bne November 2011 - EUski by Ben Aris

Inside this issue: The smell of gas in the courtroom A mammoth win for Tusk EU enlargement â&#x20AC;&#x201C; yes, no, maybe Whose mine is it anyway? November 2011 www.businessneweurope.eu

Special Report: Private equity post-crisis

EUski Russia proposes a bloc from the past

bne November 2011

Contents

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

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

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

28 6

The Insiders

A mammoth win for Tusk

EUski

Passing the buck in Slovakia

Flattening earth

Stark warnings and family values in Latvia

The shifting sands of Polish banking

Owning in Osterreich and beyond

Central Europe's property market grows up

Hungarian wine – 20 years of hard toil is just the beginning

Irrational in Budapest

Perspective

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Eurasia: Bureau Chief: Clare Nuttall (Almaty) +7 7073011495 nuttall@businessneweurope.eu Molly Corso (Tbilisi) molly_corso@yahoo.com Oliver Belfitt-Nash (Ulaanbaatar) +97688113149 oliver@businessneweurope.eu Advertising & subscription: Elena Arbuzova +7 9160015510 Business Development Director arbuzova@businessneweurope.eu Alec Egan +44 2030516548 Business Development Director (International) egan@bne.eu Design: Olga Gusarova-Tchalenko +44 7738783240 o.gusarova@businessneweurope.eu Cover illustration: Illarion Gordon

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CENTRAL EUROPE

COVER STORY

EASTERN EUROPE 14

The smell of gas in the courtroom

Where are Tigipko's promises now?

A financial BoM

Rosbank merges its way to the top

Russia struggles with electricity tariff reform

Brunswick Rail makes tracks

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bne November 2011

Contents

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

SOUTHEAST EUROPE 36

Western Balkans & EU enlargement: Yes, no, maybe

Desperately seeking fair restitution in Serbia

Romanian brain drain

EURASIA 46

Whose mine is it anyway?

Lost in transition

Kyrgyz ride roughshod over investors

Exits open as investment pours into Russia

Karachaganak deal elusive as Kazakhstan leans further toward Asia

IFC launches a Russian bank fund

Unfinished business in Bulgaria

65 50

Uzbekistan looks at alternative energy sources

New beginnings in Central Asia

Turkey – a hero to some, but a bully to others

66 51

Protecting business in Georgia

Pills 'n' thrills for Russia's biotech industry

Tilting a glass to China

CLASSIFIED

UPCOMING EVENTS

Power boats

Croatian shopping centres – too much, too young? SPECIAL FOCUS

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SPECIAL REPORT

Eco-warriors fight "Suez canal plan for Europe's Amazon"

To stay local or go west? That is the question

Beware the MBA syndrome

I The Insiders

bne November 2011

"Give me chastity, but not yet"

enshrined in the budget law, but removed in late 2008, to allow accelerated anti-crisis spending. The authorities have indicated their intention to make the -4.7% of GDP non-oil target binding again, although no clear decision has been taken yet.

Ivan Tchakarov of Renaissance Capital

istory buffs will certainly recognize the famous quote of St Augustine who, despite being credited with profoundly influencing Western Christianity in the 4th century and beyond by preaching a closer association with Christ, found his youth so full of temptations that he wanted to enjoy them just a little bit more before finally becoming a committed follower of God’s commandments. In that, we find eerie similarity with the current state of Russia macroeconomics, as the country is facing a dramatic change in its economic paradigm over the next couple of years that will determine the future course of its economic development.

Due to its prudent fiscal stance in the upswing, underpinned by saving a significant portion of the oil windfall, Russia looked much better placed than many other emerging market economies to endure the 2009 crisis by (correctly) pursuing an aggressive counter-cyclical policy in the downswing. Consequently, while cushioning the adverse impact on growth, the 10% of GDP turnaround in the fiscal position (from a surplus of 4.1% in 2008 to a deficit of 5.9% in 2009) led to a significant fiscal deficit. While the headline numbers have improved over the last two years, the government still forecasts continuing fiscal deficits well into 2014 even at oil prices as high as $100 per barrel (b).

The subtle, yet inevitable, transition from twin surpluses to twin deficits that will take place by 2014, on our estimates, and Russia’s choice of how to address this new and much more challenging environment will be the most important thing to watch by market participants. Will Russia continue to dither in addressing the imminent twin (fiscal and current account) deficits? Or, in recognizing their far-reaching macroeconomic implications, will Russia improve its investment climate image in order to finance these deficits?

Things look even gloomier were one to look at fiscal policy from the point of the non-oil deficits. While higher oil revenues create more fiscal room for spending, they also complicate macroeconomic management and foster dependence on a volatile and uncertain source of income. Therefore, a better measure to gauge the true stance of public finances is to compute the non-oil deficit, which corrects the headline number for the state of the cycle and oil revenues. We estimate that it has expanded progressively from an approximately balanced position at the turn of the century to -12.5% of GDP in 2010. We estimate that it will only fall to -10.5% of GDP in 2011 and -9.0% of GDP in 2014. This leaves it about twice the level (-4.7% of GDP) consistent with preserving the country’s oil wealth constant over time. This is also the government’s own recommended target that was

We are modestly optimistic. The great transition With fears of a new global recession looming, investors have been preoccupied with managing their asset positions. Russia has not been spared the wrath of money managers, as the stock and fixed-income markets have exhibited heightened volatility. These cyclical developments are of course important to watch, but they mask a much bigger structural issue that needs to be well understood and stay centre stage for anybody who has even a perfunctory interest in Russia. Significant twin surpluses were the name of the game pre2009, as solid economic performance and constantly rising oil prices ensured comfortably full state coffers and sizeable current account surpluses. Federal surpluses were running at 7% of GDP, while the current account surplus did not decline even during the 2008 (see graph). However, the new postcrisis normal is now starting to gradually turn the tables on the current account and even more so on the fiscal balance.

Deficits depend on oil price 20 15

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The great transition from twin surpluses to twin deficits will happen in 2013 at $90/b or in 2014 at $100/b

10 5 0 -5 -10 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Current account (% GDP), at USD100 bbl

Current account (% GDP), at USD90 bbl

Fiscal Balance (% GDP), at USD100 bbl

Fiscal Balance (% GDP), at USD90 bbl

The current account is still registering surpluses, although the very nature and structure of trade argue convincingly for a gradual decline in these surpluses, and eventual transition to a deficit position. With the better part of exports centred on oil – the extraction of which has been broadly constant over the past couple of years – and an increasing import bill, deriving from a growing economy, the current account balance is set to shrink over time, and ultimately move into deficit. This process is fully in force, as evident from the declining current account surplus, and this is despite the very favourable evolution of commodity prices over the past decade. We estimate that the current account will break into a negative territory in 2014 at $100/b and in 2013 at $90/b. Therefore, Russia will complete the uncomfortable transition from twin surpluses to twin deficits in a couple of years’ time. A very binary outcome Living with twin deficits will present a totally different set of challenges for Russia, as it will need to find ways to finance these gaps. Despite low public and external sovereign indebtedness, persistent deficits on the public and external side – which will be exacerbated by rising health and pension obligations – will require a revised approach to attracting foreign investment, including direct investment, portfolio flows and external credits. Financing these deficits will thus be a key challenge for Russia, in particular in light of the unfavourable business environment. The perennial issues of rampant corruption and lack of adequate minority rights protection continue to affect investor perception about the country. The 2010 Corruption Perceptions Index published by Transparency International does not exactly lend a helping hand to Russia, either. Its transparency rating fell from 2.2 to 2.1 on a scale of 0.0 (highly corrupt) to 10.0 (very clean), which was enough to rank Russia 154th out of 178 countries, between Papua New Guinea and Tajikistan. Other alleged unfriendly practices, including stifling business regulations, a perceived lack of rule of law and insufficient protection of minority rights, have also weighed on investors’ minds, while an unending supply of headline stories about government corporate abuse have contributed to the overall view of Russia losing against other emerging market economies in the global competition to attract foreign investment. One possible outcome would be for Russia not to do anything until 2013-14 and, just like St Augustine, defer taking the right decision until the very end. This would run the economy aground, because Russia will find it next to impossible to finance its twin deficits. This would be a regrettable outcome for Russians and a devastating one for foreign investors. We are, however, more optimistic, as we think that the Kremlin might be starting to at least recognise the gravity of the

issue. We think the authorities are gradually starting to warm to the realisation that, in an increasingly Japan-style global environment, characterised by more subdued G10 growth, the prospects for an oil price increase post-crisis similar to that seen pre-crisis are rather limited. Consequently, with the current account expected to transition to a deficit position over the medium term, and a large structural fiscal deficit, it would be imperative for Russia to improve the business climate in order to attract the requisite capital inflows to finance these deficits. Reading the tea leaves on the authorities’ intentions is a dangerous game, but in our mind the crisis has visibly brought about a new frame of mind that is more open and welcoming to foreigners. Some tentative signs are already visible; the government has started a new privatisation programme (admittedly a bit delayed now due to the unfriendly global backdrop), increased the list of the strategic enterprises open to foreign investment, made important steps in moving Russia closer to WTO membership, and accelerated the process of making the domestic bond market euroclearable. These reforms are, in our view, underappreciated and underpriced. At the same time, they will

"One possible outcome would be for Russia not to do anything until 201314 and, just like St Augustine, defer taking the right decision until the very end" be implemented only in an evolutionary manner and one would be remiss to assume that any changes – positive or negative – will happen quickly. Rather, we think it much more realistic to assume they will proceed only very cautiously. Therefore, although one should tread very cautiously when trying to extrapolate from a few data points, we think there is more serious underlying momentum to the current reform agenda. Moreover, the timing of these initiatives is, curiously, coinciding with the overall feeling of Russia waking up to living in a world that is much less conducive to an introverted standpoint. We think the less favourable external drop and the need to invest heavily in the decrepit infrastructure is inviting a fresh look into the dilemma that has plagued Russia for centuries: how to create a dynamic economy, firmly grounded in innovative thinking, higher rates of capital accumulation and healthy productivity growth. We are cautiously optimistic.

Ivan Tchakarov is Chief Economist Russia/CIS for Renaissance Capital

I Cover story

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gone some way over the past decade towards the creation of this "Eurasian Union." Putin has got one thing right: the Eurasian Union is first and foremost a trading bloc, and global trade is fast expanding: trade's share of global GDP has risen from 39% in 1990 to to 61% in 2010 thanks to globalisation. The European Union remains the biggest trade zone on the plant accounting for a fifth of the global volume, followed by developing Asia, which is quickly closing the gap. But Putin’s insight – which may prove prescient – is that the fastest growing trade route in the coming decades will be between the EU and Asian. Much of this will have to pass through the Eurasian Union lands, rising from today's trillions of dollars to hundreds of trillions by 2050, according to Citigroup. Research from the Eurasian Development Bank (EDB) shows that ties between the states of the former Soviet Union disintegrated in the first decade of independence. But the EDB's System of Indicators of Eurasian Integration (SIEI) index shows that while the level of integration within the former Soviet Union as a whole has declined since independence, the five countries of the Eurasian Economic Community (EurAsEC) established in 2000 – Belarus, Kazakhstan, Kyrgyzstan, Russia and Tajikistan – have become increasingly close.

EUski Nicholas Watson in Prague, Clare Nuttall in Almaty

prickly nationalist, Vladimir Putin has never missed a chance to put the metaphorical boot into the West, so it was no surprise that as the EU stares into the abyss, he chose now to propose a new global power bloc based on the geographical outlines of what used to be the Soviet Union. But is Putin merely trying to resurrect Russia's failed imperial past, or is this perhaps an idea that's before its time?

aim to reach "a higher level of integration – a Eurasian Union."

Writing in the Izvestia newspaper on October 4, Prime Minister (and soon-tobe-again president) Putin announced a "new integration project for Eurasia." This "ambitious goal" would "go beyond" the progress made in the 20 years since the Soviet Union fell apart in rebuilding ties between the former states; it would

Rather, in these times of crisis such a bloc would be a way for the countries of the region to create a powerful supranational association that could put its members in a "strong competitive position in the industry and technology race, in the struggle for investors, for the creation of new jobs, and the establish-

What shape would this union take? First off, this is definitely not an attempt to recreate the Soviet Union, Putin declared. "It would be naïve to try to revive or emulate something that has been consigned to history," he said, echoing Trotsky’s famous speech writing off capitalists.

ment of cutting-edge facilities." At the same time, the union would be capable of becoming "one of the poles in the modern world and serve as an efficient bridge between Europe and the dynamic Asia-Pacific region." The grouping, Putin stressed, would also be compatible with the Commonwealth of Independent States (CIS), "not an opposing force," and an open project that would take in new CIS members only when they had made a "sovereign decision based on [their] long-term national interests." Work in progress As Putin laid out in exhausting detail in the first half of the article, to some extent the post-Soviet space has already

Cover Story I 9

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The ultimate aim of EurAsEC was to create a common economic space among its member states. EurAsEc objectives include establishing a free trade zone, with free movement of capital, a common financial market, and common markets for transport and energy. Since its launch, three countries have taken observer status with the EurAsEC – Moldova and Ukraine since May 2002, and Armenia since January 2003. Uzbekistan signed a protocol of accession to the EurAsEC in January 2006, but in October 2008 suspended its participation in the community. Further steps to liberalise trade between the countries have been taken, most recently on October 19, when a new

Flattening earth

Ben Aris in Moscow The reaction to Russian Prime Minister Vladimir Putin’s plan to create a Eurasian Union was mostly scorn. Most of the would-be members don’t even like each other very much, not to mention adding another layer of bureaucracy to an already Byzantine system. Yet the creation of a new union is almost superfluous, as commerce is running far ahead of policy: burgeoning trade is already tying the Eurasian region together tighter than politics could ever hope to do. International trade has mushroomed as a result of globalisation, rising from the equivalent of 39% of global GDP in 1990 to 61% in 2010, and is expected to top 84% by 2030, according to a recent report by Citigroup. The value of this trade is also growing exponentially, rising from $37 trillion in 2010 and is expected to reach $149 trillion in 2030 and $371 trillion in 2050. That’s a 10-fold increase in 30 years, the bulk of which will come from emerging markets. Even before the western economies got into trouble, emerging markets were already proving to be as good export destinations as the more obvious developed world. Russia abruptly changed its mind about sending oil and gas to China in 2004, putting aside its traditional reservations about the Chinese Communist Party that have persisted since Stalin ran the show. At the same time, ballistic growth in developing Asia has bolstered trade across the region. And China has already become Brazil’s biggest consumer of raw materials, with Africa not far behind. "We expect world trade to expand at an average rate of 7.1% per annum between 2010 and 2030 (measured in constant 2010 dollars) and to expand by 4.7% p/a between 2030 and 2050," say Citigroup's Ebrahim Rahbari and Willem Buiter. "What will be new is the prominence of today’s emerging market economies in world trade? We expect intra-emerging market trade to overtake trade within the advanced economies by 2015 and to exceed trade between advanced economies and emerging markets by 2030." Taiwan and Hong Kong pioneered the model of getting rich from making cheap goods that could be exported to the developed world in the 1970s, but this model is rapidly fading into irrelevance as intra-emerging market trading moves to centre stage. China is obviously leading the way and will overtake the US and the Eurozone as soon as 2015, predicts Citigroup, with a knock-on effect that will drive investment in all these countries. Ten years ago, five out of the leading 19 emerging market economies sent 80% or more of their goods and services to developed markets; today, only Mexico is still so dependent on the developed world. Likewise, 12 of the major emerging markets sent 60% or more of their goods to developed markets a decade ago, but this is down to just eight countries now, according to Renaissance Capital. At the same time, only three emerging markets sent half or more of their goods to other emerging market countries in 2000, but that number has now reached eight out of 19 countries.

I Cover story

free-trade agreement was signed at a CIS summit in St Petersburg. Initial signatories were Russia, Ukraine, Belarus, Kazakhstan, Armenia, Kyrgyzstan, Moldova and Tajikistan. Uzbekistan, Azerbaijan and Turkmenistan said they would consider signing the deal by the end of the year. Putin did not release specifics of the agreement, but said it would lower prices for goods, create better conditions for business and make signatory economies more competitive. The agreement is due to come into effect in January 2012. The most important step towards integration so far, the EDB notes, was the launch of the Customs Union by Belarus, Kazakhstan and Russia. The Customs Union was created on January 1, 2010, but came into force six months later after the Customs Code was ratified in all three member states. July 1, 2011 was

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of a single currency and a bureaucracy to manage it all. The history man Putin's announcement inevitably drew a range of reactions, from the sneers of Russophobes to the drum-beating of Russian nationalists, and everything in between. However, few are in any doubt that with Putin ready to retake the presidency next year and in doing so become, whatever one thinks of him, an historic Russian figure, this represents the grand policy and vision to match his status. After all, historic figures need historic deeds. Dmitry Peskov, Putin's spokesman, highlighted the significance of the Eurasian Union when he said that, "it will be one of the key priorities of Putin's work over the next six years." Interestingly, Eugene Chausovsky of the private intelligence

"It would be naïve to try to revive or emulate something that has been consigned to history"

set as the deadline for removing all customs barriers between the three states. There is now a two-speed integration process in the region. Russia, Belarus and Kazakhstan plan to establish a Common Economic Space from January 2012, which Putin called in his article, "without exaggeration, a historic milestone for all three countries and for the broader post-Soviet space." By building the Customs Union and Common Economic Space, Putin says the countries of the region are laying the foundation for a prospective Eurasian economic union – a huge market that will encompass over 165m consumers, with unified legislation and free flow of capital, services and labour force. And from that, asserts Putin, the natural step would be this "Eurasian Union," which would include closer coordination of economic and monetary policy, including the use

company Stratfor points out that this not only shows the importance of the project for Russia's foreign policy agenda, "but also serves as evidence that Putin has been planning to return to the presidency all along." Most critics have chosen to focus on the idea's fundamental flaw: Russia is still viewed, to a greater or lesser degree, with suspicion by all the countries in the region for obvious historical reasons, and this will play a big part in how willing they will be to sign up for a project that will, regardless of Putin's denials and no matter how it's set up, be dominated by Moscow. Putin can probably count on at least the two other members of the Customs Union, the organisation out of which this Eurasian Union will evolve.

In the same newspaper in which Putin laid out his vision, Belarusian President Alexander Lukashenko, an unreconstructed Soviet apologist and now pariah of the EU after his theft of the presidential election last December, wrote a cloying piece praising Putin's vision. "This is not meant to be a compliment to my colleague, the former Russian president and current prime minister, but I must say that this article was a real event," Lukashenko gushed. Lukashenko's toadying is, of course, designed to ingratiate himself with the Kremlin, from whom he desperately needs cash in order to stave off economic disaster. Belarus is isolated more than ever and depends heavily on Russian credit and energy to survive. After Putin, the greatest enthusiast for the Eurasian integration project is probably Kazakhstan's President Nursultan Nazarbayev. Integration within the former Soviet space fits with Nazarbayev's foreign policy of reaching out internationally, as well as with his ambitions to be a global statesman. Nazarbayev has already proposed the launch of a common currency for EurAsEC. At the Astana Economic Forum in March 2009, Nazarbayev suggested that the noncash currency be named the “yevraz”. Proposed as a measure to combat the financial crisis crippling the region at that time, adoption of an entirely new currency would also be a more acceptable solution in Astana than the use of the Russian ruble as a common currency. Who else? It's inconceivable that Georgia, which fought a war with Russia in 2008, or the Baltics, firmly ensconced in the western camp, would join. Putin said in his article that the Customs Union and Common Economic Space "will expand by involving Kyrgyzstan and Tajikistan." However, Kyrgyzstan is actually undecided about joining the Customs Union, and while Tajikistan is understood to be keen to join, it could only do so after Kyrgyzstan’s accession because it doesn't share a border with any of the existing member states. However, the proposed Eurasian Union seems a step too far for Tajikistan.

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Speaking to newswire Asia-Plus, leaders of the ruling People's Democratic Party (PDP) and several opposition parties dismissed the idea as a pre-election stunt by Putin. PDP leader Usmon Soleh said the idea seemed to be intended to appeal to those within Russia who wanted the Soviet Union to be restored; Shodi Shabdolov, leader of the opposition Communist Party of Tajikistan, raised the spectre of the influence of Russia's oligarchs in the project: "It is plain to everyone today that nobody wants to unite on the basis of the predatory principles of [Anatoly] Chubais and [Oleg] Deripaska." Alluded to but not mentioned by name in Putin's article was Ukraine, the country that Russia is keener to bring back into the fold more than any other. Russia has recently been trying to tempt Ukraine into joining the Customs Union, but Kyiv worries that this would scupper its chances of joining the EU – a goal that looks more distant since a Ukrainian court jailed former PM Yulia Tymoshenko on dubious charges and the EU cancelled a scheduled meeting with Ukrainian President Viktor Yanukovych on October 18 in a show of displeasure. Putin addressed this Eurasian Unionversus-European Union tension in his article: "Some of our neighbours explain their lack of interest in joining forwardlooking integration projects in the post-Soviet space by saying that these projects contradict their pro-European stance. I believe that this is false… Soon the Customs Union, and later the Eurasian Union, will join the dialogue with the EU. As a result, apart from bringing direct economic benefits, accession to the Eurasian Union will also help countries integrate into Europe sooner and from a stronger position." It's here, note some commentators, that Putin's true thinking and motivation for the Eurasian Union lies. The Russian PM is implying that membership of the Eurasian Union offers states that have little or no chance of joining the EU the opportunity to access EU markets, technology and institutional structures through a different door. Holding open that door, of course, is Russia, whose

Cover story

position would now be enhanced and central; the other members wouldn't negotiate with the EU directly, but through Moscow as part of the bloc. Thus, by solidifying its hold over what it calls the "near abroad," Russia achieves its long-lost status as one of the global centres of power in a world of continental-scale blocs. An oversight by the Kremlin and then careless admission by an official perhaps betrays Russia's real thinking about the place its sees for the former Soviet republics in all this: spokesman Peskov told reporters that the publication of Putin’s article was not coordinated with Belarus, Kazakhstan or any partner state. The Russian leader, notes political analyst Vladimir Socar, "did not consult any counterparts, he simply purports to speak on their behalf." On paper at least, Russia's goals for the Eurasian Union project must surely look attractive to it. But the British historian Mark Mazower, writing in The Guardian, has a warning about being careful what you wish for. "If the coupling of the Russian economy to the southern Stans brings with it a decoupling from the more powerful regional dynamos to its west and east, it will end up as a drag, not a spur, to growth – and Russia will pay a heavy price for an old-fashioned dream of imperial glory."

