bne: Magazine July 2014

Inside this issue: After crisis Mints Taxing times in Hungary (again) Lions for lambs in Prague

July 2014 www.bne.eu

Bulgaria's government goes south Georgia's political MAP

RUSSIA'S CRACK PIPE TO EUROPE Will EU's addiction to Russian gas mean South Stream gets built?

bne July 2014

Contents

Editor-in-chief: Ben Aris (Moscow)

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Managing editor: Nicholas Watson (Prague)

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News editor: Tim Gosling (Prague)

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COVER STORY 6 The Insiders 8 Russia's crack pipe to Europe

CENTRAL EUROPE 30 What's bugging Polish officials?

32 A Baltic currency corridor forms

14 Perspective 15 Chart of the month

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33 Poland remains divided on euro 34 Taxing times in Hungary (again)

EASTERN EUROPE +44 7738783240

Cover illustration: Illarion Gordon

36 Lions for lambs in Prague 16 Graziadei anger towards euromaidan passionate – but no act 20 Sweating the chinovniki

38 The changing face of Czech media 40 Poland takes slow road to modern transport network

22 After crisis Mints

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23 Signs of life in Russian real estate 25 Russia's Bookmate takes on global e-book giants 27 Bondholders fret as Ukraine oligarchs suffer 28 Sberbank expands fast overseas

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Contents

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64

SOUTHEAST EUROPE

EURASIA

42

Bulgaria's government goes south

54

Eurasia's "rupture with democracy"

44

Moldova wine industry uncorks new markets

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Azerbaijan and Turkey – one nation, two states

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Croatia's oil and gas pipe dreams

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Keeping China gassy

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Georgia's political MAP

47

Croatia resumes hostilities with Hungary

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Drilling down in Mongolia

62

Uzbek motorists driven to despair

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Putting down roots in Romania

51

Croatia looks to up its economic game

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VIP treatment in Serbia

53

Newcomer leads in Slovenian election campaign

Follow us on twitter.com/bizneweurope

OPINION 64

No one wins from chaos in Ukraine

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UPCOMING EVENTS

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I The Insiders

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Ukraine, Nato enlargement and the Geithner Doctrine Professors Clifford G. Gaddy and Barry W. Ickes of the Brookings Institution “[T]he central paradox of financial crises is that what feels just and fair is the opposite of what’s required for a just and fair outcome.” – Former US Treasury Secretary Timothy Geithner, The New York Times, November 5, 2010

Figure 1. The Russia Matrix and the Missing Quadrant

Good Russia

S

ober analysis of the current standoff over Ukraine tells us we are in a deep mess, worse than people tend to recognize. The events playing out now are bigger than Ukraine. Both Russia and the West are deeply committed to broader objectives that seem fundamentally irreconcilable. There are no easy solutions to the crisis.

Timothy Geithner's remarks are even more appropriate because Russia, through its current actions in Ukraine, has exposed the post-Cold War order in Europe as the geopolitical equivalent of a financial bubble. We have enjoyed two decades of benefits from this order. But we did so under the illusion that it was nearly costless. Now we are finding out that there is a bill to pay.

The missing quadrant We can explain by using a simple framework that we first developed in 2008 after the Georgia crisis. Imagine a matrix with two columns – one labelled “Strong Russia” and the other “Weak Russia” – and two rows, one for “Good Russia” and the other for “Bad Russia.” Into the quadrants of this matrix we place the various “future Russias,” as most western policymakers envisioned then in the early 1990s.

The first possible Russia was one that would reform and succeed – that it would accept the so-called Washington consensus and develop its democracy, resulting in a strong Russia that is "good" (ie. positively inclined toward the West). The second Russia would try to reform but fail and remain weak, but was still “good.” In the third option, Russia would reject reforms altogether and remain weak, and it would refuse to accept the US-led post-Cold War international order and so be “bad.”

Bad Russia

Strong Russia

Weak Russia

Possible: Very low probability

Possible: High probability Possible: Low probability

But note that there is one quadrant that is missing. What could not be imagined at the time was a “strong, bad” Russia. Hence, no probability was attached to that outcome. All this would have been rather academic except that the assumptions of this matrix were taken as the basis for the entire post-Cold War order.

With the collapse of the USSR and the end of the Warsaw Pact, the US took the lead in establishing a new international political order in Europe. The Iron Curtain separating West and East would be torn down, and the former Soviet republics and satellite nations of Eastern Europe would be transformed into Western-style market democracies. But clearly this would be a wrenching process and so needed a big carrot to persuade the countries to participate: membership in the premier Western clubs, the EU and Nato.

The promise of Nato membership was the key. No matter how much lip service the Eastern Europeans paid to the virtues of free markets, democracy, civil society and so on, they took on the burdens of reform for one main reason: to earn a guarantee of protection against their age-old enemy, Russia.

But what was not recognized was the US assumed this perceived “Russia threat” was not real and never would be. It was assumed that Russia would slide further backwards and would always be weak, never to threaten the US-led world order. A "strong, bad" Russia was unimaginable. This was precisely the “missing quadrant."

The insurance scheme When a particular bad outcome is unimaginable, there is little cost to selling insurance against this possibility. It's like selling

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a put option that is far out of the money, as it assumes no one will exercise this option. The newly independent countries were keen to buy insurance, as they didn’t see a missing quadrant: for the countries of Central Europe the Russian threat remained real. And the US was keen to sell the insurance, because it didn’t see any danger of having to pay out on that insurance.

However, there is a moral hazard that comes with selling insurance, as the insured parties take bigger risks than they otherwise might. That is exactly what happened in the case of new Nato members, Poland and the Czech Republic, for instance, which quickly began to lobby to have American missile defence systems on their soil – something seen by the Kremlin as more threatening than Nato expansion itself. If you are Russian President Vladimir Putin, you want to indicate to the US the cost of these deployments – that the risk (and hence the cost) is not zero – which led directly to the Georgia conflict of August 2008.

The message was not received, however, much like the collapse of the subprime market should have foretold what was to come in the financial crisis. What we should have recognized between August 1998 and August 2008 was that the unimaginable had occurred: Russia had become "strong, but bad.”

The bill comes due What brought this about was the rise of oil prices from under $50 per barrel to over $100. As Figure 2 shows, by the early 1990s the world oil price had been collapsing for more than a decade and a world with $100-plus oil was also unimaginable, similar to if Martians had taken over the Kremlin. It was outside the realm of possibility.

Figure 2. The World Oil Price, 1880-2013 $100

$80

$60

$40

$20

1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

$0

Nato expansion was the geopolitical equivalent of a financial bubble, where housing prices are expected to always rise and the costs are ignored until the bubble bursts. The bill for Nato enlargement is now far overdue. The bigger the bill gets, the nastier the bill collector, in this case Vladimir Putin, has to be.

And he is not going to go away until we pay the bill.

But many seem unwilling to acknowledge the bill and are trying to avoid paying. We did this before. The US response to the war in Georgia in 2008 was the so-called "reset" – a wishful

attempt to return to the halcyon days of the Clinton-Yeltsin era by betting on thenpresident Dmitry Medvedev to maintain the illusion of the missing quadrant: that Russia could be "good."

The response in the Ukraine crisis today is different, but equally inadequate. We have imposed a set of modest economic sanctions against Russia. They are not so strong as to cause real pain, but we pretend they are enough to stop Putin and let us return to business as usual.

In fact the sanctions will not deter Putin from his strategic goal of eliminating what he perceives to be direct security threats to Russia. Indeed, the various “purely-for-show” military measures being discussed by the West – increasing American troop presence and weapons deployment in Eastern Europe and sending Nato trainers to Ukraine, Georgia and Moldova, for instance – will likely reaffirm for Putin that his message has gone unheard once again and thus guarantee that he sooner or later makes another, even more shocking, move.

The bailout The West is facing three options to deal with the Ukrainian crisis and the wider problem of what to do about Russia.

Option 1: Total bailout = total fulfilment of Nato commitments. Place military bases and missiles throughout Central Europe and turn Ukraine into a new West Germany.

Option 2: Complete default = complete abandonment of all Nato commitments. Walk away from the Nato commitments and let Russia have its head in Europe.

Option 3: The Geithner doctrine. Acknowledge Russia's rising power and work with the Kremlin to bring peace and stability in Ukraine.

Only the third option is realistic. Just as we could not let the entire financial system collapse, we cannot walk out on current members of Nato. But at the same time insisting on beefing up Nato first and then expect to get Russia’s support in stabilizing Ukraine – support that is indispensable – is backward.

At every step of the way towards crafting a long-term outcome that is acceptable to both Russia and the West, we will have to heed the Geithner doctrine. We will have to make concessions that many people will regard as unprincipled and distasteful.

The sooner we accept this reality, the better. The longer we wait, the more costly the solution becomes. We must recognize reality and forego the illusion of the missing quadrant.

Professor Clifford G. Gaddy is a Senior Fellow and Barry W. Ickes is a Non-resident Senior Fellow at the Brookings Institution

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I Cover story

Russia's crack pipe to Europe

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Will EU's addiction to Russian gas mean South Stream gets built?

Nicholas Watson, Ben Aris, Tim Gosling and Rob Whitford

Cover Story I 9

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T

he growing confrontation between Russia and the West ranges across many fronts, none more significant than in an area of rural northwest Bulgaria, where in October workers began welding pipes that will feed a natural gas compressor station near the settlement of Rasovo. However, work here on the Bulgarian section of Russia's giant South Stream gas pipeline project has now stopped – a victim of the EU's decision to punish Russia for its annexation of the Ukrainian province of Crimea, as well as its growing frustration with the Kremlin's meddling in the east of that country.

Yet in keeping with the to-and-fro of this controversial energy project and the longstanding Russian policy toward Europe of divide and rule, just three weeks after the EU told Bulgaria to halt work on the pipeline, Russian President Vladimir Putin on June 24 popped up in Vienna to oversee the signing of an agreement between the Russian state gas exporter Gazprom and Austrian state energy firm OMV to begin work on an Austrian section of South Stream, which will terminate at the Baumgarten gas hub, 70 kilometres south of the Viennese capital.

The crisis in Ukraine has galvanized both sides over South Stream, especially now that the Russians have raised the stakes by yet again cutting off gas supplies to Ukraine in June after Kyiv failed to pay off its huge overdue gas bill.

Together with its Nord Stream pipeline, which carries 55bn cm/y under the Baltic Sea into Germany, the two pipelines form a kind of pincer movement on the EU gas markets. The military allusion is not misplaced; this is war by other means.

Hard habit to break Europe's biggest problem, as our cover so vividly portrays, is that it is addicted to Russian gas. Europe relies on Russian gas for about 30% of its annual needs, some 40% of which is transited through Ukraine. In 2013, Russia increased gas exports to European markets to a record 162.7bn cubic metres (cm), up 16% from 2012 and exceeding the previous record of 160bn cm set in 2008.

And many argue that will probably rise further, even as Europe raises its efforts to secure alternative supplies to wean itself off Russian gas. Europe is looking to develop its own reserves of unconventional gas like shale gas, while importing more liquefied natural gas (LNG) from producers in the Middle East

they do arrive, will not solve the fundamental reliance that Europe has on Russian gas, which has been built up over decades. "That isn't something you can change overnight," notes Tina Fordham, senior political analyst at Citigroup, "but at a political level you will hear a lot more focus on reducing that dependence."

Russell Gamadia of KBC Process Technology points out that European demand for gas is set to peak in the medium to longer term; South Stream's developers are banking on long-­term European gas demand rising by around 160bn cm over the next two decades from the 462bn cm consumed in 2013, while conventional European gas production continues falling and no significant shale gas comes on stream.

"How are we going to supply that? If we look at the LNG market, things are very tight there. While in Asia there is not a real alternative to LNG, European infrastructures are already there and Russia has the gas," he says, concluding that Europe's reliance on Russian gas is

"The crisis in Ukraine has galvanized both sides over South Stream"

For the West, South Stream – which will eventually carry up to 63bn cubic metres of Russian gas a year (cm/y) under the Black Sea, then westward via Bulgaria and Serbia, then up through Hungary and into the heart of Europe – is regarded as a major security threat. It will entrench European states' reliance on Russian gas for decades, argues Brussels, while also neutering any remaining influence Kyiv has over its giant neighbour because it will effectively end Ukraine's status as the main transit nation for Russian gas into Europe.

and Africa, as well as starting LNG imports from the US (in March the US Energy Department conditionally approved its seventh LNG export terminal). Europe is also looking to the start of new gas supplies direct from Azerbaijan from 2015, which won't cross Russian soil.

Some 10bn cm/y will come to Europe from the second phase of Azerbaijan's BP-led Shah Deniz gasfield, which will flow through Turkey via the new TANAP pipeline and then feed into the Trans Adriatic Pipeline (TAP) being built.

This pipeline will start in Greece, cross Albania and the Adriatic Sea, and come ashore in southern Italy, allowing gas to flow directly from the Caspian region to European markets for the first time.

For Russia, it is exactly those reasons that make this pipeline so appealing.

However, analysts warn that such alternative sources of gas, if and when

set to increase. "Ultimately, when you consider all these facts, Europe’s gas deficit is clearly increasing."

That's music to the ears of Russia, which has assiduously played on fears in European capitals about gas supplies petering out, leaving Europe shivering in the cold. This has allowed it to pick off certain countries who put their own energy security needs above those of the bloc, thus preventing a unified voice coming out against South Stream. This divide-and-rule strategy is one that the Kremlin has mastered over the years.

But will it continue to work?

Members for and against The latest country to come aboard the South Stream express is Austria, joining Bulgaria, Serbia, Slovenia and Hungary

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I Cover story

in agreeing to host the pipeline. Other European countries involved in the project are Italy, France and Germany, through stakes that Eni (20%), EDF (15%) and Wintershall (15%) hold in the consortium developing the pipeline.

Gazprom holds the remaining 50% stake in the consortium.

On June 24, OMV finalized a deal with Russia's Gazprom to build a branch of South Stream through Austria. "This investment decision is an investment into the security of the gas supply for Europe," OMV CEO Gerhard Roiss told a news conference after the signing.

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This represents a remarkable aboutface on South Stream by the Austrians, since OMV, 31.5% state owned, was until recently the biggest and most enthusiastic member of the consortium behind Nabucco – the EU's grand scheme (folly?) to build a giant pipeline that would bring gas from the Caspian, Central Asia and the Middle East into Austria's Baumgarten gas hub. That over-ambitious plan is now dead, replaced by the smaller but more realistic TAP pipeline.

Planning on the Hungarian section of South Stream is also well underway.

Hungary too was once a big backer of Nabucco, but now is firmly in the Russian camp. South Stream fits well with the government's recent controversial policies toward the wider Hungarian energy sector. Lower gas prices stemming from South Stream would help the drive to push down Hungary's energy costs to the lowest in Europe. Regulated pricing has been slashed by 30% over the past 12 months. That has helped push foreign investors out of the market, with the state snapping up utilities via its new "national champion" MVM. The prime purchase was of Hungary's main

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importer of Russian gas from E.ON last year.

In contrast to many EU states, Budapest will worry little about provoking a clash with Brussels. In fact, it would likely prove a bonus for Prime Minister Viktor Orban, who has made the "defence" of Hungarian sovereignty a major plank in his domestic political popularity.

Serbia is not in the EU, though at the beginning of this year it began negotiations to join the bloc, so it doesn't want to threaten those talks. Yet First Deputy Prime Minister and Minister of

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"The timing of the completion of the EU probe depends on whether Gazprom will offer remedies that fully and effectively address the Commission's concerns" Foreign Affairs Ivica Dacic said in June that building the pipeline is a "national priority" for the government.

Currently paying amongst the highest prices in Europe for Russian gas, Serbia argues the pipeline will bring both

transit fees and lower gas prices that will help transform the economy. The national oil and gas company NIS – 51% owned by Gazprom's oil arm, Gazprom Neft – already invested €490m into the project last year after the ground work construction was begun and the total spending is planned to reach some €2bn. And the Russians are going make it easy for the Serbs by lending them the money to pay for the construction.

This was planned to start in July and the first contracts are due to be signed after the Russian loan details are squared away.

However, the whole project for Serbia is now in jeopardy after the US and EU leant heavily on Bulgaria to halt work on South Stream, which Bulgarian Prime Minister Plamen Oresharski duly did on June 8 after being browbeaten by a group of US senators. Serbia can't build its stretch of the pipeline until Bulgaria, the primary transit country for the pipeline, finishes its section.

South Stream is popular amongst politicians and the public in Bulgaria, but that wasn't enough to help Oresharski resist western pressure to stop work on it. For his trouble, he's probably lost his job: halting South Stream work managed to upset both his allies and the opposition at home, which resulted in snap elections being called for September or October.

On the face of it South Stream is certainly in Bulgaria’s interests. It removes the vulnerability of its gas supply – 100% dependent on Russia – to a Ukrainian crisis, which has been the cause of actual interruptions several times in the past. In the short term it would create jobs – 5,000 of them according to Energy Minister Dragomir Stoynev, who also reckons it would have boosted this year’s otherwise lacklustre

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I Cover story

GDP growth to 2%. It would bring in big amounts of foreign direct investment at a time when quarterly investment is measured in the low hundreds of millions, not billions, of euros. It comes with gas-price sweeteners. And transit fees, via joint venture dividends, that will boost the budget. So what’s not to like?

The problem is the European Commission raised concerns that the contracts for the Bulgarian portion of South Stream were not awarded transparently; worse, the main contract was given to a consortium led by Stroytransgaz – a Russian company owned by Gennady Timchenko's Volga Group that is a target of US sanctions.

One striking feature of the situation is that when government officials are called to account on the matter, they keep on referring to details that can’t be revealed because they are commercial secrets.

There’s also concern about who’s going to pay for what’s generally supposed to be a very inflated price (€3.5bn) for the Bulgarian bit of the pipeline. Stoynev’s position is that the pipeline won’t cost the Bulgarian taxpayer a single lev (at the time of last November’s deal he

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for a stalled project that it’s only halfcommitted itself to.

Analysts point out the EU has got a bit more leverage than it used to have over Bulgaria. The erosion of budgetary cushions built up during the boom years means the government and its budget is a lot more vulnerable to hold-ups and suspensions of EU funds than it used to be. Indeed, the EU has recently frozen funding for two regional development projects in Bulgaria after criticising the management and control of the projects, causing dismay in Sofia.

The probable winner of the snap elections, former PM Boiko Borisov's Citizens for European Development of Bulgaria (GERB), on whose watch the JV for the Bulgarian bit of South Stream was signed, has come out in defence of South Stream, though he said it must comply with all EU laws. And it is here that Brussels can apply most leverage on the pipeline's EU supporters as well as the Russians.

Third parties The EU has strict rules about energy infrastructure allowing so-called third party access, which is a crucial factor that allows competition in energy

"The South Stream offshore pipeline in this regard does not fall under the scope of the third energy package"

explained a scheme which offset some rather moderate debt against income from the pipeline, so there is no burden to the budget). In June, however, the opposition Reformist Block has been saying that it has seen a recently signed contract involving a €620m loan on (unspecified) unfavourable terms to cover the Bulgarian contribution to construction. Generally, there’s some fear that Bulgaria may find itself in a similar situation to that with the longplanned Belene nuclear power plant – ie. saddled with debts and lawsuits

markets to develop. If, say, an owner of the electricity grid or gas pipe won't allow other producers of electricity or gas access to the distribution network, how can competition exist and grow?

The EU allows exemptions to this rule in order to allow network infrastructure builders to recoup the vast construction costs, but this must be agreed through tough negotiations with the European Commission. And Brussels has been in an uncompromising mood with Gazprom for some years now.

In September 2012, the Commission launched a formal investigation into alleged price fixing and monopoly practices at Gazprom, which could result in massive fines as well as subsequent lawsuits from individual countries.

On March 26, the office of Joaquin Almunia, the European commissioner responsible for competition, said the antitrust investigation is ongoing and a completion date impossible to predict, but the timing would depend "on whether Gazprom will offer remedies that fully and effectively address the Commission's concerns," his office said in a statement. Russian delegations have reportedly visited Brussels several times this year, though details of the talks have been kept under wraps.

Certainly Gazprom has already made concessions to several European states over the past year, agreeing to big price cuts for countries like Poland, while hardball tactics by Lithuania over enforcing the EU's third energy package pressured Gazprom into agreeing on June 12 to sell its 37.1% stakes in Lietuvos Dujos and gas transmission system operator Amber Grid to Lithuanian state enterprises.

In a sign of its frustration, Gazprom in May complained about the EU's double standards in applying the rules to the offshore section of the pipeline that lies in Bulgarian waters, saying it is an import pipeline and so not part of the EU’s transmission grid, which would be subject to competition law. In a document explaining its legal position, Gazprom said the EU was applying rules to penalise Russian gas that it did not apply to the Greenstream, Maghreb, Transmed and Galsi pipelines that import North African gas into Spain and Italy. "The South Stream offshore pipeline in this regard… does not fall under the scope of the third energy package," the Gazprom document said.

Then there are the necessary permits Gazprom needs to build the pipeline across EU territory. It has the permits for the section of the pipeline that runs under the Back Sea, but it hasn't yet secured them for the whole onshore section.

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What this means, Jonathan Stern, a fellow at the Oxford Energy Institute, told Petroleum Economist, is that Gazprom and its partners are likely to build just two of the four lines, which would be enough for only around 10bn cm/y of gas to flow through South Stream from around 2020. Gazprom wants the gas to start flowing in 2015, and full capacity of 63bn cm/y to be reached as soon as 2018.

Such a scenario of low gas volumes feeds into another big problem that Gazprom has to contend with: South Stream's economic viability.

Pipelines are hugely expensive, which necessitates getting as much gas down them as possible over their lifetime in order to cover the construction costs.

South Stream is especially expensive, given the offshore section will reach depths of up to 2,200 metres beneath the Black Sea – around six-times deeper than Nord Stream under the Baltic Sea – while the pipes nearer to the shore will be coated in concrete for more

Cover story

stability and protection, says Petroleum Economist. The whole project is built to last 50 years.

In December, estimated total costs for the pipeline, including the upgrades needed on the Russian side of the

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third-party access – for example, by allowing Russian independents to use it and by giving Azerbaijan the opportunity to use their internal grid for transit purposes (though with TANAP being built through Turkey, it probably won't take up the offer).

