bne:Magazine - November 2014 by Ben Aris

Inside this issue: 25 years after Mauerfall Russia's economy is in the toilet Critics deride Hungary's Potemkin economy November 2014 www.bne.eu

Breaking the Bank Asya in Turkey Special Report Invest in Belarus

The Putinisation of Europe

bne November 2014 Senior editorial board Ben Aris (Moscow) editor-in-chief editor@bne.eu James R Hammond (Boston) publisher hammond@bne.eu

Contents

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Robert Anderson (Prague) news editor anderson@bne.eu

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Liam Halligan (London) editor-at-large LHalligan@newsparta.net

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Eastern Europe Graham Stack (Kyiv/Berlin) bureau chief stack@bne.eu Central Europe Tim Gosling (Prague) bureau chief gosling@bne.eu Southeast Europe Clare Nuttall (Bucharest) bureau chief nuttall@bne.eu

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32 COVER STORY 6 The Insiders

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CENTRAL EUROPE 30 Property restitution haunts Warsaw

8 The Putinisation of Europe 14 25 years after Mauerfall

32 Interest piqued in CEE's riskier property markets

16 Perspective

34 Good EU citizens

17 Chart of the month

35 CEZ plays "double or quits" 36 English lessons for Czech nuclear industry

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EASTERN EUROPE

Advertising & subscription Elena Arbuzova (Moscow) +7 9160015510 business development director (CIS) arbuzova@bne.eu Design Olga Gusarova (London) art director o.gusarova@bne.eu

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18 Ukrainians elect proEuropean parliament 19 Poland's patience with Ukraine begins to fray 20 Jim Rogers calls West "foolish" and invests again in Russia

38 Clouds gather over Poland's economy 39 Erste creates new CEE bond indices 40 Government critics deride Hungary's Potemkin economy 42 Cooperation not on the radar

22 Russia's economy is in the toilet 25 Russia shale-acked 26 Another voice silenced in Russia 28 Crimeans compete for best Russian wine title

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Contents

SOUTHEAST EUROPE

EURASIA

OPINION

Breaking the Bank Asya in Turkey

The peril of using bikes to bury Borat

The war that dare not speak its name

An investigation ends but questions begin

Kashagone

West-is-best delusion lives on

55 46

Bulgaria’s agony continues

Russia rekindles interest in Trans-Mongolian Railway

Bosnians to wait for progress on economy

Uzbekistan cottons on to criticism

Why a shrinking Russian workforce might let Putin off easy

70 49

Albania’s central bank on trial

Baku’s European Games

Russians march for peace in Ukraine

Life in Russia with $80 oil

Bumpy road for investors in Romania

Tajikistan's investment story is a hard sell

Not-so Great Aral Sea SPECIAL REPORT

Invest in Belarus

UPCOMING EVENTS

I The Insiders

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THE INSIDERS:

Has the ruble fallen too far? Peter Szopo of Erste Asset Management

ussia’s economy is under pressure, the most salient sign of this being the decline of the ruble.

The Russian currency lost nearly 26% of its value against the dollar over the past 12 months (to mid-October). To some degree, the ruble’s devaluation reflects the general strength of the US currency, which gained almost 7% over the same period on the back of the US Federal Reserve’s switch to a tightening bias and the robust economic data flow (which only suffered temporarily from seasonal effects in the first quarter). In fact, the Russian currency was already weakening at the beginning of 2013, but last year it still moved mostly in line with other emerging market (EM) currencies against the dollar. Since the beginning of 2014, however, the ruble also has decoupled from its EM peers, losing 17% relative to a GDP-weighted currency index covering 23 emerging markets (see chart 1). Current macroeconomic imbalances alone do not explain the ruble’s slide. In 2014, Russia’s combined current account and budget surplus is expected to exceed 3% of GDP. The country is in a completely different situation compared to other ‘fragile’ economies – originally there

Chart 1. RUB/USD vs. EM FX index (Jan 2010 = 100)

were five, but the number seems growing – which have been characterised by a combination of massive current account and budget deficits, high debt and/or significant refinancing requirements (see chart 2; note that Ukraine and Argentina, whose currencies devalued by around 60% since May 2013, are not shown in the chart because the data points would fall off the page). Of course, the coincidence of the ruble’s decline with the unfolding of the Ukraine crisis suggests some causality. The

"Current macroeconomic imbalances alone do not explain the ruble’s slide"

West’s sanctions are restricting the access of Russian banks and other entities to international capital markets as well as foreign investment in the country. A negative impact on the currency is to be expected and sanctions are certainly part of the story of why the ruble is heading south. However, even if US monetary policy and geopolitical factors have depressed Russia’s currency, the picture remains incomplete without taking into account the key factor driving Russia’s currency: the oil price. After trading for more than three years mostly in a stable range of $105115 per barrel, the price of Brent dropped $30 per barrel since the end of the third quarter, and is now at the lowest level since December 2010. The ruble’s latest leg down (-20% since June 30) was clearly triggered by the collapse in crude prices.

Source: Bloomberg; GEMetrixx. 1) EMFX: Index of USD exchange rates of 23 EM currencies.

In an effort to untangle the various drivers of the RUB/ USD-rate, we estimated a regression based on monthly returns from January 2010 to December 2013, using the parameters of the regression to forecast the theoretical forex rate changes for the first ten months of 2014. The

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Chart 2: Macro inbalances vs. FX

In other words, there is clear evidence that the ruble is overshooting. This is nothing rare in currency markets, and is usually seen as a consequence of different degrees of price flexibility in the real and the financial sectors of the economy. In the ruble’s present case the excessive devaluation is more likely the result of the Ukraine crisis. The impact of sanctions and countersanctions, capital outflows, rumours (even if false) of more bad things to come like capital controls, and speculation about how the Russian economy will evolve over the longer term are fuelling traders and investors’ expectations. In addition, the Russian Central Bank has changed its approach and has allowed a higher degree of currency flexibility than during previous periods of turmoil.

deviation between the actual and the estimated devaluation, ie. ruble movements that are not explained by the usual fundamentals factors, are likely related to the Ukraine crisis and its fallout. As explanatory variables we used in various combinations the Brent spot price (or one-month futures), the S&P industrial metals index, VIX, the gold spot price and our own proprietary EM currency index.

The flipside of the argument above is that any signs of a lasting de-escalation in Ukraine will likely trigger a rebound in the ruble. As long as sanctions stay in place – and there are strong reasons not to expect a reversal anytime soon – the ruble’s upside is limited. However, an appreciation of around 10% before year-end in response to positive signals from the geopolitical front is realistic in my view.

The outcome of this analysis (chart 4) suggests that based on this year’s trends in oil and industrial metal prices as well as considering the performance of EM currencies and the risk backdrop (VIX), the ruble should have devalued by about 11% year-to-date. In the first half of the year, oil was stable and industrial metals, after a moderate decline, even rebounded in the second quarter. According to the model, the ruble should trade at rate of 36.4 to the US dollar, while in fact it is trading close to 41 (mid-October), implying a devaluation of 24% – more than twice as big as what can be explained by the performance of the "usual suspects" like oil.

Of course, the usual caveat of "all other things staying equal" applies. Unfortunately, they rarely do stay equal. Arguably, the biggest uncertainty presently is oil. While crude prices seem to approach both break-even points of dollar shale-producers and fiscal break-even points of producers in the Middle East, nobody knows how much further the oil price will drop. $70 per barrel is in reach, which – in the current environment – could push the ruble easily down to 43-44 against the dollar. Thus, even seeing the ruble overshooting does not imply that the pressure will evaporate anytime soon.

Chart 3: RUB/USD vs Brent (USD/bbl)

Chart 4: RUB/USD - actual vs estimate

Source: Bloomberg; GEMetrixx.

I Cover story

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The Putinisation of Europe

Cover Story I 9

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David O’Byrne, Kester Eddy and Nicholas Watson

hen Hungary’s Napoleonesque prime minister, Viktor Orban, declared in a grandiose speech in July that Vladimir Putin’s Russia is a more attractive political model than the liberal democracies of the West, it confirmed the worst fears of those who worry about the dark night of fascism once again descending on Europe.

taking root elsewhere in Europe. Orban identified Turkey, but others are seeing signs of it to greater or lesser degrees in Romania and Bulgaria (both EU countries) and EU wannabes Serbia, Macedonia and Montenegro. While there are huge differences among the leaders of these countries, there are also some striking similarities.

Those countries, Orban explained, “capable of making us competitive are not Western, not liberal, not liberal democracies, maybe not even democracies.” Instead, he picked Russia, China, Turkey and Singapore.

What connects the leaders in these countries is an idea that has taken root – and articulated by the current editor of The Economist no less in his book “The Fourth Revolution: The Global Race to Reinvent the State” – that the “21st century has been

Such a bald statement about something that hitherto had only been discussed on the fringes of the political discourse was a gift to neoliberal Atlanticists who have been warning of a growing trend in Europe that bne identified in a piece about former Ukrainian President Viktor Yanukovych’s swing towards a Russian style of management in 2010: “The Putinisation of Ukraine”.

clinging onto power. December 2011 saw 100,000-strong crowds march in central Moscow for the first time in nearly a decade, but just two years on and Putin’s popularity is near an all-time high even as living standards begin to fall for the first time; as of the last week of October, Putin enjoyed an 86% approval rating, and even in Moscow where opposition against him is concentrated more than 60% want him re-elected in 2018. The side effect of the battle in Ukraine is that it has crushed Russia's nascent opposition movement. “The attacks against Putin are attacks against Russia,” an influential speaker said at this year's annual Valdai Club meeting

"What connects these leaders is an idea that has taken root that the 21st century has been a rotten one for the western model" a rotten one for the western model.” As Indian author and political essayist Pankaj Mishra explains in an article entitled “The western model is broken”, rather than every society being “destined to evolve just as the West did, where aspiring middle classes created by industrial capitalism will bring about accountable, representative and stable governments… one event after another in recent months has cruelly exposed such facile narratives.”

in Sochi, where the press is forbidden from naming speakers. "The Russian people understand that if there is no Putin, there is no Russia.”

But after failing to build up domestic support, Yanukovych’s regime swiftly collapsed in the teeth of protests against his corrupt rule, the slumping economy and a turn away from Europe, forcing him to flee to Russia where he still apparently resides (though bne sources reported seeing him in Beijing this summer).

Thus the 21st century, rather than being “the end of history” as political scientist Francis Fukuyama declared in 1989, is actually proving to be a period of great economic and political upheaval characterised by mass carnage. In such uncertain times, people cry out for stability – a desperate yearning that these European leaders are successfully tapping into. And with many predicting for Europe a decades-long period of Japanese-style stagnation, it’s likely this will prove fertile ground for breeding more such leaders.

Goulash Putinism Hungarians are wont to boast that their country was the leading light for political and economic reform in the late communist era – enjoying the fruits of a more liberal, so-called 'Goulash Communism' for a decade or more pre1990.

A purer form of “Putinisation”, where the emphasis is on establishing economic stability as cover for the less liberal aspects such as majoritarianism, appears to be

What particularly appeals to these strongmen of Europe has been the success of Putin's methods of maintaining control in the face of opposition and thus

In Ukraine, what that entailed was a creeping authoritarianism, nepotism and cronyism, rampaging corruption by connected elites, and a growing disregard for civil rights and press freedom. However, Yanukovych’s Ukraine lacked specifically what had made Putin’s model so attractive in the first place: economic stability. In the decade after he came to power at the turn of the millennium, Putin delivered on 10-fold increases in many economic measures, such as incomes, size of the economy, stock market capitalisation and international reserves.

Sanctions are justified by their Western sponsors as undermining Putinism, but Andrew Kuchins of the Center for Strategic and International Studies in Washington said at the Valdai Club: "It's only encouraging Putinism."

Twenty years later, critics argue that with the election of the first straight Fidesz government under Viktor Orban, they became the first of the new EU members to disassemble those reforms and institutions that were so painstakingly built up since the collapse of communism, and usher in a new era – which might be equally be called 'Goulash Putinism.'

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Orban returned to power in 2010 – he'd been prime minister in 1998-2002 as head of a coalition – with a promise to end corruption. Indeed, graft, along with the “failed economic policies” of the previous eight years of Socialist rule, were the mantras repeated by Fidesz politicians and its slavish right-wing media in the year up to elections in 2010. Orban returned to power with much international good-will, certainly from the European conservatives, most of whom focused on his famous “Russians-go-home” speech from 1989 rather than his clear aversion to pillars of centre-right economic policies, such as equity markets and recognition of regulated price mechanisms (eg. on household energy) in his previous tenure. But within weeks of taking the reins of power – buttressed by an all-powerful constitutional majority in parliament – his “special taxes” were applied retroactively to the financial, telecommunications, utilities and retail sectors – all of which were dominated by subsidiaries of large foreign companies. The pretext was “the economy, teetering on the brink of collapse, inherited from the Socialists” – an argument that has

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become the common narrative, despite the fact that economic growth had restarted in the second half of 2009. As the Orban-era progressed, opposition politicians and intellectuals, and even moderate Hungarian conservatives, have becomes alarmed at what they see as the prime minister's rushed drive to “renew” the country. “Orban repeatedly used and uses private members' bills to fast track legislation: this is a parliamentary loophole which avoids [otherwise mandated] consultations with affected parties and government bodies,” says Bernadett Szel, co-leader of the green LMP party. The democratic process was put into reverse and affected all aspects of life: Fidesz-loyalists were inserted into each and every institution, including the courts, state-controlled media, supposedly independent watchdogs, churches, education, security services and even the constitution itself – a new 'fundamental law' was rammed through parliament in 2011 with no cross-party consultation and minimal parliamentary debate. Meanwhile, as the European Commission and Western powers, not least the US,

began to scrutinise and critique the mass of legislation, independent media and observers began to draw attention to what they said was systematic abuse of power, with large state contracts being awarded to companies close to Fidesz. In March, 2012, Transparency International in Budapest warned in a report that the “Hungarian state” had been “captured by private interest groups” and that there was a “symbiotic relationship between the political and business elite” and that doubts regarding the genuine independence of watchdogs was “common.” The government protested that the report was not objective, and failed to take notice of a host of recently introduced anti-corruption measures. These included a new public procurement act and a “far more transparent” tendering process for EU funds, along with Hungary joining the International Anti-Corruption Academy for the first time. However, while such legislation looked excellent on paper, a combination of hard-working domestic journalists, human-rights NGOs and several (often naïve) whistle-blowers, continued to reveal evidence of carefully planned,

Photo: Northfoto

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Cover story

"Hungary is the only country where one political force could totally expropriate power"

mass cronyism. Examples included the so-called "trafik fiddle" (the allocation of licenses for newly created, statecontrolled tobacco retail outlets given, in many cases, to Fidesz supporters) and carefully selected farmers winning the right to lease large tracts of state-owned arable land at knock-down rates. But what, for government critics, was perhaps the most outrageous, in-yourface example of government hypocrisy was the case of Andras Horvath, a specialist tax inspector, who, after trying to report his suspicions to the prime minister's office – and failing to get a result – went public in November 2013 with what he said was evidence of a multi-million euro, cross-border VAT fraud in foodstuffs such as sugar. Horvath lost his job and faced police investigation as a result. In the same month, Balint Magyar, a former liberal education minister and leading dissident from the communist era, published a book entitled “Hungarian Octopus – the post-communist mafia state”. According to Magyar, the Orban government, with its two-thirds parliamentary majority, is unique within the EU. “Even in the other EU postcommunist countries, Bulgaria, Romania, Slovakia, etc, there is corruption, but there is a system of rotation. Hungary is the only country where one political force could totally expropriate power,” says Magyar. “Orban has power without control." The drift towards Putinisation reached a chilling peak on October 17 when US embassy in Budapest announced that a group of Hungarians will be banned from entering the US – mirroring the personal sanctions applied to Putin's inner circle – without specifying the reason for the bans. However, the local press reported that included on the list are representatives of the National Tax

and Customs Administration (NAV) and several Fidesz prominent figures. The row has even pulled in Victoria Nuland, the foul-mouthed US Assistant Secretary of State for European and Eurasian Affairs, who is better known for handing out cookies on Maidan in Kyiv at the height of the recent revolution there, who met with Peter Szijjarto, Hungary’s new minister of Foreign Affairs and Trade to discuss the bans in October. Nuland roasted Hungary in a speech at the start of October for contesting liberal democratic ideas, inflaming nationalist sentiment and crushing the freedom of speech. Replace the word "Hungary" for "Russia" and she could have used the same speech for having a go at Putin again. "Although the US has not revealed the reasons behind the ban it has imposed, it is most likely linked to the issue of Hungarian companies avoiding paying VAT in the foodstuff sector," wrote Andrzej Sadecki in a note for the Centre for Eastern Studies (OSW). "American company Bunge, an important cooking oil producer in Hungary, has been complaining that this practice makes it impossible for it to be competitive on the Hungarian market. For several months accusations have been appearing that NAV is favouring companies linked with the Fidesz business base." Sultan of paranoia Turkish Prime Minister Recep Tayyip Erdogan is another that seems to have been infected with Putinism. During his first five years, Erdogan gave the strong impression that his Justice and Development Party (AKP) was both capable and committed to forging a new Turkey deserving of EU membership. A far cry then from the increasingly authoritarian and paranoid administration seen today, where officials openly blame rising opposition on a shady "parallel state" groups and

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Erdogan's top advisor warned that the country's enemies were trying to kill Erdogan using "telekinesis." Many point to the Ergenekon and Balyoz trials of 2008-12 as when it began to go wrong. Those trials saw hundreds of military and civilian officials jailed on charges of plotting to overthrow the government. Emboldened by having effectively neutered the all-powerful military, the government's attention turned to civil society with many previously independent institutions seeing wholesale staff changes including the state media, which became little more than a government mouthpiece. In the private sector, questionable changes of ownership has seen many media companies transferred to more government-friendly owners. Other media groups chose voluntarily to rein in their coverage, with unexplained sackings of writers and broadcasters openly critical of Erdogan or the government becoming a common occurrence. The fact that the state was banging up journalists to the point where Turkey now has more journalists in jail than any other country has also encouraged self-censorship. The "Gezi" protests of mid-2013, in which brutal police tactics left 11 dead and around 8,000 injured, provided further excuse for more brazen government attacks on civil society, with Erdogan choosing to blame social media and subversive groups for inciting discontent. On the latter he may have a point. His acrimonious split with powerful Islamic preacher Fetullah Gulen, whose Hizmet movement is reportedly strongly represented among senior police officials, is widely understood to have resulted in the police graft probes launched in late 2013, which forced the removal of four senior ministers and the subsequent leaks of dozens of recordings of phone calls implying corruption at the highest levels of government. In response, the government ordered the blocking for several months of YouTube and Twitter through which the leaks were disseminated. Cronyism and corruption have always been a problem in Turkey, but even the

I Cover story

most cynical of observers have been shocked both by the level of graft alleged and the resulting wholesale purges of alleged Gulen supporters in the police and judiciary. Russia is regularly described as a kleptocracy, as part of the Putin model is to keep a group of powerful state officials close to him and allow them to enrich themselves in return for loyalty. The word has yet to be applied to Turkey, although the distinction between the two countries is getting increasingly difficult to see. Markedly less shocking though has been the subsequent shelving of the graft probes and Erdogan's increasingly strident rhetoric about the threat from "the parallel state" – a euphemism for Gulen supporters within the state bureaucracy. The threat of more damaging revelations appears to have inspired recent draconian new internet laws that allow websites to be blocked within minutes without a court order, as well as planned new security laws which make it simpler for police to put phone taps on suspects. And here Erdogan has gone beyond even Putin, who has tightened the state's control over the internet but shied away from actually closing down websites or actually interfering with the freedom of speech online by overt means. All this should hurt Erdogan's popularity at the polls, but doesn’t. Some 51% of the vote that saw him installed as Turkey's first elected president was significantly higher even than the 43% the AKP received in local elections in March. Having made little secret of his ambition to rule Turkey as an executive president but lacking the two-thirds majority in parliament needed to make the necessary constitutional changes, it now remains to be seen whether the AKP can garner sufficient support in next year's general election.

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On current showing, creeping authoritarianism notwithstanding, few are betting against them succeeding. You looking at me? In Serbia, the unrelenting march of Aleksandar Vucic’s Serbian Progressive Party toward being the preeminent party of power is starting to cause some concern. Vucic has been carried to the top by a wave of cynicism after years of isolation and stagnation following the Balkan Wars in the 1990s. Prime Minister Vucic, a former information minister for the former strongman Slobodan Milosevic, is a man who gets things done: establishing peace in Serbia’s former province of Kosovo, arresting and jailing the businessmen who have looted the country, undertaking (or at least seeming to) painful economic reforms. Yet he is prickly and increasingly shows certain Putin-like traits: berating underlings on television in stagemanaged humiliation sessions; likes to be caught on camera doing daring deeds such as rescuing children in blizzards. Yet this has inevitably led to some scorn and ridicule, which either he or his flunkies then overreact to, such as apparently cyber-attacking websites, and pressuring editors of newspapers and owners of television stations to tone down the criticism. bne met him when he was deputy prime minister in 2013 and found a young man (he's 44) in a worrying hurry. His manner of speaking, adopting a grave tone when mentioning Kosovo, declaring "I don't care" in a loud voice with a steely stare when asked whether the Serbian people might not sign up to the pace of change he's pushing, are all done in the manner of someone whose character formation is struggling to keep pace with his meteoric rise. Like an extremely tall, slightly baby-faced Travis Bickle practising phrases in the mirror.

"Erdogan has gone beyond even Putin, who has tightened state control over the internet but shied away from closing down websites"

Unlike Orban and Erdogan who are fighting cultural wars at home and stoke nationalism to undermine their enemies at home and abroad, Vucic has so far avoided making any conspirational accusations against the EU and US. Quite the contrary actually – Vucic is trying to drag his country into the EU and is juggling the difficult task of pleasing traditional partner Russia and the US at the same time. With his attempts to reach out to old foes in Kosovo and Albania, Vucic is clearly being afforded some slack by the EU. But Hungary and Turkey are increasingly coming under the microscope in Brussels. However, in general the EU is proving, unsurprisingly, to be a paper tiger in all these developments. In October, Stefan Fule, the outgoing European Commissioner for Enlargement and European Neighbourhood Policy, admitted to bne that the Commission had not many powers to correct backsliders such as Hungary, though said tougher measures for future violators were being prepared. “We should be first of all stringent in our own cases to make sure there is no double standards,” he said, referring to the increasingly widespread feeling that Brussels often tells its members to do as it says, not as it does. In October the European Parliament held a debate late about the situation in Hungary regarding democracy, rule of law and human rights. Inevitably, this ended up in a ill-tempered shouting match as MEPs representing the Liberal group, the Social Democrats and the Greens raised questions concerning the independence of the judiciary and media freedom in Hungary, while MEPs of the European People’s Party and other conservative representatives accused the left of mounting accusations against the Hungarian government in light of their successive defeats in Hungarian elections. Given German Chacellor Angela Merkel's Christian Democratic Union is a leading member of that European People’s Party, some would argue there's little chance of the EU doing anything substantive about Orban anytime soon. That is likely to only encourage others to follow his lead.

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

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25 years after Mauerfall Nick Allen in Berlin

he busiest spot on the East Side Gallery in Berlin is the mural of Leonid Brezhnev’s full-on fraternal kiss with East Germany’s Erich Honecker, copied from a photo of the leaders’ meeting in 1979. Tourists admiring the artwork on this preserved stretch of the Berlin Wall invariably pose and lock lips here to giggles and the flutter of iPhone cameras. No matter that Gorbachev is often their best guess when pressed to identify the kissers, or that some might take it for a tribute to the city’s prolific gay scene. This is simply the hip Berlin vacation photo and quite enough Cold War immersion before they go in search of Hitler’s long-gone bunker. Cold War kitsch Okay, it’s easy to mock the tourists, and maybe they do all Google the kiss when they get home. But as Germany prepares

to mark 25 years since Mauerfall (the Fall of the Wall) on November 9, it is curious to observe Cold War history still in flux and evolving into a gaudy parody of itself. As the capital prepares commemorative events like the 10-mile Lichtgrenze (light border) of 8,000 illuminated balloons marking the Wall’s route, the Cold War tourism industry is also turning up the heat, all the way to GDR-themed standup comedy acts. There are GDR-décor hostels where you can slumber beneath Honecker’s portrait, novelty Trabant rides (East Germany's answer to the Lada), ¤10 painted wall chunk souvenirs (all genuine), and even Stasi "Funshirts", complete with the emblem of the East German internal security service that crushed so many lives over an almost 50-year reign. “It’s a slap in the face for the victims, as if someone would go round in an SS T-shirt,” said Stefan

Weinert, a documentary filmmaker whose new work "Die Familie" (The Family) looks at the impact on relatives of the deaths of 138 people shot dead trying to escape from the GDR. But serious reflection is there for those who seek it. The Berlin Wall memorial centre at Bernau Street, with photos of the victims, preserved guard tower and "death strip" between the parallel wall lines, is the most sombre relic. And while many Germans and Berliners baulk at the prospect of another anniversary splurge, it is part of a continuing and painful healing process. Only the passage of years has enabled some people to tell their stories. Historians are also still unearthing disturbing revelations about the GDR period, including Stasi collusion by respected members of reunified German society.