"The Russian leader did not consult any counterparts, he simply purports to speak on their behalf"

I 11

I Perspective

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which would depend on the huge fiscal reserves of the likes of China and Russia, despite a mooted attempt to dress it up in an International Monetary Fund uniform. The US – where just the top six banks are reported to have exposure of $50bn to European debt – has led the increasingly alarmed calls from around the world for Europe to get its act together, though Washington would probably join the majority of European capitals in resisting the level of influence this could hand to Beijing and Moscow.

Perspective I 13 favour new clauses enabling Eurozone countries that are failing to keep their national debt within a 3% cap of GDP to be liable to legal censure and to explore the idea of having a dedicated European Commissioner in charge of enforcing budget discipline. This led Herman von Rompuy, president of the European Council, to declare that government of the Eurozone is now on the table. "The reasoning is simple. It is normal that those who share a common currency must take some common decisions related to that currency. In fact, one of the origins of the current crisis is that almost everybody has underestimated the extent to which the economies are linked."

"The longer it takes to resolve the crisis, the bigger the haircut and the larger the scale of bank recapitalisation" Meanwhile, the urgency of the situation would inevitably see the BRICS play hardball over conditions for backing the bailout. China and Russia have turned exploitation of the lack of consensus in the EU into an art form, picking off individual members as partners in projects that fly in the face of policy in Brussels. Indeed, Beijing is already said to be demanding Europe finally recognise China's market economy status in return for cash.

One-way ticket Tim Gosling in Prague

he tortuous path to agreeing a plan to deal with the Eurozone's sovereign debt crisis illustrates clearly that the EU is stuck at a crossroads. Slinging it into reverse simply isn't an option. To the right, it's pressured by the shift of global economic muscle towards emerging economies; to the left, by the demands of western investors to sort itself out. It's becoming clearer there really is little choice but straight ahead to closer fiscal union. The October 23 EU summit – advertised earlier as the latest D-day in what has been a series of such over the past few months – delayed an agreement for three days. As this issue of bne was put to bed, it was becoming clear the markets were in for further disappointment on October 26. While consensus amongst Eurozone officials on the recapitalisation of the banks appeared close, as well as an increased haircut on Greek debt and even how to boost the firepower of the European Financial Stability Facility (EFSF), little detail was expected out of this latest meeting because agreements had yet to be reached with the banks and the sovereign wealth funds that it's hoped will back the EFSF boost. This all puts the problem at the heart of the Eurozone into starker relief. The EU has had months to shore up the so-called "PIIGS" and put a floor under dwindling confidence across the globe, with partner states

increasing pressure on it to agree concrete action as markets rocked to and fro according to headlines. Yet still there's no concrete plan. Looking back, we see a path littered with a reluctance to boost the bailout fund, as member state governments baulk at presenting their electorates with yet another huge bill. The collapse of the governing coalition in Slovakia illustrates the fine line they all walk. But all this haggling only makes the challenge bigger. As Neil Mckinnon of VTB Capital points out: "Liquidity remains parked at central banks and interbank lending conditions remain seized up… The longer it takes to resolve the crisis, the bigger the haircut and the larger the scale of bank recapitalisation… In addition, the greater the loss of credibility of EU policymakers, and the longer it will take for peripherals to regain access to capital markets." At this point, there are two options left on the table to boost the EFSF's firepower. On the one hand, to use the fund to partially guarantee new debt issues; on the other, a special purpose vehicle (SPV) to back European borrowing. While the first plan threatens to establish a two-tier secondary European bond market with older debt unprotected, it may be more palatable to Western politicians than the latter,

Come together Just ahead of the EU summit, a Eurosceptic Tory peer in the UK offered a prize of £250,000 to anyone successfully answering the question: "how do you manage a country's orderly exit from the euro?" Yet contrary to the sponsor's intentions, his competition actually illustrated that no one can work out how any country could exit the currency without pulling down the whole house of cards. In the context of shifting economic power, which sees the startling prospect of China and Russia being sounded out over a European bailout, it's becoming clear to practically everyone – apart from Tory peers, apparently – that the euro is a one-way ticket. The calls to deepen integration and strengthen fiscal discipline in the Eurozone have been gathering steam throughout the last few months, and were finally formalised by the October 23 summit. Though member states were of course unwilling to commit to any far-reaching treaty changes, which would go down like a lead balloon with domestic audiences, provisions for "limited treaty change" were included in the summit conclusions in order to force more budgetary discipline on errant Eurozone members. It won't happen in a hurry – this is Brussels after all – but it certainly looks like the thin end of the wedge, with German Chancellor Angela Merkel leading the charge. She's said to

"It is normal that those who share a common currency must take some common decisions related to that currency"

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Eastern Europe I 15

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Where are Tigipko's promises now?

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The smell of gas in the courtroom Graham Stack in Kyiv

he verdict handed down by a Kyiv court against Ukraine's former prime minister Yulia Tymoshenko on October 12 put the braided lady back on the world political map, receiving a seven-year jail sentence for what seemed a bureaucratic technicality of exceeding her powers when negotiating a deal over natural gas imports with Russia in January 2009. But the target of the trial may not have been so much Tymoshenko, as the gas treaty itself. While trials like that of Tymoshenko, and the now legendary Russian prosecution of oligarch Mikhail Khodorkovsky, owner of oil giant Yukos, might get billed as show trials pitting good against evil, there are mostly very concrete questions of control and pricing of energy resources at stake. When elite conflicts erupt in such a spectacular fashion, it is usually because key players have miscalculated. And in both cases, Khodorkovsky and Tymoshenko may have miscalculated the same thing – the price of oil. The spiralling price of oil in 2003 had turned Khodorkovsky's Yukos into an asset so valuable and strategic that the Kremlin could not contemplate its sale abroad unrecompensed. Conversely, in January 2009, when Tymoshenko ordered state-owned energy company

Naftogaz Ukrainy to sign a deal with Russia's Gazprom, she had her eye on the plummeting price of oil. After hitting an all-time high of $147 per barrel in June 2008, the price had dropped like a brick as the financial crisis swept over the world in the fall. By the end of September, it had dropped by more than 50% to below the $70 mark. And on December 23, the oil price touched $30. Consensus forecasts were for $50-60 in 2009 and 2010, with a drop to $25 regarded as possible if the financial crisis spread to China. As it happened, things turned out differently. A blinking oil light Until early March 2009, the oil price fluctuated between $35-45 per barrel, then it started to crawl back up – and it's still crawling around the $100 mark. But for Yulia Tymoshenko in January 2009, memories of 1998 when the oil price collapsed into single figures may have been uppermost – with crucial implications for her strategy. Because there is no real gas market like there is for oil, prices for long-term gas contracts are indexed to those of the substitute fuel – heating oil – so the price of gas for any given quarter is an average mainly of the heating oil price over the previous nine months. With an eye on the falling oil price and a politician's gift

for wishful thinking, she could regard the gas war as won without a shot being fired. If the oil price in 2009 stayed at $30-40, Ukraine could sign up to the full European-level index price of $450 per thousand cubic meters (/'000 cm) – and still get a gas price of $129-173/'000 cm going forward, ie. less than half of what was originally on the cards. Even the consensus forecast oil price for 2009 of $50 would give a gas price of $210/'000 cm, according to the agreed formula, substantially less than the $250/'000 cm originally demanded by the Russians in 2008. And for making such a "concession" to the Russians to pay the European-level index price, she could demand something in return: the destruction of the opaque gas transport business of Dmytro Firtash, owner of RosUkrEnergo – a company selling Central Asian gas to Ukraine via Russia. RosUkrEnergo was a key financial backer of the then opposition Party of Regions and its leader, now President Viktor Yanokovych, as well as purportedly an influence over the presidential secretariat of former president Viktor Yushchenko, Tymoshenko's other arch rival. Eliminating the gas trader would also go down well in the West. Gazprom threw a sweetener into the bargain: in return for Kyiv signing up for full European prices, without even a discount to reflect the cheaper cost of

At the start of the year, Ukrainian Deputy Prime Minister Sergey Tigipko took to the road with an impressive presentation. Speaking without notes, he was a walking PowerPoint presentation, rattling off an ambitious list of reforms and promising Ukraine would "do a Georgia" – a reference to the dramatic transformation of the tiny Caucasus republic that has made it the easiest place in the Commonwealth of Independent States to do business. Where are Tigipko's promises now? In the same month that a Ukrainian court jailed former PM Yulia Tymoshenko on dubious charges for seven years, the Washingtonbased conservative think-tank Heritage Foundation issued its annual "Economic Freedoms Ranking" that shows just how bad things have got. Georgia retains its place as the easiest place in the former Soviet Union (outside of the Baltics) to do busi-

ness with a "mostly free" ranking at number 26 out of 183 countries, but Ukraine has tumbled to 164 to enter the "repressed" category – and is still falling. Poignantly, it joins the citizen-boiling autocracy of Uzbekistan and the statist dictatorship of Belarus in this category. No wonder the EU felt moved to cancel a meeting with Ukrainian President Viktor Yanukovych scheduled for mid-October. By contrast Russia is ranked at 143 in the "mostly unfree" category, but it's rising, albeit slowly. Perhaps surprisingly, Russia shares this designation with its middle-income BRIC peers – Brazil (113), India (124) and China (135). But what is more surprising is how many CIS countries are now ranked in the "moderately free" category, led by Armenia, which is on the verge of entering the "mostly free" category and is ahead of most of its far more advanced Emerging European cousins, including Turkey and Poland.

HERITAGE ECONOMIC FREEDOM RANKING 2011 Rank

Country

Freedom

change year-

score

on-year

Rank

FREE

Country

Freedom

change year-

score

on-year 0.4

Turkey

64.2

Poland

64.1

0.9

Hong Kong

89.7

Singapore

87.2

1.1

Albania

-2

Australia

82.5

-0.1

Montenegro

62.5

-1.1

New Zealand

82.3

0.2

Kazakhstan

62.1

1.1

Switzerland

81.9

0.8

Croatia

61.1

1.9

Canada

80.8

0.4

Kyrgyz Republic

61.1

-0.2

Ireland

78.7

-2.6

Azerbaijan

59.7

0.9

Denmark

78.6

0.7

Mongolia

59.5

-0.5

United States

77.8

-0.2

101

Serbia

1.1

Lithuania

71.3

104

Bosnia and Herzegovina 57.5

1.3

Czech Republic

70.4

0.6

120

Moldova

55.7

Georgia

70.4

113

Brazil

56.3

0.7

124

India

54.6

0.8

•

MOSTLY FREE

MOSTLY UNFREE

MODERATELY FREE

•

Armenia

69.7

0.5

128

Tajikistan

53.5

0.5

Slovakia

69.5

-0.2

135

China

Hungary

66.6

0.5

143

Russia

50.5

0.2

Macedonia

0.3

Latvia

65.8

-0.4

155

Belarus

47.9

-0.8

Bulgaria

64.9

2.6

163

Uzbekistan

45.8

-1.7

Romania

64.7

0.5

164

Ukraine

45.8

-0.6

Slovenia

64.6

-0.1

169

Turkmenistan

43.6

1.1

Source: Heritage Foundation, http://www.heritage.org/Index/Ranking

REPRESSED

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shipping gas to Ukraine than to Germany, Gazprom agreed to include a 20% price rebate for 2009. This got Tymoshenko a gas price for the first quarter of 2009 – ie. still linked to the oil price peak of 2008 – of around $230, lower than the price originally demanded by Russia – and sufficient for her to claim "victory" with the price to drop sharply later in the year. But by June 2009, as massive stimulus packages in the West and China started to kick in, and Opec production quotas proved more effective than thought, world oil prices were back up at $70, implying around $300/'000 cm gas according to the new formula – and prices haven't looked back since. It's the gas, stupid Tymoshenko's miscalculation explains the strange constellation of forces that formed around her trial. Former arch-enemies like current President Yanukovych and former president Yuschchenko lined up together against Tymoshenko, Moscow and the West. Russian Prime Minister Vladimir Putin himself sounded surprised at the position he found himself in supporting Tymoshenko against Yanukovych. "She's in fact a political opponent, as a pro-Western politician," he commented to journalists while on a state visit to China, while going on to explain why he found the verdict strange: "Tymoshenko herself did not sign anything." The Russian foreign ministry in a statement noted, "an obvious antiRussian subtext to the entire saga." Meanwhile Tymoshenko's former bosom ally during the Orange Revolution, ex-president Yushchenko, a passionate US-linked pro-westerner, forcefully testified against Tymoshenko during the trial, and defended the judge's verdict. "I don't see a show trial, but rather a normal judicial process. Even politicians are not above the law. Wasn't former French president Jacques Chirac also forced to stand trial?" Yushchenko told Germany's Der Spiegel in a recent interview. Representatives of the now ruling Party of Regions have gleefully pointed out that the criminal inquiry into the gas contracts with Russia was in fact

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initiated by Yushchenko's pro-Western administration in February 2009. Yushchenko hates the gas deal for weakening Ukraine's position with regard to Russia – leading directly to the 2010 Kharkiv agreements that extended the lease of Russia's Sevastapol Black Sea naval base in return for a further 20% gas price rebate. Yushchenko has frequently said he suspects Tymoshenko of having sold out to Russia as early as August 2008, when she kept uncharacteristically silent over Russia's incursion into the Georgian rebel region South Ossetia. Party of Regions supporters, for their part, hate the 2009 agreement because of the impact it's had on industry. And while the number of Yanukovych backers includes many of the country's energy-hungry industrialists, there is one man in Ukraine who may be hurting more than the others at the current spiralling price of gas: gas trader and chemicals tycoon Dymtro Firtash, coowner of Rosukrenergo. Chemical brothers After Tymoshenko's 2009 gas agreement pushed him out of the lucrative gas transit trade, Firtash bought up the lion's share of Ukraine's chemicals sector, shelling out around $2.3bn in 2010 and 2011 to now dominate the industry that accounts for around 10% of the country's exports. With gas making up 70-80% of production costs of chemicals, experts regard these plants as profitable with a gas price of around $250/'000 cm. Firtash's representatives had given to understand that he had negotiated such from Central Asian suppliers. But according to energy sector analyst Stanislav Zelenestsky of Art Capital brokerage, recent import statistics show that any cheaper price that Firtash may have negotiated nevertheless appears to be indexed to Ukraine's import price as agreed with Russia. Ukrstat and Ministry of Economy figures show that Ukraine imported Central Asian gas at an average price of $359/'000 cm in September, up from a second-quarter price of $280. According to Zelenetsky, this means that Firtash's largest chemical plant Stirol

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Eastern Europe

alone could post a net loss of $17m-18m for the third quarter, and $60m over the whole year.

VTB Bank has also taken over TransCreditBank (TCB) this year, a well-run and profitable operation that was formerly a captive bank of the state-owned Russian Railway monopoly. Together, these two acquisitions have catapulted VTB's retail arm, VTB24, into the big league, making it at a stroke the second biggest retail bank in Russia.

Opposition members including Tymoshenko have alleged that Firtash is directly linked via business interests to top members of the Yanukovych administration, including Chief of Staff Serhiy Lyovochkin, Energy Minister Yuriy Boyko and Security Service of Ukraine head Valeriy Khoroshkovsky, in turn linked to the country's largest TV channel Inter, although these officials have denied this. One part of the 2009 deal that saw gas worth about $3bn apparently owned by Firtash's Rosukrenergo and stored in Ukraine transferred to the state-owned Naftogaz, has already been reversed by a decision of the Stockholm International Commercial Court. Der Spiegel later looked into the court decision and found that, after Yanukovych won the presidency in 2010, Naftogaz had simply backed down from its claim to the gas, effectively conceding the case to Rosukrenergo. Now there seems little doubt that Ukraine will proceed to use the Tymoshenko court decision to pressure Russia to renegotiate the rest of the 2009 gas agreements. Meanwhile Ukraine's prosecutor general is making it clear that it is not yet finished with Tymoshenko: fresh charges are looming connected to a criminal case from the mid-1990s. No surprises that the criminal case is also related to the gas trade. This time round, though, Tymoshenko features not as the enemy of gas traders, but as one of the pioneers of the system, as head of gas trader United Energy Systems of Ukraine (UESU) in the 1990s – a company that allegedly ran up half a billion dollars in debt to Russia's defence ministry and then transferred the liability to the Ukrainian budget. Tymoshenko is not the first to be charged in connection with this: former prime minister Pavlo Lazarenko, widely regarded as the patron of UESU when he was in office, is already languishing in a Californian jail on a nine-year sentence for related embezzlement charges. The smell of gas in Ukraine appears to be more than the sign of a leak – it's the smell of corruption and trouble ahead.

I 17

More interestingly, VTB also now services the accounts of almost all the municipal businesses in the Russian capital. "BoM has over 100,000 municipal companies that serve the needs of the city," says Moos, sitting in his corner office of the VTB building in Moscow City, the capital's financial district, which looks out over the city spread 26 floors below. "Moscow is a huge business in its own right and City Hall's annual budget is about the same size as that of New York – $45bn a year – one of the largest in the world.

A financial BoM

www.bm.ru

Ben Aris in Moscow

ussia escaped the worst of the meltdown that destroyed large chunks of the US and European banking sectors. The Kremlin spent a total of $66bn in 2009 to prop up wobbly banks and only one biggish bank actually reached the point where the state had to step in and rescue it from collapse. So imagine the shock when two years after the eye of the storm had passed, state-owned VTB had to negotiate a $5bn bailout to save Bank of Moscow (BoM). BoM is the fifth largest bank in Russia and has a clientele to die for. Moscow is like a country in its own right: with 15m-17m inhabitants (including the illegals), it is bigger than most Central European countries and the average income is five to six times higher in the capital than in the rest of the country. No wonder that VTB wanted to take the bank over when Moscow's new mayor, Sergei Sobyanin, put it up for sale on December 10, 2010.

For over a decade and half, BoM had been the captive bank of former mayor Yuri Luzhkov, who was sacked by Russian President Dmitry Medvedev in September 2010. Most of BoM's 6.5m retail customers are from the prosperous middle classes and thanks to its City Hall connections the bank is home to some 100,000 municipal businesses. VTB Bank consolidated control of 75% over BoM in September. "The branch network and the municipal accounts would be both extremely difficult to

Missing words But the BoM deal didn't go smoothly. The bank was among the very first assets to go into the city's privatisation programme after Sobyanin began to clean out the hubris of the Luzhkovera. VTB immediately asked the bank's management for the details of its top 400 borrowers – and that's when the games began. BoM sent over the files, but once they started digging into the detail, they found many were missing. "We had selective loan files provided to us,” says Moos, who as a German is the first foreign national ever to serve on the bank’s board of directors. Things quickly got nasty. The takeover should have been a friendly acquisition, as the main shareholder, the City of Moscow, was happy to sell. But when

"There was nothing behind these SPVs but more SPVs" reproduce in a competitor bank. In this sense, the BoM's business is unique," Herbert Moos, Deputy President and Chairman of the Management Board and CFO of VTB, tells bne in an exclusive interview.

VTB turned up at the BoM offices, the management of the bank had locked them out. "The management only owned about 10% of the bank, but they treated BoM like it was their personal bank," says Moos.

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Room to grow Moscow has been named Europe's most attractive city for new office expansion for the second year in a row, according to a survey by global property consultant Cushman & Wakefield. Of 501 companies surveyed, 57 said they would open an office in Moscow within the next five years – that's up 20% from 2010. Moscow's popularity is due to a shift in priorities for European companies from developed markets to growth markets, like those of the BRIC nations. Companies surveyed viewed "new opportunities from the emerging markets for products and services" as the number-one trend for the next five years. "This [rise in corporate development in Moscow] is being accelerated by very strong expansion in consumer spending, with the potential for this to be leveraged up considerably due to the current low levels of penetration of consumer credit, strong growth in B2B [business-to-business] sales and large potential in regional cities beyond the traditional powerhouses of Moscow and St Petersburg," said Tim Millard, managing director of Cushman & Wakefield in Russia, as quoted by the Moscow Times.

