to Italy, and from there via Italy's existing backbone to markets across the continent. These will thus be far cheaper than building a whole new line like Nabucco.

Sponsored by Italy's Edison and Greek state gas company Depa, the Interconnector Turkey-Greece-Italy (ITGI) line aims to carry just 8bn cm/yr of Azeri gas and promotes itself as a cheap and simple option. But with Greece in economic turmoil and Depa in line for privatisation, few now believe the project can go ahead. The rival TransAdriatic Pipeline (TAP) project aims to start with the 10bn cm/yr of Azeri gas on offer and add up to 10 bn cm/yr of other gas later – an option its backers Statoil, EGL and E.On believe gives it greater flexibility than its rivals.

Now with the new agreement between Turkey and Azerbaijan in place, the final step is for the consortium developing the Shah Deniz gasfield – which consists of BP, Total, Lukoil, Eni and National Iranian Oil Company, in addition to Socar and Turkey's state-owned TAPO – to choose which pipeline to supply with gas. That decision is expected early in 2012, with few clues available as to which will be chosen.

"The new agreement allows for the gas to be transited through Turkey, and sold on exit," explains John Roberts, Caspian analyst at Platts, explaining that while previously Nabucco had been favourite to get the gas, the new agreement with Turkey makes it easier for the Shah Deniz consortium to supply its gas to either ITGI or TAP. Whichever route is chosen, European gas consumers, who are this winter facing gas price hikes of up to 30%, will be hoping the new line comes on stream sooner rather than later.

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INTERVIEW:

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Still westward bound

David O'Byrne in Istanbul

I

f there is one question that always comes to mind when looking into the arcane details surrounding Turkey's torturous EU accession process, it's "Why do they bother?"

If the statements of some of Europe's leading politicians are to be believed, Turkey either has no place in the EU (Sarkozy) or should be entitled to only a restricted form of membership (Merkel).

But the good news for both Turkey and the EU is that the current Turkish government remains committed to a process first started back in 1959. "Even in the worst time in our history, when our empire was fracturing, we were known as 'the sick man of Europe', never 'the sick man of Asia'," jokes Turkish Minister for European Union Affairs and Chief Negotiator Egemen Bagis.

But Bagis has a serious point – why, he asks, should Turkey be any less European now, when it boasts the fastest growing economy in Europe and is the envy of a continent locked in fearful deadlock over the future of the ill-fated single currency.

It's a good question, but one which also begs the question of why further integrate the healthy Turkish economy with those of its ailing neighbours. "The EU has its problems, but it remains the most prosperous group of countries in the world," Bagis says.

He also stresses that Turkey's commitment is not purely economic. "For us, the EU is the grandest peace project in the history of mankind... The message

Egemen Bagis

[of Turkey's membership] is bigger than either Europe or Turkey," he says, pointing out that Turkey's commitment to secular democracy is already setting an example for the newly emerging democracies in north Africa and that Turkey's EU accession could offer a positive example to states the world over which feel marginalised by the West.

In addition to the rhetoric, Bagis also offers a hard-headed assessment of just how important Turkey stands to be to a union already dependent on imports for the bulk of its energy needs. "70% of the energy resources the EU needs are to the east, south or north of Turkey," he says, pointing out that Turkey has long been

could be opened within a few months, were it not for political opposition from within the EU. Island affairs Much of that opposition stems from Turkey's refusal to normalise bilateral relations with Cyprus – a problem highlighted in the EU's recently published annual progress report on Turkey's accession progress. Turkey justifies its position on the grounds that the EU refuses to allow direct trade and transport links with the Turkish Republic of North Cyprus (TRNC), which occupies the northern third of the island and is recognised only

by Turkey. The irony, explains Bagis, is that there is one EU state that does allow

"Even in the worst time in our history, when our empire was fracturing, we were known as 'the sick man of Europe', never 'the sick man of Asia'" a member of the consortium developing the Nabucco pipeline project, which aims to break the growing stranglehold that Russia has over gas supplies to the EU by opening up a new transit route through Turkey.

direct trade and transport links with the TRNC, and that's the Republic of Cyprus itself. "Greek Cypriots can travel back and forth and trade with the north, but they won't allow other EU states to do the same," he points out.

It's ironic, therefore, that Turkey is unable to open the energy chapter of its EU accession process thanks to the opposition of Cyprus - an island isolated from European energy networks. That chapter is one of six that Bagis explains

Negotiations on reuniting the two halves of the divided island are continuing under the shadow of the Turkish threat to freeze relations with the EU during the six months from next July that Cyprus will hold the rotating EU

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presidency, unless a settlement can be reached beforehand. "We are working hard to see that a settlement is reached and that we can open five more chapters during the Greek presidency," says Bagis.

"If I was a Greek Cypriot, I would be working hard to ensure that Turkey's EU membership goes ahead," he adds, explaining that Cyprus' proximity to Turkey makes good relations between the two not just a guarantee of peace and cooperation, but also given the health of the Turkish economy an economic imperative.

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"If I was a Greek Cypriot, I would be working hard to ensure that Turkey's EU membership goes ahead" That export-driven economic success would appear to be Turkey's big advantage. But critics point out that increasingly Turkey's exports are targeted at the Middle East and question whether the country is headed in the right direction. "Around 50% of our trade is with Europe and 92% of our FDI comes from EU states," explains

Bagis. "Just because we're reaching out for new markets doesn't mean we have abandoned our target of 52 years."

Clive Rumbold of the EU Delegation to Albania says Brussels sees huge potential for Albania's development and is helping with measures to protect the environment as development unfolds, but also warns that Albania "needs to pay strict attention to protecting its natural beauty."

ment that the tourism sector can boost investment, GDP and employment.

Prime Minister Dr Sali Berisha tells bne that the government is aware of the balance needed, and is rolling out master plans for the entire coast. "The plan for the south of the country, done in cooperation with the World Bank, is complete," he claims. "There have been bad mistakes in the past, but we will not allow any more."

Aldo Bumci, minister of tourism and culture, points out that further investment has been made in upgrading and extending the utilities networks in regions with tourism potential, all of which helped boost visitor numbers by 20% in 2010, he says.

Tim Gosling in Tirana

B

lighted by over-enthusiastic tourism development, Europe's Mediterranean coast today has just one virgin territory left on it. The secret of Albania's Adriatic coast is about to come out, but industry figures insist that the government needs to do more to encourage development – and also to make sure it's the right kind.

In early November, travel guide publisher Frommers followed Lonely Planet in nominating Albania as its top destination for 2012, extolling the country's unspoilt coast, mountain ranges, historical offerings (three Unesco sites), cuisine and hospitality, all of which come at rock bottom prices for Europe. This has encouraged excitement in the govern-

campaign launched, say industry players; on the other, development needs to be controlled to avoid destroying the country's potential. A quick visit to Durres beach in central Albania – crowded with erratic development just metres from the shoreline – or the southern town of Saranda reveals the "two big mistakes" in Albania thus far, as Muhle calls them.

"Despite the current difficulties, we still believe the European Union has the right formula, and is the right place for Turkey."

It's no surprise to the state, which has raised spending on infrastructure dramatically over the last few years to create a backbone to develop the industry.

Roads have led the way, with investment peaking at $1.2bn in 2008, compared with around eight times less in 2004.

The sun rises on Albanian tourism

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The minister claims that the large role of the grey economy in the sector makes it difficult to put an exact figure on tourism's overall contribution to the country, estimating it at 10-15% of GDP currently.

Many in the industry, such as Volker Muhle, head of Lufthansa for Albania and Kosovo, suggest it has the potential to constitute 30% of the economy within the next decade. They stress, however, that depends on a comprehensive strategy from the government, a component that Roger Cherubini, general manager for Sheraton Hotels & Resorts in Albania, agrees is missing.

A question of balance On the one hand, investors need to be encouraged and a concerted branding

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I 39

Romanian holiday

Kester Eddy in Budapest For any budding foreign investor in Romanian tourism, browsing the official ministry website (www.turism.gov.ro/en/turism/promovare-turistica) is a frustrating exercise.

Sure, the site is clean and uncluttered, with English language pages. Sure, there are seven sections labelled promotion, development, privatisation, etc. But six of the sections are blank, while the seventh, as a click on 'Tourism Strategy' will quickly reveal, contains part 1 of the National Tourism Development Master Plan, a detailed, 163-page document laying out government aspirations until 2026 – in Romanian.

As the figures show, the practical barriers to investing in the sector might be similarly discouraging.

Foreign investment into Romanian hotels and restaurants averaged just ¤37m a year between 2005 and 2009; much smaller than Bulgaria, which pulled in ¤90m in each of those same five years, according to a report just issued by BCR, Romania's largest commercial bank.

If the sector were delivering, the lack of foreign direct investment (FDI) would matter little. But as the report notes, Romania, where the tourism potential is "one of the highest in the region," performs miserably on almost every indicator.

Bumci backs up the claims, pointing out that permitting authorities across the south of the country have been reformed, and that the government knows its responsibilities. "We shouldn't expect self-restraint from private business," he says.

From 2006 to 2010, Romania averaged just 1.4m tourist arrivals per year – less than half the number in neighbouring Hungary – and who stayed on average just 2.2 nights, compared with an average of 5.2 nights in Bulgaria. As a result, and most critically, the average spend of foreigners was just ¤360 per arrival, compared with ¤390 in Bulgaria, ¤460 in Poland and ¤570 in Austria.

The lay of the land At the same time, Albania needs to attract investors to help develop its potential, with a severe lack of high quality hotels and other development limiting access for visitors attracted by the unspoilt coast and unknown qualities of the Albanian Riviera.

With a mere 13-14% holding degrees, employees in the tourism sector in Romania have the lowest education profile among their regional peers, but top the charts when it comes to permanent employees, at 95%; in peer countries the ratio of self-employed is around 15%. "Tourism in Romania makes up just 1.8% of GDP, compared with 4.1% in Austria. Clearly more FDI would result in higher quality services, more jobs and more foreign tourists. Compared to Bulgaria, where conditions on the [Black Sea] coast are very similar, Romania [should be] much better positioned in terms of natural landscape, such as mountains and the Danube Delta," says Lucian Anghel, chief economist at BCR.

A major sticking point is that of property rights, with much privately held land claimed by opposing parties due to a messy privatisation process after the fall of the communism in 1991. The issue hit the headlines in 2009, when tourism giant Club Med announced it was halting a €75m resort development near Saranda after five years of fighting protests from local villagers claiming ownership of the land. That

Attracting foreign investors requires a little more than beaches, mountains and a banking sector able to process payments, however. As Anghel himself admits, Romanian inheritance laws – which allow descendants of former owners to lay claim to real estate after privatisation by the state to new owners – have bedevilled and undermined the sale of many potential tourist developments. "My personal opinion is that Romania should spruce up legislation to attract foreign investors; cases of descendants [appearing after the sale] are not the fault of the descendants, but the years-long procrastinating on the property repossessions by the justice system," Anghel said.

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was just before a Tirana court threw out the claims, and Bumci asserts that the project has now restarted.

Rumbold says the property rights issue, alongside weaknesses in the judiciary, is undeniably holding back foreign direct investment (FDI), adding that "given the potential, it might seem surprising that there has not been more development."

Both Bumci and the prime minister point out that plenty of state-owned land is available – often at €1 per square metre for major investors – and also that the parliament passed legislation last year offering guarantees to investors should they hit such a problem.

Enida Guria, CEO of the Albanian Investment Development Agency, is

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under no illusions over the importance of tourism for FDI in Albania. "We have two large investments on the drawing board currently, one for €500m and one for €1.2bn [a huge resort named Gose Island in central Albania], and they're both in tourism," she points out.

Rebranding Albania Industry figures and some officials respond by insisting that the government also needs to do more to spread the message. They claim that they are left to shoulder the burden for transforming Albania's reputation as a den of criminality and human trafficking to an idyllic tourist destination. Off the record, one official told a story of a recent meeting with a well-known spin doctor from the UK who explained:

"Albania doesn't have an international image; therefore it has a bad image."

Bumci, who says that the national strategy has changed entirely in the last six years to bring a new focus on tourism, appears to accept that more needs to be done "to tell the wider public in Europe," but suggests that resources are scarce at his ministry. "We need to select specific targets carefully," he says. "The likes of Italy, which is close, and Germany, which has a lot of big spending tourists. When the infrastructure needs are met, then we should be able to divert funds to promotion."

Nearly every scrap of land was used under the brutal Ceausescu regime, but since that collapsed in 1989 at least a quarter of the country's 12.5m hectares of arable soil have fallen derelict – some say more – while much of it is now in the hands of property speculators. Were this to be reversed, Romania's arable land area would match that of Poland and Spain, or about two-thirds of that of Europe's farming powerhouse, France.

But putting derelict land back under the plough is a formidable task. "Much of it is in a poor state, over-run with weeds and some is now turning to scrub," says farming consultant Stuart Meikle, a 48-year-old Brit based in Brasov, Transylvania. "It would be a massive investment to reclaim it. It will take more than a simple mowing or ploughing."