"Together with Nord Stream, the two pipelines form a kind of pincer movement on the EU gas markets"

border, more than doubled from initial estimates to around €30bn. By the time it's completed, inevitably that will rise further. To make all that money back, Gazprom has to send enough gas down the line over many years.

Some pundits say that the Russians probably could make South Stream pay even with granting the EU's hallowed

If the Russians manage that, plus the EU as a whole keeps up its insatiable appetite for gas while its member states continue to put their own interests above those of the bloc, then South Stream – against the odds at a time when Russia's standing in Europe couldn't get any lower – might actually get built.

www.south-stream.info

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I Perspective

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Looking down Russia-China pipeline from Beijing's end

COMMENT:

Karine Hirn of East Capital

T

he $400bn Russian gas pipeline deal has been hailed as a game-changer for Russia, but what does it mean for China? Pipelines are the geopolitical equivalent of marriage and China has happily tied itself to Russia for the next 30 years at least.

The most obvious benefit is 38bn cubic metres of gas per year (cm/y) that will be delivered to China's northern border over the next three decades. Most of China's economic development has taken place along its coast, with the interior and some of the Northern Territories remaining economically backward. Copious amounts of cheap energy will help the government in Beijing to develop this part of the country, and close the social imbalances and inequality gap with the more developed southern and coastal Chinese provinces.

But the deal is more important for the impact it will have on the whole country: diversifying China's sources of imported gas; cheaper gas for the whole country; and ensuring longterm stable supplies of gas for the energy hungry economy.

Russian gas supplies also address a second social issue that threatens to undermine Beijing's authority: pollution. Still heavily reliant on coal to meet China's burgeoning energy needs – gas penetration as a share of overall fuel use remains at a low 27.5% of the total in urban areas – the air quality has suffered and is becoming a real issue, especially for the emerging middle class.

The Russian deal for 38bn cm/y through a Siberian pipeline is roughly equivalent to a quarter of China's current gas consumption, and less than 10% of its estimated demand by 2020. In 2013 China consumed 170bn cm of natural gas, and expects to consume up to 250bn cm in 2015, according to the government. That's a cumulative increase over five years of 19% a year, if the economic growth targets are met. By 2020, China should be consuming 420bn cm in total, of which 120bn cm needs to be imported.

Russia could play a big role in supplying China with its imported gas needs. Firstly, there are clauses in the contract that would allow Russia to double its delivery of gas over

the lifetime of the deal to 68bn cm a year. While the initial investment into pipelines calls for the Russians to spend $55bn and China another $22bn on new pipelines on each side of the border, there are also plans for a second pipeline through Russia's Altai mountains to the XinJiang province, which could carry another 30bn cm/y. Analysts in Beijing believe this second pipeline could appear sooner rather than later.

Clearly Russian gas is never going to substitute China's need to import gas from elsewhere, but it will give it a very useful bargaining chip in negotiating with suppliers of alternative sources such as liquefied natural gas (LNG) suppliers from the Middle East and Australia.

Currently the deal is a pragmatic arrangement to supply China with 10% of its future natural gas consumption.

However, Beijing and Moscow are already talking about establishing "a comprehensive energy cooperation partnership" that will bring the two powers even more closely together.

In order for China to make much use of gas, lots of investment needs to be poured into the domestic gas distribution system. It is another testament to the strategic nature of the new relationship, as governments do not undertake that sort of commitment to infrastructure spending if they are not sure of their counterparty.

The Russian gas western line will connect to the current West-to-East Line 2, which is a trunk pipeline starting from the Xinjiang Tarim basin and ending in Shanghai. China’s domestic gas pipeline construction has been going on for over a decade, so initially the additional capital expenditure on new pipelines within China should be limited. The government now encourages private capital into pipeline construction business as well, which will open up a whole new class of investment opportunity for investors.

Energy supply is of strategic importance to the country and demand for natural gas is solid. Beijing is convinced it is worth spending on, but the question is more of who will bear the cost. Economic incentives for gas need to be improved

Perspective I 15

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and have already engendered an ongoing gas pricing regime reform to put the business on a commercial basis.

The closer relations with Moscow that have been cemented with the gas deal will be extended into other areas as well: China is very interested in Russia's potential water supplies from the Siberian rivers for its barren north-eastern territories, as well as land leasing for food cultivation and logging.

The political dimensions of the deal are also significant.

China clearly now views Russia as an important international ally, which was underscored when President Xi Jinping chose to visit Moscow on his first official visit abroad last spring. To China, Russia is important as a partner facing the hegemonic hold on international politics enjoyed by the US. Karine Hirn, Partner and Senior Advisor at East Capital

Russians happy but conservative

R

ussia's economy may be slowing and the country facing the worst cisis with the West since the fall of the Soviet Union, but its people are more content with their lives than at any time in the last two decades.

A June poll from the state-owned Russian Public Opinion Research Centre (VTsIOM) found Russians are the happiest they have ever been during the past 25 years, with the happiness index reaching a historic high of 64 points. That translates into a whopping 78% of the population saying they are "happy."

Given VTsIOM is state owned, that figure might raise suspicions. But actually the result fits with a string of polls taken recently that suggest Russians are even more content today than they were during the golden age of communism in the 1970s and pleased with the way Russian President Vladimir Putin is running things. According to a poll in June by the independent Levada-Centre, 86% of young people aged 18 to 24 back Putin. VTsIOM's poll found a similar result, with Putin's popularity surging on the back of a surge in nationalistic pride following the annexation of Crime to a record high of 84%.

Do you appreciate conservatism?

VTsIOM also found the number of Russians who are unconcerned about growing old has risen dramatically: two-thirds (64%) of respondents said they were not afraid of aging, with 45% saying they believed there were distinct advantages to old age, compared with just 20% a decade ago.

This suggests a sea change in attitudes to old age is underway; a poll conducted a few years ago found that 80% of Russians intended to continue in their jobs until they drop dead, which implied a basic mistrust in the government's ability to look after pensioners. Part of the reason for the reassessment is no doubt Putin's decision to hike pensions by 50% as part of his 2012 campaign to be re-elected president for the third time – a move that has materially transformed the lives of many pensioners.

In parallel with the growing Russian feel-good factor is a move towards growing conservatism in Russia. VTsIOM found that 56% of Russians were confident that conservatism helped preserve traditions and social structure, up from 44% ten years ago. A study by the Foundation for Development of Civil Society concluded that conservatism and happiness are linked.

"It is due to the social and economic development of Russia and the preservation of the conservative nature of its society that everyday Russians feel happy," the Foundation concluded.

Which statement do you most agree with?

2003

2014

Definitely yes

9

11

Conservatism is something

Rather yes

28

37

that helps preserve traditions

Rather no

24

27

of the country, current social

Definitely no

9

8

structure and moving steadily

Don't know

30

17

without perturbations

Conservatism is something

Total respondents

Aged 18-24

25-34

56

45

54

53

56

68

31

41

33

36

31

20

13

14

13

11

14

12

35-44 45-59 60 and over

that impedes moving forward Don't know Source: www.wciom.com

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though its thousands of miles away.

I’m not saying I don’t like people from Western Ukraine. I’m talking about how close I feel culturally, not personally nor in terms of friendship. So – a rather complicated answer to a simple question.

LH: How did you feel when the Kyiv protests escalated in February?

VG: I felt the initial protests were positive. I was happy Ukrainian people were standing up for their rights. And I didn’t particularly like President Yanukovich. But as the situation escalated, it became clear [Oleh] Tyahnybok [Leader of Ukrainian nationalist party Svoboda] and [Dmytro] Yarosh [who heads the far-right party Praviy Sektor] were the main agitators.

Their messages were so Russophobic, so extreme, that it shocked and scared me. With such people in charge, and Kyiv pushing an aggressive nationalist agenda, I was frightened for ethnic Russians living in Ukraine. Our country isn’t inherently divided, but is culturally diverse. That diversity can be exploited – given the differences between the traditionally rural Western Ukraine and the more industrialized East.

Graziadei anger towards euromaidan passionate – but no act INTERVIEW:

V

era Graziadei (nee Filatova) is a familiar face to British audiences, given her role in the cult Channel 4 series Peep Show, numerous TV dramas and widely-praised theatre and film work. Born in Donetsk, to a Ukrainian mother and Russian father, she came to the UK as a teenager and was educated at the London School of Economics. But Graziadei’s passions go beyond acting. Recent events in Ukraine have left her shocked and disturbed, as she tells Liam Halligan in London.

Liam Halligan: Are you Ukrainian or Russian?

Vera Graziadei: Actually, first and foremost I’m a Brit. I swore my allegiance, took citizenship and spent my formative years here, having arrived at the age of 13. Back then, I’d tell people I was Russian but born in Ukraine. That was a kid talking. As an adult, I say I’m Ukrainian. But if I meet two people from Vladivostok and Western Ukraine, I feel culturally closer to the person from Vladivostok, even

When the Maidan protesters were extremely violent towards young guys from Berkut [Ukrianian police], I got really worried. Berkut was doing its job – trying to protect gosdudarstvenost (statehood), maintaining law and order. It’s not as if they were backing Yanukovich. On 20th February, when the protesters were roused to become violent again, storming buildings, even though Yanukovich had agreed to earlier elections, I became disturbed.

Why couldn’t they wait until the newlyscheduled elections in May? Why create these extra problems?

I had little time for Yanukovich. But you must differentiate between an individual and an institution. The state, the rule of law, must be protected. The way Yanukovich was ousted undermined that. I wanted him to go in principle, but he’d been fairly elected and that democratic contract with the people was broken. When one group gets power

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using violence then other groups will think, OK, so we can also get power using violence. This was a major setback for Ukrainian democracy.

LH: To what extent were events influenced from outside, in your view?

VG: Well, we have [US Secretary of State Victoria] Nuland on tape, basically ordering who should be in the Ukrainian government and who shouldn’t. If that’s not evidence, I don’t know what is. But there is plenty more. An apparently independent Ukrainian media channel Hromadske TV is sponsored by the Dutch and American governments.

To my mind, that suggests Shell and Chevron – given the corporate struggle for Ukraine’s oil and gas. And we’ve had many Western-funded NGOs working in Ukraine before the protests, of course.

My mother is Ukrainian. I fully understand why some people want to preserve Ukrainian national identity.

Many Western Ukrainians are happy to get outside assistance to do this. It’s not a secret – they’re proud America is helping them. But many others are different from them and would prefer to be closer to Russia. They can’t expect all Ukrainians to feel the way they do, even though I understand and respect their motivation.

What I absolutely don’t respect is the way West Ukrainian forces have tried to achieve what they want. Of course, Ukrainian consciousness is legitimate and we need civic society. But the way it has been done now makes me more and more against it.

LH: Who do you think was behind the Kyiv sniper shootings on 22nd February, which killed over 60 people?

VG: I’ve become pretty obsessed with this issue. [Estonian Foreign Minister Urmas] Paet suggested someone in the Ukrainian government may have ordered these shootings, to escalate the situation and generate total disorder.

And it’s not as if he’s a friend of Russia.

I can’t say if this is true or false. But, Ukrainian citizens should demand an investigation, an explanation.

LH: As a British citizen, how do you think our government has acted?

VG: It is difficult for me to accept, as a Brit, that the British government, for many months, backed a government effectively founded on violence. All governments do some things I don’t agree with – be they British, American or Russian. But in the UK an atmosphere has been created in which, if you don’t unquestioningly support our foreign policy, backing the Ukrainian government, you’re a Putin apologist.

This makes me think people are only interested in Ukraine because they’re anti-Putin. They may know nothing about the history and culture of the country and broader region. They will just automatically say the side Putin supports must be wrong. Such narrow thinking, and claims that East Ukrainians are merely victims of Russian propaganda, is self-serving and generates more misunderstanding and tension.

LH: What do you make of how Russia is covered in the western media?

VG: I became angry during the run-up to the Sochi Winter Olympics – way before this unrest in Ukraine. There was a mania in the West to bash Russia and I felt sad for the Russian people, not least because I think they did a great job in Sochi. Many athletes, from all over the world, have since said how well organized the Games were. I was at both the opening and closing ceremonies of the London 2012 Olympics – and felt genuinely proud of the UK. I can’t be proud of the Sochi Olympics, as I’m not a proper Russian. But I was impressed – as any objective observer would be.

LH: As the Maidan riots escalated, how did your western friends respond to you?

VG: I never felt ashamed of my views, even when I was criticized for them.

They come from a place of truth, because I know what being East Ukrainian is like. I wasn’t too vocal at first, because I wasn’t sure if other East Ukrainians felt the same. But when I saw massive protests against the new Kyiv

government, I knew I wasn’t alone. For us, the violent, aggressively nationalistic and Russophobic undercurrents of Euromaidan, along with all the fascist insignia, are entirely unacceptable.

I’ve had some real insults thrown at me for not taking a mainstream stance, been called a Putin apologist and faced accusations he pays me money.

I’ve previously argued against many of Putin’s actions – so it’s been rather bizarre suddenly to find myself placed in this pro-Putin camp.

It’s pathetic blindly to accept what the Western media says without independent research or thinking. Many people I know in the arts industry were entirely uninterested in Ukraine. Then, suddenly, the rights of Ukrainian people were incredibly important to them.

Sochi was over, so this was a new thing to use to beat Russia, the big evil other, allowing the West to feel good about itself in a complex world. When you have one big bad figure, and everything is Putin’s fault, the world is simple and you don’t need to think anymore.

LH: Are western commentators right to talk of “a new cold war”?

VG: You wonder what people’s motivations are. This narrative is driven by a desire to make Russia appear weak and marginalized. Just because people write newspaper columns, it doesn’t mean they’re right. Many commentators who supported the Iraq invasion are still part of the Western media establishment, writing articles all the time. Yet that was clearly a mistake – and Putin firmly opposed it, by the way. Again, you don’t have to be an apologist to agree with some of his foreign policy decisions.

He was right again to argue against bombing Syria – as the British Parliament recognized. Acknowledging that doesn’t mean you agree with everything he does.

LH: How about Crimea? Despite its history, and a decisive referendum, what happened still transgressed international law.

VG: Yes, but at least there isn’t civil war in Crimea, as there is across Eastern

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Ukraine. Many of my friends and family from the East are now seeking refuge in Crimea.

LH: What did you think of the postprotest Kyiv government? And what of the government now?

As someone with many friends living in Crimea, who has been there every summer since I was 6 years old, I know it very well. For the majority of Crimean people, the referendum, and its outcome, was a huge relief.

I’m happy for them. And Crimea is now stable, compared to Donbass or Odessa, for instance, where we had a horrendous massacre at the Trade Union headquarters.

VG: In February I was frightened, and many in Eastern Ukraine were frightened too. The government instantly tried to delegitimize the use of the Russian language – an extremely provocative move. Svoboda would get barely 1pc of the vote. So why did they have 6 or 7 ministerial positions? Why was Yarosh allowed to oversee a legal militarized group? Praviy Sektor had been conducting atrocious crimes all over Ukraine and was then legalized. That was shocking.

This atrocity in Odessa was celebrated in the Ukrainian press. People on prime time talk shows were applauding these deaths. Tymoshenko, too, said the Odessa massacre was a great thing, along with many other Ukrainian politicians and public figures. This total lack of empathy, with Ukraine going down a genocidal path, scares me very much. We’ve just seen slaughter in Odessa, which is part of Europe. As a Brit, it shocks me the Western media has been practically silent.

And what about other war crimes – like the bombings in Luhansk, Slavyansk and elsewhere? The British public needs to know what their government is supporting. Some people in the UK think Ukraine is now quiet. Actually, there is a civil war – and it will get much worse if the Kyiv government isn’t stopped.

LH: Does Putin want Eastern Ukraine to become part of Russia?

VG: I don’t think he wants to invade and I don’t think he will. Ukraine is just too culturally diverse, even in the East.

A lot of Ukrainians, of course, want a united Ukraine – and if Putin tried taking the East of the country it would be an international scandal. On the other hand, if there’s a huge war right next to Russia’s border, some kind of action may be needed. What I think Putin truly wants is an agreement to unite Ukraine, but with Eastern Ukraine having close links to Russia. Everything should be decided, of course, by a countrywide referendum. It is for those living in Ukraine, not people abroad, to determine the outcome.

Since the election, the extremists haven’t gone away. They’re still in power. Yarosh has a senior post in [President] Poroshenko’s private army.

It makes me wonder who on the Maidan had an interest in provoking violence and getting power that way? They wouldn’t have gained power through a democratic process.

Although the May election barely happened in the East, there was a glimmer of hope within me when Poroshenko took office that he’d be more intelligent than Yatsenuk and wouldn’t just be steered by the CIA and domestic anti-Russian oligarchs.

But now I’m outraged at the bombing of civilians in the East by the Kyiv government. It’s very difficult to be positive. I don’t necessarily support DNR (the self-proclaimed Donetsk People’s Republic) but their motivations are powerful and legitimate. Where all this is going, I don’t know. But Iraq shows us that the more you suppress people, the more radical and extreme they become.

The Party of the Regions has failed the people of East Ukraine. It always represented the oligarchs’ interests anyway. East Ukrainians feel no-one is looking out for them. We’re talking about largely working class people, with few connections to the political world.

That’s why DNR has emerged – and it wants to negotiate with the government.

LH: Given your joint Ukrainianwestern background, what is your advice to western political leaders?

VG: I understand the rights of East Ukrainians aren’t the primary concern of the British government. Yet there are thresholds that mustn’t be crossed. War crimes are happening in Europe. It’s a humanitarian disaster.

Western governments must step up and tell the Ukrainian government to stop doing this. They won't do this as the Western media is showing little of what's happening – even though it's all over the internet. These crimes have been filmed by hundreds of people, from every angle, but our mainstream media isn’t showing any of it – and that’s scary.

Instead, events in Ukraine are often reported in a patronizing colonial manner. A BBC journalist visiting Eastern Ukraine saw old Soviet relics in the street and declared that local people are stuck in a Soviet mindset, leading them to support DNR. That’s entirely wrong. You’d think the BBC would make an effort to understand the concerns of local people. Such reporting brings the Crusades to mind. “These barbaric East Ukrainians have false gods! What they need is our god!”

LH: Can this rift between Russia and Ukraine be healed?

VG: I was recently at the Moscow State circus and, when a gymnast came on to a traditional Russian theme, the music triggered in me a realization of how much has been lost, that these two countries, which have always been very close, are now basically at war. I felt very sad and cried. As an East Ukrainian, I always saw these nations as brothers. Yet something has died in that relationship.

I’m now aware that, for all these years, Western Ukrainians felt differently to me. Perhaps they never had this feeling of unity that I always had.

Ukraine could split in two. Whatever happens, the outcome must be decided by those living in Ukraine. My sincere hope is that not everyone in Western Ukraine hates Russians and East Ukrainians and that, hopefully in my lifetime, these nations will come closer together again.

Eastern Europe I 19 The only magazine covering business, economics, finance and politics in the dynamic new markets of Emerging Europe and the CIS

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INTERVIEW:

Sweating the chinovniki

Ben Aris in Moscow

S

ummer has finally come to Moscow and the main hall in the Red October chocolate factory that sits on the River Moskva across from the Kremlin is buzzing with young workers flapping about in flip-flops or hunkered over computers writing code. This is ground zero for Russia's attempts to modernise itself. The iconic red brick building was converted several years ago and today is a hive of bars, cafes, conference rooms and internet start-ups. So the gaggle of bureaucrats in suits making PowerPoint presentations in the corner looks somewhat out of place.

The men are second-tier officials from Moscow City government, who are making presentations to the powerful Moscow mayor Sergei Sobyanin and his former deputy and now dean of the Skolkovo business school, Andrei Sharonov. "These chinovniki have been told to come up with new ideas for their various responsibilities and they are kind of nervous," says Sharonov, who is becoming an intellectual force in Moscow's drive to drag itself into the 21st century, using the old Soviet word for bureaucrats. "It's like an end-ofyear test."

A pet Kremlin project inaugurated by then-president Dmitry Medvedev a few years ago, Skolkovo has been struggling to gain traction, but it has been given a new lease of life since Sharonov took over earlier this year.

One of the rare examples of a can-do Russian bureaucrat, Sharonov during his time as deputy mayor oversaw the

introduction of bus lanes and paid-for parking in the Russian capital, which have reduced traffic by a quarter and vastly improved the city's legendary problem with traffic jams, among other things.

In his new job at Skolkovo he is attempting to deal with an altogether more insidious problem – the lingering Soviet mentality that is at the root of Russia's slow progress in making structural reforms. "If you meet a group of Russian businessmen and a group of Europeans, with the Russians you see brilliant individuals, but together they're bad managers and disorganised.

situation in Russia has changed a lot from 10 years ago, but there is still a big gap to close with what we expect to achieve," says Sharonov, taking a break from listening to the chinovniki's presentations, where he is acting as an advisor to the mayor. "Russia has a rich intellectual capital and even in the Soviet times there were many successes in research, but we don't have the mentality to commercialise and make unique products from our scientific endeavours."

Changing cultural legacies Much of this is due to the cultural legacy of the Soviet system. Studies

"These chinovniki have been told to come up with new ideas for the various responsibilities and they are kind of nervous" The European businessmen are less brilliant as individuals, but they work well together and create quality as a group," says Sharonov, whose athletic build and close-cropped hair makes him look a bit like the British actor Jason Statham.

Skolkovo is supposed to address this problem by training a new generation of managers, but it has yet to have had much of an impact on Russian business. Sharonov blames the wider problem of poor institutions. "The

comparing Russian and American academics found that the Russians are more focused on writing papers and winning grants, whereas their American counterparts dream of finding venture capital partners and getting into business. "There is a lack of the entrepreneurial expectations in Russia. But you have to consider that for 85 years it was almost a criminal activity to be an entrepreneur," Sharanov says, sitting by the floor-toceiling bay windows that used to light the chocolate factory's workshop.

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And this mentality has become fixed, as most of the successful businessmen that rose to prominence in the 1990s were cut from the Soviet cloth. Now they are so powerful, the barriers for entry for the new generation of more westernised businessmen remain high. "There are two types of businessmen in Russia.

The first somehow recognise that the scale of the business has overcome their intellectual capacity as a manager to cope with it and they delegate to others; the second, and by far more common type, consider that they are as good a manager for a start-up as they are for a huge industrial conglomerate. They try and control everything. They don't believe in the ability of the board of directors to manage the company and don't see it as a tool for controlling the business," he says.