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It is easy to see why. Luzhkov plucked the BoM president Andrei Borodin from relatively obscurity to run the bank when he was only 25 years old, who then ran it like it was his own personal fiefdom: Borodin insisted that all the staff empty the corridors whenever he walked through the building, according to Moos. It quickly transpired there were two banks at BoM: the public one that reported to the Central Bank of Russia (CBR), issued IFRS accounts, had credit and risk committees that vetted deals, and all the normal trappings of a successful commercial bank. But on one of the upper floors was the "Department of Investment Assets," the other bank. Some 15 people worked in these rooms, according to Moos, who fed a money chute that ran straight out the front door. "It was a bank within the bank," says Moos. "The credit decisions it made were not approved by the committees, but signed directly by Borodin and senior managers and the cash would leave the door with no questions asked." The Department of Investment Assets made it as hard as possible to see the millions of un-scrutinised loans that the bank was making, chopping them up into thousands of small pieces so they wouldn't show up in the bank's reports to the CBR and cause awkward questions. Much of this lending was not stealing per se, but simply poor credit decisions where loans were made to companies close to the City that couldn't repay them, so they were simply rolled over. However, after Luzhkov was ousted, things changed rapidly. “The lending picked up six months before VTB acquired the stake and about RUB150bn ($5bn) was lent, mostly to special purpose vehicles (SPVs) based in the Cayman Islands, British Virgin Islands and other offshore havens,” says Moos. “There was nothing behind these SPVs but more SPVs.” After the ropey state of the bank was revealed, the problems started to get serious. BoM was near collapse and if it went down, not only would 6m Muscovites lose their savings and the city's economy be brought to a halt, but the

bank was big enough to spark a systemic collapse. The solution that the CBR came up with was pretty elegant. First, the CBR conceded that the problems at BoM were nothing to do with VTB's ownership of the bank and so its shareholders should be protected from taking any losses associated with the takeover. In return, the CBR insisted that VTB consolidate at least 75% control over the bank – something it was delaying doing all that summer, much to its shareholders' chagrin – so that if the state did bail out BoM, it could be sure that the money would remain in BoM. Then the CBR drew down a 10-year loan via the deposit insurance agency to the tune of RUB295bn at 0.51% (the 0.01% was the administrative fee the DIA charged for the transaction). On exactly the same day, the Ministry of Finance issued a 10-year bond for exactly the same amount, but at an interest rate of 8.3%. The value of the spread between the loan and the bond is exactly RUB150bn at current prices, which will be used to plug the hole in BoM's books. “At the end of September Bank of Moscow’s accounts will show an accounting gain of RUB150bn, which will immediately be used to create a reserve against the SPV portfolio so the net P&L effect for the BoM will be zero,” says Moos. “The upshot is we will have sufficient reserves to deal with all the problems caused by the BoM management, but it will not cost VTB shareholders one kopek nor is this taxpayer money. The only person that takes a hit is the CBR because of the low interest rate on its loan, but that is a tacit admission it failed in its supervisory function." The whole BoM fiasco has had several consequences. The Central Bank of Russia has already sponsored a new law that gives it the power to sack a bank’s management if it's doing a bad job (or stealing). And Gennady Melikyan, deputy chairman of the CBR’s bank oversight committee, was sacked and replaced by Alexei Simanovsky in September as part of the central bank’s efforts to beef up supervision in the wake of the debacle.

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I 19

Rosbank merges its way to the top INTERVIEW:

Ben Aris in Moscow

ince the 2008 crisis, several foreign household banking names have been driven out of Russia's market, but not Société Générale – it's on the verge of fully merging its Russian assets with Rosbank to elbow aside the competition and become the largest privately owned bank in the country. Russia has left several top executives at banks in London red-faced and in some cases without their jobs. British financial powerhouse Barclays Bank bought the small Russian operation Expobank at the top of the market in 2008 for a whopping $745m and started to pour money into building a retail operation. But earlier this year, it gave up on Russia as a bad job and put its Russian assets up for sale. Likewise, HSBC trebled the capitalisation of its Russian subsidiary to $300m just prior to the crisis, but also decided competition was too stiff earlier this year and is also selling (although both banks are keeping their Russian corporate banking divisions). Italy's Intesa bank and most recently Nomura are also winding down their Russian operations. Pre-crisis, banking assets in Russia were growing by 40-50% a year, creating plenty of growing room for everyone. But as of the middle of this year, the sector was growing at only about 15%. Furthermore, the state-owned banks have become much more aggressive, putting further pressure on the commercial banks. "Sberbank has changed radically since [CEO German] Gref arrived. It has slowly become a lot more

Ulan Ilishkin

competitive and aggressive in sales and developing the relationship management," Ulan Ilishkin, deputy CEO of Rosbank, tells bne. Sberbank was once famous for its slow and surly service, but not anymore. Despite having over 25,000 branches and more than 200,000 employees, it has recently become more nimble than many of the commercial banks by devolving power to the branch heads to

Ilishkin says that the other BRIC markets have high barriers to entry and their markets are difficult to develop. However, Russia has been wide open for foreign banks. "The Russian market is still not yet saturated and it continues to grow it's a young market," says Ilishkin. The crisis has been extremely painful and the bank is still recovering, having made a loss last year, but Ilishkin is confident that things will pick up soon.

"The Russian market is still not yet saturated and it continues to grow – it's a young market" make decisions. Sberbank's market share had fallen steadily over the last 20 years, but now it's starting to grow again. Consolidation and mergers SocGen has targeted Russia from the beginning, building and buying assets over the last decade, as the management believed that Russia offered the best growth potential of the emerging markets. "SocGen has operations all over the world, but Russia is already the bank's second largest market after our home market," says Ilishkin. "In France, we have 40,000 employees and in Russia there are 30,000. This is streets ahead of Romania, the third biggest with about 9,000, and most of the other markets – including China, India and Brazil – there are 1,000 people working for the local SocGen branches or less."

"We are still here. It is not easy to enter a market as big as Russia, but once you grab such a big piece of the market then you have a competitive advantage. The contraction in the Russian banking sector is forcing a consolidation of the sector, though SocGen had already embarked on this process before the crisis struck. And Ilishkin is the man to do it. Having worked for Rosbank, which used to belong to Russian oligarch Vladimir Potanin, he probably has more experience of merging Russian banks than anyone else in the country. Following the last crisis in 1998, Russia went through a similar consolidation process; Rosbank bought first OVK in 2003, the rump of failed high street bank SBS Agro, the

I Eastern Europe

first major Russian banking merger that made Rosbank one of the biggest retail banks in the country. "I was on a plane for two years putting all those banks together, as actually OVK was six legal entities â&#x20AC;&#x201C; one for each of its main regions. Technically, the merger was only completed three years ago," says Ilishkin. Having finished one set of major mergers, Ilishkin had to start on another set almost immediately. SocGen started buying pieces of Rosbank in 2007 at a hefty premium and brought its stake up to 75% last year. Russia's state-owned VTB Bank holds another 11% and Potanin continues to own the rest. In addition, the French bank owns 100% of mortgage specialist DeltaCredit, consumer finance bank Rusfinance Bank, and set up its own greenfield retail operation under the Bank Societe General Vostok (BSGV) brand.

bne November 2011

However, over the last two years SocGen has been merging this jumble of assets into a single group and begun to streamline the whole operation into a single banking giant. RusFinannce is one of the few pieces that will retain a separate identity. Formerly a car loan specialist based in Samara in the Volga basin, it will retain its specialist function, although all the branches will be closed and representatives concentrated at the points of sale â&#x20AC;&#x201C; mainly car showrooms. Car financing deals will be cleared and settled in the Rosbank offices. The mortgage specialist DeltaCredit will also keep its brand identity and both Delta and Rusfiannce have already been merged in January this year to become daughter banks of Rosbank. SocGen has decided to close its own retail operation BSGV completely, which

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Eastern Europe

When the plan in all its glory was finally shown to Prime Minister Vladimir Putin in February, he was caught by surprise and said the tariff hikes were "too much." Everyone started back pedalling quickly. The government had already got egg on its face at about the same time from a hike to social taxes that everyone now agrees was too high and has hurt consumer spending this year. The Federal Tariff Agency is responsible for calculating tariffs, but maybe the PM didn't get the memo, as it refused to take responsibility for the actual level of the tariffs.

was legally subsumed into Rosbank in July with the technical merger of their IT systems due to be completed in October this year. However, it will take another year for all the BSGV offices to be re-branded Rosbank. BGSV also has insurance, leasing and factoring subsidiaries that will also be included in the roll up. Small is beautiful, but with another crisis looming in Russia at the moment big is better. At the end of the process, Rosbank will have increased the number of branches to around 1,000, but more valuable will be its unique marketing position. "We decided to keep the Rosbank name rather than the French identity, as we hope to get the best of both worlds: a Russian bank with international backing," says Ilishkin.

I 21

Russia struggles with electricity tariff reform

COMMENT:

Sergei Bubnov of Renaissance Asset Managers

ad news for Russia's utility sector after the government got its calculations wrong for the second time this year. On January 1, Russia's utility sector switched from the crude "cost-plus" calculation to set electricity prices, to a "regulatory asset base", or RAB, for power distributed by network companies. But now politics has thrown the whole RAB policy into question. Before you nod off, it is worth reading on a little as while the power sector is notoriously boring, getting the price for power right is one of the biggest challenges for Russia's government and will determine the pace of economic growth for decades to come. The battle that has broken out to increase the tariffs for power is, well, maybe not exciting, but at least very important to Russia's nearterm future. And the government has already fluffed it. The generation part of Russia's power sector has already been broken up in an extremely successful privatisation, which must count amongst the biggest sell-offs in the world's history. However, the network and distribution part (wittily dubbed the "discos") that actually connects houses and factories to the grid over the "last mile" has not been

reformed and can't be sold until a formula to determine how much they can charge for their services is decided on.

Power politics Russia's power industry is badly in need of more capital that it can earn from higher tariffs. Over the last two decades it has been starved of investment funds as the government held down tariffs as part of its drive to bring down inflation. That aim was achieved at the start of 2008 when inflation fell to single digits for the first time in modern history.

Everyone hates the cost-plus formula, as all it does is drive up costs without actually bringing greater efficiency. So the switch to tariffs linked to the value of assets should have been a big improvement, as the discos would have an incentive to invest in their companies and make them more valuable.

The state has since turned its attention to creating cash for investment and switched to the RAB system ahead of a new round of privatisation in which the regional distribution grids, grouped under MRSK Holding, will be sold off. These discos have remained in majority government ownership on the grounds that as there can be no competition in distribution, they must therefore always be regulated.

The government spent the second half of 2010 negotiating with these companies

MRSK Holding was included on the list of major state-owned companies earmarked

"The battle that has broken out to increase the tariffs for power is, well, maybe not exciting, but at least very important to Russia's near-term future" before finally settling on a formula that was launched on January 1 this year; under the new system, tariffs should have increased by 15-20%. Trouble is, no one had explained to the Kremlin just how much prices were going to rise â&#x20AC;&#x201C; and in an election year too.

for sale in March of this year: the proposal was that the government's stake would be cut from 53.69% to 50% plus one share. However, when the final list was approved by the government in early August, the privatisation plans for MRSK were made subject to confirmation.

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The tariff regime is a crucial prerequisite to the privatisation of the discos, but as autumn closes in on Moscow the government has backtracked on RAB and suspended the new tariffs, allowing power tariffs to rise at the slower pace of about 6% so far this year and grid companies' tariffs will be hiked to 11% from July 1 next year.

bne November 2011

Now the whole RAB policy is in question. The government has already said that the RAB programme needs to be revised, but there is no clarity on how this should be done. Under the RAB system, assets are valued and the tariffs are then set for five years, after which the assets' value is assessed again. As most of the assets were valued

before the 2008 crisis struck, there is clearly room to reassess them (downward) and so the tariffs will almost certainly fall. The government is expected to make its recommendations by the end of this year and actual changes to be effected in the regions in the second half of 2012.

Brunswick Rail makes tracks

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to attract investment into the aging rolling stock. Freight One is the next daughter company to go under the gavel on October 24 and owns 200,000 cars.

Despite this, Lelekov says he is mostly happy with the efforts of the government, which has "largely delivered on all the promises it made at the start of the process." Ben Aris in Moscow

runswick Rail's timing was immaculate. Russia's only independently owned leaser of freight railcars was set up in 2004 just as the government launched a massive reform programme for the railway sector. The western founders, Martin Andersson and Gerald De Geer, had made a fortune after they sold their investment bank Brunswick to UBS in 2003 and were looking for something new to do. Their partner Garry Wendt, who they had brought in from GE Capital, suggested setting up an independent railcar leasing firm, because the government had just embarked on a wholesale liberalisation of the sector. The business hasn't looked back. Rail is Russia's lifeblood and probably the most advanced of all the state's plans to improve infrastructure, bar the electricity sector. As some 85% of all cargo

Vladimir Lelekov

in Russia is delivered by rail, against 15% in Europe and 45% in the US, it is a reform that the state has to get right. "You have no other choice," says Vladimir Lelekov, CEO and managing partner of Brunswick Rail. "The sea in the north freezes and is only navigable for four months of the year, and most of the rivers run south to north but the cargo runs east to west. If the government doesn't deliver on its promise to reform, then Russia faces severe transport problems." Fleet of foot Brunswick Rail is unusual, as nearly all the other companies operating in the industry have either an oligarch or large Russian company standing behind them, whereas the biggest shareholder in Brunswick Rail owns just 15%. The company has been built up in the classic western way: the founders invested some money and bought their first rail cars in 2004. Once the business was up

and running, there were three rounds of fund raising that brought in first high net worth individuals; then funds and strategics like UFG Asset Managers, VTB Capital, Macquarie Renaissance Infrastructure Fund, Sumitomo and the World Bank's International Finance Corporation. In all, the company has raised about $350m, says Lelekov, and has assets worth $1.4bn. Brunswick Rail is also unusual in that it has built up its fleet of 20,000 cars from scratch. "Rail is a capital intensive business, but 90% of our cars are brand new, whereas the average age of cars in Russia is 17-18 years against a useful life of 25," says Lelekov. The main thrust of the government's reforms so far has been to split off the cargo business from the state-owned monopolist Russian Railway (universally known by its Russian acronym of RZD)

stock; in Russia there are thousands of car operators, most of them small local affairs. Indeed, a quarter of the cars that Brunswick Rail owns came from

"You have no other choice than rail – the sea in the north freezes and is only navigable for four months of the year, and most of the rivers run south to north but the cargo runs east to west" The two likely buyers – Gennady Timchenko, who owns oil trader Gunvor, and Vladimir Lisin, who owns the Novolipetsk Steel mill – highlight one of the difficulties of privatising this sector, as both deal in commodities and need rail services. If these two investors win the auction, their competitors will be in the uncomfortable position of buying an essential service from a rival.

INTERVIEW:

Eastern Europe

Still, the government did make some mistakes. For example, it turned out that putting all of RZD's railcars in commercially oriented companies wasn't an entirely good idea. "RZD discovered that some small company at the end of a branch line that needs four cars were being ignored because all the operators only wanted the contracts that call for 400 cars," says Lelekov. "So in the end, RZD had to lease back 200,000 cars – a fifth of Russia's entire fleet – to make sure these small and medium-sized companies are still served. There is a social aspect to this reform." More reform is still needed. As the volumes of rail freight go up, the efficiency of RZD goes down dramatically, says Lelekov. This is because while volumes are rising, they aren't rising fast enough to keep pace with demand. And the sector needs to see a lot more consolidation. In the US, half a dozen private operators own half the rolling

acquisitions and the work of buying out small local operators has really only just begun. "Since we launched in 2004, the company has been developing the railcar fleet rapidly with a [compound average growth rate] of 33% a year, excluding this one," says Lelekov. "And we will continue to grow; we hope to have 50,000 cars in a few years. The market is volatile at the moment, which makes it harder to raise financing. Growth will probably slow going forward, but are still only half way through the liberalisation process so we still have plenty to do."

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ring instead to implement smaller and less controversial steps. Jacek Rostowski, the finance minister who is so far the only minister guaranteed to retain his portfolio, has successfully imposed a fiscal squeeze, driving the deficit down to about 5.6% of GDP this year from 7.9% in 2010. He has pledged to reduce the deficit to below 3.0% of GDP next year, a goal that may be more difficult because of the likely slowdown in Western Europe. "The existing coalition of the Civic Platform and the PSL is expected to broadly meet

The worries at the rating agency were reinforced by an interview given by Tusk's economic advisor Dariusz Filar, who called the deficit target "practically impossible" and suggested that the budget imbalance next year is more likely to approach this year's target of 5.6%. He added that the feared slowdown in the Eurozone could limit Polish growth to 2.5% at most. Neil Shearing, chief emerging markets economist at Capital Economics, says that as things stand, he expects a budget deficit of 5% of GDP next year, which

"Even the favourable outcome of the elections does not fully remove uncertainties regarding the budget outlook."

A mammoth win for Tusk

www.premier.gov.pl

Jan Cienski in Warsaw

onald Tusk, Poland's prime minister, scored a dramatic victory in October 9th's parliamentary election – returning to office for a second four-year term, the first time that has happened since the end of communist rule in 1989. The news was greeted with relief by financial markets, though warnings over an economic slowdown and the budget deficit quickly doused any euphoria. Tusk's Civic Platform party won nearly 40% of the national vote and 207 seats in the 460-seat lower house. The Civic Platform's previous coalition partners, the rural Polish People's Party (PSL), took over 8% to give it 28 seats, enough to secure the coalition a majority. Tusk said he will seek to form the new cabinet by the November 22 deadline. The election ended up being a much clearer win for Civic Platform than had seemed possible just a week ear-

lier, when PiS appeared to be gaining momentum in opinion polls. Kaczynski tacked to the centre, dropping scary talk of a Russian conspiracy that killed his brother, Poland's president Lech Kaczynski, in last year's air crash over Smolensk, Russia, and appearing to be a moderate. However, just days before the election, past comments from Kaczynski that appeared to call into doubt the legitimacy of the election of Germany's Chancellor Angela Merkel again raised the spectre of Kaczynski's visceral dislike of Germany and Russia defining Polish foreign policy. As a result, moderate voters roused themselves, handing the election to Tusk and his party. "It was a very professional campaign by PiS, until the very last moment when the whole Merkel issue came up," said Eryk Mistewicz, a political consultant. A beaming Tusk told his cheering supporters minutes after the polls closed

that, "We will have to work twice as hard in these next four years, we'll have to be twice as fast." Indeed, they will, for while the news was greeted with relief by financial markets, which had worried about a strong showing by the PiS and Kaczynski, who had espoused controversial ideas like a bank tax, warnings over mounting economic problems quickly surfaced. "The victory of the Civic Platform is seen as a market-friendly outcome and may improve the perception of Poland among foreign investors," said a note from Austria's Erste Bank. "Nevertheless, even the favourable outcome of the elections does not fully remove uncertainties regarding the budget outlook." Back to reality Tusk has been very cautious about undertaking the far-reaching reforms suggested by economic liberals, prefer-

the goal of cutting Poland's general government deficit from 8% of GDP in 2010 to 5.6% this year. However, this is due in part to one-off measures such as the diversion of private pension flows into the state budget. The slowdown in Poland and the wider euro area crisis could knock Poland off course unless further, more structural action is taken,” warned Fitch, the ratings agency. On October 11, Moody's Investors Service said the country's rating outlook may come under pressure unless the government presents "contingency plans" to reduce the budget deficit as economic growth slows from the European debt crisis. The government's plan to cut the deficit to 2.9% of GDP next year "might be out of reach," Jaime Reusche, an assistant vice president for sovereign risk at Moody's in New York was quoted by Bloomberg as saying. "Underestimating the risks of what is to come is dangerous, but policymakers in Poland are conscious about these challenges and the uncertainty that surrounds the operating environment. Nevertheless, we have not yet seen contingency plans by the government, and this could certainly impact the stable outlook."

would push public debt to almost 58% of GDP – dangerously close to the level that would force dramatic fiscal tightening. "Either way, though, the key point is that far from being supportive, fiscal policy will now be a drag on growth. Indeed, the real risk is that debt ceilings force the government into self-defeating fiscal tightening, which exacerbates the economic slowdown, lowers tax revenues and ultimately widens the budget shortfall," he says in a note. The upshot is that while Poland will continue to outperform its Central European neighbours, not least because it is a less open economy and is therefore less exposed to weaker euro-zone

demand, the degree of outperformance is likely to be smaller than in 2008-09. Tusk's teeth For now, the markets are taking the optimistic view. In the weeks following the election, Poland’s 10-year bonds became the best performing sovereign debt worldwide, after being the world’s third-worst performers in the previous quarter. Government zloty bonds due in 10 years or more jumped 7.4% in October for the biggest gain in dollar terms among 144 debt indexes compiled by Bloomberg. The yield fell 18 basis points to 5.73%, about half the rate of 11.6% for similar maturity bonds sold by Portugal. The much-battered zloty too benefited, rising over 2% to hit a threeweek high by mid-October, the biggest weekly gain seen since January 7. Investors also see a further impetus to reform may come from the surprisingly strong performance of Janusz Palikot, a former member of Tusk's party who set up his own grouping and ran on a programme of reducing the influence of the Catholic Church in Polish life as well as slashing red tape, freeing up business and pushing liberal economic reforms. Palikot's eponymous party took 10% of the vote, heavily skewed towards the young. He is unlikely to become a formal part of the coalition, both because of his views on allowing gay marriage and soft drug legalisation that cause difficulties for the more conservative wing of Tusk's party, as well as the bitter personal relations between the two men – Palikot wrote a tell-all book accusing senior members of Civic Platform of drunkenness and arrogance.

"It was a very professional campaign by PiS, until the very last moment when the whole Merkel issue came up"

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23, which had been earmarked to fully implement the bloc's plan to contain the sovereign debt crisis. PM Radicova put on a brave face, claiming their sacrifice was worth it to protect Slovakia's reputation. "We belong to Europe, we belong to the Eurozone, and today we confirmed this commitment," she told the TASR newswire, adding that Slovakia would no longer be labelled a "black sheep, black hole, and an irresponsible and untrustworthy country."