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O

n paper, Romania should be able to produce enough food to feed its 21m population four times over. In reality, it only produces enough to feed half of them.

While employing a quarter of workers,

agriculture generated just 6% of GDP last year, half the contribution it made in 2004. Over the long term, around 5%, twice the EU average, would be about the right level, reckons Lucian Anghel, chief economist at BCR bank.

But at the same time, the number of

driven with no regard for land being the foundation of an agri-food industry," says Meikle.

Irrigation and drainage systems, which often depend on the cooperation of land owners to keep them operating, have fallen into disrepair. "Multiple owners have to agree on investing or maintaining this infrastructure. It has not hap-

The plots thicken What remains are largely subsistence smallholdings. Post-communist governments returned land to the descendants of those from whom it was seized. This was popular, but led to fragmentation, eliminating economies of scale and diluting farming expertise. "It was politically

Southeast Europe

go before the problem of fragmentation is overcome. Together, the land area of large, commercial-scale farms accounts for less than 10% of farmland. "There is a lot of room to improve that share," Anghel says.

Farmers also need to learn to cut costs by working together. Anghel admits that is tough for Romanians who come

"What would just be a normal farm elsewhere in the EU is seen as a major success" pened and probably will not happen," says Meikle. Only around 3% of land is irrigated or drained as well as it was 20 years ago.

people working in the sector should be cut in half and output would need to stop falling so fast.

Down on the Romanian farm

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"Progress needs investment," says Meikle, "and investment needs consolidated and controlled areas of land." The farms as they are, are too small to supply the large volumes needed by the recent influx of supermarkets, which largely stock imported food. There are very few success stories, "What would just be a normal farm elsewhere in the EU is seen as a major success."

A fiendishly complex system of grants set up a decade ago has also failed to reach farmers. Consequently, machinery and buildings are almost completely dilapidated. A simpler grant system like that of post-war Britain and Holland is needed, where a simple application procedure was backed up by a regime of rigorous on site inspection.

The paperwork associated with purchasing land is also prohibitively high, which discourages land consolidation.

In some cases, the cost of paperwork can exceed the price being paid for the land itself. Banks, for the most part, have little interest in the sector. Higher taxes on uncultivated land could help get the market moving, BCR's Anghel says. A few big players have started to buy up Romanian land, among them foreign investors from Italy, the UK and Arab states. But there is a long way to

from the communist era and its forced collective system to accept, but says farmers need to overcome those negative associations and band together to gain critical mass. Otherwise, he argues, "It's very difficult to invest in fertilisers, tractors and so forth."

At the same time, there is little political appetite to turn the sector round. Even the Agriculture Minister Valeriu Tamaru says the decline in agriculture's economic importance is a positive sign that Romania is moving away from an inherently risky sector. Meikle begs to differ.

"If the agri-food industries were working as they should, they would be the driver of the overall economy." Anghel agrees:

"If the agri-food industries were working as they should, they would be the driver of the overall economy" "We should come back to base and the base is agriculture."

However, there's little chance of any immediate conversion to this point of view. In the run-up to elections next year, a politician mentioning agricultural reform would jeopardise his or her chances of winning the votes of the roughly 2m agricultural workers.

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its diplomatic support over Kosovo, it is "cracking under the pressure of western diplomats urging Tadic to align with EU and Nato policies through the creeping recognition of Kosovo and behind-thescenes moves to get closer to Nato".

"Such moves," he asserts, "were skilfully created to break close relations between Belgrade and Moscow."

Russia in Serbia – out from the cold or feeling the heat?

www.srpska.ru

Ian Bancroft in Belgrade

R

ussia's ambassador to Serbia, Aleksandr Konuzin, has for the second time in recent months courted controversy over public remarks unbefitting a diplomat. As Serbia heads towards general elections in spring next year, Konuzin's remarks have simultaneously exposed both the unease of political parties about Russian influence, and Russia's own sense of frustration about the nature of its relations with Serbia.

Back in early October during the inaugural Belgrade Security Forum – which deliberately avoided debating a Nato-led peacekeeping force's recent actions in support of the installation of Kosovo customs officials in the (Serb-dominated) north of the country – Konuzin took to the floor to ask, "are there no Serbs in this room?", before proclaiming that "there is nobody defending Serbia's interests" – except, of course, Russia.

Then there was Konuzin's active participation in a recent rally by the opposition

Serbian Progressive Party (SNS) in Nis, which has led to accusations that the ambassador is interfering in Serbia's internal affairs, with the League of Social Democrats of Vojvodina (LSV) calling for Konuzin to be declared per-

Progressive vs reactionary The forceful reaction to Konuzin from the country's more liberal elements highlights some of the tensions that will define next year's elections, particularly efforts to frame the vote in terms of "modern", "progressive" forces, versus those of "traditional", "reactionary" Russia. Such dichotomies are, however, illsuited to Serbia's fragmented and fluid political party system.

The two main opposition parties and potential coalition partners – the SNS, which has already successfully wooed Brussels, and the Democratic Party of Serbia (DSS) – have, according to Mitic, both signed "documents on strategic cooperation with [Prime Minister Vladimir Putin's] United Russia" party and have "never had better relations with Moscow."

Foreign embassies and foundations have long-sought to influence electoral politics in Serbia – from the direct and indirect funding of certain parties,

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Southeast Europe

But after being largely sidelined since the turn of the millennium, Russia has recently adopted a more assertive stance towards the region – and Serbia, in particular – one that can be traced back to President Dmitry Medvedev's visit to Belgrade in October 2009. As Professor Aleksandar Fatic, director of the Centre for Security Studies in Belgrade, asserts: "Moscow's decision to build South Stream [gas pipeline] through Serbia reflects the long-term strategy to maintain European dependence on Russian energy."

Longer term, Russia's interests in the Balkans can be partly linked to its own domestic security concerns. "Were Serbia's section of the South Steam pipeline to be guarded by the Russian Army, then it would demonstrate how serious Russia is about countering Nato in the Balkans," says Fatic. "Don't forget, it is in Russia's vital interest to prevent a future expansion of Nato, and Serbia is the only Balkan country that still hesitates over Nato membership… It is therefore certainly a strategic marriage of convenience."

Though Serbia has not, in Fatic's opinion, always had a consistently favourable attitude to Russian investment and strategic interests, as demonstrated by Belgrade's reluctance to sell control of its oil company Nis to Gazprom, changes appear to be afoot. As Mitic notes: "Economic cooperation between Belgrade and Moscow is gaining ground – Serbian exports to Russia have increased more than 40% in a year as companies finally start to exploit the Free Trade Agreement with Russia."

In mid-October, Russia's minister for emergency situations, Sergei Shoigu – alongside Serbia's interior and foreign ministers, Ivica Dacic and Vuk Jeremic – opened a regional humanitarian centre in Nis, in south Serbia. Though its stated purpose is primarily to provide responses to natural disasters, this hasn't prevented rumours about its potential use as a military base. Indeed, Fatic even raises the prospect of Russian missiles one day being positioned on Serbian soil.

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

"Are there no Serbs in this room? There is nobody defending Serbia's interests – except, of course, Russia." sona non grata and Serbia's president, Boris Tadic, criticising his actions.

Konuzin's remarks highlight the tightrope that Serbia is being forced to walk. As Aleksandar Mitic, chairman of the Center for Strategic Alternatives in Belgrade, explains to bne, though the current pro-western government wants good relations with Moscow because of

to the calculated timing of specific advancements towards the EU, such as the signing of the Stabilization and Association Agreement (SAA) just prior to the last elections, which was designed to boost the pro-Europe coalition. Such influence, however, tends to be more subtle and refined than Konuzin's very public approach.

Whether this "marriage of convenience" proves fleeting or fulfilling will in many ways depend upon Serbia's European course. With Euro-scepticism on the rise and Serbia's potential membership a good decade off – especially because of profound differences over Kosovo – Russia has an important window of opportunity to assert its influence. Trade, energy – particularly the construction of South Steam – and security co-operation will be pivotal in this regard.

Given Belgrade's recent unreliability, however, the Serb part of neighbouring Bosnia-Herzegovina, Republika Srpska – through which a section of South Stream is expected to run – will continue to be on the receiving end of Russia's affectionate glances. As such, Russian influence in the Balkans shows few signs of fading.

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In nearby Atyrau, the centre of Kazakhstan’s oil and gas industry, police shot dead a man they believed was planning to commit terrorist acts on August 30.

Kazakhstani officials initially denied that the country was being targeted by terrorists, and have played down the risk of extremism, blaming organised criminals rather than religious groups.

However, as the attacks become more deadly, it has become clear that Kazakhstan is under threat from militants. On October 31, two bombs exploded in Atyrau, the first near the regional government headquarters, and the second outside the general prosecutors office. One man, who is believed to have been the perpetrator, was killed in the second blast.

Anna Walker, analyst at Control Risks Group, tells bne that the government had been “caught on the back foot” by the earlier attacks and was reacting rather than coming up with a coherent strategy. International oil and gas companies operating in west Kazakhstan have stepped up their security measures.

Terror on the Steppe Clare Nuttall In Alamty

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azakhstan is in a state of shock after a gunman, said by security forces to be a “Jihadist”, killed seven people then blew himself up in the southern city of Taraz in November.

The scale of the attack was unprecedented in a country that has maintained good relations between its many religious groups, though recent months have seen an escalating series of bombings and shootouts in west Kazakhstan, leaving the entire country now on high alert.

On the morning of November 12, a man identified by police as “M K Kariyev”, shot dead two members of Kazakhstan’s security forces who were following him.

He then went on a deadly rampage through the quiet provincial town.

When cornered by police, he set off

explosives strapped around his waist, killing himself and a police officer.

inspecting the documents of bearded men and women wearing hijabs.

Security has been stepped up across Kazakhstan, as police and security forces investigate the incident and try to forestall further attacks.

Before this spring, Kazakhstan had no history of terrorism. May saw the country’s first suicide bombing, when a man blew himself up outside the National Security Committee building in the western city of Aktobe, killing himself and injuring three bystanders.

Following the attack, there was a big military presence in Kazakhstan’s largest city Almaty, where armed soldiers patrolled the city centre, and police stopped cars with out-of-town number plates. Security forces were reportedly

A battle between police and an armed group in Aktobe left four policemen and nine suspected militants dead in July.

"The government has been caught on the back foot by the attacks”

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Snap but predictable elections in Kazakhstan

bne Kazakhstan is expected to hold early parliamentary elections in January next year after members of the lower house of parliament, the Majilis, asked President Nursultan Nazarbayev on November 10 to disband the chamber. Without a hint of irony, officials explain the motive behind the request, signed by 53 of the Majilis’ 107 deputies, as being to enable the government to get the elections out of the way so it can focus on dealing with the next wave of the crisis.

The president has the right to dissolve the parliament after consultations with the speakers of both houses of parliament and the prime minister. After the parliament is dissolved, elections must be held within two months, meaning the parliamentary elections originally scheduled for August 2012 will now take place around eight months earlier.

Parliament member Nurtai Sabilyanov told journalists in Astana that the move was intended to get elections out of the way so that the government can focus on the economy. "Another wave of the global economic crisis is expected next year. Its scale is unpredictable. Therefore, it is important to complete the election cycle early to let the government and the parliament concentrate on anti-crisis measures," Sabilyanov told an Astana press conference.

Afghan blowback No one has claimed responsibility for the Taraz attack, but there is speculation that Jund al Khilafah (Soldiers of the Caliphate), the organisation responsible for the Atyrau bombings, may have been behind it. The group is believed to have been set up by Kazakhstan-born militants who had been fighting alongside the Taliban in Afghanistan. In a video released after the Atyrau bombings, Jund al Khilafah threatened further violence in Kazakhstan if the government does not repeal the new law on religions adopted in October.

The current crisis in the Eurozone has not yet had a significant effect on Kazakhstan’s economy, although share prices have dropped as investors pull back from Kazakhstan and other emerging markets. However, if the global economy enters a second crisis, this is likely to hurt Kazakhstan’s main exports – oil, gas and metals. "We believe that Kazakhstan, as with many other countries, could face difficulties were the global economy to deteriorate markedly, notably if commodity prices came under sustained pressure," says a research note from Visor Capital. "Although the country has over $42bn available in the National Fund, any use of this would obviously require decisions of the political apparatus."

Even before its adoption, critics of the law had said that although its aim was to discourage extremism, it could have the opposite effect. The law introduced new restrictions on freedom to worship, including a requirement for all religious groups to re-register with the authorities. There is also a ban on prayer rooms in state buildings.

Predicting the result before the election had been called, presidential advisor Yermukhamet Yertysbayev indicated on November 10 that the Ak Zhol ("shining path") party would be able to take some seats in the upcoming election. "Nur Otan will come first in the future elections, followed by Ak Zhol, as the party that has been the most active in recent months," Yertysbayev told Interfax-Kazakhstan. "Over the last half year, it has welcomed 8,500 new members to become the second largest party in Kazakhstan with 180,000 members. It stands a good chance of passing the 7% election threshold or getting even more votes."

