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Inside this issue: Made (badly) in Russia Highway robbery in Czech Republic The lonely life of Turkish Cypriots Mongolia's crucial month June 2012 www.businessneweurope.eu

Special Report: Private equity in CEE/CIS

POLITICAL FOOTBALL


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Contents

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

21 COVER STORY 6

The Insiders

22

Made (badly) in Russia

8

Political football

23

Belarus ready to start sale of state-run banks

9

Crisis? What crisis?

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Business counts cost of Ukraine's isolation

13

Poles apart from Ukraine

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Kicking up a fuss in Poland

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Perspective

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Emigration and demographics are CEE's next crisis

25

Latvia - where history is never in the past

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Hungary's schizophrenic moves

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Warnings signs in Poland

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Highway robbery in the Czech Republic

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Bankruptcy befalls Krajbanka

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CENTRAL EUROPE

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The biggest bank in the world

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Kremlin takes revenge

19

Seeking justice in Russia

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The myth of Russian capital flight

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Contents

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SOUTHEAST EUROPE

EURASIA

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Island troubles

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A toxic issue

36

The lonely life of Turkish Cypriots

48

Asian plays

48

Nabucco is dead; long live Nabucco West

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Mongolia's crucial month

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EDB a catalyst in the Eurasian economic space

37

In Cyprus, life's a gas

38

Turkey's Akbank young at heart

OPINION 57

Essential kit for the emerging market explorer

58

Russia's new government

SPECIAL REPORT

40

Shock Nikolic victory in Serbia

42

Dreams of longevity in Romania

44

Quo vadis Croatian tourism?

54

Carrots and sticks in Kazakhstan

55

From rubble to rubles in Georgia

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More funds required

63

High performance

65

Falling out of favour

66

Vladimir & Igor's excellent venture

68

Funding small business in the Caucasus

70

CLASSIFIED

70

UPCOMING EVENTS

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I The Insiders

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Jim O'Neill chides Russia's critics

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"T

he most important thing linking Russia to the global market is the low expectations," Jim O'Neill, chairman of Goldman Sachs Asset Management and investment guru, told a recent conference of VTB Capital in London. "I get at least an email a day telling me to take the 'R' out of BRIC and I take them as a reverse indicator: the more of these emails there are, the less Russia has to do to surprise everyone." O'Neill – who coined the term BRIC about a decade ago as a marketing term for the opportunities to be found in Brazil, Russia, India and China – remains upbeat about Russia's prospects and gave the country's detractors a stinging rebuke for what he calls judgements that are "narrow and mired in personal interpretation" more than in fact. Russian stocks have been punished more than most since the financial meltdown in 2008 and are currently trading at a 50% discount to their emerging market peers. And since panic began sweeping the market again in the wake of Greece's failure to elect a new government in the first half of May, the market has been punished again, seeing more investors exit than any other major emerging market. Yet the economy is doing surprisingly well. "In the first quarter of this year, Russia was the only BRIC to put in a positive surprise with its 4.9% growth [against the official forecast of 3% of this year]. All the sell-side analysts ended up revising up their forecasts for the year. In Europe, growth was slow and the UK underperformed even that. Russia once again was exceeding expectations." Russia's economy remains fundamentally strong, sporting some of the best macroeconomic numbers in the world. O'Neill says the task for Russia to continue to surprise is simple. "All Russia has to do is not have a crisis," says O'Neill

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plan to create an international financial centre won't happen unless the things I listed happen." Still, O'Neill was critical of the government's attitude to oil prices and the heavy spending the state is engaged in now that requires an oil price on the order of $120 for the budget to break even. "Russia needs a budget that assumes prices [of oil] will fall, otherwise it will confront its main danger – crisis," says O'Neill.

Jim O'Neill, Chairman of Goldman Sachs Asset Management Photo: (CC) Financial Times

without irony, as Russia has suffered about six crises of varying severity in the last two decades. "What people don't appreciate is the size and importance of the economy. If Russia has no crisis, then it will contribute more to the global economy in dollar terms than the entire European Union combined." Hopeful indicators Goldman tracks emerging market countries using 18 indicators covering the gamut of business life, and here too Russia can surprise. "Russia is not the weakest overall, India is the weakest," says O'Neill. "Of course, Russia is very bad on several counts, including the rule of law and corruption. But

"All Russia has to do is not have a crisis" on other things like technology and schooling, it is number one. Somehow, Russia needs to keep being best at these and get better at the others." And this is the hope for the new government that was officially appointed by President Vladimir Putin on May 21. O'Neill laid out three goals the new administration needs to achieve: diversify away from oil, improve the corporate rule of law (especially in the context of privatisation), and finish capital market reforms. "There are some good faces in the new cabinet. [Deputy Prime Minister for Industry and Energy] Arkady Dvorkovich is a natural reformer and the

Finally, O'Neill was also upbeat on the long-term potential of Russia's growth. The demographic problems have been often cited as one of the most crippling of Russia's difficulties. Indeed, GDP growth is predicted to slow to under 3% by 2050 due to the shrinking size of the population. "This means that diversification and increasing productivity in Russia is very important," says O'Neill. "But one of the best things that has happened in the Putin decade is the demographics are improving. Male life expectancy has gone from 59 years to about 65 due to the policies to reduce the life-threatening consumption of alcohol. If this continues, then there is a real possibility of an upside shock to our projections." Ironically, the next crisis that Russia will have to face will probably not be of Russia's own making for once. O'Neill says that June will be a crucial month for the entire global economy. "If the EU financial authorities can't manage with greater success the situation, then it will affect everyone, including Russia," warns O'Neill. "Russian growth was unexpectedly strong in the first quarter, while the opposite was true in the UK. It says a lot about the underlying economic situation in the two countries. Countries need to make sure that the things they have control over are robust in preparation for what comes next as what else can you do?"

"One of the best things that has happened in the Putin decade is the demographics are improving"


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ran through Europe, and brought an avalanche of declarations that national representatives and European Commission officials should not and would not attend Euro 2012 matches in Ukraine.

Political football Graham Stack in Kyiv

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kraine's hosting of this summer's European football championships, the world's fourth largest sporting event, should have been a game changer for perceptions of the country in the West, but President Viktor Yanukovych has, it seems, done everything in his power to turn it into a catastrophe. Even then, it took a photograph of a bruised and apparently beaten former prime minister in a jail cell for the ball to finally end up buried in their own goal. The Euro 2012 football championships should have been a gift from the gods for Yanukovych in the run-up to challenging parliamentary elections in October 2012, giving him a chance to be seen hobnobbing on home territory with the crème de la crème of the European political elite. Yet this gift he did not deserve, since the original decision by football's governing body Uefa to award the championships to Ukraine together with Poland was largely the fruit of Ukraine's "Orange Revolution" of 2004 - which was in turn inspired by the desire of hundreds of thousands of Ukrainian who took to the streets to keep Yanukovych out of power and overturn rigged elections he claimed to have won. It seemed a bitter irony of history that this one last remaining fruit of the Orange Revolution should be plucked by the people the Orange Revolution was launched against.

But Yanukovych did not seem particularly grateful for his luck when in October 2011 a Ukrainian court widely seen as acting at his behest sentenced Yulia Tymoshenko, the firebrand leader of the Orange Revolution and former PM, to seven years in jail for abuse of power. In the following months, a further three close Tymoshenko allies all received long jail sentences. The imprisonment of the opposition prompted widespread consternation in European diplomatic circles, but Ukraine has always been skilled in playing Europe off against Russia. And while European politicians made unhappy noises, no concrete action was taken against Ukraine for fear of pushing Ukraine into Russia's embrace. The EU instead decided to rely almost entirely on carrot rather than stick – dangling the prospect of the signing of a highly sought-after Association Agreement and Deep Free Trade Zone as soon as Ukraine released Tymoshenko and the others. The EU even proceded to initialize the agreement in April 2012 as a sign of good faith. There was above all a silent consensus not to politicise Euro 2012, which was intended to symbolise Ukraine's move towards Europe, and which had a powerful defender in the form of Ukraine's co-host Poland. "Keep

politics out of football," was the Polish watchword. There was in fact little to show that the EU was more put out by Tymoshenko's imprisonment than Russia, which believed that the Tymoshenko trial had an "anti-Russian motive", according to Russian Foreign Minister Sergei Lavrov. Dictatorship All that changed with one picture: a reclining Tymoshenko with bruises across her bared midriff and forearms, following what she claimed was a beating by prison guards as she was forcibly taken for treatment for a back problem. The photograph has already become an iconic image on a par with the facially scarred Viktor Yuschenko of 2004 and the bald Vladimir Litvinenko of 2006, both victims of political poisonings. A picture speaks louder than a thousand words was the motto in print media days, but in the era of the internet and a $100bn Facebook – the right image is easily worth a million words. The Tymoshenko photo turned what had been a diplomatic question into a domestic issue for European politicians. With the Euro 2012 championships looming, there was no way of avoiding the connection. A wave of condemnation