Passing the buck in Slovakia Tim Gosling in Prague

lovakia was plunged into political chaos in October as the opposition used the parliamentary vote on the Eurozone bailout fund to force a collapse of the government. The episode put into sharp relief both the primitive politics in Bratislava and the massive problems facing the Eurozone; it also leaves Slovakia without a functioning government at the worst possible time. Preparing to cast the last vote amongst the 17 Eurozone countries to approve the expansion of the European Financial Stability Facility (EFSF) in early October, Slovakia suddenly found itself the subject of front-page headlines across the globe, much of it featuring patronising adjectives. "Plucky" was a favourite of opponents of the EU plan to raise the lending capacity of the EFSF to €440bn, as it became it became clear that Prime Minister Iveta Radicova's coalition was lacking the votes necessary to pass the bill. Holding the global economy to ransom would've been more appropriate however, as markets wobbled ahead of

the first vote in the Slovak parliament on October 11. The government pushed the boat out in the face of the refusal of the junior member of the governing coalition, the Freedom and Solidarity (SaS) party, to back the bill, attaching a no-confidence motion in an attempt to concentrate minds and force the legislation through. In the end, SaS abstained, as did the opposition Smer party, causing the government to collapse and forcing it to

However, Jakub Groszkowski, an analyst at the Centre for Eastern Studies, believes the damage has already been done. "Slovakia, which rejected the loan to Greece last year has tarnished its reputation as a reliable partner in the EU once again." Leaderless and rudderless Former prime minister and head of the opposition Smer party Robert Fico may have done the country a more direct disservice, however, by causing a seizure in the country's political leadership at a critical juncture. Governments across Central Europe are struggling to push through tight austerity budgets for 2012, while freely admitting that, in the face of the huge uncertainty over the EU economy as a whole, their economic forecasts could be way off the mark. In Bratislava, at the time of writing it appears likely that Radicova may be left to head an interim minority government for the next five months, with SaS moving into opposition. That admin-

"Slovakia will no longer be labelled a black sheep and a black hole"

negotiate early elections on March 10. The EFSF bill was promptly passed two days later with an overwhelming majority, just over a week before a European Council summit scheduled for October

istration's first test will be Slovakia's 2012 draft budget, agreed amongst the cabinet in August and demanding a deficit of just 3.8% of GDP, which is yet to be put before parliament. That

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the plan has spending cuts rather than tax increases driving the reduction in the budget gap is unlikely to meet the approval of Fico – who has pledged not to join any governing coalition ahead of the snap elections.

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Stark warnings and family values in Latvia

Mike Collier in Riga Rating agency Standard & Poor's was quick to flag its concern, with analysts telling the local press on October 14 that the country's 'A+' rating – which it only earned in August – could be at risk should planned reforms to boost economic efficiency, ease labour costs and promote sustainable public finances be derailed by the political logjam. "In case the current political situation leads toward a lower commitment for consolidation of public finances and a considerable delay of reforms, we will consider whether the current rating reflects reality," S&P analyst Ana Mates told the SME daily. The Eurozone's Achilles heel The EU's path towards solving the sovereign debt crisis has been littered with scares, with the Slovak need for a second round of voting only the most dramatic example of the way in which the resolution is exposed to the wiles of domestic politics. Pressure on Europe to move, and to do so quickly and decisively, has been building for months, coming to a head at a meeting of the G20 on October 15, when the US led the charge in demanding that Germany and France carve out a consensus and lay out concrete plans to solve the euro's problems. The drama in Bratislava also brought into sharper focus the contradiction at the heart of the Eurozone – namely, monetary union without tighter fiscal or political governance – and increased the calls for greater centralisation. Shrugging off the increasingly mainstream opinion that the Eurozone should oust weaker economies, European Central Bank President Jean-Claude Trichet joined calls to change the EU treaty in order to strengthen governance of the euro. "In my view, it is necessary to change the treaty to prevent one member state from straying and creat-

An unlikely battle for the future of Europe's money took place in the Latvian capital Riga on October 12. At the annual conference of the Latvian central bank held in the slightly past-it Daugava hotel, European Central Bank board member Jurgen Stark issued a series of grave warnings and demands for Europe-wide control of both monetary and fiscal policy in a dour succession of PowerPoint slides. On the other side of the water at the far swankier Bergs hotel, the flamboyant mayor of Ventspils, Aivars Lembergs, beamed as he opened an attache case full of freshly printed notes as he announced the arrival of the "vent" – his port city's brand new unilateral currency. Since handing in his resignation on September 9, the influential Stark has shown little inclination to shut up before his replacement is found, and took full advantage of the opportunity to blast the US for blaming the world's current economic woes on Europe, saying: "All those who give advice to the Europeans should get their own house in order before they give advice." While the newswires buzzed with every word of Stark's suggested solutions, including his demand for a "major strengthening of the rules which govern economic and fiscal policies" and the formation of a "European finance ministry with direct powers to interfere in national budgets," which would "require the transfer of national sovereignty," they ignored the jollier proceedings at the Bergs. But the contrast between the moustachioed German's flag-waving for "supranational" solutions with more than a hint of authoritarianism about them and the light-hearted launch of the vent (convertible at a rate of 100 venti to the lat) has a deeper significance than just a simple marketing gimmick designed to draw tourists to Ventspils, which with its huge commercial port and oil terminal may not be the most obvious destination for a weekend break, but which works overtime to make the most of what it does have (kids' playgrounds, a beach, castle and open air museum). As mayor for the last 20 years, Lembergs is the virtual Doge of Ventspils and while he is generally despised by the chattering classes of Riga as one of Latvia's "oligarchs," he retains a genuine following in his coastal fiefdom despite his involvement in court cases in Latvia and the UK centring on corruption and fraud charges. The secret of his popularity is simple: the streets of Ventspils are clean, the police carry out regular patrols, and the hospital and schools are decent. But the launch of the currency is just part of what Lembergs tells bne is, the concept of a state within a state. "The city prides itself on its own flag, its own language and even its own time zone, which is why the decision to introduce the vent seems self-evident," he says, outlining what sounds almost like the revival of the medieval city-state and the very opposite of Stark's vision of cross-continental homogeneity. "Marketing is marketing, but our city's philosophy is the philosophy of the family," adds Lembergs – and you can't get less supranational than that.

I Central Europe

ing problems for all the others," Trichet said on October 16. He added, however, that he expected existing rules would be applied much more rigorously in the future, even without a change in the treaty. "We don't have a federal budget, we don't have a political federation, so we have to fully respect the constraints and the mutual supervision rules that exist in the Eurozone," he said.

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At the same time, the Slovaks are not alone in their objections to almost doubling their contribution to a bail out fund for the continent's 'advanced' economies – in Slovakia's case it will need to stump up $7.7bn. The prime ministers of the Czech Republic, Hungary and Poland joined the chorus on October 14, complaining about the irresponsibility of current Eurozone members and making it clear they're in no hurry to join the single currency.

Emerging markets have also called for more bulk for the International Monetary Fund (IMF) in a bid to secure themselves a safety net. "We heard loud and clear that the emerging markets in particular were very concerned about the risk of contagion from advanced economies," IMF chief Christine Lagarde told a news conference on October 15, promising to help "nonconsenting victims of the economic crisis."

rescued by authorities in Dublin. If it adds Kredyt Bank to BZ WBK, Santander will be the third-largest player on the Polish market, which is dominated by two large banks, the state-controlled PKO BP and Bank Pekao, a unit of Italy's UniCredit Group, with a raft of secondary banks making up the rest of the country's top-10. "Although there is still some chance that KBC will pull the deal due to an unsatisfactory price, a deal has clearly become more probable," writes Mark MacRae, an analyst with Wood & Co, a Central European investment bank.

The shifting sands of Polish banking Jan Cienski in Warsaw

pain's Santander is moving fast to realize its ambitions of playing a significant role in the Polish banking market – filing a binding offer to buy Kredyt Bank, a unit of Belgium's KBC thought to be worth about PLN4bn (€930m). If the transaction goes through it will mark another ownership change in a rapidly shifting Polish banking market.

KBC is selling the bank, as well as Warta, a Polish insurer, in order to raise the money needed to repay the Belgian government for a bailout that rescued the bank during the first wave of the economic crisis. That was the same reason that led to Santander's first large Polish acquisition, the purchase of Bank Zachodni WBK for €3.1bn from Allied Irish Banks, which in turn had been

The sale of Kredyt Bank is not the only change in the offing in the Polish banking sector. Portugal's Millennium BCP, which has also run into trouble at home, is selling its Polish subsidiary for an estimated €827m. The banks reportedly expressing an interest in buying the Polish Millennium include France's BNP Paribas, as well as PKO BP and Pekao. There are also rumours that Alior Bank, a recent and quite successful start-up, may also be on the market. Best of both worlds Polish banks are an attractive acquisition target because the sector is very profitable. In the first half of the year, Poland's banks reported a profit of PLN7.7bn, a 50% increase over the same period in 2010. For the year, the sector looks set to earn a record PLN15bn, beating the PLN13.9bn earned in 2008, the last precrisis year. "Polish banking has many of the positive aspects of a classic, developed-market banking sector, with the

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additional bonus of still having growth potential," says David Nangle, head of research at Renaissance Capital. There had been worries that Polish banks would run into trouble because of their earlier propensity to lend in Swiss francs, popular before the first wave of the economic crisis because of the lower interest rates charged on such mortgages compared to loans denominated in zlotys. Swiss franc mortgages make up about 54% of all outstanding mortgages, even though banks and regulators have made access to such loans increasingly difficult. Their true cost became apparent once the zloty started to lose ground against the franc, first sagging in 2009 before regaining some strength, and then falling steeply this year to almost PLN4 to the franc, while some mortgages taken in 2007 were signed when the franc was at about PLN2.

The franc's rise has strained the wallets of the approximately 700,000 Poles with Swiss franc mortgages, but so far they have been doing a good job making regular payments on their debt. Only about 1.6% of all such mortgages are in arrears, slightly lower than the level for zloty mortgages, and significantly below the level seen in Hungary, where borrowers were unable to take advantage of the cuts in Swiss interest rates because their rates were fixed, unlike the Polish floating loans. The slack performance of the zloty is creating problems in covering liquidity positions for some banks with large Swiss franc portfolios, as they are having to scramble to increase their deposits. But because of the sector's profitability, and the economy's strong growth prospects, Polish banks are still attractive targets for foreign buyers. "There is a real sense that almost every bank in Poland is for sale if a buyer can

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

be found," says Mariusz Grendowicz, former CEO of BRE Bank, a unit of Germany's Commerzbank. But rather than looking for deals among the cash-strapped banks of Western Europe, which are bracing for another wave of crisis to hit the eurozone, the answer might be to look east. In a harbinger of what might be a future trend, Russia's Sberbank recently agreed to buy most of the international operations of Austria's Volksbank. Such a transaction would not muster much enthusiasm among Polish banking regulators, but cash-flush banks from Russia, China and other points east might make better partners for Poland's profitable banks.

What you need to know

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BRICKS & MORTAR:

Owning in Osterreich and beyond

Nicholas Watson in Vienna

o witness the return of the property market in Austria, you need only take a glass lift up the OBB Tower. There, spread out before you, is 1m square metres (sqm) of construction site that will be the new main railway station and its surrounding commercial district, Vienna's answer to Berlin's ultramodern Hauptbanhof. This giant project is a sign of the good times returning to the Austrian real estate business, which has had an unfortunate recent history. The global crisis of 2008 struck Central and Eastern Europe, the stomping ground of Austria's developers, particularly hard, revealing a number of unsavoury scandals that raised questions about the transparency and management structure of Vienna's publicly traded real estate funds. "Confidence in the sector will take some time to recover after the scandals and the exposure to CEE," admits Holger Schmidtmayr, member of the board of Sparkassen Immobilien, which wasn't, it must be stressed, one of the firms tainted by scandal. Still, Vienna's residential market is going some way to achieving that, being currently the best performing part of CEE's real estate business, with the office market in the Bulgarian capi-

tal of Sofia the worst, and everything else in between. According to Gunther Artner of Erste Bank, the price of existing flats in Vienna rose 4.4% in the first quarter of this year from the previous quarter, but grew a huge 13.6% in the first quarter compared with the year-earlier period. "The shift in investor focus regarding residen-

mentals of the economies of Emerging Europe – lower debt levels in particular – should help them sustain growth during this tricky period. "CEE is certainly one of the better prospects," says Artner. This is reflected in the flow of investment into real estate in the region, most of which, about 70%, has gone into Poland, Russia and the Czech Republic. This

"Confidence in the sector will take some time to recover after the scandals and the exposure to CEE"

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tial real estate is not concentrated on the yields, but rather on price stability and potential gains deriving from any future asset sale," says Artner. "Investors were mainly private buyers and foundations, but also institutional investors." Better foundations With the sovereign debt crisis really beginning to bite in the Eurozone and economists predicting the spectre of stagflation haunting the region for years to come, the relatively solid funda-

year's investment volumes, mostly from Austria and the UK, had reached €6.9bn by the middle of August, which is about 20% higher than that for all of 2010. The office market in CEE is holding up particularly well, with growing office take-up reducing the overall vacancy rate in the region to 13.8% in the second quarter of this year compared with the 15.7% rate seen in the last quarter of 2010. The vacancy rate varies widely across the region, though, with just

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I Central Europe

"We need markets with inherent growth and that's Romania"

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6% in Warsaw compared with 24% in Belgrade. Likewise, there's increasing divergence seen in office rents across the region; rents are stable in most CEE countries, but range from €500 per square metre (sqm) in Moscow to just €168/sqm in Sofia. The retail segment is not much different to office and reflects the macroeconomic situation in CEE, which is better and more stable than further west. Rents across the region remain very diverse, ranging from €480/sqm in Sofia to €3,708/sqm in Moscow. Rent levels have risen most in Warsaw, St Petersburg

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and Moscow, while the biggest yield compression – a fall in the implicit yields paid for real estate on the investment market, which translates into higher prices – was seen in Moscow, St Petersburg and, surprisingly, Bucharest. Romania was particularly hard hit by the 2008 crisis and its institutional weaknesses has meant it's struggling to recover. But S-Immo's Schmidtmayr likens today's Bucharest to Prague in 1999. "It's the right place to invest 20% of our portfolio. Where's the growth? We need markets with inherent growth and that's Romania," he says.

Central Europe's property market grows up

Hungarian wine – 20 years of hard toil is just the beginning Robert Smyth in Budapest

Jacy Meyer in Prague Investors, local and international, see the Czech property market as confident and maturing, while real estate consultancies are murmuring that the wild east is settling down into a stable, grown-up investment market. Even after a couple of turbulent economic crisis years and a recent return to more volatile markets, brokers believe that the property industry in Central Europe is now on a firmer footing. "In 2008, investors pulled out of [Central and Eastern Europe]. This time we aren't seeing that," says James Chapman, partner at Cushman & Wakefield Czech Republic. "The trend is that the Czech Republic and Poland are increasingly being viewed as Western European markets – we aren't there yet, but that's the direction it's going." The end of summer and beginning of autumn saw instability return to the markets from the sovereign debt crisis in the Eurozone, but neither Chapman nor Omar Sattar, managing director of Colliers International Czech Republic, believe another crisis is on the doorstep. "The markets are improving, we can see it in the statistics and we hear it from our clients, but there's still a cloud of uncertainty due to the global economic difficulties," says Sattar.

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One local company that is having a banner year is the CPI Group. At the beginning of October, they announced the acquisition of 19 office buildings throughout the Czech Republic from Czech billionaire Petr Kellner's PPF Group. The company has stated they expect to spend CZK15bn (¤600m) on property investments this year, exceeding the amount they invested in 2010. The buildings from PPF alone cost nearly CZK5.4bn. Contrast that with Praguelisted property group Orco who announced a ¤7.5m loss for the first half of the year, compared with a profit of more than ¤237m for the same period in 2010. Chapman estimates about ¤1bn have already been done across the market and Cushman & Wakefield themselves expect to close deals totalling a further ¤500m by the end of November. He adds that in 2010, the total market only saw ¤550m. "We've seen significant improvement on the year and expect full-year volumes close to ¤2bn," says Chapman. "That's second only to 2007, which was ¤2.3bn. It demonstrates how significant this upturn has been."

n the 20 years of its existence, the Budapest Wine Festival has grown from a few huts on bijou Vorosmarty square to packing out the grounds of the imperious Buda Castle. This year's sun-blessed festival that ran from September 7-11 saw almost 50,000 people spend a record amount on wine and reflected the optimism of Hungarian winemaking as its winemakers anticipated a bumper vintage of top quality grapes, in stark contrast to the rain-drenched festival and sub-standard vintage of 2010. But while the Budapest Wine Festival represents a magnificent showcase for a Hungarian wine industry that has been transformed since 1989, without a coordinated marketing strategy like many of its competitors have, many of the country's best wines are destined to remain in Hungary. "This is by far the most important festival of the year and there are many. We're very happy with our position and

the number of potential new customers we can get to know," Norbert Bodorkos, estate manager of Kreinbacher, one of the two largest wineries in the Somlo region, told bne at the festival. Somlo is Hungary's smallest region, but it is renowned for intense, fiery whites from its volcanic basalt soil that were once a favourite tipple of Queen Victoria, who is said to have believed

Hungary. "The main question is not about selling just Kreinbacher wines, but rather building a market for Somlo wine. If we can't sell our increasing output at home, then our future will lie abroad," said Bodorkos. Kreinbacher already exports 20-25% of its 30,00035,000 bottles of annual production. But if history is any guide, creating that international market for the country's best wines won't be easy. Marketing miss Izabella Zwack, head of the wine division of Budapest Stock Exchange-listed drinks company Zwack and owner of internationally-acclaimed Tokaj winery Dobogo, says that while there are many exciting and unique wines coming through, "in some ways Hungarian wine as a whole has unperformed expecta-

"Our wines are not going to be cheap, but will offer excellent value for money"

that drinking wine made from its Juhfark grape would help produce male heirs. Despite its small size, Somlo is prized almost as highly as Tokaj by wine experts for its volcanic influenced wines, but is far less known outside

tions, especially when it comes to communicating with the outside world." "For Hungarian wine to become a hot category internationally, we need more concentrated efforts," she insists.

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Irrational in Budapest

Kester Eddy in Budapest Lajos Bokros, MEP and the former Hungarian finance minister who oversaw the largest privatisation sales in the mid-1990s, on October 10 savaged Hungary's current economic policy, deeming it a "complete failure" and accusing the Fidesz government under prime minister Viktor Orban of "mortgaging the future" of the country and its people with measures such as the nationalisation of the private pension funds. Never far from controversy as a minister, Bokros' wide-ranging attack comes at a time of renewed worries over the Hungarian economy, caused by the crisis in the Eurozone, weakening demand for exports from Germany, and growing mistrust of the Hungarian government's self-declared "unorthodox" policies â&#x20AC;&#x201C; the most recent of which enables mortgage lenders to pay off their foreign-currency loans with forint at a discount of some 25% on current market exchange rates, causing consternation among the banking industry and beyond. Bokros told a press conference hosted by the Freedom and Reform Institute, a right-leaning think-tank of which he is president, that the Orban government's economic policy "is irrational, unprofessional, unsuccessful and dishonest," and is set to make Hungary "totally uncompetitive" vis-a-vis its peers in Central Europe. While the Fidesz administration, which regularly denounces Hungary's communist past, is typically described as a centre-right regime, its economic policy is far from the classical conservative line, Bokros argues. "The ruling party's view is that a western-style economy, based on the principles of freedom and markets, has failed. [So] the time has come for a big, strong state, for governments to determine the functioning of markets, and to intervene deeply into the lives of businesses... This concept echoes the Chinese and Russian models, and gives rise to an economic policy which is completely irrational in a small, open and converging economy," he said. Bokros focused some of his ire on the foreign-currency mortgage repayment scheme, denouncing it as "legalised robbery." The banks, already suffering from a crisis tax imposed last year that largely wiped out profits, are outraged by the latest move, and have threatened to appeal to the European Court against it. Bokros warned that if the banks lose out, ultimately "trust and confidence will shrink, savings and investments will fall, and a credit crunch will set in." Despite improving the fiscal balances and state debt in its first year of power, the outlook for the Fidesz government is not improving; the normally buoyant Ministry for National Economy (the former finance ministry) has toned down growth predictions to a mere 1.6% this year, followed by 1.5% in 2012. As a result, the 2012 budget increases the standard VAT rate from 25% to 27%, delays various planned tax cuts and hikes the legal minimum wage by 18% (to around Â¤300) â&#x20AC;&#x201C; all moves criticised by Bokros. "Changes to the personal income tax system and the unrealistic increase of the minimum wage will destroy jobs with low-added value," he said.