In politics it is known as Russian President Vladimir Putin's verticalnaya vlast, or vertical power – a narrow pyramid of power where all the decision-making is concentrated in the hands of a very few people right at the top, who insist on micromanaging the process right down to the bottom. The same mentality is rife in the corporate world too.

The concentration of power and wealth in the hands of the few is made worse by the poor quality of the institutions that govern business in Russia, argues Sharonov. In a speech last year, Putin acknowledged that most of Russia's economic problems today are internal, and not caused by the global crisis. A World Bank study a few years ago found that 60-80% of Russia's productivity gap with the US was caused simply by bad management. So bringing the quality of managing up to US standards could result in the economy doubling in size without investing a cent.

To his credit, Putin has launched a comprehensive drive to do something about Russia's legendary red tape.

In a series of decrees issued in 2012, the president spelled out in detail the changes that governments and regions should make. However, two years later the government admitted in June that less than half of these orders had been implemented. An

Eastern Europe

ambitious privatisation programme has gone nowhere. A ban on offshore accounts and assets designed to reduce corruption in the government has not been implemented on time. And a package of rules designed to improve the transparency of state spending is only half finished. A lot of progress has been made with tax administration and connecting businesses to the electricity grid, but Russia still remains one of the worst places in the world for obtaining construction permits. All in all, the government has carried out only 121 of the 218 tasks that Putin set it.

Better than nothing And prospects for more reform have been hurt by the Ukraine crisis. The Kremlin's knee-jerk reaction has been to close ranks. Big state companies have been given more power as they play a more overtly political role. Putin has stamped out the nascent opposition movement, which in any case was dealt a body blow by the rise in nationalist and patriotic sentiment amongst the Russian population. "There's a basic contradiction here," says Sharonov. "If those who are trying to promote the new institutions don't believe in them, then they will fail."

Sharonov remains pragmatic in the face of these problems. The government has taken closer control over the stateowned companies, however the new companies, dealing largely with the Russian consumer, are being given increasing freedoms to work as they

I 21

please. "It's better than nothing," says Sharonov wryly.

This mixed attitude to the structure of the Russian economy is also reflected in the Skolkovo MBA programme, which includes a unit that sends candidates to do internships in both federal and regional governmental bodies. "We have to be realistic," says Sharonov. "In Russia it is necessary to understand how government works and you have to be able to interact with it."

It could take a generation before the new thinking reaches the upper echelons of power. But there is hope, as Sharonov himself is the epitome of the new thinking that is needed – albeit constricted by the existing system.

The hope is that Russia's current economic difficulties will be the goad the government needs to make the changes. "We need a new perception, a new set of values in Russia that are more based in reality," says Sharonov before returning to the Moscow city chinovniki presentations.

Here there are already visible signs of change. City bureaucrats can no longer sit in their offices and dream up schemes to enrich themselves. Now they have to produce comprehensive PowerPoint presentations for their bosses. They are visibly sweating – and not just because a heatwave has briefly descended on Moscow.

"Even in Soviet times there were many successes in research, but we don't have the mentality to commercialise our scientific endeavours"

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(MGIMO), where he studied marketing and foreign trade.

Photo: www.o1properties.ru

BRICKS & MORTAR:

After crisis Mints

Ben Aris in Moscow

R

ussia's real estate sector boomed and then went bust in spectacular fashion during the 2008 crisis. But as it starts to come out the other side, investors in the sector have dropped down a gear. "Real estate investment now is more like a fixed income asset that pays a high yield in a low interest rate world, rather than a speculative bet on rising property valuations that it was before," says Dmitri Mints, CEO of O1 Group, which bought up stalled projects in 2009 and is now the leading real estate company in Moscow's lucrative premier office segment.

The Russian-language Forbes magazine recently ranked O1 Group as one of the six largest commercial real estate companies in Russia. It was troubled office development deals that shunted the company to the top of the pile: O1's first-quarter profit grew three and a half times on year even though the Russian economy is barely growing at all. Russia may be shrouded by a pall of pessimism due to political and economic problems, but O1's prospects are good enough to have persuaded Goldman Sachs to take a 6% stake in the company in May.

Banking on real estate Mints is part of the post-Soviet generation that is building the new Russia. Born in 1991 in the town of Ivanovo – a textile hub near Moscow that used to largely employ women and was known in Soviet times as the "city of brides" as it lost

While still a student, Mints cut his teeth working for TransMashHolding, one of Russia's leading producers of railroad equipment and rolling stock. But after graduating he went to work as an analyst at SDM Bank, a leading mid-tier bank that specialises in catering to the needs of Moscow's medium-sized enterprises and factories. Still only in his twenties, Mints was tasked with leading a fund that specialised in investing Russian money into foreign real estate. "There was a huge real estate boom in the Baltics and a very profitable story in Latvia and Estonia. We got in early and got out at the right time," he says.

After three years Mints left SDM to join Otkritie Bank, an up-and-coming investment bank where his father was a co-founder and 50% shareholder.

Otkritie was also interested in real estate and launched a fund to finance the construction of a huge office complex behind the Paveletskaya train station in southern Moscow. "In March 2008 we pre-sold the offices to the German real estate investment fund KanAm for $1bn.

At the time it was the biggest forward sale of real estate on the market, but the problem was the deal wasn't completed

"You can't find that kind of return anywhere else in the world at the moment"

so many of its menfolk in World War II – his entry into the commercial world was made easier as Mints' father, Boris, worked in the Yeltsin administration in the 1990s, first as a property manager for the state property fund, and later running the presidential administration's relationships with smaller cities.

The family moved to Moscow when Mints was 13 years old, and he finished his studies at the prestigious Moscow State Institute of International Relations

before the current crisis struck that autumn," says Mints.

The project had been financed with loans from Deutsche Bank and Bank of Austria. In the mess that followed the collapse of Lehman Brothers, Mints says they bought the Deutsche Bank loan out, although Bank of Austria stayed in as a creditor, taking three buildings as collateral. As part of the resolution, 01 Group was created and took over the remaining assets to finish one office and

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the hotel, which was financed separately and sold. The spring of 2009 was not a happy time for Russia. The equity market was in free-fall and the economy had more-or-less collapsed, shrinking by 7% in that year alone. The real estate bubble popped and a lot of people found themselves and their projects in trouble.

"At the beginning of 2009 we looked more closely at the markets. We bought buildings that were half-finished. Otkritie put up some money to finance these projects and we raised more," says Mints.

Mints Snr's partner at Otkritie, Vadim Belyaev, was not interested in getting into the real estate business, so Mints sold some of his shares to raise cash and 01 Group became a separate company.

With money in the bank, the company went shopping for troubled projects, quickly completing them and leasing them out to tenants.

More like fixed income The nature of investing in real estate has changed since the crisis. Previously investors were looking at the rapid appreciation in the valuation of buildings for their returns. Development was done on debt and real estate companies listed on the exchanges to raise cash and tap the bullish outlook for investments.

These shares soared, making everybody a lot of money, but since the crisis stock prices have collapsed and the volume of development projects shrank dramatically.

Mints says that investing into real estate these days is more like investing into fixed income. "Our model is different. If Russia doesn't collapse and the economy continues to grow by about 1% per annum, then investing into real estate can be very profitable. With leverage it can pay a high cash-on-cash yield of about 12% backed by tenants of the highest credit quality. You can't find that kind of return anywhere else in the world at the moment," says Mints.

Interestingly, many Russians agree with him. One of the side effects of the West's threat to impose sanctions on Russian businessmen over the Ukrainian crisis has been that a lot of Russian money has left global tax havens and returned home

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Signs of life in Russian real estate

bne Real estate is the bellwether of any economy: it's the first to collapse when times get tough and the last to recover when crises pass. Comatose for the last six years, Russia's real estate sector seems to be finally coming out of intensive care.

Russian investment banks have started issuing research again on the sector, putting 'Buy' recommendations on what they call "the Russian troika" of real estate companies. "The recent results and corporate developments have led us to revisit our view on the Russian real estate sector. The strong cash flow generation in 2013 and robust outlook on 2014 financials tended to be overlooked in times of political turmoil, so have not, therefore, been fully recognized," VTB Capital's real estate analyst Maria Kolbina said in a report released at the start of June.

Despite the slow pace of economic growth, demand for new housing remains extremely high in Russia – and so are the margins. One of the oddities of the crisis is that it didn't depress residential real estate prices; people with attractive apartments just took them off the market to wait for better times.

With over 80% home ownership, Russia is in a unique position in Europe.

As homeowners are not exposed to mortgage payments, they can simply sit in their apartments and wait until prices recover, which makes the market extremely robust.

VTB highlights the stocks of three of Russia's leading real estate companies as offering investors the most attractive exposure to the sector: LSR Group, PIK and Etalon – all specialists in residential development. "In 2013, we saw record high deliveries of 69.4mn [square metres] and the number of registered housing rights hit 11.6mn," Kolbina writes in her report. "The political uncertainties and ruble devaluation skewed the annual demand to first quarter of this year and is likely to cool activity in the coming quarters, capping the price inflation behind the CPI in the Moscow and St Petersburg metropolitan areas."

The sector's recovery is also been driven by the switch amongst Russian banks from consumer lending to the more profitable mortgage lending business; mortgage lending has more-or-less been doubling in volume every 18 months or so since 2008. "Mortgage origination topped RUB1.35 trillion ($38.5bn) in 2013, as banks switched their focus to more secure lending and the investment attractiveness of housing over deposits grew in times of declining interest rates," says Kolbina.

LSR is also a top pick of Swedish-based investment firm East Capital.

Managing partner of the Russian fund Jacob Grapengiesser said during the company's recent investment conference in Belgrade that: "LSR is our top pick from the real estate sector. Income is growing at 50% and the dividend yields are an attractive 7%. But most exciting is a huge new project to convert the last big factory in Moscow, a 13-hectare site that is equivalent in size to all the company's other projects put together."

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in just the last few months. "These guys are looking around for something to do with their cash and many of them have put it into real estate," says Mints.

However, the outlook for the real estate sector in Russia is mixed. Precrisis, the economy was growing by 5-6% and many tenants had plans to expand rapidly, as their business plans predicted strong growth. Not now. Mints says office demand has fallen away as most tenants are not investing in their businesses and instead are concentrating on improving efficiency rather than scaling up.

Foreign exchange dynamics have also had a large effect on the real estate sector. Nearly all of Moscow's big real estate deals are priced and paid for in dollars. That includes the rent. Pre-crisis the ruble was appreciating strongly,

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68% is owned by the Mints family and 1% by management. In April the Russian industrial group ICT, owned by tycoon Alexander Nesis, bought 26% of the company (he is also getting into banking and bought a stake in Otkritie).

The money he spent on O1 Group has gone into setting up a pension company.

"The sale to ICT was more like a partial exit. We took the cash out and have used it to invest into a non-state pension fund business that is now part of the O1 Group," says Mints.

A month later O1 Group sold another 6% to Goldman Sachs. The US investment bank has good form in Russia, as it was an early minority investor into leading online bank Tinkoff Credit Systems (TCS), which floated in London in October last year with a $1bn valuation.

Clearly Goldman would like to see another IPO and Mints says it is definitely

"You can't find that kind of return anywhere else in the world at the moment"

which meant rents were becoming cheaper and cheaper as most companies working in Russia make their money in rubles. That had the effect of driving up real estate valuations.

Post-crisis, the ruble has been depreciating; the value of the ruble against the dollar has fallen by about 15% this year, although it has recently stabilised. That makes the dollardenominated real estate projects and rents more expensive.

on the table, but only when market conditions improve. "Goldman Sachs has invested into the company as a financial investor and their money – about $100m – has stayed in the company. It is being used to extend the business," says Mints.

Taking the biscuit Real estate tends to lag behind the rest of the economy: when times get tough

it is the first sector to go into crisis, and when times improve it is the last to recover. "The Russian office market has always been, is, and will continue to be a tough market," says Mints. "Not many deals are being struck at the moment, but lots of people are starting to look at the sector again. And banks are still financing projects so we're not sitting on our hands."

Currently 01 Group's biggest project is the renovation of the Bolshevik Biscuit factory on Leningradsky Shosse, just north of Belaruskaya station in Moscow's heart and one of the choicest locations in the capital.

Bolshevik Biscuit is an iconic location.

The factory was the first in the Soviet Union to use electric light bulbs when the world was electrified a century ago.

It was also one of the very first Soviet enterprises to be put into the voucher privatisation in the very early 1990s.

The 6-hectare site was bought by Kraft Foods in 2012 and used as a production centre, but more recently the company relocated its production to the more cost-effective Golden Ring city of Yaroslav and sold the site to O1 Group.

The company has been renovating the 16 impressive Tsarist-era buildings and intends to lease them out to top-end clients. French media firm Publicis has already taken leases on three of the buildings and is in the middle of fitting them out. "Publicis was the first prelease deal since the crisis," says Mints.

"For most of the last five years nobody was leasing a building until they had seen the finished product."

Demand has also been dampened by the exit of many foreign investors; pre-crisis, most of the money for developments came from outfits like German pension funds or UK hedge funds. "Now those guys have all disappeared," says Mints.

The upshot is real estate development has become a more exclusively Russian business backed by Russian money. 01 Group is a family trust, of which about

Photo: www.o1properties.ru

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Eastern Europe

Russia's Bookmate takes on the global e-book giants Ben Aris in Moscow

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aunched in 2010, Bookmate. com is Russia's fastest growing online book service, whose radical subscription model threatens to disrupt the global giants of the electronic book market.

Subscriptions are a new idea to the book-selling business. The rampant intellectual property abuse in Russia meant that Bookmate had to do some innovative thinking if it was to make money from its users. "It has been an advantage setting up the business in Russia," says Simon Dunlop, Bookmate's co-founder. "We were forced into thinking out of the box when it came to monetizing e-books. Like any emerging market, piracy is rife. It is impossible to make a user pay for a title when it is so simple for them to download a pirated copy for free. This pushed us to concentrate on the overall experience, not just on selling titles.”

That led to subscriptions. Music blazed the trail when it comes to getting punters to sign up and pay a monthly fee for content and the industry has

now accepted that subscriptions is the way forward. Sites like Spotify and Pandora are growing exponentially, while the number of downloads of songs on iTunes has begun to slow.

Video is going down the same path with services such Netflix, but books have been slow to convert to the new paradigm.

Part of the reason is the way people read books. If you listen to music or watch a movie, it is possible to do something else at the same time. But the book is a

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Russian reading habits Reading e-books has grown fast in Russia. Today, Bookmate has 1.2m users and carries 400,000 titles, including 250,000 Russian titles (the lion's share of all the best-known Russian authors – both classic and contemporary). The company has signed deals with about 300 Russian publishers that represent about 90% of Russia's publishing industry, worth a total of about $2bn in 2012, of which the licenced e-book business makes up only 0.4% of the total. By comparison, e–books already make up 11% of the publishing business in the US and just the e-book business alone is the same size as the entire Russian publishing sector, or $2bn in 2011, and this is doubling every five years or so.

Bookmate identified several Russian reading habits that have led them to their subscription model. "For many Russians, their phone is their primary computing device and they tend to read books on mobiles more than any other device," says Dunlop. "A key element of our success has been to integrate e-books into the device where Russians spend most of their time. Reading competes with mobile games, social networks, Twitter etc. so to win you need to remove any barriers to reading, such as having to carry a separate device such as a tablet and to provide the content in a way that adds value for the subscriber.”

One of the most basic changes the subscription model brings is the ability to start books to see whether you like them, and discard them without penalty if you don’t. "The model changes

"We were forced into thinking out of the box when it came to monetizing e-books" serious commitment of 10 to 20 hours of your time when you can do nothing else. That means the user is much more committed to choosing a title and the publishers compound this behaviour by focusing on the sale of files or titles.

everything," says Dunlop. "When you decide to read a book it is an emotional decision. When you decide to buy the title you also have to make a monetary decision. By removing the monetary decision after you have subscribed, you

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have the freedom to read whatever you want and it is a more satisfying experience for the user."

Finding books that you might like is actually quite difficult. Most people rely on the recommendations of friends or book reviews. The unfettered access to over a million titles means that Bookmate can take advantage of social networking in order to help people find titles that they will enjoy.

Once you sign up to the service, you can link friends who can recommend books that will automatically appear in your bookshelf. The company is rolling out a service that scours your Twitter and Facebook feeds for book mentions: if anyone in your circle mentions a book, then it will appear in your bookshelf.

"This totally changes the relationship between the reader and the publisher.

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Moreover, the online book business allows the same publishers in the West to tap into the huge emerging markets that they have not yet touched.

"Western publishers have invested heavily in printing and distribution networks in the West. But because of the piracy they have made few investments in emerging markets. There are more English speakers outside of Britain, USA, Canada and Australia than inside. Altogether, if you add up the number of English readers in places like India, Nordics, SE Asia and Eastern Europe, there are over 400m people which are not catered to at all," says Dunlop.

Western interest Bookmate was launched with a Russian catalogue, however it has signed contracts with publishers producing English, Spanish and Turkish books,

"With electronic publishing the role of the publisher is more like that of a sports agent"

In the past publishers have financed the physical printing and distribution of books. Then they collect the money from the retailers and return it to the author," says Dunlop sitting in their spacious offices on top of the iconic Central Telegraph building in the heart of Moscow. "Today, with electronic publishing all of these services have disappeared and the role of the publisher is more like that of a sports celebrity's agent, managing the author's brand rather than producing physical books."

and is launching its services in at least six new non-Russian speaking countries this year, which has piqued the interest of some of the more established publishers in the industry. "We are disrupting traditional models used by Google, Apple and Amazon. What is true for emerging markets can also be applied to more developed markets.

Spain has one of the higher levels of book piracy in the world. We have been able to mitigate piracy issues by enriching the user's experience," says Dunlop.

In the West publishers have been reluctant to switch to a subscriptionbased model because they are afraid it will cannibalise their existing business.

However, in developing markets the publisher's business has already been cannibalised by piracy, so they are much more open to the prospect of incremental income through a subscription model.

Subscriptions tripled in 2014 as Bookmate introduced new ways of selling their product. It comes back to leveraging that substantial commitment a reader makes when they decide to spend several days reading a book.

Bookmate partners with several types of distributors in what it calls a B2B2C (“Bookmate to Brand to Consumer”)

model in order to distribute and sell its subscriptions. Most important among them are mobile phone operators, which have been losing their traditional voice business to online services like Skype, WhatsApp and Viber. These alternatives cut into mobile phone companies' revenue and also mean that users tend to change services regularly – the so-called churn.

Bookmate has already signed deals with leading mobile phone operators in Russia, such as Tele2, so that its service can be bundled as a valueadded offering to their customers.

"The mobile phone companies love it because once a user spends some time and effort to build up a library of books on their phone they're much less likely to change services and be forced to build their library all over again," says Pavel Pak, head of Bookmate's business development. "And it is good for us because the mobile phone companies already have a billing relationship with their customers.”

At RUB150 a month ($5), the service is inexpensive and Dunlop says that most punters trying out the service out for three months usually decide to subscribe.

In addition, Bookmate partners with handset manufacturers (such as Samsung and Philips) – both local and international – where Bookmate is preinstalled on mobile phones, and also with e-retailers looking to increase the life-time value of their customers.

Finally, Bookmate has struck deals with the Moscow City government to provide this service in public spaces. People can use a limited version of Bookmate for free on a park's WiFi or when they leave a library they can continue to read the book on a handheld device. "Over most of the last 10 years Russian online companies have mainly been copying ideas that are already working in the West," says Dunlop. "But as the market matures we start to see Russia producing innovative products that address its more specific problems, that in turn can change the way things work in the rest of the world."

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Eastern Europe

Bondholders fret as Ukraine oligarchs suffer Nick Kochan in London

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Pinchuk is an extremely high profile figure in Ukraine. He is married to the former president Leonid Kuchma's daughter and counts amongst his friends Tony Blair and Bill Clinton. But his company, Ukraine’s largest maker of steel pipes and steel railway axels, is based in Dnepropetrovsk in the increasingly insecure Russian-speaking east of the country.

kraine’s security crisis is hitting bond investors in some of the country’s largest companies.

A combination of the deteriorating economic situation, falling currency, increased Russian import duties on Ukrainian goods and rising gas prices has meant big local firms are struggling to meet coupon payments and are in danger of defaulting on their debt.

group. "Many portfolio managers are not allowed to invest in this bond, as it is considered junk by credit rating agencies. Interpipe bonds are regarded as high risk and there is a strong likelihood that they could be restructured again," Churin says, referring to the fact the bonds have been restructured on a number of occasions in recent years.

A series of Ukrainian companies linked to key oligarchs like Rinat Akhmetov, Ihor Kolomoisky, Victor Pinchuk and Dmitri Firtash are thought to be in increasing difficulty as a result of the critical financial and the economic situation due to the unfolding crisis in the country. This is vividly illustrated by Russia closing down the Crimean plants belonging to companies owned by newly elected President Petro Poroshenko after it annexed the peninsula in March.

Concorde Capital in Kyiv has advised clients to be very cautious when picking Ukrainian bonds.

The company's troubles are reflected in the price of its bonds, which have fallen to 80 cents of par value while yields have soared to close to 20%.

That compares with the 89 cents on the dollar investors are paying for bonds of MetInvest, the biggest steel and mining group and part of the industrial group controlled by Ukraine's richest oligarch Akhmetov, which were yielding 12.5% at the time of writing.

Interpipe's bonds have already been delisted from the Luxembourg stock exchange in 2010, and despite requests to Interpipe from the Trustee to relist them – a requirement stipulated by the original covenant – they remain unlisted. Deutsche Bank, which is acting as the trustee for the bonds, issued a notice last December that said the failure to relist the bonds was an "act of default." Rating agency Fitch Ratings reacted last year by downgrading the company to default.

Ukrainian bonds have always been risky, and the opacity of the issuers only adds to the difficulties as the political and economic situation in the country continues to deteriorate. "Minority bondholders are dependent on the decision of the majority bondholder and we understand he is in a friendly relationship with the Interpipe Group.

Most portfolio managers who deal with

Any failure by the company to pay its coupons could be the final nail in the coffin for minority shareholders who have had, in the words of one, a "very rough and rocky ride" over the seven years since the bond was issued.