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Most damaging of all, Europe's most powerful politician German Chancellor Angela Merkel branded Ukraine outright a "dictatorship" on a par with pariah Belarus. Merkel called out the elephant in the room: Ukraine's government has imprisoned its opposition leaders, and this is something only dictatorships do. Ukraine's leadership has been left reeling – Prime Minster Mykola Azarov has avowed that Tymoshenko's bruises were cleverly applied make-up, but there was no touching up the fact that on a visit to Brussels May 18, not a single topranking EU official could find a minute of time to meet with him. European Council President Herman van Rompuy was even quoted by Euronews advising Azarov to "stay at home". Serhiy Tigipko, a bigwig of the ruling Party of Regions and deputy prime minister, duly acknowledged May 19 that Ukraine's government's image has been damaged "externally, but not internally". "This is clear now from the statements of European leaders," Tigipko admitted. Only Yanukovych appears impervious to the new reality. "Ukraine has not suffered any deterioration in relations with a single European country," he insisted on television on May 20, in the face of what is seen as his biggest foreign policy crisis since coming to power over two years ago. Anarchy in the Ukraine The economic fallout from the deterioration in relations with Europe was not long in coming (see accompanying story). With the euro in flames, stock markets dropped across Europe in the first weeks of May - but nowhere by more than in Ukraine. The bottom has dropped out of the Ukrainian stock market, with a fall of 20% since the start of May outpacing even Greece to become the world's worst performing stock market. While the domestic collapse also relates to

Crisis? What crisis?

bne Ukraine's economy is not in crisis – but it is not far from it either. Another external shock could tip the balance, as the economy remains very fragile. With only a little more than three months worth of import cover as hard currency reserves, Ukraine is living dangerously. Last autumn Ukrainians, fearing another devaluation that had already reduced the value of the hryvnia from UAH5/USD1 pre-crisis to about UAH8/USD1 now, withdrew some $3bn worth of currency almost sparking a financial crisis. The National Bank of Ukraine managed to calm those fears, but a devaluation still lurks in the wings, which analysts believe is almost inevitable. Indeed, in May the NBU supervisory board member Yuri Poluneev admitted as much, saying there is a "high probability" that the central bank will allow a gradual hryvnia devaluation, although it is unlikely the government will allow this to happen until after the general election in October. Analysts at ING expect the hryvnia to end the year at about UAH8.41/USD1 and a growing current account deficit will put even greater pressure on the hryvnia. In the meantime, strong consumer spending in the first quarter of this year, up 12.7% on year, heavy investment into football-related infrastructure, and a buoyant agricultural sector has been propping up growth. Still, Ukrstat reported that year-on-year growth in the first quarter was an anaemic 1.8% and industrial production has been shrinking since the summer of 2011. Local think-tank ICPS forecasts annual economic growth will slow to 3% in 2012, compared with 5.2% in 2011. Yet the government seems unconcerned by the fragility of the economy and continues to spend heavily ahead of the elections. With revenues lagging the budget plan, analysts worry about a ballooning budget deficit this year. "Ukraine is growing more susceptible to external shocks as the economy becomes more imbalanced," ICPS said in an outspoken report in April, which accused the government of dodging badly needed reforms because of the looming election. The lack of progress also means the IMF has suspended its stand-by agreement, which is unlikely to resume this year, cutting Ukraine off from its fiscal parachute. "The Yanukovych Administration is failing to deal with the country's most urgent economic problems," ICPS said. "The president's economic reform plan, which should have dealt directly with these issues, remains a paper tiger."


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low liquidity, London-traded Ukrainian titles on the London Stock Exchange plunged 5-8%. "[May 14] saw a capitulation of Ukrainian equities," Dragon Capital analysts said. Debt markets have also reacted nervously, with Ukraine's sovereign credit default swaps spiking 40 points since early May. The drastic deepening of the split with the West is raising massive question marks over what were Ukraine's key anchors for investors: the proposed EU Association Agreement and Deep Free Trade Zone put on hold, and partnership with key lenders such as the Interna-

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dollars of investments in the last two years alone, even the most adventurous leading world brands like Ikea and Starbucks have yet to set up shop in Ukraine. And even the one sector that should benefit most directly from the Euro 2012, tourism, looks set for collateral damage from the image wars. Ukraine does not currently figure on European tourism's radar screen, but the Black Sea country has famously rich potential appreciated by its eastern neighbours for centuries. Sports events can be a game-changer for national

'Keep politics out of football', was the Polish watchword" tional Monetary Fund, World Bank and European Bank for Reconstruction and Development (EBRD). Andre Kuusvek, Ukraine country head at the EBRD, has warned publicly that Ukraine was facing pariah status because of the Tymoshenko case. "Laws are implemented in a speculative way. And that is affecting the security of investments," Kuusvek said at the EBRD's annual general meeting in London on May 18. Euro 2012 was intended as a motor for foreign direct investment (FDI), but the opposite is now becoming true. Foreign direct investment is almost dead. Despite rising wages and a mini-retail boom, net FDI fell by 6.9% on the year in the first quarter of 2012, the third quarter in a row to show a drop. "The majority of FDI in Ukraine recently does not represent new investments, but rather the support of existing business by foreign owners," comments ING analyst Alexander Pecherytsyn. And most of those existing businesses are simply the moribund subsidiaries of European banks being recapitalised in the face of swelling bad loans. While the fast food chains and multinational consumer goods companies are racing to set up shop in Russia with tens of billions of

image and tourism – witness Germany's 2006 World Cup turning the "grey" country into a hip party destination, and the Chinese Olympics and South African World Cup doing PR miracles for their respective host countries as great places to visit. Image gains from the world's fourth largest sports event should be a no-brainer, but it looks like the opposite will come true: since Ukraine is co-hosting with Poland, international media are gearing up to milk Poland for the feel-good vibe they need from the games, while tapping a salacious vein of bad news from Ukraine and hanging it on the Tymoshenko peg. Before the games have even started, the "Poland good, Ukraine bad" story has written Ukraine off as a country you don't want to go to – the British press in particular having a field day with neo-nazis waiting to skin you, gloating HIV-positive hookers and extortionate hoteliers. "Anarchy in the Ukraine," screamed the headlines in the UK's Sun tabloid, the country's largest circulation paper. "Unlike the tourists, the journalists will come," blogs veteran US Ukraine watcher and scholar Alexander Motyl. "But the games will not be a story

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Cover story

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– unless the Ukrainian team manages to pull off an upset victory. Ukraine’s descent into authoritarianism, rampant Regionnaire corruption, Tymoshenko’s imprisonment, violence against women, Yanukovych’s palatial lifestyle, the sex industry and many other dark sides of life in 'Yanukostan' will be."

stance could have repercussions on its trade with Kyiv. "Without the [Association] Agreement, German access to the Ukrainian market will be limited," Kozhara told Spiegel Online, in reference to the stalled Association Agreement. "German producers would be the losers."

The big questions are why Yanukovych has risked this fallout with Europe and is there anything that can save Ukraine's Euro 2012 from falling apart.

This raises an interesting point. Although the commercial consequences of a fall-out for Ukraine are clearly major, with Germany being the secondlargest investor in the country, providing thousands of Ukrainians with jobs, the affair also begs the question: how much do German firms stand to lose from the souring in relations between the two sides?

The answer to the first question is, as usual for most Ukraine-related matters, natural gas. The option of integrating with Europe for Yanukovych and his cronies is simply a card to play in negotiations with the Kremlin over the price for Russia's gas so crucial to its economy. Imprisoning Tymoshenko for signing the 2010 gas deal that Ukraine desperately wants to revise is an even better card, while neatly also removing the most potent opposition politician from the stage. And what could save Ukraine's Euro 2012? Apart from a surprisingly brilliant performance from Ukraine's national team, perhaps the fact that when people do get to Ukraine – and with Germany, England and France all due to play in Ukraine, the fans will potentially number in the hundreds of thousands – they will find it a surprisingly pleasant and livable place in summer. But even here Ukraine has shot it itself in the tourism foot. With preparations for the tournament plunged into chaos during the country's economic collapse 2008-2009, two of the four competition venues went to towns in the far-flung east of the country – Kharkiv and mining town Donetsk, Yanukovych's home town, where slag heaps count as tourist attractions. At the same time, Ukraine managed to completely exclude the worldfamous 18th century Black Sea mecca of Odesa, "St Petersburg on the Black Sea", a tourism pearl in close proximity to the beach resorts of Crimea. Ukraine it seems has once again shown its unenviable talent for dragging defeat from the jaws of victory.