Kazakhstan’s last parliamentary election, in August 2007, saw all the seats in the Majilis, with the exception of those allocated to the People's Assembly of Kazakhstan, won by the presidential Nur Otan party. However, it has since been decided in Astana that more than one party should be represented in the parliament.

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The Taraz attack was not only the largest to date, it also brought the reality of terrorism uncomfortably close to home for many Kazakhs. The previous bombings and shootouts were all in Kazakhstan’s oil rich “Wild West”, which is separated from other major cities by thousands of kilometres of steppe and desert. Taras, however, is in the densely populated south of the country, and only 350 kilometres from its largest city Almaty – just down the road in Kazakhstani terms.

The attacks were also shocking because they do not seem to have come in the context of an increase in religious fervor or social instability. There have been no great social changes; in fact, Kazakhstan has long prided itself in being the most stable of the post-Soviet republics.

One of the achievements of President Nursultan Nazarbayev’s rule was to maintain harmonious relations between the many ethnic and religious groups

"Kazakhstan has seen an increase in religious observance among young people, the post-Soviet generation" represented in the country. The majority of Kazakhstan’s population are Muslims, but there is a sizable Orthodox Christian minority, and dozens of smaller religions.

Kazakhstan has seen an increase in religious observance among young people, the post-Soviet generation. However, compared to the more traditional south Central Asian republics, the country is relatively secular.

For most of the post-independence period, Tajikistan and Uzbekistan have struggled against terrorism and insurgency. In both countries, the influence of Soviet atheism was small, and Islam is widely practiced. But with war-ravaged Afghanistan just across the border and the fear of an Islamic rebellion, the authorities in Dushanbe and Tashkent exert tight control over religious activity.

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In Uzbekistan, President Islam Karimov’s repressive regime inspired the creation of the Islamic Movement of Uzbekistan (IMU), a militant Islamist group set up to overthrow Karimov and establish an Islamic state under Sharia law across Central Asia. The IMU became a pan-regional threat, making several raids into south Kyrgyzstan in 1999 and 2000. However, it was virtually destroyed after fighting with the Taliban against coalition forces in Afghanistan. The remnants of the group are reported to have opened training camps in Pakistan.

Assets sold so far have been a mixed bag and include agro-business Asia Agroresource and sugar producer Ditis, as well as hotels and holiday homes owned by former government officials or their relatives. No buyers came forward for the Bakiyev family residence in JalalAbad, although the committee managed to sell off the Bavaria-38 Cruiser yacht, which was originally owned by Aidar Akayev, son of Kyrgyzstan's first president, before being acquired by the Bakiyevs.

Upcoming sell-offs promise to be more high profile. The State Property Committee has announced that a 49% stake in Megacom operator Alfa Telecom will be auctioned on November 29. According to a source close to the committee, Zalkar Bank is due to come up for sale on November 15.

Emomali Rakhmon, Tajikistan’s president, has maintained security in the volatile country since the end of the civil war in 1997, when his forces defeated the Islamist opposition with help from Russia. Since then, Rakhmon’s government has kept a tight hold on religious activity. Dozens of suspected members of the banned Hizb ut-Tahrir movement have been arrested in north Tajikistan in recent years.

Like Karimov, Rakhmon is aware of the threat radical Islam poses to his regime. Measures to prevent the spread of religious fervour include appealing to parents to withdraw their sons from overseas madrassas (religious schools) and banning children from entering mosques or other places of worship except on religious holidays.

Last August, a mass breakout from a high security prison in Dushanbe was followed by a series of bombings. The Raksh Valley, always an opposition stronghold, seemed to be throwing off control by the central government. However, Dushanbe has now re-exerted control over the country and the last of the 25 escapees, Azam Ziyoev, was rounded up on November 14, the rest having already been killed or captured.

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On the block in Kyrgyzstan Clare Nuttall in Almaty

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yrgyzstan's president-elect, former prime minister Almazbek Atambaev, is pushing ahead with the privatisation of companies and other assets nationalised after the April 2010 revolution. Revenues so far have been modest, but two large and highly controversial assets – a stake in mobile telecommunications company Megacom and Zalkar Bank, the successor to AsiaUniversalBank (AUB) – are due to be auctioned off later in November.

Kyrgyzstan's State Property Committee is aiming to raise around 5.5bn soms ($120m) from the sale of these nationalised assets, but as of October 17 just under 40m soms had been raised, 24.kg reports. The largest asset put up for sale, the Chakan Hydropower Plant, did not find a buyer.

Selling off assets seized from the family of ousted president Kurmanbek Bakiyev

and alleged associates is one of several steps the Kyrgyzstan government is taking to try to reduce country's budget deficit. Tax revenues slumped in 2010 when the revolution sent the economy into temporary freefall. Despite donor assistance and a strong recovery this

Calling investors When President Kurmanbek Bakiyev was overthrown, one of the first acts of Roza Otunbayeva's interim government was to place the country's largest bank AUB and several smaller banks under the control of the central bank while alleged links to the Bakiyev family were investigated. AUB's former management, led by ex-chairman Mikheil Nadel, have always denied links to the Bakiyevs, but attempts by AUB shareholders to regain control of the bank have been unsuccessful.

AUB has since been split into a "bad bank" and a "good bank", which was renamed Zalkar Bank and prepared for

"I believe some international mobile companies are interested in Megacom, but there are still questions about ownership" year (the International Monetary Fund forecasts 7% growth in 2011), there is still not enough in government coffers to fund both the reconstruction of the south after the June 2010 ethnic violence, as well as salary increases for state workers.

re-privatisation. Though the turbulence of the last 18 months has taken a toll on the bank's business, Zalkar Bank still has Kyrgyzstan's second largest branch network, and is the seventh largest bank in terms of its asset base.

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The new man in Kyrgyzstan Clare Nuttall in Bishkek Kyrgyzstan has elected its first president since the April 2010 revolution, bringing hope that Almazbek Atambaev can maintain stability and revive the struggling economy.

Atambaev, who had been Kyrgyzstan’s prime minister until he stepped down to run for president, won the election in the first round with 63.2% of the vote. His two closest rivals, Adakhan Madumarov and Kamchibek Tashiev, took just 14.7% and 14.3% respectively, splitting the anti-Atambaev vote neatly between them.

At press conferences immediately after the election, both Tashiev and Madumarov angrily accused Atambaev of the misuse of state resources and said they didn't recognise the result. The days following the election saw small-scale protests in the southern cities of Osh and Jalal-Abad, but Tashiev quickly called off his supporters saying he would challenge the result through official channels. Madumarov is also seeking a recount.

However, with almost all Kyrgyzstan’s 5.3m population yearning for an end to the petty politicking and a return to normal life under a stable government, fears of widespread post-election unrest proved unfounded.

Atambaev is due to be sworn in on December 1, replacing Roza Otunbaeva, who has served as interim president since the 2010 revolution.

International election monitors including the OSCE Office for Democratic Institutions and Human Rights (ODIHR) gave the electoral process a positive overall assessment, while pointing out “significant irregularities on election day”, especially regarding voter lists and the tabulation process. The biggest problem on election day was unconnected to any single candidate, and stemmed from the recent reforms to the electoral law, which required voters to register in advance. The new law was adopted just three months before the election, giving the Central Elections Commission insufficient time to ensure that the country’s entire adult population was included on the voter lists. This resulted in many people being turned away from polling stations.

This was a campaign run on personalities rather than policy, and no great changes are expected after Atambaev, a close political ally of Otunbaeva, takes over. During his term as PM, Atambaev won support by raising salaries for teachers, doctors and other government workers, and increasing living allowances for students. However, this, added to the costs of reconstruction after the revolution and the June 2010 ethnic violence in the south, has left Kyrgyzstan with a growing budget deficit.

Tackling that deficit will be the new government’s main challenge.

A former businessman, Atambaev is seen as the business-friendly candidate, as well as Moscow’s preferred man, making it likely he will take Kyrgyzstan into the Customs Union founded by Russia, Belarus and Kazakhstan. “People voted for Atambaev to become president because they think he will bring peace and stability,” says Aktilek Tungatarov, executive director of the International Business Council (IBC) in Bishkek.

“We don’t expect reforms; we just want stability.”

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counterpart Serzh Sarkisian in Moscow on October 25, Russian President Dmitry Medvedev said that discussions were continuing, and he hoped the two countries would work out an optimal scheme for cooperation. "Frankly, it requires massive incentives, as these are not cheap projects," Medvedev told journalists.

The planned sale of 49% of Megacom operator Alfa Telecom is equally controversial.

BiMoCom, the original operator of the Megacom network, was majority owned

by Russia's Eventis Telecom until Alfa Telecom, a company allegedly affiliated with Maxim Bakiyev, took over the assets in October 2009. After the April 2010 revolution, the government tried to nationalise Alfa Telecom, but Eventis moved to reassert control over its original 51% of the business. This, however, was not to the liking of the new government in Bishkek, which launched a criminal investigation into Megacom's directors in the hope of taking full control of the operator.

That case brought down Kyrgyzstan Prosecutor General Kubatbek Baibolov, who was sacked after his wife's links to Megacom emerged; he later ran against Atambaev in the October presidential elections. However, the government's plans to take over the whole of the business were thwarted by a Supreme Court ruling on June 21. It was then decided to sell off the 49% stake of Alfa Telecom that is currently in government hands.

But with Megacom's murky history and still contested shareholding structure, it's doubtful whether any investors will be interested, even though telecoms are one of Kyrgyzstan's few consistently profitable sectors. "I believe some international mobile companies are interested, but there are still questions about ownership," says Umet Daletbayev, managing director of Aiten Consulting.

Kyrgyzstan's recent history of nationalisations and lack of protection for property rights following the latest revolution have alarmed potential investors. "Foreign investors thinking of putting money into Kyrgyzstan saw the instability and postponed their investments because they need to be sure their money will be safe," says Aktilek Tungatarov, executive director of the International Business Council (IBC) in Bishkek.

With the Eurozone deep in crisis, few investors in any case are looking to highrisk frontier markets like Kyrgyzstan.

I 49

Armenia resists calls to close nuclear plant Clare Nuttall in Almaty

T

Stress tests Calls for Metsamor to be closed are renewed each time an earthquake hits the region. The deadly one on October 23 in neighbouring Turkey's Van region again raised questions about the plant's safety. Turkey's Energy and Natural Resources Minister Taner Yildiz says he will appeal to the International Atomic Energy Agency (IAEA) for the plant to be closed. Government officials from Azerbaijan, which has even more hostile relations with Armenia than Turkey, have also appealed for closure of the plant.

The Armenian government insists that Metsamor, despite being one of the world's oldest nuclear power plants, is safe and points out that it was built to withstand earthquakes of a magnitude of up to nine points on the Richter scale. A team of experts from the IAEA visited Armenia from March 16 to June 2 at the government's request, concluding that Metsamor's "level of risk is acceptable". Most of the problems that

he recent earthquake in Turkey may have sparked fresh calls for the quick closure of Armenia's ageing Metsamor nuclear power plant, but with Yerevan struggling to find the $5bn needed to build a replacement, they are likely to fall on deaf ears.

year signed an agreement on technical and financial cooperation for the project. "For us there are no doubts... We are not just ready, we want to participate in the elaboration of the financial

Local environmental groups and Armenia's neighbours have long been lobbying for the Soviet-era plant to be closed.

They fear its location in the densely populated south Caucasus, which is a highly active seismic zone, could lead to a worse disaster than Chernobyl.

Yerevan does plan to decommission Metsamor, which was built in 1970, and replace it with a new nuclear power station. This was originally due to happen by 2017, but it is looking increasingly likely this could be delayed by at least a few years.

"My own feeling is that no reactors should be constructed in a seismic area"

Russia is committed to helping Armenia build a new power plant. The two countries set up a joint venture to build the new plant in 2009, and the following

package," Rosatom deputy director Nikolay Spassky told journalists in Yerevan on October 27.

Up to one fifth of the total project cost of around $5bn could be covered by the Russian government and Russian energy companies. However, recent comments by Russian officials show an awareness that the project will be both difficult and expensive. Speaking after a meeting with his Armenian

the final report identified concerned employee practices rather than the plant itself. There are plans to carry out additional stress testing in April 2012, with experts from the EU and the Council of Europe taking part in the examinations.

The IAEA inspection followed the crisis at Japan's Fukushima plant, which was severely damaged by the magnitude-9 earthquake on March 11. According

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to Ferenc Dalnoki-Veress, scientistin-residence and adjunct professor at the James Martin Centre for Nonproliferation Studies, the similarities of Metsamor with Fukushima are striking.

"My own feeling is that no reactors should be constructed in a seismic area, especially not as active as Armenia and not a third-generation nuclear power plant," Dalnoki-Veress tells bne. "There is also the security issue that needs to be discussed. Armenia is in a very contentious area in terms of security and just as a natural event could cause a lack of cooling, a terrorist event could do the same. This needs to be also taken into account."