Minorities have watched helplessly as the date for the return of their investment has been postponed and the coupons they are owed by the company

Take for example Interpipe, the industrial group belonging to Ukrainian oligarch Pinchuk, which is already in real trouble. The company has not defaulted on its $200m worth of bonds yet – it paid the last coupon in February – but it has already been marked down to "restricted default" by the global rating agencies. Philipp Thomas, a lawyer acting for a fund that holds Interpipe's bonds, said: "It is ever more doubtful whether Interpipe is going to continue paying the coupons and eventually the principle on its notes. Covenants in the agreement have already been breached. They are close to default."

This view is shared by Dimitry Churin, head of research at Eavex Capital, a Ukrainian banking and investment

Interpipe was already struggling under the weight of the economic crisis that has afflicted Ukraine since the global meltdown in 2008. It has repeatedly failed to publish its financials; the last time it released a set of accounts was in 2012.

"It is ever more doubtful whether Interpipe is going to continue paying the coupons" this bond understand that all decisions are made by Interpipe Group and its founder Pinchuk," says Churin.

Interpipe did not respond to a request for comment.

delayed. What is worse is that Churin's analysis of the company’s cash flows shows it has the money to meet its obligations and pay the coupons.

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Sberbank expands fast overseas INTERVIEW:

Ben Aris in St Petersburg

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ussian state-owned banking giant Sberbank is on a roll. Since it launched a drive to expand overseas, its international assets have grown 50-fold in the last three and half years to top $75bn by the end of 2013.

Already by far the biggest bank in Russia, Sberbank is well on its way to becoming one of the biggest banks in Europe.

And it's making good money too. "We were making a loss when we started the expansion, however last year we made more than $900m in net profit," says Sergei Gorkov, head of Sberbank's international business, speaking to bne on the sidelines of the annual St Petersburg Economic Forum at the end of May. While its state-controlled peer VTB was quick to move into international markets after it took over the half-dozen foreign branches of Russia's Central Bank (legacy branches left over from Communist days), Sberbank has been taking its time and really only threw itself into international expansion in about 2010; from more-or-less a standing start, the Russian retail behemoth now has operations in over 20 countries. "The strategy has been very simple. We go into markets where we enjoy a natural synergy. It can be that there are large trading volumes between the country and Russia, or there are large amounts of mutual investments," says Gorkov. "We follow our large clients and cover their typical needs."

Trade volumes led Sberbank to buy a bank in Turkey, while large investments

by German companies in Russia prompted Sberbank to set up a branch in

Berlin that will open in July. Sberbank has even opened a branch in India and expects to follow with a Beijing branch as part of Russia's "pivot to Asia". "We are looking at opening a China branch.

It is a huge market that we need to find a niche to operate there. The Chinese banks already operating are enormous because of the huge size of the population," says Gorkov.

However, the majority of the expansion has been in its backyard of Central and Eastern Europe. This growth is mostly organic and concentrated on providing services to corporate clients. "We're not opening lots of branches in foreign markets. We are there to do business for corporate clients, although we are

year ago. And Croatia is not enjoying positive GDP growth. There is always something going on in this region," says Gorkov.

The biggest headache is, of course, Ukraine. Sberbank set up a Ukrainian business some six years ago that was very successful, but that has been punished recently in the showdown between the West and Moscow. "It's a very difficult situation, as lots of things are happening with no logic to them.

In our worst-case scenario we never expected the situation in the country to come to what it is. Ukraine is a very important market for us, especially given the strong trade relations. It's not just about energy; we share a long culture

"The strategy has been very simple: we go into markets where we enjoy a natural synergy" beginning to offer retail services in a few of these markets," says Gorkov. "We need to grow in these markets. We hope to become twice as big in every foreign market where we are present over the next four years."

Exposure to instability Sberbank suffered along with everybody else in the turmoil that swept the world following the 2008 crisis, however it has the added headache of being exposed to many of the less-stable markets in CEE. "Belarus keeps going up and down.

Hungary has been a very fruitful market for us. Slovenia has had a big crisis one

and history with Ukraine. We launched [the Ukrainian branch] about six years ago and it's been very successful.

Sberbank actually managed to earn some profit in Ukraine in the first quarter of this year, but it wasn't very much. Gorkov says that the impact of the turmoil on the bank's balance sheet won't be seen until the second quarter this year. "I hope following the presidential elections things will become more stable," says Gorkov.

Despite Russia's obviously close relations with Ukraine, Sberbank is still chasing

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the other international banks operating there. Two domestic banks lead the market in terms of assets, followed by Austria's Raiffeisen Bank International in third place and Italy's UniCredit Group in fourth place. Sberbank trails in eighth place. Still, the crisis could play into Sberbank's hands: most of the other international banks have pulled in their

Eastern Europe

market and it is growing better than the rest of Europe," says Gorkov.

remains a rather insular market with complicated historical ties to Russia.

It also took a big step buying Volksbank International (VBI) from its Austrianbased parent Volksbank AG. The acquisition of VBI brought a network of nine subsidiary banks in eight CEE countries: Slovakia, the Czech Republic,

This new foreign focus has also affected the bank's domestic business. For example, in Tatarstan Sberbank has opened a special Turkish desk in the capital of Kazan. The predominantly Muslim state has built up its own relations with both the Muslim world, including Turkey, and attracted significant investment from those countries. Sberbank has responded by hiring Turkish speakers to offer special services to the incoming investors working in the autonomous Republic of Tatarstan.

"We are looking at opening a China branch" horns or simply left the market. "We have less risk in the Ukrainian market than international banks," says Gorkov.

"But all the banks have stopped lending and all the banks have lost deposits."

Perhaps Sberbank's most successful foreign investment to date has been the acquisition of a 99.85% stake in Turkey's Deniz bank in September 2012, a top10 private bank with just shy of 600 branches. "Turkey is a very important

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Hungary, Slovenia, Croatia, BosniaHerzegovina, Serbia and Ukraine.

Western banks were quick to move into these Emerging European markets in the early 1990s. However, there is still plenty of opportunity, especially for a Russian bank due to the growing amount of trade it enjoys with the other counries of the region. Poland is the one exception; Sberbank has no plans to open operations in Poland, which

Gorkov says that Sberbank has already mostly achieved the share of foreign business in Sberbank's total business that it was hoping for. At the end of 2013 international assets accounted for 12% of the bank's total assets, and 7% of total profits. Gorkov says the goal is to maintain the assets contributed from foreign business at around 10% of total and the share of the profits at 8%.

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What's bugging Polish officials?

Jan Cienski in Warsaw

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onald Tusk, Poland's prime minister, is hoping that he has managed to head off a bugging scandal that has embarrassed key ministers, shaken domestic politics and endangered Warsaw's key foreign relationships, by blaming the mess on “criminal groups” and making allusions to Russian involvement.

considering he heads a coalition with a majority support in the legislature, he easily won, which dispelled the notion that his government was about to crumble.

The prime minister also unleashed the full force of Polish law enforcement on finding the leakers, and some early arrests have been made.

The scandal has consumed Poland since mid-June after the Wprost news weekly started to publish transcripts of illegally obtained private conversations of senior ministers, Poland's central bank chief and other top level officials who had been caught on tape while tucking in at some of the capital's best restaurants.

But Tusk's recovery is still fragile. His Civic Platform party is losing ground in opinion polls to the opposition Law and Justice party, and there is the danger that Wprost may have still more damaging transcripts in its quiver, ready to publish over coming weeks.

The initial reaction to the leaks was that Tusk's government could collapse, forcing early elections and the likely exit from power of an administration that has governed since 2007. But in the last few days of June, Tusk seemed to have regained control of the narrative. He pushed through a vote of confidence in parliament on June 25. To no surprise,

Unpleasant reading The leaks so far have not made for very pleasant reading for Tusk. The most significant international splash came from a conversation between Foreign Minister Radek Sikorski and former finance minister Jacek Rostowski. The two were dining in the Amber Room, a supposedly discreet restaurant located

in a neo-Italianate palace which houses the country's most exclusive business club.

In a widely ranging conversation salted with racy jokes and lots of crude language, the two gossiped about personalities, talked of their personal ambitions, and then Sikorski laid into Poland's relationship with the US and lambasted UK Prime Minister David Cameron.

Sikorski, once seen as a stout proAmerican, ridiculed Poland's alliance with the US as “worthless”. He continued, “Complete bullshit. We'll get into a conflict with the Germans and the Russians and we'll think that everything is super because we gave the Americans a blowjob.”

Sikorski and Rostowski, both educated in England and Poland's most Anglophile politicians, then ridiculed Cameron, denouncing his attempts at buying off his Eurosceptic back-benchers with “stupid manipulations” that would end up

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backfiring and driving the UK out of the EU. “As I predicted, it's all turning against him,” said Sikorski, who was a member of same rowdy upper class Bullingdon drinking club at Oxford University as Cameron. “He should have told them, 'fuck off', to convince people and isolate the others. But now he's given them room and they will humiliate him.”

The brutal language from a man who had been seen as Cameron's personal friend was sprayed over the front pages of British newspapers. It was an unexpected and unwanted blow to Cameron, who is already facing a losing battle in his attempt to prevent Luxembourg's Jean-Claude Juncker from becoming the next head of the European Commission.

Sikorski's assessment of Poland's relationship with the US was less surprising, given that the comments were made in January. At the time, Poland's top diplomat had shifted Poland's foreign priorities to a closer relationship with Germany and the EU. He had been dismayed at the US backing away from plans to build a missile defence shield partly based in Poland and more broadly over the Obama administration’s pivot away from Europe towards Asia.

The US raced to dispel notions that the relationship with Poland was in trouble, refusing to comment on the particulars of Sikorski's private conversation, but saying that ties with Warsaw were “very good”.

There is also a recognition that events have moved on since January thanks to Russia's annexation of Crimea and its apparent support for an armed insurgency in eastern Ukraine. Since then Poland has made a point of re-emphasising the closeness of its security ties with the US, and has been very upset at western European, and particularly German, reluctance to shift Nato forces to Central Europe.

Breaking the bank The other recorded conversation that caused a stir, this time in financial markets, was one between Bartlomiej

Sienkiewicz, the interior minister, and Marek Belka, the governor of Poland's central bank.

Although at times crude as well as wide-ranging and interesting, the most controversial segment had Sienkiewicz spinning a hypothetical scenario of an economic crisis that could see Law and Justice take power. Asked if the central bank could use unorthodox instruments to prop up the economy, Belka agreed, although he named a price. “My condition is, excuse me, the dismissal of the finance minister,” Belka said, referring to the minister as “Count von Rostowski”.

at a handful of Warsaw's most exclusive restaurants.

The public response “has been more one of amusement than anything else, and commentators wonder whether or not their release means that more significantly damaging material simply does not exist,” says Simon QuijanoEvans of Commerzbank. That is certainly Tusk's hope.

Rostowski was removed as minister in a cabinet reshuffle last November, although both he and Tusk insist it was of his own volition. Another of Belka's conditions, a change in regulations governing the National Bank of Poland, is working its way through parliament.

Authorities have arrested two waiters who worked at the restaurants, as well as two businessmen, reportedly for supplying Wprost with the recordings.

One, Marek Falenta, had invested in Sklady Wegla, a coal distribution company which imported cheap Russian coal for retail sale in Poland. He denies any wrongdoing. The company had recently been the subject of a police probe, and several executives had been arrested on money-laundering and tax fraud charges.

Financial markets were shaken when the revelations came out on June 16.

There were fears that Belka had lost all credibility and would have to be replaced. But Belka has decided to hang

Tusk made as much as possible of the Russian connection, even though it is still very far from being proven. “I don't know in which alphabet this scenario was written, but I know very well who

"We'll get into a conflict with the Germans and the Russians and we'll think that everything is super because we gave the Americans a blowjob" on, and markets quickly rebounded.

“Most people would accept that Belka has done a good job heading the NBP,” said Tim Ash of Standard Bank.

“Ultimately the question is: has the public's faith and trust in the institution of the NBP been damaged by this somewhat unsavoury saga, and does Tusk think that hanging on to Belka damages his own position as elections approach?”

Other than those two conversations, there has been little repercussion from other published recordings from ministers, executives and other officials, all of whom were bugged while eating

could be the beneficiary of political chaos or the lowering of the reputation of the Polish state,” he told parliament, adding that people mixed up in the Russian coal trade and in building gas connectors to help speed Russian gas to Europe without transiting across Ukraine may have been involved.

If true, Tusk would be able to shift public scrutiny from the failings of his ministers and security services on to Russia, Poland's ancient foe.

The prime minister’s hope is that this narrative holds for long enough for his government to regain popularity before next year's scheduled elections.

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prosperity: the country’s per capita GDP has risen from just 35% of the EU28 average in 1995 to a projected 78% in 2015."

Rehn also rehashed the pro-euro arguments that will be repeated mantra-like in Vilnius for the remainder of the year – just as they were in Riga and Tallinn – to try to win over public opinion that remains at best lukewarm, with only 40% of Lithuanians in favour of the move according to the most recent polls: "The Economic and Monetary Union remains an attractive community to be in. The euro area today has more effective economic policy coordination, a robust financial firewall to safeguard stability and, from this year, a banking union. All of these Lithuania is committed to participating in and to further strengthening. Thanks to the efforts of the past five years, this ship is far better placed to navigate rough seas than it was at the outbreak of the crisis,” said Rehn.

A Baltic currency corridor forms Mike Collier in Riga

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altic state Lithuania gained an allimportant rubber stamp from the European Commission on June 4 to adopt the euro and drop its litas as its currency from January 1, 2015. The move all but guarantees euro adoption will proceed exactly as it did in Estonia in 2011 and Latvia in 2014, creating a single Baltic currency corridor extending all the way from the Polish border to northern Finland.

With the experiences of both Estonia and Latvia to draw on, Lithuania should complete the remaining formalities with ease: barring some major surprises with economic data, approval votes from EU finance ministers and the European Central Bank should be regarded as mere formalities.

Unveiling the verdict, EU Monetary Affairs Commissioner Olli Rehn said: “Lithuania’s readiness to adopt the euro reflects its long-standing support for prudent fiscal policies and economic

Overdue The thumbs up from Brussels rights what many Lithuanians feel was a definite wrong eight years ago when the country was refused euro entry because it failed to meet the inflation criterion by a mere 0.1%. Meanwhile countries such as Greece were waved into the single currency bloc by using the simple expedient of cooking their books.

“Over the reference period from May 2013 to April 2014 the 12-month average rate of inflation in Lithuania was 0.6% – well below the reference

"If and when Poland ditches the zloty, the euro will form an unbroken chain from Gibraltar to beyond the Arctic Circle"

reforms. That reform momentum, driven in part by Lithuania's EU accession ten years ago, has led to a striking increase in Lithuanians’

value of 1.7% for the criterion on price stability. In 2013 the general government budget balance showed a deficit of 2.1% of GDP and was below

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the 3% threshold, meanwhile, the general government gross debt-to-GDP ratio stood at 39.4% – well below the 60% reference value. Lithuania also fulfils the criterion on the exchange rates – the Lithuanian litas has been participating in the ERM II since the 28 June 2004 and Lithuania has not devalued its currency’s central rate against the euro. The average longterm interest rate in Lithuania in the year to April 2014 was 3.6%, below the reference value of 6.2%.” said Swedbank in a commentary.

However, the Swedish-owned bank, which is the largest in the Baltic region, warned that, “a few challenges” remained before Lithuania could flop over the finish line.

“Similarly to the case of Estonia and Latvia, the ECB has expressed concerns about the sustainability of price stability in Lithuania, given the possibility of higher wage pressures, as well as the continuing catchingup process with the developed EU countries. According to the ECB, improvements in the functioning of the labour market, productivity enhancing structural reforms, reduction of energy intensity and dependency on energy imports, reduction of the shadow economy and corruption, an increase in the public administration efficiency, stronger counter-cyclical policy instruments, and higher confidence in the soundness of the financial sector, would help to achieve an environment conducive to sustainable price stability,” Swedbank said.

The final decision on Lithuania’s admittance to the euro area will be adopted by the EU Council on July 22 or 23.

If and when Poland ditches the zloty as – in theory at least – it is bound to do at the earliest opportunity, the euro will form an unbroken chain from Gibraltar to well beyond the Arctic Circle.

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Poland remains divided on euro

Jan Cienski in Wroclaw The euro has always been at least as much a political as an economic project, and Poland's approach to eventually joining the common currency shows that politics is still a primary driver.

With the threat from Russia looming ever larger in Polish minds, Bronislaw Komorowski, Poland's president, has called for the country to begin moving smartly to adopting the euro. “If we want to seriously talk about the need to strengthen Poland's position and seriously treat the proposal to ensure Poland's place at the centre of European decision making and not on its margins, then we need to courageously deal with this challenge,” he said in an address to parliament on June 4.

He was backed by Marek Belka, the central bank governor, and by Mateusz Szczurek, the finance minister. Lech Walesa, the legendary leader of the Solidarity labour union, said that Poland would be “safe” once inside the Eurozone.

Poland has long seen the euro as a way to ensure that it is a core EU country; not being in the euro consigns it to the periphery – an increasingly dangerous place in today's risky geopolitical environment.

One of the greatest recent enthusiasts is Radoslaw Sikorski, the foreign minister. Sikorski is no economist, and views the common currency largely as a security issue.

The problem for the government is that the euro is deeply unpopular among ordinary Poles, dating back to the recent Eurozone crisis. A new opinion poll shows that 62% of Poles are opposed. The leading opposition Law and Justice party is also unenthusiastic, and without their votes the necessary changes to the Polish constitution that would allow the euro to become the national currency are impossible.

Donald Tusk, the prime minister, has been very aware of these limitations. He was lukewarm about the idea after Komorowski's speech, saying the euro issue raised questions for him. He said the government's main job was to meet the Maastricht criteria on deficits, public debt and other indicators Poland needs to fulfil in order to join. A key metric is driving the deficit below 3% of GDP, something Tusk should happen by 2015. “Whether we join the Eurozone will be decided in the future by a constitutional majority in parliament,” Tusk said.

Tusk has already been burned by the euro. In 2008, just weeks before the collapse of Lehman Brothers and the onset of the global economic crisis, he called for Poland to join the euro by 2012. Not being in the euro allowed the value of the zloty to fall in the first phase of the crisis – sparing the economy from the recession suffered by every other EU country.

But now the Russian threat is making economics take a back seat to politics.

“Events happening in Ukraine should mobilise us to faster integration with the eurozone,” Sikoski said in his own address to parliament.

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PwC last year showed, every HUF10 spent on advertising results in HUF47 added to Hungary's GDP,” Balogh tells bne.

Taking cash out of the system via an additional tax has the opposite, magnified effect on the economy – most particularly through job losses as the industry trims budgets to balance the books. “If there is a loss of HUF8bn, we estimate that, mid-term, there will be an annual loss to the economy of between HUF30bn-40bn,” she argues.

Taxing times in Hungary (again)

Confused policy But it is the publishers and broadcasters who are grappling with the immediate effects of the tax – and, not for the first time – legislation rammed through by the Fidesz government is causing confusion and uncertainty. “There are some fundamental problems with this law,” says Tibor Kovacs, president of the Hungarian Publishers' Association.

“Nobody really knows how the players will react.”

Kester Eddy in Budapest

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ungary's controversial new advertising tax, fast-tracked through parliament via a private member's bill on June 11, is not only harmful to media independence, it will also have a negative impact on the economy, say industry specialists, some of whom have pledged to fight the law “by all legal means.”

The new tax, which at the top rate amounts to 40% on ad revenues of media companies, prompted publishers to print blank pages and broadcasters to suspend programming in protest at what they say is an attempt to curb media freedom. However, the government of Prime Minister Viktor Orban justifies the move by what it terms the need for “burden sharing” from a “highly profitable” industry, while it specifically denies any intention to discriminate against any companies within the sector. The tax is expected to raise some HUF8bn (€26m) in additional budget revenues annually.

But while the initial outcry surrounding the tax centred on suspicions that it

is intended to target broadcaster RTL Magyarorszag – it is the only company affected by the 40% tax bracket – everyone in the Hungarian media and advertising world is apprehensive about the tax's wider impact.

Virag Balogh, international spokesperson for the Hungarian Advertising Association (MRSz),

First and foremost, the government once again used a private member's motion to bring the bill before parliament – thereby avoiding the discussions with affected industries that are mandatory for governmentsponsored bills. As a result of this short cut, media companies have to make the first new tax payment at the end of August, totally upsetting business planning, says Kovacs. “No company

“We've had demos and blank pages, that's all very nice, but I think this is something we have to challenge legally”

argues that the tax will backfire on the government over the medium term, slashing up to HUF40bn (€132m) – or roughly 0.1% – off Hungary's GDP. “It's well known that the advertising industry has a multiplier effect: it promotes innovation, competition and consumption. So, as a study done by

had prepared to pay millions [of forint] with two months' [notice],” he says.

The reaction of RTL – how it will cover the enormous increase in costs it now faces – is likely to impact negatively on the media sector. “Over the last 10 years, the two main commercial TV

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channels [RTL and TV2] have been the price dictators, and all the other players followed,” Kovacs says.

pay up is “the $64m question,” says Kovacs. “It's a problem the European Union itself has been struggling with.”

The fear is, he says, that RTL will increase its advertising rates, creating a “a kind of vacuum cleaner effect,” with much of the national advertising spend being sucked into the major TV

Peter Nadori, deputy chief executive of Lapcom, an independent Hungarian publisher, argues the law must be examined at the highest level. “We've had demos and blank pages, that's all

"We estimate there will be an annual loss to the economy of between HUF30bn-40bn" stations, to the detriment of smaller media companies, particularly print.

very nice, but I think this is something we have to challenge legally,” he says.

The law also seeks to tax online advertising, which was worth HUF39bn last year, the second largest slice of the market. But exactly how the government is going to force providers with no legal presence in Hungary to

Since the Hungarian Constitutional Court will be “pretty much a nonstarter” – as it can no longer rule on tax matters – he reasons the industry may be forced to turn to the EU or European Court of Human Rights, “because

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

this has very heavy free speech, free press implications,” Nadori says. “I, personally, am in favour of doing everything and anything of any legal form to challenge this.”

But any such legal challenge could take years before a verdict is reached.

Meanwhile, Hungary's advertising market will have to deal with the consequences of the tax. With a total spend of HUF175bn (€560m) last year, it has already shrunk some 30% since the recession of 2008. Industry analysts say media close to the Fidesz government have seen healthy advertising revenues since 2010, but many without such connections have struggled to survive this far.