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One man who was shot twice while escaping from the GDR in 1963, Wolfgang Engels, joined a recent protest over awards conferred on a university rector who had been revealed as an ex-Stasi informer. Engels, 71, was shocked when elderly colleagues of the academic came up to him and hissed, “The Stasi should have taken better aim that night”. “That these people are still around us 50 years later and cling to their old beliefs shook me more than what happened in 1963,” he said. Built and enlarged from August 1961, the Berlin Wall was portrayed as an “antifascist barrier” intended to keep Nazis from sabotaging the nascent GDR workers’ state. In reality, it was meant to stop the outflow of skilled workers and their families to the West. Prior to construction, the flood of refugees threatened to destroy the GDR’s economy and overwhelm West Germany. Some 3.5m people fled west before August, including 100,000 in the first half of that year. But apart from surviving members of the old guard, few people would argue today that Mauerfall was a bad thing. Just as Mikhail Gorbachev knew that the Soviet Union had to reform in order to survive, the stubborn refusal of the East German regime to follow suit ultimately sealed its fate. Neighbours like Hungary and Czechoslovakia decisively pricked the bubble earlier in 1989 by opening their borders, allowing thousands of East Germans to flee to Austria. The demise of the Berlin Wall and the inner German border was only a matter of time. But the irony lies in the true agenda of Western leaders. While US President Ronald Reagan publicly demanded that Gorbachev “tear down this wall” in Berlin in 1987, there was an underlying fear of upsetting the European apple cart. Stirring the embers Nine months before the Wall fell, according to Gorbachev’s adviser Anatoly Chernyaev, Margaret Thatcher told the Soviet leader that the UK and Western Europe were “not interested in the unification of Germany”, nor in “the destabilization of Eastern Europe or the dissolution of the Warsaw

Cover story

Pact.” Reagan’s successor George H. Bush felt the same, she assured Gorbachev. Meanwhile, the economists are still thrashing out how much reunification has cost Germany since 1989. With estimates running as high as ¤2 trillion, the issue has triggered a fresh round of unseemly squabbling in this commemorative year. “Instead of recognizing and valuing this as a great feat of solidarity that we have accomplished in Germany, the discussion is being reduced to a one-sided transfer balance sheet,” Reiner Haseloff, the state premier of the east German state SaxonyAnhalt, told media. Nor does Cold War history end with the bill for the momentous changes of the 1980s, followed by the Soviet collapse in 1991. Kremlin foreign policy is again turning over the embers and sending tremors westbound with the annexation of Crimea and by waging a proxy war in Ukraine. In April, two German tabloids sought to do some historical revision by launching a petition to remove two Soviet T-34 tanks removed from their city centre pedestals and relocated because of Russia’s actions in Ukraine. “In an era when Russian tanks are threatening free and democratic Europe, we don’t want any Russian tanks at the Brandenburg gate,” the organizers said. The campaign failed after the German government said it remained committed to preserving Soviet war memorials.

I 15

There has been no such dedicated preservation at the most iconic Berlin Wall site of all, however. There is almost nothing left of the original installations at Checkpoint Charlie, with the last East German watchtower being removed in 2000 to make way for an office block. Now drenched in razzmatazz, the site’s only authentic remaining relic is the wooden checkpoint signpost. Still, like the Socialist kiss, the details don’t seem to matter much to visitors convinced they are getting the ultimate Berlin Wall experience. But for all the shuddering about commercialization, this could also be the best affirmation of the hunger for freedom that toppled the hated Wall after 28 years. That you can ride an open-top Trabant through East Berlin drinking champagne and not wind up in a Stasi cell, buy a random piece of painted concrete for ¤10, or simply not know who Erich Honecker was. Fast food giant McDonalds would seem to think so, having opened an outlet at the checkpoint site in 2009 in one undeniable affirmation of the West’s triumph over the Eastern Bloc. But for those with a broader Weltanschauung and palate, there is always the complimentary taster at the German Currywurst (curry sausage) museum round the corner.

I Perspective

PERSPECTIVE:

No such thing as a “safe haven” in emerging markets Dr Nicholas Spiro of Spiro Sovereign Strategy

hortly after the 2008 global financial crisis erupted, many investment strategists argued that emerging markets (EMs) had become anchors of stability.

Untainted by the problems of sub-prime mortgages, financially stricken banks and heavy debt burdens plaguing many developed economies, EMs – which at that time were hauling the global economy back from the brink of an economic meltdown – were even perceived to have “decoupled” from Western economies. But when the Eurozone crisis escalated dramatically in the second-half of 2011, the “decoupling” thesis was quickly debunked as investor sentiment towards mainstream EMs tracked the deterioration in market conditions in developed economies. In 2011, outflows from EM equity funds amounted to $46bn, compared with a record $96bn of inflows in 2010, according to data from JP Morgan. Last year’s “taper tantrum,” triggered by the unexpected announcement by the US Federal Reserve in May 2013 that it planned to start scaling back its programme of quantitative easing (QE) was the final nail in the coffin for the “decoupling” thesis: outflows from EM equity funds last year totalled $26.7bn, according to JP Morgan. Indeed EM equity funds are still suffering net redemptions this year despite enjoying huge inflows in the first-half of 2014 stemming from the significant improvement in sentiment towards EMs. So when rating agency Moody’s Investors Service, in a note on September 30, referred to Poland – one of the largest EMs accounting for 10% of JP Morgan’s EM local currency government bond index (GBI-EM) – as a “safe haven,” there are plenty of grounds for scepticism. To be fair, Moody’s treats Poland as a safe haven solely within the Emerging Europe region itself. Yet even this label doesn’t stand up to scrutiny. The zloty has been one of the worst-performing EM currencies against the dollar of late, losing a whopping 10.5% since midJuly and 1.2% since the start of October. Polish shares have fallen 3.5% since the beginning of this month – a sharper decline than in Turkey and Russia, and significantly worse than the 0.8% fall for EM equities as a whole.

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If a safe haven is an investment that retains its value or even increases its value in times of market turbulence, Polish assets hardly qualify on that score given their status – in particular the zloty – as a proxy for sentiment towards the Emerging Europe region as a result of Poland’s deep and liquid capital markets. Indeed over the past several years, Poland has become more sensitive to shifts in risk sentiment. In 2010, foreign investors accounted for some 20% of Poland’s local currency government debt market. Now, they hold more than 40% of Polish domestic bonds – one of the highest shares in EMs along with Hungary, Malaysia and Indonesia. The Fed’s withdrawal of monetary stimulus and the persistent uncertainty about the timing and pace of US interest rate hikes have thrown the vulnerabilities of EMs into even sharper relief. More resilience There are no safe havens in developing economies. There are, however, countries whose financial markets are more resilient than others, partly because of their stronger underlying fundamentals. Moody’s is right to attribute Poland’s relative resilience to the country’s “stable economic performance as well as its sound and predictable policy framework.” Despite the high share of non-resident investors in Poland’s bond market, the yield on the country’s 10-year domestic debt currently stands at just below 3% – down from 4.75% at the end of January. Although the rally stems mainly from expectations that the European Central Bank (ECB) will eventually be forced to launch full-blown QE (and that Poland’s own central bank will once again trim interest rates, which is likely to happen at its next rate-setting meeting on October 8), Poland’s strong fundamentals ensure that its bond yields remain at relatively low levels during periods of financial market stress. While the Czech Republic is the closest thing there is to a perceived “safe haven” in Emerging Europe, mainly because of the country’s modest debt levels, very low foreign currencydenominated debt and limited foreign participation in its domestic debt market (14%), Poland qualifies as one of the cleaner shirts in the dirty basket of developing and developed sovereign credits. Playing in Poland’s favour is the persistently favourable view of the country in the eyes of investors. Poland has enjoyed good PR since the 2008 financial crisis erupted because of the country’s solid track record of growth – the nation’s positive growth rate at the height of the crisis in 2009 still figures prominently in articles about Poland in the financial media – and, more recently, the woes of Russia and Turkey which make Poland the only large market in Emerging Europe whose reputation is still intact. In the realm of investor perceptions, Poland is one of the most successful EMs. Poland’s brand is strong and, for the time being, is helping mask many of the country’s domestic and external vulnerabilities. This shows that the qualitative determinants of sovereign creditworthiness are just as important – if not more – as the quantitative ones in the minds of investors.

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Chart I 17

CHART:

Russia

Is Russia still an "ethical" investment? Source: Sources: Heritage Foundation, 2014 Index of Economic Freedom; Reporters Without Borders, World Press Freedom Index 2014; World Bank, Doing Business 2014; Transparency International: Corruption Perceptions Index 2014. Ethical index score (0-100) 0.0

s Russia still an ethical investment? bne sources say some fund managers have been pulling their money out of Russia, afraid of reputational risks or simply because they don’t want to support a military aggressor on principle. So just how does Russia stack up against its emerging market peers for things like business freedoms, corruption, free press and so on? Certainly the Russian stock market is being punished by this sort of thinking: the RTS index broke out of its 1,110-1,400 range at the end of October on the downside on the back of more Russian war games in the Baltics, amongst other bad news. This month’s chart attempts to shed some light on the question by comparing a raft of indices from organisations like Transparency International, Reporters without Borders and the World Bank. Last first: we averaged all these indicators together to give an overall score to every country that includes things like press freedoms, property rights, corruption and so on. On this (admittedly somewhat arbitrary) basis Russia comes out in the middle of the range, but slightly ahead of all its BRICS peers, bar South Africa. Russia's overall score was 49.9 out of 100, versus China's 50.9, India's 56.9 and Brazil's 57.3. South Africa was far ahead at 63.6 (where 100 is best) putting it on a par with many European countries. Other notable countries that did well include Kazakhstan (61.1) and the standout of Georgia (71.8) that is on a par with the leading economies in western Europe. The other noteworthy result was Ukraine (50.6), which is slight worse than Russia, yet is seen to be good enough to receive an invitation to partner with the European Union.

100.0

Flicking through the various subcategories and as might be expected Russia score card is mixed. It does badly on property rights (25), corruption (22), and financial freedoms (30). But in none of these is it that much different from its peers (and on corruption it is again better than Ukraine, which Transparency International dubbed "the most corrupt country in Europe"). However, in other categories Russia does pretty well compared with its peers. On press freedoms Russia (57.2) easily beats China (27) and Turkey (54.1), which currently has the most journalists in jail in the world. And in a few categories like fiscal freedoms (85.6) Russia scores better than many developed world countries. For example, Russia is in the global top ten for the quality of its tax administration – a function of the extremely simple flat tax regime it adopted. Putting the question the other way round: if investors exclude Russia as an unethical investment, then they would probably have to exclude all emerging markets because they suffer from more-or-less the same problems. The final question to pose is whether Russia should be excluded for its unprovoked military invasion of Ukraine. If this is grounds to withdraw investment, then fund managers might also be forced to withdraw their investments in the US, as Washington was arguably responsible for launching an unprovoked war on Iraq.

To see the interactive version, go here: http://www.bne.eu/ content/story/bnechart-russia-still-ethical-investment

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bne November 2014

Opposition Bloc, which came in fourth place with 9%. Pro-European nationalist populists Oleh Lyashko and his Radical Party, and Yulia Tymoshenko with her Batkyvschina party, were on 8% and 6% respectively. Turnout decisive The pro-European vote was helped by a turnout that neared the 70% mark in the West Ukraine regions of Lviv and Ternopol, which boosted the vote for Yatsenyuk's People's Front while also propelling Lviv mayor Sadovyi's Sampomich party to a surprising third place.

Ukrainians elect proEuropean parliament bne

krainians have elected a proEuropean parliament in snap elections on October 26, according to preliminary results. The results show pro-European parties headed by President Petro Poroshenko and Prime Minister Arseny Yatsenyuk respectively are neck-and-neck for first place, with 20% of votes counted. Both men said they would form a coalition with each other. The results broadly tally with preelection opinion polls and exit polls in giving a large majority to pro-Europe parties. But with parties registered by Poroshenko – the Petro Poroshenko Bloc – and Yatsenyuk – People's Front – hardly older than the election campaign itself, and around 30% of voters undecided down to the wire, the exact distribution of voters among the proEuropean parties was always uncertain. As it was, it seems voters have given a rebuke to Poroshenko, who took a barnstorming 52% in presidential elections held May 25 but whose eponymous party has now managed to garner less than half of that, following a lost war against Russianbacked insurgents in East Ukraine and the collapse of the currency in the

intervening months. Poroshenko's votes went to Yatsenyuk's People's Front, who like Poroshenko is a pro-Western liberal technocrat, but has consistently taken a more hawkish position on Russsia than has the president. Exit polls suggest that the two parties would take over 50% of seats in the Rada, which is elected using a mix of proportional representation and firstpast-the-post constituencies. Surprise performer of the day was the Samopomich party of pro-European Lviv

The collapse of the pro-Russian vote is the result of Ukraine's loss of control over its former pro-Russian heartland of Donbass and Crimea in the east, following Russia's annexation of Crimea and Russian-backed rebels seizing control of Donbass. But there were worrying signs of political disaffection across the Ukrainian-controlled south and east. The voter turnout was low at just over 30% in the Ukrainian-controlled parts of Donetsk and Luhansk regions, and around 40% in Odesa and Kharkiv regions. Exit polls showed that of those who turned out to vote across East Ukraine, around 30% voted for the Opposition Bloc, headed by figures associated with the former administration of ousted president Viktor Yanukovych. Yanukovych's Party of Regions, which governed Ukraine

"There were worrying signs of political disaffection across the Ukrainian-controlled south and east"

mayor, Andri Sadovyi, which surged to third place with just over 10% of the vote.

until Yanukovych's ouster in February, did not run in these elections.

The traditional opponent of Ukraine's pro-European groups – the pro-Russian East Ukrainian voters –were represented this time round by the newly formed

The only immediate response of rebel leaders in Donbass to the Ukrainian parliamentary elections was to announce that they would not put the clocks back

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to winter time like the rest of Ukraine did on October 26, but retain summer time, thus switching to Moscow time, as Crimea has already done. Coalition talks Pro-European forces announced that talks on a coalition had already started. The strong result of PM Yatsenyuk's People's Front means he is almost certain to retain his job. On the other hand, President Poroshenko has until now lacked his own political force in the Rada. While the result of his Petro Poroshenko Bloc came in lower than expected, it will still entitle him to put his own people in key parliamentary and government positions. Yatsenyuk was staying mum about the demands his strong performance will enable him to make, saying only that the government should be "comprised exclusively of professionals able to conduct reforms needed to change Ukraine," in a statement at his party headquarters in the evening after the vote. The new government will have to take responsibility for swingeing austerity measures demanded of Ukraine by the International Monetary Fund and EU, the country's main donors, to fend off a looming default. One potential source of friction between Porosenko and Yatsenyuk in coalition talks, according to analysts, could be Poroshenko's drive to secure a coalition with a constitutional majority of over two-thirds of seats, in order to amend the current constitution. This would necessitate including in the coalition third place Samopomich and smaller parties. "We will offer [participation in the coalition] to very many parties… in order to attain a constitutional majority," Poroshenko said in the wee hours of October 27. But Yatsenyuk is unlikely to see the necessity of taking on board smaller parties, and indeed in changing the constitution, which in its current position provides for a strong prime minister, Volodymyr Fesenko of Penta political consultancy told bne.

Eastern Europe

I 19

Poland's patience with Ukraine begins to fray

Jan Cienski in Warsaw Poland has been Ukraine's most voluble supporter in the EU and a strong backer of sanctions against Russia, despite the consequences for the Polish economy – but Warsaw's patience with Kyiv is beginning to fray. There is a growing sense that Poland is being taken for granted, that Ukraine is putting its own domestic political and economic interests ahead of cultivating a close relationship with its western ally. The latest irritant is Ukraine's refusal to buy Polish coal. Ukraine's coal output plummeted by 96% in September compared with the same period last year – a consequence of the war in eastern Ukraine, where most of the country's coal industry is located. So when Poland offered to sell coal to Ukraine, the feeling was that the Ukrainians would jump at the offer of diversifying some of their energy needs away from Russia. But instead, Ukraine decided to keep buying Russian coal. “We hear that that there is only interest in Polish coal from the Ukrainian side on the condition that it is free,” Janusz Piechocinski, the economy minister, said in a radio interview on October 15. “I am disgusted by that.” Poland is also furious that Ukraine has for months blocked the import of some Polish meat for health reasons. “If there is a continuing problem with 2,000 tonnes of meat on the bone, please don't be surprised if there is a rise in unfriendly opinions about Ukraine,” said Piechocinski. The complex internal dynamics of Ukrainian politics are also annoying Poles. In October, thousands of Ukrainian nationalists demonstrated in Kyiv, calling for the recognition of the wartime Ukrainian Partisan Army. UPA, which has strong roots in the west of the country, had a complicated war, wavering between support and opposition to the invading Germans while fighting the Soviets. Members of the guerrilla force also helped massacre local Jews, and the UPA ethnically cleansed western Ukraine (which before the war had been eastern Poland) by killing about 100,000 Poles. Leszek Miller, a former Polish prime minister and head of the ex-communist Democratic Left Alliance opposition party, tweeted on October 14, “March of UPA supporters in [Kyiv]. `We are proud.' Of what? Of massacring Poles in Volhynia [a region in western Ukraine]?” The friction is likely to strengthen Poland's new foreign policy direction, which is much more cautious about taking a leading role over Ukraine. In her maiden address to parliament at the beginning of the month, Ewa Kopacz, the new prime minister, stressed that Poland would no longer be out in front of other EU countries when it comes to policy on Ukraine. “It is impermissible for Poland to be isolated as a result of setting itself unrealistic goals,” she said.

I Eastern Europe

bne November 2014

exclusive interview with bne from his home in Singapore. "The conflict in Ukraine has certainly been a setback, but it's not the end of the world. [US oil major] Exxon just announced that it's found oil in the North [Arctic] and [even if] Exxon closes this camp and goes home, then the oil is still there and it will be exploited by someone. This is a blip and no more," Rogers says confidently.

Photo: Gage Skidmore

Jim Rogers calls West "foolish" and invests again in Russia INTERVIEW:

Ben Aris in Moscow

egendary investor Jim Rogers calls the US government foolish, arguing that the only longlasting effect which Washington's confrontation with Moscow over the fate of Ukraine will have is to drive Russia into the arms of the Chinese – something that is not in the US' longterm interests. Best known for being the other half of George Soros' Quantum Fund that forced the Bank of England out of the European Exchange Rate Mechanism in the 1980s and made the two men super-rich, Rogers – who was hired by the Russian investment bank VTB Capital last year as an advisor – said he started

to invest in Russia this March, following Russia's annexation of Crimea. Despite the fraught political situation and fallout from the civil war in Ukraine, he says he is still in the money.

Commentators have warned that the West's attempts to isolate Russia will set the country's development back and the economy, according to the World Bank's latest economic forecast released in September, is already close to stagnation. However, Rogers takes a longer-term view. Being cut off from Western finance and technology will slow Russia's development, but that does not mean it will be isolated. "The upside of the US actions will be to force Asia and Russia together. It will be exploited and China and Russia are welcoming each other with open arms. In the long run this new relationship will hurt the West more than it hurts Russia," says Rogers, who speaks with just a slight hint of an accent from Alabama where he grew up. Other places to go The latest round of sanctions imposed on Russia in September have also more-or-less cut the Russian government and the country's leading companies off from the international capital markets in London and New York, but that problem too can be overcome, says Rogers. "Hong Kong and Singapore are not New York and London, but they are both growing

"The conflict in Ukraine has certainly been a setback, but it's not the end of the world"

"Two years ago Russia was like the backend of the world and no one was paying attention. Now the US has shot itself in the foot," says Rogers in an

rapidly and there are gigantic pools of capital in Asia," says Rogers. "The problems in Eastern Europe will help the Asian market to develop and catch

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Eastern Europe

up with the West. There is a lot of money in Asia and expertise."

out to destroy a legitimately elected government and it's backfired."

Behind the West's actions lie the assumption that cutting Russia off from Western money and technology means it has nowhere else to go. But that is not true, argues Rogers. "I'm stumped when people call South

Buy on sound of cannons Rogers is nothing if not a contrarian. Having made his fortune by betting against a central bank, he is playing that role again with his Russian investments. "Russia is perhaps the

"We need to engage in Russia – open our hearts and minds to Russia – as engagement is always better than isolation" Korea an emerging market. Singapore is also an emerging market, but yet it is one of the richest countries in the world on a per-capita basis," says Rogers. "Emerging markets are only those countries that you read about in the Financial Times or the New York Times." It is these assumptions that have led policy astray in the West and Rogers thinks the US will pay a price, while investors with the courage to continue to invest in Russia and the other emerging markets will benefit from these misperceptions. Rogers is quite outspoken, blaming "bureaucrats" for mismanaging US foreign policy. "The USA is acting foolishly and accelerating the change in the geopolitics of the world,” says Rogers, recalling the well-known leaked recording with US Assistant Secretary of State for European and Eurasian Affairs Victoria Nuland telling the US ambassador in Ukraine, "fuck the EU, we want to bring down this government.” Rogers complains that the US was encouraging people to bring down an elected government. "[President Viktor] Yanukovych may have been a horrible guy, but he was elected. Presidents George Bush and Barack Obama may also be horrible, but they were also elected. However, the US set

most hated market in the world certainly it's in the bottom five. But the reality on the ground has started to change. [President Vladimir] Putin is also a different man to what he was in 2000 when he was elected," says Rogers, who says he has been following the country's path since he visited the Soviet Union as a student in 1966. Rogers began investing in Russia after the market collapsed in March after the annexation by Russia of Ukraine's Crimean peninsula. "You shouldn't listen to me as I'm the world's worst market timer, but I am surprised and delighted that the market today is still above its levels in March," says Rogers. And he bought again in May, and says he is looking to buy more, although his Russian portfolio still represents a tiny part of his overall investments. Amongst the companies that Rogers has invested into is the Moscow Exchange that was floated in February 2013 following the merger of Russia's two biggest stock markets, the RTS and Micex. "Putin has committed himself to making Moscow an international financial centre. Many may find that laughable, but it doesn't matter if it works; Russia will spend huge amounts of money to try and make it work," says Rogers.

I 21

Other companies he's invested in include Aeroflot and fertiliser producer Phosagro, of which he was recently appointed a director. "I'm wildly bullish about agriculture and definitely bullish about Phosagro," says Rogers. "Phosagro is an opportunity in the agricultural sphere, because agriculture is only going to increase in demand. It's a very wellplaced company and even if sanctions are imposed against it, it is still has the opportunity to sell to Asia and other countries." With peace now possible in Ukraine, Rogers thinks that once investors switch from following current affairs to looking to the future again, investment will return. "There is an old adage: invest when there is blood on the streets and usually it is correct. Investors have very short-term memories – it’s a fact. Who remembers Tiananmen Square in the 1980s? But today we are pouring trillions of dollars into the Chinese economy," he says. "We need to engage in Russia – open our hearts and minds to Russia – as engagement is always better than isolation."

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Gulag Archipelago. They thoroughly modernised the 25-year-old plant and launched their flagship Veiro branded top-end two- and three-ply toilet paper into an increasingly competitive market.

Russia's economy is in the toilet Ben Aris in Moscow

ussia's ruble is tanking and growth has stalled. The economic news could not be much direr. But even in the worst economic climate there is one product that people will always need – toilet paper. "For the tissue paper market there has been practically no crisis, as we are a cheap product and, after bread and milk, probably the third most essential item in the average shopping basket," Mark Reznik, CEO of Syktyvkar Tissue Group (STG), Russia's second biggest maker of quality toilet paper, tells bne. One of the most remarkable differences between the current crisis and the last big one in 1998 is that the Russian population has so far been largely sheltered from the pain. Russia's macroeconomic picture is bleak, but at the street level wages have continued to rise by about 10% a year since 2008, supported by the slowly shrinking working population, which has also led to record low post-Soviet unemployment rates. It has only been in the last half a year

that consumer spending has started to slow and Russians became worried enough about a currency devaluation to start buying dollars again. The toilet paper business turns out to be a case study in the microeconomic impact of the crisis on Russia's development. At this level the picture

By 2005 Russia's boom was well under way and many Russians had already moved beyond buying little luxuries, such as imported cigarettes or cured meats, to bigger ticket items like washing machines and cars. Changing up from Soviet-era single-ply to more luxurious products like Veiro was a no-brainer for most people. Quality toilet paper was already in high demand, yet the market still has a long way to grow. "In America the people consume about 25kg of toilet paper a year, whereas in somewhere like Germany it is 15-20kg. In Russia people only consume 3kg a year, but we think the market should be closer to southern Europe where they consumer about 8kg a year. There is a huge growth potential – the market should at least double or triple in size in the coming years," says Reznik. From the launch in 2005, production soared from 14 tonnes of tissue a year in 2005 to 44 tonnes in 2013 – enough to make 240m rolls of toilet paper. Production increased five-fold, but revenues have gone up ten-fold, from RUB299m ($7.5m) to RUB2,419m

"In Russia people only consume 3kg a year, but we think the market should be closer to southern Europe where they consumer about 8kg a year"

looks much more like business-asusual, which has also supported Russian President Vladimir Putin’s sky-high popularity. STG comprises a group of private Russian investors who bought out the Syktyvkar paper mill in 2005 in the Komi Republic, one of the regional capitals of Solzhenitsyn's

($60.4m) over the same period. "The increases are due to the factory's modernisation and the growth of the underlying market, which has increasing by 10-12% a year over the last decade," says Reznik. Roll out the rolls By 2008 STG's factory was running at close to full capacity and the company

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Eastern Europe

began to look at raising money to build a second facility. At first, STG tried unsuccessfully to sell shares in an IPO to raise the investment cash. After the 2008 collapse of Lehmann Brothers, the Russian stock market index recovered from its low of about 500 in the spring of 2009 to over 2,000 by 2011, approaching its all-time high of 2,488 set in May of 2008. It seemed like a good time to float the company

the financial hatches. The economy has been just ticking over ever since. Business confidence has yet to recover and the fight in Ukraine has only made things worse; the RTS has been range bound, trading between 1,100 and 1,400. STG's decision to pull its IPO was the right one. But the company still wanted to raise money so it hired boutique investment bank Velles Capital to find a partner.

"For the tissue paper market there has been practically no crisis" on the local Moscow Exchange. "We had done the paperwork and were ready to list on MosEx. There was an interest in the press and also amongst potential investors. MosEx was keen to see the IPO happen as they were promoting [small business] IPOs on its exchange," says Reznik. STG were hoping to raise RUB500m ($12m) from the sale of a 25% in the company, but the management pulled the IPO at the last minute as the market began to fall heavily in May 2011, as fears of a third wave of the crisis in Europe emerged. This spilled over to businesses, which cancelled investment plans and battened down

Eventually a 30% stake was sold to VIY Management, a private equity fund co-founded and managed by Andrei Yakunin (the son of Russia Railways boss Vladimir Yakunin), which also recently bought into chocolate maker French Kiss. At the same time STG took a loan from Gazprombank and used the capital to build a second plant in the Yaroslav Oblast, a few hundred kilometres from Moscow, Russia's biggest regional toilet paper market. "It was a brownfield development, on the site of a former mechanical parts factory. But that meant it came with power, railway links, all the infrastructure

Tissue market share in Russia, % total in 2012

I 23

you need," says Reznik. "Raising the money from the bank was not hard. They can see there is a real project from an existing company, which has revenues and collateral to put up. We could have taken the loan from anyone," says Reznik. Wiping clean the competition However, STG is not the only group to identify toilet paper as a lucrative market. STG's Veiro rabbit finds itself vying for attention on shop shelves with Kleenex's cute Labrador puppies and Turkish producer Metsa Tissue Corp. cutsie lambs. (For obvious reasons all the toilet paper makers use cute animals for their brands, as they canâ&#x20AC;&#x2122;t very well put attractive bottoms on the packages.) As of the end of last year STG has the second largest market share (7%) after SCA's 20% that trades under the Zewe brand and is Europe's biggest producer of toilet paper. The other large players include NChKBK (Naberezhnochelninsky Kartonno-bumazhny Kombinat National Enterprise), a Soviet-era factory that continues to churn out the pink pre-1991 style single-layer cheap toilet paper, but has a 12% market share. And half the market is still made up of small legacy toilet paper makers left over from the Soviet era that have done little to change their ways.