Back in 1998, Metsamor was closed down by Soviet officials after the devastating Spitak earthquake, which killed over 25,000 people. However, the Armenian government decided to reopen the plant seven years later because

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of the newly independent country's pressing need for energy. The economic blockade imposed by its neighbours Azerbaijan and Turkey after the Nagorno-Karabakh war threw Armenia back on its own resources.

Local and international environmental groups are calling for Metsamor to be closed without delay, and they oppose plans to replace it with another nuclear power plant. Jan Beranek, nuclear energy project leader at Greenpeace International, describes Metsamor as "a significant threat" to the region, and points out that there is the danger of an accident even at the most modern reactors. "The probability of a heavy accident could be even higher in Metsamor due to high seismic risks, obsolete design and aging reactor," Beranek tells bne.

Lacking the rich fossil fuel resources of its neighbours, Armenia has relied for

the last four decades on nuclear energy.

Although relations with Turkey have thawed slightly, Armenia still has no relations with its oil and gas rich neighbour Azerbaijan.

There has been some progress in developing alternative energy sources.

A report from the World Bank, "Energy Reforms in Armenia: On the Way to Energy Security", points out that the market for small hydropower stations is well developed. The country already has over 90 small hydropower plants, and the government has adopted legislation that requires that the national electricity grid buy electricity generated by small hydropower stations for the first 15 years after they become operational. However, Armenia does not yet have alternative means to generate the 40% of its electricity needs that are currently supplied by Metsamor.

A

deal to bring two Bollywood film shoots to Georgia is raising expectations that the country's struggling cinema industry could get a second chance.

Georgia on my screen Molly Corso in Tbilisi

Filming for two Indian movies – "Bilia 2" and "Double Trouble" – is slated for October and November, an investment that Georgian officials and film directors believe will lead to more interest and investment in Georgia cinema. "In Bollywood, there is about 500 new movies a year, at least two movies a day. So when one producer discovers [a location], they have a pulling effect… I am sure that next year we will have more and more movies coming into Georgia," she said. "[The movie business] is really good for the budget in two ways. Whatever the investment that comes to the country, it stays in the country. It makes the economy move forward," says the director of the Georgia National Investment Agency, Keti Bochorishvili, who adds that bringing Bollywood to Georgia has been a government focus.

Chakri Toleti, the director of "Bilia 2", tells bne in a phone interview from his

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office in India that he plans to spend roughly $500,000 in Georgia during his 20-day shoot in November. After travelling around Georgia in search of a new location, he said the country's variety of landscapes, towering mountains, sandy beaches and barren deserts, all within hours of each other, convinced him it was the right location for his latest project.

The government is also hoping to cash in on the Bollywood effect, the apparent power of Indian films to draw scores of Indian tourists to the countries where their favourite films are shot. From Scotland to Switzerland, Indian film shoots are having a dual effect on state budgets: movie productions spend money in communities on local staff, restaurants and hotels – then movie fans follow their lead, giving the tourism sector a boost.

Bochorishvili says the government is hoping to mimic that success. Officials spent months trying to win over the Indian movie producers. But now that they are coming, tourists and more film companies will follow, she believes. "We want this sector to develop in Georgia, for Georgia to become a film production location… the biggest result that it will create is the awareness of the country," she says, noting scores of Indian tourists have flocked to Switzerland to visit the backdrop for their favourite films. "We would expect increased numbers of tourists coming to Georgia… and it will be easier for us to talk about Georgia after this movie than it has been before this movie."

Toleti says that Georgia has the makings of a new international filming location. "I think that once we expose Georgia to our film industry, others will want to come," he says.

Backdrop Toleti and his colleagues are following a long cinematic tradition of filming in Georgia. A favourite backdrop for Soviet directors for decades, the country's diverse climates and good weather have the potential to compete with places like Prague, reckons international awardwinning Georgian director Nino Kirtadze.

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"In a very small country you can have totally different and varied landscapes"

Kirtadze, now based in Paris, says she returns to Georgia to film every year because of the locations, crew and cost.

"In a very small country you can have totally different and various landscapes. You can have a desert, you can have a mountain… you have sea, you have mountain, you have cities."

You can shoot Iran, for example, in Georgia, she says. "If Georgia plays its advantages in a right way and if the ground is prepared, meaning have the crew here, having facilities, having professional people in every stage of film development, of course everyone will be ready to shoot because Prague now is very expensive."

Stefan Tolz, a German filmmaker who has been shooting documentaries and fiction in Georgia for 20 years, agrees the country has the potential to bring in foreign film productions. He cautions, however, that this will have a limited effect on Georgia's own local movie industry.

Georgia, he says, has a "rich history" of movies that trace back to pioneers in black and white films from the first days of cinema. "This was always a cultural essence – Moscow and Russia of course had some cities where you had film industries starting… but the success story, especially internationally, came from Tbilisi," he says. "So [foreign film production] might be a very important step for the future that the current government has been putting a lot of energy…[though] I doubt this will affect Georgian cinema itself very much, but of course it will bring a lot of people who work in cinema jobs and possibilities to work here."

The Georgian film community, Kirtadze says, is excited about the potential that Bollywood could bring to the industry,

but she warns there is a limit to what foreign productions can do for the local cinema. "[Bollywood coming] is good. And probably someone else will follow… but to rely only on whoever will come, I think it is not right," she says. "I think that Georgia should think more about what they will produce, or co-produce… I think it will move much, much faster this way. I am not saying say no to whoever comes, no. But also do something, take risks, assume your risks and move forward."

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Mongolia, the new Azerbaijan Around 2007, international investors who had made a bundle in emerging markets were moving on to look for new opportunities in the so-called "frontier markets".

Mongolia was one of several that attracted attention – and capital – partly as it could sell itself as an adjunct to the China story that obsesses most investors these days.

Special focus: Mongolia

The economy was already on the fast track before the crisis struck, expanding by nearly 19% in 2006. The crisis of 2008 brought the growth abruptly to a halt, but unlike many of the other emerging markets, the subsequent economic contraction was mild at 1.6%.

Over the last two years, the economy has quickly recovered and put in 6.1% growth in 2010; it should perform even better this year, with analysts expecting growth to hit a historic high of 9.7%, which would put Mongolia on a par with the superstars of the emerging world, Turkey and China.

from about $15bn in 1995). The only thing that Azerbaijan produces of note, a backward former Soviet vassal state on the Caspian Sea, is oil and gas. Having struggled for most of the decade following its forced independence in 1991, the economy suddenly took off in 2006 when the oilfields were finally hooked up to a pipeline that connected it directly to western markets, bypassing Russia. The economy soared, growing by an extraordinary 35% in the first year and despite the current crisis the economy is expected to grow by at least 3.5% a year for the rest of the decade.

Mongolia should do even better. The forecasts vary, but most analysts agree that like Azerbaijan the economy will take off dramatically around 2013 when the OT mine comes onstream and generates an estimated $3bn a year in revenue. And that is not counting the coal exports that Eurasia Capital estimates could climb to $7bn a year by the middle of the decade.

Mongoia, Azerbaijan GDP forecasts

Sometimes it pays to be isolated. Mongolia was hurt by the 2008 global crisis that swept the world, but while most major economies were crushed, Mongolia did no more than stub its toe.

Mongolia’s economy has been growing nicely now for several years as it finally gets hooked up to the rest of the world. For most of the last few decades, per-capita GDP income was stuck at $2,000 – putting it slightly ahead of both China and India – but since 2007 it has started to move up in tandem with the rest of the world.

The difference was a combination of progress made by what is today one of the most democratic governments in the former communist space and the arrival of big international miners who are interested in the country’s treasure trove of raw materials, which are feeding China’s insatiable appetite.

The government has identified 15 strategic deposits that between them contain an estimated $1.2 trillion worth of minerals. That in an economy where nominal GDP in 2010 was $6bn. The biggest problem Mongolia

has to face in the coming years is what to do with all the money that flows in.

The most advanced is the Oyu Tolgoi (OT) copper and gold deposit that is being developed by Ivanhoe Mines and is due to come online in 2013, which should earn $3bn a year from sales by itself. Altogether it is thought to contain $132bn worth of metals. Then there is the Tavan Tolgoi coking coal deposit that holds an extraordinary $387bn worth of coal, various iron deposits worth $100bn, uranium deposits worth $18bn, and small change in silver and other metals accounting for several more billions of dollars. Currently, the country’s main exports are goat skins (better known as cashmere to the shopping public) and copper produced at the Erdenet mine that was set up in Soviet times. Just the copper reserves are the second largest in the world – a quarter of the planet’s total – or 236m tonnes. And the 100m tonnes of coal is the world’s fourth.

Located about as far away as it is possible to be from anywhere else in the world, the Mongolian story is still one of the best kept open secrets in the world.

Going forward, growth will depend to a large extent on international commodity markets, which will make it

"The biggest problem Mongolia has to face in the coming years is what to do with all the money that flows in" erratic, but it should stay around the 10% growth level.

By 2025, Mongolia will reach a GDP level of over $100bn, according to Metatron Capital, overtaking Qatar.

But a better comparison would be with Azerbaijan (which is expected to reach just over $100bn in 2015

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At the same time, other economic indicators have remained tolerable: inflation is in single digits and forecast to remain at 8% this year. Mongolia really only came to international investors' attention in April 2010 and finished that year with $1.6bn of net inflow of capital, 5.3 times more than in 2009. This year is expected to see at least as much investment arrive again. And the country’s gross international hard currency reserves are a comfortable eight months of import coverage, or a bit less than $2.5bn, whereas most developed countries hold only about three months. "The budget is in surplus, we have record high level of cash in our coffers, we have created the stabilisation fund [that is] expected to hold $200m by year-end," Vice Finance Minister Ganhuyag Chuluun Hutagt, said at the World Economic Forum East Asia Summit in June. "There is no immediate, urgent needs for additional funds.”

Special focus: Mongolia

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Inbound direct investment is mirrored in the country’s stock market, which more than doubled its capitalisation at the start of this year when a few large investments sent the Mongolian Stock Exchange (MSE) index leaping to over 30,000. One of those was James Passin of US investment firm Firebird Management, which started snapping up majority ownership through the open market in several key companies and now owns almost 40% of all shares traded on the exchange. “Last year, Mongolian capital market participants were only dreaming about an MSE with a real pool of financial sources, but today it is being realised,” says Dale Choi, chief investment officer at Frontier Securities.

Although the index quickly dropped back to around 20,000 after the Firebird shopping spree stopped, it has remained there for the rest of the year, ignoring the selloff that hit most bourses in August this year: it seems Mongolian stocks are one of the few "safe havens" in the world for equity investors. The trouble is, with a daily turnover on the exchange of only about $100,000 a day, global investors can't hide more than their lunch money

in the MSE. But this year the government retained the London Stock Exchange to oversee reforms to the market that should start to kick in next year.

Special focus: Mongolia

Mongolia has made a lot of progress in the last couple of years, but it still has a long way to go before it can start to enjoy its newfound prosperity. Late to the party, the country still remains at the very start of the reform process and has nearly everything to do: the lack of infrastructure in what is a largely bucolic economy

remains a bottleneck to further growth; it has added no new power generation capacity for over two decades; and business is in desperate need of new rail routes, border crossings and a functioning financial sector. But men like Vice Minister Ganhuyag have a vision for what he dubbed the "Wolf Economy". "We need to dream big and aim high,” says Ganhuyag.

A bit of stability on the international markets would also help.

Oliver Belfitt-Nash in Ulaanbaatar

Such a situation is a product of how the MSE came into being. When Mongolia transformed its economy into a market-oriented one in 1990, a stock exchange was quickly set up and 334 companies appeared on the list to be traded. Citizens could buy shares in any company

Indeed, the country’s stock market more than doubled its capitalisation at the start of this year when a few large investments from investors such as Firebird Management sent the index leaping to over 30,000.

To attract foreign investors, the bourse needs to offer more than extreme volatility; there must be publicly available information on a company's activities, liquidity in the market, and reliable legal infrastructure that supports both companies and investors. "Millenium IT is the latest software used in the London Stock Exchange and we are in the final stages of testing for Mongolia," says Saruul. "This will upgrade all areas of the MSE – surveillance, clearing, the trading platform and the exchange platform, and allow us to link to foreign exchanges to open up the investor base."

54

In 2010, the MSE's Top 20 index rose 138% over the year to make it the world's best performing equity market.

In fact, Mongolia's stock market had the distinction of being the best performer in the world over the previous decade, up 1,600%. Such a performance should've been enough to attract droves of new international investors, but with the vast majority of shares in the pockets of very few investors and an average daily turnover of just $100,000 for the whole exchange, manipulation and insider trading are commonplace.

case. "The FRC has investigated such companies and while some are accused of manipulation, we have found that there are also players in the market who can see value and are genuinely building up positions," says Saruul.

London calling Still, these are the signs of a young market that the new management is keen to purge. And so on January 18, the government signed an exclusive Strategic Partnership Agreement with the LSE to help it restructure and develop the MSE. "This is a giant project for the Mongolian Stock Exchange and for Mongolia," says Ganbaatar.

"We have been working hard and fast to bring the MSE up to London's standards."