Even if, for smaller companies, the new tax payable is small or even zero, Kovacs says, it all leaves “a huge question mark over Hungary's media market.”

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decision. This initiative is all about the veterans. This is one of those projects which have no commercial, political or economic purpose – it just felt like the right thing to do from the word go… I would like to thank the Ministry of Culture and to Prague 1 for their support," said Euan Edworthy, the initiator of the Winged Lion project, following Herman's intervention.

Muddy waters For many in Prague, the whole affair refocused attention on fundamental problems with the city's planning system.

Lions for lambs in Prague Nicholas Watson in Prague

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he unveiling of a memorial in Prague to the Czechoslovaks who served in the Royal Air Force during World War II went ahead on June 17. But an unseemly spat over the location of the memorial in the run-up to the event highlighted planning issues that property developers in Prague have been complaining about for years.

On May 30, the minister of culture, Daniel Herman, intervened in a simmering row between the organisers of a private initiative by the British community in Prague to build a memorial to the roughly 2,500 Czechoslovak airmen who served with distinction in the RAF during WW2.

Herman's decision to throw his weight behind the memorial came after the Czech National Heritage Institute (Narodni Pamatkovy Ustav, or NPU) on May 22 turned down the Prague 1 planning application to locate the memorial in Klarov, a square beside Manes Bridge whose grassed area already hosts a memorial to those who resisted the Nazi occupation in 1938-1945.

The culture ministry's intervention was timely, because the memorial, an impressive bronze-cast Winged Lion designed at considerable cost by the British sculptor Colin Spofforth, was due to be unveiled at a grand event on June 17 that was planned to include an RAF band and a flyby of a Spitfire.

Dignitaries planning to attend included Nicholas Soames MP, Sir Winston

The reasons the National Heritage Institute (NPU) gave for turning down the application was that the Winged Lion Memorial was “inappropriate and incompatible” with this part of the historical centre of Prague, which is a conservation area on Unesco’s World Heritage List. This piece of public art was also not chosen in a competition, unlike the 1938-1945 War Memorial, which it claimed was won by Vladimir Preclik. However, controversial Czech artist David Cerny points out that he actually won the competition, though a political row meant it ended up being awarded to Preclik.

Ondrej Šefcu, director of the NPU, in a statement detailing the reasons for turning down the application, referred to other more suitable locations for the

“Because everything takes so long, the incentive is there to pay bribes”

Churchill’s grandson, and Air Chief Marshal Sir Stuart Peach, the Vice Chief of the Defence Staff.

Herman's statement that "the events planned for 17 June must not be threatened by administration" came as huge palpable relief for the organisers of the project. "The Winged Lion Appeal welcomes the Ministry of Culture’s

memorial, “which were rejected without giving any coherent reasons.” This is probably a reference to a site offered in the Prague suburb of Zizkov, whose cemetery contains the remains of top communists such as Klement Gottwald, president of Czechoslovakia in 1948– 1953. This was not thought appropriate given that the ex-RAF airmen were treated abominably by the communists,

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who peevishly stripped some of their jobs, apartments and welfare payments, forcing them into menial jobs and sending others to jail or forced labour camps, because they wanted to maintain the narrative that it was the Soviet Union alone that liberated Czechoslovakia.

Sources in Prague point out this was a strange statement to make by Šefcu and show the muddled thinking at the NPU, because the Prague 1 planning application was about this site, not any others, so it seemed odd for alternative sites to be brought up. The Free Czechoslovak Air Force Associates, an organisation dedicated to keeping the memory alive of the ex-RAF airmen, also point out that the memorial occupies a space near a plaque for Air Marshall Karel Janousek, who was the leader of the Czechoslovak airmen in Great Britain during the war. "It's hard to think of a more suitable place for the Winged Lion Memorial," the organisation says.

Critics of the NPU says it's par for the course. An ultraconservative and faction-ridden body, the NPU is seen as often bandying together with other like-minded groups such as the Club for Old Prague (KZSP) to fight any developments in Prague, using the country’s pretty woeful legal system to delay and halt projects. “The NPU’s default position is that they don’t like change and it’s hard to understand why some things get approved and some things don’t,” says one developer speaking on condition of anonymity.

"Other World Heritage cities like Rome manage to achieve sensitive development while at the same time remain really quite beautiful."

To some extent the NPU and KZSP are acting on behalf of an understandable growing public backlash against what is regarded as a string of terrible developments in Prague since the Velvet Revolution, in which historical buildings have been bulldozed in favour of shopping malls and glass office buildings. Too often, say critics, Prague’s main City Council has bowed to the wishes of developers, while the

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country lacks the sort of legislation typical in other European countries that sanction developers or councils for not protecting historical buildings. This being the Czech Republic, there are also mutterings of corruption in the granting of planning permissions.

However, developers complain that the planning system is broken, allowing shady individuals and other unaccountable groups to hold up developments that have already been approved. The system is an open invitation to bribery and blackmail, sighs one foreign developer. “Because everything takes so long, the incentive is there to pay bribes,” he says.

Take Wenceslas Square (Vaclavske namesti). It holds an almost mythical place in foreigners’ minds as the centre of the Velvet Revolution, yet visitors today can’t hide their disappointment at the mix of mediocre shops, casinos, drug dealers, prostitutes and sex clubs that blight this iconic square. Repeated attempts to restore the square to its former glory have been thwarted by a mix of corruption, nimbyism and resistance to change.

The upshot of all the legal and procedural uncertainty, worry some, is that Prague will no longer attract the type of investment that has made it today one of Europe’s premier capitals.

There are still many derelict buildings in the centre that remain tied up in legal problems, while investment that might improve the centre and keep it vibrant and dynamic is starting to flow to the outskirts where planning permissions are treated in a more transparent and timely way.

However, all this is of little concern to the few remaining Czechoslovak ex-RAF pilots still alive and their relatives, who might rightly feel that they their service in liberating their country was once again dishonoured by becoming embroiled in a public spat.

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Slurred speech A Dutch professor teaching political sciences in Vilnius plans to establish an independent media network in Ukraine that would be financed from vodka sales to Russian-speaking populations in Europe, the Lithuanian daily Lietuvos Zinios reported in June.

Robert van Voren, who has lately spent a lot of time in Ukraine as crisis grips the country, is a wellknown Sovietologist who teaches political sciences at the Vytautas Magnus University in Lithuania and the Ilia State Universtity in Tbilisi. Van Voren, who has been collecting funds for various projects over the past 35 years, says financing has become rather more complicated these days as competition for funds increases just as supply decreases due to the crisis. Therefore, he argues that selling vodka to the Russian-speaking diaspora across Europe that Russian President Vladimir Putin talks about "protecting" would be an ideal way to finance this media network to counter the toxic propaganda coming out of Russia.

Russians, who have a proverb that says "vodka is our enemy, so we'll utterly consume it", are notorious consumers of alcohol, especially vodka. A study published in January in The Lancet found that 25% of Russian men die before they are 55, and most of the deaths are down to alcohol. The comparable UK figure is 7%.

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of between €70m-90m. This deal means he owns the influential economic daily Hospodarske noviny and the opinion magazine Respekt, as well as other specialised and electronic media.

The changing face of Czech media

Bakala's acquisition began this new era that replaced the previous one of the 1990s, when Czech media outlets were often sold by the new post-communist management to foreign publishers. At that time concerns were raised about the "Czech family silver" being sold to German companies; reading between the lines lay fears about revisionism over World War II. This was never proved, with foreign owners appearing only concerned about financial results and not about the content of their publications, but the fear of media being used for some hidden agenda has lingered.

David Binar in Prague

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lmost 25 years after the Velvet Revolution, the Czech Republic, like other countries in the old Soviet bloc, is seeing a concentration of ownership in the media that many fear is its “oligarchisation”. But new, mostly internet-based outfits, many led by disaffected journalists, are springing up to counter this worrying trend.

The man who triggered the talk about oligarchisation and personifies the trend is Andrej Babis. Slovak by birth, Babis is today a Czech citizen, minister of finance and billionaire owner of the Agrofert group – a conglomerate of companies active in the agricultural and chemical sectors.

Angry at the dire political situation in the Czech Republic and the ubiquitous corruption, he formed his own political party called ANO (“Yes”) in 2011.

The movement succeeded in the parliamentary elections in October 2013, becoming the second strongest political party in the country and making Babis finance minister and vice-premier of the coalition government.

Alongside this success came something more worrying in 2013. In a surprising coup, he succeeded in acquiring Mafra, publisher of the best selling Czech nontabloid newspaper Mlada fronta DNES,

the influential daily Lidove noviny and other media, turning him overnight into a media tycoon. The combination of commercial, political and media power in one person makes Babis probably the most powerful person in the country.

The public doesn’t seem to care much about his numerous conflicts of interest, but obviously it is more of an issue for journalists as well as for his political and commercial opponents. It’s probably not by chance that only weeks after Babis’ Mafra deal was announced, the billionaires Daniel Kretinsky and Patrik Tkac, who earned their first millions with the Slovak investment group J&T, acquired the publishing activities from the German-Swiss Ringier Axel Springer CZ with its popular tabloid dailies Blesk, Aha and Sport, and the popular weekly magazine Reflex. According to its new owners, the Czech News Center – as it is called today – is the largest media outlet with the most readers on the Czech market.

However, the first of the country's so-called "godfathers" (there are seven, including Babis) to become an important media owner was the financial investor Zdenek Bakala, who in 2008 bought the publishing house Economia from the German Verlagsgruppe Handelsblatt for what was considered a premium price

Media independence Today, concerns are being raised again, but this time the fear of German revisionists endangering media freedom has been replaced by domestic oligarchs using their media power to support commercial and/or political interests.

Arguably, there's probably more grist for the mill here.

"The concentration of major print dailies in the hands of two business magnates, one of whom fared well in the 2013 general elections, points to growing ties between business, politics, and the media," US watchdog Freedom House said in a recent report on the state of democracy in the post-Soviet bloc.

When Babis announced his Mafra deal in June 2013, he promised not to interfere in his journalists’ work. “If I wanted to influence media, the journalists would tell each other and I’d be a dead man,” he wrote on his Twitter account.

Actually, this promise lasted only a few hours. The very next morning he called a Lidové noviny reporter to enquire why the daily hadn't reported on an ANO press conference from the previous day.

“I hope the boys know what they’re doing. They probably don’t know who they have the privilege to deal with,” he reportedly told the journalist, referring to the newspaper’s management.

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To be fair, that is the only known case of Babis' interference with Mafra media, and he has since done much to emphasise their independence. The new editor-in-chief of Mladá fronta DNES, the well-known and respected journalist Sabina Slonkova, took on the role of guaranteeing the daily’s independence and she doesn’t tire of saying that any interference by Babis would result in her immediate resignation.

She confirmed her stance to bne, reiterating that Babis doesn't interfere with the paper's news coverage. “If there were any interventions, I wouldn’t be working here,” says Slonkova, adding that she doesn't even see any self-censorship tendencies among her colleagues. “On the contrary, from time to time they're even more critical in order not to be accused of siding with the newspaper's owner.”

Even so, most journalists from outside Babis' media empire find it hard to believe in Mafra’s total independence.

A different approach was taken by Bakala's Economia. Their declared policy is to tackle their conflict of interest head on and simply not write anything about their owner’s activities. This approach is criticised as highly problematic given Bakala’s

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notes Hvizdala, who in the wake of Babis buying Mafra cooperated in the writing of a publishers' code that seeks to formalise editorial independence of their media assets. What is bad, he says, is when you combine politics and business in media ownership.

What the future holds Few experts believe that the media shopping spree is over. Babis is reportedly interested in extending his empire to the most influential media – television.

The finance minister is said to have led negotiations with the owners of the two largest Czech commercial TV-stations – TV Nova, owned by Central European Media Enterprises (CME), founded by Ronald Lauder and now part of Time Warner, and FTV Prima, owned by the Swedish Modern Times Group (MTG).

Despite claims from all parties that the owners have no intention of selling, experts still expect changes in ownership in the segment over the next few months.

In May, weekly news magazine Euro (owned by media tycoon Frantisek Savov) reported oligarchs and coal barons Jan Dienstl and Pavel Tykac were looking to set up their own TV station to counter Babis' influence. According to the

“If I wanted to influence media, the journalists would tell each other and I’d be a dead man” huge economic influence. Bakala is the owner of the country's largest coal miner, New World Resources, and the major employer's rocky finances have recently become a political hot potato.

The renowned independent journalist and media expert Karel Hvizdala believes the media becoming more of a business and being bought up by domestic billionaires is not in itself a bad thing. “This happened in Germany after WWII, the media in the USA are mostly owned by big corporations,”

magazine, the two businessmen intend to spend CZK2bn (€73m) to establish the broadcaster, and CZK2bn annually on the production of programmes.

An important player in this area is the public Czech Television (CT), whose news programmes are closely monitored by politicians, the Council for Radio and Television Broadcasting, and the Czech Television Council. The members of these institutions are approved by parliament and represent the political parties. Questions about political

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interference in news programmes crop up regularly, as well as journalists leaving and blaming politicians for their departure. The Freedom House report states that, "The election campaign [in October 2013] also featured attempts to curb editorial freedom at the public television broadcaster."

According to Hvizdala, the state-owned media – Czech Television and Czech Radio – have lost their oversight function of the political elite and have instead become what he calls “parliamentary media” – ie. mouthpieces for the parliamentary parties.

The recent changes in media ownership have subsequently led to journalists moving between existing media outlets and to the foundation of new, mostly internet-based media.

A number of journalists left Babis' Lidove noviny to establish the news server Echo24.cz, while Deník Referendum unites left-oriented journalists and publicists who feel they lack opportunities to present their views.

Former Mladá fronta DNES editor-inchief Robert Casensky has announced the launch of an investigative monthly magazine for September; unlike other media start-ups, his Reporter is supposed to be printed.

Falling profits Ultimately, say experts, it's hard to believe that the new owners of the mainstream media won't seek to influence the output of their new assets.

The situation of the traditonal media in the Czech Republic is no different to that elsewhere in the world: falling circulation, viewers and listeners, and a desperate scramble to counter that trend and to at least stabilise revenues.

It’s hard to believe the new owners weren't aware of this situation when they acquired their assets, even as they claimed to be making these acquisitions primarily for business reasons. With the assets losing money and relevance, it's only natural they will try to maximize any remaining influence these outlets still have.

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to pick up after Alpine and finish the project was none other than … Alpine – which had in the meantime filed a suit against the agency for the full value of the original contract.

The road, with the complicated bridge, was now supposed to be finished in April 2012, in time for the expected flood of fans heading north for the European football championships being held later that summer. But by May of 2012, the building inspector had found growing problems with the bridge and demanded changes. The fight with Alpine proved irreconcilable and the Austrians were ousted for a second time.

Poland takes slow road to modern transport network Jan Cienski in Warsaw

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t first glance, the creek running near the southern Polish town of Mszana doesn't look like much of an obstacle to crossing, if one doesn't mind getting one's feet a little wet, but the stream running along a shallow valley ended up causing years of delay to Poland's highway construction programme and helped propel a prominent Austrian construction firm into bankruptcy.

The 400-metre bridge over the stream, an enormous pyloned purple affair, was finally opened in May, completing the southern leg of the north-south A1 highway that is eventually supposed to connect the Baltic coast with the Czech Republic. But the trouble encountered in completing it casts some light on Poland's broader problems in building a modern highway system – one of the key goals of the current government of prime minister Donald Tusk.

The 18-kilometre stretch of road has been one of the most difficult projects in Poland. The original €272m contract to

build the stretch of road was tendered in 2007 and it was supposed to be completed in 2010. In the end, it took four contracts to complete.

The original tender was won by Austria's Alpine Bau, but the contractor ran into problems with unexploded World

A year later the Austrians were bankrupt. The Polish project was worth only a small fraction of the almost €10bn in bankruptcy proceedings, but it meant that the agency had to again reopen the tender and find a company willing to take the risk to complete the project. In the end, two Polish companies finished the bridge, and the road was opened in late May, but the whole mess casts a sharp relief on the trouble Poland has had in upgrading its road infrastructure.

Accelerating As of this year, Poland has 2,800km of highways and slightly lower quality expressways. That marks a sharp increase from 1989. At the time that Poland broke with communism, the only

"Efforts to build more modern roads stumbled through the 1990s and early 2000s, hampered by a lack of money and by a complex legal code"

War II era bombs and with the bridge project, which the Austrians claimed had become more complicated and expensive than in the original tender.

After 15 months on the job, the government road building agency tossed Alpine off the project and reopened the tender. The winner of the 2010 contest

highway in the country was a potholed mess near Wroclaw that had been part of the prewar Berlin to Breslau autobahn.

Efforts to build more modern roads stumbled through the 1990s and early 2000s, hampered by a lack of money and by a complex legal code that made it very difficult to expropriate property

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and very easy for companies which lost tenders to challenge the process.

A flood of EU structural funds after Poland joined the Union in 2004, together with legal reforms, sped up the process, but progress is still fairly languid for what is one of the EU's larger countries by territory.

This year, the road building agency expects to complete 340km of new highways end expressways. Next year that falls to only 72km, in part because EU funds from the 2007-2013 budget are drying up, but money from the next financial package is not yet fully on stream.

Despite all the building, there are still big gaps in the system. The goal was to build a main north-south artery, the A1 and two east-west ones, the A4 running along Poland's southern border from Germany to Ukraine, and the A2 from Germany, through Warsaw and on to Belarus.

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The A4 still has an unfinished stretch near the Ukrainian border that was supposed to be completed in 2012.

The A1 has a big gap in south-central Poland near the city of Czestochowa.

There, the existing road, now potholed

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A further problem is that the rush to complete projects has led to substandard work. Large chunks of the A4 have been closed for repairs. The same is happening to the A2, where contractors two years ago were racing to complete the highway ahead of the

"The fight with Alpine proved irreconcilable and the Austrians were ousted for a second time" and unsuited to modern traffic, was build by Polish conscript soldiers in the 1970s, part of a project by the then Communist Party chief Edward Gierek to connect the capital with his home region in Silesia's coal belt.

Finally, the A2 stops in Warsaw. Projects to connect it to Belarus have been pushed far into the misty future.

football tournament; a failure to finish would have created a public relations disaster for the government.

The PR costs of repairing badly made roads years after the tournament are significantly lower.

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Bulgaria's government goes south Clare Nuttall in Bucharest

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ulgaria is heading for early parliamentary elections for the second time in less than two years, after even the ruling coalition joined the chorus of demands for Prime Minister Plamen Oresharski's government to quit. There are hopes a new round of elections could give Bulgaria a stable government and end the ongoing political uncertainty, but with no party taking a majority in the recent European Parliament elections, Bulgaria may again be left floundering with a fragile coalition.

The current government's single rocky year in power started with street protests over the appointment of a controversial media tycoon to head the state security agency, and ended in a dispute over the Russia-led South Stream gas pipeline project amid growing criticism from the EU.

Pressure on Oresharski's government has been building since before the May European Parliament elections, when the centre-right opposition party Citizens for European Development of Bulgaria (GERB) took 30.4% of the vote

nationalist Ataka party joining GERB to call on the government to resign. On June 10, BSP leader Sergei Stanishev acknowledged that it would be better to call early elections than to cling onto power.

"This interim government operated under conditions of unprecedented parliamentary and extra-parliamentary opposition pressure" – almost twice as much as the ruling Bulgarian Socialist Party (BSP).

This sparked a slump in support for the government, with both the BSP's junior coalition partner, the ethnic Turkish Movement for Rights and Freedoms (DPS), and its sometime ally the

Oresharski managed to scrape a victory in the government's fifth no-confidence vote in the last year on June 14, but both the BSP and MRF made his resignation – expected within weeks – a condition of their support.

After consultations with party leaders, President Rosen Plevneliev announced

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June 17 that elections would take place in late September and or early October.

"The political parties agreed the need for a smooth transition to political stability and the need for further political consultations to set up early elections in the period between Sept. 28 and Oct. 12," Plevneliev said, Reuters reported.

According to an note from Sofia-based Elana Trading, early elections could be a first step to a new and more stable government, "reducing the current political instability, which is starting to transform into economic uncertainty."

Interim troubles In an interview with Bulgarian daily 24 Hours, Oresharski himself described his government as an "interim government" that had operated under "conditions of unprecedented parliamentary and extra-parliamentary opposition pressure." The technocratic Oresharski came to power after GERB leader Boiko Borisov was forced to resign following mass street protests over falling living standards and a series of corruption scandals. However, Oresharski's rule was mired in scandal from the outset, when he appointed controversial media tycoon Delyan Peevski as head of the state security agency, triggering a new wave of protests.

Another serious crisis erupted in April when the European Parliament voted to suspend the South Stream pipeline project as relations with Russia worsened. The pipeline, which will ship gas from Russia to central and southeast Europe bypassing Ukraine, was a priority project for Bulgaria. However, bowing to EU pressure, Oresharski said June 8 that Bulgaria had suspended construction of its section of South Stream. "I have ordered to stop construction until the procedure is agreed with Brussels," Oresharski said following a meeting with US senators in Sofia. His handling of the situation pleased neither Brussels nor Moscow, and has angered his allies at home.

The government came in for further criticism over its selection of a

consortium led by Stroytransgaz – a Russian company owned by Gennady Timchenko's Volga Group and one of the targets of US sanctions – to build the Bulgarian section of the pipeline.

Opposition leaders claim the â‚Ź3.5bn project cost has been inflated. The European Commission said June 3 that it had launched an infringement procedure against Bulgaria over its section of the South Stream pipeline, with a commission spokesperson citing a lack of transparency in the awarding of contracts for the work. In a further blow for Sofia, the EU has frozen funding for two regional development projects in Bulgaria after criticising the management and control of the projects.

Further recent crises include the run on Bulgaria's fourth largest bank Corporate Commercial Bank caused by corruption rumours, and the energy regulator's announcement that it would revoke the operating licenses of three foreign-owned power distributors.

There have been some positive developments in the last year, notably the improved performance of the

citing the challenge it poses "for the implementation of reforms needed to tackle deep-rooted institutional and economic problems". "We expect that the political landscape will remain volatile over the coming months and will likely not be conducive to implementing potentially unpopular reforms," the rating agency said.