Tissue market share in Russia, % total in 2020 (estimate) Other 19% SCA 21%

SCA 20% Other 49% NCHKBK 12%

Arkhbum Tissue Group 10%

NCHKBK 9%

Hayat 11% Syassky TSBK 9% STG 7% Metsa Tissue 3%

Syassky TSBK 12% Metsa Tissue 5% STG 13%

I Eastern Europe

The market share of the single layer toilet paper makers is still big, but is falling as average incomes rise: in 2013 single-layer toilet paper accounted for almost half the market; two-layer paper was 45%; and only 8% was the top-of the-range threelayer paper. But Reznik says the single-layer business should shrink to about 25% by 2020 as competition increases and prices fall in the next few years. All the main players are investing in new production, and new players such as Hayat from Turkey and Arkham Ticcuo, Ukraine's leading tissue producer, are expected to enter the Russian market shortly, eating into the share of the single-layer producers. As a result, the market will likely suffer from an oversupply for several years, says Reznik, that will peak in about 2018 and drive margins down into the low teens from about 23-24% now. "The overcapacity will kill off the small firms left over as a legacy of the old system, which account for just under half of total production now," says Reznik. "By the end of last year their share had fallen to 44% and we expect it will be 26% in 2016." A private future Outside competition is going to get stiffer, but the real threat to STG's margins will come from inside Russia. Russian retail is rapidly organising with the leading supermarket chains rolling out new branches without pause, as like the toilet paper makers they have also been largely unaffected by the crisis. The main retailers are increasingly introducing "private label" brands for generic products like packets of pasta, cans of corn or toilet paper. The thing with toilet paper is that it is easy to make and no matter how many layers of paper you use or how cute your animal is, at the end of the day if the supermarket's own version meets some basic quality standards, it will always win on price: in Germany 80% of toilet paper sold is already sold as the private label of the leading

bne November 2014

Private label toilet paper market share 2013 90%

Belgium

80 70

Germany

Denmark

Switzerland

France

Austria UK

Spain

Netherlands

Portugal

Canada

Italy USA

Finland

Russia

Toilet paper use (kg/yr) 2011 2015 25,0 20,0 15,0 10,0 5,0

USA

Germany Japan

S.Korea Brasil

supermarket chains and the range in the rest of Europe is between 30% and 60%. In Russia the share of private label is currently 10% of the total market, one of the lowest shares in Europe, but that is growing by 12% a year, says Reznik. The private label segment will inevitably eat into STG's profit margins in the long term, but its rise also presents a new business opportunity. The company doesnâ&#x20AC;&#x2122;t produce its own paper pulp, but buys the raw cellulose it needs from the market: STG uses

China

Russia Indonnesia World

70% of this raw cellulose for its own tissue production, but the other 30% is already used to manufacture private label tissues for corporate customers â&#x20AC;&#x201C; mainly in the hospitality and medical industries. The private label business currently accounts for 9% of STG's revenues, but Reznik expects this to rise of 25% by 2020. "We expected to retain our current market share of our own brand toilet paper, but in the long term the private label production will obviously become a more important part of the business, even though the margins there are lower," says Reznik.

bne November 2014

Eastern Europe

I 25

to leverage its domestic expertise, though this will likely delay production estimates by several years. As such, the previous goal of producing 1m barrels of shale oil a day by 2020 is not likely to be reached until 2025 at the earliest. Nails in the shale-coffin Since Russia began throwing its military weight around Eastern Europe in March, the EU and US have walked essentially hand in hand in their sanctions policy against Moscow. Sanctions have effectively restricted Western companies’ participation in Russia’s Arctic and shale sectors. These sanctions are compounded by restrictions already in place that will limit the transfer of technologies developed on US projects.

Russia shale-acked Joe Parson in Strasbourg

ith the oil price falling to $85 and Western sanctions kicking in, Russia’s dreams of exploiting its huge shale oil resources are about to be shattered. The US Energy Information Administration in 2013 estimated that Russia holds the world’s largest shale oil reserves at 75bn barrels of recoverable crude oil, giving rise to hopes in Moscow the country could mirror the massive shale boom in the US and help offset dwindling output from mature fields in West Siberia. Shale oil is liquid crude trapped within geological shale rock formations that have not merged into a conventional reservoir. Because this oil is trapped in small and disparate pockets within porous shale rock, exploitation of these formations requires a combination of horizontal drilling and multiple-stage hydraulic fracturing, or fracking – technologies that were refined during the US shale boom. The price of Russian crude is historically closely tied to Europe’s Brent oil price,

which as of October 15 was trading at a four-year low of $85.27 a barrel. Russia’s own export blend price averages only 1.5% below Brent, thus it's rapidly approaching the $80 break-even price for Russia’s shale projects to be economical. Some analysts assert that the break-even price for these projects is actually above $90, given unforeseen expenditures and lessons learned

Before the Western sanctions were imposed, a slew of companies were involved in the Russian oil sector, most notably ExxonMobil, Shell, Total, BP and Statoil. Total’s CEO, Christophe de Margerie, commented on September 22 that its joint venture with Russia’s independent major Lukoil has ground to a halt due to the sanctions. Salym Petroleum Development (SPD), a longstanding Shell and Gazprom Neft venture, has likely already fulfilled initial exploration and development investments and so might be insulated from the sanctions in the near term, but Shell announced it is no longer able to continue work with SPD. Although BP and Total could resume certain generic geological exploration activities, the companies

"Sanctions have effectively restricted Western companies’ participation in Russia’s Arctic and shale sectors" from exploiting the US Eagle Ford and Barnett shale deposits.

have shown no indication they intend to violate the spirit of the sanctions.

As if the economics weren’t bad enough, sanctions have forced US and European companies to halt or reduce their shale development plans. Russia could seek

Meanwhile, Rosneft’s continued participation in ExxonMobil’s US operations is unlikely given the controversy over the latter’s continued

I Eastern Europe

Another voice silenced in Russia bne Russia's leading quality independent newspaper Vedomosti is set to be sold to businessmen close to Russian President Vladimir Putin, in a move that will further narrow the space for critical opinion in Russia's media. According to Bloomberg, businessmen close to the president are preparing to buy the respected paper that was founded in 1999, only months before Putin shot to power on the back of a war against militants in Chechnya. At its launch, the paper advertised with the slogan, "Any oligarch can buy us. At kiosks," referring to the purchase months before of rival Kommersant by the late oligarch Boris Berezovsky. The paper was co-founded by the Wall Street Journal and Financial Times, each of which hold 33% stakes in the paper. Finnish media outfit Sanoma owns the remainder. While Vedomosti has a print run of only 75,000, its high standard of reporting has lent it wide influence. Despite its foreign ownership and frequent criticism of the government, the paper seemed to have been accepted as an institution and an integral part of Russian public life, read in the Kremlin while also enjoying access to the top figures in Russian politics and business, with Prime Minister Dmitry Medvedev having being interviewed as recently as September. The paper has also run hard-hitting and respected investigations into alleged corruption in the Kremlin. In particular the paper has explored the links between Putin and energy and finance businessmen such as Gennady Timchenko, Arkady Rotenberg and Yury Kovalchuk – Putin friends of many years standing, who have enjoyed meteoric rises to wealth during his time in power. It is these investigations that may have prompted the paper's sale, reckon experts, since they largely served as a basis for the West to impose individual sanctions on these businessmen as a means of punishing Putin over Russia’s aggression in Ukraine. As part of a wave of anti-Western hostility in response to sanctions, Russia's Duma passed a law restricting foreign ownership of any media resource to a total of 20%, prompting Vedomosti's owners to seek a Russian buyer. Putin signed the bill into law on October 15. According to Bloomberg sources, it is likely that precisely the businessmen close to Putin who were subjects of numerous Vedomosti investigations have now acquired the paper, in the form of either Gazprom Media or banker Yury Kovalchuk. However, Bloomberg reports that in order to make the deal acceptable to current owners, there may be an intermediary buyer in the form of Peter Gerwe, a Moscow-based American with Russian backing. Gerwe confirmed in an email that he is interested in the assets, but denied he would act as an intermediary. Putin’s deputy chief of staff, Vyacheslav Volodin, accused Vedomosti of serving foreign interests at a meeting with Russian newspaper editors in September, according to Tatiana Lysova, the paper’s chief editor. Another respected Western-owned investigative publication, the Russian edition of Forbes, is threatened by the restrictive law on media.

bne November 2014

operation within Russia’s Arctic. On October 10, Norway effectively cut off Statoil’s potential involvement by announcing its support for the EU’s latest round of sanctions imposed on September 11, which included the sanctions on oil and gas technologies. Priced out The oil price has actually been on a downward trend since 2001. This is a catastrophe for a 2014 Russian budget that relies on an average oil price for the year of $100. Bloomberg analysis says the oil price would have to rally for the rest of the year near $117 in order to average out third-quarter declines, while The Economist claims Russia might require an average oil price in 2015 of $110 to balance the budget. Previous long-term forecasts of rising oil prices relied to a large extent on assumptions that demand in Northeast Asia was set to continue growing – an assumption that has since been undermined. The collapse in the oil price poses a very distinct threat to Russia’s nascent shale sector. Rosneft has frequently compared its shale deposits to ExxonMobil’s operations at the Texas Eagle Ford shale deposit. Analysis by The Oil Drum, a website devoted to energy issues, put the actual break-even price for shale oil produced at Eagle Ford above $90 a barrel. If these comparisons are substantive, then Russian projects are in peril. Without government support, outside investors are not likely to stick with Russian projects in the near term. Last year, Gazprom Neft’s head of Geological Research said that the break-even price for Russia’s shale is $60-80. The break-even price includes the amount of money necessary to cover day-to-day operating costs as well as initial capital investment. The break-even price is likely a very lowend estimate given that even Rosneft estimates for only operating costs range up to $40 per barrel. Home-grown solutions Many of Russia’s domestic oil companies have some experience in

bne November 2014

Eastern Europe

"As such, the previous goal of producing 1m barrels of shale oil a day by 2020 is not likely to be reached until 2025 at the earliest" both horizontal drilling and fracking, which are also used to exploit conventional deposits of oil and gas, but few believe this will be enough to make up for loss of Western know-how and technology. Surgutneftegas, a conservative oil company with murky ownership and suspected strong ties to the Russian leadership, has been exploring potential shale deposits in West Siberia, but any economic discoveries have yet to be announced. Some suspect that

exploiting unconventional oil and gas. Indeed, the entry of a governmentfavoured services company could well create obstacles in attracting necessary outside expertise within the conventional oil sector.

recent legal actions by the Russian authorities against conglomerate AFK Sistema and its owner over the controversial acquisition in 2004 of the oil company Bashneft could be driven by Bashneftâ&#x20AC;&#x2122;s advanced experience in fracking. Bashneftâ&#x20AC;&#x2122;s production from fracking in 2013 was double that achieved at Rosneftâ&#x20AC;&#x2122;s most successful Samotlor field. And Kremlin plans to create a national oil services company are unlikely to substitute Western expertise in

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

In the medium to long term, it is likely that if Western sanctions persist, then exploration licences that have been granted to foreign companies but which are not currently being exploited will be revoked. It is possible, though unlikely, that Russia could revoke these licences as a retaliatory measure to Western sanctions. Russia might be able to supplement Arctic investment from Asian companies, but there is no such near-term alternative for the shale oil sector.

What you need to know

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www.bne.eu

I Eastern Europe

bne November 2014

Crimeans compete for best Russian wine title Ben Aris in Krasnodar

ussian sommeliers, oenophiles, government officials, businessmen and bibulous journalists turned out in force to attend a gala dinner in the grand hall of the former imperial vineyards of Abrau-Durso on October 18 next to the Anapa lake in Krasnodar. They had assembled to celebrate the annual award of the title of "best wine in Russia" to the leading producers in the country. The big difference with this year's competition is that the Crimea counts as "Russia" for the first time and wineries from the former Ukrainian peninsular all made the trip too, as they have been locked out of their traditional Ukrainian market and have little choice but to build up their business in the rest of Russia.

The main event was the result of the "best Russian wine for 2014" competition, where much slurping and sloshing of wine accompanied the announcements as the audience had a taste of each of the five finalists. The white wine category was won by a 2011 vintage from the wellknown (in Russia at least) Chateaux le Gran Vostok, produced by Elena Dnisova, a fruity and crisp beverage that would not be out of place in any good Western restaurant. The winner of the red wine category went to Verdernikov's 2012 Krasnostop Zolotovsky (a well-known grape in Russia), which has established itself as one of the very best local wines and is already on the menu at the

Ritz-Carlton in Moscow, Russia's most exclusive hotel. "The Russian wine industry is coming up very quickly, probably more quickly than somewhere like New Zealand's, which took many years to mature," says Roger Joseph, an international wine entrepreneur, former wine columnist for The Telegraph and one of the judges of the competition, who has been coming to inspect Russia's vineyards for about a decade. After the awards ceremony was over, it was time for what all the participants were looking forward to most; down into the cellars and a chance to try many of Russia's leading wines. But the talk quickly turned to politics. At least four of Crimea's leading wine

bne November 2014

producers were official present at this year's competition, as they are now official "Russian producers." Complex bouquet Their reaction to the sudden change of statehood was decidedly mixed. "We were Russian before and now we're back!" gushed Irina Pavlenka, director Novi Svet, one of Ukraine's best-known classic champagne producers in Crimea. The factory was founded by the same prince Galitsin that set up AbrauDurso and was until recently owned by the Ukrainian state. "We plan to in double our production on the Russian market to 2.5m bottles a year," Pavlenka said with enthusiasm, pointing to the increasingly affluent society of 143m people. Since Crimea's annexation, Novi Svet's sales are already rising. Other producers were less sanguine. The sales director at the Esse stand, who didn’t want to give his name, was stoic about the change over. "What can we do about it? We weren’t really given a choice," he said with a glum face. Owned by Ukrainian entrepreneur Igor Samsonov, Esse is the maker of a well-known (and extremely palatable) red wine in Ukraine, selling 2m bottles a year on the Ukrainian market and exporting another 3m to Russia. It is also one of the few

Eastern Europe

"The Russian wine industry is coming up very quickly, probably more quickly than somewhere like New Zealand's"

Everyone admits that the Russian bureaucracy is a major headache for the latest addition to the Russian vinifamily – even the government. The Duma deputy Zvagelsky candidly admits that the Russian rules are too strict. "Currently, all alcohol production comes under the same regulatory regime – whether it is beer and wine producers or whether it is vodka and spirit makers. We need a lighter regulatory touch for winemakers to encourage the sector's development," argues Zvagelsky. And the problems run deeper than mere red tape: the former Ukrainian producers have been given a temporary license to operate in Russia and must complete the formalities by January 1, 2015. However, the whole operating environment in Russia is totally different. Rapacious tax officials and the threat of expropriation by venal oligarchs are a constant threat in Ukraine, where the alcohol business is as opaque as mud. Russia is not perfect, but its ranking according to corruption watchdog Transparency International has been

"We were Russian before and now we're back!" Ukrainian wineries to have invested in modern equipment. But since March, the company's Ukrainian business has more-or-less come to halt, while it can't restart its sales on the Russian market until it has finished re-registering as a Russian legal entity. "We want to live as we did before, but Russia is a very big and prospetive market. The trouble is getting documents to work in Russia is more difficult than in Ukraine."

I 29

improving in recent years, whereas Ukraine officially became the "most corrupt" country in Eastern Europe in 2012 under ousted president Viktor Yanukovych. "The main problem for the Ukrainian producers is 80% of their work was on the black market and they don’t know how to work in a white market," says Zvagelsky. A few of the Ukrainians at the event were openly resentful of the changes

forced on them. "I was born in Crimea. My family is from Crimea. We have always lived in Crimea. But now I am foreigner in my own country," says Irina Segan, wife of the brand ambassador for champagne producer Inkerman, a household name in Ukraine. Inkerman is a case in point: it produces a whopping 30m bottles of wine a year and used to sell 70% of its production in Ukraine, exporting the rest to Russia. Irina's husband is more pragmatic and says it is still too early to tell how the new flag atop the parliament will affect business, as they are still ploughing through all the paperwork. But he made the trip to Anapa because clearly the company has to re-orientate to the Russian market. On the other side of the fence the small Russian producers have welcomed the sanctions on European food products that have helped burnish their products' image. Katarina Malik runs the Donskaya Grozd vineyard together with her father and is typical of the new generation of Russian winemakers. The Maliks went to the Russian Wine Institute and got hold of some of those seeds the Cossacks brought back from Paris – the actual 200-year-old seeds – and used them to populate their vineyards. Last year Donskaya Grozd produced 25,000 bottles including a Tsimlyansky and Krasnostop – the same grape that won this year's Russian competition – as well as a Sibirkovy white wine, a grape that only grows in Krasnodar, and a Seperavi, the most famous of the Georgian grapes. Malik says that the current showdown with Ukraine has altered Russians’ attitude to business and will be a huge boon to producers like Donskaya Grozd.

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bne November 2014

Property restitution haunts Warsaw Jan Cienski in Warsaw

arsaw’s local government election campaign is turning on a topic that is almost 70 years old – the confiscation of much of the city’s private property after the war. This is an issue that continues to drain the city’s budget, haunts real estate developers and fills thousands of tenants with terror. The reason is that the Polish capital has never dealt with the consequences of the 1949 law, promulgated by Boleslaw Bierut, the hardline Moscowbacked leader at the time, which seized most of the property in the devastated city. The ostensible reason was to allow for a quick and uncomplicated reconstruction of the ruins left behind by the German occupation, but the main goal was to redefine prop-

erty in Warsaw to conform to the new communist system. Although Polish communism ended in 1989, the legally tangled and very expensive issue is still largely unresolved. As a result, students in one of the city’s best middle schools, located in the heart of downtown Warsaw, are preparing to move after the city was forced to return part of their school territory to a businessman who had bought the claim on the property from the heirs of its pre-war owners. In another case the heirs to the Zamoyski family, Poland’s wealthiest pre-war aristocrats, two years ago regained a plot of land located inside one of the city’s loveliest downtown parks. In another case, the previous

offices of the mayor of Warsaw have been handed back to heirs of the last pre-war owner. Even the Polish parliament has been stymied in its effort to construct a new office building close to the legislature because the ownership of the land is in question. Sitting tenants Elsewhere, pre-war owners are regaining apartment buildings filled with tenants. In many such cases the new/ old owners increase rents both to make their properties economically viable and in some cases as a way of expelling tenants in order to upgrade and sell valuable buildings. In September, dozens of protesters holding banners denouncing the return of pre-war properties disrupted

bne November 2014

a city council meeting. In many such cases, the pre-war owners, exhausted by years of court battles and tangles with the city bureaucracy, sell their rights to well-connected business people who seem to have a knack for quickly bringing such cases to a conclusion. In 1999, Jan Zamoyski, the last pre-war owner of the family fortune, sold off his rights to a downtown Warsaw palace for a fraction of its value after trying for a decade to get it back. The new owner managed to arrange the return of the property in just a few weeks. The issue also bedevils property developers, who have to deal with claims from pre-war owners which make it almost impossible to develop many downtown lots. The city of Warsaw had tried without success to get parliament to do something about reprivatisation. As a result, about 10% of the city’s annual budget is spent on compensation for confiscated property. In all, about 8,000 cases have been filed against the city, and the full value of the claims comes to about ¤10bn, or more than three-times the city’s annual revenues. Only about 200 cases are resolved every year, meaning that the issue will continue to complicate life in the capital for decades. “The problem is that Poland did not conduct reprivatisation after 1989,” Hann Gronkiewicz-Waltz, Warsaw’s mayor, told the Rzeczpospolita newspaper, noting that before the war only about 15% of Warsaw was public property. “In the first instance we have to defend schools and playing fields against which claims have been filed.” Poland is the only Central and Eastern European country that has avoided dealing with the issue of pre-war property owners. And it is not just thousands of Warsaw properties. When the communists came to power, all landed estates were confiscated around the country, as were most factories, shops and private businesses. While Hungary, the Czech Republic and other CEE countries have largely resolved the problem – often by pay-

Central Europe

ing previous owners a fraction of the property’s value – Poland has not. One reason is that there is little political will to pay out enormous sums or to return attractive properties to the children and grandchildren of Poland’s pre-war elite. Another is the added complication of Jewish owners. Poland had Europe’s largest pre-war Jewish community, most of which was wiped out by the Germans. Most of their property was taken over by Poles, and the Polish government has been sluggish about returning it to the heirs of Holocaust survivors, creating a perennial irritant in relations between Poland and Jewish communities in the US and Canada.

"The city of Warsaw had tried without success to get parliament to do something about reprivatisation"

In 2001, a bid to pay owners 50% of the value of their properties was vetoed by the president as it applied only to Polish citizens and would have excluded foreign nationals. Since then, governments have proposed various legislative solutions, but the efforts have stalled because of the enormous costs and political risks of such a scheme. “Finding PLN20bn (¤4.8bn) in a situation when the state is fighting with the deficit proved to be impossible,” Marcin Kerwinski, an MP for the ruling Civic Platform party and author of a reprivatisation bill languishing in parliament, told the Gazeta Wyborcza newspaper. But the failure to craft an acceptable solution has saddled the Polish capital with huge potential costs and risks.

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instantly shed over 8% to a two-year low on the Warsaw Stock Exchange after the announcement. However, the shares recovered by the close on September 15 to reduce the loss to around 3%, with investors apparently split on whether the time is right to start buying CEE real estate again. Recently appointed CEO Thomas Kurzmann tells bne that the company can't be left behind. "People are starting to move," he says, "and we must be involved in that." Many industry analysts agree, but opportunities remain highly speculative for the meantime.

Interest piqued in CEE's riskier property markets

Waking up The property market in CEE has been surprisingly quiet over the past six years, given that a furious boom met such a sudden and deep crisis in 2008. While a steep selloff might have been expected as investors struggled to reduce heavy debt on assets with rapidly dropping valuations, little actually happened.

BRICKS & MORTAR:

That's because lenders had few options to enforce terms on that debt. On the one hand, they stood to make losses should they repossess and sell; on the other, with credit markets seized and a deep global crisis unfolding, there were few potential suitors. â&#x20AC;&#x153;Extend and pretendâ&#x20AC;? was how one industry player termed it.

Tim Gosling in Prague

However, with banks again ready to lend, the markets are waking up, says Hadley Dean, managing partner for Eastern Europe at Colliers International. "We're likely to start seeing portfolio sales now," he suggests. "Low interest

nvestors were underwhelmed in late September when Polish real estate investor GTC announced a rights issue to fund an acquisitions drive across Central and Eastern Europe. But analysts also think that now is the time to strike on real estate in riskier markets in the region, although the strategy remains simplistic. Saddled with a portfolio weighed down over the last five years or so by sluggish economic growth around the region, GTC has been struggling in recent years. The Â¤70.1m loss it reported in the second quarter of the year was led by huge cuts in valuations, with assets in Croatia and Romania doing the most damage.

However, with US fund manager Lone Star in control since November, GTC is now hunting for more capital to finance acquisitions in the same region. The

"The Polish market hit bottom some time ago" company announced on September 15 a plan to issue 140m shares, expanding outstanding stock by 43%. Shareholders will vote on the plan at a meeting on October 13.

rates make property an attractive deal even with [real estate] yields pulling in, while the pricing in bonds and equities helps make the sector even more attractive."

GTC's share price, already having slumped on the poor recent results,

In short, cheap money and the global hunt for yield are pushing investors into

Central Europe I 33

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Following the macroeconomic recovery story, the more developed Central European markets such as Poland and the Czech Republic have already seen the arrival of money accelerating. Now, Hungary and Romania are rolling out the welcome mat.

force for the likes of GTC, which is looking to leverage its regional experience and greater appetite for risk to take advantage as arriving cash pushes prices higher. It's a simple plan that casts aside tricky issues such as fundamentals or asset management. "Developed markets are becoming very expensive now," argues Kurzmann. "We want to buy before investors arrive in CE and SEE. We can buy top assets for 8.5-9.0%, and with debt at 3.5-4.0%. Then you have the capital from institutions arriving to improve values."

Kurzmann pledges the geographic balance of GTC's portfolio will be maintained, with Poland accounting for the largest share, but the main focus

As Motyl â&#x20AC;&#x201C; clearly happy to see the US fund directing strategy at GTC â&#x20AC;&#x201C; notes, Lone Star is opportunistic by nature. "Romania and Hungary have liquidity

CEE. Lukasz Motyl, head of CEE Real Estate for UniCredit Group, adds that, "investors have now seen stable trends in the region for macro-economics and the real estate market for several quarters."