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Since the collapse two years ago of a sleek marketing programme (due to members not paying fees on time), Hungary's wine marketing has continued to lack the focus of most of its international competitors ranging from Austria to Australia. Various associations do carry the can for their own regions or subregions and Hungary's Agricultural Marketing Centre runs campaigns at home and attends wine fairs abroad, but the international impact is limited. Nevertheless, several of the country's larger wineries like Torley, Hilltop, Nagyrede and Danubiana each export millions of entry-level, mid- and upmarket bottles to markets like the UK, Germany and Sweden. Further, many lower volume premium categoryfocused wineries have already succeeded in shifting significant quantities onto foreign markets. However, Hungary has failed to create a buzz internationally like its neighbour Austria, which with its lower output than Hungary has succeeded in targeting lucrative wine specialists in the international arena. Many Hungarian winemakers are also reluctant to export when they find foreign markets are unlikely to pay the same high prices that their wines fetch at home. Poland, one of Hungary's traditional export markets, is the exception and is increasingly on Hungarian winemakers' radar, especially since Poles have been seen to be moving up from entry-level Hungarian wine. Hungarian wine there has been boosted by the country's historically strong relationship with Poland, with only Hungarian wines poured at Poland's Eastern Partnership Summit held at the end of September. Hungarian wines will also be poured at all high-level events during Poland's six-month stint at holding the rotating EU presidency, which runs until December. Addressing the press and winemakers at this year's Pannon Wine Challenge, John Szabo MS (Master Sommelier) described Hungary's strong suite of indigenous grape varieties as a national

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treasure that should be championed for export markets. "It is important for producers to determine which markets they're after," he said. It is not only its grapes that are special, however. "Hungary has a wealth of extraordinary terroirs and the potential for world-class wines that deserve to be served on tables around the world and can happily stand up against any wines in the world," furthered Szabo. It's not just in marketing where Hungarian wines are falling short, however. "We've seen the effort that's gone in over the last 20 years, but we're a bit concerned that the final step in getting to the consumers is letting producers down," cautioned Caroline Gilby MW (Master of Wine) on delivering the jury's verdict at the Pannon Wine Challenge. She mentioned the relatively low quality of corks, packaging and exposure to oxygen at bottling as negatives. "There's

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consumers then trying a wider range of Tokaj and indeed Hungarian wines in general. London Tokaj is a start-up that's looking to sell 100,000 bottles of premium Hungarian wine to the UK market each year, promoting Hungarian wines around the slogan of wines from the "New Old World". Its founders, Frank Smith and Giustino Palazetti, were at the Budapest Wine Festival meeting new winemakers to include in their online-based portfolio. "The UK wine market has matured, we need to hit the premium end of the market via communicating strongly with the press and trade with unknown but unique wines. Our wines are not going to be cheap, but will offer excellent value for money," said Smith. Dry Furmint will be a key part of their message, but the traditonal sweet Tokaji Aszu will be crucial, especially in targeting restaurants. The pair will work with

"If we can't sell our increasing output at home, then our future will lie abroad" been a higher level of cork taint and early oxidation than I've seen in a while at international competitions," she said. Changing tastes Zwack and many others, including Hungary's most internationally acclaimed winemaker Istvan Szepsy, believe that the dry Tokaj from the Furmint grape is the spark that could ignite Hungarian wine internationally. First foreign and then local investors piled into Hungary's legendary region of Tokaj, which has the world's oldest vineyard classification system, following the end of communism, only to find the market for its legendary sweet Tokaji Aszu was limited due to changing consumer tastes. But after 10 years of perfecting dry Furmint, the hope now is that positive consumer experiences with the dry style will lead to

London-based Hungarian sommelier Gergely Barsi-Szabo who will specifically target the on-trade. "Tokaji Aszu is more understandable than other sweet wines and could really appeal to lovers of claret, with the acidity creating balance and layers of flavour rather than overt sweetness," he said. Szabolcs Ujfalussy, head of sales at Tokaj winery Oremus, which is owned by prestigious Spanish winery Bodegas Sicilia, noted that sweet wines continue to drive turnover. Oremus exports around 60-70% of its output to 50 countries. After a 25% drop in sales abroad in 2009 in the depth of the global crisis, 2010 saw an increase of 50% over 2009. "In Hungary, sales of dry wine has been going up, while internationally dry dropped back a couple of years ago but is now increasing again," said Ujfalussy.

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Hungarian wine appears to need foreign markets, especially now that the domestic market has been further hit by the continued surge of the Swiss franc against the local forint, which has left hundreds of thousands of mortgage holders with even less disposable income. "It's awful at the moment, some regular customers are coming in much less than they usually do," lamented one wine trader.

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"Serbia has certain principles regarding territorial integrity it is not going to give up on"

Serbia as a potential candidate for EU membership. But the outbreak of intercommunal violence in Kosovo in recent months undoubtedly complicated the proceedings.

Western Balkans & EU enlargement: Yes, no, maybe Guy Norton in Zagreb

s was widely expected, Serbia on October 12 was finally awarded the status of being an official candidate country for membership of the EU. But given the tetchy relations between Serbia and its erstwhile province Kosovo, the EU offer came with strings attached – namely that accession negotiations would only begin when Serbia achieves "additional significant progress in further normalisation of relations with Kosovo." The typical Brussels-style fudge will no doubt delight the pro-EU lobby in

Belgrade, but it holds out the possibility that the nationalist wing of public opinion in Serbia could still derail the EU accession process in the Balkan state. Although 22 members of the EU have recognised Kosovo's independence, five members – Cyprus, Greece, Spain, Slovakia and Romania – have refused to do so and consequently the EU didn't

stipulate recognition of Kosovo as a formal requirement for Serbia's EU candidacy. Ever since the arrest of war crimes suspects Ratko Mladic and Goran Hadzic in May and July respectively, it was commonly expected that the European Commission would endorse

"The people in Serbia should be proud"

In particular Germany, the key economic and political force in the EU, has ostensibly tied recognition of Kosovo's independence to Serbia's future EU membership. In June, a German parliamentary delegation on a visit to Belgrade told local media that Serbia would have to recognise Kosovo's independence otherwise German MPs in the Bundestag would not approve its accession to the bloc. Although they said that EU membership negotiations could start and end without a de jure recognition of Kosovo by Serbia, they said a de facto recognition must be accepted, including accepting Kosovo's membership in the UN and international organisations. Commenting on the European Commission's decision, which still has to be ratified by the European Council of Ministers in December, Serbian President Boris Tadic told Serbian news agency Tanjug: "The EC recommendation is an important economic signal to investors because it says Serbia is on a steady course towards EU integration." He added that the recommendation signalled the success of recent reform efforts such as the fight against organised crime, corruption and judicial changes. "I take pride in the fact that the EC has qualified as very successful the reforms Serbia has carried out... The people in Serbia should also be proud." With regard to the stipulation that Serbia improve relations with Kosovo,

Tadic said that the authorities in Belgrade were committed to mending ties with Pristina, but added: "However, Serbia has certain principles regarding territorial integrity it is not going to give up on, but that does not mean it is impossible to find a political solution to the crisis, as long as the other side has the will to do so." Mixed news elsewhere Meanwhile, the Commission recommended the opening of EU accession talks with Montenegro, which received candidate status last year, but which has had to strengthen anti-corruption and judicial reforms in the last 12 months. And Croatia, which completed EU membership talks in June after six years, is to set to join the EU on July 1, 2013, pending a local referendum on EU membership provisionally scheduled for January 2012, following parliamentary election on December 4. Based on Croatia's experience, Serbia would join the EU in 2020 or 2021.

Bulgaria collared According to the EU's anti-fraud agency, Bulgaria had the highest number of new cases of abuse reports out of all EU27 member states in the last reporting year. In its 2011 report published October 19, OLAF said it handled a total of 419 investigations in EU member states in 2010, 81 of which were in Bulgaria and 41 in Italy. Belgium came third with 37 cases, though that country is a special case because it hosts the EU institutions themselves. OLAF said the bulk of the investigations concerned EU institutions (139) and the agricultural sector (117). Given Bulgaria also topped the ranking last year, the news sent the local press into conniptions. "Bulgaria is again the champion of EU fraud," the national daily Sega cried in a front-page headline. Together with Romania, Bulgaria is also among the EU countries with the lowest absorption rate of EU funds, as a result of both corruption and administrative incompetence. Still, at least Sofia is talking about it; according to Euractiv, the news of the OLAF report went virtually unnoticed in Italy.

There was bad news, however, for Albania, Bosnia-Herzegovina and Macedonia, all of whom failed to progress on their journey towards EU membership. The EU said that Bosnia's progress towards membership had been "very limited," no doubt complicated by the fact that the ethnically divided nation has been without a government since elections last year. Similarly, political tensions in Albania were cited as the basis for the Commission's statement that, "conditions for the opening of accession talks have not yet been met." Meanwhile, Macedonia – which became a EU candidate nearly six years ago – still sees its progress towards the EU stymied by Greece's objections over its name. http://ec.europa.eu

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Though intended to regulate property ownership, the law is prompting concerns amongst some regarding the distribution of state-owned assets. "The main purpose of the ruling Serbian 'partiocracy' is to maintain – at least during the transitional stage – its monopoly over such state-owned properties, as a means of having them transferred in the interim, via the planned law on Public Property, to lower party-controlled entities – for instance, local municipalities and numerous public enterprises – before having their ownership transferred for good to private parties, namely the politically connected and the regime's privileged few," Antic tells bne.

Desperately seeking fair restitution in Serbia Ian Bancroft in Belgrade

fter years of wrangling, Serbia's parliament – under the EU's watchful gaze – finally adopted at the end of September a law on the return of property nationalised by the socialist authorities following World War II. A key plank of Serbia's EU ambitions, the bill has pleased few and angered many, particularly the country's large ethnic Hungarian minority in Vojvodina. Disputed property ownership has long been a key impediment to investment and redevelopment, with Serbia one of the last remaining transition countries to provide a framework for compensation. Some 150,000 citizens are now expected to file claims (though the actual number could be much higher due to the Serb diaspora) and, where feasible, land or property will be returned to its rightful owner. In most cases, however, compensation will be paid in the form of state bonds worth up to €0.5m over the course of the next five to 15 years. Critics line up Though a €2bn compensation fund – financed in part through the issuance

of a $1bn, 10-year Eurobond – has been established to fund the claims, the precarious state of Serbia's finances leaves many sceptical about the future value of the bonds. The law's potential financial impact also helps to explain some of the previous government's apprehension over doing anything about the issue. Others are concerned about more malign motivations. Milivoje Antic, coordinator of the Network for Restitution

Going Hungary A stipulation denying World War II occupying forces and their descendants compensation, meanwhile, has caused outcry amongst Serbia's 350,000-strong ethnic Hungarian population. Most reside in the Autonomous Province of Vojvodina – a comparatively wealthy region in the north of Serbia, whose desire for greater autonomy (it recently opened a representational office in Brussels) continue to concern Belgrade. As Laszlo Varga, an MP for the Alliance of Vojvodina Hungarians and Chairman of the European Integration Committee of the Serbian National Assembly, tells bne: "Codifying the notion of collective guilt into law amounts to contempt for the basic values of civilization. It approaches absurdity that the Bill excludes from restitution even those individuals who were involuntarily

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a Hungarian Member of the European Parliament and shadow rapporteur for Serbia, explains how the EU sees restitution as a domestic issue, not an EU issue. Therefore, "the notion of collective guilt is unacceptable to the EU… and this affects not just Hungarians, but also Serbs, Romanians and Ruthenians in Vojvodina who served in the Hungarian – or more specifically, German – army. So this is not just a Hungarian issue; Serbs are also discriminating against their own," he says. With respect to Serbia's European perspective, Professor Schöpflin tells bne that Hungary supports Serbia's membership of the EU. "It makes no sense to have a non-member state immediately to its southern border. We've had good relations, certainly better than with Slovakia. The Hungarian foreign minister, Janos Martonyi, previously visited Belgrade and reached an agreement, but the Serbs went back on it… we want to

"This is a mistake – whilst it may get Tadic more votes, it damages relations with Hungary"

see Serbia inside the European Union, but not at any cost. We want to see a restitution law that does not discriminate." Though amendments have been proposed, there appears to be little parliamentary will to support them. For Professor Schopflin, he views this as part of the electoral campaign, with Tadic playing the Serbian nationalist card. "This is a mistake. Whilst it may get him more votes, it damages relations – particularly when people realise that this [the restitution law] applies to others, not just Hungarians." Given Serbia's record of non-transparent and poorly-regulated privatisations of

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

state-owned assets, there are well-justified concerns about the state's role in the transfer of property ownership, with fears that deficiencies in the adopted legislation will be further exposed by its actual implementation. By including measures deemed discriminatory against a sizeable minority community, meanwhile, Serbia has antagonised internal and external relations at a key juncture for its European ambitions. How the issue of restitution is handled in future will therefore have an important bearing on the country's economic growth and European perspective.

What you need to know

"This is not just a Hungarian issue; Serbs are also discriminating against their own" in Serbia, argues that the government's insistence on measly financial compensation represents an obvious attempt on the Serbian political elite's part to hide huge amounts of state-owned property that have never been recorded as such and which, as a result, will now be plundered via documentary falsifications in the land Cadastres.

drafted by the military of the – as the Bill puts it – occupying powers, even if those individuals prove their innocence through a rehabilitation process in a court of law." Indeed, Hungary has even threatened to veto Serbia's EU candidacy bid because of the law. Professor Gyorgy Schopflin,

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www.bne.eu

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experts. And how could doctors not be tempted by offers advertised at job fairs periodically organised in the country's biggest cities to work in Western Europe for up to €10,000 a month when they only get the equivalent of between €300 to €1,500 a month at home depending on their degree of expertise.

BLACK SEA BLOG:

Romanian brain drain Bogdan Preda in Bucharest

he implications of the government's failure to put in place the sort of policies that would encourage Romanians to stay at home rather than make money working or committing crime abroad are terrifying.

August: "How did Romania manage to find itself alongside Somalia, Jamaica, Afghanistan and Nigeria?... Romania is a country that's ignoring its citizens, it has forgotten them… It has lost its significance as an organisation for its citizens."

Eurostat statistics show that more than 2m Romanians are resident in other EU countries, having left the country to work abroad since the country broke with communism in 1989 then enjoyed visa-free travel after joining the EU in 2007, most of them to Italy, Spain, France, Germany and the UK. The numbers are in fact believed to be higher if illegal workers are included, making Romanians the most numerous migrants within all of the EU.

The more serious issue is not, however, that some Romanians are committing crimes abroad – actually, that there are less criminals in Romania is one of the indirect benefits that the lifting of visas

And not all that popular with their host countries. Of the 2,000 young criminals aged between 10 and 18 years taken into custody in the UK over the last year, 63 were found to be from Somalia, 48 from Romania, 41 from Jamaica, and only after come the young criminals from Afghanistan, Nigeria and Algeria. Romanian leading business daily Ziarul Financiar asked in an editorial in

The terrifying consequences of such skills disappearing abroad is that the quality of services in Romanian hospitals has decreased dramatically to such an extent that Romanians who earn considerably more than the average net monthly wage equivalent to about €350 often resort to travel to clinics in Austria or Germany to get treated. People are discouraged by the lack of basic medicines and normal medical supplies in hospitals at home, plus the customary bribes that the vast majority have to pay for care in state hospitals, which they are entitled by law to receive for free under their state health insurance. And this is happening even as the health budget has doubled from 10 years ago. Why? Because corrupt practices in the health system result in public money being spent on acquisitions and contracts that don't have an immediate effect on the quality of services. Similarly, parents who can afford to pay don't waste a minute looking for high schools or universities in the country, but pay for their children to study in Western Europe or the US. And no one should blame them after statistics showed that the 2011 summer-autumn

"How did Romania manage to find itself alongside Somalia, Jamaica, Afghanistan and Nigeria?" has brought – but that Romanians of all stripes have lost faith in the idea of building a future at home. This phenomenon has massive implications for the economy. Skills shortage The country has lost and continues to lose its best physicians, nurses, teachers, engineers and many other types of

high school graduation session was the country's worst in 20 years, as the EU demanded a higher degree of monitoring of testing. Graduation rates of only 40% in the capital Bucharest and countless cases of fraud during tests, to which teachers often turn a blind eye, depict a grim landscape in Romania's education system, which in the past produced extremely well-trained professionals.

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EU funds EU Commissioner for Regional Policy Johannes Hahn on September 23 warned Romania that "it's now or never" in terms of absorbing EU structural funding totalling some €2bn from the trading bloc, plus another up to €6bn from the country's own budget contribution. Romania has thus far taken less than 15% of that amount due to poor planning of projects that are closely monitored by the EU to prevent the funnelling of cuts to third parties as well as dodgy practices by the civil service. Instead of using non-reimbursable funds from the EU to generate more wealth, the government has borrowed billions from the multilateral lenders like the International Monetary Fund, the EU and the World Bank to avoid default on payment of state salaries and pensions. And instead of working on EU-funded projects, more such borrowing is expected as the country prepares for legislative elections next year and has to produce some evidence to voters that it's giving them something. But that won't bring back those that have already left the country, nor will it consistently improve living standards and revive hope. "The economic crisis is transforming the emigration from Romania into a life horizon,'' the German foundation Friedrich Ebert said in a study released by its Bucharest office October 4. "Not only those that have relatives abroad are willing to leave, but people from almost any generation, with very different ethnic and professional backgrounds. Thus, emigration is triggered not only by the low level of income, but also by the lack of trust in the institutional system and decision makers." The bottom line is that Romania is losing even what's left of its valuable people and proven talents and it will need generations to restore such a deficit of skills. And all of this is happening at a time when the country needs the best of its resources in place.

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Unfinished business in Bulgaria

Andrew Jardine in Sofia A common sight for visitors to Sofia and its surrounds is the trail of halffinished building sites, remnants of projects left abandoned as the 2008 global crisis struck. As the Bulgarian economy began to recover there were hopes these projects might be completed, but as markets brace themselves for another, perhaps even deeper recession, the feeling locally is more needs to be less. European office markets recovered modestly in the second quarter, but the Bulgarian retail and prime office rental markets appear to be bumping along the bottom, according to Forton International. Total built-up office space available in Sofia reached 1.367m square metres (sqm) at the end of June and only two new projects with a combined area of 12,900 sqm actually completed in the April-June period. This contrasts sharply with the record volume of new office space completed in 2010, 287 000 sqm, but still the market is over-saturated and completions on many major projects have been postponed again to ensure a more substantial level of occupancy. Office space under construction in Sofia stood at around 580,000 sqm at the end of June, of which another 140,000 sqm is expected to be completed by the end of 2011. The office markets' main driver is for tenants to move to a prime site office space and at a more attractive price, which at best produces a transient user base as opposed to the much required new demand for the ever growing supply. The story is much the same in the retail property market. 2010 was characterised by a record amount of shopping centre projects being completed, with CB Richard Ellis quoting an annual increase of 123% as retail space hit 627,000 sqm. Available retail space occupancy is currently being shaken by the 237,000 sqm under construction and further delays and cancelations are expected as demand for this new space continues to struggle. "The real estate market in Bulgaria is on hold. Supply is huge and tenants are looking for the best place and the best price. Tenants have different choices and new offices are flooding the market," says Teodor Georgiev, economist at the Management and Business Academy of Sofia. "A lot of commercial property suffers with low occupancy, so expect a serious drop for rentals with potential tenants and buyers waiting for lower prices." But it's not all doom and gloom. While some significant retail projects are not proving so lucky – eg. Mega Mall and Evropa Center in Sofia, the Markovo Tepe Mall in Plovdiv, Sun City Center in Burgas, Mall Pleven in Pleven and the Danube Mall in Russe – some enterprising investors are looking to change the function of projects, say sources. For example, one of Bulgaria's biggest developers is considering transforming an unfinished office space into an exclusive private hospital if no interest is forthcoming in the near future.

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Gareth Jenkins, an Istanbul-based security analyst. Noble's affiliate, Israel's Delek Group, has also proposed building a gas export plant on Greek Cyprus. Delek and its subsidiary Avner each have the option for 15% of the rights to the reserves, which are located in a field known as Block 12. The deal is waiting for approval by the Greek Cypriot government, which has pressure stacked on it to come up with new energy supplies after an explosion damaged its main power plant.

Turkey â&#x20AC;&#x201C; a hero to some, but a bully to others Justin Vela in Istanbul

he EU's 2011 progress report on Turkey highlighted concerns over a growing energy dispute with Greek Cyprus and comes at a low-point for Turkey-EU relations. Riding a wave of popularity as the Arab Spring struggles on, Turkey is increasingly throwing its weight around the region â&#x20AC;&#x201C; a hero to some, but a bully to others. "The accession negotiations with Turkey have regrettably not moved into any new areas for over a year," read the EU report published October 12. One of the key issues that would give its accession process new momentum is normalising relations with Cyprus. Yet here is an unfortunate example of Turkey playing the bully. In September, Turkish Prime Minister Recep Tayyip Erdogan described exploratory drilling for oil and gas being carried out by Cyprus as "madness." This was in response to Cyprus allowing Texas-based Noble Energy to explore energy reservoirs south of the island, in an area called the Levant Basin. A 2010 US Geological Survey estimates the area contains 1.7bn barrels of oil and 3.45bn

cubic metres of natural gas, which would make it one the world's top-10 gasfields. Noble is also involved in drilling further east in the Mediterranean, in waters belonging to Israel, Turkey's estranged ally. Greek Cyprus and Israel have

Trying to halt or at least slow the drilling, Turkey argued that any revenues from the energy should be shared with northern Cyprus, a Turkish protectorate since the 1974 Greek military intervention. Drilling should not begin until

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reunification talks are complete, argues Turkey. Furthermore, with a report on talks between north and south Cyprus due at the UN later in October, the Greek Cypriot decision to begin drilling is unduly provocative, Turkey says. Unfortunately for Turkey, Greek Cyprus won't back down. The US and EU vocally supported their decision to begin drilling. The country is completely within its rights in terms of international law: the drilling is taking place in an Exclusive Economic Zone (EEZ) recognised as belonging to Greek Cyprus. Turkey did not sign the 1982 Convention on the Law of the Sea that stipulates EEZ's extend for 200 nautical miles from the edge of a country's territorial waters. States have the right to sole exploitation of natural resources within their EEZs.

Following the announcement that Nobel would begin drilling, Turkey sent its own exploratory rig, the Piri Reis, to conduct seismic research off Cyprus, escorted by warships. Turkey also signed an agreement with Turkish Cyprus to demarcate sea borders between the two and to explore for energy. The potential for a clash appears high. Greek and Turkish media reported that the Piri Reis sailed into the island's southern waters for a time before returning north. However, part of the area where the Piri Reis is exploring overlaps with where Noble is drilling, reports Bloomberg.

Cyprus split in two in 1974 following an attempted coup d'etat by Greek Cypriot nationalists backed by the Greek military junta and the subsequent Turkish invasion of the northeast of the island. The Republic of Cyprus joined the EU in 2004; Turkey remains the only country to recognise the northeast of the island as an independent republic.