Business counts cost of Ukraine's isolation Sherelle Jacobs in Cologne

"E

conomics, politics and personalities are often inseparable," an American businessman-turned-state-governor once said. Entanglements between these three forces have seemed even more pronounced than usual in the stand-off between the German and Ukrainian governments over the latter's treatment of its former prime minister Yulia Tymoshenko. Germany has been at the forefront of formulating a strong European position against President Viktor Yanukovych's administration over Tymoshenko's imprisonment for seven years in October for abuse of office (she is accused of signing two gas deals with Russia, which left Ukraine with losses of $190m) and alleged beatings suffered in jail. Berlin was the first major European power to announce its intention to boycott the Euro 2012 football championships (albeit so far only the German development minister) that are due to be co-hosted in Ukraine and Poland this

summer. And German Foreign Minister Guido Westerwelle asserted that the EU Association Agreement, which has already been drawn up and is intended to bring the former Soviet satellite one step closer to EU membership, will go no further until the matter is resolved.

Prices paid There is certainly a sizeable contingency of German companies with an important stake in Ukraine. Its proximity makes doing business logistically easier. Cheap land and labour are also appealing points. And the Ukrainian market is appealing for investors, according to experts. "If you look at the market, it is roughly 45m people. By geography, it is the biggest country in Europe. It is also a whole country that needs reconstruction," says Florian Stache, a doctoral candidate at the Freie Universität in Berlin who formerly worked as a freelance business consultant in Ukraine.

"Ukraine is now in limbo – everything is pretty much on hold" It is also a German doctor who has been treating Tymoshenko after she started a hunger strike and refused to be treated by Ukrainian physicians. The German government's head-on approach has enraged its Ukrainian counterpart, which has duly sent economic-themed waves of warning westwards. In May, Leonid Kozhara, deputy head of Yanukovych's ruling Party of Regions, implied that Berlin's

The country's economic performance after 2000 was also a pulling factor. "Ukraine is a very interesting market. Its experience of very high growth before the crisis was noticed by German investors," says Robert Kirchner, a consultant at Berlin Economics, an economic consultancy firm. Furthermore, a proportion of German companies have perhaps taken the leap into the Ukrainian market not just


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because it is lucrative as it stands, but also as part of a long-term strategy to be firmly established in the country by the time Ukraine becomes fully integrated into the EU. "The big push for German firms came in 2005, following the 'Orange Revolution'," says Kirchner. "That political change somehow brought Ukraine closer to Europe and this clearly had an impact on investment figures." And there have been recent glimmers of progress when it comes to the "Europeanization" dream for Ukraine in the form of the EU Association

"Politics will only interfere with business there if real political instability occurs" Agreement, a key step in EU accession; it includes a framework for Ukraine's alignment with EU standards in democracy, law and human rights, as well as a free trade agreement. Legal and bureaucratic issues, as well as corruption, which remain big barriers to doing business in the country, would be greatly improved. Crucially, many of the German firms that have so far expanded into the country have managed to generate impressive profits in a tough market. According to research by the German Chamber of Commerce in Ukraine, two-thirds of German businesses posted either good or very good sales improvements in 2011, and more than half expect the trend to continue. Nearly a third of German firms in the study said they had plans to take on more staff in 2012. Therefore, it's understandable that worries are growing over whether the recent breakdown in EU-Ukraine relations could spoil the party. Analysts warn that isolating Ukraine could push the country back into a closer embrace with Russia, reversing much of the "Europeanization" progress that

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Cover story

some German firms have been banking on. Some further suggest that such a grim outlook, especially in terms of the Association Agreement, could have a huge impact on German companies already operating in the country. "The Agreement is key for future economic relations and if it cannot be concluded, then this will have a negative effect on business in the long term. Ukraine is now in limbo – everything is pretty much on hold." says Kirchner. The current uncertainty could also put off a cautious group of potential German investors who have not yet set up business in Ukraine but are waiting in the wings for the business climate to improve. Many mediumsized companies, Germany's famed Mittelstand, which are especially vulnerable to the repercussions of a hasty business move, come under this category. "Those German companies that are not yet in the country and don't really know Ukraine could now hesitate," says Stache of Freie Universität. Yet there are optimists who aren't convinced that events have reached a point where the confidence of many German firms active in Ukraine will be punctured. "We are sometimes overevaluating the political factors. What does the Tymoshenko case mean to a firm exporting windows to Ukraine? Politics will only interfere with business there if real political instability occurs, like a civil war, which was very likely during times of the 'Orange Revolution'," says Stache. In fact, argues Stache, firms that are not put off by political events could even be at an economic advantage: "It's simple: for those companies who dare, competition will be less."

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ing airport terminals in the four host cities, improving local transport such as trams, buses and local rail, as well as ambitious plans to upgrade Poland's woeful road and rail infrastructure. Those are projects that would have happened anyway, but whose timing has been dramatically speeded up by the fast-approaching deadline of the championships. Herra estimates that Poland will get a boost to its GDP of PLN18bn-30bn from 2012 to 2020 because of the faster completion of infrastructure projects. "We are doing these investments three to five years more quickly than we would have without the Euro [2012]," he says.

Poles apart from Ukraine Jan Cienski in Warsaw

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hen the Greek and Polish teams kick off the 2012 European football championships in Warsaw's new national stadium on June 8, millions of fans will be cheering – but the bean counters will be even happier when they consider the tournament's economic impact. The actual earnings of the tournament will not be that large after Uefa, the body in charge of European football, takes its cut – but the much bigger impact will come from the rush to build infrastructure in time to host fans from across the continent. "Euro 2012 has been a very concrete motivator for development," says Marcin Herra, CEO of PL.2012, the government body in charge of organising the Polish half of the championships (the other co-host is Ukraine). Organisers estimate that Poland will bear PLN150m-200m (€35m-47m) in

extra costs because of the tournament for things like building fan areas and hiring more security, but that additional revenues – in part from the up to 1m extra tourists coming for the champion-

Successes and failures The most successful projects were the stadiums, all of which have been completed on time. The government hopes that they will become self-sustaining after the championships – unlike those in Portugal, which hosted the tournament in 2004 – by holding conventions, sports events and concerts, and with offices and restaurants integrated into the facilities that are supposed to earn year-round cash. "They've been planned in such a way that they will generate revenues," says Herra. The airports, the route by which most fans will get to Poland, have also been

"We are doing these investments three to five years more quickly than we would have without Euro 2012" ships – will come to about PLN600m. But that is small change compared with the longer-term benefits. The entire budget for key facilities tied to the tournament comes to PLN95bn, although only PLN4.5bn of that went for the four stadiums – in Warsaw, Gdansk, Poznan and Wroclaw – where the matches will be played. The rest, which includes funding from the EU, went mostly on projects like modernis-

completed on time, and the four cities hope they will provide a long-term boost to tourist and business traffic. Herra estimates an increase in tourist spending of about PLN3bn-4bn over the next four years. The biggest failure comes in the ambitious road and rail projects, which were supposed to transform Poland's links to the rest of Europe and which accounted for about 60% of the Euro 2012 budget.


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Kicking up a fuss in Poland

Bogdan Turek in Warsaw Union membership may be on the wane in Poland, once famed for its Solidarity trade union federation that was instrumental in the toppling of communism. But this summer's Euro 2012 football championships are providing a useful backdrop for labour protests against the government's attempt to restructure the pension system and other reforms. Among the disgruntled are cab drivers, upset by new regulations that no longer require examinations to get a taxi license, who are planning to block the roads to the brand-new National Stadium where the opening ceremony will be held June 8; road construction companies owed money are preparing to block access roads to Warsaw; and custom officers seeking wage hikes are threatening tough inspections of the tens of thousands of incoming football fans, or even blockades at the borders. On top of that, Piotr Duda, the clever new leader of the 700,000-strong Solidarity union, has mapped out protests and a modern propaganda campaign in the media that could undermine the government without provoking it to use violence. Although the minimum wage and working conditions are also at issue, the main bone of contention is the retirement age. The government is sticking to a plan that both men and women will work until the age of 67 – two years longer for men and five years for women. Miners and some uniformed employees – police, army and firefighters – have already carved out exemptions for their workers. Union membership has dropped dramatically, from the 10m-strong level of the Solidarity era to about 16% of those employed today, partly because Poland's economy is now characterized by small businesses, of which 96% employ fewer than 10 workers. Furthermore, the self-employed – who account for 23% all workers – are not allowed to join a union. But the retirement age scheme has ignited protests not only from Solidarity, but also from the former communist union federation OPZZ and the non-political Federation of Labour Unions (or Forum FZZ). Three-quarters of the country's 25,000 company unions belong to one of these three confederations. "The goal of Solidarity is not to let the government pass the law on the prolongation of the retirement age," says Duda, 50, a former paratrooper who served as a soldier in the Golan Heights. A machine tool worker by profession, Duda held several jobs in the union before replacing Janusz Sniadek, more a politician than a unionist, in 2010. The government launched the retirement project four months in advance of the football tournament, which is scheduled to begin on June 8 in Warsaw and conclude July 1 in co-host Ukraine's capital of Kyiv, apparently in the hope that opposition would be tempered by football fever. It hasn't worked.