"Now that the market is growing again, so must we. Otherwise we may as well give up on real estate and start in some other line of business" of opportunity for many investors has clearly moved south. "The Polish market hit bottom some time ago," points out Dean, who says it makes sense that GTC is scouting in Budapest and Bucharest. Supply and demand in those two cities are balanced says Kurzmann, and leasing is now picking up. That sets up a simple equation. "Russia and Turkey are out of the picture due to politics," Motyl says, "and Central European markets are already getting crowded." He adds that while clients are showing lots of interest in Hungary and Romania, their eyes are also being drawn farther afield to markets such as Serbia. Bulgaria and Croatia, on the other hand, remain "very quiet," the banker adds. Oversupply in real estate and continued economic weakness means the banks are still not ready to lend to property investors in those markets, with the only activity centered on distressed assets. Quick flip That building interest is the driving

coming. I expect to see a lot flipping in the former especially." Kurzmann notes that if GTC sells newly acquired assets quickly, "it will be due to pressure from larger investors." At the same time, as the caution of institutional investors illustrates itâ&#x20AC;&#x2122;s a strategy that carries risk. The economies in the region remain highly dependent on the Eurozone, which is seeing its recovery stall. The banks in Southeast Europe are still struggling under mountains of non-performing loans and government pressure, while the US Federal Reserve's winding down of quantitative easing threatens to raise the cost of capital and dampen the hunt for yield. To cap it all, the whole of CEE is on tenterhooks over the Ukraine crisis. However, Kurzmann throws these concerns out one after the other. A weak Eurozone will mean continued low rates from the European Central Bank, more competition to lend by European banking groups, and attract investors hunting for faster economic growth

I Central Europe

Good EU citizens bne Member states in Central and Eastern Europe often receive a regular bashing from Brussels for their failure to implement EU policies. However, a new report on infringements of EU legislation shows that they are better than most at respecting the bloc's rules, with Latvia the most obedient of all. The relatively larger role of the state in the economy, dirty energy, corruption and human rights protection are all issues that might be expected to increase tensions between the new member states to the east and Brussels. Yet a new report from the European Commission on cases brought for violations of EU law in 2013 shows them outperforming the old EU-15. "The correct application of EU law is a cornerstone of the EU treaties and at the heart of the Commission's regulatory fitness programme (REFIT)," the report comments. As in 2012, most infringements (62% of all cases) concern compliance with EU law on the environment, taxation, transport and internal market and services. Latvia presented the fewest problems for EU regulators, racking up just 20 instances of late or incorrect transpositions of EU legislation. The Baltic state has just eight infringement cases open against it. It is closely followed by Malta and fellow Baltic states Estonia and Lithuania. That performance looks even more impressive given that the Baltics are still recovering from the deep recession they tumbled into in 2009. It's little coincidence that Italy, Spain and Greece are the worst offenders, with Rome facing a total of 24 infringement cases, and 104 late or incorrect transpositions. Perhaps most surprising of all, however, is that Hungary sits happily in the top 10 for obedience, with no more than 16 infringement cases against it. Budapest has fought a running battle with Brussels since Prime Minister Viktor Orban came to power in 2010, with the EU criticising government policies on the economy, judiciary, media and human rights. The European Parliament has just blocked the country's nominee for the European Commission, with Tibor Navracsics judged unsuitable to oversee the education portfolio. The Czech Republic beat Hungary, despite being led by the eurosceptic ODS until mid-2013, and then being under a caretaker administration for the remainder of the year. Slovakia, the only Visegrad state in the Eurozone, trailed some way behind. However, Poland is the bad boy of CEE, with the sixth worst record, despite Warsaw's strongly pro-EU policy in recent years. Despite Poland's heavy use of coal and strong opposition to EU environmental targets, it was taxation that incurred most of the 20 infringement cases opened against it last year.

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compared with Western European markets, he claims. The crisis in Ukraine offers similar opportunity, he suggests. "We're optimistic it will end soon," the CEO says. "Then we will see lots of money coming into the region." No choice Others without a shareholder meeting on the horizon are less bullish, even if they support the strategy. "These are very fragile markets," Dean admits, "and a global shock would see a retreat from Hungary and Romania. But the macro risk is priced into the yields already." Yet that would hardly insure against another serious wave of crisis. In short, the dovish global environment has investors brushing aside the risk. "We can assume yield compression in these countries in the coming years purely powered by investor interest," sums up Motyl. That sounds eerily reminiscent of the boom years before the crisis, albeit valuations are nowhere near the inflated state seen in 2006. However, the UniCredit analyst offers a note of caution. The banks, especially the German ones, are getting very keen, and are starting to underprice risk as they fight for business. "It's starting to remind me of 2007," Motyl worries. Yet Kurzmann, who insists he has "no idea" why GTC stock dropped when the new strategy was announced, says he fully expects shareholders to vote in favour of the rights issue and acquisitions drive at the meeting later this month. The company has no choice but to buy and grow, he asserts. "We lost heavily on purchases made in 2006 and 2007," he sums up. "Now that the market is growing again, so must we. Otherwise we may as well give up on real estate and start in some other line of business."

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Central Europe

I 35

of carbon credits. CEZ continues to benefit from a generous allocation of carbon credits secured from its government owners, which it has been able to sell for a profit in the market. However, the European Commission now plans to tighten the carbon credit regime, which could threaten the viability of CEZ’s lignite plants in the long term.

CEZ plays "double or quits" Robert Anderson in Prague

EZ, the largest power group in post-communist Central Europe by market capitalisation, is reacting to the serious challenges it faces by playing "double or quits" with a possible large acquisition. Power prices are expected to stay near current lows, the EU is putting together a tougher carbon credit regime and CEZ’s foreign investments have soured, yet nevertheless the state-owned Czech group is planning to bid for its Slovak counterpart Slovenske Elektrarne and build new nuclear reactors at home. Martin Novak, finance director, admits that the short-term outlook for power prices (and CEZ profitability) is unpromising. “We don’t see any signs of significant change [in prices],” he says in an interview, pointing out that forward contracts for next year – CEZ is almost sold out – are barely above the current low price of around ¤35 per megawatt hour (MWh). According to some analysts, this price level will soon make CEZ cash-flow negative. “If your generating portfolio

is a bunch of large inflexible power plants [like CEZ's], you will not make much money,” says Jan Ondrich of Candole Partners, a Prague-based consultancy. CEZ used to make big profits from electricity exports to Germany when prices were high, exploiting its lowcost installed base of lignite-burning

Novak argues that the lignite plants are being retrofitted to extend their life and make them cleaner, and that in the shorter term CEZ will actually benefit from an increase in the carbon credit price and the knock-on effect on power prices. He says CEZ will receive carbon credits for free until 2020, and any rise in the price of credits will therefore boost its profitability. “For our profitability, the higher the carbon credit price the better,” he says. Another splurge During the boom years of high prices, CEZ used its cash pile to go on a spending spree in Southeast Europe, snapping up distribution companies in Bulgaria, Romania and Albania, and building Europe’s largest onshore wind farm in Romania. Many of these investments, made from 2005 onwards, went sour after the global financial crisis as local energy regulators intervened to cut power prices to struggling households, and govern-

"E.ON recognised things were going wrong sooner and acted; CEZ was reluctant, so they sat on the assets" and nuclear power stations. Since the global financial crisis, howere, power demand has fallen back – a shift accentuated by improvements in the energy efficiency of industrial companies and “non-market mechanisms” introduced by governments to boost renewable power, Novak says. The power price has also slumped because of low coal prices and a glut

ments made renewable energy subsidies less generous. Ondrich blames CEZ for what he calls “terrible value destruction” and compares its speed of reaction to the changing market unfavourably with E.ON of Germany. “E.ON recognised things were going wrong sooner and acted,” he says. “CEZ was reluctant, so they sat on the assets.”

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English lessons for Czech nuclear industry bne The EU gave the UK the green for public funding of its Hinkley Point nuclear power plant, a decision that was welcomed in the Czech Republic, which hopes to use a similar model to expand its Temelin facility. However, Brussels warned the UK case is "not a blueprint" for the rest of Europe, and Austria instantly launched a legal case. On October 8, the European Commission as expected approved the UK's "contracts for difference" funding model after London made concessions. Under the approved contract, the UK will offer public guarantees to pay £92.50 (¤118) per megawatt-hour over the next 35 years – double the current market price – to EDF, the French operator of the first new nuclear plant to be built in a generation. The European Commission's earlier challenge to the UK project was seen as a key part of the Czech government's decisions in April that it would not give CEZ any guarantees for the ¤10bn expansion of the Temelin plant. The state utility, having struggled throughout to win pledges of public support, promptly dropped the tender on the project, which had been fraught by controversy over the exclusion of France's Areva. Analysts welcomed the news, having complained for years that the project was economically unfeasible and would stretch CEZ's finances unreasonably. However, the very same figures that helped kill the previous competition – President Milos Zeman, powerful Finance Minister Andrej Babis, who has since effectively taken control of the CEZ board, and Minister of Industry and Trade Jan Mladek – were back within months calling for the scheme to be resurrected. While apparently ruling out Russian state nuclear agency Rosatom – one of the two finalists in the abandoned tender – the Czech government says South Korean and Chinese companies have indicated they intend to take part in the next hunt for a contractor. CEZ CEO Daniel Benes told local press on September 30 that a green light for London would help relaunch the Temelin tender. "It is always good when someone big clears the way for you," he remarked to business daily Hospodarske Noviny, adding: "I have tried to explain the contractfor-difference scheme... to probably three governments and it was always difficult." However, European Commission Vice-President Joaquin Almunia stressed that approval for Hinkley Point "will not set any precedents". And Kelvin Ross, editor of Power Engineering International, tweeted that European Energy Commissioner Gunther Oettinger backed his colleague up when speaking at a conference in October, saying that Hinkley Point is "a special case, not a blueprint for other new build nuclear plants" in the EU. Yet there is another potential obstacle to reviving the Temelin tender closer to home than Brussels. Following up rising threats ahead of the Hinkley Point decision, Austria confirmed immediately following the announcement from the European Commission that it is launching a legal challenge.

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CEZ has recently reached a settlement with the Albanian government to sell its distribution company back for the ¤102m it paid, but it is still in dispute with Bulgaria and Romania over issues such as the investment commitments it made, as well as the level of domestic power prices or subsidies for renewable energy. Novak blames the global financial crisis for the group’s woes. “There was a big portion of bad luck,” he says, before adding that most of the investments were relatively cheap anyway. He says that all of CEZ’s investments are Ebitda positive now, but admits that “some generate profits lower than expected.” “I would not look at it negatively. We learned a lot," he insists. Undaunted by this record, or the unpromising outlook for power prices, CEZ now plans to bid for the 66% of Slovakian utility Slovenske Elektrarne that Enel of Italy has put up for sale. Novak argues that the cultural and technical similarities of the two companies – which were once united in the former Czechoslovakia – offer substantial synergies. “There is nothing that would better suit us,” he says, though he stresses that the shape of the sale is still unclear. “It is all about price and risk-sharing... Are we obsessed with it? I don’t think so.” The Czech centre-left government so far appears divided over the merits of such an acquisition. Social Democrat Economy Minister Jan Mládek is a supporter, but Andrej Babis, the powerful finance minister and leader of the centrist ANO party, has questioned it on the basis of CEZ’s troubled acquisition record. Babis, whose ministry controls the government’s 67% stake in CEZ, recently cleared out the group’s supervisory board to tighten his grip on the country’s flagship state-owned enterprise. Some analysts fear that acquiring Slovenske Elektrárne (and its debt and nuclear liabilities) could endanger CEZ’s A- credit rating. “Acquisition of whole SE would probably lead to

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lower dividends and negative market reaction,” commented Petr Bartek of Erste Bank Group in a recent note. Patrick Hummel of UBS has estimated that Slovenske Elektrarne has an enterprise value (equity plus debt) of up to ¤4bn, plus nuclear liabilities of a further ¤3bn, and that there would be a risk that CEZ would have to issue new equity or hybrid debt to pay for it. Novak dismisses such concerns, arguing that CEZ remains one of the most profitable (in terms of Ebitda margin) and least indebted utilities in Europe, and points out that the company

Central Europe

state aid. A settlement between the UK and Brussels has now been reached, which could enable the Czech tender to be reopened. CEZ continues to push for the project, but Novak admits that without some kind of power price guarantee it will not fly. “Without this kind of support, nobody would be able to take the risk of building the plant,” he says, though he insists that it will happen one day. Economy Minister Mladek also remains keen on the project, pointing out that “the Ukraine crisis supports the case for building nuclear power in

"There was a big portion of bad luck" recently announced plans for a 16% cut in costs over the next two years. He says the group could buy Slovenske Elektrarne without needing to raise equity. “An equity increase is one of the last things we would do,” he says. Nuclear horizons Looking longer term, CEZ remains keen on expanding the nuclear power stations at Temelin and Dukovany, which would maintain security of supply – and make the country more energy independent – when the ageing lignite plants eventually have to close as lignite supplies dwindle. However, CEZ had to cancel the tender for a partner for Temelin in April after Brussels began a probe into whether a similar investment contract between EDF of France and the UK government to build Hinkley Point C was illegal

the Czech Republic,” as the country needs to become more energy independent, though he says that perhaps a fully state-owned entity might have to build the plants. The government should publish a new nuclear power strategy by the end of the year. Novak admits that both acquiring its Slovak counterpart and expanding its nuclear plants would keep CEZ’s asset portfolio focused on generation, at a time when other struggling European utilities are trying to move away from this. But he points out that CEZ is also diversifying by investing into renewable energy, gas supply, small co-generation plants and customer services such as telecommunications. CEZ’s strong fundamentals mean, he contends, that “there can be growth through acquisitions to extend our business further.”

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Finally, the US Federal Reserve is likely to start increasing interest rates next year, potentially causing problems for emerging markets like Poland, which are dependent on external capital flows. Poland also faces domestic uncertainty. Donald Tusk, who headed the Polish government since 2007, is leaving Warsaw to take the EU's top job of president of the European Council. His successor, Ewa Kopacz, has to seize control of her fractious Civic Platform party and lead it into next year's parliamentary election, trying for the party's third victory in a row.

Clouds gather over Poland's economy Jan Cienski in Warsaw

dam Krzanowski lives in Krakow, but he is being directly affected by the Ukrainian-Russian conflict 1,500 kilometres to the east. The co-founder of Nowy Styl, one of Europe's largest office furniture makers, he set up a Ukrainian subsidiary together with local partners operating a large factory in Kharkiv producing largely for the fast-growing Russian market. “There is a double digit drop in sales in Ukraine – about 30%,” he complains. “The Russian economy is also starting to sag.”

slowdown being battled by people like Krzanowski, and by Polish exporters hit by Russian sanctions. To the west, the Eurozone seems to be unable to restart higher growth, part of a dismal record in Western Europe that has the region performing more poorly than it did during the Great Depression

Although growth in the first two quarters was still relatively strong, coming in at an annual 3.4% and 3.3% respectively, the outlook is worsening. In its analysis, Erste Bank predicts expansion will slow through the second half of this year and the only growth driver will be Poland's large domestic market. “The fragility of the Eurozone recovery and aftermath of the Ukraine crisis poses some downward risks to next year’s economic outlook,” the bank said, dropping its forecast for growth in 2015 to 3.0% from an earlier 3.5%. However, even a glummer outlook for this year and for 2015 still leaves Poland as one of the fastest growing economies

"We are selling much less to Russia, but you simply have to roll up your sleeves and work"

Krzanowski's troubles are one sign that the atmosphere around the Polish economy is becoming a lot more troubled. The prediction is for growth of 2.9% this year and 3.1% in 2015 according to Eurostat, the EU's statistical agency. That compares to a lacklustre 1.6% eked out last year, when the economy appeared to be in danger of falling into its first recession in two decades. But those predictions are now being called into question by a more hostile economic climate. Squeezed To the east, there is war and economic

of the 1930s. Second-quarter growth showed small contractions in Germany (Poland's largest export market accounting for a quarter of exports and 10% of GDP) and Italy, while France remained flat. “The external environment will remain challenging in the coming months, with spillover from the Russia-Ukraine standoff and weak growth in the eurozone representing a downside risk,” notes a new report by Standard & Poor's, the rating agency.

in the EU (although that low bar for success stands as a condemnation of the EU's inability to kick-start a vibrant expansion). Sunshine through the clouds There is some additional help on the horizon. The country has seen inflation turn into deflation, and the expectation is that the central bank's rate-setting Monetary Policy Council will cut the already record low benchmark of 2.5%. Erste predicts a total cut of 75 basis points by the end of 2014.

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Kopacz is also scrambling to cement her popularity before the 2015 parliamentary vote. In her maiden speech to parliament on October 1, she promised to slash the red tape that has been a perennial complaint of Polish business, as well as to make the tax system more comprehensible, in measures aimed at reducing structural impediments to growth. Although Poland has been rising in the ranks of the World Bank's "Doing Business" survey (it does slightly better than its regional peers), it still has a long way to go to match Europe's most competitive economies. One measure that could improve Poland's standing is Kopacz's promise to improve procedures for construction permits, one area where Poland has one of the worst performance metrics in the world.

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Erste creates new CEE bond indices Nicholas Watson in Prague Central and Eastern Europe’s bond markets are growing fast, outperforming their more developed counterparts and showing scope for more improvement. To capture this trend, Erste Bank Group has developed two bond indices to help potential investors get a quick take on the region’s government bonds. The region’s third-largest bank on October 2 unveiled the “Erste CEE Eurobond Index” and the “Erste CEE Local Currency Bond Index". The countries included in those indices are Croatia, Czech Republic, Hungary, Poland, Romania, Slovenia and Slovakia, while the last two are omitted from the local currency index because they are both members of the Eurozone. Russia and Turkey were excluded from both, as their size would simply overwhelm any effect from the smaller markets. Poland is the largest in terms of weightings. Weights in Erste CEE Indices

The need for such steps can be seen by Poland's growth statistics. Since joining the EU in 2004, Poland has averaged annual growth of 4.1%, but the results in the last few years are well below that average. “While the Polish economy has recovered from the slowdown in 2012 and 2013, its middling real performance in [the second quarter] points to an unsettled recovery and a deteriorating business sentiment across neighbouring EU countries more generally,” says Marco Zaninelli, assistant vice president of Moody’s, in a new report from the rating agency. While Kopacz and the central bank's interest rates are important, Poland's resilience really depends on people like Krzanowski. Nowy Styl recently bought a second smaller German competitor, which helps it compete in markets where a “Made in Germany” label does much more for sales than a “Made in Poland” one. The company is also building a factory in Russia, avoiding UkrainianRussian border troubles and the potential impact of more sanctions against Russia. “We are selling much less to Russia, but you simply have to roll up your sleeves and work,” says Krzanowski.

weights (2Q14)

Erste CEE Local Currency Index

Erste CEE Eurobond Index

22%

17%

49%

18%

40%

11%

“In order to better track performance of the region’s bonds, we wanted to have one number to show how the region is doing. So we have introduced two Erste CEE bond indices – two because not all investors are allowed to invest in local currency bonds – which give investors a glance of the performance of government bonds in CEE,” Juraj Kotian, head of macro/ fixed income research CEE at Erste, tells bne. The indices are synthetic and non-investable, in that they simulate investment in five-year government bond paper and calculate the total return in euros, including the currency gain/loss if local bonds. “They are instructive as an indicator of CEE bonds, not the CEE bond market,” Kotian says, adding that Erste is in talks with Bloomberg about having the indices fully updated with the financial data provider. Kotian says the main reason behind the idea is that the CEE sovereign bond market is now worth about ¤400bn, making it the fifth largest in Europe and larger than the Dutch, Belgian or Austrian government bond markets. “Apart from Poland, the bond markets of individual CEE countries are relatively small, but pooling them together creates the fifth largest government bond market in continental Europe,” the bank notes. The region’s bond markets are also performing well; since the beginning of this year to September 15, investments in CEE local currency bonds and Eurobonds with a maturity of around five years were yielding a total return measured in euros of about 5.3% and 6.9%, respectively. By contrast, the five-year German Bund or French bond over the same time period returned just 3.8% and 4.6% respectively. This in turn is attracting more money, as the low interest rate environment forces more investors to diversify into other assets outside of their traditional markets.

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Government critics deride Hungary's Potemkin economy Kester Eddy in Budapest

ozsa Beer is crystal clear when it comes to offering her opinion on the Hungarian economy. Mrs Beer, 59, who has retired from running a small knitting business with her husband, reels off a list of reasons why she and her family are happy with local economic developments. "We've got a large house in the Budapest suburbs, and the utility bills have really got cheaper because of the [government mandated] regulated price cuts,” she says. Her daughter, who is buying a house with a foreign-exchange based mortgage loan, expects to see a “significant” reduction in monthly repayments due to the government's efforts to get such loans judged “unfair.”

Meanwhile, having just had a baby, the same daughter will see the extra housekeeping costs greatly eased by the latest child benefit schemes. “She can get full child allowance after going back to work when the baby is 12

Little wonder Mrs Beer voted to give Viktor Orban and his conservativenationalist Fidesz party a second consecutive four-year term in general elections last April – she “fully agrees” with government slogans that “Hungary's doing better.”

"This government promised 1m new jobs when they came to power in 2010. They have created nothing in terms of private sector jobs – no net jobs whatsoever"

months. This, and the personal income tax rate [of 16%], really favours families with kids," she says.

Stats behind the slogans Regardless of the prodigious output from its formidable communications

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system – which typically repeats the same upbeat news items in several thinly disguised packages – the government claims are not mere rhetoric: the Hungarian economy grew beyond most analysts' expectations to hit 3.7% in the first six months, buoyed by a strong performance in construction – up 19% in the second quarter – and manufacturing, which continued to benefit from the expanding automotive sector.

Central Europe

nothing in terms of private sector jobs – no net jobs whatsoever. The public sector jobs [public works schemes]… are not sustainable from an economic point of view,” says Lajos Bokros, a professor at the Central European University and former finance minister in the 1995-96 Socialist-liberal coalition. As for GDP growth, while analysts accept the veracity of the data, its make-up is considered less than ideal.

foreign-currency loans into forints will ultimately reduce the forex risk of households, but they are adding huge uncertainties to the financial sector, Vertes argues. “Hitting the banking system by another HUF1,000bn (¤3bn), the estimated costs of the conversion, will make the recovery of business lending impossible,” he says. This, and talk of additional austerity measures to keep the budget deficit to

Meanwhile, unemployment statistics for July, released earlier in October, put the jobless rate at 7.8%, down from 10.2% a year earlier, and good in comparison to the European average of, coincidentally, also 10.2%.

"If you have to live off one job in Hungary, it's darned difficult"

Based on such figures, together with the healthy current account surplus and the added fillip of the International Monetary Fund (IMF) raising its forecast for full-year growth to 2.8%, Orban boasted in a statement prior to the EU summit in Italy on October 8 that Hungary had “proved that jobs can be created while budget discipline is sustained and state debt reduced.”

“This year, the expansion is partly connected with temporary effects, such as very high funding from the European Union, much of which has financed the boom in [state-driven] construction projects,” Andras Vertes, chairman of GKI, a Budapest economic institute, tells bne.

While this conveniently ignored news that Hungary's public debt had climbed to a record high of 85% of GDP at the end of the second quarter, the economic progress, real or perceived, helped ensure Fidesz won out in local elections throughout Hungary on October 12 – replicating the party's victories in the general election of April and European Parliament election in May. However, the seemingly good news – and its sustainability – is, needless to say, questioned by economists and opposition leaders alike. The employment statistics – boosted as they are by Hungarians living abroad but still registered in Hungary, and by public works schemes designed to get the long-term unemployed into some sort of work routine – are treated with particular scepticism. “This government promised 1m new jobs [in the next decade] when they came to power in 2010. They have created

True, with inflation at around zero, real earnings are expected to rise by between 3-4%, in turn boosting consumption by some 2% – a level not seen since 2006. Yet despite this, and the boost to higher earners by the introduction of a flat rate tax in 2011, Hungarians on average are worse off than a decade ago. “Consumption in 2014 will be 0.5% above that in 2010, but still 2% below the level of 2004,” Vertes says. At the heart of the matter is the uncertain business environment caused by erratic government policy since 2010.“There has been a deterioration in the investment climate, and legal security due to bad governance, including hostile policy to the banks,” says Vertes. This in turn has led to a decline in investment. “Net foreign direct investment over the first six months this year was zero. If you exclude the various bank recapitalisations, it was negative,” he says. The latest government measures aimed at forcing banks to convert

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below 3% of GDP, makes many a Magyar wary of the economic future. Awaiting passengers for his cycle rickshaw in downtown Budapest, Gergely Nagy, 33, certainly sees his financial circumstances very differently from Mrs Beer. “I was an entrepreneur, but there was no government support for the self-employed, whatever they say,” he tells bne. As for growth of 3%, “I've not experienced that. This is my second, third job even. I'm a swimming instructor at a hotel for my main work,” Nagy says, “If you have to live off one job in Hungary, it's darned difficult.”

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Cooperation not on the radar Nicholas Watson in Prague

nother pan-regional project fell by the wayside as the Czech Republic said on September 30 it would hold an international tender for a new radar system to replace its obsolete Soviet system, abandoning heavily criticised plans to try to build its own system with other Central European partners. The project for a Mobile Air Defence Radar (MADR) had taken on greater urgency given justifiable worries by the so-called Visegrad Group (V4) â&#x20AC;&#x201C; Poland, Hungary and the Czech and Slovak Republics â&#x20AC;&#x201C; about an increasingly assertive Russia. However, an idea first mooted back in June by the V4 to build their own system rather than purchase an off-the-shelf system from the likes of Saab, Thales, Selex or Raytheon had caused consterna-

tion within defence circles, which feared that such a strategic initiative was being used as a means to prop up the local defence industry rather than promote regional security. In the statement, the Czech defence ministry said: "[it] has decided to

bidding process... In the first phase till 2017, the requirement is for five 3D radars to replace the obsolete Soviet design technology still in the inventory. The envisioned lead time is 18-24 months from contract signature. To that effect, the Ministry will soon prepare an international

"What might be a politically attractive project for V4 would be extremely expensive and difficult to maintain" acquire a three-dimensional Mobile Air Defence Radar (MADR) capability through an international competitive

tender. The value of the acquisition is expected to oscillate between CZK1.51.7 billion."

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The Czech MoD essentially acknowledged what defence insiders had being saying all along: namely, that such a complex system could not be built within the short timeframe available. Said Saab in a statement on September 21: "We launched our next generation air defence radar system at the beginning of 2014 after more than 5 years of development, within a similar timeframe as some of our international competitors. With the utmost respect to the great expertise and skill of the local industry, we are afraid it is not realistic to produce such a sophisticated system considerably faster, as the need of V4 armed forces demand." Usual failings Signs that the pan-regional plan to build their own radar system was in trouble had been building in the leadup to the Czech announcement. On September 14, the Financial Times reported that Poland, the regional leader with the largest defence industry and most aggressive posture towards Russia, had decided to pull out of the project, after concluding that the other members of the V4 had little to contribute to the modernisation of its military and defence industry. A spokesman for the Polish defence ministry denied to the FT that the country had pulled out of the project, saying discussions were a “work in progress." Without the Poles involved, insiders said the Czech defence industry would not be able to handle the project – Slovakia and Hungary have little in the way of defence companies – within the time constraints, and costs would inevitably spiral. Given that the radar market is already overcrowded with prices to match, any domestic solution would be far more expensive. For this reason it would also be uneconomic. Defence sources say that in order for the project to be economically feasible, the V4 consor-

Central Europe

tium building it would need to sell a lot more of its radar system than what could be absorbed by just the V4 countries. Given that the orders from the four countries would only amount to 17 radars worth about ¤300m, the consortium must sell more globally into what one industry insider calls an already "saturated" radar market. "The likelihood of finding a customer outside the V4 is not realistic," says one industry insider. "What might be a politically attractive project for V4 would be extremely expensive and difficult to maintain." Critics of the project also point out that local industry would in any case benefit if open tenders were held by the countries in question. This is because such defence projects inevitably contain what are called offset programmes, whereby local industry is involved in the delivery and maintenance of the project. For example, Saab's offset programme for the Czech Republic's leasing of 14 Gripen fighter aircraft provided almost ¤1bn of work to the broader local economy over a 10-year period. Such a point was tacitly acknowledged in the Czech defence ministry's statement September 30. "With a view to the centrality of the order for national defence, the supplier will be required to be solidly embedded in the Czech Republic; the Ministry will therefore insist on engaging the domestic defence industry," it said. Disconcertingly for the Central European governments, this is another example of a failed attempt at a panregional project. Such regional efforts have a poor history: for example, a project to build a new nuclear plant in Lithuania between the three Baltic countries and Poland has fallen apart; and since it achieved its initial goal of getting the four countries into the EU in 2004, the V4 has attempted to foster cooperation in cultural and security matters, but has to date singularly failed to deliver anything in the way of the latter.