Moreover, the chances of any party scoring an outright victory in the upcoming election are slim. GERB, the largest party in the current parliament, took the biggest share of the vote in the European Parliament elections, and is widely expected to maintain this lead through to the autumn.

Should the party be returned to power, Borisov has already outlined his position on South Stream, telling Bulgarian national radio that he would proceed with the project only with backing from the EU. A GERB government would also cancel the Stroytransgaz contract. "We will carry a new procedure based on European rules, which will be transparent and clear," Borisov said. However, GERB may struggle to find allies to build a

"Oresharski's rule was mired in scandal from the outset" Bulgarian economy; the International Monetary Fund (IMF) forecasts a "modest pick-up" in growth this year.

However, the IMF warned at the same time that political uncertainty poses a risk to faster growth. "The effects of domestic political uncertainty on reform momentum and investment, as well as lingering uncertainty in the outlook for key euro area trading partners, remain key risks to the outlook," said Michele Shannon, IMF mission chief for Bulgaria, at the conclusion of a staff visit on June 11.

Growing political risk also contributed to the decision of Standard and Poor's to lower Bulgaria's sovereign credit rating by one notch to 'BBB-' in June,

stable coalition, as it did after the 2013 elections.

"Certainly the expected lack of a clear winner of the elections will face Bulgaria into some challenges, but scheduled at the end of the year early elections will be a step forward in resolving some problems, connected to public support, investor sentiment, trust to Bulgaria and inefficient government institutions," writes Elana Trading. "We do not believe that the new government will uproot the bribery and corruption in the country, but a more stable one will be a right step in regard to restoring country's attractiveness to foreign investors, especially if there is more transparency."

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of technical barriers to trade at the start of this year. A further opening of EU markets to Moldovan producers is expected after Chisinau signs its EU free trade and association agreement on June 27. While a dramatic overnight change is not expected, Gogu forecasts a steady increase in sales.

Moldova wine industry uncorks new markets Clare Nuttall in Bucharest

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he largest market for Moldovan wines has traditionally been Russia and other former Soviet republics, but repeated closures of the Russian market combined with the opening of EU markets to Moldovan producers have caused a shift in the export strategy of local wineries.

company’s sales, with the remainder divided between the local market, the Commonwealth of Independent States (CIS), and other countries in north America, Africa and the Far East. Gogu, who comes from a sales background, says she is constantly pushing to open up new markets.

Chateau Vartely’s general director, Ludmila Gogu, has to refer to a world map to show the farthest flung market for the company’s wines. The company, which has vineyards in central and southern Moldova, recently shipped its first container of Cabernet Sauvignon to the Pacific island of New Caledonia, following a chance encounter made at Moldova’s annual wine festival.

As a relative newcomer that produced its first vintage in 2004, Chateau Vartely does not benefit from the name recognition enjoyed by Moldova’s older and larger wineries – in particular the legendary Cricova. However, its recent launch means it does have the advantage of modern facilities and equipment, located in the cool depths of a former limestone quarry near the town of Orhei. At the same time, the company sticks to Moldovan traditions, including harvesting its grapes by hand.

A medium-sized player on the Moldovan market, Chateau Vartely has 250 hectares of vineyards where it grows both European grape varieties and indigenous grapes such as feteasca alba and neagra, and rara neagra. Europe now accounts for more than half the

New markets Like other Moldovan wineries, Chateau Vartely recorded an increase in sales to European markets after the lifting

This should help to offset the hit that Moldovan wineries took when Russia banned imports of wine and spirits in September, in response to Moldovan plans to initial the EU deal at the Vilnius Summit two months later. The head of Russian consumer health watchdog Rospotrebnadzor, Gennady Onishchenko, claimed the ban was due to concerns over quality control, telling Rossiya 24 news channel, “We have a feeling that the state has absolutely no control over the country’s major industry.”

As a result of the closure of the Russian market, Chateau Vartely’s total production is set to fall from 3.5m-3.6m bottles to around 2.6m-2.8m this year, despite the expected increase in exports to Europe. The ban, which follows an earlier closure of the Russian market in 2006, is also expected to have longterm consequences, with Gogu saying it is unlikely Chateau Vartely will return to the Russian market even if the ban is lifted. “The rules of the shelf are that if your product is absent for more than one month, your place will be occupied by others. Russian politicians carried out very bad PR around Moldovan wine, and people who don’t understand the politics behind the ban will still have the impression that it is poor quality and dangerous,” she says.

While the ban has not extended to the other countries of the Russia-led Customs Union, in both Belarus and Kazakhstan sales are also down, due to a combination of stricter certification rules within the bloc, which have created new barriers to trade with Moldova, and the depreciations of both countries’ currencies. Meanwhile, in Ukraine, usually another major buyer of Moldovan wine, the ongoing conflict has hit trade with Moldovan exporters.

This has forced Moldovan wineries to

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look to other export markets, where the country and its wines lack the same level of recognition as within the CIS. Gogu reports that when attending international wine fairs and meeting with international buyers, she often encounters a sceptical reaction – despite there being evidence of viticulture in Moldova from over 4,000 years ago.

Moldovan wines are now struggling for shelf space against bottles from betterknown wine regions.

State aid To overcome this, Gogu believes a concentrated effort from the industry and the government is needed. A recent positive development has been the launch of the National Office of Vine and Wine, a government initiative to promote the industry outside Moldova. “In selling wine you are not selling just the product.

You are selling the terroir of the wine: the history, the legend, the vineyard, the soil, the weather – everything that goes into

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At the same time, she stresses the importance of growing on the domestic market. While Chateau Vartely only sells around 250,000 bottles a year on the domestic market – about 7% of its total production – the company's sales within Moldova are growing by around 10% a year. A large part of this increase is the transition from drinking wines from so-called “garage wineries” to professionally produced wine sold in shops. “It’s traditional to grow grapes and make wine in Moldova. Almost every farmer produces their own wine and has their own cellar, so we have to work very intensively to develop a culture of wine consumption from the bottle, not from the barrel,” says Gogu.

This includes organising wine tastings and promotions, and working with the local hotel, restaurant and catering sector. “From year to year it is becoming more difficult to play on this market because the number of wineries,

“The rules of the shelf are that if your product is absent for more than one month, your place will be occupied by others" creating the quality of the wine,” Gogu says. “If you look at examples like Chile, they demonstrate that you need time, money and effort before your wine is present everywhere.”

including small wineries, is increasing.

Many of them offer very good quality wines, so competition is becoming very tough.”

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the EU’s energy policy, even if economic concerns have led to some countries backing away from green energy in recent years, but that this will go handin-hand with the growth of gas.

Driven by Ukraine Josipovic was speaking after the publication of an op-ed in the Financial Times in April in which he said that the Ukraine crisis had underlined how vulnerable many eastern members of the EU are to “energy supply disruptions and price increases that harm competitiveness and energy security throughout the region.”

Croatia's oil and gas pipe dreams Andrew MacDowall in Zagreb

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roatia can “lead by example” in Europe by enhancing its own energy self-sufficiency and become a regional centre for energy in the wake of the Ukraine crisis, the country’s president, Ivo Josipovic, tells bne in exclusive comments.

Despite a breakdown in relations between the EU and Russia over Ukraine, which has led to the worst tensions since the Cold War, Josipovic emphasises that the two will remain inter-dependent, while urging Brussels to support the development of domestic resources to promote energy security.

Croatia is seeking multi-billion investments in its energy sector. The country in April launched its firstever tender for offshore oil and gas exploration, and is also looking to develop a liquefied natural gas (LNG) terminal on its Adriatic coast and play a leading role in the Trans-Adriatic gas Pipeline (TAP), which will bring Azerbaijani gas into Europe without crossing Russian soil. All could help reduce Europe’s dependence on Russian imports.

“Croatia’s role in terms of EU-wide energy policy is to lead by example – by developing both internal capacities in the Adriatic Sea, an LNG terminal and an interconnector to TAP, Croatia could become the best example of how diversification of supply and even self-sufficiency can be accomplished,” Josipovic tells bne. “Leading by example is often the best practice. At the same time, Croatia would also play an

The situation in Ukraine has once again raised the prospect of shortages of gas in Central and Eastern Europe, where many countries are heavily reliant on Russian imports, much of it transiting via Ukraine. Several times in recent years – in 2006, 2008 and 2009 – Russia’s Gazprom has shut off the gas supply to Ukraine, leaving countries like Bulgaria, Hungary, Serbia and Greece in the lurch. Josipovic foresees a future in which Europe continues to buy Russian (and Norwegian) gas, but will have a more diversified range of energy sources to boost competitiveness and energy security. “Europe and Russia are and will continue to depend on each other in the energy sector – and both Europe and Russia are aware of this interdependency,” he tells bne. “However, short-term supply interruptions such as the one of 2006

“Croatia’s role in term of EU-wide energy policy is to lead by example" important role as an energy hub for all of these resources in the context of its neighbouring countries. Alternative supply routes and sources are important for increasing long-term security of supply in Eastern Europe.”

Josipovic’s main focus is on broadening gas supply. He adds that renewables must continue to be a central plank of

may occur again, and this is why more supply alternatives are necessary.

In Croatia’s case, this would come both from domestic sources (offshore oil and gas) and imported (via LNG and TAP).

All could help the wider region.

One expert on the Western Balkans, who asked not to be named, said that

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Josipovic’s FT piece should be seen in the context of Croatia’s attempts to promote the oil and gas exploration licensing round that it launched in April. The government hopes that the concessions for 29 blocks over 36,823 square kilometres will draw in $2.5bn in investment in the next five years. A survey by Spectrum, a Norwegian seismic-imaging company, has estimated that Croatia could have reserves of up to 3bn barrels of crude oil offshore – though some analysts are sceptical, and Croatian officials will only say that the prospects are promising. Croatia already has substantial proven oil and gas reserves, but until now most exploration and extraction has been done by the ailing domestic player, INA Group.

Domestic supply Josipovic says he hopes the EU would support eastern member states to develop their own energy reserves – including Poland’s shale gas. “Most importantly for Croatia, Poland and other countries with potential resources of their own, the EU must help the development of infrastructure that will support and make investments in exploration and production more attractive to investors, as economic viability of each such project is the only assurance of its sustainability,” he says.

The Ukraine crisis has increased the volume of lobbying for shale development. However, fracking for Polish shale gas is even more controversial than Adriatic oil and gas exploration. France’s Total recently pulled out of shale exploration in the country.

Another regional security and energy analyst tells bne that Poland and Croatia are two of the most crucial players in energy diversification in CEE, not only because of domestic resources, but because of LNG supply. Poland already has a terminal under construction on its Baltic coast. “LNG is a proven solution to such short-term disruptions and today, there is a network of LNG terminals that are being constructed throughout Europe that will improve its position in this regard,” says Josipovic.

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Croatia resumes hostilities with Hungary

Guy Norton in Zagreb The protracted tug-of-war between Croatia and Hungary over control of Croatian oil and gas firm INA took several twists and turns in June, as the judicial authorities in Zagreb said they would try in absentia on bribery charges the CEO of the Hungarian oil and gas firm of MOL, who it is reported tried to pre-empt such a trial by suing himself in Hungary.

In another release of illegally taped recordings by the Polish weekly Wprost on 23 June, Jacek Krawiec, CEO of Poland's state-controlled energy company PKN Orlen, can allegedly be heard discussing with Polish Treasury Minister Wlodzimierz Karpinski how MOL's CEO Zsolt Hernadi arranged to have an unsuccessful lawsuit filed against him by the wife of a "trusted associate," in order to pre-empt any trial in Croatia.

The thinking by Hernadi's lawyers, according to Krawiec, was that "if there's a case brought on the same matter in any EU country and there's a notguilty verdict, then all EU countries have to respect it" and Hernadi would once again be free to travel around Europe without fear of being extradited to Croatia. "Can you imagine something like that happening here?" marvelled Krawiec.

Analysts point out that indeed Hernadi was cleared in Budapest on May 26 in a case brought by a MOL minority shareholder, who was suing over losses stemming from the corruption scandal. MOL's shares have lost over 40% of their value since June 2011, when Zagreb first announced a review of a 2009 deal that saw the government of former Croatian prime minister Ivo Sanader award MOL management control over INA even though the Hungarian firm only held a 49% stake in the company. The Croatian state holds 44% of INA. Sanader is currently serving a 10-year sentence handed down last year for accepting a ¤10m bribe from Hernadi in return for those management rights.

On 10 June, it became clear that Croatia intends to press on with putting Hernadi on trial, even though Hungary refuses to accede to the extradition request made in October 2013. Hungarian Prime Minister Viktor Orban has accused Croatia of applying “non-economic” methods to intimidate MOL in its fight to regain control over INA. And on 26 May a Hungarian court acquitted Hernadi on a charge of fraud and dismissed a charge of bribery in connection with the 2009 deal.

This ownership fight comes at a bad time for INA, which is at the forefront of Croatia's efforts to develop newly discovered oil and gas resources off the Adriatic coast, licenses for which went up for grabs in April. These new discoveries are regarded by the EU as crucial to help wean the continent off Russian gas – a process given further urgency by the current crisis in Ukraine.

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A not-so academic fight The issue of academic plagiarism by future politicians has been a problem across Central and Eastern Europe for many years; unfortunately, so is the increasing use of heavy-handed tactics by governments against the press that expose such misdeeds.

After several Romanian ministers were revealed a few years ago to have plagiarised their theses at universities, in June it was the turn of Serbian Interior Minister Nebojsa Stefanovic to face similar accusations, which he denies.

On June 2, Pescanik.net (Hourglass) published a piece by three British-based academics that were critical of Stefanovic's doctoral thesis as part of his suspiciously short two-year period at Megatrend University in 2011 gaining a PhD. The title of his doctoral dissertation was “The New Role of Strategic Management in Local SelfGovernment: The Case of the City of Belgrade.”

Pescanik.net said it obtained the paper and a detailed analysis of it with the help of academics revealed that, "Stefanovic’s work is heavily plagiarized and for this and other reasons it fails to meet the criteria for a successful PhD." Cue the website being the victim of a series of denial-of-service attacks (DoS), in which large amounts of data caused it to crash.

Serbian PM Aleksandar Vucic dismissed the idea the government was behind such an attack, though the increasingly populist and prickly leader has form when it comes to using such tactics against media he doesn't like. The OSCE recently pointed to the removal of online content that criticised the Serbian government's response to the May flooding in which 51 people died, as well as content that ridiculed Vucic personally for his somewhat hapless efforts to rescue people during severe weather in January and February.

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A Croatian LNG regasification terminal, to be located on the tourist-hotspot island of Krk, has long been mooted, but is some years from becoming a reality. In April, Economy Minister Ivan Vrdoljak said that Croatia would push ahead with the project, with a view to completing it in 2016 and supplying Hungary, Slovakia, Romania and even Poland.

On TAP The third prong of Josipovic’s diversification strategy, TAP, is also some way from completion, with gas only expected to flow in 2019, Laurent Ruseckas, senior advisor for global gas at IHS Energy, says.

reducing energy usage.

Ruseckas agrees with the president that Europe and Russia will remain interdependent “unless Europe takes some rather bold steps,” but that this is not news. He expects that, “the EU will be the main forum where the various views and ideas about Europe’s future energy security get discussed by policymakers,” though countries will move ahead at different speeds.

Josipovic, of course, would like Croatia to be one of the trailblazers.

Josipovic’s clarion call receives a mixed response. Statements about the need to diversify are not new – and action on them has been slow. The projects he champions will take years to implement, even if all parties are in agreement.

The security and energy analyst tells bne that Croatia certainly has a central role to play in the region. And the future of INA, currently the subject of a dispute between the two major shareholders, the Croatian government and Hungary’s part state-owned energy company MOL, could be an important factor. “Energy security is indeed imperative for CEE,” he says. “It is timely that the comment comes from the Croatian president because Mol is trying to sell its stake in INA and Gazprom and Rosneft are keen to buy it, and no-one else seems keen to. Given Croatia’s strategic importance both for LNG and for gas pipelines, if the Russians were to acquire INA from MOL, it would be a severe blow to Europe’s energy security. While the Hungarians have publicly shown enthusiasm for selling to the Russians, in the current situation it’s practically impossible that such a deal could go ahead. This nevertheless leaves a strategically important company in a vacuum.“

The first analyst is sceptical, given that even within CEE “countries have a variety of different problems and don't have much in common.” She highlights the environmental risks of further oil and gas exploration along Croatia’s coast (the heart of its crucial tourist industry), and adds that Croatia might be better off addressing its own problems in the electricity sector and

The case for European energy diversification has been made many times before, and as Josipovic notes, should not become less relevant even as the Ukraine crisis fades. The Croatian President highlights practical projects with his country as a central player that, if not utterly transformative on a continental level, can make an impact regionally. The task now will be to implement them.

The main route of TAP, which would be supplied by gas from Azerbaijan’s Shah Deniz II field, runs from Turkey to the Albanian coast and under the Adriatic to Italy. Croatia would be supplied via a proposed pipeline along the Adriatic coast. With proposed capacity of 10bn to 20bn cubic metres (cm) – compared with the 115bn cm that Russia supplied to Europe last year – TAP will not have a huge volumetric impact on the continent’s gas supply, but in conjunction with LNG, shale and Adriatic and Black Sea gas, it could still help loosen Russia’s grip, says the security and energy expert.

“Europe and Russia are and will continue to depend on each other in the energy sector"

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in their portfolios, alongside America and Australia, are typically looking to the [Central and Eastern European] region,” says Adam Oliver of agricultural consultancy Brown & Co, which is active in several CEE countries. “Most view Romania and Poland as being the most important markets. Further east outside the EU, risk levels quadruple or more.”

Putting down roots in Romania Clare Nuttall in Bucharest

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rawn by the prospect of rising land prices as much as Romania’s fertile soil and good climate, foreign investors started snapping up farmland long before the country joined the EU. Recently, the profile of those investors has started to change with small-scale European buyers, many of them farmers, being replaced by institutional investors – a shift that has sparked fears among Romanian farmers of a land grab.

An estimated 3m hectares of Romanian farmland is now owned by foreign investors. While this is still a relatively small share of the country’s 14m ha of arable land, of which only around 10m is in use, it has been enough to raise concerns among Romanian farmers worried about being priced out of the market.

Recent entrants to Romania include Southern Harvest, part of US-based Anholt Investments, which announced in April that it had acquired around 6,000 ha of agricultural land, producing crops including wheat, corn, mustard and sunflower seeds, in two separate deals. The acquisitions bring Southern

Harvest’s global portfolio to 29,000 ha, the majority of that in Paraguay and Uruguay. “We find Romania to be an exciting jurisdiction, both in terms of the quality of the land and the nature of the commercial opportunity. We look forward to continuing our growth in

Top topsoil The growing popularity of Romania among international investors has resulted in prices more than doubling between 2007 – the year Romania entered the EU – and 2012, a DTZ Echinox survey says. However, at €2,000-6,000 per ha, land prices are still well below those in Western Europe or even earlier EU entrants such as Poland, and a steady increase is therefore expected.

Romania also benefits from the ability to produce commodity crops. Its several climatic zones allow it to produce a variety of crops, as does the famously fertile “chernozem” black topsoil on around 60% of its territory. As a result, “Agriculture is an important sector in the Romanian economy, contributing between 7% – 10% of GDP, depending on the year and climatic conditions.

Given the resources used, however, this

“Most view Romania and Poland as being the most important markets" Romania, as well as in South America,” said Anholt partner Rudolph Krediet in a statement.

Anholt is an example of the major institutional investors that now have Romania in their sights; other entrants include the US-based Black Sea Agriculture and Dutch-held Rabo Farm, a division of Rabobank. “Investors from both the Middle East and North America have shown an interest in Romania, as part of strategies to diversify their agricultural portfolios.

Those that include the European theatre

is well below its potential contribution,” the DTZ Echinox report says.

This is partly due to the high degree of fragmentation in Romanian land ownership. Much of the country’s farmland is split into parcels as small as 0.2 ha when land was handed out after the collapse of communism. Investors are now parceling up small segments of land – a lengthy but potentially lucrative process.

Peter Beerents of Cibus Farmland Club, a Dutch joint venture set up to acquire and

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manage Romanian farmland, considers the country is “still at the beginning of a big reconstruction” requiring both capital and technical know-how, much of which will be provided by foreign investors. “We believe the land consolidation of the majority of the numerous small land plots will be completed within some five years from now... thus leading to a better economy of scale and improved crop yields,” Beerents tells bne.

With little investment over the last several decades, Romania needs new

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However, while risks have fallen since Romania’s entry to the EU, there is no lack of cautionary tales of fraudsters preying in particular off small-scale investors in the real estate sector.

Related risks for land purchases include confusion over land titles and competing claims to land parcels from creditors or former owners.

The opening of the Romanian market to foreign buyers – from January 1 this year foreign individuals have been able to directly purchase farmland – has also added to political risks by sparking

"Further east outside the EU, risk levels quadruple or more" grain storage and handling systems, irrigation systems and land drainage.

“Part of the investment thesis is that the sector has been starved of capital for 50 years, therefore there is an opportunity to improve the land’s productivity through infrastructure investments,” says Oliver.

fears of a land grab by foreigners. This is a common theme around the world, as both governments and private investors seek to secure productive farmland.

Even Romania’s president, Traian Basescu, weighed into the debate in May

2013, saying that mass land purchases by foreigners were putting the domestic agricultural sector at risk, and advising land owners not to sell. “If we like to believe that we don’t sell our country, then I would like to see Romanians not selling their land. This is the first condition to prevent the land being sold,” Basescu told the annual meeting of the Romanian Agricultural Producers’ League, according to Business Review Romania.

The further opening of the market to foreign investors has made the question of land ownership – a growing concern across several continents – a hot political issue in Romania. During a year of first European and later presidential elections, politicians have sought to drum up support by proposing new limits on foreign land purchases.

However, Olover points out that Romania remains “at the more open end of the spectrum” in terms of attitudes to foreign land ownership. Restricting purchases by foreign buyers would in any case require a renegotiation of Romania’s EU accession treaty, meaning that the current political grandstanding is “largely meaningless.”

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Croatia looks to up its economic game Guy Norton in Zagreb

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hen Croatian Prime Minister Zoran Milanovic took his seat alongside Brazilian President Dilma Roussef for the Brazil-Croatia football match, the opening game in the 2014 Fifa World Cup on June 13, he no doubt pondered the fact that whatever the result – tournament favourites Brazil eventually ran out 3-1 winners – the Croatian football team has historically been far more successful than the Croatian economy.