Mongolia's rising stock

The Mongolian Stock Exchange may have been the best performing stock market in the world in 2010, but issues of transparency and liquidity keep foreign investors at bay. But the arrival of the London Stock Exchange this year to help modernise and regulate the bourse promises a new dawn.

bne December 2011

with vouchers handed out by the government, but the MSE acted as a privatisation mechanism rather than a functioning platform for trading. Now over half of these stocks have been suspended by the Financial Regulatory Commission (FRC) and only 20 or so are worth considering as a serious investment. "We must remember that these companies were forced to list, they had no choice," Saruul Ganbaatar, chief strategy officer of the MSE, tells bne. "It doesn't mean they are bad companies or are acting immorally now - they may actually just want to be private."

Some of the names listed on the exchange give a new meaning to the term "penny stock", with market capitalisations of no more than $3,000 and traded only once or twice every year. Others have such small free floats that one keen investor can send the stock soaring. For example, Sudut Joint Stock Company hit the 15% gain limit for eight consecutive trading days as its market value grew from $50,000 to $840,000 in the last three months. This provided investors lucky enough to find shares to buy with a 1,700% return. These numbers scream market manipulation, but that is not always the

are being rated by international rating agencies and are in discussions with international custodian banks," says Saruul. "With the FRC's approval, they will be able to be a clearing bank and keep investors' funds, offering the relevant interest rates and security to investors. Settlement with be with the Mongolian Central Bank, offering maximum security to investors."

Upcoming IPOs by leading Mongolian companies and the planned continued privatisation of state-owned enterprises over 2011 and beyond should further support the MSE's performance, say analysts. In 2012, the government plans to list the $15bn coking coal miner Erdenes Tavan Tolgoi in London, Hong Kong and Mongolia. The company is around eight times larger than every other MSE-listed company combined, and will represent many firsts for the Mongolian market.

The MSE must be up to scratch by the time they go public, as elections loom in June 2012 and time is running short. "We are on the fast track," says Saruul. "We have an excellent relationship with Erdenes Tavan Tolgoi and I am almost certain all will go ahead as planned. The market is now full of opportunities and the MSE will have a driving role in realising them. It is a great place to be."

On the legal side, a new "Company Law" was passed by parliament in November, which will ultimately give companies a choice: either adhere to the exchange rules, or delist and go private. Criteria include floating at least 30% of the company and disclosing the required data to the MSE on a regular basis. Companies have until July 2012 to choose, and seeing as most listed companies have under a 5% free float, there may be a mass exodus from public to private once the deadline arrives.

The biggest change for the MSE will come from the new "Securities Law," currently with the cabinet. This long-awaited legislation will be the sturdiest pillar yet in Mongolia's push to bring up its stock market to international standards and is expected to be approved by the new year. "The new law will be like an umbrella under which details can be finalised and narrowed down. It may not be perfect, but it will leave room to adapt to the changing market going forward," says Saruul.

The financial sector will have a large part to play in these changes, as Mongolia currently has no custodian bank and all data, shares and funds are kept by the Clearing House and Central Depository (CHCD). "Banks

"It doesn't mean they are bad companies or are acting immorally – they may actually just want to be private"

Special focus: Mongolia

bne December 2011

55

56

I Special report

bne December 2011

The dominant state of Russian banking

Top 200 Eurasian banks N

Bank

Country

Assets in $

Reporting date

1

Sberbank

Russia

290,740,782,903

01.10.2011

2

VTB

Russia

120,332,143,818

01.10.2011

3

Gazprombank

Russia

60,695,948,583

01.10.2011

4

Russian Agricultural Bank

Russia

40,972,652,787

01.10.2011

5

VTB 24

Russia

35,777,079,601

01.10.2011

6

Bank of Moscow

Russia

32,344,580,131

01.10.2011

7

Unicredit Bank

Russia

27,684,811,772

01.10.2011

8

Alfa-Bank

Russia

27,271,815,509

01.10.2011

9

Rosbank

Russia

18,406,022,516

01.10.2011

10 Raiffeisen Bank

Russia

18,099,292,090

01.10.2011

11 Privatbank

Ukraine

17,678,540,075

01.10.2011

bne

12 Kazkommertsbank

Kazakhstan

17,485,834,562

01.10.2011

G

13 Promsvyazbank

Russia

16,166,749,112

01.10.2011

14 Halyk Bank of Kazakhstan

Kazakhstan

14,773,222,414

01.10.2011

15 Belarusbank

Belarus

14,139,274,834

01.10.2011

16 Nomos Bank

Russia

13,685,188,508

01.10.2011

17 TransCreditBank

Russia

13,348,944,597

01.10.2011

18 Bank URALSIB

Russia

13,025,622,859

01.10.2011

19 AMT Bank (former BTA Bank)

Kazakhstan

11,526,577,012

01.10.2011

20 MDM Bank

Russia

10,644,675,895

01.10.2011

21 Oschadbank

Ukraine

9,422,970,624

01.10.2011

22 Bank Saint Petersburg

Russia

9,368,155,185

01.10.2011

23 Ukreximbank

Ukraine

9,138,242,687

01.10.2011

24 Ak Bars Bank

Russia

8,768,612,737

01.10.2011

25 Citibank

Russia

8,696,474,027

01.10.2011

26 "BANK ""ROSSIYA""

Russia

8,525,580,660

01.10.2011

27 OJSC Nordea Bank

Russia

7,530,339,520

01.10.2011

28 ATF Bank

Kazakhstan

7,472,114,529

01.10.2011

29 Belagroprombank

Belarus

7,360,927,169

01.10.2011

30 JSC Bank CenterCredit

Kazakhstan

7,335,506,510

01.10.2011

31 CREDIT BANK OF MOSCOW

Russia

6,865,568,203

01.10.2011

32 Bank of Khanty-Mansiysk

Russia

6,691,193,522

01.10.2011

33 Raiffeisen Bank Aval

Ukraine

6,649,035,929

01.10.2011

34 Bank Petrocommerce

Russia

6,602,322,547

01.10.2011

35 Zenit Bank

Russia

6,311,671,504

01.10.2011

36 International Bank of Azerbaijan

Azerbaijan

6,255,824,120

01.10.2011

37 Sviaz-Bank

Russia

5,743,663,033

01.10.2011

38 Vozrozhdenie Bank

Russia

5,508,116,070

01.10.2011

39 ING Bank Eurasia

Russia

5,348,341,015

01.10.2011

40 Bank OTKRITIE

Russia

5,246,846,559

01.10.2011

41 GLOBEXBank

Russia

5,166,766,677

01.10.2011

42 Ukrsotsbank

Ukraine

4,955,598,214

01.10.2011

43 National Bank TRUST

Russia

4,852,444,036

01.10.2011

44 Russian Standard Bank

Russia

4,769,562,317

01.10.2011

45 VTB Bank

Ukraine

4,584,785,463

01.10.2011

46 PromInvestbank

Ukraine

4,411,884,246

01.10.2011

47 Deutsche Bank

Russia

4,162,532,015

01.10.2011

48 Moscow Industrial Bank

Russia

4,009,867,206

01.10.2011

49 MBRD

Russia

3,862,786,982

01.10.2011

50 B.I.N Bank

Russia

3,737,147,960

01.10.2011

iven the tumultuous change taking place in the global financial system, it's perhaps surprising how little appears to have changed in this year's bne Eurasian bank survey. Look closer, though, and big shifts are underway.

Special Report: Eurasian bank survey 2011

Special report I 57

bne December 2011

Like last year, the size of banks has grown marginally, but still at nothing like the blistering pace seen in the earlier part of the previous decade when Russian banks, for example, grew at 40-50% in the glory years of 2005-2008. Since the financial crisis first struck in 2008, we have clearly entered a phase of lower growth for some years to come, with the sector growing at only about 15%.

Needless to say, the list of the top 10 banks in the Eurasian region remains a Russian affair. Russian savings bank Sberbank leads, followed by the other state-influenced banks VTB, Gazprombank and the Russian Agricultural Bank.

The effect of recent M&A is making itself felt. Rosbank, in 18th place last year, has merged its way up to 9th spot on this year's list. Rosbank is the consolidation platform for French Societe Generale's Russian businesses such as Rus-Finance. CEO Vladimir Golubkov told newswires earlier this year that he's aiming for the bank to be among the top five Russian banks in assets and equity, right behind the state-owned lenders.

VTB Group now has three subsidiaries in the top 10 after coming to the rescue of Bank of Moscow (BoM) earlier this year with a $5bn bailout. VTB Bank consolidated control of 75% over BoM in September. After a complex takeover due to the previous management's misrule, VTB believes it has a gem on its hands. "The branch network and the municipal accounts would both be extremely difficult to reproduce in a competitor bank. In this sense, the BoM's business is unique," Herbert Moos, chief financial officer of VTB, told bne in an exclusive interview.

Russian banks too have risen up the ranking at the expense of many of their Eurasian counterparts. Belarusian and Kazakh banks have all fallen down the ranking in general.

> Russia

Ukraine

Belarus

Azerbaijan

Kazakhstan

Georgia

58

I Special report

The Belarusian banks have been hit by the escalating economic problems of the country. Belarusbank has fallen to 15th spot from 12th last year and Belagroprombank is down to 29th place from 25th.

The Belarusian ruble has lost two-thirds of its value this year as a result of a balance-of-payments crisis sparked by massive state spending to keep the economy afloat. The central bank raised its refinancing rate to 40% from 35% in November in the 11th increase this year. Meanwhile, annual inflation hit 92% in October.

Kazakh banks too fell slightly again this year, though analysts say that apart from BTA Bank, Kazakhstan’s banking sector is in much better shape than it was three years ago and has proved remarkably resilient so far to the Eurozone crisis. The elephant in the room is, of course, BTA, which announced huge losses of KZT102.6bn ($693m) – considerably higher than expected – for the first half of 2011, prompting concerns that unless it gets additional help from its majority shareholder, Kazakhstan’s sovereign wealth fund Samruk-Kazyna, it could collapse.

Ukraine's banking sector may be coming apart at the seams, but many of its banks have actually risen in this year's list, most notably Privatbank, which reached 11th spot from

"The effect of recent M&A is making itself felt" 17th last year, Oschadbank, which rose to 21st place from 29th, and VTB's subsidiary, which rose five places to 45th.

Many Ukrainian banks also managed to increase their assets, surprisingly given the country's problems, with Privatbank's growing $4.5bn and Oschadbank's growing $1.9bn.

Azerbaijan's sector has also benefited from its relatively conservative banking culture within a sound regulatory framework, coupled with the stable economy that's supported by rising oil and gas exports. The country now has five banks in the top 200 – International Bank of Azerbaijan, Kapital Bank, Xalq Bank, Texnikabank and PASHA Bank – most of which have grown substantially over the year. Texnikabank rose from 198th spot to 183rd, Kapital Bank rose from 158th spot to 122nd, and Xalq Bank rose from 187th to 160th.

bne December 2011

Special report

bne December 2011

I 59

N

Bank

Country

Assets in $

Reporting date

N

Country

Assets in $

Reporting date

N

Country

Assets in $

Reporting date

51

PUMB

Ukraine

3,661,500,944

01.10.2011

101 Sberbank Rosii

Ukraine

1,890,666,933

01.10.2011

151 Metallurgical Commercial Bank

Russia

956,795,515

01.10.2011

52

Alliance Bank

Kazakhstan

3,560,349,184

01.10.2011

102 DeltaCredit

Russia

1,824,344,908

01.10.2011

152 Tavrichesky Bank

Russia

951,143,382

01.10.2011

53

Home Credit Bank

Russia

3,518,161,881

01.10.2011

103 Priorbank

Belarus

1,796,511,948

01.10.2011

153 Sarovbusinessbank

Russia

943,295,079

01.10.2011

54

National Clearing Centre bank

Russia

3,510,436,749

01.10.2011

104 TBC Bank

Georgia

1,794,902,429

01.10.2011

154 Independent Building Bank

Russia

926,157,832

01.10.2011

55

Orient Express Bank

Russia

3,476,315,385

01.10.2011

105 Baltinvestbank

Russia

1,735,362,410

01.10.2011

155 Kreshatik

Ukraine

915,125,746

01.10.2011

56

Alfa-Bank

Ukraine

3,271,146,655

01.10.2011

106 LOCKO-Bank

Russia

1,729,380,037

01.10.2011

156 Kuban Credit Bank

Russia

899,919,589

01.10.2011

57

OTP Bank

Russia

3,224,850,981

01.10.2011

107 HSBC

Russia

1,709,989,661

01.10.2011

157 Credit Dnipro Bank

Ukraine

898,736,916

01.10.2011

58

SB JSC «Sberbank»