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performing loans (NPL) of 10% – way above the 2.5% average for all Turkish banks and the 3.5% average for Turkey's Islamic lenders. "A high NPL ratio means high provisioning, which again reduces liquidity," explains the analyst, pointing out that despite the liquidity issue, on paper at least, the bank remains in good health with a capital adequacy ratio of 15%, comfortably above the 12% minimum decreed in Turkey's banking regulations. A TRY225m ($100m) capital increase was approved on October 15, which will provide the bank with some short-term relief, but analysts suggest it’s likely to be followed by further requests for funds.

Breaking the Bank Asya in Turkey David O'Byrne in Istanbul

little over a year ago, Turkey's largest Islamic finance house, Asya Katilim Banka, boasted Sharia-compliant assets of $12.1bn – enough to place it in the top 30 of the world's Islamic financial institutions. Today, however, the future of Bank Asya, as it’s commonly called, is in doubt following a roller coaster few months that saw its shares repeatedly suspended over mounting criticism of the bank's operations and suspected government pressure over its ownership. Much of that criticism has come from pro-government quarters, culminating in the claim by Turkish President (formerly prime minister) Tayyip Erdogan in midSeptember that Bank Asya was effectively bankrupt and that the country’s banking regulator, the BDDK, should step in and take it over. Certainly market confidence in Bank Asya, has taken a hit. Suspended for five weeks to September 15, when the shares started trading again on the Istanbul Stock Exchange (BIST) they immedi-

ately fell by 40% to an all-time low of TRY0.64, less than a third of their price a year earlier. In the short term the bank's problems stem from second-quarter results that showed a 25% fall in deposits over the first half of 2014 – a capital outflow widely blamed on state companies and government supporters closing their accounts. Media reports suggested this resulted in as much as TRY4bn ($1.76bn) being withdrawn in the second quarter alone. "A huge outflow of deposits, especially from state companies, has caused a short-term liquidity problem for the bank," says a banking analyst at a major Istanbul brokerage, asking not to be identified. This liquidity problem has been exacerbated by an unusually high rate of non-

Ownership issues Analysts concur that Bank Asya's position is unlikely to be solved without a change in the bank's main shareholders. Currently 54% of Bank Asya stock is Photo: Dusan Milenkovic traded on the BIST, with 40% of the remainder held directly or indirectly by the bank's eight-man board, all believed to be supporters of the religious movement of US-based moderate Islamist preacher Fetullah Gulen. Heading a movement that reportedly boasts anywhere from 1m to 8m adherents in Turkey and a business empire that includes Turkey's Zaman newspaper group and Samanyolu TV channels, and a nationwide chain of schools, Gulen was until around two years ago an important ally of Erdogan's Justice and Development Party (AKP). The relationship benefited both sides: Gulen's support is widely credited with having helped bring the AKP to power in 2002, and the resulting favourable economic climate in turn helped the movement's businesses. Bank Asya itself enjoyed a rapid expansion from being a minor participation bank (as Islamic banks are called in

"Bank Asya didn't do anything wrong; before the capital withdrawals it was in good shape"

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Turkey) with a few branches, to a major provider of small business loans with a countrywide network of 272 branches and even a branch in the Iraqi Kurdish capital of Erbil.

An investigation ends but questions begin

That rapid growth though has contributed to the bank's current dire position, argue analysts. Unable to compete directly with Turkey's main small and medium-sized enterprise (SME) loan providers Halkbank and Garanti, Bank Asya has grown aggressively by targeting second-tier SMEs, which by definition carry a greater risk of default.

A prosecutor on October 17 dismissed charges against 53 people in a corruption case that targeted President Recep Tayyip Erdogan’s inner circle, and resulted in the resignation of four ministers when the scandal broke in 2013. The prosecutor argued there were problems with collecting evidence, and the case lacked proof of criminal elements, though the move is sure to renew criticism that Erdogan and his government are undermining the independence of the judiciary.

The spectacular fallout between Erdogan’s AKP and the Gulen Movement, which resulted earlier this year with the leaking allegedly by Gulen supporters of illegally recorded phone conversations suggesting corruption at the highest level of government, has made that risk look all the greater. Manoeuvrings What will happen now is unclear. Analysts suggest that the country’s banking regulator could press for a change in the major shareholders, but talks over the summer between existing shareholders and both Qatar's Islamic bank and Turkey's Ziraat bank came to nought, with the latter instead being granted approval to launch its own Islamic banking arm. Bank Asya itself has warned it may take the banking regulator to court if it doesn't act to protect the bank from damaging reports. Indeed, Turkish banking law allows for the prosecution of anyone disseminating negative publicity about a bank that could cause it to collapse – a stipulation apparently lost on both the government and much of the progovernment media. "Bank Asya didn't do anything wrong; before the capital withdrawals it was in good shape," says Emre Deliveli, economic columnist on Turkey's English language daily Hurriyet Daily News, suggesting that the bank's problems are a direct result of government actions. "The bottom line is that if you do anything to displease or anger Erdogan, you can expect problems," he says.

Kivanc Dundar in Istanbul

The suspects included the sons of former interior minister Muammer Guler, former economy minister Zafer Caglayan, Turkish-Iranian businessman Reza Zarrab, and the former manager of the state-run lender Halkbank, Suleyman Aslan, in whose home police found $4.5m cash in shoe boxes. Businessmen with close ties to the ruling Justice and Development Party (AKP) were also detained when the corruption scandal erupted on December 17, 2013. All suspects were later released pending trial. Zarrab was suspected of forming a criminal network that bribed state officials to facilitate illegal gold trading with Iran via Halkbank, in breach of international sanctions. The ministers Guler, Caglayan, and then EU affairs minister Egemen Bagis were accused of taking bribes, and resigned from office. Ministers and lawmakers can be tried in court only if parliament decides to remove their parliamentary immunity. A special commission has been set up in the AKPdominated parliament to investigate the corruption allegations against the ministers, but this investigation continues at a snail’s pace. In February 2014, several audio recordings started to circulate on the internet, through the social media platforms Twitter and YouTube, purportedly showing corruption in the highest circles of the government. In one of these leaked recordings, Erdogan was allegedly discussing with his son Bilal how to get rid of vast sums of cash stashed at their home. The conversation between Erdogan and his son was supposedly recorded shortly after the corruption investigation was launched on December 17. The postings were all anonymous and the authenticity of these leaked voice recordings has not been verified. Later the government blocked access to Twitter and YouTube, prompting a backlash from the EU and the US. Erdogan always maintained that the voice recordings were fake and had been fabricated by elements within the police and judiciary loyal to his foe US-based cleric Fethullah Gulen. Erdogan also claimed that the corruption probe was a conspiracy orchestrated by foreign powers and their local collaborators to topple his government. Erdogan’s strategy played well with AKP’s core constituency. His party won the March 2014 local elections and he won the presidential election in the first round in August. The government also responded by replacing and reassigning prosecutors and thousands of police officers who took part in the investigation. In September, dozens of police officers were detained on suspicion of illegal wiretapping. On October 12, government-backed candidates defeated Gulen-affiliated candidates in elections for the Supreme Board of Judges and Prosecutors (HSYK). Government-backed candidates won eight of out of 10 seats in HSYK, a body responsible for the appointment of judges and prosecutors.

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Bulgaria’s agony continues Sandy Gill in Sofia and Clare Nuttall in Bucharest

hree weeks after snap elections were held October 5, former prime minister and GERB party leader Boiko Borisov was still struggling to form a coalition. The political instability that has plagued Bulgaria for almost two years looks set to continue. On October 20, Borisov said he would hold another round of talks with potential allies in an attempt to avoid a repeat of elections in Bulgaria. The largest party in Bulgaria’s fragmented new parliament, GERB (Citizens for European Development of Bulgaria) announced October 16 that it had agreed with the nationalist Patriotic Front coalition to work together in government. The Patriotic Front also agreed to support centre-right toughguy Borisov as prime minister. This gives GERB the 19 seats held by the Patriotic Front – comprising the Bulgarian National Movement (VMRO) and the National Front for the Salvation of Bulgaria (NFSB) – in addition to the

84 seats that it holds, meaning Borisov will need to find at least another 18 seats for a majority in the 240-seat national assembly. Striking the deal with the Patriotic Front was good news for GERB, which the previous day had failed to make headway in talks with the Reformist

tion expressing frustration with the Reformists. Writing on his Facebook page after the talks, Borisov slammed the Reformist Bloc as “ill-prepared” and "an unstable” partner. "I am extremely dissatisfied with the Reformist Bloc's preparation for today’s consultations,” he wrote.

"GERB faces some unpalatable choices, including an alliance with nationalist parties which might strain relations with some of Bulgaria's Western allies"

Bloc, the rightwing coalition considered to be its most likely ally in government. Six hours of talks on October 15 ended with no agreement between the two parties, with the GERB delega-

After meeting all seven of the parties represented in Bulgaria’s new parliament, GERB now plans to hold another round of talks with four parliamentary parties including the Reformists, the

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Patriotic Front and – more surprisingly – the Bulgarian Socialist Party (BSP) and the leftwing Alternative for Bulgarian Revival.

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Bosnians to wait for progress on economy Clare Nuttall in Sarajevo

"The natural ally for GERB is the Reformist Bloc, which shares many points of their platform, but there is a very strong animosity between the parties’ leaders," says a report from the Centre for Eastern Studies (OSW). "The Reformist Bloc... are traditionally reluctant to engage with Borisov, as he has taken over the centre-right electorate." Other areas of conflict include the Russian-led South Stream gas pipeline project and the expansion of the Kozloduy nuclear power plant. Far end of spectrum The deal with the Patriotic Front confirms forecasts that Borisov would have to search among Bulgaria’s far right and nationalist fringe parties to put together a coalition. Tim Ash of Standard Bank forecast after the vote that forming a new government would be “acutely difficult” for GERB, which faces “some unpalatable choices, including an alliance with nationalist parties which might strain relations with some of Bulgaria's Western allies.” The Patriotic Front "seems willing to enter into a coalition, but its nationalistic rhetoric may raise tensions with Bulgaria’s neighbours and the EU," agrees OSW's report. Should Borisov fail to put together a coalition, Bulgaria may have to yet again head for early elections. However, President Rosen Plevneliev spoke out against this option on October 20. “To me there is no option for new elections,” Plevneliev told journalists, according to local daily Sega. The October 5 elections were Bulgaria’s second early elections in less than two years. It’s been political mayhem, in fact, since early 2013, when Borisov was pushed from office by mass demonstrations over high electricity bills and other factors such as high-level corruption. Though his GERB remained the largest political grouping following the elections, there emerged a precari-

Three nationalist candidates won the race for Bosnia and Herzegovina’s rotating presidency on October 12, while no party took a majority in the early parliamentary elections held on the same date. With the vote merely opening the way for negotiations on a new coalition government, delays can be expected before much needed action on the economy is taken. Early elections were called in February after protests over corruption and unemployment erupted into the worst outbreak of violence since the end of the Balkan War in 1995. However, hopes of improvements this year were dashed after some of the worst flooding on record hit large parts of the country. At the beginning of this year, Bosnia was on track for annual GDP growth of around 2%, but forecasts have now been slashed to close to zero, because of a combination of flooding and slow recoveries in Croatia and Bosnia’s other trading partners within the EU. Investment decisions have also been put on hold during the last eight months of political uncertainty. “Bosnia has a history of coping with an unstable political environment, but... investors want stability,” Erste Bank analyst Alen Kovac tells bne. Nor has there been much progress on reforms to the business environment, while privatisations of major companies including BH Telecom have stalled. The European Bank for Reconstruction and Development’s (EBRD) “2013 Transition Report” identified areas where work was needed, including infrastructure development, improving the business climate, energy sector reform and privatisation of state owned enterprises. “Since then, there hasn’t been much progress, especially in recent months due to the combination of the pre-election period and the aftermath of the floods,” says the EBRD’s lead economist for Southeast Europe, Peter Sanfey. While things are “not at a complete standstill” – there has been some progress for example on business registration and within the framework of Bosnia’s IMF programme – “we would hope after there is a new government there would be progress,” Sanfey says. Speedy progress on these issues after the election is not expected, since Bosnia has a history of taking a long time to form a new government. “Votes don’t mean much – the party with the most votes will not necessarily be in government because at least five or six parties are needed to form a government at the state level,” Ivana Maric of Sarajevo-based think-tank Populari tells bne. The latest round of elections has brought the complex power-sharing structure of the Bosnian government under scrutiny, sparking calls for political reforms. The system of two autonomous republics, intended to ensure peace within Bosnia, has the downside of creating conditions for political deadlock that has prevented reforms from being introduced, as well as creating opportunities for corruption. However, economic issues remain the most pressing tasks for Bosnia’s new leaders. According to Maric the population is “moving forward from national topics to real topics – unemployment, corruption and living standards.”

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ous government of the former communist Bulgarian Socialist Party (BSP) and the mainly ethnic Turkish Movement for Rights and Freedoms (MRF), commanding exactly half the members of the 240-seat parliament – and incongruously supported when necessary by the extreme nationalists of the Ataka party. The attempt in June 2013 to install Delyan Peevski, a controversial MRF parliamentarian and businessman, as chief of the national security agency triggered mass protests that continued in general anti-government mode months after the appointment had been withdrawn. The government rode those out, only to succumb in June this year to a cluster of catastrophes: poor BSP results in European Parliament elections unsettled the coalition, while

Brussels’ objections to Russia’s South Stream gas pipeline – a project dear to BSP hearts – divided it further. Then a fallout between Peevski and his old ally Tsvetan Vasilev provoked massive withdrawals from the latter’s Corporate Commercial Bank (KTB), sending Bulgaria’s fourth biggest lender into special administration. With the government promising to resign in late June – and actually doing so in late July – unfinished business looms for Bulgaria’s next government when it is actually formed. Populist tariff cuts have produced a massive and threatening hole in electricity system finances. No decision has been taken on rescuing – or failing to rescue – KTB, whose depositors are currently in limbo,

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

Boby Dimitrov denied access to theirPhoto: deposits or to deposit insurance. And parliament failed to agree on a budget update that would manifestly be necessary well before the year’s end. Not empowered to alter the budget or raise foreign debt, the presidentially appointed caretaker government of Georgi Bliznashki that took over on August 6 has been holding the fort.

GERB has a reasonably successful record in government between 2009 and 2013, and during its election campaign the party touted its demonstrated ability to get infrastructure built and EU funds flowing. However, the party first needs to bring new allies on board if it is to create a stable government capable of addressing these problems.

What you need to know

www.bne.eu

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Lack of supervision While Fullani has not been accused of direct involvement in the thefts, he is ultimately responsible for the alarming lack of supervision within the bank. Since the BOA is also responsible for supervision of the Albanian banking sector, this concern extends to how effectively it has carried out that role. In particular, given Albania’s large informal economy, and the problems of drug and human trafficking in the country, there are questions about to what extent illegal profits have been channeled through the banking sector.

Albania’s central bank on trial Clare Nuttall in Bucharest

he discovery that ¤5m worth of cash had been stolen from Albania’ central bank resulted in a large-scale inquiry with more than 16 of the bank’s employees including its now ex-governor Ardian Fullani facing trial. The negligence discovered on the part of Fullani and other senior officials raises questions about the supervision of Albanian banks, and whether prosecutors will seize the opportunity for a wider investigation into suspected corruption in the financial sector. Thefts amounting to ALL715m (¤5m) in cash emerged in July, when seven Bank of Albania (BOA) employees were arrested on suspicion of stealing from the bank over a four-year period. One economist confessed to police that he had smuggled banknotes out of the building inside his clothes or old books. Ardian Bitraj told police he used the money to gamble, stealing notes daily during the 2014 World Cup.

As the probe widened, pressure mounted on Fullani, who had chaired the bank since 2004, to resign. On September 5 he was taken into police custody and is now under house arrest while several charges against him are investigated. And on September 18,

The Financial Action Task Force (FATF), an inter-governmental body that promotes policies to combat money laundering and terrorist financing, reports that while the BOA established a task force to confirm banks’ compliance with customer verification rules, “enforcement remains poor in practice.” Other reports point out that the relatively large proportion of cash transactions in the Albanian economy have made it easier to launder funds. “The relative size of the cash-based informal economy facilitates the laundering and integration of proceeds of crime,” says a 2011 report from the International Monetary Fund (IMF). “The number of sectors identified with illegal practices, including illegal gambling establishments and exchange bureaus, as well as the vulnerabilities that relate to cross-

"The lack of responsibility in the management of the Bank of Albania raises questions about the supervision of the banking sector" Albania’s parliament voted to dismiss him from his post for alleged abuse of office. A statement from Albanian prosecutors said that Fullani, together with the bank’s inspector general Elivar Golemi, “because of their inactions, have created conditions to violate the security of money in the administration of the Bank of Albania.”

border transportation of currency, also make Albania at risk for [money laundering] activity.” A 2014 report by two members of the Albanian National Bar Association, titled “Laundering of Crime Proceeds in Albania”, agrees that the country is “a suitable place for money laundering

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because of the corruption, cash transactions and the informal economy... The construction sector, creating commercial companies, and opening casinos and gambling are the main means of money laundering in Albania.” While the report adds that, “These methods appear to be less sophisticated than countries that have developed financial markets and where money laundering is done through complex

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opposition from Socialist Party MPs. Discussions on his re-appointment took place at the same time as the trial of former deputy PM Ilir Meta on charges of asking for favours in return for public tenders. Fullani’s wife was one of the panel of judges who acquitted Meta. Albania’s then prime minister, Sali Berisha, whose Democratic Party of Albania was the senior partner in the

"Albania has developed a reputation for being a crossroads for drug trafficking, human trafficking and money laundering"

financial transactions,” it is unlikely that corruption on this scale is possible without involving the banking sector. “Albania has developed a reputation for being a crossroads for drug trafficking, human trafficking and money laundering. There is no way that these activities could make up such a large proportion of GDP without using the banking sector,” Gary Kokalari, founder of Albanians for a Democratic Albania, which is involved in fighting corrupt practices in Albania, tells bne. Kokalari believes that the “lack of responsibility in the management of the Bank of Albania” raises questions about the supervision of the banking sector. Full of Fullani This is not the first time that Fullani has been the subject of controversy. A career banker, he joined the BOA as deputy governor in 1992, and was appointed governor in 2004. However, he was known for cultivating close links with politicians from both left and right, and was more often seen in Tirana restaurants than behind his desk at the bank. In 2011, Fullani was re-appointed for a second seven-year term, despite fierce

coalition government alongside Meta’s Socialist Movement for Integration, proposed that Fullani serve a second term. The Socialist Party, which came to power under Edi Rama in September 2013, opposed the appointment, claiming it was connected to Meta’s trial. Socialist PMs also accused Fullani of striking deals behind the scenes with the government, including over the financing of the budget deficit. Albania is the most corrupt country in Europe, according to Transparency International. In 2013, Albania dropped to 116th place among the 117 countries on the anti-graft NGO’s annual “Corruption Perceptions Index.” PM Rama came to power promising, like many Albanian leaders before him, to be tough on crime, corruption and drugs. In June, police launched a dramatic operation at Albania’s so-called “marijuana mountain,” where an estimated ¤4.5bn worth of the drug is produced every year. Around 800 police were involved in the operation, which resulted in several arrests and the destruction of billions worth of drugs. However, according to Kokalari, this was a relatively easy and high-profile target compared to making progress against trafficking in hard drugs,

money laundering or government corruption – for example by revisiting past privatisations of companies such as Albtelecom and Albpetrol. EU push Tirana now has a new incentive to address corruption. After numerous failed attempts, in June the country was finally given EU candidate status, although European foreign ministers said that more progress in tackling organised crime and corruption would be needed before it can join. There is some evidence of progress recently. A spokesperson for Albania’s Ministry for European Integration tells bne that Albania has been working in close cooperation with European partners, and “anti-corruption measures have been focused on increasing transparency and creating a track record.” A 2014 report from the European Commission also identified “continued political will to act decisively... and fight against corruption, as shown by the adoption of new legislation in this area.” The government has prepared a draft law on protection for whistleblowers, with a focus on the public sector, that is due to be presented to the parliament in November. The six months after Rama’s election, from October 2013 to March 2014, also saw a 16% increase in the number of corruption cases referred to prosecutors, though the conviction rate remains relatively low. Meanwhile, at the BOA Rama appears determined not to appoint a Fullani clone. Shortly after Fullani’s arrest and subsequent sacking, the PM indicated he could look outside the country for a replacement. However, with his first candidate – the former governor of the Bank of Argentina Mario Blejer – rejected by President Bujar Nishani, it may be some time before order is restored at the bank under a new governor.

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Bumpy road for investors in Romania Clare Nuttall in Bucharest

n any discussion about the difficulties of investing in Romania, the state of the country’s transport infrastructure is likely to compete with the tax regime and corruption as the worst obstacle. Bucharest is now drawing up a new transport strategy for long-term development of the sector, but so far successive governments have been long on ideas and short on concrete progress. At a conference in Bucharest in September, Romanian President Traian Basescu struck a chord with investors when he slammed the way his country's governments had failed to use EU structural funds to invest in infrastructure. During the 2007-2013 EU budgetary period, Romania absorbed only 37.2% of the ¤19bn available, spending around ¤7.1bn. “We must spend ¤12bn by the end of 2015 so as not to lose this money,” Basescu told the Forbes CEE Forum, but adding sourly that, “I can’t be optimistic that Romania will succeed.” New strategy A new transport strategy currently being drawn up by the government is due to be completed in October. However, the presidential elections the following month mean that decisions on the sector are not expected immediately, and unless new legislation setting out specific actions is adopted, ambitious plans could yet again fall by the wayside. This is partly due to a government focus on short-term over long-term goals. Bogdan Belciu, partner at PwC Romania, points out that despite a relatively generous allocation of budget funds for infrastructure investment, “recently the government has kept the budgetary deficit under tight control mostly by limiting capital projects spending. While this helps keeping the macroeconomic stability of the country, it fails to address Romania’s long-term development needs.” The long-running saga of delays and poor decisions on Romania’s A3 motorway

highlights the lack of progress. First proposed back in the early 1970s, the A3 was dreamed up as a way to connect Bucharest to the road network in neighbouring Hungary across Transylvania via Ploiesti, Targu Mores and Cluj-Napoca. Back in 2003, the Romanian government signed a ¤2.2bn deal with US construction company Bechtel to build 415km of the planned highway. The contract was finally cancelled in May 2013 with just 52km completed, although Bucharest still ended up with a ¤1.4bn bill, most of which was penalties due to Bechtel. The highway is finally close to completion, but until that happens companies that set up operations in central Romania are at a clear disadvantage to their peers closer to the Hungarian border; the latter benefit from Hungary’s more developed road network, which can quickly whisk their products away to Germany and other European markets. Meanwhile, manufacturers in central Romania are forced to build in extra delivery time for exports due to their slow and unreliable route to international markets. Poor road infrastructure is also affecting the level of traffic through the Black Sea ports in Romania and neighbouring countries. Manufacturers in cities as far northwest as Vienna are closer as the crow flies to Romania’s Constanta than the North Sea ports. However, “due to the poor state of the Romanian roads, they send their goods north to Hamburg or Rotterdam. Even some companies in northern Romania are choosing to send their goods north,” according to Tomas Moser, chairman of Danube Logistics SRL. Reputation damage Overall, Romania only has around 450km of highway – a tiny amount for Europe’s 12th largest country. As a result, investors continue to curse the lack of investment into transport infrastructure. PwC forecasts that infrastructure spending will increase

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by a steady 5% a year to reach $30bn by 2025. However, the firm’s “CEO Survey 2014” finds that transport infrastructure is still one of the country’s “main economic vulnerabilities.” 88% of CEOs surveyed said that the government should make improving infrastructure a priority – the highest percentage in any of the countries in the worldwide survey. 78% of respondents thought the government had failed to put sufficient emphasis on infrastructure. “Romania’s attractiveness as an investment destination for manufacturing industries depends on improving the country’s transport infrastructure,” Belciu tells bne. Other studies confirm the damage that a lack of investment in road and rail infrastructure is doing to Romania’s reputation among investors. The latest global competitiveness index from the World Economic Forum (WEF) finds that although Romania advanced to 69th place on this year’s index, its score is still dragged down by the poor state of its transport infrastructure. Romania’s roads are not the only problem. While railways operator CFR has invested into some fast intercity lines, the average speed of trains on intercity lines is just 87km/hour. Data published by Eurostat in December 2013 shows that amid a pan-European decline, Romania had seen one of the sharpest falls in rail freight transport. Even river transport is problematic; the stretch of the Danube, one of Europe’s major waterways, along the Romanian-Bulgarian borders is one of the worst maintained of the entire river, making it difficult to navigate and deterring traffic. Despite these obstacles, PwC’s Belciu believes that, “Romania could position itself to be a European eastern gateway by improving its transport infrastructure.” This would require investment into highways, developing sea and river ports, making use of the Danube-Black Sea canal and introducing multimodal connections (truck and train) across the Carpathians. The government’s new transport strategy is expected to set out some new goals for this sector, but only a serious commitment to increasing spending will stop poor transport infrastructure weighing down the Romanian economy.

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l’Avenir on August 28. His positive test followed those of the Iglinskiy brothers, Maxim and Valentin, who were both caught using the banned blood booster EPO. Maxim had helped Nibali to win the yellow jersey this summer. Speaking to bne at the beginning of the Almaty Tour on October 5, the current Astana Pro Team's general manager, Alexandre Vinokourov said that because of cycling, “Now the whole world knows about Astana and Kazakhstan.” Indeed, but perhaps not in the way that President Nazarbayev and his advisers had planned.