Turkey sees the Greek Cypriot drilling as an attempt by hostile states to outmanoeuvre it in the Mediterranean. Along with seeing itself as the primary force in the Mediterranean, Turkey wants to increase its importance as a transit route for energy to Europe. Should the energy reserves prove as bountiful as estimated, a pipeline is likely to be built directly to the EU via Cyprus and Greece, bypassing Turkey. "The EU would rather import from another EU member than a loose canon like Turkey or Russia," reckons

Still, Turkey's policies remain practical in practice, if not in words. The threats of increasing its naval presence on the Mediterranean have more growl than bite. While the rise in tensions is real, and has the EU concerned, a military confrontation between Turkey and Greek Cyprus or Israel remains unlikely. A greater problem looms in 2012, when Greek Cyprus is due to assume the EU's rotating presidency. Should this happen, Turkey has said it will cut relations with the EU. Some analysts liken the EU to a huge oil tanker that takes kilometres to turn around. Cyprus assuming the presidency is a done deal, they say. Others are confident EU-Turkey relations are too important to abandon. Feisty rhetoric aside, Turkey and the EU are ultimately inseparable.

out in Istanbul's Tuzla dockyards, has just been sent to Iraq to join two previous launches that are meeting the needs of Iraq's gas and oil rich, but power starved, Basra province. With effectively limitless volumes of associated gas currently being flared from the province's oil wells and equally no shortage of fuel oil cheaply available, Iraq's southern port is a prime target market for Kares, despite the country's plans for rapid development of its power sector. A blueprint for the construction of a slate of massive new combined cycle gas turbine plants, which will both end the ubiquitous power cuts and meet growing demand, was unveiled earlier this year. However, bureaucratic obstacles coupled with dissent among the partners in the country's fractious coalition government have stalled the necessary investment decisions, opening the door to temporary solutions such as Kares' floating power plants.

"Turkey sees the Greek Cypriot drilling as an attempt by hostile states to outmanoeuvre it in the Mediterranean" already signed an agreement for cooperation on energy and agreed upon a maritime demarcation line.

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Power boats David O'Byrne in Istanbul

t's such a beautifully simple idea, it's a wonder nobody thought of it before. Take an existing cargo ship, install generators and transformers in the cargo area, and then dispatch it to wherever there's a ready availability of fuel and a ready market for power.

For Kares, the energy subsidiary of Turkey's Karadeniz Holding, it's proving to be a highly profitable business, with the company launching its fifth power ship since the first was produced less than three years ago. The latest vessel, the 110-megawatt (MW) Irem Sultan fitted

Quick refit According to Kares CEO Ugur Soku, it takes only three to four months to reconfigure and kit out an existing cargo ship as a power ship using off the peg generators, transformers and transmission gear. After this, it's a simple matter to sail

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the ship to the required location, hook it up to the local grid via three simple cables scarcely thicker than a child's wrist, and power up with whatever fuel is available. "Our plants can operate on natural gas, or on a range of fuel oils and bunkering fuels – whatever the Iraqi government wants to supply us with," he tells bne. By the end of October, Kares will have three ships operating in Basra; the 110-MW Irem Sultan is set to join the 144-MW Dogan Bey, which arrived in early 2010, and the 200-MW Rauf Bey, which arrived six months later in August 2010. All are operating on three-year contracts between Kares and the Iraqi government in Baghdad, and these are expected to be extended for as long as required, explains Karadeniz Holding's commercial manager, Nuray Atacik.

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Two other ships – the 220-MW Kaya Bey and the 110-MW Ali Can Bey – began operating in Pakistan in October last year and January this year, respectively. All the ships are suitable for meeting either general base load or peak demand, depending on the needs of the customer, says Atacik, adding that with an expected generating life of 30 years each ship could serve a number of customers. While all of the five ships completed so far have been mid-sized vessels and power plants, Atacik explains that the company has also prepared designs for off-the-peg vessels of both larger and smaller capacity. Smaller plants of 10-40 MW could be built in three to four months and made available on shortterm contracts of between three and nine months; larger vessels of 500-1,000 MW, which would take two to three

BRICKS & MORTAR:

Croatian shopping centres – too much, too young? Guy Norton in Zagreb

he dog Latin phrase, "Res emptito, ergo sum" (I shop, therefore I am), could easily have been coined with your average Croatian in mind. No surprise then that Croatia's shopaholic tendencies are behind a planned wave of new malls in the country. Fervent Roman Catholics they may be, but Croatians also show an almost equally religious zeal for shopping until they drop - Sundays included. At €930 per year, for example, research by retail consultancy RegioPlan demonstrates that the average free-spending Croatian spends far more on clothes than their more thrifty counterparts in Slovakia

(€750), the Czech Republic (€580) and Poland (€520). The recent recession in Croatia may have dampened the pace of new retail developments, but with the Croatian economy posting positive GDP growth of 0.8% in the first half of year, there's a growing belief – among developers and retailers at least – that there is more than enough consumer demand to support the dozen or so new shopping centres that are due to be built in the country over the next few years. At 450 square metres per 1,000 inhabitants (sqm/'000), the Croatian capital

years to kit out, could be made available on longer-term contracts of 15-25 years. For Kares, the economics have improved after it abandoned using Far East shipyards in favour of Turkish yards, meaning the cost per MW compares favourably with that of normal land plants, Atacik explains. Little wonder then that Kares has already registered interest from a number of potential new customers, with the company hosting several interested groups on board the Irem Sultan before it set sail. "After the earthquake in Japan earlier this year, we were contacted by the Japanese, but we didn't have a ship ready and available," she says, pointing out the suitability of Kares power ships to meeting emergency power needs after natural disasters of all kinds.

Zagreb already boasts more shopping centre space than the likes of Vienna. And although at 225 sqm/'000 inhabitants the average for the country as a whole is much lower, it is nevertheless still a chart-topping figure for Central and Eastern Europe. Alongside three major new malls in the capital Zagreb, there are also plans for fresh developments in important regional centres such as Pula, Rijeka, Rovinj, Sibenik, Slavonski Brod and Split. But with new centres set to sprout like mushrooms after the rain in the next few years, is Croatia really such a retail mecca? New malls Certainly, Austrian developer Braunsbeger Holding thinks so. It has just started work on City Point, the first shopping centre in the northern Croatian town of Varazdin, a €50m development whose director Harald Peham claims is already 70% pre-let before construction has scarcely begun. When complete in March 2013, City Point will provide employment for over 600 people, a very welcome figure in a country that has shed 150,000 jobs in the last couple of years.

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New foreign retailers in the Croatian market are reporting good business conditions. Swedish fashion retailer Hennes & Mauritz (H&M), which only set up shop in Croatia in March with the opening of a flagship store in the Svjetni Trg development in downtown Zagreb, reported €13.5m worth of sales in its first six months of operation. According to Emmanual Bakic, head of retail at global real estate consultancy CBRE in Zagreb, that is at least 30-40% ahead of what were already highly optimistic projections. Small wonder then that H&M is gunning for a dozen stores in Croatia by the end of 2012. While there's undoubtedly grounds for optimism, it's equally fair to say that there's more than enough scope for pessimism as well. In mid-October Illuminato, the developers of the downtown Zagreb mall Cascade, told tenants that the centre, which only opened in 2009, would close for an undisclosed period because it couldn't afford to pay Energon, which oversees the technical maintenance, cleaning and security services at the mall. Meanwhile, Blanka Braccia, head of retail at Croatian real estate consultancy Spiller Farmer, says that the recession of the last two years has severely curtailed the ability of Croatian retailers, which were often key anchor tenants in shopping centres, to take up space in new malls. "Retail sales have fallen 20% in the downturn, reducing local firms' ability to invest in new outlets." She adds that while developers previously held out for premium retailers as tenants, discount chains are now increasingly welcome. Braccia believes that in the absence of a major influx of foreign retailers, rental levels could fall by 20-30% in the coming years. Bakic at CBRE reckons that vacancy levels at the existing malls are likely to rise in the next couple of years when many existing leases expire. He says that at present vacancy levels are relatively low at 5-10%, but they could grow sharply if shopping centre owners are unwilling slash rents from those levels agreed in the economic boom period of 2003-2008 in Croatia.

Southeast Europe

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Eco-warriors fight "Suez canal plan for Europe's Amazon"

Guy Norton in Zagreb Local and international environmentalists are in uproar over the Croatian government's plans to revive an 18th-century project to canalize three major rivers in eastern Croatia using funds from the EU. As part of her electioneering odyssey around Croatia, Prime Minister Jadranka Kosor, who heads a right-wing coalition which faces a tough fight in parliamentary elections on December 4 to stay in power, recently gave the green light for work to begin on the fiercely contested Visenamjenski kanal Dunav-Sava (VKDS)/Danube-Sava multi-purpose canal (DSMC) project that will link the Danube, Sava and Drava rivers. The estimated €950m development would entail the construction of 61.4 kilometres of canals, five ports and docks, and 23 road and pedestrian bridges. It will be carried out under the auspices of state-owned utility Hrvatske Vode (Croatian Water), with building set to start as early as next year. The development will form part of the 570-km Danube Corridor that will run from the Adriatic Sea in the west of the country through to the east. Alongside better railway links, it will improve transport connections between Croatia and Central Europe, claims Branko Bacic, minister for environmental protection, spatial planning and development. According to Bacic, the canal, which has been proclaimed a national priority project, will make the rivers navigable by both freight and tourist ships and will also ease irrigation problems for roughly 36,000 hectares of agricultural land, as well as reduce flooding in the eastern Croatian counties of VukovarSrijem and Slavonski Brod-Posavina, the heart of the country's farming belt. For a cash-strapped Croatia, the project represents a major investment, given that it will cost almost twice the HRK3.8bn (€508m) that the country allocated to its agriculture, fisheries and rural development budget in 2010. The authorities are therefore hoping that the EU will stump up at least part of the money for what is being dubbed Croatia's version of the Suez Canal. However, the revival of this project, which was first proposed as long ago as 1737 but subsequently dropped because of the astronomic construction costs, has been met with a storm of protest by environmentalists who are contesting its implementation at home and abroad. Tibor Mikuska, head of the Croatian Society for the Protection of Birds and Nature (CSBNP), has filed a complaint with the Constitutional Court in Croatia alleging that the government has failed in its duties to properly assess the environmental aspects of the project, including having a potentially devastating effect upon the Spacva forest, one of the last major oak forests in Europe. Critics also argue the canal will prove to be an economic white elephant, with questions hanging over whether the project will ever attract the shipping volumes to justify the initial investment and support its continued upkeep given the fact that only around 200 boats a year currently use the country's waterways.

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debt crisis, to withdraw their money from risky places, putting Mongolia squarely in the firing line. Ivanhoe's shares dropped almost 25% after the news, wiping off about $7.7bn from its market capitalization, which is almost the same as Mongolia’s entire GDP, though the shares have since recovered to just above their previous level after Ivanhoe, Rio Tinto and the Mongolian government issued a joint statement soon after to declare the original Oyu Tolgoi agreement would be honoured. The letter from the MPs also came as copper prices saw their biggest monthly fall since October 2008, dropping 24% on the London Metals Exchange. "These 20 MPs picked the worst possible time to complain about the agreement," Ganhuyag Chuluun Hutagt, vice minister of finance, told bne. Ivanhoe was not the only victim. Other Mongolian mining firms suffered, with Mongolian Mining Corporation, the country’s largest coking coal exporter, falling 45% during September. The local currency, the tugrik, also saw a rapid depreciation against the dollar, hitting this year's low of 1,294 to dollar.

Whose mine is it anyway? Oliver Belfitt-Nash in Ulaanbaatar

n October 19, 20 opposition MPs submitted a letter to the Mongolian parliament demanding that the prime minister resign – the same group who have been agitating to have the government renegotiate an investment agreement for the giant Oyu Tolgoi copper-gold project with Ivanhoe Mines and Rio Tinto. Mongolia's politics and its relations with foreign investors are becoming increasingly tense. The $16bn Oyu Tolgoi investment agreement was signed in October 2009, giving Mongolia a 34% share in the world's largest undeveloped coppergold project, which is set to become the country's biggest earner. The other 66% was retained by Ivanhoe Mines, who are now 49% owned by global mining giant

Rio Tinto. This agreement put an end to years of wrangling between successive Mongolian governments and Ivanhoe, bringing with it hopes that this ush-

of the 76 MPs in the Mongolian parliament. Its demands were to increase Mongolia’s stake in Oyu Tolgoi to 50%, saying that due to rising copper prices

"These 20 MPs picked the worst possible time to complain about the agreement" ered in a new era of relations between foreign investors and their hosts, with foreign direct investment reaching $1.6bn in 2010 as a result. But on September 28, a letter was published in the local media from 20

the state would not receive enough tax and royalty revenue compared with the profit made by Ivanhoe and Rio Tinto. Inevitably, the international press and investment community were quick to condemn the action, which caused investors, already spooked by the global

Eurasia I 47

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With the next elections due in June 2012, many believe the MPs were playing to the widespread "resource nationalism" sentiment among the population to gain votes. Yet with such a swift rebuttal of their demands, this will have done little to raise their credibility. Although local media has often been wary of the sudden influx of foreign investment and ownership, the majority of parliament support cooperating with foreign investors to bring about the much-needed development in the country. Although the joint statement did much to calm investors' nerves, not all has been forgotten. Recent events may have caused many investors to re-assess their risks in Mongolia more widely. The country is heavily reliant on China to buy its copper, gold, coal and other resources, and a slowdown in China’s economy would be disastrous. "The biggest unknown factor is the Chinese

economy, as over 80% of Mongolia's exports are destined for China," says Amar Hanibal, managing director of TenGer Financial Group. "A slowing Chinese economy and real estate market

"The biggest unknown factor is the Chinese economy, as over 80% of Mongolia's exports are destined for China" correction may dampen demand for imported raw materials such as copper. There are already signs of stress among Chinese developers, as reflected by the pricing of Chinese real estate bonds. We are likely to see defaults among secondtier players." Hot coals Despite all this, Mongolia's government continues its investment push in order to meet the election promise of the Mongolian People's Revolutionary Party to give every citizen as much as MNT1.5m in dividends (about $1,200) from the country's mining boom. Key to that is the massive Tavan Tolgoi mine, reckoned to be the world's biggest coking coal deposit. On October 13, the Mongolian state-owned mining company Erdenes-Tavan Tolgoi signed the contract with the BBM Operta Group, a joint venture of Germany's Operta and Australia's Macmahon Holdings, to develop Tavan Tolgoi at a ceremony attended by German Chancellor Angela Merkel. Mining will commence in January 2012 at a rate of 3m tonnes of coal per annum (t/y), utilising existing equipment. In the second year, production is expected to ramp up to 6m t/y and will require additional capital expenditure. Once the entire mine and transport infrastructure is established, production is estimated to rreach 15m t/y. At the same time, the government is pressing on with its plans to carry out an international IPO of Erdenes-Tavan Tolgoi, which is expected in 2012 and set to raise as much as $15bn.

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withdrawn personnel from the camp with only a few security staff staying behind. Operations are not continuing at the moment." Bad for business The decision is bad news for Kyrgyzstan’s government and its ambitions to attract investment to the mining sector. Security has been one of the top issues for the interim government that took power after the April 2010 revolution.

www.orsumetals.com

Kyrgyz ride roughshod over investors Clare Nuttall in Almaty

here may be gold in them thar Kyrgyz hills, but Talas Copper Gold's attempt to get at the deposits has been put on hold after a violent attack by armed horsemen. TCG, a joint venture between South Africa's Gold Fields, which holds a 60% stake, and minority shareholder Londonbased Orsu Metals, said it has suspended its operations in Kyrgyzstan after a violent attack by armed horsemen earlier in October and it won't restart work until the Kyrgyz government can guarantee the safety of local residents. The mining camp operated by TCG in west Kyrgyzstan’s mountainous Talas region was attacked shortly after midnight on the night of October 7-8. A group of eight to 10 horsemen armed with petrol bombs torched several buildings rented by the joint venture, the company said, and the attackers attempted to murder the security manager in one of the burning buildings. The joint venture's owners had initially decided to go ahead with a drilling programme scheduled for November after already surviving two revolutions and a similar attack by armed horsemen earlier this year. TCG acquired its

first Kyrgyz mining licences in February 2005, and has so far invested $15m in the Talas region. It had planned to invest an additional $25m over the next three years provided exploration results were favourable. However, community leaders in the nearby town of Aral and the farmer who had rented buildings to the joint venture are facing severe intimidation including death threats, said the statement from Gold Fields. Although top government officials including acting Prime Minister Omurbek Babanov have pledged their support, the company has decided to suspend drilling. "TCG has suspended

A wave of squatting and illegal expropriations of land and small businesses followed immediately after the revolution. Two months later, at least 400 people, mainly ethnic Uzbeks, were killed in ethnic clashes in the south. Many buildings in Osh, Jalal-Abad and smaller settlements were torched. A report from the international commission led by Finnish MP Kimmo Kiljunen (which was subsequently slammed by the Kyrgyz government) said that a lack of preparedness by the authorities was partly to blame for the scale of the violence. According to Kate Walker, Central Asia analyst at Control Risks Group, security has increased in the run-up to the October 30 presidential elections, but the focus is on the south, and especially on ethnic issues. But TCG, one of just a handful of international companies pursuing mining projects in Kyrgyzstan, operates in a remote mountain area that does not benefit from these efforts. While Kyrgyzstan has substantial untapped deposits of precious and base metals, the combination of official corruption and, after the 2010 revolution, concerns over protection

"We have withdrawn personnel from the camp with only a few security staff staying behind – operations are not continuing at the moment" the drilling programme that was scheduled for November until the authorities can guarantee the safety of our employees, contractors that those communities that are trying to work with us,” a Gold Fields spokesman tells bne. "We have

for property rights has deterred many potential investors. "It also doesn’t help that there are politicians using nationalist rhetoric and speaking out against foreign companies taking shares in Kyrgyz projects," she says.

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Eurasia

Karachaganak deal elusive as Kazakhstan leans further toward Asia Molly Corso in Tbilisi

s Kazakhstan's energy policy edges closer to Beijing, eastward pipeline projects have forged ahead while Astana has been slow to resolve long-standing disputes with western oil majors. The key question at Kazakhstan's annual oil and gas conferences in October – Kazenergy and Kioge – concerned the Karachaganak oilfield. Agreement between the Kazakh government and the Karachaganak Petroleum Operating (KPO) consortium is not expected before the end of this year, at the earliest. With the second phase development of the Kashagan oilfield still undecided, operations across west Kazakhstan are stalling. Exceptions include Sino-Kazakh projects, in particular the expansion of the Kazakhstan-China oil pipeline. Top Kazakhstani government officials have indicated that a resolution of the long-standing dispute over Kazakhstan's Karachaganak oilfield could be reached by the end of this year. Speaking at the Kazenergy conference in Astana on October 5, the chairman of Kazakhstan's state holding company Samruk-Kazyna, Timur Kulibayev, said the government would be willing to pay between $700m and $1.1bn for a share in Karachaganak – the most concrete figure yet disclosed. The following day, at a press conference at the Kioge conference in Almaty, Oil and Gas Minister Sauat Mynbayev was less forthcoming. Mynbayev told journalists there were not yet any specific parameters for a transaction between the government and KPO. He added that

Kazakhstan did not plan to write off the consortium's tax debts in exchange for a stake in the project. There is speculation that the consortium may give the Kazakh government a 5% stake in the project and sell an additional 5% at market value. Getting greedy Karachaganak is one of the world's largest oil and gas fields, with reserves of 1.2bn tonnes of oil and condensate, and

I 49

share in the largest oil and gas projects has put Astana at odds with investors. The first inklings of trouble came with the negotiations over financing for the second phase expansion of the Tengiz oilfield. "This was resolved, but there was a lasting ill effect. It was the start of a solid shift away from the west – or at least a divergence between the strategies of western investors and the Kazakh government," says Andrew Neff, senior energy analyst at IHS Energy. The government then put pressure on the consortium developing the Kashagan oilfield. This resulted in state oil and gas company KazMunaiGas taking a stake in 2007. With commercial production now due to start in 2013, there are further concerns over the timing and technical viability of the second phase. Akiakpar Matishev, executive director of the Kazakhstan Association of OilGas and Energy Sector Organisations (Kazenergy), says there is now a new model for relations between Kazakh-

"Our international partners are looking for a financial payback on their investments, and we need to maintain investment attractiveness" over 1.35 trillion cubic metres of gas. A 40-year production sharing agreement was signed in 1997 with BG Group, Eni, Chevron and Lukoil. The Kazakh government first expressed an interest in taking a stake in the project in 2009. A series of disputes over taxes, export duties and environmental violations have followed. In 2009, the consortium was slapped with a $1.2bn bill for unpaid taxes, as well as hefty environmental fines. In the early years of independence, Kazakhstan's new government was keen to attract western oil firms, who contributed both money and technical expertise. More recently, however, the government's ambitions to take a greater

stan and foreign investors. "We are trying to lead the situation rather than being led. Kazakhstan is strengthening its presence on Caspian shelf projects in line with the national interest," he told Kioge delegates. "We also understand that our international partners are looking for a financial payback on their investments, and we need to maintain investment attractiveness." Kazakh officials point out that both Kazakhstan and the global oil market have changed substantially in the last two decades, while investors argue that recent actions go against Kazakhstan's reputation as a safe and stable destination. "Recent actions undermine Kazakhstan's long term commitments to sanctity of contracts," said Daniel Stein,

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Uzbekistan looks at alternative energy sources

Clare Nuttall in Almaty With its oil and gas reserves diminishing, Tashkent is starting to explore alternatives to fossil fuels. Russia's Lukoil and the Asian Development Bank (ADB) are considering building one of the world's largest solar power plants in Uzbekistan. The plant would have initial capacity of 100 megawatts, rising later to 1 gigawatt. Lukoil is already active in Uzbekistan's oil and gas sector, where it is planning to invest up to $500m to develop new projects; the plans for the solar sector are at an earlier stage. An ADB spokesperson tells bne that currently, "ADB has only had very preliminary discussions with Lukoil on the project. ADB is not even at the stage of being mandated to undertake any due diligence on the project." The Tashkent-based think-tank the Center for Economic Research (CER) forecasts that if current consumption rates continue, Uzbekistan will only have sufficient gas for the next 28-30 years. If exports to China increase as expected in 2012, Uzbekistan's gas reserves could be used up even more quickly. Oil reserves are expected to run out in just 10-12 years at current consumption rates, and coal in 40-50 years. To maintain energy stability, from 2030 Uzbekistan will have to substitute at least 12m-13m tonnes of oil equivalent a year with alternative energy sources. "The problem of scarcity of hydrocarbon resources will grow after 2020 and will pose a threat to the country's energy security and its economic security as a whole by 2030," says a report from the CER. "According to the pessimistic scenario, after 2020 Uzbekistan's production of natural gas will stop growing, which based on rising domestic consumption will require a cut in exports by 10bn cubic meters in 2030 as compared with 2020."