Kazakhstan

3,138,111,743

01.10.2011

108 Temirbank

Kazakhstan 1,700,542,788

01.10.2011

158 VTB Belorussia

Belarus

892,407,865

01.10.2011

59

SME bank

Russia

3,104,527,344

01.10.2011

109 FundServiceBank

Russia

1,656,870,103

01.10.2011

159 Chelyabinskinvestbank

Russia

891,815,789

01.10.2011

60

Absolut Bank

Russia

3,094,424,073

01.10.2011

110 CreditPromBank

Ukraine

1,655,933,369

01.10.2011

160 Xalq Bank

Azerbaijan

890,435,888

01.10.2011

61

Nadrabank

Russia

3,072,224,654

01.10.2011

111 Royal Bank of Scotland

Russia

1,651,506,665

01.10.2011

161 Chelindbank

Russia

881,680,349

01.10.2011

62

BPS-Bank

Russia

3,048,277,604

01.10.2011

112 Center-Invest

Russia

1,647,678,293

01.10.2011

162 Bank Standard

Russia

879,386,199

01.10.2011

63

BNP Paribas Russia

Russia

3,011,667,736

01.10.2011

113 IBSP

Russia

1,647,622,329

01.10.2011

163 Express-Volga

Russia

852,773,030

01.10.2011

64

Transkapitalbank

Russia

2,906,786,173

01.10.2011

114 Evrofinance Mosnarbank

Russia

1,622,187,076

01.10.2011

164 Imexbank

Ukraine

847,345,647

01.10.2011

65

Investtorgbank

Russia

2,888,925,164

01.10.2011

115 Sovcombank

Russia

1,603,059,950

01.10.2011

165 SDМ-Bank

Russia

841,369,044

01.10.2011

66

SME Bank

Russia

2,874,900,529

01.10.2011

116 Calyon Rusbank

Russia

1,596,469,106

01.10.2011

166 Universal Bank

Ukraine

835,327,589

01.07.2011

67

Citibank Kazakhstan

Kazakhstan

2,866,513,412

01.10.2011

117 Metkombank

Russia

1,576,331,236

01.10.2011

167 Kedr Bank

Russia

834,719,963

01.07.2011

68

SKB-Bank

Russia

2,862,736,686

01.10.2011

118 Russian Capital

Russia

1,573,545,002

01.10.2011

168 Swedbank AB

Russia

832,567,113

01.10.2011

69

OTP Bank

Ukraine

2,854,606,506

01.10.2011

119 Forum

Ukraine

1,557,304,003

01.10.2011

169 Index-Bank

Ukraine

825,804,435

01.10.2011

70

UBRD

Russia

2,853,239,614

01.10.2011

120 Belvnesheconombank

Belarus

1,536,010,410

01.10.2011

170 Mezhtopenergobank

Russia

817,980,660

01.10.2011

71

Uniastrum Bank

Russia

2,791,887,138

01.10.2011

121 ATB

Russia

1,533,340,673

01.10.2011

171 Gazbank

Russia

802,155,559

01.10.2011

72

Credit Europe Bank

Russia

2,770,249,362

01.10.2011

122 Kapital Bank

Azerbaijan

1,522,134,960

01.10.2011

172 Intercommerzbank

Russia

791,969,947

01.10.2011

73

Citibank Kazakhstan

Kazakhstan

2,758,734,881

01.10.2011

123 Metallinvestbank

Russia

1,505,269,729

01.10.2011

173 Mosoblbank

Russia

789,943,849

01.10.2011

74

Finance&Credit Bank

Ukraine

2,713,515,001

01.10.2011

124 Surgutneftegazbank

Russia

1,417,369,231

01.10.2011

174 First Republik Bank

Russia

786,290,906

01.10.2011

75

Rusfinance Bank

Russia

2,704,147,898

01.10.2011

125 NRBbank

Russia

1,405,365,587

01.10.2011

175 Promtorgbank

Russia

786,211,865

01.10.2011

76

Banka Intesa

Russia

2,656,647,991

01.10.2011

126 Westlb Bank

Russia

1,387,593,896

01.10.2011

176 Bank Primorie (Primbank)

Russia

782,639,520

01.10.2011

77

Kaspi Bank

Kazakhstan

2,638,433,696

01.10.2011

127 Renaissance Capital

Russia

1,380,463,376

01.07.2011

177 Kyivska Rus

Ukraine

778,616,360

01.10.2011

78

Probusiness Bank

Russia

2,601,306,197

01.10.2011

128 Investbank

Russia

1,374,854,095

01.10.2011

178 GE Money Bank

Russia

770,304,952

01.10.2011

79

Kit Finace Investment Bank

Russia

2,595,543,631

01.10.2011

129 ING Bank Ukraine

Ukraine

1,355,970,887

01.10.2011

179 Dalcombank

Russia

768,000,311

01.10.2011

80

Bank of Georgia

Georgia

2,514,627,293

01.10.2011

130 National Standart

Russia

1,326,432,794

01.10.2011

180 Krayinvestbank

Russia

767,975,335

01.10.2011

81

Centrocredit Bank

Russia

2,488,792,806

01.10.2011

131 Pivdennyi Bank

Ukraine

1,316,839,038

01.10.2011

181 Barclays Bank

Russia

763,949,580

01.10.2011

82

SMP Bank

Russia

2,465,319,682

01.10.2011

132 ERSTE Bank

Ukraine

1,305,262,434

01.10.2011

182 Severgazbank

Russia

753,993,149

01.10.2011

83

Novikombank

Russia

2,458,650,327

01.10.2011

133 RBS (Kazakhstan)

Kazakhstan 1,283,112,266

01.10.2011

183 Texnikabank

Azerbaijan

747,045,368

01.10.2011

84

Brokbusinessbank

Ukraine

2,425,923,239

01.10.2011

134 Housing Construction Savings Bank of Kazakhstan Kazakhstan 1,271,076,466

01.10.2011

184 Interprombank

Russia

743,687,948

01.10.2011

85

Vneshprombank

Russia

2,412,127,873

01.10.2011

135 Rodovidbank

Ukraine

1,171,071,621

01.10.2011

185 Tinkoff Credit Systems

Russia

741,746,808

01.10.2011

86

Eurasian Bank

Kazakhstan

2,404,015,727

01.10.2011

136 SB Bank

Russia

1,168,894,550

01.10.2011

186 Akibank

Russia

736,509,156

01.10.2011

87

Delta Bank

Ukraine

2,358,039,343

01.10.2011

137 National Trade Bank

Russia

1,127,258,518

01.10.2011

187 PRAVEX-Bank

Ukraine

732,154,872

01.10.2011

88

Rosevrobank

Russia

2,342,462,006

01.10.2011

138 International Financial Club

Russia

1,119,569,729

01.10.2011

188 Russian International Bank

Russia

706,871,878

01.10.2011

89

Bank Soyuz

Russia

2,322,521,395

01.10.2011

139 Commerzbank Eurasia

Russia

1,109,821,395

01.10.2011

189 Primsotsbank

Russia

700,642,510

01.10.2011

90

Baltiyskiy Bank

Russia

2,307,441,576

01.10.2011

140 Pervobank

Russia

1,104,812,083

01.10.2011

190 AVBank

Russia

696,469,978

01.10.2011

91

Tatfondbank

Russia

2,150,849,673

01.10.2011

141 VAB

Ukraine

1,087,808,111

01.10.2011

191 Morgan Stanley Bank

Russia

690,525,755

01.10.2011

92

Sobinbank

Russia

2,133,802,055

01.10.2011

142 MoscomprivatBank

Russia

1,086,081,065

01.10.2011

192 Lipetskombank

Russia

682,690,408

01.10.2011

93

Avangard Bank

Russia

2,077,149,922

01.10.2011

143 HSBC Bank Kazakhstan

Kazakhstan 1,075,275,558

01.10.2011

193 Devon-Credit

Russia

680,670,165

01.10.2011

94

Master-Bank

Russia

2,023,278,293

01.10.2011

144 Swedbank AB

Ukraine

1,074,148,043

01.10.2011

194 Moskommertsbank

Russia

679,880,723

01.10.2011

95

Belinvestbank

Belarus

2,012,933,558

01.10.2011

145 Unicredit Bank

Ukraine

1,064,099,646

01.10.2011

195 Forabank

Russia

679,869,604

01.10.2011

96

Zapsibcombank

Russia

1,996,242,510

01.10.2011

146 Belgazprombank

Belarus

1,023,498,465

01.10.2011

196 CITI Bank Ukraine

Ukraine

678,388,755

01.10.2011

97

UkrGazBank

Ukraine

1,993,545,765

01.10.2011

147 Stroycredit

Russia

1,010,379,508

01.10.2011

197 Kub

Russia

663,775,771

01.10.2011

98

Russian Regional Development Bank

Russia

1,990,805,170

01.10.2011

148 NOTA-Bank

Russia

1,006,881,719

01.10.2011

198 M2M Private Bank

Russia

661,357,210

01.10.2011

99

Nurbank

Kazakhstan

1,960,783,885

01.10.2011

149 Finansova Initsiativa Bank

Ukraine

981,116,266

01.10.2011

199 Toyota-Bank

Russia

652,518,032

01.10.2011

Russia

1,893,685,768

01.10.2011

150 Dalnevostochny bank

Russia

964,236,313

01.10.2011

200 PASHA Bank

Azerbaijan

630,585,843

01.10.2011

100 Peresvet

Russia

Ukraine

Belarus

Azerbaijan

Kazakhstan

Georgia

Bank

Bank

Source: bne, central banks in the regions

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new paradigm, with a cash-rich business from a so-called emerging market, buying assets from a capital-poor business from a so-called developed market," says Mayer.

The hunted become the hunters Guy Norton in Zagreb

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iven the topsy-turvy times we live in, it was inevitable there would be a reordering of the ranks in the financial services sector in Central and Eastern Europe. The result is that Russia and other emerging markets are now as likely to be buyers of banks as sellers; or put another way, the one-time hunted are now the hunters.

That's certainly the view of Ithuba Capital, the Vienna-based investment banking boutique which oversaw the recent sale of Volksbank International (VBI) to Russia's Sberbank, a deal which it claims represents the start of a new era for the financial services sector in Europe. In September, Sberbank inked a deal that will see it pay an initial €585m for VBI, 51% owned by Osterreichische Volksbanken, with France's Banque Populaire Caisse d'Epargne and Germany's DZ Bank/WGZ Bank holding 24.5% each.

Thomas Mayer, managing partner at Ithuba, which advised Osterreichische Volksbanken on the sale of its CEE subsidiary, believes that the groundbreaking transaction marks a major reversal of

the previous M&A trends in the region.

Previously, the norm was for banks and insurance companies from the US and Western Europe to buy operations in CEE. Now, however, after first taking a hit from the bottom falling out of the

Tricky times The sale came at a vital time for Osterreichische Volksbanken, which in July was one of only eight Eurozone banks out of 90 that failed the European Banking Authority's stress test on whether they could survive another financial crisis.

At the same time, there were increasing doubts about whether Osterreichische Volksbanken, Austria's fourth biggest lender, could continue to service a €1bn bailout package provided by the authorities in Vienna. "The VBI sale was a very important step in the restructuring of Osterreichische Volksbanken," says Mayer.

Although the VBI disposal was characterised as a fire sale in some quarters – a €1bn price tag was floated when the transaction was first mooted last year – Mayer says that ultimately both sellers and buyer achieved a fair price. "VBI was sold at 1x book value – it's hard to find many banks trading at that value in the current markets," says Mayer, adding that as Sberbank's first major acquisition outside of its immediate neigbouring markets such as Belarus

"Sberbank's purchase of VBI is one of the defining deals of the new paradigm" mortgage securities market and now the rapidly falling valuations of bonds issued by highly-indebted Eurozone sovereigns, US and Western European banks find themselves under severe pressure to offload assets in order to shore up their rickety balance sheets.

Increasingly the buyers of those assets will come from Russia and other emerging markets, which haven't been as badly affected by the first and now second wave of the crisis. "Sberbank's purchase of VBI is one of the defining deals of the

and Kazakhstan, it "wanted a Central and Eastern European banking platform in a digestible size."

At the initial price of €585m, the VBI purchase price represented less than 10% of Sberbank's forecast 2011 net profit of over €8bn. The price is also a fraction of the 3.8x book value that buyers paid on average for CEE banks before the global credit crunch hit in 2007.

For such a relatively modestly outlay, Russia's biggest bank gets access to the bank-

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ing markets of Slovakia, Czech Republic, Hungary, Croatia, Bosnia-Herzegovina, Serbia, Ukraine and Slovenia. The purchase also doesn't include VBI's heavily indebted Romanian operation. However, it's true to say that the acquisition hasn't found universal favour with banking analysts, with some claiming that Sberbank has done little more than acquire a minor presence in CEE. "Because VBI has a very small asset base and fairly tiny market shares in all of its markets, Sberbank essentially agreed to acquire several banking licenses rather than a major regional player," point out credit analysts at Raiffeisen Bank International.

Svetlana Kovalskaya, banking analyst at Renaissance Capital in Moscow, agrees "the VBI deal is too small to make a difference to Sberbank currently, in our view," though she says the Russian bank might be able to tap into the growing role that Russian corporations are playing in CEE. Ithuba Capital's Mayer disputes the criticism that VBI's small market shares in the CEE markets mean that Sberbank has done little more than acquire a nameplate presence in the region.