The peril of using bikes to bury Borat Jacopo Dettoni in Almaty

talian cyclist Vincenzo Nibali made his way towards the start line amid dozens of excited fans wearing sky-blue T-shirts celebrating national cycling hero Alexandre Vinokourov and flying Kazakhstan flags. Born and bred in Sicily, Nibali sported a cycling jersey printed with the colours of Kazakhstan's national flag and the name of the country's capital city, Astana. After his triumph on the ChampsÉlysées at the 2014 Tour de France, the slender Sicilian stole the spotlight at the start of the Almaty Tour on October 5, a professional cycling race that has featured on the International Cycling Federation's (UCI) calendar since 2013. Willing or not, he has become an ambassador for Kazakhstan since he joined the Astana Pro Team, a cycling powerhouse backed by President Nursultan Nazarbayev himself. But as the Almaty Tour began, storms were gathering over Nibali’s Tour

de France triumph and his Astana Pro Team that threaten to leave Nazerbayev sporting dream in tatters. On October 16, it emerged that Astana Pro Team is to be subjected to “a full review” of its licence over the next month following a third positive

Club of kings Established in 2006 on the initiative of Vinokourov himself when his previous squad, the Liberty SegurosWürth team, went belly-up after a doping scandal, the Astana Pro Team has – with the president’s backing – navigated its way through recurrent doping allegations to emerge as a major force in the cycling world. It won a first Tour de France with Spanish Alberto Contador in 2009 and nailed a second success with Nibali in 2014, although it never completely shook off the reputation of being a doping-prone team. Contador was stripped of a second Tour de France title in 2010 after testing positive for

"Winning important stage races like the Tour de France really pays off in terms of image for the whole country"

doping test in the space of a few weeks. Ilya Davidenok, a young rider who has spent the past two years with Astana’s development team, returned what the authorities described as “adverse analytical finding” for anabolic androgenic steroids in a sample collected at the Tour de

traces of banned substance clenbuterol. Another two of the team's top riders, Kazakhstan's Iglinsky brothers, tested positive for EPO just a few weeks before this year's Almaty Tour, forcing the team to eventually withdraw from the Tour of Beijing, which ends the UCI World Tour calendar.

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Hoping to replicate the team's achievements, at least those not tainted by doping scandals, in other sports and burnish the image of the country further, Nazarbayev launched the Astana Presidential Sports Club in 2012, which is a multi-sports club that together with the cycling team also includes: a boxing team, a basketball team, a cycling team, a hockey team, a football team and even a Dakar Rally team. "Our champions, just like our [economic] success or our new capital [of Astana], constitute Kazakhstan's national brand,” Nazarbayev said in 2013 during a celebration at the club's headquarters in Astana. “Sports achievements make our country memorable by demonstrating our strongest qualities to the world. Kazakhstan should be known as a nation of victors.” In order to translate ambition into sporting success, Nazarbayev mandated Kazakhstan's sovereign wealth fund, Samruk-Kazyna, to provide the club with generous financial support. The total budget for 2014 was on the order of $150m, with ¤15m going to the cycling team alone. That’s big money for a sport which traditionally requires much smaller budgets than other mainstream disciplines like football. “I chose to join the Astana Pro Team in 2013 because the team brings to the table an important budget able to build up a team fit to compete for the best stage races like the Tour de France,” Nibali told bne. Race to the finish As Nibali and his fellow teammates seize the opportunity to achieve sporting and financial success, Kazakhstan’s ruling elites are looking at the bigger picture. In a move that brings to mind the obsession for sports of the old German Democratic Republic or the USSR, “the Nazarbayev regime has made ample use of the strategy of promoting sport as a means to simultaneously increase nationalist sentiment and

Kashagone Naubet Bisenov in Almaty Delays in the resumption of oil production from the giant offshore Kashagan field have dashed the Kazakh government's hopes of increasing oil output before 2016. Fearing that the delay in the start of Kashagan’s commercial production will damage economic performance, the government is trying to compensate for the shortfall by increasing output from other fields. Kazakhstan will maintain oil output at last year's 81.8m tonnes this year and next year, Magzum Mirzagaliyev, deputy energy minister, told journalists at the KIOGE oil and gas conference in Almaty on October 1. "Our plans for this year remain at 81.8m tonnes. We expect we will fulfil the plans," Mirzagaliyev said. "We are now looking for reserves, particularly, TCO [Tengizchevroil] has a great impact on the [total oil] output." Tengizchevroil, which is developing the onshore giant Tengiz field, is expected to produce 27m tonnes of oil this year, he noted. TCO is planning repairs in October that are expected to be completed quickly, Mirzagaliyev explained. The deputy energy minister said that the government was in talks with other oil producers to increase their output. "We are closely working with each licence holder to issue necessary permissions and consider necessary project documentation as quickly as possible," Mirzagaliyev said. Production at Kashagan was launched on September 11, 2013, but a leak on the gas pipeline running to the onshore processing facility at Bolashak led production to be halted on September 24. An attempt to restart operations was abandoned on October 9. Astana expected Kashagan to resume production in July, and forecast it would produce 2.5-3m tonnes of oil by the end of the year. Myrzagaliyev suggested that production would now resume in the field in the second half of 2016. "Judging by information we receive and technical forecasts we see, it [resumption] should be in the second half of 2016," he said. The Kazakh government is now holding talks with the Kashagan developers on the penalties they will face for delaying commercial production, and costs borne by them since the suspension will not be covered, Mirzagaliyev said. "On September 11, 2013, you remember, the contractor [NCOC] achieved commercial production. Costs borne under the phase one since October will not be compensated for," he said. However, "the sum hasn't yet been determined”. The Kazakh government had, until recently, been forecasting a major leap in oil output this year on the back of the start of commercial production at Kashagan. Over the next five years, Kazakhstan's oil production was expected to increase by around 25%, from 82m tonnes in 2012 to 102m tonnes in 2017. Kashagan, in the Caspian Sea, was the largest oilfield discovery in the world in the last three decades, and has estimated recoverable reserves of around 13bn barrels of oil. Kashagan is being developed by the international consortium NCOC. Stateowned KazMunaiGas owns an 16.88% stake in the project, Eni, Shell, Total and ExxonMobil hold 16.81% each, with Japan's Inpex owning 7.56%.

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"The cycling team is seemingly benign, but this impression is precisely what soft authoritarian leaders seek to cultivate in their nation-building projects" international prestige (and thus popular legitimacy),” Nicole Koch, a researcher at Syracuse University in the US, wrote in a 2013 paper focusing on the Astana Pro Team experience. “While the Astana cycling team example is seemingly benign, this impression is precisely what soft authoritarian leaders seek to cultivate in their nation-building projects… Not only do they naturalize paternalist state society relations in which citizens are actively assigned the role

criticism for his patchy record on human rights and democratic practices.

of passive spectator, but they are more broadly put to work in legitimating the unequal distribution of power and wealth,” Koch wrote.

Deaf to critics, Nazarbayev has raised the stakes by leveraging the Astana Pro Team's PR success to launch a bold bid to host the 2022 Winter Olympics. It may pay off too; in a surprising turn of events, Almaty and Beijing are the only two cities still running for the event, as all the other bidders – Krakow, Lviv, Oslo and Stockholm – have pulled out.

In power since the country's independence from the Soviet Union in 1991, Nazarbayev takes most of the credit for the impressive economic growth the country has experienced over the last decade, thanks to the development of abundant oil and mineral resources. At the same time, the “leader of the nation” has drawn

Nazarbayev, speaking at the Astana Presidential Sports Club in 2013, quoted German philosopher Hegel: "if the strong men unite, they become invincible.” The president might not be the best example of fair play at work, but for sure he is surrounded by an aura of invincibility, at least in Kazakhstan's sporting arena.

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Russia rekindles interest in TransMongolian Railway Terrence Edwards in Ulaanbaatar

he Trans-Mongolian Railway badly needs an overhaul if it is to operate as an effective trade route between Russia and China. That could finally happen now both of Mongolia's powerful neighbours have good reasons for doing so, which would have the added effect of opening up more of Mongolia's vast mineral wealth to foreign investors. The Trans-Mongolian Railway is 1,800 kilometres of 1950s-era track bisecting the landlocked country between China and Russia. It is slow and can only haul a little over 20m tonnes of cargo across the country a year. The direct route across Mongolia also fails to

reach the valuable mineral deposits that are peppered throughout the country. Russia is a 50% partner with Mongolia of Ulaanbaatar Railways, which owns and maintains the rail route. But Russia has shown little interest in the joint venture in the years since it cut Mongolia loose when the Soviet Union

broke apart. But now Russiaâ&#x20AC;&#x2122;s disputes with the West have put Mongolia in an enviable position to facilitate trade between Russia and China as well as step up its own trade in goods such as meat products. Now Russia has promised to help Mongolia upgrade the TransMongolian's rail capacity to 100m

"Developing the railway network will help Mongolia to open up rich but for now hard-toaccess deposits"

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tonnes a year by 2020 as part of Moscow's “pivot” towards Asia. “Developing the railway network will help Mongolia to open up rich but for now hard-to-access deposits, and make broader and more effective use of its potential as a transit country,” Russian President Vladimir Putin said during a visit to Mongolia in September. Mongolia’s upgrade and expansion of its railway network has been a slowgoing process, which has affected the development of the country as a whole. Bottlenecks in delivering coal to China for example, has limited the growth of the coal mining industry. The metals and mining consultancy CRU Group, in a report released in October, notes that shortcomings in Mongolia’s rail infrastructure were a part of wider logistical issues of “paramount importance” if the country is to ever see worthwhile returns from its still-infant mining industry. Giving mines rail access to deliver minerals such as coal and iron ore to China would cut transport costs in half, argues the report. That counts even more these days given the tough market for coal and China's push to wean itself off the black stuff in an effort to clean up the polluted skies above cities such as Beijing. Gateway to Russia Interest from Moscow in Mongolia's rail has also pushed the country to prioritise Sydney-listed Aspire Mining's Northern Railways project. The project has been added to a list of projects the country is actively seeking private partners to realise, according to a statement from the junior miner on October 13. Aspire Mining's subsidiary Northern Railways was established in 2010 to build 547km of tracks west from Erdenet in northern Mongolia to the Nuurstei and Ovoot deposits. The final stop would be the Arts Suuri border point in northwest Mongolia, which also serves as a gateway to the Tuva Republic of Russia.

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"Even though coal prices were high at the time, to be an efficient supplier we needed rail brought to the deposit"

Aspire hopes to negotiate a “buildoperate-transfer” contract with Mongolia through Northern Railways, under which it would manage the line for at least 20 years, says David Paull, Aspire Mining's managing director. “We did it because we knew we had a large discovery,” says Paull about Ovoot, which is currently the country's second largest known coal deposit. Its coal is “a bulk commodity some distance from existing rail. Even though coal prices were high at the time, to be an efficient supplier we needed rail brought to the deposit.” Mongolia would probably own at least 51% of the rail line under the partnership, Paull adds. Exports to Russia from Mongolia have never meant much, especially compared with resource-hungry China. But Yondon Manalaibayar, Mongolia's state secretary for rail and transport, points out that if the Northern Railways line could be extended even further north into Russia, to the city of Kyzyl, as Mongolia hopes, it would link up to Russia's wider rail network. “Russia and China are looking for 2.5-times expansion of trade,” says Manlaibayar. “We want to facilitate all this trade. We [Mongolia and Aspire] have mutual interests.” Wrestling for dominance China also stands to benefit from an overhaul of the Trans-Mongolian Railway. Mines linked to the TransMongolian will also now have access to overseas markets such as Japan or South Korea because China has permission from Mongolia to deliver up to 30m tonnes of freight a year to eight additional sea ports. Up until now, Mongolia has only had access to the Tianjin port, but it has never been much of a launch pad for

its minerals, aside from a small trickle of copper from Mongolia's Erdenet copper mine, says Manlaibayar. “Tianjin is only a container site, but what Mongolia really needs is what's called break bulk shipping” for the overseas transport of many tonnes of minerals, he says. However, one condition that Russia might impose on Mongolia if it is going to help finance renovations to the Trans-Mongolian Railway is the abandoning of any plans to build a Chinese-gauge railine in Mongolia. Russia has enjoyed strategic control over the Trans-Mongolian since it helped put it into commission in the 1950s and Moscow is keen to protect that. Local Mongolian newspaper Udriin Sonin reported in September that the president of Russian Railways, Vladimir Ivanovich Yakunin, wrote directly to Mongolia's prime minister to try to discourage construction of a Chinese gauge rail. “To create a railway with narrow gauge is the wrong decision,” Yakunin wrote, adding that the Trans-Mongolian “represents Russian interests as much as Mongolia's in terms of the railway.” Russia uses a slightly wider gauge of 1,520 mm compared with China's 1,435 mm, which is also the international standard. Those who favour the Chinese gauge argue on the grounds of the economic cost of moving the coal from one wide gauge carriage to one with the narrower gauge when the train enters China. But opponents lean on Mongolia's historical misgivings towards China and its favouritism to Russia. The physical difference may be about the size of a credit card, but its political size in Mongolia is measureless.

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increased to 500,000 tonnes [a year] by the end of 2015." At the fair Uzbekistan signed contracts to supply 580,000 tonnes of cotton fibre to foreign consumers, 100,000 tonnes fewer than last year. According to the Uzbek PM, major markets for its cotton are China, Bangladesh, Turkey, Russia, Singapore and South Korea â&#x20AC;&#x201C; a geographic spread explained by the success of a campaign to boycott Uzbek cotton launched in the West over forced and child labour practices. Photo: Tracing Tea

Uzbekistan cottons on to criticism Olim Abdullayev in Tashkent

zbekistan's government has used an international fair to brag about apparent achievements that the country has made in its cotton industry since it became independent in 1991. But critics charge that despite government attempts to cover up the practice, itâ&#x20AC;&#x2122;s continuing to use forced labour, including children, prompting global retailers and apparel brands to avoid the use of Uzbek cotton in their products. Uzbekistan is one of the world's largest exporters of cotton, producing over 3m tonnes of raw cotton and 1m tonnes of cotton fibre annually. Cotton is a major source of revenue for the impoverished Central Asian state, raising roughly $1bn in export earnings for the government in 2013, Uzbek Prime Minister Shavkat Mirziyayev told the 10th International Uzbek Cotton and Textile Fair in Tashkent on October 13. He said the country expects to earn $1.2bn from exporting cotton and textile this year. Uzbekistan has been increasing the volume of cotton processed

domestically, as it faces an international boycott because of the continued use of forced and child labour in the cotton industry. According to local media, the country increased the volume of cotton processed domestically from 7% of total production in the 1990s to 44% in 2014. Mirziyayev was quoted as saying by Trend the government plans to increase

Forced labour Mirziyayev praised local breeders that developed 160 new varieties of cotton with "exceptional whiteness, early maturation, high yield and length of fibre, as well as resistance to diseases and pests" last year alone. This meant that over 90% of cotton harvested last year was of "superior" quality, according to local media. But observers says the high quality of Uzbek cotton can be explained by the fact it is mostly handpicked by students and public-sector employees such as teachers, doctors and nurses. Mechanised picking is believed to be damaging for cotton fibres if a machine fails to remove cotton wholly from the boll. This is confirmed by the government figures that only 1,200 cotton-picking combines are involved in this autumn's cotton picking compared with over 40,000 in 1991.

"Although the government continues to publicly deny the use of forced labour, the worst forms of child labour in cotton production continue"

the share of Uzbek cotton processed domestically to 70% by 2020. "The Uzbek government is steadfastly continuing a policy of reducing exports of cotton fibre through creating new production facilities and boosting processing capacities, which will be

Despite ratifying the International Labour Organisation's (ILO's) Worst Forms of Child Labour Convention in 2008 and the ILO's Minimum Age Convention in 2009, Uzbekistan is still widely accused of continuing to use child labour. "In 2013, Uzbekistan made

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no advancement in efforts to eliminate the worst forms of child labour," the US Department of Labour said in its 2013 “Findings on the Worst Forms of Child Labour” report published on October 7. "The national government maintained

the cotton harvest, a manager at a small enterprise outside the capital, Tashkent, tells bne. "Private small businesses have to send at least one employee to pick cotton," he says. "Instead of releasing our workers

"Private small businesses have to send at least one employee to pick cotton" policies in the cotton sector, which mandate harvest quotas and cause local administrators to organise and impose forced labour on children and adults. Although the government continues to publicly deny the use of forced labour, including of children, in the cotton harvest, information indicates that children continue to be required to engage in the worst forms of child labour in cotton production.”

Tajikistan

Uzbekistan allowed the ILO to monitor the cotton harvest last year, and its monitors reported 57 confirmed cases of children working in the cotton fields, including 53 children aged 16 and 17. The US Department of Labour's report cites NGOs and US embassy information that "there were isolated incidents of children as young as 10 working in the cotton fields." The Cotton Campaign, an umbrella of human rights organisations, trade unions, socially-responsible investors and business organisations, which was established in 2007 to end forced labour of children and adults in the cotton industry in Uzbekistan, says that every year the Uzbek government forces "over a million children", teachers, public-sector workers and employees of private businesses to manually pick cotton under threat of expulsion from school or loss of employment, pensions and child benefits. While the government has stopped sending schoolchildren into the fields to pick cotton, it is continuing to enrol college students aged 16 and 17 in

we hire day labourers and pay them UZS50,000 [$17 at the black-market exchange rate] a day to pick cotton.” Tesco jumps on bandwagon Uzbek rights activists' efforts to publicise the use of forced and child labour in the Uzbek cotton industry resulted in the launch of the Company Pledge Against Child and Adult Forced Labour in Uzbek Cotton, simply known as the Cotton Pledge, in 2008, which has now been signed by over 160 brands and companies which are committed to preventing Uzbek cotton from entering their supply chains. "Markets for Uzbek cotton sourced with forced labour continue to diminish as consumers become more aware of the egregious human rights violations that occur during the Uzbek cotton harvest, with over four million Uzbek citizens forced to pick cotton under threat of penalty," according to Responsible Sourcing Network (RSN). The RSN said in a press release on October 9 that the world's second largest retailer, Tesco, was the latest multinational retailer to sign the pledge to join Target, Walmart, C&A, Marks & Spencer, Ikea, Adidas, Nike and H&M. “I applaud Tesco and the other retailers and brands for maintaining their commitments to avoid cotton from Uzbekistan,” the press release quotes Patricia Jurewicz, director of RSN, as saying. “Having the largest retailers in the world standing united shows that they are committed to doing their part to end forced labour, both of children and adults.”

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Photo: Lebedev_S

INTERVIEW:

Baku’s European Games

Carmen Valache in Baku

ith fewer than 250 days left until the opening ceremony of the European Games in Azerbaijan, the Baku European Games Operations Committee (BEGOC) is hard at work to deliver an event budgeted at more than $8bn, complete with what it describes will be the most spectacular show in Azerbaijan’s history. “This is going to be the most fantastic show ever staged in Azerbaijan, one that will make the Eurovision song contest seem like a small local event,” BEGOC Chief Operating Officer Simon Clegg tells bne of the opening ceremony, while refusing to reveal any of the acts. However, the appointment of Dimitris Papaioannou, the artistic director of the Athens 2004 Olympic Games ceremonies, as the artistic

director of the Baku 2015 opening ceremony speaks volumes about the intent to stage a show to remember. BEGOC has expanded significantly over the last two months, from 670 to 900 employees, reflecting a pickup in the pace of the preparations. Clegg cites time pressure – BEGOC only had 30 months to deliver the event – as the key aspect that differentiates these games from large-scale sporting events elsewhere. “Our preparations are time sensitive, and we have to compress some elements that are typical of multi-sport events, like transportation, accommodation, the accreditation process or dealing with the international media.” The Azerbaijani government is in charge of ensuring that the 18 venues

in which competitions will be held are ready for the June 2015 event. All eyes are on the National Stadium, a 65,000-person venue and on the athletes’ village. The government will take advantage of the occasion to inaugurate a new airport terminal and upgraded subway and bus systems. Conversely, BEGOC will be responsible for everything related to the organization of the games. Attracting high-quality athletes was an important first step, Clegg contends, and it was accomplished by ensuring that 16 of the 20 participating sports can use the Baku Games as a qualifying or ranking event for the Rio 2016 Olympics. Negotiating with broadcasters was the next step. So far, broadcasters for Turkey, Romania, Hungary, Belgium

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and Germany have been announced, and talks are being held with a number of other countries. While the games will be a European event, Clegg wants to ensure that it is broadcast all over the world, from Australia to South America. The total budget for the event has not been made public. However, an October 2013 announcement revealed

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of purchase of tickets. Some 6,000 athletes and 3,000 officials from the National Olympic Committees of Europe have confirmed their participation in the games, which Clegg believes will be the “second most important event in the history of Azerbaijan after the signing of the contract of the century in 1994,” referring to deal with an international consortium to develop the giant Azeri,

"This is going to be the most fantastic show ever staged in Azerbaijan, one that will make the Eurovision song contest seem like a small local event"

that Azerbaijan’s 2014 state budget had provisioned $7.7bn for the event, $1.25bn of which would be allotted to BEGOC for hosting the event, according to Eurasianet. Sponsors and visas BEGOC’s two-tiered sponsorship scheme will complement the budget allocated by the Azerbaijani state. The committee is seeking to sign up eight official partners that would benefit from branding and advertisement at all the competition venues. So far, six companies have agreed to sponsor the event in this capacity, including Azerbaijan Airlines (AZAL), P&G, Tissot, Nar Mobile, as well as SOCAR and BP. Clegg notes that accommodating both energy giants as part of the PR exercise “required a bit of creativity on our part,” but that it was important for them both to sponsor the event, in their capacity as Azerbaijan’s state oil company and its largest foreign investor respectively. The government has already altered its immigration policy to waive the visa requirement for all participating athletes and officials in lieu of an accreditation card. In addition, all foreign spectators will receive visas upon arrival based on proof

Chirag and deepwater Gunashli (ACG) oilfields. Clegg expects the vast majority of spectators from abroad to be friends and family of participating athletes. Given this, the majority of the 900,000 tickets on sale will be marketed at the local population. The ticketing policy has not been made public yet, but Clegg assures that pricing will be reasonable. “We recognize that there is not a huge culture in this country of buying tickets for events outside football and pop concerts. We have had to be very reasonable with our prices,” he explains. Clegg concedes that this is the biggest sporting event he has organised and that the time pressure, coupled with the fact that the brand of the European Games depends on BEGOC’s delivery, is “daunting, but exciting.” An avid sportsman and former CEO of the British Olympic Association, his take on leadership at BEGOC is to mould his management style to the local culture to maximise results. Conversely, he expects that the 1,600 staff that BEGOC will hire by the beginning of the games and the 12,000 volunteers will walk away

with new skills and an appetite for volunteering in sporting and other types of events. Azerbaijan will host a Formula 1 event in 2016, the Chess Olympiad, the Islamic Games, and, having bid twice for the Olympic Games, it may ultimately host the event in 2024 or 2028. “We are up-skilling the workforce, either to work in future sports events in Baku, internationally, or to be better positioned to provide leadership and management roles in other sectors,” he says. Clegg’s definition of what constitutes a successful first edition of the European Games encompasses various aspects. His main goal is to create a great experience for athletes, because “sports should always be about the athletes. I would want the athletes to go away with a fantastic experience of Baku and of the European Games.” He also wants to create a tradition of the European Games after Baku, and is hopeful that the competition will be held regularly after 2019. Lastly, he is hoping to achieve President Ilham Aliyev’s goal of showcasing Azerbaijan’s development to the rest of Europe and to the world, and to move sports up the social agenda in the country. “Sport in itself is a basic human right as recognized by the UN, and the staging of sport will help move sport up the social agenda, it will create interest in sport and will give greater access to sport in Azerbaijan,” he concluded.

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businesses were implemented in the country."

Photo: Nikita Maykov

Tajikistan's investment story is a hard sell CONFERENCE CALL:

Ben Aris in Dushanbe

ore than 500 investors, state officials and representatives of leading international financial institutions gathered in the shadow of the Pamir mountains in mid-October to listen to the government of Tajikistan sell the small mountainous republic at the country's first ever international investment conference. And it did a reasonable job, but it was always going to be a hard sell. Wracked by a nasty civil war between 1992 and 1997, the country's economic recovery has only gotten underway relatively recently. The poorest country in the Commonwealth of Independent States (CIS), Tajikistan still has everything to do – it can’t even offer a reliable power supply. But the government is well aware of the problems and is grasping the nettle. "We realise that we are not one of the best countries in the world, or the most attractive for investment. Nor can we offer the best platform [for investments]," Djamoliddin Nuraliev, the ebullient and Englishspeaking first vice minister of finance,

who previously worked for both the International Monetary Fund (IMF) and the World Bank, told the Tajikistan Economic & Investment Forum. "But we are committed to change. We have implemented serious reforms, started to introduce [global standard] IFRS accounts, and do everything possible to facilitate investment." The state has already made considerable progress. Over the last decade the size of the economy has expanded ten-fold and the poverty level shrank from 83% of the population in 2003 to 35% today, according to the government. "Reforms only started in 1997 and so have not had a very long history,” Tajik President Emomali Rahmon told delegates in his keynote speech October 15. "The government of Tajikistan, in its long-term development strategy, identified the development of the private sector and investment as one of the top priorities of its economic policy… Over the recent years, a series of reforms in doing business aimed at reducing administrative barriers and state interference in the activities of

And these reforms are starting to have an impact. While Tajikistan slid two places in the World Bank's “2014 Doing Business” ranking to 143rd place out of 188 countries, it has made great strides in several of the key subcategories: Tajikistan is ranked at 87th for the ease of starting a business and 78th for registering property, and has extremely high rankings for contract enforcement (39th) and protecting investors (22nd). "Business registration has been simplified so there is a single window to set up a company… and four special economic zones have been established where our partner investors are released from almost all taxes," Rahmon told the packed room of investors. "Tajikistan is in a sustainable development phase and is strengthening its position every day. But more needs to be done to bring our investment climate into line with the international norms." The country earned considerable brownie points after it successfully acceded to the World Trade Organization in 2012. "Tajikistan… has been strengthening its position in the global political and economic arena every day. The accession of Tajikistan to the WTO in 2012 as a vivid sign of this policy will definitely open wider horizons for the integration of our country into the global economy and global trade processes," the president said. Of course, there is still an enormous amount of work to do, as the country ranks near the bottom of the list in things like getting electricity, issuing construction permits, trade and paying taxes. But the president laid out a comprehensive programme of reforms to deal with all these issues. The simplification of the bureaucracy surrounding business is also part of the government's general drive to improve transparency and reduce corruption. Recently, the state begin to introduce

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international accounting standards (IFRS) for the largest companies, which is not obligatory but the standards have been adopted by many of the leading companies. The main task that the government faces today is mobilising investment into the economy. Foreign direct investment is a modest 2% of GDP, but has recently had a huge fillip after China earmarked several billion dollars to build a gas pipeline across the territory, though more is needed. "Both [domestic] private investment and foreign direct investment have to rise dramatically if the standard of living is to rise for the people," said Richard Jones, the European Bank for Reconstruction and Development's (EBRD) Tajik country manager. Power to the people The answer to many of the government's problems is to tap into the country's enormous hydroelectric power potential. The biggest problem Tajikistan faces today is the country's power deficit. There is sufficient power in the capital of Dushanbe, but blackouts and even power rationing plague the countryside. But if the government succeeds in its plans to build several hydropower plants, not only will domestic demand be met, but the country could become a major power exporter to the energy-hungry region. Hydropower was a constant theme running throughout the conference. The cost of power production in water-rich Tajikistan is in the order of 2.5 cents per kilowatt hour (/kWh), but neighbours like Afghanistan and Pakistan with a power deficit are willing to pay 18-23 cents/kWh, making power exports extremely profitable for Tajikistan. "We have 527bn kWh of potential power production, but currently we are only using 6% of this. And realising this potential will not benefit just Tajikistan but all our neighbours too," Rahmon said. Tajikistan already boasts the world’s highest dam, the 300-metre Nurek,

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built in the 1970s, but the government would like to add the even taller Roghun hydropower plant that would at a stroke solve all its problems. However, the project has been plagued by political and financial difficulties. Still, several other smaller power stations are in the works. Business and banks In the meantime the state is pushing on with other reforms that should help improve the investment climate. The government has set up four Special Economic Zones (SEZ) – in the regions of Sughd, Panj, Dangara, and Ishkashim – which offer substantial tax breaks and investment incentives. It has also established an enterprise fund to support local business projects, which will receive a big increase of funds to TJS1bn ($200m) next year. Perhaps most progress has been made in the banking sector. Banking penetration is still low with only about one in five Tajiks holding a bank account and total credits as a share of GDP are a modest

As the reforms take hold, the economy is beginning to diversify, led by the growth of small and medium-sized enterprises (SME), which is also bringing more business back into the formal economy. However, the lack of access to financing has slowed the pace of this growth. "The SMEs are developing, but they need access to capital to grow and develop," says Atobek. "Their main problem is the rates are still very high – typically about 25% a year – which means they cannot borrow a lot and have to borrow over the short term." The low penetration of the banking sector is behind the high rates and the difficulty that small businesses have in raising credit. Without a large deposit base, banks are struggling to fund loans, which in turn reduces their role as financial intermediaries. But the global financial institutions are committed to helping and the EBRD has already launched its highly successful SME support programme in

"We realise that we are not one of the best countries in the world, but we are committed to change" 30%, according to the EBRD. However, the sector is developing quickly with the use of debit cards on the rise, and consumer lending is also taking off, partly thanks to stiff competition since the leading Kazakh banks entered the market a few years ago. And the country recently launched its first credit bureau to further support consumer credit business. "The sector is starting to develop more quickly now," Gulanor Atobek, Deloitte's Tajik general director, tells bne. "Just a few years ago plastic cards were rare. In 2007 it was usual to pay workers in cash, but more recently companies have started paying into workers’ bank accounts and people are getting used to using cards in the supermarkets."