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In 2008, the government announced that it planned to build 900 kilometres of highways and 2,100 km of slightly lower-grade expressways. None of those projects have been completed. The A1, the main north-south highway that is to run from Gdansk on the Baltic coast to the Czech border, has a big gap in the middle that will take years to finish. The A2, joining Warsaw to the German border, also may not be finished, although hundreds of workers are on site 24 hours a day as a frantic Slawomir Nowak, the infrastructure minister, pushes the construction companies to at least have the road drivable if not formally completed by early June. "I'm afraid we may not win this race against time," he said while visiting the site. The A4 highway linking southern Poland to Ukraine will also have gaps as it approaches the border. Of the express roads, only 739 km have been completed, and none of the segments encompasses a complete route. There have also been problems with trains. Rail travel from Warsaw to Gdansk was supposed to take three hours after a renovation of the tracks that has played havoc with schedules for years. However, the work is unfinished and the journey takes almost five hours. The delays have led to a shift in government rhetoric. Nowak now says, "We aren't building for the Euro [2012], we're building for Poland" – which, from the point of view of investors who will soon be flying into new airports and speeding down modern highways within the next year or two, is true. But not, alas, for the football fans.

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Facebook vs Ukraine Lucas Romriell of SP Advisors

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rom about 2006 to late 2007, I headed up the sales desk for one of Ukraine's biggest share placement agents for local companies. True, we never had any "real" IPOs. Mostly we did private placements for little companies from regional cities. The management of several of these companies were fascinated that we could get money for them and they did not have to pay it back. I distinctly remember the wideeyed expression in the eyes of a doctor in charge of a small medical clinic as one of our bankers told him he could sell 20% of his company at a ridiculous valuation and then he could "just keep the money" – minus our fee of course. Most of us were very young. If I remember correctly, our CEO and founder was barely 30. Like most of our staff, I was in my late 20s and eager to make some money. I knew virtually nothing about stocks and markets. I could speak fluent English and wear an expensive suit and tie. That was my job. My poor grounding of the fundamentals of company valuations was almost an asset to my employer. We sold banks at 4x book value. We even once tried to sell one at a multiple of 6x. We sold overpriced real estate developers, a sugar company that would eventually specialise in stealing from itself to make up for managerial incompetence, a pharmaceutical company with no intention of ever putting the capital we raised to work, and – our crowning achievement – an electronics retailer at 100x projected earnings. What was that Facebook valuation again? Investors who protested against our high valuations "didn't understand." Ukraine was different. It was a frontier market poised to grow. Economic projections and cash flow estimates could not reveal an accurate picture of surging power of this future Eastern European juggernaut. Much, when I come to think of it, the same way that investors annoyed at the price of Facebook were told they do not understand how the company will capitalise on the future of social media. In mid-May, another group of ambitious 20-somethings, led by opportunistic bankers, came to market. They took a promising young company to market with much fanfare and hype. Just as investors lined up in 2006 to be part of a new emerging market, so investors lined up to be part of a new emerging social media business. 900m users and endless possibilities!

What could go wrong? The multiple it was floated at was high, but surely that only reflected the incredible growth potential. Those who did not believe simply failed to grasp the story. The bankers, seeing the opportunity, boosted the offering by 25%, according to a recent Bloomberg article. Usually, the share price of our over-priced companies would tank or languish unchanged for years on end. They never rose without pressure from our brokerage. Usually, when management would see how well the deal had done they would ask to sell a few extra shares. I think we increased the size of every offering, regardless of how poorly the issue went. Years later, I even learned that bankers from our company had, months in advance, bought shares in some of the structures we were to sell. The verdict is still out on Facebook, but at its current price the company has a lot to prove and investors are none too pleased. Unlike Facebook, no one really noticed what we had done. Our deals were so small and peripheral to most fund managers that they would just let it slide. It would take years for them to realise how a bunch of 20-somethings had stuffed their portfolios full of expensive lemons. We took so much value off the table that there was nothing left for the investors. I left at the end of 2007. I thought I had seen it all. As my understanding of financial markets grew, there was no way I could continue. I left, my conscience wracked with guilt, though I cannot say I felt compelled to give back all the money I earned. I lost some in bad investments, so I guess there is a little justice. I considered using my online brokerage account to put in a little bid for Facebook. "Surely, investors will overlook the glaring fundamental problems with the valuation and bid it up," I thought. The company is a household name. Then it hit me. "100x earnings? Where have I heard that before?" I had seen it all. And one day, we will see it all again.

Lucas Romriell is Director of New Business at SP Advisors, a company providing business advisory and intelligence services for Ukraine, Georgia, and other parts of the post-Soviet space.


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dd as it sounds, Sberbank is the biggest lending institution in Russia yet also has one of the lowest non-performing loan (NPL) ratios in the sector. Not only that, but commercial banks interviewed by bne recently also complain that the one-time Soviet dinosaur is dancing circles around them as they struggle to compete with its speed of service and prices. Dinosaurs in tutus? It certainly is a strangle image, but the bank is in the midst of a revolution that has gone a long way towards making Russia's most popular bank like any of its western counterparts. Anton Karamzin, deputy chairman of Sberbank, tells bne in an exclusive interview that Sberbank's advantage is that thanks to a new $1.2bn data processing centre, among other things, it can leverage its huge volume of transactions and so has the most accurate risk assessment tools in the industry by a long chalk.

The biggest bank in the world

Ben Aris in Moscow

Buying hi-tech solutions to deal with business issues is a pretty standard strategy around the world, but Karamzin points out that the larger part of Sberbank's success is the fundamental attractiveness of the banking business in Russia. For the bank, the key is how best to manage this opportunity. "The credit quality of the Russian consumer is one of the best in the world. Russian banks suffer from less fraud and bad loans than other European countries because Russians don't like to load up on debt," says Karamzin. "And this was true before Communism. Every 20-30 years something happened: a war, a bad Tsar, a revolution – and you don't want to owe money in hard times." Managing opportunity is the hard part and something Russians have historically not been very good at. Mismanagement was, after all, what brought the Soviet superpower to its knees. But Karamzin thinks that after 20 years of independence enough has been learnt to finally get things right. "Sberbank is four years through a five-year strategic development plan and we are now starting to see the results," says Kara-

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mzin. "The plan covers every aspect of the bank's life and we are doing this systematically, as we want to create a self-perpetuating system that will continue to function when the current management team eventually leaves." The goal is to make Sberbank as agile as a small bank. It sounds like nonsense, as Sberbank is already the second largest bank in Europe after HSBC in terms of assets and three times larger in terms of the number of branches. "If you measure Sberbank's size in proportion

"If you measure Sberbank's size in proportion to Russia's GDP, then we are already by far the largest bank in the world"

to Russia's GDP, then we are already by far the largest bank in the world," says Karamzin. The answer to the conundrum of how to run a huge institution as if it had the sensitivity and nimbleness of a small regional player is IT. Moving money and managing risk is all about manipulating numbers, so banking is a business that lends itself to IT like no other. In November 2011 at the bank's 250th birthday, Sberbank launched the eighth largest data processing system in the world and the biggest in Europe at a cost of an astounding $1.2bn. Just the electricity bill to run this mother-of-allEuropean-computers runs to $200m a year to keep liquid helium flowing that allows for superconducting electronics that can process 17m transactions a week. Dinosaurs were clumsy because they had walnut-sized brains. What Sberbank has effectively done is put in place

Kremlin takes revenge

bne The Kremlin took its revenge on rebel regions at the end of April by sacking the leader of Russia's most democratic region. One of Dmitry Medvedev's last jobs as president was to dismiss Sergei Vakhrukov from his post as Yaroslavl region's governor after it scored the lowest level of support for United Russia in the December 2011 parliamentary election and for president-elect Vladimir Putin in the May presidential election. United Russia won a mere 29% of the vote in Yaroslavl, against the 49.3% the party took in the overall vote. Putin won only 54.5% of the vote in the region, the second lowest result in the country, bar the heartland of the protest movement in Moscow, where he won 47%, well below the 63.6% overall tally. And things in Yaroslavl have gone from bad to worse after former local legislator and independent candidate Yevgeny Urlashov thrashed the United Russia candidate and prominent local businessman Yakov Yakushev in the closely watched mayoral vote in April. Medvedev chewed Vakhrukov out publicly for choosing the "wrong" candidate. The election was seen as the first major test for United Russia after the Duma elections and it failed miserably. Medvedev accepted the "resignations" of a dozen regional chiefs since the Duma vote in December that was a PR disaster for the Kremlin. In his final televised interview as president, Medvedev said he had replaced half of Russia's regional heads during his time in office and admitted that even when the official statements said the governors had resigned of their own free will, sometimes they had been fired. Before he left the presidency, Medvedev introduced a bill to the Duma that will reinstate the elections of governors. But before the first round of voting due this autumn, the Kremlin has been shoring up its control and appointing new governors, in effect putting off elections in those regions for about five years – or until after the next Duma elections have passed. The new law on regional elections is a step towards increasing democracy in Russia, but typically it is being implemented so that the transformation towards great democracy is moving at a glacial pace. In effect, the Kremlin is saying it accepts the need for more democracy, but doesn't intend to let go of the levers of power until after 2020, when the current development strategy expires.