"Sberbank has taken a very disciplined approach to its expansion into Central and Eastern Europe, which is of supreme strategic importance for it. VBI is the right size for Sberbank," says Mayer, adding that Sberbank is acquiring over 300 branches across the region and an experienced management team. "VBI has a fairly low-risk business model and long-term experience in Central and Eastern Europe, and so it ticked all the boxes for Sberbank."

For its part, Sberbank says it's looking to double VBI's current lowly return on equity of 5.5% by 2014. This is in line with Sberbank's target of earning around 5% of net profit from its international operations by 2014, compared with the 2.3% it reported at the start of this year.

Willi Hemetsberger, who founded Ithuba Capital in 2008, expects further sell-offs by other cash-strapped Austrian banks such as Hypo-Alpe-Adria, which was nationalized by the Austrian gov-

ernment in December 2009 and is now looking to restructure its operations.

Elsewhere in the region, Poland is seeing a reshuffle of its banking sector as several banks have either been sold or are up for sale by their foreign owners to help them meet the new capital requirements at home. They include Banco

"Sberbank has taken a very disciplined approach to its expansion into CEE" Comercial Portuguese's 65.5% stake in Bank Millennium and Belgian bank KBC Group's 80% stake in Kredyt Bank.

Spain's Santander, which in September 2010 bought 70.4% of Poland's fifth largest bank Bank Zachodni WBK for €2.9bn, has filed a binding offer to buy the Kredyt Bank stake, thought to be worth about PLN4bn (€930m). However, analysts say that cash-flush banks from Russia, China and other points east might make better partners for Poland's profitable banks, though offers from Russian interests wouldn't be received with much enthusiasm from Polish banking regulators, many of whom want to see a "re-Polonisation" of the country's banking sector.

Russian banks will be more welcome in Lithuania, where the governor of the Bank of Lithuania said he has no objection to Russian banks setting up shop.

"Whether it is Russia, China, Zimbabwe, some Burundu Murundu or Mars, it does not matter. The bigger the competition, the better for us. I have no prejudices in this case," Vitas Vasiliauskas, told newswires in November.

Vasiliauskas said several Russian banks are targeting the Lithuanian banking market, with one such bank's plans fairly advanced. Without providing names, the governor said that the establishment of a Russian subsidiary in Lithuania would be considered at the next meeting of the central bank's board of directors.

According to local media, it is Russia's Investment Trade Bank.

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Capital Management (SCM), the holding company of Ukraine's richest man Rinat Akhmetov. Renaissance's investment banking division is still operating, but half the desks in the swanky Parus Business Centre in central Kyiv are empty, as there is little going on in the capital markets these days: daily turnover on the local equity market can be counted in the single digit millions of dollars against the several billions a day that Moscow's exchanges turn over.

Ukraine's banking disaster in the making Ben Aris in Kyiv

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n August 2005, Austria's Raiffeisen International started a gold rush with its purchase of leading Ukrainian bank Aval. Over the next 18 months, everyone who was anyone with Eastern European ambitions charged into the market, paying extraordinary amounts of up to 6x book value for local banks. Married in haste, they now repent at leisure.

"There are lots of banks that would love to sell – if there were any buyers," says Konstantin Golovynsky, head of investor relations at Renaissance Capital in Kyiv.

"If there is a run [on banks], the whole sector will collapse, as unlike 2008 there are no European banks standing by to prop up the sector."

The 2008 crisis would have wiped out Ukraine's banking sector had it not been for the European banks with operations in the country bailing out their local subsidiaries. But as the next wave is striking at the heart of Europe, the foreign banks have mounting problems at home.

Trouble at home It's mortgage loans that have done the most damage in Ukraine, half of which were taken out in foreign currency; the 30% devaluation of the hryvna during the crisis has sent borrowers' monthly payments soaring while house values have dropped like a stone. Unable to pay the bills or sell their houses to recoup

their investment, many Ukrainians have chosen to simply default. Banking sector non-performing mortgage loans are estimated to top 40%.

In the last few months, those that could leave the Ukrainian market have, while the rest are powering down. Sweden's Swedbank and Holland's ING have both closed their retail operations, leaving only the corporate banking in place – a

The same is not true of BG Capital, the investment banking arm of the CIS banking wunderkind Bank of Georgia. It got off to a good start at the beginning of this year when the economic recovery looked like gathering momentum. CEO Nick Piazza came out with all guns blazing at an in-house investment conference, selling the "BUGs" – Belarus, Ukraine and Georgia – as the new high-growth markets of the east. BG Capital even managed to organise two IPOs for Ukrainian companies on the Warsaw Stock Exchange earlier this year. But by summer, both the Ukrainian and Belarusian economies had blown up and while Georgia is doing well, by itself it's too small to create much excitement. "I'm writing to inform you that in line with Bank of Georgia's strategy to focus more on its home market,

"If there is a run on Ukrainian banks, the whole sector will collapse" classic half-measure to deal with markets in trouble. In November, Germany's Commerzbank also said it might sell its holding in Forum Bank as part of a new strategy to "focus on core markets" after losing over $600m in 2010 and remaining loss-making over the first nine months of this year. And according to locals, UniCredit Group's local branch has lost a total of $3bn.

Russia's Renaissance Group is one of the few that managed to get out while the going was good. It sold off its retail arm, Renaissance Credit, after five years of operation in December 2010 for an undisclosed amount to System

and given the changing business and political climate in Ukraine, the Bank has decided to close BG Capital's Ukrainian office," Piazza wrote to customers on November 1.

Still, one man's woe is another's opportunity, and the leading Russian banks have moved in over the last two years.

The huge state-owned Sberbank and VTB Bank have both opened Ukrainian branches in the last two years. With abundant liquidity at home, VTB closed a deal to lend SCM $500m at the end of October – by far the biggest deal this year – as the Russian banks are now the only game in town.

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In a conference call after the release of the latest results, Anvar Saidenov, chairman of BTA’s board of directors, confirmed that the bank is in talks with Samruk-Kazyna, and that a decision about restructuring BTA’s negative carry swap would be made within the context of a wider decision about the bank. “Fixing BTA has proved an expensive task for the government, and Samruk-Kazyna's involvement is likely to be necessary for some time to come,” Renat Syzdykov, senior analyst, financial sector research at Visor Capital, tells bne. “There would be many negatives if BTA defaulted, mainly in terms of confidence in the banking sector and the government's reputational risk. It would also harm the government's finances, the banking sector and increase the cost of borrowing.”

Kazakhstan's bad apple in banking barrel Clare Nuttall in Almaty

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azakhstan’s banking sector is in much better shape than three years ago and has proved remarkably resilient to the Eurozone crisis. The glaring exception is BTA Bank, whose latest results have raised fears about the bank’s future survival.

A year ago, BTA was being touted as a restructuring success story. After months of negotiations, the bank struck a deal with creditors on the restructuring of around $10bn worth of debt. In December 2010, Kazakhstan’s central banker, Grigoriy Marchenko, boasted at an Almaty financial conference that Ireland – at that time struggling with a mortgage crisis – could have used Kazakhstan’s experience.

Today, BTA is spelling out “Big Trouble Ahead” just as clearly as it did back in 2008 when the first wave of the financial crisis was approaching. On October 21, the bank announced net losses of KZT102.6bn ($693m) – considerably

higher than expected – for the first half of 2011. There are growing concerns that unless BTA gets additional help from its majority shareholder, Kazakhstan’s sovereign wealth fund SamrukKazyna, it could collapse.

Until recently, Samruk-Kazyna officials have maintained that no further help would be forthcoming. However, Samruk-Kazyna CEO Timur Kulibayev said

On November 14, Fitch Ratings announced a downgrade of the bank because of the increased probability of a default in the near to medium term.

Fitch cited both the “sharp deterioration” in BTA’s financial position and “the apparent readiness of the bank and the Kazakh authorities to consider a range of options, including less creditor-friendly ones, for restoring the bank's solvency”.

Shaping up While BTA’s management works to save the bank, the rest of the Kazakh banking sector is in much better shape.

Three years ago, banks were over-burdened with billions of dollars worth of debt. Today, analysts agree, the picture is very different. The Eurozone crisis may have brought valuations down, but the sector fundamentals are in good shape

“Fixing BTA has proved an expensive task for the government" on October 4 that the fund was ready to provide further support if needed.

Samruk-Kazyna has already reshuffled BTA’s top management in the hope of improving performance.

and banks are much less vulnerable to external shocks. “In the three years since the start of the crisis, a lot has changed at sector level, at regulatory level and at individual banks. The banks have deleveraged and built up their deposits.

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Overall, we have a healthier banking sector although there are some areas for concern,” says Ainur Medeubayeva, equity analyst at Troika Dialog.

According to a report from Renaissance Capital, Kazakhstan’s has been a classic de-leveraging story. In contrast to 2008, Kazakh banks are sufficiently capitalised, and their balance sheets are deleveraged, and comfortably – or in some cases overly – liquid, says the report, “Kazakh banks: This time is different”.

While the dramatic growth of the mid2000s is a thing of the past, lending has gathered pace since the start of this year. Banks have been building up their deposit bases even faster, and loan-

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deposit ratios have dropped dramatically. Much of the increase in lending this year has been driven by small and mid-size banks – among them BankCenterCredit, Eurasian Bank, Nurbank and Kaspi Bank – which did not have such a large backlog of debt to deal with.

“We do not expect another major crisis looming for Kazakh banks, as liquidity is abundant and asset quality problems are localised and well provided for three years after the crisis of 2008-09,” says the Renaissance Capital report.

“The constraints remain on the side of growth, where the 'go-go' years are gone for good at least for the medium term.”

stan shows that NPLs reached a historic high of $25bn, or 36.6% of total loans, in September 2011.

However, the extremely high percentage of NPLs is partly because the tax code still penalises banks who write off loans.

Banks are still waiting for the government to take action by amending the tax code; they also hope the government will create a new distressed assets fund. Government action has long been on the horizon, and banks are hopeful that a decision on both the tax code and the fund will be made soon, so that the sector can finally leave the crisis legacy behind.

Needless to say, it's not all good news.

Data from the National Bank of Kazakh-

VTB turns the super-tanker

Ben Aris in Moscow

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t is hard to turn super-tankers around, but once they are headed on a new course, their size and weight make their momentum irresistible. Russia’s second biggest bank, the state-owned VTB Group, has finished its eight-year-long development plan and is now pointing its prow at the rest of world under the slogan “going global.”

VTB’s transformation started in the streets of swinging London in the 1960s.

Andrei Kostin was a young Soviet diplomat assigned to the sought-after posting to the UK. He shared his stint with Viktor Gerashchenko, the official representative of Gosbank, the paymaster of central planning in the Soviet-era.

Relying on retail For the second step, the bank needed a retail arm to collect more deposits without competing head-to-head with the state-owned retail behemoth Sberbank.

An opportunity presented itself during the mini-banking crisis in 2004 when Guta bank went to the wall. VTB stepped in to rescue the bank by taking it over, killing two birds with one stone. "We started our retail operation in 2005 and six years later we are the second biggest retail bank in Russia," says Moos. "Sberbank was handed a significant natural monopoly and to avoid direct competition we focused on the 'mass affluent', upper middle class and high net worth individuals."

And VTB has continue to add to its retail network, most recently buying the captive banks of the state-owned railway monopoly, TransCreditBank (TCB), followed by the more controversial takeover the Bank of Moscow. Together these two banks add another 8.5m new customers and made VTB24, the group's retail arm, the second biggest retail bank in the country.

INTERVIEW:

Herbert Moos, deputy president, chairman of the management board and chief financial officer of VTB

But the decadence of Carnaby Street and the hippie revolution passed the two young men by (or rather they had to ignore it if they were to survive under the communist regime) and they returned home to end up as governor of Russia's central bank for most of the 1990s and head of impossible to say Vneshtorgbank, now renamed VTB Group, the second largest bank in the whole of the former Soviet Union and one of the biggest banks in all of Europe.

Uncharacteristically, the first thing Kostin did on taking over VTB in 2003 was to reach for outside help, bring in western consultants McKinsey & Co. Kostin liked the plan and simply implemented

it (hiring away Ekaterina Petelina, the author of the plan, in the process.)

The first task was to bulk up. The bank's state origins made this task relatively easy. When Kostin took over, VTB had $4bn in assets; today it has $160bn. "It was not unusual to see the balance sheet double in a year," Herbert Moos, deputy president, chairman of the management board and chief financial officer of VTB, tells bne in an exclusive interview. "But the problem was always with funding: today we have two-thirds coming from deposits – both retail and corporate – with the rest funded by borrowing – both domestic and international. Opposite picture to what we had historically."

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However, the surprise success in retail was the blistering growth of VTB24 Private Banking, which was set up two years ago and targets the mega-wealthy. Moos says private bank accounts already hold a quarter of the group's entire retail deposits. VTB24 Private Banking has collected some $10bn of Russian money returning from overseas in the last two years after interest rates turned positive due to the crisis and the average deposit in its vaults is $1m. "Wealthy Russians naturally want to keep their money at home in rubles, as that is where most of their business is," says Moos. "But with negative real interest rates, the natural hedge is to put the money in deposit offshore in another currency. However, now Russian interest rates are positive… they have been returning their money home."