Tajikistan, where it lends banks money to fund loans and micro-loans to small business. The president neatly summed up the challenges facing the country in his closing remarks to the forum's delegates: "We definitely need huge investments to fully and effectively use the outlined resources and potential," he said. "Therefore, the local businesses need to avail this opportunity of your visit and establish mutually beneficial cooperation to identify priority areas in the development of production and expansion of export of final products to overseas."

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Not-so Great Aral Sea bne

he eastern basin of the South Aral Sea, also known as the Great Aral Sea, completely dried up this summer, according to NASA pictures taken in August. The Aral Sea was the world's fourth largest lake until it started drying up in the 1960s because of extensive cotton production in Soviet Central Asia. "Summer 2014 marked another milestone for the Aral Sea, the once-extensive lake in Central Asia that has been shrinking markedly since the 1960s. For the first time in modern history, the eastern basin of the South Aral Sea has completely dried," the NASA-run Earth Observatory website said on September 26. "This is the first time the eastern basin has completely dried in modern times," said Philip Micklin, a geographer emeritus from Western Michigan University and an Aral Sea expert, according to Earth Observatory. "And it is likely the first time it has completely dried in 600 years, since Medieval desiccation associated with diversion of Amu Darya to the Caspian Sea." The Aral Sea started drying up in the 1960s when the Soviet government diverted Central Asia's two major rivers the Amu Darya and Syr Darya - to cotton

fields. The sea, once covering an area of nearly 70,000 square kilometres and containing over 1bn cubic km of water, split into the northern and southern parts, now known as the Little Aral Sea and Great Aral Sea, in 1989 and the southern part split further into western and eastern lobes in 2003. Micklin explained that the eastern lobe first disappeared in 2009 but it rebounded the following year because of wet years. The dry conditions in 2014 meant that the eastern lobe has now disappeared completely. The two pictures below show first the Aral Sea in 1960, followed by the August 2014 image that shows the eastern lobe gone.

Little Aral Despite the disappearing sea, cotton is still the main crop in Central Asian countries, especially Uzbekistan, after the countries obtained independence in 1991. This has meant that water from the Amu Darya and Syr Darya continues to be diverted to cotton fields. The situation on the Amu Darya is further complicated by the fact that the Karakum canal which feeds water to the Turkmen capital, Ashgabat, withdraws up to 45% of the river's flows. As a result, the Amu Darya,

which used to feed the sea from the south, hardly takes any water to the sea at the moment. Unlike the Amu Darya, the water released from upstream Kyrgyz reservoirs along the Syr Darya for power generation reaches the northern part of the Aral Sea in winter and spring. In the 1990s the local population on the Kazakh side twice built a sand dam to stop water from flowing into the south. Having realised that the northern tip of the sea could be saved by a dam, Kazakhstan completed the $86m, 13km-long Kokaral dam across the Berg Straight with funding from the World Bank in 2005, which has resulted in the sea level in the Little Aral rising by 12 metres from its low point in 2003. The shore is now under 40 km from Aralsk. Emboldened by the project, the Kazakh government now plans to build another dam to fill in the Saryshyganak Bay, stretching up to 40km in length and 16km in width. This will bring water to Aralsk and increase the water body of the Little Aral from the current 27 to 59 cubic km and decrease the water salinity to 3g per litre. The government hopes the second phase of the project will boost fishing and improve the environmental situation in the northern part of the Aral Sea.

Opinion

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The war that dare not speak its name

STOLYPIN:

Mark Galeotti

o German military thinker Karl Von Clausewitz, war was a continuation of politics by other means. By the same token, the present Western sanctions regime against Russia ought truly to be considered a continuation of war by other means, one geared for a post-industrial and globally interconnected age. Of course, no one in the West will admit this – any more than Moscow admits that its activities in Ukraine ought really to be considered war, too – but the implications are important, and need to be acknowledged. First of all, wars need clear objectives if they are to be fought well and have a chance of being brought to a successful conclusions – just look at the messy and inconclusive conflicts in Iraq and Afghanistan as cautionary tales – but it is still unclear what the Western aims are. To a large extent, this reflects a lack of unity in that inchoate bloc, "the West." Is it simply to force Moscow

"The Western sanctions regime against Russia ought truly to be considered a continuation of war by other means" to pull back from its aggressive adventure in eastern Ukraine? That is doable, even if the key sticking point will be the optics: Vladimir Putin needs to be able to claim a victory, but Ukraine's Petro Poroshenko cannot afford to give him that. Or is it to see Crimea returned to Kyiv's rule – over the objections of a majority of the peninsula's

population? That will happen over Putin's (politically) dead body, and this seems to be recognized, and it is unlikely that this is truly an aim. Or is it, even if no one may want to articulate this openly, that the true aim is, in effect, regime change? This might mean an actual change of the guard in the Kremlin, or at least to force policy redirections so extensive and lasting as to mean a redefinition of the existing regime. In other words, a Putin government that is not truly sovereign – and sovereignty is a central element of Putin's very concept of Russia. It is hard to see Putin broken to the point at which he is willing to, as he would see it, simply become the West's local satrap. Indeed, this would probably represent such an existential challenge to Putin's image not just of Russia but of himself (and we should never underestimate the power of the vanity of a near-absolute leader) that he might even feel he had no option but to up the stakes in the hope of scaring off the West. Further incursions into Ukraine, escalating pressures along the Nato border, digging in his heels over Syria, massive cyberattacks, expropriating Western corporate assets in Russia, militarizing the Arctic – all of these might seem acceptable risks. Risks for the West After all, just because the sanctions regime is a sublimated surrogate for war, that does not mean the policy does not have risks and costs. Consider the present White House's pyrotechnic enthusiasm for the drone as an instrument of national security policy. Drones allow an administration that has a terror of being entangled in foreign adventures, yet which has been faced with a range of challenges it feels it cannot ignore, a seeming opportunity to square this circle.

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Minimizing the flow of flag-draped coffins coming home comes at different, less obvious costs, though. "Collateral damage" â&#x20AC;&#x201C; civilian casualties â&#x20AC;&#x201C; from poor intelligence or targeting decisions appear all the more inhumane when

all wars do. Nonetheless, in this economic war, the balance of power is overwhelming in the West's favour, at least if it can find the political will to mobilize its capacities. Russia's "energy weapon" pales before the West's capacities to withhold finance, and no, China isn't eagerly waiting to step in at anything other than exploitative rates.

"Sanctions are an inverse neutron bomb, leaving people alive while shattering economic infrastructures"

delivered by robot, leading to yet greater resentment. Furthermore, as drones cannot build schools or kick a football with local kids, the range of policy options they offer shrinks to essentially kinetic ones: killing people. Sanctions, of course, don't kill people. In some ways, they are an inverse neutron bomb, leaving people alive while shattering economic infrastructures. But they also, as Europe in particular is discovering, cost money to fight â&#x20AC;&#x201C; as

But wars must end, and a well-planned war needs an achievable, meaningful goal. Again, let the recent adventures in Afghanistan and Iraq loom in the corner as bloody reminders of the risks in having no such goal. Until the West not only clarifies its collective goals, in the most explicit terms, and communicates this to Moscow, the risk is that Putin will assume the worst. I find more and more of my Russian interlocutors from government circles talking in apocalyptic terms, of a West determined to break, tame or humble the Motherland. And if Putin comes to believe he has nothing to lose in this undeclared war, what is to stop him escalating, invoking the most extreme and disruptive asymmetric options at his disposal?

Mark Galeotti is Professor of Global Affairs at New York University's SPS Center for Global Affairs and blogs at In Moscow's Shadows.

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Opinion

bne November 2014

INVISIBLE HAND:

The West-is-best delusion lives on Liam Halligan in London

t’s 25 years since the fall of the Berlin Wall. Billed as the most important political event of the second half of the 20th century, the collapse of Communism has been much commented upon but rather less widely understood. Far from marking the “end of history,” the demise of stateplanning in Russia and Central and Eastern Europe, and the subsequent dissolution of the Warsaw Pact, ushered in an era when history significantly sped up. Developments that took decades or even centuries in other parts of the world, have been compressed into just a few tumultuous years. As the Wall fell in November 1989, the entire Soviet power structure – with its closed borders, economic oppression and ghastly mind-controls – started to come down with it. A welter of previously closed, moribund economies across CEE and the Commonwealth of Indepemdent States (CIS), spluttered into life, enduring much hardship and uncertainty, yes, but clearly lurching forward. Diverse nations, lumped together as the “Eastern bloc” in the news bulletins of my youth, began to open up and adopt free markets. Controlled prices were liberalized and voucher privatizations spread, constitutions were hastily re-written and companies began to incorporate. Above all, across the region people previously living under communism, in their hundreds of millions, were suddenly able to work for themselves, get a normal job, do business, travel, consume foreign media, express themselves, be part of the rest of the world. The “transition” was confused, chaotic, often deeply unfair and, in many countries, still has a long way to go. But, on balance, it’s extremely good news economic and political freedoms have been extended and totalitarian nostrums smashed. Despite all that, Fukuyama’s “end of history” thesis, coined the year the Berlin Wall fell, was still glib, triumphalist nonsense. The message from this Harvard-trained Japanese-American academic was that now communism is over and the US has won, we’re on a fast-track to liberal democracy across the globe, an Anglo-centric nirvana where “the Western model” will reign supreme.

It hasn’t happened like that. A quarter of a century after the demise of an essentially bi-polar world, with two superpowers on either side of an Iron Curtain, we’ve ended up with something more complex. History in our new multi-polar, globalized age isn’t only faster and less predictable, but a lot more unstable. The West’s enemies are now numerous and extremely hard to identify, clustered under headings ranging from “terrorists” and “separatists” to “radical Islamists.” While the ideological battle of the Cold War is over, it strikes me the true battle has only just begun. It’s no longer Marx versus the market, but a sustained struggle between the determination of Western hawks to maintain and sustain our economic and political hegemony, pitted against the determination of non-Western and increasingly powerful nations to assert themselves, finally taking full charge of their own natural resources and affairs. As such, we now see the West directly involved, or pulling the strings, in a quite staggering range of crises and conflicts, not least in Iraq, Syria, Gaza, Libya and – in a (sort of) Cold War throwback – East Ukraine. All these tragedies, and thousands of related deaths, demonstrate that globalization hasn’t brought global governance. Since the Berlin Wall fell, a pattern of officially-recognized, easily-explained conflicts has given way to an anarchic, belligerent mess. Catch-up economics Politically-speaking then, Fukuyama’s “end-of-history” thesis could hardly have been more mistaken. But it was wrong economically too. For while state-planning has thankfully retreated and property rights have spread, the “Western model” most certainly hasn’t won. On the contrary, it’s suffering from a deep crisis of credibility. Back in November 1989, songs of freedom rang out over Berlin's Alexanderplatz. Thousands of scruffy students braved the cold to smash down the Wall. I was proud to be among them, having absconded from university in the UK and hitchhiked to Berlin. I vividly remember during those heady early days of change, and in the months that followed, taking part in numerous

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discussions in Berlin and elsewhere about what would happen next. There was a near-universal opinion among mainstream Western academics and commentators, almost an imposed blanket view, that we were about to see a worldwide upsurge of capitalism and liberal democracy. It wasn’t just Fukuyama arguing that Western economics and its associated lifestyle was the final destination of mankind’s social and political evolution. He just seemed to get the most publicity. What we’ve seen, though, is that all kinds of countries have taken all kinds of economic routes – part capitalist, part stateplanned – combined with democracy in various guises, from universal suffrage to none. It’s not true that nations across the CIS and beyond – with their own distinctive histories, cultures and codes of moral conduct – must go through some kind of replica Western European or American historical experience to achieve economic and political success. That was always an absolutist, nonsensical argument, however fashionable it was back in 1989. The non-Western world, despite developing its own economic and political models, is catching up fast. In 1999, after a decade of traumatic transition, Russia’s GDP per head was roughly a quarter that of the US. Today, the figure is almost a half. Kazakhstan’s income per head was just a fifth of the US' 15 years ago. This year, it’s two-fifths. In Poland the same proportions are 30% and 44%. In China, they’re 8% and 22%. These numbers are clearly dependent on many factors – including starting point, resource endowments and population growth. But they show that while these four nations have each achieved an impressive partial “catch up,” they’ve used entirely different political and economic means to do so.

"Non-Western nations aren’t petridishes for Western social scientists"

Russia’s model, while far more democratic and marketoriented than most Westerners give it credit for, still involves significant state intervention. China and, to a lesser extent, Kazakhstan, meanwhile combine rather vibrant and increasingly modern market economies with authoritarian dictatorship. Poland, by far the most “Western” of the countries mentioned above, while growing quite well, has actually staged the least impressive economic performance. I’m not saying liberal democracy isn’t a good thing. But non-Western nations aren’t petri-dishes for Western social scientists and ancient societies aren’t made up of laboratory rats. Various emerging markets, across CEE/CIS and beyond are finding their own way, with no inclination to emulate the route we took – and doing fine, thank you.

Opinion

Why would they follow the West, anyway, when they’re now seeing where the Western model leads? The 2007 subprime crisis was self-imposed, as woefully under-regulated Western banks collapsed, sparking a systemic meltdown of over-leveraged equity markets, so exposing and then compounding the fiscal weaknesses of some of the world’s leading economies. We’ve responded not by fixing the underlying causes of the most catastrophic break-down of Western economics in 80 years, by making meaningful regulatory changes and getting our public finances in order. On the contrary, we’ve extended and pretended, hosing down difficult decisions with virtually printed money and sticking our heads in the sand. Across the “advanced world” inequality is now spiraling, as is political unrest. And what growth we have lately mustered is largely dependent on debt. Why would anyone emulate that? War by other means I’m less worried about non-Western nations not following precisely in our footsteps than I am about growing signs of systemic East-West conflict. The end of Soviet Communism, combined with the earlier decolonization of Africa and Asia, has seen the creation of a group of emerging markets which, while diverse and with conflicts of their own, shares an extremely powerful economic and emotional interest in showing that the West can no longer assume to run the world. Such nations now account for over half of global GDP, three-quarters of foreign exchange reserves and four-fifths of humanity. Their economies, while very far from perfect, are certainly much faster-growing, more dynamic and far less indebted than those of the West. That makes them far better able, in an increasingly unstable world, to endure global financial shocks. Yet the West continues to snub such countries, printing money like crazy and imposing self-serving currency depreciations, excluding them from the higher-echelons of supranational institutions, promising to change voting quotas at the likes the International Monetary Fund but refusing to do so in practice. Then we scoff when Brazil, Russia, India and China – countries with a combined GDP now nine-tenths that of the US and EU combined – set up their own development bank. The adoption of Fukyama’s absurd, egocentric West-is-best thesis was just about forgivable during the early flush of our Cold War victory. Twenty five years on, its enduring influence amounts to dangerous delusion.

Liam Halligan is Editor-at-Large of Business New Europe. Follow him on Twitter @liamhalligan.

Opinion

bne November 2014

Why a shrinking Russian workforce might let Putin off easy

COMMENT:

Mark Adomanis in Washington

ussia’s economy is a mess right now: inflation is above target and rising, capital flight shows no signs of slowing down, consensus projections on full-year economic growth have been repeatedly lowered towards zero, major state-owned companies have been frozen out of Western capital markets, and the ruble has fallen to its lowest ever levels against both the euro and dollar. Oh, and as if all of that wasn’t enough, the price of oil has gotten clobbered over the past month, suggesting that Russia’s previously (roughly) balanced budget could be thrown into significant deficit. In such a bleak situation optimism

"How could unemployment continue to fall when the economy is misfiring? The answer lies in the demographics of Russia’s labour force" doesn’t seem merely unwarranted, but actively foolish. Despite all of this bad news, however, Russians haven’t turned against their government. Poll after poll has shown that Russians remain supportive of President Putin’s aggressive policy towards Ukraine, and Vladimir Vladimirovich’s approval numbers remain in the stratosphere (the latest Levada poll has him at 86% support). Other polls have indicated general support for

the ban on Western produce, and even expectations that sanctions will have a salutary effect on Russia’s economic development. At first glance this might appear completely irrational: why would Russians, who have so enthusiastically embraced Western consumer culture, be supportive of a leader who is taking them straight towards economic stagnation and ruin? Why aren’t they upset that Russia’s fitful attempts at economic integration with the West are now moving in reverse? Russia’s relatively upbeat public opinion makes a lot more sense when you look at the condition of the labour market. Despite the litany of ills I’ve catalogued above, Russia’s unemployment rate has actually been decreasing in recent months. The trend of decreasing unemployment continued unabated even after the introduction of sanctions and an obvious reduction in the economy’s total growth rate. The latest data from Rosstat showed that, over the summer, Russia was at 4.8% unemployment – a level that could reasonably be argued is actually above full employment. How is this possible? How could unemployment continue to march downward when Russia’s economy was so clearly misfiring? The answer lies in the demographics of Russia’s labour force. Where did the workers go? I’ve written widely on the recent improvements in Russia’s demography. These improvements are real, and they

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mean that rather than naturally shrinking by 700,000 or 800,000 people a year, Russia’s population has actually experienced modest growth over the past several years. The future remains highly uncertain – population forecasts over the next 30 years range from 120m to 150m – but the improvements of the past several years are real and important. Despite the moniker of being a “dying nation,” by 2014 Russian life expectancy was at an all-time high and the total fertility rate was marginally higher than the allEU average (and substantially higher than the EU’s newest members in Central and Eastern Europe). But how could the workforce shrink if the overall population is growing? Precise definitions vary, but the “active workforce” is generally defined as the number of people between 20 and 65. It’s true that this is a somewhat crude definition. Even in Russia, college has become the norm and people do not generally get their first job until they are 22 or 23. On the other side of the spectrum, Russian law allows people to retire when they are in their mid-50s (though in practice a great number of “pensioners” continue to work other jobs). Looking at this chunk of the population though does give one a sense of the maximum possible number of citizens that could be engaged in economically productive activity. And even though Russia’s overall population is growing, the workforce has been shrinking since late 2012 and will continue to shrink for at least the next five years. Put simply, the children born during the recent (and rather modest) “baby boom” won’t enter the workforce until the late 2020s or the early 2030s. And the recent improvements in life expectancy mean that more and more Russians (though still far too few!) are living past 65. Perfect demographic storm In the meantime there is a perfect demographic storm. The cohort leaving the labour force is the large one born during the post-war years, the last time that Russia had substantially above-replacement fertility, while the cohort entering the labour force is the tiny one born during the

Opinion

“demographic hole” of the 1990’s. There are simply too few young people to replace all of the old ones leaving the labour market. This all suggests that Russia will continue to experience full employment even in the absence of strong economic growth. Given the basics of supply and demand (ie. a shrinking supply of workers) wages will grow and employers will have to offer more and more attractive deals simply to retain their existing employees. To the man on the street, then, the Russian economy will feel as if it’s performing reasonably well.

"Russia will continue to experience full employment even in the absence of strong economic growth"

The overall economic costs to Russia from a shrinking labour force are real, and I do not intend to discount them. In the long term, Russia will have to find a way to address the issue, most likely through increased importation of labour from Central Asia and “the near abroad.” But in the short term, the shrinking labour force strongly suggests that the anti-Putin uprising many Western commentators have been predicting will not occur. The “pain” from Western sanctions and from Russia’s own policy miscalculations will only cause mass dissatisfaction if negatively impacts the labour market – and the odds are firmly against that occurring.

Mark Adomanis is an MA/MBA candidate at the Lauder Institute at the University of Pennsylvania. He regularly contributes Russia-related writings to a range of outlets such as True/Slant, Salon, Forbes and The National Interest.

Opinion

bne November 2014

Russians march for peace in Ukraine

Julia Reed in Moscow

o many Russians, and certainly to most Russian politicians, the issue of Ukraine seems as touchy as the subject of teenagers leaving the nest feels to some parents: what’s wrong with their home? Aren’t they happy with their parents? Why now, at this inappropriate moment? It seems so unfair and they so ungrateful. How dare the kids prefer the company of their new friends and not even calling except when they need money? It may be hard for an outside party to appreciate Russia’s sensitivity when it comes to Ukraine’s decision to abandon the Customs Union with Russia in order to sign a free trade and association treaty with the EU. To Russians it feels like a betrayal, the end of a special relationship that has lasted centuries. A great number of Russians have Ukrainian roots and still have family in Ukraine – and vice versa. There are strong cultural, religious and emotional ties between the two countries. And what’s more, quite a few Russians do not see Ukraine as an independent state in its own right but as a “junior” sibling in the Slavic brotherhood of Russia, Ukraine and Belarus, who is rebelling under the influence of its cunning and calculating new friends, the US and EU. The Crimea, in particular, is seen as Russian territory, given away by former Soviet major domo Nikita Khrushchev on a whim at the end of a drinking session. Seeing Ukraine leave is hard for Russians to swallow. The annexation of Crimea in March (supported by the Twitter hashtag #Crimeaisours) is seen as moral restitution of a wrong committed in another era when leaders could not even envisage the possibility of Soviet dis-Union, let alone fragmentation. So emotions are high and further inflamed by Russian TV, which is fuelling the tension by running stories of how the rights of Russians in Ukraine are being violated and how "new fascists" in the form of the Ukrainian ultra-nationalists, also known as the Right Sector or banderovtsi, have now come to power to burn Russian homes and kill innocent Russians. The effect on ordinary

Russians is to lead some to volunteer to fight in Ukraine, while others collect humanitarian aid and money at stalls outside of Moscow shopping centres for the rebellious Donbass region. Russians in support of East Ukraine do not mind the sanctions imposed by the West nor the reciprocal food sanctions imposed by Russian President Vladimir Putin, which ironically have probably had a bigger impact on the average Russian than anything Brussels or Washington could organise. “How dare they impose sanctions on Russia? Why do the States and the EU think they are allowed to rule the world?” fumed Lyubov Petrova, 36, a manager in a souvenir-making company. “I didn’t eat oysters and expensive cheeses, I prefer to buy local food anyway. I’m not going to swallow my pride for mozzarella,” smiled Mikhail Loktev, 39, a marketing manager in a chain selling carpets. “When I was growing up after the war, we lived very modestly. I’m used to a simple and austere life. It’s the younger generation who are going to suffer. They have been spoiled by trips abroad and Western goods. I do not need very much, I will survive. I support the course of my state,” says Galina Mitroshkina, 63, a pensioner. Solidarity with Ukraine or “March of the Traitors”? Feeding public support for the current Russian ideology of relying on internal resources, rejecting global liberal values and replacing them with the “Russian world,” uniting ethnic Russians of East Ukraine with "the mainland" to create Novorossiya are the heavyhanded state propaganda, burgeoning censorship, and a fragile and fragmented opposition movement. But there is a minority of Russians who do not support the annexing of Crimea or the pro-Russian separatist republics of Donetsk and Lugansk. They are widely seen as traitors of Russian national interests, as suckers to the West.

bne November 2014

Opinion

Not surprisingly the state media commonly airs prime time documentaries on TV exposing the "secret-dealings and motives" of these prominent "quislings" who have failed Russia by showing open support of Ukraine and branded "friends of the junta." Not surprisingly the state-run media was silent about a Peace March held on September 21 in Moscow to allow ordinary Russians who oppose Russia's actions in Ukraine to show some solidarity with the new government in Kyiv. An officially authorised March gathered an estimated 30,000 people – a large demonstration by recent standards. Despite the general feeling that the opposition movement has faded away in the face of the tsunami of nationalism that Putin has successfully harnessed, this was about the same size protest as the first big anti-Putin protest in December 2011, following flawed parliamentary elections. Prior to the event, I spoke to one of its key organisers, Serge Sharov-Delaunay, 58, a historian and architect. A descendant of a Napoleonic soldier who was wounded during the siege of Moscow in 1812 and left behind in a hospital by the defeated French army, Sharov-Delaunay sees himself as following the footsteps of his Soviet dissident relative, Vadim Delaunay, who was one of the seven dissidents that took part in a well-known protest on Red Square on August 25, 1968, following the occupation of Czechoslovakia by the Soviet tanks in attempt to supress the Prague Spring. “It is important to show the people of Ukraine our solidarity, that not all Russians are pro-war," said Sharov-Delaunay. "It’s also important for us and the government to see that opposition to the current regime is not that small. We are expecting great numbers to attend and not just in Moscow and St Petersburg.” “I was only 12 when Vadim went to that protest on Red Square [in 1968]. I knew nothing about it. But I always knew that my family was different, they didn’t support the Soviet regime, our circle of friends were mainly dissidents. For a protest that lasted no longer than a few minutes, Vadim got three years in a camp in Tyumen. I decided not to join the Komsomol (the youth Communist organisation) because of what happened to my cousin.” Vadim Delaunay and his dissident wife left the country in 1975 and in 1983 Vadim died in Paris. Sharov-Delaunay, in turn, has become well known for his affiliation with the "Case of the 6th of May," which saw protestors on that date in 2012 given long prison sentences. Sharov-Delaunay has organized an extensive publicity campaign in order to encourage scrutiny of the trials of the protesters jailed after that antigovernment protest on Bolotnaya square turned violent. Since then, he has been an eloquent opponent of state policies and a voice in support of freedom of speech and a fair court system in Russia. “As for the March of Solidarity, I have no doubt that most Russians are against the war with Ukraine and this sentiment will grow once our soldiers start coming back to Russia in coffins. They’ve

started coming already and so far the media largely managed to keep it quiet, but they won’t be able to continue if the casualties begin to mount. I have no doubt that the current policies of our government are not sustainable in today’s world. They will not be able to re-create the Soviet Union in the 21st century,” asserts Sharov-Delaunay. The voice of Sharov-Delaunay is echoed by an ordinary Muscovite I met on the March on September 21: “I came today to show my disagreement with what is going on in the only way I can. I try to take part in as many protests as I can, if only they are deemed to be legal. The government needs to know that people have an alternative opinion,” comments Ekaterina Parkhomova, 41. Following the protest, I asked a friend living in Ukraine to comment on how she feels about such displays of solidarity. “I was born in Lviv, but live in Dnepropetrovsk. Russian is mainly spoken in this city, but I’ve always considered myself Ukrainian, even though I speak both languages. It’s a lie that Russians have been suppressed in Ukraine. There are a great number of Russian schools in the city. The ethnic problem is manufactured by propaganda. We are very tired of the war. And to me this march is great support. It feels good to be united with the people of Russia even though Russian TV has been turned off here for about a month now.” Despite the peace march having failed to gather the 100,000 people that were hoped for by the organizers, it clearly showed a strong feeling of opposition by active young Russians to the policies of isolation and generally to war with Ukraine. It was also the first march where several democratic Russian opposition parties have come together as organizers with similar slogans. The march, whose participants were primarily people in their 40s and younger, was aimed mainly at showing solidarity with Ukraine and did not have any political demands except for “Stop the War!” Yet, it showed a growing public dissatisfaction with the current regime and its attempt to re-create human values and re-draw borders. Despite record presidential approval ratings, there is a growing appetite for global, and European in particular, integration amongst the young and educated members of Russian society.