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I Eastern Europe a huge brain that allows this dinosaur to dance. Makeover Upgrading Sberbank's hardware with the sci-fi-esque data processing centre is the most expensive change the bank has made, but probably just as important in the long run is that it's also upgraded the bank's operating system. The traditional clunky Soviet-era branches with their famously sour service and long queues are increasingly hard to find these days (in Moscow at least). Following a major makeover, increasingly the bank looks – and more importantly runs – like any western bank. In the 1990s Sberbank had an 80% market share of deposits, but the start of banking reforms in 2004 saw that reduced to 46% as commercial banks ate into its business. However, in the last two years Sberbank has reversed the trend and is currently pushing at the 50% mark as it aggressively expands its product offering.

Anton Karamzin, Deputy Chairman of Sberbank

"Sberbank is four years through a five-year strategic development plan and we are now starting to see the results"

For example, under former chairman Andrei Kazmin, the ultra-conservative bank was very reluctant to get into the unsecured credit card lending business. In those days, the standard joke was you had to deposit your grandmother with the bank as collateral if you wanted a loan. Current chairman German Gref finally launched credit cards in 2008 and in April this year the bank became market leader with 18% of all the true credit cards in Russian wallets today. The story is the same in pretty much any product you care to mention – mortgages, car loans, credits for small and medium-sized enterprises: Sberbank is the market leader in all these products and unassailable. "One out of every four people in the country bank with us. We are the financial system," says Karamzin. "We have a system now where every step in the bad loan recovery process is recorded in the system together with the recovery plan schedule and deadlines. If say some deadline goes overdue by one day anywhere in any region, then it is immediately flagged in the system. We know here in Moscow, and can call down to the regional branch to ask what has gone wrong."

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Sberbank is attempting a Herculean transformation. The classic approach to turning a company in a new strategic direction is to focus on two or three strategic goals and push them through, but Sberbank is too big for that. "If we did it that way, the simple inertia of the bank would pull it back to its old habits. We have to do everything at once. We currently have 740 strategic projects running concurrently," says Karamzin. "It's like flying a plane and fixing the engines in mid-air. It takes military discipline to make it work."

INTERVIEW:

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Seeking justice in Russia

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Julia Reed in Moscow Hairy as it sounds, the new system seems to be working. Under the old regime, the control mechanisms were repeated at every level – federal, regional, down to the sub-regional branches – but the new system fully integrates them into a single, national whole. The attempt to remake Sberbank's management system strikes to the core of all of Russia's problems. And its success testifies to what could be a dramatic acceleration if businesses are only run a little more efficiently – and without spending an extra kopek in investment. The World Bank found in a study that 60-80% of the productivity gap between Russia and the US was simply due to poor management. The trouble with changes in the operating system is they are hard to quantify. Apart from the physical facelift at bank branches, the same people are working in the same branches servicing the same customers doing essentially the same jobs as before. Changing management practices and employees' mentalities is an intangible that only shows up at the end of the day in the bottom line. "Otto von Bismarck said that Russians are the slowest getting the horse hitched to the cart, but fastest when it came to driving," says Karamzin adding that Russia is still at the beginning of developing its banking system. "Consumer loans grew by 40% last year, but penetration of banking services into the economy is still extremely low. The potential of the Russian banking sector can still grow many times over."

Olga Romanova

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he smoky room in a small basement café in downtown Moscow is filling up, mostly with women of all ages, well made up or washed out, noisy and animated. An outsider might be tempted to call them desperate, but they don't want to come across as such. In Russian folklore they are known as zechki (wives of prisoners). They have come for a weekly gathering of "Rus Sidyashaya" (Russia in Jail), to share their sorrows and problems, to have some food and a chat, to listen to some music by a friendly guest musician and to see Olga Romanova, the opposition journalist and civil rights campaigner, in the hope she can help. Most of these women, like Romanova, have fallen foul of Russia's justice system and have nowhere else to turn. With all eyes in the room on her and her phone ringing every minute, Romanova sits at the small round table in the middle of the room smoking and listening to everyone in turn, offering comfort and advice where she can. This feisty journalist became well known during her campaign to free her husband Alexei Kozlov from jail. Crossed by a former business partner and exsenator Vladimir Slutsker, Kozlov was accused of fraud and money laundering, and jailed in 2009 for eight years. Then the Moscow State Court cut the sentence to five years. "The case was ordered and fabricated by Slutsker," says Romanova, who conducted her own investigation and found what she claims is hard evidence proving her husband's innocence.

Unwilling to accept such a blatant miscarriage of justice, Romanova wrote multiple complaints and appeals to the higher courts, to the supreme court and to the general prosecutor's office, and her campaign grew as others in a similar position joined her. Kozlov was briefly released in September last year and immediately started publicly campaigning for the release and new trials for other victims of fabricated

conversations that Romanova had passing tedious hours in queues outside pre-trial detention centres where she and other relatives had gone to deliver parcels or have a rare meeting with their loved ones awaiting trial. Instead of crying and complaining about their lot, Romanova and the other zetchki clubbed together to offer comfort and legal advice to those caught in similar traps. In the last four years, the group has grown to number 6,000 members and the ad

"The judge is reading exactly this verdict, word for word, without even changing a word! How dare she!" cases he met in jail. He arranged for a letter to be sent to the General Prosecutor's Office that listed the details of the legal violations of several high-profile cases to be published in the Russian biweekly Bolshoi Gorod. Readers were asked to cut them out and post them in an attempt to raise public awareness of mass violations in the justice system. But Kozlov didn't stay free for long. Despite the ruling of the Supreme Court in 2011 to dismiss all previous charges and review the case due to numerous procedural and legal violations, in March he was tried and convicted again on the same charges for another two years.

hoc meetings have become an organised network that increasingly includes concerned members of the public.

Time served "Rus Sidyashaya" was born out of the

Her campaign is a constant embarrassment for the judiciary. The most effec-

Romanova is fighting back with the only weapon the opposition has: publicity. She writes almost hourly on Facebook, laying bare the details of private lives. She blogs, she speaks, she writes articles. She is a co-founder of the Voters League, set up to monitor elections. She helps raise financing and helped organise the December demonstrations in Moscow. A pugnacious campaigner, Romanova likes to say: "I live in live broadcast", and is in the face of the system every waking moment.


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Full metal jacket Russian small-arms company Izhmash, which produces the famous Kalashnikov assault rifles, is to produce Kalashnikov fashion clothes under its world-renowned brand, RIA Novosti reports local media as saying. Izhmash General Director Maksim Kuzyuk said his company intends to consolidate the brand, the rights to which currently belong to the family of the famous arms designer Mikhail Kalashnikov. The Kalashnikov family has long been licensing the production of non-core goods under the legendary name, and the Glazovsky liquor plant has been producing Kalashnikov-brand vodka since 1995, while a German company, MMI, already has the rights to produce watches, umbrellas and other everyday goods under the Kalashnikov brand. "Izhmash is currently holding negotiations with Mikhail Kalashnikov on the provision of professional services for brand management. For this purpose, it is necessary to ensure that only Izhmash should exclusively represent the brand and have the possibility to determine the policy of its use," he said. Izhmash plans to produce a variety of Kalashnikov-branded products from clothes to souvenirs, and brand specialists think the potential price of the Kalashnikov brand could be as high. "The real value of this brand is around the $10bn range and may potentially grow to $100bn-150bn. By comparison, Beeline (mobile phone) brand is worth about $5bn,” said BrandLab managing partner Alexander Yeryomenko.