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senior adviser to the special envoy for Eurasian energy at the US State Department. "We understand that sometimes governments need to make changes for economic reasons, but this should be done through good faith negotiations between the partners."

close out new competition and control prices, she claims. "There are no effective legal barriers [to stop them]," argues Kutivadze, adding that by restricting new players in the market, these monopolists can engage in price discrimination

Asia shift At the same time, there has been a growing shift towards China in Kazakhstan's energy policy. In the early independence years, the focus was on the west â&#x20AC;&#x201C; Russia, the US and Europe. Now, not only has China made inroads into the oil and gas sector, investment from India, Japan and Korea is also growing.

The pharmaceutical industry, petroleum import and sugar imports are among the most widely perceived monopolies in the country.

"There was tangible progress with the Kazakhstan-China pipeline while relations with Russia and western investors stalled," says Neff. He points out that while western companies were debating over Karachaganak and Kashagan, China speedily built a 3,000-kilometre long pipeline across Central Asia in just two and a half years. "In the early years, Kazakhstan performed a geo-political balancing act with the US, Russia and the EU, while Asian companies were relatively absent. Over time, there has been a shift in power towards Asia, in particular China," Neff added. "Kazakhstan is no longer trying to balance geo-political interests, it is pursuing its own interests, which happen to align more with China's than with Russia or the West."

Happily, the CER points out, "the stock of renewable energy sources in Uzbekistan is three times as large as the stock of hydrocarbons." The ADB plans to set up a Solar Energy Institute in Uzbekistan by 2013, to develop solar power projects. There is also potential for hydropower, geothermal and biomass energy in Uzbekistan, as well as for alternative fossil fuels such as liquefied natural gas. However, for these to be used, changes to both the law and to feed-in tariffs will have to be made. Uzbekistan's national electricity grid has extremely low feed-in tariffs thanks to the country's cheap and readily available fossil fuels. Unless these are changed, solar energy, which is relatively expensive, will not be economically viable.

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"Over time, there has been a shift in power towards Asia, in particular China"

Protecting business in Georgia

Indeed, Lejava cites official studies, such as the 2010 World Bank study on investing across borders that found the Georgian economy is "completely open" for business, to back up his argument.

Molly Corso in Tbilisi

Open for business Vato Lejava, chief advisor to Prime Minister Nika Gilauri, however, argues that the widely held perception that monopolies flourish in Georgia is a misconception. "There are no monopolies in Georgia in the sense popular sentiment or anecdotal evidence suggests," he says in an email. "All those markets have more than three to four players and relevant markets are dynamic. Even the regulated markets (eg. mobile communication) with high entry barriers, with very few players, are clearly with fierce competition."

new draft law on free trade and competition could move Tbilisi closer to a free trade agreement with the EU, while at the same time combat persistent allegations that its laws have allowed monopolies to feed off Georgia's liberal economy.

reforms kicked in. While government policymakers argue there are no monopolies in the Georgian market, economists and watchdog organisations like Transparency International maintain the government has allowed

The draft law, tentatively slated for discussion in parliament by the end of October, is a gesture to the growing demands to tighten regulations on the Georgian economy. If passed, it would define criteria for a dominant company in any given sector, as well as what constitutes an abuse by a dominant company. It also foresees a competition agency and regulation over company consolidation like mergers and acquisitions.

"There are no monopolies in Georgia in the sense popular sentiment or anecdotal evidence suggests"

The law on monopoly and competition was scrapped following the 2003 "Rose Revolution" as the number of regulatory bodies was slashed and economic

monopolies to flourish as a result of its anti-regulation policies. Natia Kutivadze, an analyst for Transparency International Georgia, notes that no provisions were made to fill the legislation gap that prevented monopolies from taking hold â&#x20AC;&#x201C; a vacuum that helped businesses work together to

Brussels, however, has been pressuring the Georgian government to come up with new legislation that would bring its free trade and competition legislation closer in line with European stan-

dards, and economist Davit Narmania says the new draft law is "important" as Tbilisi gears up for negotiations with Brussels on a free trade agreement (DCFTA). So how does the draft law stack up? Virginie Cossoul, a policy officer at the European Commission, tells bne that

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Tilting a glass to China

Molly Corso in Tbilisi Georgia is looking east to bolster trade, with officials picking China's rapidly growing market for wine imports as a particular target. The push east is being driven by the government’s focus on diversification, Irakli Matkava, deputy economy minister, tells bne while on a trip to South Korea. "Naturally, we want to be plugged in the global economy as widely as possible, so all regions are interesting and all partners are important," he says. "Asia is very interesting for wines and spirits companies and their products. All global companies are fighting for market share there and we have to become part of this competition and try to be successful." In 2009, the Chinese drank 1.156bn bottles of wine – a 104% increase from 2004, according to a study by Vinexpo. The potential for Georgian wines is good, says Giorgi Gaganidze, head of Georgia’s former export agency, who reckons the large Chinese market would offer a good balance to existing niche markets in Europe and North America. "The major problem of Georgian wine: where should Georgia go? This is the question, because we are a country with very little land resources," he says, noting that just 90,000 tonnes of wine was produced in Georgia last year – a limited supply when divided among the country’s 12 types of wine. "We should make a strategic decision [and] I think that now we are – some portions should go to the very high-quality wine and on the other hand, produce high volumes. If you are producing the high volumes, then you have these very good opportunities in, say, China," he says. Breaking into the Chinese market could be a windfall for Georgian wine producers who are still struggling to replace the Russian market, which has been closed to Georgian wine exports since the 2006 embargo. Wine exports have increased to new markets, like the US and the EU, but the volume of wine sales has never reached its pre-embargo height. In 2005, Georgia exported $81m worth of wine; last year, wine exports were roughly half that at $39.2m. While the Russian market was "important" for Georgian producers, Matkava stresses that diversification has made Georgian exports stronger. "The Russian market was an important market, yet most Georgian companies did manage to diversify away," he says. "[Now] the objective should be to penetrate high-growth, high-potential markets of the Gulf and East Asia. The potential is truly remarkable."

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"The Georgian market is a very small market and the medium and big companies tend to cooperate with each other to take the biggest part"

the draft law is a "major improvement" to regulate trade and competition. "We are happy because we think the law is an improvement from what we have now," she says. TI's Kutivadze also says the draft law is a good start, though raises concerns about plans to consolidate sector regulatory bodies under an umbrella competition agency. Lejava, however, stresses that the draft law is based on EU standards, including the provisions for the competition agency. And Cossoul says that "certain provisions" of the draft will be "subject to detailed discussions" during the negotiations, including the power of the competition agency – and guarantees that it will be an independent body. Narmania applaudes the "political decision" to regulate the market - a step he believes is vital to ensuring greater competition. But he stresses the law will be useless if there is no political will to implement it. "The Georgian market is a very small market and the medium and big companies tend to cooperate with each other and take the biggest part of the Georgian market," he said. "I think the political decision to regulate the Georgian market [is very important]."

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When a few years into her career and in her mid-20s, Iva Ivanova, like many young professionals, began to feel the need to enhance her understanding of business.

Special focus: MBA schools in CEE

True, she held a post-graduate diploma in general management (along with a first degree in literature and linguistics) from Saint Kliment Ohridski University in Sofia, Bulgaria. But while these formed a good foundation, Ivanova, then a marketing manager with the Bulgarian wing of TBWA global advertising group, reasoned an MBA with a more international flavour would provide a much better grasp of global business in general, and marketing in particular. Going through the vast array of MBAs available to consider elements such as educational content, affordability and life's practicalities (such as location and maintaining her career), she plumped for an executive MBA (ie. one designed for students with some years of business experience) at IEDC School of Management, Bled, Slovenia. "IEDC met my requirements to the greatest extent. I was looking for a school with great professors and a programme for reasonable money, as well as a modular approach to be able to continue my job during studies," she says.

To stay local or go west? That is the question

MBA STUDY:

In addition, Bled is relatively close to her home base, with the important bonus of being "a small, beautiful town," which Ivanova found very conducive to learning.

Kester Eddy in Budapest

"I think that the atmosphere as a whole is beneficial for the study process. The calm, beautiful nature helped me to concentrate better on studies, was a source of inspiration and good for [necessary] relaxation," she says. Every year, thousands of young (and some not-so-young) professionals like Ivanova struggle to decide on whether to take an MBA – and where to apply. For those in Central and Eastern Europe, the decision is typically complicated by more limited financial means and the question of whether to opt for a local or regional school – in all likelihood one with no more than a 20-year history – or opt for a more-established, and possibly prestigious, but much more expensive school in Western Europe or North America. East or West – what's best? Surprisingly, despite stern frowns from party apparatchiks at the time, some attempts to introduce modern business education had been initiated at spots across the CEE region even before the collapse of communism (including, as it happens, IEDC Bled – which celebrated its 25th anniversary just last month). But it was clear in 1989 that such efforts had only made a token contribution to bringing management education up to the standards needed to support functioning market economies. "One study at the time estimated that CEE needed 2,500 properly trained faculty to staff the

ASEBUSS, Institute

Caucasus School

Gdansk Foundation

Corvinus University

IEDC-Bled School

International

ISM University of

University of Pittsburgh,

Kyiv-Mohyla

for Business Admin-

of Business (CSB),

for Management

of Budapest School

of Management

Institute of Business,

Management and

Joseph M. Katz Graduate

Business School (KMBS)

istration, Bucharest

Caucasus University

Development (GFMD)

of Management

Kyiv (IIB)

Economics

School of Business

Location

Romania

Georgia

Hungary

Poland

Hungary

Slovenia

Ukraine

Lithuania

Czech Republic

Ukraine

Programmes

· EMBA (in partnership

· MBA (In Partnership

· Full-time MBA

· GFKM International

· Full-time MBA

· EMBA -1 year

· EMBA

· Masters in International

· EMBA

· Presidents’ MBA

with Kennesaw State

with Georgia State,

· EMBA

· Part-time EMBA

· EMBA - 2 years

University, Atlanta,

Atlanta, USA)

· International

USA)

· GGSB (Grenoble

CEU Business School

Executive MBA (IMM)

MBA Programme

· Presidents' EMBA -

· GFKM Executive (9 programmes in

of Business)

total)

· EMBA

Management

· Master in Business

3 years

MBA Programmes,

Graduate School

· Marketing and

Leadership [MBL]

· CSB Dual MBA Programme. Accreditation

AACSB

IQA

AMBA

IQA

EFMD

AMBA, IQA

AMBA

IQA

AACSB

IQA

(through Kennesaw) Number of students

269

118

105

182

Prague 16 (78 worldwide)

Number of faculty

Number of visting

EUR 20,000,

MBA - up to USD 8,650

MBA - EUR 12,250

EUR 9,000

MBA - EUR 12,000

1-year EMBA

EMBA - EUR 17,000

LIT 27,600

USD 48,500

PMBA - USD 33,750

including books

EMBA - EUR 12,000

EMBA - EUR 15,250

EMBA - EUR 15,000

EUR 23,000

EUR 7,800

(Includes books)

[Plus international

(Including reading

(EMBA includes

2-year EMBA

Study Tour]

packs, case studies)

books)

EUR 28,500

EMBA - USD 21,500

3-year EMBA

[Plus International

EUR 34,000

Study Tour]

faculty Tuition cost

MBL - USD 16,900

Special focus: MBA schools in CEE

bne November 2011

business schools required in the region," says Milenko Gudic, a director at the Central and East European Management Development Association (Ceeman).

Special focus: MBA schools in CEE

"For those who like to think out-of-the-box or have an entrepreneurial spirit, I would probably recommend one of the good local business schools" And in the early 1990s, some of the attempts to service these needs – both from domestic and western schools operating at local centres in the region – were of dubious quality. Partly as a result, business school associations in the region - such as Ceeman, Russia's Rabe and the Baltics' BMDA - began working to raise standards, and now point to what they say is huge progress over the past two decades. (Interestingly, Ceeman's annual two-week IMTA faculty development programme, designed to nurture CEE assistant lecturers, now attracts young western academics keen to benefit from the training on offer.)

But for today's would-be MBA student in Poznan or St Petersberg, the crucial question is: have business schools in CEE developed to match their peers in Western Europe and the US? "It's true that around 1990 there was no [modern] management education in our part of the world, so we learned and are still learning from our western partners," says Virginijus Kundrotas, president of the Baltic Management Development Association (BMDA), and associate professor at Lithuania's ISM University of Management and Economics. Even so, he argues, the pace of change in the region has been "extremely high," with regional schools also developing their own approaches to local management challenges based on creativity, entrepreneurship and innovation. "Yes, some schools are still lagging. Asked for advice [in choosing a school], I would first ask where this person is planning to work after graduation," he says. For Kundrotas, the best western business schools (and the best in CEE) are "rather good" in teaching management professional skills, such as processes, administrative subjects, finance, and marketing, and in such areas as quantitative research methods, presentation and social skills. And for someone wishing to work globally, many have recognised brands. However, he argues that western schools are often so focussed on the "right way" of doing things, that "they pay less attention to the entrepreneurial side, creativity, innovations and thinking

Accreditation notes:

Kozminski University

University of New

Moscow School

York in Prague

of Management Skolkovo

Location

Poland

Czech Republic

Russia

Programmes

· European MBA -

· General MBA plus

· MBA

7 specialities, eg

· EMBA

with Bradford University · Euro MBA -

MBA in Marketing

with Euro Consortium

The most widely recognized accreditation bodies in this region are: AACSB · The Association to Advance Collegiate Schools of Business - www.aacsb.edu AMBA · Association of MBAs · www.mbaworld.com EPAS · Educational Planning and Assessment System · www.act.org/epas EQUIS · European Quality Improvement System, awarded by EFMD · www.efmd.org IQA · International Quality Award, from Ceeman, the Central and East European Management Development Association · www.ceeman.org Some schools also list local accreditation bodies. In general, these have no standing outside their own nations.

Accreditation

EQUIS, AMBA, AACSB

Prospective applicants should also note that membership of an association is different from accreditation. A number of schools are members of, but do not have accreditation by, the above associations.

National Accreditation

Number of students *European - 33 / Euro - 45

102

166*

Number of faculty

*European - 15 / Euro - 25

Number of visting

*European - 8 /Euro - 9

Jan-04

21*

European - EUR 12,300*

EUR 13,000

MBA - EUR 60,000* for MBA

faculty Tuition cost

Euro - EUR 26,500

(includes books, computer, studies tours to India/China

* nb 2010 data

and USA, and living) EMBA - EUR 90,000* (also includes all) * nb 2010 data

bne has used the IQA – set up to serve the region – as the basis for the listing here. bne has also sought out other schools which hold westernbased accreditation awards. bne has sought to provide a table of regional schools offering MBA or EMBA programmes, and apologises for any omissions. If your school has been omitted from the list, kindly contact us for possible inclusion next year. Prospective students should use this table for guidance only. Conditions, including cost of programmes are liable to change. This table is not a ranking, merely a list of schools in the region offering MBAs or EMBAs in English language. bne has sought to check the facts, but can not guarantee all data supplied by the schools.

bne November 2011

out-of-the-box," because they operate in stable, rather than in growing, fast-changing economies. "In other words, they do not teach, or to be more exact do not teach enough, how to notice the new opportunities and take the advantage of them," he says. In contrast, CEE schools have been in the maelstrom of transition for two decades, and are therefore better adapted to "teaching students flexibility, sensitivity and how to question existing procedures and ways of thinking." Hence, for students who want a local or regional career, or for those that "like to think out-of-the-box or have an entrepreneurial spirit, I would probably recommend one of the good local business schools," he says. For almost everyone, the final decision on a school is a compromise of sorts. Anna Zelentsova, who now works for the ministry of finance in Moscow, wanted to take a British MBA programme to help her international career, but needed to keep working and could not afford the price of regular travel to the UK. She chose to take the Bradford University programme at Kozminski University in Warsaw. She appreciated the diversity on hand. "We had professors and practitioners from different countries including the USA, UK, Canada, and Spain. [We had] some of the best specialists in particular disciplines such as lean thinking and strategic management," she says. For Iva Ivanova, the choice of IEDC Bled also exposed her to a wide variety of foreign faculty – the school, though awarding its own degrees, relies on a pool of foreign professors who fly in for each programme. Nearly two years after graduation, she is now an account manager with the same agency and although the move was not directly linked to her new degree, she has no regrets about her choice of MBA. "It was a very valuable experience, with different study-work situations, knowledge [input] in different fields from very good professors, and a multicultural atmosphere. The school ethos is open, innovative and creative, and the intensity of the study process helps you to mobilise your energy and knowledge, to work in different situations and react quickly, which is often needed in practical business life," she says. And, perhaps in contrast to some aspiring MBA candidates, rather than providing some sort of energised boost to a more high-octane, big-bucks career, the EMBA has given Ivanova a better basis to assess her life and its aims. "I would say that there is no difference in the work itself. I didn't plan to change my job immediately after graduation, nor did I have expectations that an EMBA meant total change. What has changed is more in my perception of the business processes, and my horizon as a person not only in work but as a whole. I have more confidence, a broader perspective for every business situation and that's important for me," she says.

Beware the MBA syndrome While an MBA will give the holder more awareness of business skills and – as in Iva Ivanova's example – may boost confidence in both professional and personal life, working professionals invariably warn that it is, of itself, no talisman guaranteeing a successful future career. And that includes MBAs from even the most costly, highly ranked schools, as Mladen Fogec, chief executive of Siemens in Croatia, relates to bne – though stressing that he was speaking for himself, not Siemens' company policy. "Theory is one thing, and practice is another. I prefer practice; I think the best way to learn is experience," he says. Yes, he admits a professional needs a good foundation – and an MBA can help with that – but "experience is something on top, which makes you successful, or not," he says. Fogec's own experience has been greatly influenced by an encounter with one of the more loathsome types of MBA graduate. "I want to tell you a story. I won't comment; it's up to you to draw a conclusion. Seveneight years ago, I had a colleague who came back to the company as a fresh MBA graduate from a famous French school. He sat in as part of a team on a career review board. After one hour with him in this team, I asked him: did you finish an MBA in Paris or a modern inquisition studies in Spain? I don't want to express any more," he says.

"After an hour, I asked him: did you finish an MBA in Paris or modern inquisition studies in Spain?"

Special focus: MBA schools in CEE

bne November 2011

I Special report

bne November 2011

Special report I 59

bne November 2011

Lost in transition Nicholas Watson in Prague

Special Report: Private equity post-crisis

rivate equity funds launched at the bottom of an economic cycle have traditionally yielded the best returns. But for those funds focused on Emerging Europe, this time around things might not be quite so simple. According to DB Research, over the last 25 years private equity funds have provided their investors with higher average returns than they could have earned from either equities or bonds. "And the rates of return generated by private equity even held up fairly well during the financial and economic crisis, in contrast to equities," notes Thomas Meyer of DB Research. This outperformance is even more marked if you look at the returns generated from the funds' vintage years (the year in which a fund is launched); it seems that the worse the economic situation in the vintage year, the higher the return (see chart). This anti-cyclical correlation exists for two main reasons: the lower valuations of companies when the fund starts deploying its capital, and the benefits of riding the economic recovery wave during which

the companies in question should outperform. "The gloomy current economic outlook might therefore offer opportunities for new private equity funds with well-constructed portfolios – for example, because the prices of potential buyout targets are falling," suggests Meyer. As well as this historical trend, private equity funds focused on emerging

markets are also predicted to benefit from the general move by investors to increasingly look for targets in higher growth regions as the recovery in traditional stomping grounds of the US and Western Europe remains so anaemic. Some 23% of the capital raised in the second quarter of 2011 was by funds that focus on emerging markets, according to DB Research.

GOOD INVESTMENT IN CHALLENGING TIMES GDP growth and returns on private equity (by vintage year), USA 35 30

Real GDP growth (%, right)

6 5 4

2 1

0 -1

10 5 0

-2 US private equity (IRR, left) 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 *08 *09

IRRs represent the internal rate of return for amounts paid into and distributions paid from PE funds – net of fees, expenses and carried interest – since the fund was launched. The residual value of the fund is recognised as a final cash flow. *PE funds launched in 2007 or subsequent years do not yet enable any meaningful analysis to be conducted. Sources: Cambridge Associates, DB Research, Global Insight, 2011

-3 -4

I Special report

All this would suggest boom times ahead for private equity funds in Central and Eastern Europe. But people in the industry say much has changed in the region since the global crisis broke in 2008, placing a question mark over such predictions. New days One of the most important changes has been that private equity, certainly the large-cap funds (which chase companies with an enterprise value greater than €150m), don't perceive the new EU members states like Poland and the Czech Republic as emerging markets anymore. "Poland is no longer perceived as an emerging market, but a peripheral

bne November 2011

the value of those companies as the stock market soared.

not fully appreciated by investors looking at the region from outside."