Competition in the retail segment is hotting up, but VTB is being aggressive and offers a premium service, which means that its deposit growth is rising faster than the sector average. Having

a de facto state guarantee for deposits above and beyond that offered by the deposit insurance agency helps; few Russians believe the state will ever let VTB go under, no matter how bad any future crisis.

Going global The third plank of the strategy was to expand VTB's international reach. This part was made easy after the government decided to close down the central bank's Soviet-era international daughter banks scattered around the globe – some of them, like Moscow Narodny bank in London, with pedigrees stretching back to tsarist times. VTB's new Bloomberg advertising intones: "VTB the global bank", omitting the word "Russia." And that's the point.

Today, VTB has 20 international branches with the latest additions being Beijing, Shanghai, Singapore, Hong Kong and New York, all of which have opened or are opening this year. "The strategy is to try and facilitate all the inbound and outbound flows of money to and from Russia," says Moos.

All the major international banks are in Russia and servicing its largest companies, but Moos argues that VTB is the only big bank that specialises in Russia.

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At first glance, launching an investment bank in the midst of a crisis might seem a little crazy, but with capital available it is actually an ideal time to set up shop, argues Moos. VTBC hired away almost the entire Deutsche Bank investment banking team and cherrypicked amongst the other banks based in Moscow to build up sales and marketing. "The 2008 crisis helped a lot, as the other banks were bleeding their best people and were unable to keep their top guys."

Phase two: from muscle to margins VBT has more-or-putting all the pieces of the McKinsey plan into place. From here on in, the group is going to shift its emphasis from expansion to profits, says Moos. Among other measures, Moos told all heads of all the foreign subsidiaries they have to generate a return on equity of at least 15% by 2013 – or face closure.

An integral part of this change is to completely privatise the bank as part of President Dmitry Medvedev's relaunched privatisation programme and the management are actively working to push its sale through as fast as possible.

VTB already carried out an IPO in May 2007, well before the privatisation pro-

"We started our retail operation in 2005 and six years later we are the second biggest retail bank in Russia" "We want to leverage what we are good at and the strengths of Russian companies," says Moos. "It is our focus on certain sectors where we already work with the biggest companies in the world where we can add the value.”

The fourth and final plank of the McKinsey strategy was to build an investment bank to better serve those large corporate clients. VTB Capital (VTBC) was launched in 2008 in the midst of the international meltdown, as bne was the first to report.

gramme got going, and followed this up in February with a second sale of 10% during the brief window of enthusiasm for the Russian story that closed so decisively in August this year. Moos says the plan is to continue selling 10% a year until the bank is 100% privately owned.

The seas of international capital markets are stormy now, but VTB has already changed course and since it turned the engines to full steam ahead there seems little that can stop it from reaching its goal.

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CORPORATE STATEMENT:

"We are proud of this result, as it shows a conservative strategy can still produce emerging market growth rates, profitability and return on assets," says Landsman. "And a conservative strategy is a natural choice, since our market is more prone to crises than those of the more developed world."

SDM-Bank – rediscovering classic banking in Russia

Small business SDM-Bank has focused most of its efforts on servicing the needs of Russia's fast growing and dynamic SMEs, which parallels the goals of both the European Bank for Reconstruction and Development (EBRD), which bought a stake in SDM-Bank last year, and the Russian government, which wants to see SMEs account for half of Russian GDP by 2020. But Landsman says helping SMEs develop and grow has many difficulties that are not confined to Russia.

SDM-Bank is unusual for a Russian bank simply because it follows a classic banking model.

Anatoly Landsman, the Chairman of the Board of Directors, SDM-Bank

E

merging markets are full of risk, but SDM-Bank's ultraconservatism has been the natural and proven response to the uncertainties of dealing with the volatile nature of the Russian market.

"We have to be very conservative, as there is a lot of additional risk in Russia," says Anatoly Landsman, SDM-Bank’s Chairman of the Board and a majority shareholder of the bank. "Nothing has changed this in recent years and the recent crisis has only highlighted the wisdom of this strategy.”

While many of Russia’s fastest growing banks have either concentrated on booming sectors like real estate or consumer express loans, SDM-Bank’s strategy has been to focus on the tough and difficult work of lending to Russia’s dynamic small and medium-sized enterprises (SMEs).

while the bank’s non-performing loan (NPL) ratio was only 4.5% of the total loan book, against the sector's average that topped 15% according to some estimates. Many Russian banks claim to have a low NPL ratio, but SDM-Bank’s was audited twice a year by Deloitte using international, not Russian, standards. And while Russian bank regulations declare a loan bad after it is overdue for 90 days or more, SDM-Bank uses a cut-off of only 30 days, the international norm. Moreover, if a loan becomes overdue, the bank creates reserves for the entire loan, rather than only the overdue interest payment that's actually in default.

While many Russian banks leveraged their balance sheets during the boom years, borrowing on both the local and international capital markets, SDM-Bank was funding all its lending using only the bank’s retail and corporate deposits.

Many banks around the world focus on chasing after very large corporate customers because the perceived risk and reward is assumed to be better. The SME sector is often neglected, particularly in the emerging economies. Of course, there are good reasons why SMEs are difficult to work with – transparency, lack of accounting standards, lower individual transaction volume, tough competition.

During the financial crisis, the Central Bank of Russia, in line with most other international central banks, offered extensive support to struggling financial institutions in Russia.

SDM-Bank, on the other hand, believes that SMEs are great clients. Long-term SME relationships enable business growth that is equal, if not faster, than the wider financial sector. The attraction of SMEs is particularly strong in Russia, where the sector is underdeveloped and historically has been under-banked.

The bank’s solid reputation and zero leverage made it a natural safe haven in the aftermath of the crisis as companies looked for a safe place to park their capital. Because of this, SDM-Bank has moved up 15 places to become 106th largest bank in Russia by assets.

“SDM-Bank's conservative business approach bodes well for its SME clients because they know that the bank is constantly focused on mitigating risks – something that SMEs are doing everyday to survive in a tough competitive environment," says Landsman.

As the crisis recedes, the quality of the bank's capital and the low level of provisioning to cover bad debt have allowed it to ramp up lending at a time when most banks are still struggling. The bank's credit portfolio increased by just under 20% in the second quarter year on year, more than twice that of the leading state-owned banks, and despite the bank’s reluctance to take risks or tap the capital markets, its assets have been growing at 30% a year for much of the last decade, ahead of the sector’s average.

At the height of the financial meltdown, international ratings agency Fitch Ratings announced that SDM-Bank was among Russia’s top-20 banks in terms of the quality of its capital,

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“SDM-Bank remained profitable throughout the crisis and did not need any state funding even during the darkest days of the crisis," says Landsman.

"The issue of capital allocation to the SMEs is not a Russian problem – it is global. We can see it in the UK, the US and most of the developed world countries, but especially in Russia, where the issue is more acute and the solutions need to be found faster if the government's goals are to be met,” says Landsman.

The current global crisis has highlighted the need to diversify economies and promote SMEs, as the developed world became vulnerable in part because of the concentration of capital in a few "too big to fail" institutions. The SMEs tend to get forgotten by big business and government, and so find it difficult to gain access to the capital they need to grow. In Russia this has

"SDM-Bank is classic banking rediscovered in a Russian context" become especially true, as the bank sector is dominated by a handful of state-owned banks that have become more aggressive post-crisis.

"SDM-Bank is not trying to reinvent the wheel. We are doing what banks everywhere should be doing: it is classic banking rediscovered in a Russian context," says Landsman.

The bank launched a new strategy in September last year when the EBRD agreed to buy a 15% stake for RUB352m ($11.7m). At the same time, the EBRD opened a RUB225m credit facility to support SME lending and another RUB150m facility for microfinance, partly financed by the EBRD's Russia Small Business Fund.

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these come from the resources of the international financial institutions, but we are also contemplating issuing some ruble or international bonds," says Landsman. “The goal is to create a platform in SDM-Bank that can take all these resources and effectively and efficiently channel them to the SMEs where they are most needed.”

The partnership is already producing innovations for the bank, which has traditionally offered a "360 degree solution" for its clients, providing for the financial needs of the corporation, employees and owners. A micro-financing facility has been set up to provide very small loans to individual entrepreneurs.

"It is a new direction for us, but you need to have built up years of experience in SME lending before you can tackle a business like micro-financing," says Landsman.

Many multinationals are rapidly scaling up domestic production capacity that requires a broader penetration of the Russian economy across sectors. In particular, SME coverage is increasingly, if not already, a very real and important topic for corporate sales teams. But for many large corporates, it is very expensive to do due diligence, finance and monitor SMEs. “SDM-Bank provides an efficient, transparent and robust SME financing platform with a proven track record. We are able to help many multinationals to deal with Russian SMEs in a cost effective and risk prudent fashion,” says Landsman.

"SDM-Bank's leasing platform is already providing solutions for tier-one international corporates that enhance their domestic manufacturing and distribution capacity. In particular, SDM-Bank is focused on the speed of its decision-making process. On the one hand, quick decisions enable SMEs to secure funding, subject to high quality checks. On the other hand, tier-one international manufacturers are able to broaden and accelerate product placement into the wider economy," says Landsman.

Further out, Landsman says he remains open to several possibilities. The bank might offer bonds on the domestic or international capital markets, or possibly boost capital by inviting other investors in as shareholders. But the factor that will really drive the bank's growth is not its own ambition, but the rate of growth of the Russian market, which is what SDMBank is all about: being prudent and expanding in line with the economy.

The tie-up with the EBRD represents a new direction for SDMBank and the opportunity to expand its business thanks to, "a new image, more capital and the opening up of new opportunities,” says Landsman.

"The EBRD is also very focused on developing SMEs and the partnership has added new funding possibilities. Some of

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73 Volokolamskoe Shosse, Moscow, 125424 Tel.:+7 (495) 705 9090, +7 (495) 490 6509 www.sdm.ru

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Emerging Market Investments Summit 2012 (30 - 31 January) Marcus Evans +357 22 849380 Fairmont Le Montreux Palace, Montreux, Switzerland summits@marcusevanscy.com http://www.emisummit.com

BANCASSURANCE FORUM 5th Annual with 2 streams: Life & Non-life

Corporate Governance in CEE, Russia & Turkey (31 January - 1 February) C5 Warsaw

Program Request barbora.kuckova@flemingeurope.com European Renewable Energy Project Finance Summit (7 - 8 February) United Market Insight Amsterdam, the Netherlands www.umievents.com

Russian Insurance Forum (7 - 9 February) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

CIS Metals Summit (14 - 16 February) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

CIS Pharmaceutical Forum (14 - 16 February) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

Ukrainian Energy Forum (28 February - 1 March) Adam Smith Conferences +44 20 7017 7444 Kiyv, Ukraine events@adamsmithconferences.com

Funds Russia Forum (29 February - 1 March) Adam Smith Conferences +44 20 7017 7444 Grand Marriott Hotel, Moscow, Russia events@adamsmithconferences.com

7th Caspian International Conference and Showcase BANKING & FINANCE (1 - 2 March) Iteca Caspian LLC +994 12 447 47 74 Baku, Azerbaijan banking@iteca.az www.banking.iteca.az

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I Events

HSE in OIL and GAS. Russia and CIS (13 - 15 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

Agribusiness in Ukraine (13 - 15 March) Adam Smith Conferences +44 20 7017 7444 Kiyv, Ukraine events@adamsmithconferences.com

Russian Automotive Forum (20 - 22 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

Bonds & Loans Russia (21 - 22 March) Gulf Financial Conferences Moscow, Russia www.bondsloansrussia.com

Russian Retail Forum (26 - 29 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

Airport Development Russia & CIS (27 - 29 March) Adam Smith Conferences +44 20 7017 7444 Moscow, Russia events@adamsmithconferences.com

Russian Wood and Timber (27 - 29 March( Adam Smith Conferences +44 20 7017 7444 Grand Marriott Hotel, Moscow, Russia events@adamsmithconferences.com

bne December 2011

CASPIAN TELECOMS 2012 - 11th International Caspian and Black Sea, CIS countries Telecommunication and IT Conference & Showcase (19 - 20 April) ITE Moscow LLC +7 495 935 7350 Hilton Hotel, Istanbul, Turkey Kochergina@ite-expo.ru www.caspiantelecoms.com

KITEL 2012 (29 - 31 May) ITE Moscow LLC +7 495 935 7350 Almaty, Kazakhstan Kochergina@ite-expo.ru www.kitel.kz/en/

SuperReturn Emerging Markets 2012 (25 - 28 June) ICBI Intercontinental Hotel, Geneva, Switzerland www.informaglobalevents.com

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bne April 2010

FUELING CASPIAN GROWTH

The International Bank of Azerbaijan is a universal bank and fullservice financial services company. IBA is a National Development Bank, contributing significantly to the strength, stability and transparency of Azerbaijan's banking system. This status ensures shareholders' and people's trust in the Bank both domestically and globally, and assists in the country's socio-economic development.

awards 2009

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