Although US investment bank Goldman Sachs has forecast that Croatia has just a 0.1% chance of winning the World Cup, domestic cynics believe those are better odds than the country ever topping a global economic performance league table.

On June 10 when he left Zagreb to travel to Sao Paulo for the much-anticipated match at the Arena Corinthians, the Croatian Bureau of Statistics (CBS) announced the doleful news that the Croatian economy had contracted for the 10th consecutive quarter, crushing any hopes of a feel-good factor on the economic front in Croatia even before a ball had been kicked in Brazil.

According to CBS data, GDP in the first quarter of this year shrank by 0.4%, continuing a series of disappointing figures that have seen the Croatian economy contract by a total of 12% since 2009. The tenacity of the negative economic climate that has buffeted Croatia in recent years has caused raised eyebrows among international institutions, with the International Monetary Fund (IMF) recently expressing surprise at Croatia’s “unusually long recession”.

Last year GDP shrank by a relatively modest 1%, but even that performance still left Croatia lagging far behind many

of its Central and Eastern European peers. In 2013, for example, Romania recorded growth of 5.2%, Hungary and Poland each grew by 2.7%, while the Czech Republic and Slovakia posted rises of 1.3% and 1.5% respectively.

No accession benefit Although the former Yugoslav state achieved its long-cherished dream of EU membership on July 1 last year, there’s been no discernible economic benefit for Croatia from entry as yet. In the period 2007-2103 Croatia garnered just under 22% of the pre-accession funding that it was eligible for from the EU, and there are fears the country will continue to miss out on billions of euros from Brussels because of its failure to present projects suitable for EU funding.

Furthermore, as a result of the country’s 6% budget deficit in 2013 Croatia was forced to enter the EU’s excessive deficit

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which in recent years have tended to be wildly over-optimistic. On the pension front, Croatia has to introduce legislation harmonizing the retirement age for men and women, make plans for an increase in the statutory retirement age to 67 years, reduce opportunities for early retirement, and implement stricter assessment and control of disability pensions.

With regard to the labour market, Croatia needs to produce an action plan to boost the effectiveness and scope of labour market policy, in particular with regard to getting young people, the longterm unemployed and older workers into employment.

In terms of the ​​business environment Croatia needs to significantly reduce administrative barriers and para-fiscal levies, while it also needs to produce an action plan for the effective management of state assets and to guarantee the transparent management of public enterprises, while improving the legal oversight of the country’s prebankruptcy settlement procedures.

Thin-skinned Reactions to the European Commission’s analysis and proposed reforms were predictably mixed in Croatia, with some

“The question remains whether and how fast these measures will be implemented” procedure, under which it must slash its fiscal gap to less than 3% of GDP by the end of 2016. In the run-up to Milanovic’s trip to Brazil, the European Commission expressed its approval for the measures proposed by the Croatia government to cut its budget deficit by 2.3% of GDP this year, but also stipulated a series of economic issues it expects the authorities in Zagreb to address over the next 18 months.

These include improving economic planning, with an emphasis on improving the accuracy of macroeconomic and budgetary forecasts,

observers believing them to be just and appropriate, while others dismissed them as wrong-headed or insufficiently rigorous.

Deputy Prime Minister Branko Grcic, head of economic strategy for the Croatian government, told state news agency Hina that he felt the Commission’s views were “objective and realistic”, acknowledging the effectiveness of efforts that had already been put in place by the centre-left administration in the last two and a half years, while at the same time providing welcome suggestions for further reforms

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VIP treatment in Serbia

Ben Aris in Dubai You can expect VIP treatment in northern Serbia as an investor. That doesn't stand for a "Very Important Person", but the Vojvodina Investment Promotion agency, which helps attract investors to a region in the northern half of the country.

Investment promotion agencies have become all the rage across Emerging Europe, and Serbia is the latest country to get into the game. Established in 2004, VIP looks to bring investors to a special economic zone that surrounds Novi Sad, Serbia's second most important city located in Vojvodina – an autonomous province within the country that has its own budget and has a lot of power in setting its own regulations.

"VIP was set up to attract foreign direct investment. We offer opportunities in agriculture, automotive parts manufacturing, which is very strong, ICT, electronic components manufacturing in general, and metal construction," Emilija Stefanovic, head of the Regents investment promotion agency, told bne recently on the edges of the Dubai International Investment Forum.

"And most recently we are starting to invest in renewables."

The region has already attracted a fair amount of attention, largely because it offers cheap wages for a relatively high skilled labour force that is not very far away from the rest of Europe. Some 20 foreign companies have already sunk $320m into just the automotive sector. The temperate climate and fertile soils have also attracted significant investment into agriculture: Nestle, Coca-Cola, Pepsi, Carlsberg and Heineken have all set up operations in the region. All in all, around 50 foreign companies have invested a total of $2bn in the Vojvodina region. "We offer a great combination of cost versus quality. If you ask people why they have come, they also say they like being in Central Europe and that it is an advantage not to work in the EU," claims Stefanovic.

Serbia stands at a nexus between Western Europe, the Middle East and Northern Europe. Also as a Slavic country, it enjoys a free trade agreement with its old friend Russia that makes VIP a good location for manufacturers exporting to the vast Russian market, but at the same time it enjoys a preferential trade agreement with the EU. "The free trade agreement with Russia makes us different, as there are only four other countries [not in the Russian-led Customs Union] that have the same deal," said Stefanovic.

So far, the main exports from the region are agricultural products – things like fruits, grain, and vegetable oil. However the automotive and engineering sectors are growing fast and Serbia is becoming a just-in-time/just-in sequence supplier to companies like Bosch and Siemens.

Although Stefanovic is not keen to emphasise it, the biggest appeal is being able to find qualified workers in Europe that cost between ¤373-611 a month. "There's a high level of education. Novi Sad has the second biggest university in the country... And we enjoy a traditionally good education system," said Stefanovic.

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which would help put Croatia back on the road to economic recovery.

According to Zdeslav Santic, chief economist at Splitska Banka, the assessment of the Croatian economy by the Commission was relatively positive, but cautioned: “there is still a long way to go as far as the stabilisation of public finances is concerned.” He welcomed the fact that Brussels was exerting pressure on the authorities in Zagreb to press ahead with much-needed economic reforms, but said: “The question remains whether and how fast these measures will be implemented.”

For his part, labour leader Kresimir Sever, chairman of NHS, the independent Croatian trade unions movement, said most of the reforms proposed by the Commission with regard to fiscal consolidation by the Croatian government would be acceptable to his members, but he questioned the logic behind some of the proposals in the pension field. “The recommendations are a bit contradictory, because on the one hand [the Commission] is seeking to penalise early retirement, while on the other hand it mentions the needs to create the conditions for the increased employment of young people, "said Sever.

Finally, Davor Majetic, chief executive of HUP, the Croatian employers association, told Hina that while he welcomed the raft of economic reforms proposed by the European Commission, he said he wished that the timetable for their implementation was tighter. "Europe wants to give Croatia the time to sort out and prepare for the reforms that must be implemented,” he said, adding that the government needs to start work on proposed changes straight away “because we do not have more time”.

So as PM Milanovic watched his compatriots put in a good performance against the footballing superstars of Brazil (but were hard done by from a terrible referee), he was no doubt hoping that a strong showing in the rest of the World Cup tournament by the Croatian team will help to ease his task of pushing through socially painful economic reforms in the months ahead.

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Southeast Europe

Newcomer leads in Slovenian election campaign

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Cerar has already indicated he wants to roll back the Bratusek government’s privatisation programme. In a televised debate on June 20, he spoke out against the planned privatisation of Telekom Slovenije, the largest state-owned company currently earmarked for sale. "We will aim to stop it if that will be possible," Cerar said, according to Reuters.

Clare Nuttall in Bucharest

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n another case of Europeans fed up with their country's corrupt, venal and incompetent politicians, opinion polls show the frontrunner in Slovenia’s parliamentary election campaign is Party of Miro Cerar, launched by the political outsider less than six weeks before the July 13 election.

Barely a week after his centre-left party’s launch on June 2, Cerar took the lead in the opinion polls and has managed to maintain that position. Law professor and parliamentary advisor, Cerar launched his eponymous party with a manifesto that promotes the rule of law and accountability, economic freedom and social stability.

While his political platform appears to have struck a chord in Slovenia, Cerar’s sudden arrival on the political scene is just as important among an electorate fed up with political infighting, corruption scandals and a stagnating economy.

Voter disillusionment was evident in the April European Parliament elections, when a little over 20% of the electorate turned out to vote, despite the poll being viewed as a dress rehearsal for widely expected domestic elections later in the year. The ruling Positive Slovenia party performed poorly, taking just 6.61% of the vote – too little to take even a single European Parliament seat.

A recent poll carried out by Ninamedia for broadcaster POP TV and the daily Dnevnik put Cerar’s party in the lead with 19.8% of the vote. In second place was the conservative Slovenian Democratic Party (SDS) with 15.2%, despite the conviction of its leader, former prime minister Janez Jansa,

who started serving a two-year prison sentence for corruption on June 20.

The SDS also took the largest share of the vote in the European Parliament elections in an apparent backlash against the ruling Positive Slovenia.

In May, Prime Minister Alenka Bratusek was ousted as leader of Positive Slovenia in favour of the party’s founder and former leader, Zoran Jankovic. After the resignation of Bratusek, Slovenia’s first female prime minister, President Borut Pahor dissolved the parliament and called snap elections for July 13.

Comebacks and debuts Before Cerar launched his political career, there was speculation that Bratusek could stage a comeback in

Cerar added that while he was not against privatisation per se, companies of “strategic importance” should remain in state hands. The Telekom Slovenije sale process is already underway, with the Slovenian government inviting binding bids for a 72.75% stake in the company on June 9.

Despite Cerar’s popularity, none of the polls give him a large enough share of the vote to form a government alone. According to a note from Teneo Intelligence, no single party is likely to win a majority in the upcoming election, putting Slovenia on track for a new round of negotiations to strike a coalition deal. With the vote now fixed for July 13, “the formation of the new government is only expected

by September, due to the likely slow

"The formation of the new government is only expected by September" the election. On May 31, she launched her own party, the Alliance of Alenka Bratusek, taking with her a splinter group of Positive Slovenia MPs, leaving Jankovic in charge of a muchdiminished force.

Bratusek is popular with international financiers after she launched a farreaching economic rescue programme in 2013, managing to help Slovenia avoid having to ask for an international bailout. However, she has not managed to hold onto support at home and there is growing opposition to her government’s measures including the privatisations of major state companies.

coalition negotiations in the summer period,” writes Teneo’s Otilia Dhand.

A protracted period of negotiations is likely to slow investment and may dash hopes of an economic revival this year.

Slovenia, along with neighbouring Croatia, has been slow to emerge from the recent economic crisis, but its economy is expected to grow by a modest 0.8% this year, according to a May 2014 report from the European Commission. However, the report warns that a return to political turmoil would put the country’s privatisation and deleveraging processes at risk, and jeopardise growth prospects.

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Eurasia's "rupture with democracy" bne

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he crisis in Ukraine has underlined the growing ideological divide between the countries of the postSoviet sphere and the new democracies in Emerging Europe, though this trend has been happening for a decade, according to the Washington-based democratic watchdog Freedom House.

16 countries suffering downgrades, five improving, and eight not registering any score change.

Ringleader As to who is the guilty party in this process, Freedom House is in no doubt.

"The events of 2013 show that the regime in Russia is a role model for

report. "Ten years ago, one in five people in Eurasia lived under Consolidated Authoritarian rule, as defined in the report. Today, it's nearly four in five, and the trend is accelerating."

The Ukrainian crisis has been the most dramatic manifestation of Russia's return to some of its Soviet habits. By

"The fault line between these two regions has been deepening for many years, and Russia’s malign influence on the governance practices of its neighbors was rising long before the invasion of Crimea," says Freedom House in its "Nations in Transit 2014" report released June 12.

"Russia’s malign influence on the governance practices of its neighbors was rising long before the invasion of Crimea"

Of the 29 countries in Central and Eastern Europe/Commonwealth of Independent States (CEE/CIS) assessed in 2013, 13 were rated as democracies, six as transitional regimes, and ten as authoritarian regimes. As in every year for the past decade, the average democracy score declined in 2013, with

other authoritarian leaders, even in states where the authorities already surpass their Russian counterparts in institutionalized brutality and intolerance," says Sylvana HabdankKolaczkowska, project director of the

annexing Crimea, launching Russian military exercises on Ukraine's border, and fuelling insurrection in Ukraine's eastern provinces, Russian President Vladimir Putin has sparked talk of a new Cold War and worse. The resulting crisis

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is the most serious since the collapse of the Soviet Union in 1991, but has also had a major impact on democracy in Russia as the Kremlin stokes nationalism and takes ever stricter measures over civil society and the media to ensure control.

Other countries in the region are following Putin's lead and exacerbating the growing divide between east and west. "This crackdown in Russia established a pattern for the surrounding region, where country after country in 2013 took up anti-democratic innovations that were pioneered by Moscow," Habdank-Kolaczkowska says.

Two of the many Russian innovations such as the law requiring civic groups to register as "foreign agents" and the law against "gay propaganda" received serious consideration in Kyrgyzstan.

Similar talk took place in Kazakhstan, Georgia and Armenia.

Russia served as an inspiration for Azerbaijan and Turkmenistan where government and law-enforcement

already surpass the Russian counterparts in "institutionalised brutality and intolerance", the report says. Both countries adopted legislation similar to Russia's "foreign agents" law.

Freedom House describes Azerbaijan as a country that has the democracy rating of a "deeply entrenched Central Asian dictatorship" with less freedom of assembly or expression than Tajikistan and more corruption than Kazakhstan,

various democracy indices, again received the worst possible ratings on most indicators in Freedom House's report.

Kyrgyzstan received praise as the only country in Central Asia that has seen a greater opening up for civil society and the media, while still suffering from the dominance of the presidency, unstable and undisciplined legislature, and an unprofessional judiciary.

"Ten years ago, one in five people in Eurasia lived under Consolidated Authoritarian rule; today, it's nearly four in five" which was rapped in the report for the "broad extra-legal enforcement" of its already draconian law on religious activity using "extremism" charges.

Uzbekistan and Turkmenistan, which persistently end up at the bottom of

Apart from Kyrgyzstan, Georgia is the only other country in Eurasia whose ratings have improved in the past few years, largely thanks to free and fair elections in 2012 and 2013, and important amendments to the media law, Freedom House says.

Nations in Transit 2014

www.freedomhouse.org

The map reflects the findings of Freedom House’s Nations in Transit 2014 survey, which assesses the status of democratic development in 29 countries from Central Europe to Central Asia during 2013. Freedom House introduced a Democracy Score – an average of each country’s ratings on all of the indicators covered by Nations in Transit – beginning with the 2004 edition. The Democracy Score is designed to simplify analysis of the countries’ overall progress or deterioration from year to year. Based on the Democracy Score and its scale of 1 to 7, Freedom House has defined the following regime types: consolidated democracy (1–2), semi-consolidated democracy (3), transitional government/ hybrid regime (4), semiconsolidated authoritarian regime (5), and consolidated authoritarian regime (6–7).

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produce 4.95m t/y of low sulphur diesel, knocking an estimated $2.5bn off Turkey's current account deficit.

In addition, it will supply an annual 1.3m t/y of Naphtha and 455,000 t/y of Xylenes as feedstock for the adjacent Petkim petrochemical plant, which is 61% owned by Socar. "This is the biggest real sector project in Turkey for the past 30 years," said Socar Turkey's head, Kenan Yavuz, at the signing ceremony, explaining that sourcing feedstock from the new STAR refinery would save Petkim as much as $100m a year and greatly enhance the company's ability to compete with imports.

Azerbaijan and Turkey one nation, two states David O'Byrne in Istanbul

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wo signing ceremonies a week apart have served as concrete evidence of the oft-quoted maxim of the late Azeri president Haydar Aliyev, that the relationship between Turkey and Azerbaijan is one of, "One nation, two states".

Aliyev was referring to not just the geographical proximity of the two countries, but the ethnic and linguistic ties, which bind the two: the two languages, Azeri and Turkish being largely mutually comprehensible, and Azeri and Turkish cultures being particularly close. But arguably nowadays it is the economic ties between the two that bind the most strongly.

The first ceremony on May 30 saw Turkey's state upstream operator TPAO buy up Total's 10% stake in Azerbaijan's Shah Deniz gasfield, taking its holding to 19%, while Turkey's state gas transit company Botas took a 30% stake in the Azeri-backed Trans Anatolian gas Pipeline (TANAP) – a project that will

carry that Shah Deniz gas to Europe by 2018.

The second saw Azeri state oil company Socar sign a credit agreement with 23 international finance institutions including the Exim banks of the US, Canada, Japan, Spain and Italy for $3.29bn towards the $5.6bn cost of its planned 10m tonne a year (t/y) STAR oil refinery to be built on Turkey's Aegean coast. This deal is not only the

According to Socar president Rovnag Abdullayev, the STAR plant is only one facet of a total $10bn investment in the Petkim site, which will also see the creation of a dedicated chemical industry park and logistics complex.

Azeri Energy Minister Natig Aliyev noted that the STAR refinery and Petkim investments coupled with the TANAP pipeline will see Azerbaijan investing over $20bn in Turkey over the next five years. "From the first days of independence, our road (to markets) was through Turkey," he said.

"We used to receive assistance from other countries, now we invest in other countries."

Pipeline to Europe Arguably the most important part of that investment is in the 31bn cubic metre a year (cm/y) TANAP pipeline, planned to carry Azeri gas to Europe via Turkey. The $7bn pipeline will be

"From the first days of Azerbaijan's independence, our road to markets was through Turkey" biggest project finance deal in Turkish history, but at 18 years also boasts the longest maturity.

It will have huge economic consequences for Turkey. Once operational in 2018, the plant will

developed by a consortium in which Azerbaijan holds 58%, Turkey through Botas 30%, and BP having agreed to take a 12% stake.

Speaking to bne at the recent TANAP and Shah Deniz signings, BP Turkey

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president Bud Fackrell said that with Turkey's TPAO having taken over Total's stake in the Shah Deniz gasfield, the two projects now have greater alignment and will be able to progress much faster.

The BP-led consortium developing Shah Deniz made its final investment decision on the second phase of the field late last year and will now push ahead with development to produce an annual 16bn cm/y of gas by 2018, which will be delivered to Turkey via the existing South Caucasus gas line. From there, it will be transited across Turkey through the planned TANAP line.

Turkey will take 6bn cm/y to meet growing local demand in the west of the country, with the gas being taken off close to the western city of Eskisehir.

The remaining 10bn cm/y will be transited to the Turkey-Greece border where it will pass into the planned 20bn cm/y Trans Adriatic (TAP) Pipeline.

TAP, which is being developed by a consortium led by Socar (20%), which last year bought 66% of Greek transit pipeline operator DESFA, will run through Greece and Albania and then across the Adriatic Sea to Italy, from where existing transit lines can carry the gas to markets in central and northern Europe.

Other TAP consortium members are currently BP (20%), Statoil (20%), Fluxys (16%), Total (10%), E.ON (9%) and Axpo (5%). That though may be set to change with Socar officials telling reporters that both Total and E.ON are planning to leave the TAP consortium.

Neither company has yet commented on the reports, but if correct it would offer an interesting opportunity for Turkey's Botas to take a stake in a gas pipeline downstream from Turkey, further cementing ties with Azerbaijan. And, in the process also further cementing relations with neighbouring Greece, to which Turkey has for the past seven years been exporting volumes of the Azeri gas it has been importing via the South Caucasus pipeline, and further contributing to much-needed stability on Turkey's western borders.

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Keeping China gassy

Naubet Bisenov in Almaty Central Asia is now supplying nearly half of China's needs for imported natural gas, with the majority sourced from Turkmenistan, according to a June report from BP. And this is only set to rise as Beijing continues its drive to raise imports from the region.

China gas needs are soaring. In 2013, it consumed 170bn cubic metres (cm) of natural gas, and predicts it will need up to 250bn cm in 2015. That's a cumulative increase over five years of 19% a year, if the economic growth targets are met. By 2020, China should be consuming 420bcm in total, of which 120bcm needs to be imported.

While from 2018 Russia is set to become a major provider after the two countries in May signed a $400bn deal for 38bn cm per year (cm/y), Central Asia remains its key supplier of gas.

Turkmenistan supplied 24.4bn cm of gas to the world's largest energy consumer in 2013. Uzbekistan delivered 2.9bn cm that year but Kazakhstan managed just 0.1bn cm, according to the BP Statistical Review of World Energy 2014. The news comes just days after China inaugurated a third line of the Central Asia-China gas pipeline.

China also imported 24.5m tonnes of liquefied natural gas (LNG) last year, which translates to almost 34bn cm a year (cm/y). However, gas supplies by ship from suppliers such as Brazil, Australia and Indonesia are growing riskier by the day given the rise in tension between China and its neighbours over islands in the South China Sea. The BP data shows Central Asia accounted for 45% of China's gas imports in 2013. Yet it still wants more, and on June 15 inaugurated Line C of the Central Asia-China gas pipeline. Running from Turkmenistan through Uzbekistan and Kazakhstan to China's western Xinjiang Uyghur Autonomous Region, it will eventually carry 25bn cm/y. A fourth line with similar capacity is due to see construction start later this year.

Turkmenistan and Uzbekistan are reported to be pumping 30bn cm/y into the 1,833-kilometre Lines A and B, which were completed in 2009 and 2010 respectively.

Yet Beijing will need to help the countries of Central Asia boost production.

According to BP, Turkmenistan's gas output rose by a meagre 0.4% to 62.3bn cm last year. Kazakhstan managed a 0.8% rise to 18.5bn cm, while Uzbekistan saw production actually fall by 2.8% to 55.2bn cm.

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Georgia's political MAP Monica Ellena in Tbilisi

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ecent events in Ukraine have made Georgia's desire to join Nato even stronger, but mixed mesages coming out of the Alliance show that membership criteria for this Caucasian state will be a function of internal alliance politics as well as external reality.