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tive tactic the group employs is simply showing up for each other's trials. "If a group of 200 strangers all wearing their uniform white 'Rus Sidyashaya' scarves suddenly come to the courtroom, which is usually empty, it makes a profound impression and applies moral pressure on the judge," says Romanova. In her fight against corrupt judges, Romanova does not hesitate to make them look ridiculous and immoral. Recently, she has published pictures of a state prosecutor in his swimming trunks, holidaying with his wife, lifted from his own social network pages. "I can post such pictures of myself, but he shouldn't. He represents the state." On another occasion, Romanova asked online how a young judge that had sentenced her husband could afford to buy a country house in a prestigious development outside of Moscow just a week after the sentence was handed down. The second conviction of her husband was especially galling. Romanova had gotten hold of a copy of the prearranged verdict before it was delivered and had to sit in court listening to the judge read out the staged sentence word for word. "The judge is reading

Romanova uses her acquired and now extensive knowledge of the law in her fight and acted as a defence witness for her husband, and later others, in the battle with the system. "The purpose of 'Rus Sidyashaya' is to put itself out of existence," she continues. "When people start getting fair trials, there won't be

Eastern Europe

The Russian legal system is heavily biased towards the prosecution, with 99% of all cases that go to court in Russia ending in conviction. The presumption of innocence, hard evidence, witness testimony, alibis, correct legal procedures and even not-guilty verdicts in previous trials of the same case carry little or no weight. The law is secondary to processing the person who has been categorised as a criminal as soon as he or she enters the system. The graduates of prestigious Russian law schools usually do not work in the courts, but typically end up as corporate lawyers. Russia's judges are drawn from the secretaries of the court. And it is a good job. A typical judge earns on average RUB200,000 a month (just under $7,000) and about RUB60,000 a month on retirement ($2,000) against the average Moscow salary of RUB45,000 ($1,500) a month. Romanova tried to persuade her husband to leave the country before both of his convictions, but he refused – the emotional cost of leaving Russia and never being

able to come back was too high. "Also, he didn't want to harm the other businesspeople in similar circumstances. If he ran away from bail, the others would have to go straight to jail for economic cases," says Romanova. "I am proud of my husband. Before his first sentence he was just an ordinary businessman, nothing interesting. But on the day of his second conviction he told me: 'I go in as a businessman and will come back as a politician'." As she was giving this interview, at Romanova's house lay sleeping a teenage boy, the now homeless son of a recently convicted businessman she had been campaigning for.

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rather than in dollar-, sterling- and eurodenominated debt. Add to this the very real risk of a systemic collapse of the western banking system and this rebalancing of credit portfolios is accelerating as things get worse in Europe. For once Russia’s financial system is looking a lot more stable than that of Western Europe. Just two companies – the stateowned gas monopolist Gazprom and oil company Bashneft – between them repaid $6bn of foreign debt in 2011, or nearly a tenth of the total "capital flight."

any need for us… In the four years I've been going to courts, I only met one judge who knew the laws."

"When people start getting fair trials, there won't be any need for us" exactly this verdict, word for word, without even changing a word! How dare she!" Romanova wrote on Facebook as the sentence was being read. Emulating the mother of jailed oligarch Mikhail Khodorkovsky at his sentencing, Romanova said loudly as the judge was leaving: "I curse you, bitch."

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The myth of Russian capital flight Ben Aris in Moscow

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ommentators have blamed the reappearance of capital flight from Russia on fear, assuming that oligarchs, terrified of political uncertainty, are moving their money to safer havens in Swiss bank accounts or buying posh apartments in London. There is a little bit of truth to this – but not much. Money has been flowing out of Russia in the last year for the first time since the chaos of the 1990s. In 2011, a total of $80bn left the country with another $35.1bn departing in the first quarter of this year. Much of this has been blamed on the rising political uncertainty in the country since the demonstrations that began in December against the ruling Kremlin-backed United Russia party's disputed win in parliamentary elections and the return of Vladimir Putin to the presidency. However, the irony is that the real driver behind the capital flight is more a function of Russia’s booming economy than fear. Banking blues The biggest culprit was not the oligarchs, but foreign banks with branches

in Russia, which accounted for half of all the money that left – some $40bn. The banking sector in the West is in deep crisis and many western banks are actually walking zombies with heavy unrealised debt on their books. Like an alcoholic father, western banks are desperate for cash to shore up their balance sheets and have been borrowing from their Russian daughters. Half of last year’s outflows – some $40bn – was down to Russian subsidiaries lending to their western parents, according to Prosperity Capital Management’s chief economist, Liam Halligan. The sums got so big that the Central Bank of Russia (CBR) called in the heads of foreign banks and told them to down tone the lending or else it might impose restrictions. A second big source of outflows has been wrought by the economic changes the 2008 crisis has created. Before the bust, it was cheaper and easier to borrow abroad, but post-crisis both interest rates and inflation have fallen to 20-year lows, meaning many Russian companies are starting to refinance in rubles

Thirdly, Russian companies are starting to hit their stride and are increasingly investing abroad. Unknown to most people, Russia has always been a net exporter of capital: Russian companies routinely invest more in other countries than Russia attracts as foreign investment. The difference now is that whereas in the past they invested in places like Kazakhstan and Ukraine, now they are big enough to move into developed markets: oil company TNK-BP spent $772m on a Brazilian oil and gas stake; Sberbank bought Austria’s Volksbank for $585m; and technology company Digital Sky Technologies spent $563m for a 10% stake in Twitter in 2011. In general, Russian companies with branches abroad – and there are an increasing number of these – are reinvesting their earnings locally, which the CBR also counts as "capital flight," when actually this "outflow" is simply a function of success. The detailed breakdown of the CBR’s data suggests that the other half of the "capital flight" is mostly loan refinancing and overseas M&A, which means the “true” capital flight is tiny. Finally, it only remains to point out that if Russia has become such a scary place to do business, then why was foreign direct investment (FDI) in 2011 up by over a quarter from the year before to $49bn? Indeed, in terms of FDI per head, Russia attracted twice as much money as Brazil, five-times more than China and 13-times more than India between 2006 and 2010.


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Made (badly) in Russia Ben Aris in Moscow

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hat does Russia actually produce? Vodka and caviar spring immediately to mind. More recently, it has spawned a range of beer brands and a few dairy products that are unique to Eastern Europe like kefir, the sour yoghurt-like drink. At the other end of the scale there is of course oil, metals, minerals and diamonds. Oh and weapons – the AK-47 remains the world's most popular assault rifle. But that is pretty much it. The government desperately needs to diversify the economy, but despite investing several billion dollars into the effort there has been little progress. Talk to the Russia Venture Company or the Direct Investment Fund and they will invest in any project that has the word "Russia" in the prospectus, because of the dearth of viable projects at home. And things just got worse. In the middle of May, one of the very few Kremlinsponsored programmes to have actually produced a new product ended in tragedy. A newly minted Sukhoi Superjet 100 passenger aircraft strayed off course during a demonstration flight during the Indonesian air show and crashed into a mountainside killing all 45 people on board, including the deputy transport minister, who was presumably a possible buyer of the plane. At the time of writ-

ing, it was not clear if the disaster was due to pilot error or a technical problem with the plane, but the latter would deal a body blow to Russia's already poor image for aviation safety. Planes, trains and automobiles The Superjet is the culmination of five years of work to re-create the Russian aviation industry and establish a third player in the international plane-making industry after Boeing and Airbus. The government has sunk hundreds of millions of dollars into creating the Superjet passenger plane and nominally Russia is

personal project of Vladimir Putin, the Superjet factory was opened in 2007 with a target to sell $250bn worth of the aircraft by 2025. However, sales have been slow. The first plane sold abroad was to Armavir, Armenia's national airline, which has four. Aeroflot also took delivery of four planes earlier this year, but immediately sent them back, officially because the interior decorations were wrong. In all, the company claims it has 170 orders so far (bne counts only 10 actual deliveries), but even this is well off the 1,000 the company needs to sell to be viable. Indonesia was going to buy 30 planes. Despite its foreign engines, avionics and a price that is a two-thirds of its rivals, the plane seems to underwhelm buyers. The biggest potential deal announced so far was from Irish budget carrier Ryanair, which said it was interested in buying 70 planes last year, but there has been no follow up. The story is similar with cars. The state has lent the struggling Russian automotive industry, aka Lada-maker Avtovaz, $1.56bn in the last few years. And in a recent interview with bne, Avtovaz CEO Igor Komarov boasted that the company had already caught up with its peers in places like Romania in terms of productivity and was still aiming higher. However, the Kremlin has given up what was obviously the hopeless task of catch-

"Relying on the military-industrial complex to stimulate modernisation is a poor plan" still good at making planes – the parent company Sukhoi also makes the world's only fifth-generation fighter jet, the T-50. "If [the Superjet crash] was pilot error, then it is not a huge blow to the Russian aerospace industry. However, if it was a technical problem with the aircraft, then it could really affect customer perception of the aircraft and order capability," says Tom Chruszcz, a director at the ratings agency Fitch Ratings. Not that the Superjet programme was a roaring success even before the crash. A

ing up with the international carmakers, many of whom now have factories in Russia. The production of the iconic Lada 2107 was halted in April and then in May the government signed off on a deal to give control of the company to the French-Japanese Renault-Nissan alliance. Truck-maker Kamaz is now the only truly Russian automotive producer left and even that is already working with Daimler and likely to be merged with Belarus' maker of giant mining trucks MAZ.