This makes raising money outside the region for funds, certainly for those chasing larger deals, a tougher sell. "CEE is having a harder time competing for emerging market capital," says Wardrop.

Indeed, Szczepanski argues that the global crisis has actually aided this feature of the market. Before the crisis, these fragmented markets contained many players of similar size and it was a bit hit-or-miss whether you managed to back the right horse. "In many markets, there is now a clear leader because sound companies run by quality management teams were able to benefit from the slowdown and strengthen their market position, so it's less of a casino and more visible whom you should bet on."

In the mid-market, companies with an enterprise value of €100m-150m, the picture is more encouraging, as strong local or regional players aren't competing with money pouring in from large-cap foreign funds, meaning also the valuations levels for target companies are more reasonable. "In the mid-market segment, those funds that have freshly raised money to

"Should CEE be in the European bucket or the emerging market bucket? Increasingly it's the former" market that's part of the core EU private equity market where the risks are more manageable," says Przemek Szczepanski, partner at Syntaxis Capital in Warsaw.

invest should have a good chance to perform strongly," says Szczepanski, whose own firm is approaching the final close of its second fund.

Brian Wardrop, managing partner of Arx Equity Partners in Prague, calls Emerging Europe outside of Turkey and Russia a "hybrid" market, where you have marginally better growth prospects than in Western Europe, but where there's greater familiarity with the rule of law, management quality, foreign exchange etc., yet it's far from producing the kind of spectacular returns that funds investing in China and Brazil have been enjoying of late. "Should CEE be in the European bucket or the emerging market bucket? Increasingly it's the former," Wardrop says.

Buy-and-build Furthermore, there are some key features of the market in CEE that makes investing in them still attractive.

At the same time valuations in the region, especially for companies at the larger end of the market, have "remained stubbornly high," says Szczepanski. The private equity market in Poland, for example, has faced stiff competition from the Warsaw Stock Exchange, which provided a home for many small and mid-sized companies that would normally have been fodder for private capital, while also pushing up

For all its development over the last decade, Emerging Europe's industries and sectors are still very fragmented compared with those in western markets and thus provide considerable scope for consolidation. For private equity firms, that means it's possible to buy one of the larger players in the market, and then spend subsequent capital on what's called "add-on" acquisitions. "These relatively fragmented industry structures more easily facilitate the implementation of buy-and-build investment theses… where acquisitions tend to be more readily identifiable and can often be acquired at attractive valuations due to their relatively small size and market shares," says Wardrop, whose own firm has completed five add-on acquisitions so far this year. "This is a feature of CEE's more nuanced 'hybrid' status that we feel is sometimes

Special report

bne November 2011

But the acquisition game was taken to a whole new level last December when Coke's main rival PepsiCo paid $3.8bn for a 66% stake in Wimm Bill Dann, to become Russia's single biggest dairy producer overnight. The Pepsi-WBD deal opened the flood gates and a slew of other strategic investors have either bought out their partners or ramped up investment in Russia. Danone followed hot on the heels of Pepsi, with the buyout of St Petersburg-based dairy Unimilk in 2010. And this summer Yum! Foods, owner of KFC, bought out Rostik Group, its partner of over five years in a fried chicken restaurant chain, and has since started re-branding all the outlets with the Colonel Sanders logo.

Another positive feature of the CEE private equity market is the successionrelated buyouts that are becoming increasingly prominent. Unlike succession deals in Western Europe, the companies in question are not family-owned businesses but rather those that were, like many businesses in Central Europe, started (or privatised) by a group of entrepreneurs in the 1990s after the collapse of communism, who have since grown the businesses and are now in their 50s and approaching retirement age, with some wanting to stay connected to the company, others wanting to leave entirely, and others wanting to take some money off the table and remain minority shareholders. For private equity firms like Arx, these companies, worth about €50m, provide rich-pickings. "As the first institutional owner of these firms, it's easier to add value. If you're the third owner, the company is probably bigger, more diversified and less risky – however it's also more difficult to add value as a PE investor," says Wardrop. This is a particular theme in the Czech Republic, where the voucher privatisation programme created many companies that are owned by a group of private individuals of the same generation. By Arx's calculations, in 2003 the number of companies with annual revenues of over CZK200m (£6.64m) and at least one owner older than 50 years old was 323; in 2008, this number had grown to 1,080, a compound average growth rate of 27%.

I 61

Exits open as investment pours into Russia

And there seems to be no let up in the pace. In just the first two weeks of October, Unilever announced it would buy 82% of Russian shampoo maker Kalina for $535m and Italy's De Cecco closed a deal to take over Russia's First Pasta Company.

Ben Aris in Moscow

The volume of mergers and acquisitions (M&A) has led the broader recovery. M&A volumes totalled $55bn in the first three quarters of this year, reports Mergermarket, up 58.8% from the same period a year earlier, making it the second busiest period since the recordbreaking 2007 at the height of Russia's

t's every entrepreneur's dream: you set up a company, spend a decade building up the business, and finally sell out to a strategic investor, pocketing billions of dollars. That dream is coming true for an increasing number of Russian business owners: in the last 12 months, a slew of multinationals have taken the plunge and spent billions of dollars buying a slice of the Russian consumer market.

Lebedyansky in 2008. But many have remained queasy about buying expensive Russian companies; Wal-Mart baulked at the high prices and abandoned its efforts to buy into Russia's retail sector earlier this year after a decade of dithering. FOREIGN INVESTMENTS IN RUSSIA USD bn 250 225

Apart from a brief window in the first half of this year, the equity markets have been largely closed to owners and private equity funds that have wanted to exit their businesses, but as the crisis forces companies to go global strategic deals have mushroomed. The world's biggest companies with longterm horizons have always been in Russia, but their acquisitions have come piecemeal for most of the last two decades. Coca Cola was among the first of the multinationals to arrive with its purchase of juice maker Multan in 2005 and then

200

FDI »

175

Portfolio »

150

Other »

125 100 75 50 25 0

Source: Reuters EcoWin, Danske Markets

I Special report

bne November 2011

"Russian owners' expectations have changed. Before the crisis, all they saw was never-ending growth; now some have decided taking out a hundred million is a good idea after all"

boom. In only the third quarter of this year, there were $15.7bn of deals, the second busiest quarter on record. The price is right All this activity has been partly driven by falling asset prices and partly by the sluggish, but inexorable, economic recovery. "At the start of the crisis, owners remained confident that Russia would rebound, but the crisis got worse suddenly as the economy went into a tailspin and the fear took hold," says Martin Diggle, co-founder of Vulpes Investment Management. "Prices suddenly fell, although they have started to recover more recently." During this, foreigners have played a disproportionate role, with foreign investment up an astounding 923% over the first nine months of the year to $26.6bn, while Russian investment abroad was $5.6bn, up 13% on the previous year. In general, the headline rate of foreign direct investment (FDI) is recovering nicely (but still off from its $80bn peak) and was expected to top $31bn, according to preliminary estimates for the first nine months of this year, Economic Development Minister Elvira Nabiullina told reporters in October. But this doesn't capture the frenetic activity going on in the retail sector, where FDI by some estimates has has tripled. And those multinationals that weren't in the market to buy Russian companies

Special report

bne November 2011

have nevertheless been ratcheting up their commitment to Russia. Coca-Cola said it would invest another $3bn into Russia, Siemens launched a $1.37bn investment plan that will run to 2014, brewer SABMiller transferred its $1.9bn Eastern European business to Russia to become the second biggest producer in the country, and French supermarket chain Auchan committed itself to about $200m to develop its Russian business, to name a few of the announcements made in the last two months. At the same time, a string of companies that have never had Russian operations chose this summer to enter the market: in the space of about two months, Burger King, Wendy's and Dunkin' Donuts all arrived and Moscow is currently plastered with hamburger adverts as these firms vie to gain a toehold in this new market. "The international crisis has been described as a perfect storm, but now as the crisis recedes we have the perfect conditions for entering Russia," argues Roland Nash, chief strategist with Verno Capital. "Asset prices have come off the crazy valuation levels of the boom years, but the economy, and especially Russian incomes, are still going up. At the same time, Russian owners' expectations have changed. Before the crisis, all they could see was never-ending growth, but now some of them have reassessed and decided maybe taking out a couple of hundred million is a good idea after all. But more than anything the buyers are looking at their home markets and can't see any growth for years to come so they have to move into the emerging markets."

"Buyers are looking at their home markets and can't see any growth for years to come, so they have to move into emerging markets"

I 63

is hoping to offer great returns to investors during what it hopes is a protracted recovery. "In all the years I have been in Russia, the one thing I have learned is that the Russian banking sector is cyclical," says Timothy Krause, the fund's manager, who first arrived in Russia in the mid-1990s. "The Russian banking sector remains one of the fastest growing in the world and the crisis means this is a great time to be investing."

IFC launches a Russian bank fund Then there's the Renaissance Capital Financial Institutions fund that came into being shortly after in 2007. Both funds have a similar strategy: take minority stakes of about 10-15% to boost the bank's capital and provide technical help on managing the business to allow the bank to grow.

Right time, right place The fund comes at just the right time, as the Russian government is keen to pull in more investors. And it has put its money where its mouth is: the fund has been seeded with a $250m contribution by the IFC, matched by $250m from Vnesheconombank (VEB), the stateowned development bank, and another $50m from the Russian Finance Ministry. Krause is now on the road trying to raise at least another $500m from private investors, pension funds, sovereign wealth funds and institutional investors.

The performance of both these funds highlights how volatile investing in Russian banks can be. The long-term growth

Indeed, at first the IFC was not very keen on the idea of the fund, floated by the Russian banking association, which

Ben Aris in Moscow

he World Bank's commercial arm, the International Financial Corporation (IFC), is getting into the Russian fund business. In June, it launched the third private equity fund focused on the country's banks, the Russian Banking Opportunity Fund, which it hopes will tap into the potential growth of Russia's financial sector and help drive its consolidation at the same time. There are already two private equity funds focusing on banks in Russia. The pioneer was what is now called the East Capital Financials Fund that miraculously opened its doors in 2006 just ahead of the mega-wave of banking acquisitions that swept the region. However, more recently the fund has suffered: while East Capital was an early investor in the Bank of Georgia story â&#x20AC;&#x201C; probably the best rags-to-riches tale in the entire Commonwealth of Independent States â&#x20AC;&#x201C; it got burned on its investments into Nadra Bank in Ukraine and BTA Bank in Kazakhstan during the recent crisis and the fund is down 11.24% this year.

When Krause first arrived in Russia, Russian banks were going for up to 4.5x book value â&#x20AC;&#x201C; quadruple the valuations that countries in Central Europe got for their banks when they were privatised in the 1990s. But the prices have come off since: the mid-tier commercial bank Nomos bank floated earlier this year with a valuation of 1.5x book value and investors' favourite Sberbank was trading at 1.2x book value in the middle of October.

"In all the years I have been in Russia, the one thing I have learned is that the Russian banking sector is cyclical" of the country's financial sector over the last 15 years has been phenomenal and on an assets/per-capita basis Russia remains at the bottom of the league in Europe. By launching its bank fund during the tail end of this crisis, the IFC

was looking for ways to finance smaller banks as the tsunami from the global debt crisis broke on Russia's shores. But during the International Monetary Fund's annual meeting in Turkey in 2008, the then-Russian finance minister

I Special report

bne November 2011

Alexei Kudrin cornered Lars Thunell, IFC's executive vice president and CEO, and badgered him into the idea. The IFC is already long in the tooth when it comes to investing in Russia and has made several banking investments off its own bat. The idea with the fund is to leverage this experience and tap international capital. And as an international financial institution, Krause believes the IFC's development mandate is actually an advantage, as the fund continues to invest even when the investment climate is poor. "All these private equity funds are chasing the sweet deals, but they chase sweet deals with the wrong people, which regularly blow up in their faces," says Krause. "There is a positive relationship between investments and the development impact: if something is to make a development impact, it has to create something that wasn't there before and this is usually good business." The fund's strategy is two-fold. First, it is targeting 10-15% stakes in mid-sized

banks ripe for growth, which can in turn acquire smaller banks. These will be groomed and then either sold or floated on the stock market. "Currently, the state banks dominate and both Sberbank and VTB are listed. At the other end of the scale, there are a handful of listed private banks with a tiny free float," says Krause. "The IPO of Nomos Bank earlier this year is somewhere in the middle, but it is only one bank. It is very hard for investors to get exposure of the burgeoning banking sector." The second plank is to buy up to 40% in niche players and knock them into shape. Krause says the "sweet spot" investment is to take a 25%-plus-oneshare stake and maybe co-invest with other funds to control 50% plus one share of the whole bank. "We don't want to manage the banks, but if we feel that it needs a new CFO or major change in strategy, we need the ability to impose these decisions via the board," says Krause, who has already done a deal like this in partnership with Barings Vostok

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

Capital to jointly own a controlling stake in Orient Bank, which has been buying up smaller competitors all year. The partnership with the Russian state organs should give investors some comfort and is a model that the state is actively pushing. In the summer, VEB also made the first $2bn investment of a $10bn total in the newly established Russian Direct Investment Fund (RDIF), which is supposed to partner with foreign private equity investors into everything – except banks. But the key will be if Krause can attract some serious international investment. No one doubts that big institutional investors are interested in Russia, but so far they have invested next to nothing. "I am confident they will come. It is a question of education, but international investors remain nervous of Russia – despite its good returns," says Krause. "But that is our job: to convince them it is a good deal and now is the time.

What you need to know

www.bne.eu

Special report

bne November 2011

New beginnings in Central Asia

Clare Nuttall in Almaty

ureos Capital has made its second Kazakh investment by buying a stake in Derzhava Corporation and the emerging market-focused private equity firm plans to close two more deals by the end of the year. Further proof, say analysts, that the combination of the global crisis and the subsequent recovery is opening up new opportunities for private equity in Kazakhstan and the wider Central Asian region. Aureos bought a 49% stake in Derzhava, a manufacturer of paints, lacquers and varnishes, through its Aureos Central Asia fund, which closed at $70m in 2008. The size of the deal has not been revealed, but Aureos makes investments in the $2m-10m range. Founded in 1998 by a group of local businessmen, Derzhava has a market share of 6.93% across the entire Kazakhstan paint products market, according to IGM Consulting Company. However, within the niches where it operates, Derzhava is the main producer in the country. "No other Kazakhstan-based companies are active in the niches where we are operating," says Derzhava CEO Nariman Mamedov. "We are aiming to increase our market share to around 10% following the investment from Aureos. We don’t expect to compete with the market leaders, but in the niches where we are situated, there are very good [prospects] for growth." Derzhava’s total production capacity is 12,700 tonnes of finished products a year, but due to its low level of working capital, the company is currently only using 40% of its capacity. "This company, like many companies, suffered from

insufficient working capital. With our investment, it has new perspectives for growth," says Talgat Kukenov, managing director of Aureos Central Asia. Speaking to journalists in Almaty, Mamedov said that Kazakhstan's paint products market is seasonal, but that with Aureos' investment the company would be able to boost production to up to 90% of capacity at peak times. The investment will also be used to develop the manufacturing process, and to improve Derzhava's sales, marketing and PR operations. "We are joining the business for five years maximum. Within this period, the company must boost sales and manufacturing, and increase its market share," says Kukenov. "As

I 65

Leasing Group and Bishkek-based cable television company Ala TV. Investors in the fund include Kazyna Capital Management, International Finance Corporation, the UK's Commonwealth Development Corporation and the European Bank for Reconstruction and Development. Holding on Private equity was slow to get off the ground in Kazakhstan. Entrepreneurs are reluctant to give up equity stakes in their businesses, and with cheap credit readily available through the mid-2000s, there was little incentive to seek alternative forms of finance. After the crisis hit and cheap credit dried up, businesspeople were more willing to work with private equity investors, but by then many companies were too over-leveraged to be attractive. Now, however, there are more opportunities as balance sheets are getting cleared up and Kazakhstan’s economy is back to steady growth. Most of the private equity and venture capital funds active in Kazakhstan were established with investments from Kazyna Capital Management, the investment arm of sovereign wealth fund Samruk-Kazyna, or its subsidiary the National Innovation Fund. The NIF was the cornerstone investor in four

"After the crisis hit and cheap credit dried up, businesspeople were more willing to work with private equity investors" expected, the fund will exit from the project in the future. A potential exit scenario would be the sale of our stake to a major international strategic investor." The Derzhava deal, which was announced on October 5, is the third investment from the Aureos Central Asia fund, which plans to close one or two more deals by the end of this year. Previously, the fund, whose main focus is on Kazakhstan in addition to other Central Asian and Caucasian countries, has invested into Kazakh leasing company

domestic venture capital funds, while KCM has invested into larger private equity funds including the Macquarie Renaissance Infrastructure Fund, CITIC Kazyna Investment Fund I and the ADM Kazakhstan Capital Restructuring Fund, in addition to Aureos Central Asia. "For us, it's very important that investment capital that such instruments as private equity works here and we are always stably working with the funds in which we invest in Kazakhstan," says Alexey Ten, managing director of KCM.

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Russian hi-tech pharmaceutical global, leveraging Kremlin cash along the way.

would have taken perhaps four years. Now we can go forwards immediately."

Bringing together biotech companies from Russia, the UK and Germany to develop nine new drugs based on cell-based, gene and post-genome technologies for both the Russian and international markets, SynBio is almost the perfect poster boy for the government's drive to modernise its economy and diversify exports away from oil and gas through innovation.

Overcoming the barriers On top of the cash, Rusnano also helped with the "complicated legal deal" and the business model, which sit behind a JV spread across Russia and two EU countries, Isayev points out. This is also

Rusnano result? The involvement of Rusnano – one of a pair of giant state corporationscum-venture capital funds tasked with leading the modernisation charge – is a significant positive. Thus far, just like its industrial cousin Rostekhnologii, Rusnano has struggled to produce much of anything in return for the billions of dollars that the Kremlin has pumped into the hi-tech incubator, and cynicism over its capabilities abounds.

Pills 'n' thrills for Russia's biotech industry Tim Gosling in Moscow

final deal on SynBio – the first Russian-led international joint venture in the biotechnology sector – was sealed in September, with a €30m investment from Rusnano as a cornerstone. With Synbio planning to launch innovative drugs on international markets by 2015, is Rusnano, one of the Kremlin's giant modernisation venture capital funds, finally about to start delivering concrete results?

The pharmaceutical sector has often been cited as a potential driver to modernise the economy, but there are numerous barriers for Russian companies trying to develop innovative drugs. In a bid to overcome them, SynBio – led by Human Stem Cells Institute (HSCI), the first company from Russia's pharmaceutics sector to go public in 2009 – and a consortium of international partners are launching a bid to take

Artur Isayev, who heads HSCI, SynBio's largest private investor, tells bne he used to share that view, but claims he finds it hard to maintain his doubts since Rusnano committed to invest RUB1.3bn (€30m) in SynBio in return for a 41.4% stake. "I've always been sceptical about government policy, especially when they're talking about modernisation," Isayev says. "But it's hard to be sceptical now that I have a real example of what they're doing to try to develop the pharmaceutical industry." The private partners in Synbio – HSCI, Russia's Pharmsynthez, Germany's SymbioTec and British-based Lipoxen – will contribute the remainder of the RUB3.2bn investment into the joint venture over the next four years, via a combination of cash, intellectual property and stock. The venture is targeting revenue of RUB700m in 2015, when it launches its first drugs around the globe. "Right now, SynBio is a result produced by Rusnano," Isayev asserts. "It's giving us the opportunity to perform second-stage clinical trials on these new drugs. Of course, we could have found an investor ourselves, but it

Special report

bne November 2011

"It's hard to be sceptical about government policy now that I have a real example of what they're doing to try to develop the pharmaceutical industry"

vital, as it's SynBio's international profile that's key to overcoming the barriers to the Russian biotech industry.

can perform outsourced services, and "even if you're lucky enough to find one," explains Isayev, "it's unlikely to meet the GMP [good manufacturing practices] guidelines required." At the same time, Russia's weak intellectual property protection puts companies that can find a third party to perform manufacturing or other outsourced services at "high risk" of having the project stolen, he adds. All these issues are holding back development of the Russian biotech market in general, which only compounds the problem. Without large Russian biotech players, small and innovative companies struggle to find buyers for their technologies, forcing them to "provide huge amounts of investment and expertise," Isayev says. "Russian biotech is left to do all the things that big pharma does in other countries – taking on the full process from R&D, through manufacturing and on into sales." SynBio's international profile will help here also, the director claims, by easing access to capital markets. "We're not looking for funding right now," states Isayev, "but we do expect SynBio to go public."

On the one hand, running clinical trials outside Russia will free SynBio from "insufficiently developed legislation," states Isayev. "Sometimes it's easier for the ministry of health to simply stop a project than approve new tests," he laments. "The bureaucrats are scared of anything new." However, the key point is that SynBio will overcome the barriers to international markets that are the result of the under-developed Russian biotech sector. "In the US, pharmaceutical consumption is $900 per person, in Russia it's $90," Isayev says. "Russian biotech companies simply can't work for just the domestic market." That sets up a vicious cycle, with Russian biotech drugs struggling to meet the standards demanded for entry to developed markets because the domestic sector is so underdeveloped. For instance, there's a severe lack of companies that

"We're not looking for funding right now, but we do expect SynBio to go public"

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