On June 4, Anders Fogh Rasmussen, the Nato secretary-general, acknowledged Georgia's "remarkable progress", but added that "there is more work to be done" before Nato membership becomes a possibility. Georgia is hoping to get a Membership Action Plan (MAP) at the next Nato summit in Wales, in the UK in September.

Rasmussen's remarks made after a meeting of the Nato-Georgia Commission at the level of defence ministers in Brussels followed the less ambiguous comments by German Chancellor Angela Merkel after her meeting with Georgian PM Irakli Garibashvili in Berlin on June 2. "On the question of MAP, I think it will not be an agenda item of the next summit of Nato," she said, adding that there are options other than MAP through which Georgia's progress can be acknowledged in summit decisions.

For Michael Cecire, associate scholar at the Washington-based Foreign Policy Research Institute, such statements

Bucharest all over again Tornike Sharashenidze, professor of International Relations at the Georgian Institute of Public Affairs and a former director of the Nato Information Centre in Tbilisi, sees a Bucharest 2008-like scenario playing out, where the US, Canada and most Central European states were in favour of awarding Georgia a MAP at the summit held in the Romanian capital, but Germany, France and other Western European states voted against it. "I am sceptical anything will come out in September," Sharashenidze reckons.

"It seems we are stuck at Bucharest as divisions remain. What remains as well is the threat that Russia poses to Georgia. If Georgia will not initiate the membership process, it should receive defence weapons or some kind of Nato presence on its soil to deter this threat."

The idea of deploying defensive Nato assets on Georgian territory is not new.

In May, Georgian Defence Minister Irakli Alasania made a public request for them during his trip to the US. "The idea never gained much traction," adds Cecire.

"We are concerned the Mongolian exit visa system is being misused to pressure foreign investors to settle civil and investment disputes"

underline a basic reality. "Nato is not united. Not on Russia, not on Ukraine, not on collective defence, and certainly not on enlargement," he tells bne in an email interview. "The use of vague terms to answer what should be a straightforward question demonstrates that Georgian membership criteria does not comport to any objective standards, but is instead tethered to the whims of internal alliance politics."

Rasmussen acknowledged the repercussions that the crisis in Ukraine is having for Georgia, the region and EuroAtlantic security, but also reiterated that, "Georgia will become a member as soon as it fulfils the requirements of membership."

"Again, the issue remains political will within Nato, which is simply not there."

Moscow vehemently opposes Nato membership for Georgia – as well as for Ukraine – and has turned its relationship with the Alliance into a battle of wills.

In December, Russian Foreign Minister Sergei Lavrov said that Nato was reverting to the "old inertia logic of the Cold War," and "is not only preserving dividing lines, which we are all obliged to remove, but also moving them further to the east, which is absolutely contrary to the obligations, which we have undertaken at summit level in respect of the indivisibility of security. Nobody should undertake steps that create risks for the security of their partners."

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Hunting for MAP Following the collapse of the Soviet Union, many of the former Soviet republics, including Georgia, joined Nato's "Partnership for Peace Program" in 1994.

Full Nato membership became a foreign policy cornerstone of the westernminded leadership who took power following Georgia's Rose Revolution in 2003. President Mikhail Saakashvili tried to speed up closer ties with the Alliance by deploying troops to Afghanistan to assist the Nato-led International Security Assistance Forces (ISAF), while Georgia became the first country to sign the Individual Partnership Action Plan, the IPAP. The plan sets precise requirements not only in the armed forces, but also in human rights and democratisation. Georgia did not tick all the boxes, but it was promoted two years later to the current stage, the Intensified Dialogue.

But since then progress has stalled. In November 2007, Georgian police brutally crushed anti-government protestors on the streets of Tbilisi. How significant that was to what followed is unclear, but a few months later Georgia missed out on MAP in Bucharest in 2008. The opening of hostilities in South Ossetia in August 2008 and the brief war with Russia that followed took Nato membership for Georgia off the table.

Still, Brussels realized Georgia's volatile precarious position versus Russia and at the end of 2008 re-opened the dialogue, started a programme to support the reform of the armed forces, and set up the Nato-Georgia Commission that was tasked with monitoring the Annual National Program. By the 2010 summit in Lisbon, the possibility of MAP for Georgia was revived.

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Ready or Not? Not everyone is convinced by the messages coming out of Nato. "Any country, even existing Nato members, could have their shortcomings magnified as a reason not to be brought into the Atlantic alliance," explains Cecire. "But by any objective standard, Georgia has all the attributes that make it a very eligible candidate for a MAP, if not outright membership. Any areas for improvement at this point are best serviced through a concrete benchmarks. The fact that Nato is unwilling to take that step shows their true intentions on the matter."

Indeed, reality shows that requirements can be loosened up: while all the members are supposed to spend at least 2% of GDP on defence, few of them actually do.

But there are also technical issues. Even before recent developments in Ukraine, members lacked consensus over how Georgia's membership would affect the country's breakaway regions – Abkhazia and South Ossetia– and if and how to apply the crucial Article 5, which requires Nato members to militarily intervene in the case of another member coming under attack.

Although Georgia's armed forces are in a much better shape than August 2008, full reform is a "multi-year process," says Cecire. Still, "it is possible now to start looking at acquiring more advanced defensive weaponry because there is a feeling that the Georgian army is now in a place where they can use them effectively."

The inevitable, though unpredictable, reaction from Moscow over Georgia's joining of Nato is an incentive for the Alliance to continue to play it cautiously.

"The issue remains political will within Nato, which is simply not there."

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began testing at a recently acquired license for copper.

But junior miners such as these are struggling to attract the kind of investment they are looking for due to the wider economic struggles that the country is labouring under. Foreign investment into Mongolia was down 64% on year at the end of April and GDP growth of 11.7% last year and 12.3% in 2012 was well down on the astounding 17.5% growth recorded in 2011.

Drilling down in Mongolia Terrence Edwards in Ulaanbaatar

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he summer months in Mongolia are a time of big exploration for the country's army of junior mining companies as they drill in search of the coal, iron ore, copper and gold that has put this country on the world map for natural resources. Investor sentiment toward these companies is still rather cool compared with the weather here, but a joint venture deal between Australia's Aspire Mining and Noble Group has given the sector a lift.

On June 13, Aspire Mining, which is developing coking coal assets in northern Mongolia, said it had agreed to buy 50% of a venture with Noble Group as it looks to expand their partnership in Mongolia, which already involves the Hong Kong-based global supply chain manager providing project financing and transport for the Australian miner.

“It's a notable transaction, especially due to Noble Group's involvement, as they have clearly demonstrated they are a long-term investor in Mongolia,” says Chris MacDougal, managing director of

Mongolian Investment Banking Group (MIBG). “[Noble's] actions suggest that they believe in the fundamentals of the country.”

Aspire Mining's 50% purchase of the joint venture from another local junior miner, Xanadu Mines, shows strong interest still exists in Mongolia's vast

The wider global mining industry has its own problems, according to auditor PricewaterhouseCoopers' (PwC) "Mine 2014" report. PwC cited “diminished profitability and shrinking cash, [and] underlying performance in the industry” for 2013, as well as the market capitalisation of the industry falling by $280bn.

PwC found that miners operating in emerging markets last year outperformed their developed counterparts, earning $24bn collectively compared with losses of $4bn in developed markets. That is a sentiment echoed by the chief executive of local junior explorer Erdene. “I think we've seen a return to favour for juniors, generally,” says Akerley about mining worldwide. “In regards to Mongolia, you're seeing an uptick in activity in the past few months, but the main issue is globally there is still difficulty

"Globally there is still difficulty in attaining funds for exploration and that’s compounded by Mongolia being a difficult place to do business"

trove of minerals. Ulaanbaatar-based MIBG in a note to investors highlighted an increase in summer exploration campaigns of local small and mid-sized miners like Xanadu Mines, Erdene Resource Development and Kincora Copper. Since the exploration season began in April, Erdene has found significant gold deposits, while Xanadu

in attaining funds for exploration and that’s compounded by Mongolia being a difficult place to do business.”

Hard feelings Mongolia's mining boom first began to tail off after the government overplayed its hand with investors in 2012 by passing legislation that

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most in the mining sector regarded as too restrictive. A month before parliamentary elections in 2012, Mongolia felt threatened by a bid from Aluminum Corporation of China, or Chalco, to buy a majority stake in coal miner SouthGobi Resources. Mongolia – fearing the gradual takeover of its mining industry by China – labeled mining a “strategically important sector” and required government approvals for any group attempting to buy more than a third of any strategic asset.

Mongolia tried rectifying its mistake on the investment front last year when it removed the need for private investors to seek government approval for investments in mining assets and other strategically labeled assets with a new Investment Law. But lingering disputes show that there is still much work to be done.

Toronto-listed Kincora Copper is still waiting on a promised resolution from Mongolia’s mining ministry after it saw its licenses taken away. The company was forced to inform investors of a C$7m writedown for the company after a judge ruled that about 106 licenses were invalid after the top bureaucrat that had approved them was found guilty of corruption. A four-year ban on the issuance of new exploration licenses is also becoming worrisome the longer it remains in place, because it has “signifcantly reduced the total amount of land available for exploration,” says Sam Spring, chief executive officer of Kincora Copper.

The moratorium will likely remain in place until after the parliament passes an amendment to the mining law that it has repeatedly delayed. Meanwhile, many of the licences are nearing their expiration dates, which makes it hard to market those assets. “Less than 9% of exploration licence will see a natural death in the next few years because of the lengths of their terms,” says Spring.

“Investors have max nine-year terms and then must convert to mining licences.”

Deal or no deal One thing holding back investors is that Mongolia’s new Investment Law

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remains untested. Some also have little faith the laws will remain consistent for very long or that Mongolia will stand by the tax stabilisation agreements introduced by the 2013 Investment Law. “Honestly I don’t think it’s been a positive change,” says one investor who is actively seeking to buy mining assets in Mongolia. “It’s quite dubious, these investment guarantees, as opposed to international agreements because the [former] are now just permits that a Mongolian agency is giving out. They can change their mind any time.”

The investor, who requested anonymity, added that there was no comfort in the fact that disputes would likely have to

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Erdene or spend C$3m. ”As long as they see good results and evidence Mongolia is taking the right steps to improve the environment, they'll continue forwards,” says Erdene's Akerley.

The sale of parent company Turquoise Hill Resources’ stake in SouthGobi Resources would be the first major sign for investors that things are improving.

Bloomberg reported that a deal could come at the end of the June, but interested parties have yet to be named.

Many investors have grown frustrated with the political outbursts from Mongolia, but PwC stresses that investing in emerging markets has

“Honestly I don’t think it’s been a positive change” be resolved locally rather than through international arbitration under the new scheme. “The local agency will never side against the local implementers.”

Majors have shown interest, but are cautious. Teck Resources has been purchasing the equity of Erdene on the basis that the government has looked to be improving the investment environment. A strategic alliance has Teck set to purchase up to 19.9% of

always been a game for risk-takers.

Mongolia isn’t the only country guilty of shaking up the investment regime ahead of elections. "[T]he licence to operate in all corners of the globe is becoming more challenging, with governments increasingly eager to expand their share of royalties and taxes,” reads the PwC report. “Election results in 2014 in Brazil, India, Indonesia and South Africa may further alter the influence of emerging markets on mining.”

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regulations that require imported cars to be equipped with at least one airbag, an anti-lock braking system, specific attachment points for child-safety seats and daytime headlights, among other things.

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he Uzbek government makes it painfully hard for motorists to buy a car. And even though the main domestic producer of vehicles, GM Uzbekistan, is suffering from falling exports to its main markets of Russia and Kazakhstan, perverse regulations and policies are making it even more expensive and difficult to purchase one.

sales of Uzbek cars in Russia fell by 14% on year to 17,369, continuing a trend that started a couple of years ago when car exports to Russia fell from a peak of 92,778 in 2011 to 60,829 last year. Sales in Kazakhstan had grown from 3,829 cars in 2011 to 13,371 cars in 2013, but similarly fell in the first quarter by 53.7% on year to 1,691 cars.

Central Asia's largest car producer, GM Uzbekistan, a joint venture in which the US' General Motors holds a 25% stake and the Uzbek state the rest, is expected to produce more than 250,000 cars this year, Uzbek media bragged earlier this year. The Uzbek-US joint venture, located in the town of Asaka in the Fergana Valley, produced 246,641 cars last year, and had increased its output to 52,782 cars in the first quarter of this year, up by 15.7% from the year-earlier period.

The reason behind the fall in sales is Russia's introduction of a recycling duty on imported cars following its accession

Despite the rising output, sales of Uzbek-made cars, namely the bestselling Nexia and Matiz models, have been falling in the major export markets of Russia and Kazakhstan. First-quarter

These decreases have largely hit the sales of GM Uzbekistan's most popular Nexia and Matiz models. Perhaps in response to the shrinking export markets and in order to maintain high prices on the domestic market, GM Uzbekistan cut output of these cars by 3% and 4% in 2012, respectively, and by 29% and 43% in 2013. The joint venture cut the number of Nexia and Matiz cars further by, respectively, 10% to 11,613 and 59% to 2,830 in the first quarter of this year.

Tricks of the trade A paradox of the Uzbek car market is that the price of a locally produced car in Uzbekistan is actually higher than in foreign markets, and the price of a used car is higher than that of a new car. The Uzbek authorities have imposed high import duties and levies (at 30% of a new car's customs value plus $1.8 to $3 per cubic centimetre of an engine exceeding 1,000 cc) which, Uzbek motorists say, makes imported cars prohibitively expensive.

They complain that because of this, customers are forced to buy local cars "at any price". By keeping prices high on the local market, the Uzbek government subsidises exports to maintain access to foreign markets to earn hard currency. For example, according to GM Uzbekistan's website,

"If Uzbekistan had a decent customs policy, no one would drive Uzbek-made cars" to the World Trade Organization (WTO) in 2012. This levy has driven up the price of Uzbek cars on the Russian market, making them less competitive.

At the same time, the recent fall in Uzbek car exports to Kazakhstan is blamed on new Customs Union

dealers can buy the cheapest Nexia for UZS31.307m ($13,652 at the official exchange rate or around $10,500 at the black exchange rate) or $9,546 for cash dollars. The prices of Nexia in Kazakhstan and Russia are $8,200 and $8,450, respectively.

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The trick to buying a car in Uzbekistan is that GM Uzbekistan releases a limited number of cars onto the domestic market two or three times a year. Dealerships open subscription periods, during which potential buyers rush to enter contracts on the purchase of a car and make downpayments worth around 85% of the price of the car in the national currency. (During such campaigns the national currency, the som, briefly strengthens against the dollar on the black market as buyers exchange dollar savings). Those who manage to conclude such contracts (often by bribing dealers) will then have to wait up to a year until they actually receive their cars. "This means GM Uzbekistan builds a car after it receives payment for it," points out one driver who drives a Russian-made Lada.

If during the wait GM Uzbekistan increases the prices of its cars, then potential buyers will have to pick up the difference or get a refund to their credit card (which they won't be able to swap

for cash). Last July, car prices went up by between 7.4% to 28.1% from the prices set in May 2012, depending on the model. Inflation was officially 6.8% in 2013.

Those who don't want to queue at dealerships (or rather storm, as this video shows) during subscription campaigns opt to buy a car on the second-hand market. Since the government has banned the sale of new Uzbek cars within the first year of purchase, the price of a year-old car ends up being higher than the price of a new car: the lowest asking price of a 2013 Nexia ranges from between $12,500 and $13,000 in cash dollars at Tashkent's Sergeli car market.

One motorist told bne that in order not to wait for a year to buy a new car he had used the services of one of the many leasing firms whose prices depend on the size of downpayment, monthly or quarterly instalments and duration of

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

the arrangement. Depending on these factors, a car can ultimately cost as much as $20,000, he explained.

Instead of diverting the cars that are unwanted abroad onto the local market or even increasing production to meet the extra demand, GM Uzbekistan is increasing the production of expensive high-end cars, which aren't popular with most Uzbek drivers. The firstquarter production of Malibu saloons and Captiva SUVs increased by 110% and 310%, respectively, even though these cars have failed to find much of a market in Uzbekistan where the average salary barely exceeds $300. At prices in excess of UZS100m ($33,300 at the black market rate), Malibus and Captivas can be purchased freely at Tashkent dealerships.

"If Uzbekistan had a decent customs policy, no one would drive Uzbek-made cars," reckons the Lada driver from Tashkent.

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STOLYPIN:

No-one wins from chaos in Ukraine Mark Galeotti of New York University

T

here is a new orthodoxy in some western quarters about how “masterful” Russian tactics have been over Ukraine.

To be sure, Moscow demonstrated a deftly ruthless hand in spreading chaos in the east. But as week of anarchy and impasse follows week, it is worth noting that this may prove something of a Pyrrhic victory. Perhaps the best hope for peace is to be found in the fact that the status quo is in no-one’s interests.

Certainly not Kyiv’s. Although Donetsk and Luhansk received extensive government subsidies, they represent the heart of the country’s industrial base. Considering that its economy was already in a bad shape, a rump Ukraine to which the east is lost would face formidable challenges in trying to stay economically afloat.

How long would the EU be willing to bankroll it? This is especially important considering that Ukraine’s energy debt to Russia and its continuing need for its gas mean that in effect, Brussels would be subsidizing Moscow.

The longer the conflict continues, the harder it is for Kyiv to maintain its legitimacy and credibility. It also increases the tendency already seen with the rise of the National Guard – many of whom are ultra-nationalists hurriedly sworn into service and given guns and the most basic of training – and local forces such as the militia bankrolled by oligarch Igor Kolomoisky, governor of Dnipropetrovsk region. The danger is that the conflict devolves into a struggle of warlord versus warlord, with Kyiv relegated to onlooker and cheerleader.

But even if Kyiv looks as if it might be able to re-impose its control over the east through military means – which looks unlikely at the moment – the odds are that Moscow would simply up the ante in response. It could increase the deniable assistance it provides the rebels or decide it has no option but to intervene directly, “responding to requests for assistance.”

After all, Putin has placed too much political capital into his Ukrainian adventure to be able to accept anything that he cannot at least plausibly spin as a win.

However, we shouldn’t assume that Moscow is not uncomfortable, too. This is not just a question of Western sanctions although – jokey bluster aside – many within the elite are genuinely concerned about their scope to travel and trade abroad.

More generally, what was presumably envisaged as a quick and dirty piece of political-military blackmail, akin to starting a fire and standing with one foot on the hose, is proving more dirty than quick. The Kremlin appears genuinely to have believed that Kyiv would come quickly to terms. Whether through determination or disorganization, they did not,

"Many within the elite are genuinely concerned about their scope to travel and trade abroad"

and now the newly-inaugurated Ukrainian president Petro Poroshenko must work in a political environment saturated with nationalist rhetoric and often unrealistic expectations.

The big moment Meanwhile, the insurgency in eastern Ukraine has acquired its own momentum. Strongmen are building their own pocket fiefdoms. Some of these are simply gangsters seizing the opportunity to turn underworld coercive power into political authority. Indeed, we are beginning to see signs of eastern militias turning on one another.

Thus, Moscow faces the daunting prospect of civil war on its own border. Furthermore, many of the Russians who have chosen to go fight come from the more unappetizing nationalist extremes. The irony is that while Putin has been stoking Russian imperial sentiments of late, as a source of

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legitimacy if and when the economy worsens, he has carefully not allowed this to assume the character of racist xenophobia.

His is a nationalism of the Russian state, not an ethnic one.

This is a subtlety likely to be lost on many of the Russian “war tourists.” Instead, the conflict is arming and empowering – amongst, to be sure, a range of adventurers with less toxic beliefs – extremists whose racist ideals are problematic to say the least to the Kremlin. After all, it is deeply aware that perhaps 20% of its population is non-ethnic-Russian, and it has to work with non-ethnic-Russian elites across the country.

Some day, these people will come home, and they are unlikely to check their guns or their beliefs at the border when they do.

Talk of allowing or encouraging the east to become some new de facto statelet or statelets under Russian dominion and protection, like Transdnistria, South Ossetia or Abkhazia, also understate the difficulties this would bring Moscow.

Supporting such a large and industrialized pseudo-state would be a great financial imposition, not least as Kyiv would presumably block its borders and the West bring sanctions to bear on those who traded with it.

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Russian satellite, but he has also talked up the need for peace.

It remains to be seen how much real flexibility he will show in private negotiations, how far his rhetoric is to establish a strong position from which to be haggled down, or else to reassure the West Ukrainian nationalist constituency.

Nonetheless, although reaching any deal will be extraordinarily hard in the short term, the outcome of not being able to do so will be a great deal harder on everyone in the long. It is in no-one's interests, not Kyiv's, not Moscow's, not Akhmetov's nor even Donetsk's, for this to continue indefinitely.

Mark Galeotti is Professor of Global Affairs at the SCPS Center for Global Affairs, New York University, who writes the blog "In Moscow's Shadows"

Many Ukrainian defence plants on which Russia relies, such as the transport airframes of Kyiv’s Antonov, would be closed to them. Others in the east, such as Zaporizhzhya’s Motor Sich, would require extensive support from the Russian budget.

Perhaps worst of all from Moscow’s perspective, the West would likely feel it had no option but to extend even greater aid to Kyiv, out of both embarrassment and common sense – the EU hardly wants a failed state on its doorstep. Gaining the east (at considerable cost) would also definitely lose western Ukraine.

Private armies Are the oligarchs benefiting if they are getting to raise private armies? Hardly; the point of being an oligarch in somewhere like Ukraine is that you can concentrate on making and enjoying money. Your bribes and gifts, campaign contributions and exhortations to your workers to vote the “right” way are all intended to ensure that you have a compliant government that protects your interests and stays out of your affairs.

Kolomoisky has made his choice and is sinking his own assets into making up for the shortfall in the government’s security apparatus. Viktor Pinchuk, an early defector from former president Viktor Yanukovych’s side, has seen his businesses badly hit by retaliatory sanctions from Russia, previously his main market. Rinat Akhmetov has been more circumspect, but ultimately had to side with Kyiv in May. Although he would hardly be a pauper if his businesses in the east were expropriated, there are voices calling for such a move.

At present, it is too early to say what the chances of peace in the near term may be. President Poroshenko has been publicly bullish about his country’s future in Europe rather than as a

"It is in no one's interests, not Kyiv's, not Moscow's, not Akhmetov's nor even Donetsk's, for this to continue indefinitely"

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