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Call to arms Russia is even having problems with the handful of products that it's famous for. In April, the Izhmash gun plant went bust, the maker of the world famous Kalashnikov AK-47 assault rifle. The problem is that although the AK-47 remains the most widely used rifle in the world, it is increasingly becoming outdated compared with modern weapons. Izhmash attempted to keep up with a new model, the AK-12, but the gun flopped and the company finally filed for bankruptcy after making an $80m loss in 2011. Likewise, the Russian Ministry of Defence abruptly cancelled a multi-million order for Tiger battle tanks this time last year because they were not good enough. Increasingly, the defence ministry is shopping overseas for arms and has purchased Mistral helicopter carriers from France, unmanned aerial vehicles from Israel, and Iveco armoured vehicles from Italy. It specifically criticised Russian-made tanks, reportedly saying "it is better to spend the money on German Leopards." Indeed, the Kremlin just announced that it was withdrawing its modernised version of the T-90 full order battle tank – the flagship of the fleet – at the Defexpo India 2012 that is about to open, without explaining why. Still, Putin has made it explicit that while he may have given up on the Russian carmakers, he is not prepared to do the same with the Russian defence sector – just yet. In his sixth newspaper article in Rossiiskaya Gazeta published in February ahead of the presidential elections, he committed Russia to spending a "non-negotiable" RUB20 trillion ($655bn) on modernising the defence sector. Putin rejected as "deeply untrue" the notion that developing the defence industry is an unnecessary burden and that militarisation bankrupted the USSR. He believes the planned spending "will modernise the entire economy", as a revived military industry will act "as a locomotive" that can pull the national economy into the future, creating new jobs and technologies.

Eastern Europe

Belarus ready to start sale of state-run banks Sergei Kuznetsov in Minsk Belarus is ready to embark on the process of selling the country's staterun banks, starting with Paritetbank, the smallest of the four state-owned lenders, the governor of the National Bank of the Republic of Belarus, Nadezhda Ermakova, tells bne. The deal could be the first of several in the country's banking sector over the next year. VTB (Belarus), the subsidiary of Russia's VTB Bank, wants to buy the 25.9% interest that the Belarusian state currently owns in the lender through state oil and chemistry concern Belneftekhim. Belarus' central bank has also suggested that Russia's VTB Bank sell its Belarus' subsidiary, Moscow-Minsk Bank, to the Belarusian government so it can then merge it with state-owned Belinvestbank to beef up the institution. Ermakova says that Paritetbank, a medium-sized bank on the list of Belarus’ 32 banks, will be sold in a tender. "The tender will be held in the middle of 2012 or during the second half of the year," she says. Ermakova says several contenders have already having expressed an interest in buying Paritetbank, with one of them being Poland's Getin Holding, which bought Belarusian Sombelbank in 2008. "We received a letter from the holding [Getin], in which it expresses its interest in acquiring Paritetbank and says that it is ready to make its bid in the tender," she says. Getin, controlled by Polish businessman Leszek Czarniecki, controls financial firms across Central and Eastern Europe, in Poland, Romania, Russia, Belarus and Ukraine. Hopefully for the cash-strapped Belarusian state, this attempt to sell Paritetbank will be more successful than its first. In 2008, Moscow Bank for Reconstruction and Development (now called MTS Bank), which is controlled by Russian holding company AFK Sistema, announced its firm intention to buy the Belarusian lender. However, this transaction was not completed for reasons that have still not been disclosed. Sergei Dubkov, the deputy governor of the central bank, told bne in an interview in February that the strategic objective of the Belarusian regulator remained unchanged – to bring in a strategic investor to Paritetbank. "A strategic investor must have banking as its core business and provide technology and capital," Dubkov explained. The sale of Paritetbank would point to a restart of the Belarusian government's stalled privatisation effort. Last year's economic meltdown in Belarus amid a serious shortage of hard currency reserves indicated that the government would have to step up its privatisation efforts. But since the sale of a 50% stake in Beltransgaz to Russian gas giant Gazprom for $2.5bn in November, the government's plans for the privatisation of major state-owned enterprises remain unclear, with signs that President Alexander Lukashenko had personally intervened to halt the process.

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to tackle the exodus, the population could drop to just 1.6m by 2020. Even before then, the country might experience serious labour shortages that will hinder its continuing recovery from what was the deepest recession in the world during the global financial crisis of 2008-09, when GDP fell by a quarter over two years. The scale of Latvia's economic collapse saw even more Latvians leaving their homeland in search of work as unemployment topped 20%. "In 2020, we might be facing a 15% decrease in the working age population and a 10% increase in economic demand," says Economy Minister Daniels Pavluts. "The first issue is to stop emigration; the second stage is to utilise the diaspora. As a labour supply of last resort, we have to think about attracting skilled workers from abroad."

Emigration and demographics are CEE's next crisis Mike Collier in Riga

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ince accession to the EU, it has been assumed that the countries of Central and Eastern Europe would provide a virtually unlimited supply of good-quality, cheap labour to the West. But demographic trends across the region suggest that like the other dominant resource of developed economies – oil – the time to worry about shortages at both ends of the supply chain is already here, and nowhere provides a better example of the looming crisis than Latvia. "We have a joke that in 2030 the last Latvian can switch off the light at Riga airport," says Aldis Austers, chairman of the European Latvians' Association. "Emigration creates two major problems: it weakens the fiscal position of the state... and the outflow presents questions on the preservation of national identity."

Austers was among the speakers at an April seminar in the Latvian capital considering how to turn the decadelong tide of emigrants from the small Baltic state. It was the second event in as many weeks, following on from an

the potential... You need the diaspora's knowledge and skills to break the vicious circle of emigration," Austers argues. The figures are daunting. A 2011 survey revealed the Latvian popula-

"We have a joke that in 2030 the last Latvian can switch off the light at Riga airport" even more apocalyptic forum run by the American Chamber of Commerce titled: "Too late to defuse the ticking timebomb for Latvia?" In Austers' view, the Latvian diaspora needs to be turned into a potential resource rather than a drag on development. "Development agencies do not see

tion shrank from 2.2m in 2000 to just 2.0 – a 13% reduction in little more than a decade. The UK and Ireland are particularly popular destinations, and the fear is that the emigrants who tend to be younger and better educated than the general population may never return. According to projections by the Economy Ministry, if nothing is done

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The fear is that the real picture could be even worse than predicted due to the lack of reliable, comprehensive migration data, as the European Commission's representative in the country, Inna Steinbuka, admits. "I spent six years working in Eurostat... and I learned from my own experience that correct measurement of migration is not currently possible for all sorts of reasons," she says. However, Steinbuka is convinced Latvia's brain drain is "no longer a risk, it is a reality." Professor Mihails Hazans, a leading academic whose studies paint a particularly bleak picture of what he unflinchingly calls Latvia's "demographic disaster," agrees. "The census number is just an upper estimate and no one really knows how many there are in reality," he says. Hazans' views are not popular in official circles, but he does have a knack of producing data to back up his arguments that makes him difficult to counter. According to his research, emigration is rapidly accelerating the pace of underlying demographic decline. "The important thing is we supply labour to countries that have much less of a