Opinion

bne November 2014

Life in Russia with $80 oil

Chris Weafer of Macro-Advisory

the previously close mutually beneficial relationship is no longer there.

The weaker oil price certainly suits the US administration’s geopolitical position and, as the US is still the world’s biggest importer of oil, it also acts as a further stimulus to the economy. But the idea that the White House is leaning on the government in Riyadh to keep supply high in order to kill the price is ridiculous. Relations between the two countries have become very strained in recent years as a result of the US support for Qatar and, most recently, the plan to cooperate with Iran in the battle against ISIL. Qatar has been a very open supporter of the Muslim Brotherhood and gave substantial financial aid to Mohamed Morsi’s government in Egypt. The Saudis have always had a huge fear of a Muslim Brotherhood revival and the threat it posses to the region. The Riyadh government, and others amongst the Gulf Cooperation Council states, were very suspicious of the Morsi government and were relieved to see it replaced. Beyond that, the Saudi-US relationship has deteriorated in recent years as the US weans itself off Middle East oil and pursues its strategy of winding down its military presence in Afghanistan. The need for

Saudi Arabian Oil Minister Ali Naimi has always said that the Kingdom views $100 per barrel (Brent) as the correct price for both producers and consumers. But he has also very clearly stated that Saudi Arabia will not revert to its previous role as swing-producer within Opec. Specifically, the Kingdom will not unilaterally cut production in order to support the price of oil for all other producers. It wants all Opec producers to share in any cuts required to support the price.

rom late 2010 until the middle of August this year, the price of Brent crude has traded within a relatively narrow range and averaged close to $110 per barrel. Over the past two months the price has collapsed from a high of $115 per barrel to just over $80. For commentators with more of a political than energy bias, the explanation for the sudden price collapse is because of collusion between the US and Saudi Arabia to damage their respective enemies, Russia and Iran. It has also led a spate of headlines suggesting that weaker oil will collapse the Russian economy and bring about the demise of Putin’s rule. Both are very wide of the mark.

Fed's fault There are several reasons for the oil price fall, but the catalyst came not from the political machinations of the US President but from the actions of the 68-year-old, silver-haired, mild-mannered chairman of the US Federal Reserve, Janet Yellen. Her comments about Fed policy resulted in a strong rally in the US dollar which, in turn, undermined confidence in emerging market economies and hit the oil price. Historically there is a very close correlation between the value of the dollar and the price of crude, because all of the major Opec producers have currencies pegged to the dollar. Once the decline started it was easy to pile on other reasons, such as the Internationa Energy Agency's demand forecast cut and the partial resumption of Libyan exports.

A major part of the reason for that stance is because of the big increase in budget spending by the Arab producers since the Arab Spring. They have all had to substantially raise both social and defence spending in a sort of carrotand-stick response. At its current volume of production,

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close to 9.5m barrels per day, Saudi will need between $85 and $90 per barrel to balance its budget in 2015, depending on spending plans. But not before trying to secure a new deal within Opec to ensure that any pricesupport cuts are spread amongst all member states. The next policy meeting will take place in Vienna on November 27 and that is likely to bring the showdown between the Saudi, UAE, Kuwait faction on the one side and the Iran, Venezuela led faction on the other. The former group can live with a lower oil average for longer than the latter, eg. Iran now requires $130 per barrel to balance its budget because of the lost export volumes, but will eventually have to try and rally the price back towards $100 per barrel. A period of weak oil seems inevitable ahead of that meeting and until the moderate Arab producers get an agreement on production cut sharing. Only then may we see the market return to balance and the price rally. In the meantime, of course, the risk of a price-supporting event remains reasonably high. Libya has managed to raise daily exports to close to 500,000 barrels, but the civil war there is worsening rather than easing and that supply remains vulnerable. For now the US-led coalition appears to be containing Islamic State (IS), but one successful attack on a southern oil pipeline or refinery would certainly spook oil traders. Boko Haram has raised its threats against Nigeria’s oil industry in recent weeks and Venezuela’s ability to sustain current output is questionable. On top of that, the cost of maintaining much of the US shale oil production has been rising very steadily as the easy oil is depleted and extraction becomes more difficult. Below an $80 per barrel average, a lot of the oil added over the past two years becomes uneconomic. So while a recovery towards $100 per barrel is dependent on complex Opec politics, traders are more likely to see $80 per barrel as a support level because of the evident risks. What $80/b means for Russia For Russia, $80 oil would mean a ruble-dollar exchange rate of approx RUB41.50. However, the Central Bank of Russia (CBR) may reduce that to RUB40.0 if it raises its Key Rate by at least 100 basis points later in October. At that oil price and ruble exchange rate, the federal budget would likely run a deficit of approximately 2.5% of GDP. Hardly the sort of scenario which would crash the economy or kill public support for the president. The reason for the relatively benign scenario is because of the CBR’s changed stance on the ruble since it last spent over $200bn in a futile attempt to defend the currency in 2008-09. Now it allows the ruble to free float against the oil price. In the year to date, the ruble has dropped 25% against the dollar and that is exactly the same price decline for Urals crude. The CBR’s currency flexibility, which is not available to the major Opec producers, makes

Opinion

a huge difference this time around and places Russia in a better position to ride out a period of lower oil. It also has the added advantage of providing a boost to the competitiveness of domestic producers and to efforts to promote import substitution. But it is also only a survivalist strategy and cannot lead to a recovery in growth. Continuing capital flight, negligible foreign investment flows, high inflation and an excessively high cost of capital are more likely to lead to prolonged stagnation. Russia needs reforms and an improved investment climate in order to attract the much-needed boost to inward investment which President Putin clearly identified in his state of the nation address last December as an essential condition for long-term growth. In early 2009, when oil traded below $40 per barrel and the economy was in recession, we saw a greater emphasis on reforms and efficiency initiatives within government and the big state enterprises than ever seen previously. Regrettably the price of oil rallied too quickly in the second half of 2009 and most of the reform plans were placed back in the pending tray. Different this time? One big difference is that Janet Yellen and Elvira Nabiullina are much more important than many of the emotion-charged politicians. For that at least we should be thankful.

Chris Weafer is Senior Partner at Macro-Advisory, which offers bespoke Russia-CIS consulting.

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Special report

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Belarus' Snopkov says economy doing better than it appears Ben Aris in New York

elarus held its first investment conference in New York on September 22 to introduce the Eastern European republic to the international investment community. Once the production base for finished goods in Soviet times, Belarus is looking for help to retool and reform to retake its place as the manufacturing jewel of Eastern Europe. Nikolai Snopkov, Belarusian Minister of the Economy, talks exclusively to bne. Like everywhere else, Belarus has been hurt by the pall hanging over the Continent and economic growth is expected to be a modest 1.7% this year, according the state committee on statistics. "In the current global economic situation it is not possible to have high economic growth," says the ebullient Snopkov, sipping coffee on the 16th floor terrace bar of the Grand Hyatt in New York where the Belarusian Investment Forum took place. "It also would contradict the government's policy of macroeconomic balances. We are trying to rethink our situation and

looking for new factors for growth. We are not pursuing high growth in the near term. Instead, we want to invest into the fundamentals and build up a foundation so that we can grow in the long term." Belarus has a long tradition of manufacturing. Under the communists production of nearly everything was split between the various republics and regions, but all these inputs were often gathered in Belarus for final assembly where the quality of work was highest. Since independence in 1991 the republic has managed to hang onto this tradition and is one of the few Eastern European countries to export finished goods – such as its famous Minsk fridges and the giant MAZ dumper trucks amongst other things – to the rest of the world. Green shoots Despite the soggy growth, the minister points to several signs that the Belarusian economy is doing better than it might first appear. "The industrial

complex is showing signs of recovery," says Snopkov, "and services sector has maintained its high rate of growth throughout the crisis period." No one is denying the economy remains weaken by the years of crisis. The country's hard currency reserves are low, but still sufficient to ensure the value of the currency following two painful devaluations in recent years (though the current account deficit of $4.5bn in 2013 has shrunk to next to nothing as exports recovered this year). And the open trade regime that Belarus runs – 50% of its exports go to Russia and 20% to the EU – exposes it to external shocks. "External shocks are happening all the time," says Snopkov. "Against this we have to ensure that the internal growth of the economy is well balanced, which makes it easier to deal with these external shocks. But if we have an open economy, then we need to able to absorb these shocks and improving efficiency, and attracting investment will help make the economy more robust."

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The key to reforming the Belarusian economy will not just be attracting more foreign direct investment, but to improve productivity, says Snopkov, and this means changing the way the government works. "We need to change the system of how the ministries work from being just regulators to increasing their productivity," says Snopkov. "This means changing the system of internal governance and separating the functions of who owns an industry from who governs it." This approach is being applied to the whole economy, but part of these changes will be privatisation. "The main idea of privatisation is not just to sell the companies, but to find a strong investors that can run the companies more efficiently than the state," says Snopkov, who addressed over 100 US investors at the conference. Snopkov said the state is interested in any deal that will deliver on this end from an outright sales through joint venture â&#x20AC;&#x201C; everything, he says, will be considered. Opportunity in crisis Even though the economy is growing only slowly, Belarus is still doing better than most of its peers thanks to the already relatively diversified economy. And the sanctions that Russia imposed on EU agricultural products in September will give it another fillip as Belarusian producers rush to fill the gap. "Russian sanctions on food imports from EU is an opportunity for us, but we have a saying in Belarus: 'if our neighbour suffers, then it is not possible to build our success on his suffering'," says Snopkov. Still, Belarus will rally to Russia's aid and its agricultural sector is expecting to see exports of some products leap in the short term. The sector can also expect new investment from Russia. However, Snopkov's comment on neighbours is an illustration of a theme that has run throughout the Belarusian Investment Forum: when you invest into Belarus, you donâ&#x20AC;&#x2122;t just tap its market of 9m souls, but have direct access

to the much larger market of 170m in the Customs Union of Belarus, Russia and Kazakhstan. Belarus is an attractive and fast growing market in its own right, but this free trade area set up in 2010 (and about to become the even more integrated Eurasia Economic Union in January next year) means the small republic could become an entrepĂ´t or manufacturing centre to service the much larger area that currently could soon also encompass Armenia and Kyrgyzstan too. "Today we are intending to use this advantage to maximum effect," says Snopkov, who has been spearheading Belarus' efforts to modernise itself. "Currently the whole world is in competition for investment and we need to make the most of our competitive advantages if we are to stay in the race." Russia is already the second largest consumer market in Europe and unlike the countries in the West its retail turnover continues to grow in double digits in most segments. And Belarus is catching up fast as its own middle class emerges. Today some two-thirds of Belarusians consider themselves to be middle class, while those who define themselves as lower middle class only account for 3.5% of the population and those living in poverty are less than 1% of the population. "In terms of the Gini coefficient, Belarus ranks among the top ten in the world," says Snopkov, referring to the economic measure that is used as a broad calculation of wealth by including non-liquid assets like property. And the entrepreneurial class is also growing, says Snopkov. About a third of the middle class describe themselves as entrepreneurs and these small and medium-sized enterprises (SME) already account for about a quarter of GDP. "Our task is to increase this share of SMEs to 50% of GDP by 20210," says Snopkov, "as this is one of the most important parts of the economy, playing a fundamental role in the wellbeing of the of the population."

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Belarus makes pitch to US investors Ben Aris in New York

here is Belarus heading? What will be the nature of the structural and institutional reforms we are carrying out? The answer to these questions is both simple and complex: simple as we know what we need to do, but complex as this requires knowledge, resources and energy. Belarusian Prime Minister Mikhail Myasnikovich opened the first Belarusian Investment Forum on September 22 with a pragmatic, rhetorical question and called on US investors to take advantage of a "reset" that the Republic is enjoying in its relations with the West. About a 100 US investors turned out to listen to a high-powered

panel that as well as the PM included the minister of the economy, the deputy finance minster and the head of the Republic's development bank, expound on the progress the country has made in recent years. "Our intention is to create a productive environment for companies that want to come and work with us," Myasnikovich told the assembled delegates. Myasnikovich admitted frankly that despite the recent progress and recovery, Belarus needs help if it is to fulfil its potential. "So we came here to build a solid future together with our American partners, and we want our partners to benefit from our success together," said Myasnikovich. "Our economy is based on knowledge and innovation, and we are committed to

opening up on these lines. Buffing up image The conference was the first step in addressing the country's poor image and low profile amongst the international investment community. And obviously investors' curiosity was piqued, as there was barely an empty seat in the hall of the Grand Hyatt's ballroom in the heart of New York. But the PM has a good story to tell. While this year's economic growth is expected to come in at just 1.7%, that is still a lot better than most of its peers. And the country boasts a long tradition of manufacturing excellence it has managed to capitalise on post-independence; not only does Belarus have a reasonably diversified

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economy, it is also the only country to have significant exports to both Russia (50%) and the EU (20%). "Industrial production has increased and surpassed the levels of in the Soviet Union, while per-capita GDP has increased three-fold since 2000," Myasnikovich told delegates. "Poverty is amongst the lowest in the region and indeed is lower than in most of the developed countries of Europe. We have a balance budget and low state debt, while our trade has grown consistently each year. However, we need to look for new sources of growth and a key will be improving the productivity of the existing capacity." That was the core of the pitch to the US investors: we need your help to continue the progress we have already made. The government has been investing heavily into its capital – both fixed and human – and is already reaping rewards in several sectors, with IT standing out as the most prominent amongst them. Capital expenditure is running at about 30% of GDP, with a third of this going into

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heavy industry, according to the Ministry of Economy. The upshot is that Belarus has one of the most diversified economies in the former Soviet Union. Minister of Economy Nikolai Snopkov rattles off a long list of the republic's achievements that are unique in Eastern Europe: the republic produces 16% of the world's Potash, 30% of its dump trucks, 6% of its tractors and 16% of its linen. It is the sixth largest cheese producer in the world, the third largest butter producer and the number one IT services producer in per-capita terms. But this positive side of the Belarusian story is not well known, which was the point of the conference. The National Investment Agency has recently been beefed up and the state has introduced a raft of incentives to appeal to potential investors. The republic already offers attractive tax conditions: profit tax have been slashed to 18%, which is one of the lowest levels in the CIS; and workers pay a flat 12% income tax, slightly lower than even Russia's 13% flat tax.

But the main focus has been, as in other countries, on creating industrial parks and special economic zones that have been used to such great effect by the Chinese. Today, there are six special economic zones and several specialist industrial parks, with a new large Sino-Belarusian industrial park in the works. In these business havens, companies enjoy a 10-year tax holiday and a 50% discount on profit for the next decade. For the high-tech park, profit tax is also 0% and VAT is 0%, although companies have to pay their workers social taxes. For Belarus, it will be a hard sell to attract the kind of share of FDI the government needs, but it seems committed to making the effort. “I sincerely believe that this forum and a series of other major political events initiated by Belarus, including the Ukraine peace process, will result in the restart of the relations between Belarus and the United States," the PM noted. “We are open for a dialogue – so is our country."

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There is an extensive privatisation programme on the agenda and the plan is to sell off many of the companies via IPOs. But progress has been slow and the poor state of the global economy has stymied these efforts.

Belarus looks to develop international financial centre in Minsk Ben Aris in New York

However a lot more progress has been made with building up an insurance industry, which is growing fastest. "It is not large, but it has been developing very dynamically in recent years," says Yermolovich. "The total assets of the sector were $750m in 2013, but that was up 43% year on year. It is a huge potential market." Insurance has the advantage that it has existed since Tsarist times. The leading companies were taken over by the Communists and today the stateowned BelGosStrakh remains the market leader. Currently, the insurance sector accounts for about 1% of GDP, but the minister says the goal is to increase this to 3% of GDP by 2025, when a single regulator will also come into existence. "We are already ready for foreign investors to come into the sector and the Ministry of Finance has already liberalised the legal framework to accommodate them.”

elarus plans to turn Minsk into an international financial centre as part of its ongoing reforms to create a domestic capital market.

of a capital market have already been put in place," Deputy Finance Minister Maxim Yermolovich told delegates at Belarus' first international investment forum in New York at the end of

On September 22, Belarusian President Alexander Lukashenko signed a decree to create the “Experimental multi-purpose complex Minsk-Mir" – a building that will house a new stock exchange that the government hopes will become the centre of the republic's international financial centre.

"All the legal instruments to that lay the foundation of a capital market have already been put in place"

The new building is a physical manifestation of a raft of reforms the government has pushed through to deepen the country’s nascent capital market and so make more financial resources available to its leading companies. "The financial markets are growing dynamically and all the legal instruments to that lay the foundation

September. "Large companies can now report in IFRS and launch an IPO if they want." The government has been moving towards establishing a liquid capital market for some time, but the efforts have begun to gather pace recently.

“After 2025, these companies will also have access to the entire Eurasian Eco-

nomic Union markets of 170m people," Yermolovich added. Currently there are some 25 insurance companies operating on the market, of which 11 have foreign capital participation.

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Belarus' agricultural sector set to be big winner from turmoil bne

elarus' agricultural sector is set to be the big winner from the turmoil in Eastern Europe. Happily, Belarus forecasts good harvests for this year. Following Moscow's decision to ban imports of European agricultural products earlier this year in retaliation at Western sanctions, Russia has turned to its smaller neighbour and fellow Customs Union member to help keep Russian shop shelves stocked. Russia has long been one of the main export markets for Belarusian agricultural goods, however the trade is getting an enormous fillip from the fact that most of the European competition has at the stoke of a pen disappeared. In some product categories exports to Russia are expected to double or treble this year alone. Following Moscow's decision on the EU ban on August 7, it immediately turned to Belarus and agreed to increase Belarusian agricultural exports to Russia, Russian Deputy PM Arkady Dvorkov-

ich told Russian news agency Tass on August 13. According to Adrian Rogstad, an analyst at IHS Global: "Russia's ban on Western food imports and its turn to Belarus for increased import volumes is good news for Belarusian exporters at a time when regional exports have fallen, in large part due to the regional instability as a result of the conflict in Ukraine. Exports to other Commonwealth of Independent States (CIS) countries, including Russia and Ukraine, fell by 5% year on year in January-June 2014 due to the conflict in Eastern Europe, while exports to other countries rose by 3.5%.” "Belarusian importers could benefit from the ban as Western exporters seek new ways of reaching the Russian market," Rogstad added. "Belarusian producers of processed food, including seafood and meat-based products, could benefit from a re-direction of exports to Belarus for processing ahead of export to Russia." Belarusian dairy products in particular are set to soar. Even before the bans,

Russia was a net importer of raw milk and has now cut itself off from major supplies in Western Europe. In August-December, Belarus intends to ship roughly 40% more milk and dairy products to Russia than it did in the same period of 2013, according to the Belarusian Agriculture and Food Minister Leonid Zayats. “In August-December 2014 the volume of dairy supplies will grow by roughly 40%. Those will be cheese, skimmed milk powder and full-cream powder, whole milk products,” Zayats said in remarks quoted to BelTA. Next year, Belarus is ready to ship over 4m tonnes of dairy products in milk terms to Russia, he added. Meat products are another item where exports will increase. The Agriculture and Food Ministry estimates in 2015 that Belarusian manufacturers will be able to ship about 400,000 tonnes of meat products to Russia. “If necessary, we can ship more without hurting the domestic market,” Zayats said.

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Other products that will see the volume of exports increase are: over 100,000 tonnes of rye flour; 12,000 tonnes of colza oil; about 1m tonnes of potatoes: 107,000 tonnes of carrot, 30,000 tonnes of cabbage, and 27,000 tonnes of apples. Happily, Belarus along with the other countries in the CIS are on track for record harvests. “Despite the weather, we expect a better vegetable crop than last year and these will be high quality vegetables,” Deputy Minister of Agriculture and Food Vladimir Grakun told local newswires. The boost to exports is like to feed back into Belarus' industry, as the windfall profits will be reinvested in domestic production. For instance, the fight for market share amongst cheese producers has become fierce in recent years and Ukraine in particular has several large hard cheese producers in direct competition with Belarusian cheese producers on the Russian market. However, as this competition has largely disappeared as a result of the tensions, Belarus is expecting to see cheese exports to Russia become a veritable mountain – an increase of 70,000 tonnes of cheese exports in August-December alone. “Belarus has a perfect chance to export 200,000 tonnes of cheese instead of the current 100,000 tonnes,” the press service of the Belarusian Ministry of Agriculture and Food quoted Sergei Fankvert, the head of Russia’s veterinary and sanitary watchdog Rosselkhoznadzor, as saying in August. Another side effect of the sanctions has been to improve trade relations between Belarus and Western Europe. As the smaller countries in the region that are not under the Russian ban scramble to feed the 143m-strong Russian population, Minsk decided to lift an import ban on live cattle from Europe in order to adequately supply its food processing industry with meat to produce exports to Russia. Exports of meat and meat products to Russia were worth $1.35bn in January to May, but are expected to rise by somewhere between 15% and 40% in the second half of this year.

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Lukashenko the most popular politician in Ukraine, finds poll bne A survey conducted by the Ukrainian pollster Rating asking the population about their attitude to global leaders found that the Belarusian president, Alexander Lukashenko, was the most popular foreign leader. Some 62% respondents in the “Ukrainians' attitude to global leaders” survey said they have a positive attitude to Lukashenko, beating US President Barack Obama (54%) and German Chancellor Angela Merkel (51%). Russian President Vladimir Putin scored just 16%. Lukashenko was most popular in the southern and eastern parts of Ukraine, whereas those in the western, central and northern regions were more inclined to support Obama, Merkel and Poland's president, Bronislaw Komorowski. In general, the survey found that Ukrainians have the most positive attitude to Belarusians (53% definitely positive and 41% rather positive) amongst their surrounding neighbours. The attitude to Russians has deteriorated sharply (39% definitely positive and 33% rather positive). The poll is mirrored by similar polls at home for Lukashenko: the president's ratings have increased by five percentage points since December, to reach 39.9%, while over the past six months the number of Belarusians who think that the country is headed in the right direction is up by nearly 10 points from 31.9% to 42.3% – the highest approval rating in three years, according to the Independent Institute for Socio-Economic and Political Studies in Minsk.

Meat imports is one of the most lucrative items amongst food categories under the interdiction. Russia imported $17.2bn of food last year from countries covered by the ban, of which $9.2bn was in the affected categories, the International Trade Center, a joint venture of the UN and World Trade Organization, said. The ban should also catalyse joint ventures. Russia's milk deficit has already spurred Belarus to open talks with neighbour Lithuania on milk production joint ventures, according to the Lithuanian Minister of Agriculture Virginija Baltraitiene, who was in Minsk in August shortly after Russia imposed its ban. Perhaps the most significant effect of the current crisis will be to allow

Belarus to set up agricultural companies in Russia, Belarusian President Alexander Lukashenko said in a television interview on in September. "They tell me however that all kinds of outlets called Belarusskoye (Made in Belarus) open in Russia and Ukraine; however, these outlets sell nothing made in Belarus. This brand is used to sell anything but Belarusian. We do our best to prevent it," the president said. But according to Lukashenko, Belarus has been upgrading its facilities in Russia and hopes to expand its cooperation with Russia significantly. "The high quality of Belarusian products is well-known in Russia and Belarusian products are very popular there."

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