Latvia – where history is never in the past

bne If you are a history buff, Latvia is paradise. This small country is obsessed with its history, and not in the castles-and-palaces heritage style of Western Europe; in Latvia, history is an omnipresent force underlying everything. A quick glance at the calendar is all you need for evidence of this historical fetish: as well as Independence Day, there's Restored Independence Day, Jewish Holocaust Memorial Day and Soviet Holocaust Memorial Day, Constitution Adoption Day and plenty more, all of them demanding that you fly a flag from your house or face a fine from the flag inspectors. But two days that don't appear on official calendars provide the best evidence of Latvia's historical obsession. On March 16, Russians go into an apoplexy about a parade in central Riga commemorating members of the Latvian Legion, a combat unit of the Waffen-SS. Then, two months later, with the predictability of a home-and-away fixture in some World Series of historical argument, the roles are reversed and Latvians decry the celebration of Soviet Victory Day on May 9 as providing all the evidence you'd ever need of how Russians regard 50 years of Soviet domination to be something less than a brutal occupation. Latvia officially marked the end of World War II on May 8. A few hundred people including the president and prime minister gather at the main war cemetery and bow their heads. 24 hours later Russians flock in their tens of thousands to the massive Soviet Victory Monument. This year's event was bigger than ever, with people of all ages laying flowers on a warm spring day while serenaded by children's choirs and admiring the medals of the veterans who for this day at least feel like they can wear them without the risk of being fined for displaying a banned symbol. Two tram stops away from Victory Park on the other side of the River Daugava, a small group of elderly figures mull around the Museum of the Occupation of Latvia. Led by Uldis Freimanis, a notorious right-wing wacko with a penchant for badly-matched pieces of German field kit, they processed through the cobblestoned streets of the Old Town waving banners with atrocity photographs and various "send them home" type slogans. Scandinavian tourists looked on with equal parts amazement and horror. Caught between the opposing tides of history, the Latvian government adopted the classic strategy of wrapping itself in the flag. Not the Latvian flag in this case, but the reassuringly boring blue and gold of the EU, as May 9 also happens to be the birthday of the EU. "To mark the occasion an eight-metres-wide and fourteen-metres-long flag is being unfurled by participants holding 1,000 blue balloons and twelve yellow umbrellas," says the Latvian foreign ministry. All of which makes you realise that however divisive and unending the historical debates between Latvians and Russians might be, at least they aren't silly.


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demographic challenge – so it's a much bigger problem," he says. "Most emigrants are young – about 80% of recent emigrants are younger than 35 – hence the remaining population is ageing faster," he warns. Thus the "donor" countries of CEE will actually leapfrog the likes of Germany, the UK and France in terms of ageing population – hardly the sort of convergence catch-up they had in mind when they joined the EU. "Do we have some hope that they will come back? Unfortunately not very much. The longer they stay, the more likely they will stay forever. After three years, the number who are planning to come back in the short run drops from 10% to 3%," he says. Hazans even has ideas about how to stop the outflow, suggesting that the destination countries to which migrants head could pay some sort of labour levy to lessen the impact on donor countries. It sounds completely unworkable, but at least it's something.

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their homeland to carry out research instead of working abroad – not that far from a rarefied version of Hazans' labour levy in some ways. "I see that as an issue of the brain drain," Dombrovskis says. "But the main reason behind emigration is the economic situation: lack of jobs, and lack of well-paid jobs. That's what we need to concentrate on if we need to deal fundamentally with emigration."

the two institutions, interpreting the change as indicative that Hungary is intent on reaching an agreement.

So far, fresh initiatives have included proposals to improve access to kindergartens, give increased social security contributions to parents and revive fertility treatment programmes that were cut during the crisis.

But large-scale emigration has social as well as economic costs. When parents leave to work abroad, children are left behind and the strain on them can be extremely damaging, says Dace Beinare, a family-based care adviser with the charity SOS Children's Villages. "Many children are left with grandparents and are effectively abandoned when a parent or both parents have left... They are forced to be more responsible than they are capable of being at that age and face many emotional problems," she tells bne.

Varga's appointment makes perfect sense, David Nemeth, chief economist with ING Bank Hungary, tells bne. "When you start negotiations with the IMF, you have to create a very detailed programme, for example [specifying] what kind of laws will be created, their effect on the budget, their timetable. From this perspective, having a more financially [savvy] guy is more important than in the pre-negotiations, which focus more on political issues," he says.

Dombrovskis is also floating the idea of using EU funds to try and persuade skilled expatriate scientists to return to

"Emotional problems will eventually become problems for society as a whole," Beinare concludes.

For despite everyone agreeing that the CEE brain-and-body drain is becoming a real crisis, ideas about what to do about it are thinner on the ground than residents in the disappearing villages of Latgale. But with the worst of the economic crisis apparently over, officials are finally turning their attention towards the shrinking population. "The demographic situation is certainly one of the big worries of society," Prime Minister Valdis Dombrovskis tells bne, pointing to his decision to set up a special Demographic Council to come up with new ideas to counter a situation he describes as "among the worst in the EU27."

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www.bne.eu

Viktor Orban, the Hungarian prime minister, announced the move in his weekly radio broadcast, saying Hungary needed a specialist to continue the procedure while praising Varga's predecessor, Tamas Fellegi. "The country owes him a great debt," he intoned.

Hungary's schizophrenic moves Kester Eddy in Budapest

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t a conference in Budapest on banking in the region in April, the panel on Hungary offered some divergent opinions on the good and bad in the sector – but on one issue they were fully united. As Istvan Racz, former chief economist with the Hungarian financial regulator, noted: "The economy is pretty much on the verge of recession... with all major indicators pointing in the same direction... [so] I think it would be tremendously important to grab an EU-IMF [precautionary loan] deal as quickly as possible." The credibility gained from an agreement between Hungary and the EU and International Monetary Fund would greatly ease market concerns and

thereby reduce financing costs, both for the country and commerce in general, Racz underlined, with accompanying nods from other panel members. Little wonder then, that the markets warmed to the news on May 11 that

But even as Orban's Hungary appears to make one step forward, not for the first time it takes two steps back. For no sooner had it reiterated its pledge to end the "crisis" taxes on the energy, telecommunications and bankingfinancial sectors, than it imposed replacements, leaving many top managers in the affected sectors dismayed at yet another example of the government ploughing its own furrow with scant concern for the implication of its decisions on the real economy. Called to account As an example, the government had ignored a politely-worded warning from the telecom sector in which the three leading mobile firms in Hungary had jointly stressed that the threatened new tax involving a HUF2-per-minute

"One wonders why the IMF or the EU would negotiate under such circumstances" Mihaly Varga, a former finance minister in the first Fidesz government from 2001-2002, was to take the helm on Hungary's negotiating team with

levy (less than 1 cent) on calls and on individual text messages would ultimately impinge on customers and cause a reduction in VAT revenues.


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Vice presidents A Bloomberg survey has found that the Czech Republic topped its Global Vice Index. Using data gathered by the World Health Organisation, the UN and other specialised organisations, the survey focused on consumption per capita per year in four fields: alcohol consumption, cigarettes, drugs and gambling. The Czech Republic scored in first position among 57 countries with some 69 points. The Czech Republic placed first in average alcohol consumption (16.5 litres) and fifth in smoking (2368 cigarettes). In the drugs category, the country came second after the US, occupying first position in marijuana consumption (15.2%), second position in ecstasy (3.6%) and 6th position in amphetamines use (1.7%). Czech national anti-drug coordinator Jindrich Voboril told CTK that proposals to restrict alcohol drinking and the use of drugs are being prepared, because even children drink beer, wine and hard alcohol. "We want to continue taking measures. We will also focus on advertising and on places where alcohol is sold," Voboril said.

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On May 14, while telecom bosses wrestled with the technical and financial implications of setting up systems to measure and collect the new tax by July 1, the three companies again expressed willingness to negotiate a new tax system, warning that the tax as it now stands will "jeopardise Hungary's competitiveness" and its business sector. "The minute-based tax included in the current draft would not mean a predictable revenue source for the state budget and it would considerably change the telephone usage habits," the companies claimed. Bankers were giving similar, if not more desperate, messages, saying that the latest tax of 0.1% to be levied on all transactions – targeting HUF130bn (€443m) in revenues – could have devastating consequences on the sector.

laws, and how they were announced, further undermines business confidence the regime, argues ING's Nemeth. "I think the IMF will be asking how this tax affects the banking sector and the economy in general. They will want detailed studies," he says.

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Warnings signs in Poland

Varga, it seems, will have to hit the ground running. Jan Cienski in Warsaw But for some observers, whether Fellegi or Varga heads the negotiating team rather misses the point. "Varga is a perfectly nice man with appropriate, if not outstanding, credentials as an economic policymaker. His promotion, if being given this assignments can be called that, is merited and welcome," Peter Rona, economist and lecturer at Oxford University, tells bne. "But this is not the issue. The issue is that the man in charge of Hungarian economic policy, [Gyorgy] Matolcsy, has no credibility... with international institutions."

Mihaly Patai, president of the Hungarian Banking Association, told Hungarian television that the new taxes were in total contravention of an agreement patiently negotiated with the government last December regarding future cooperation. "Banks are not ready to pay a further HUF130bn in taxes after two disastrous years. The new measures could cripple the financial sector," as they contain "idiotic elements" that could greatly harm financial liquidity in Hungary as the tax would impede normal cash management operations.

According to Rona, Varga's appointment only exacerbates the existing absurd situation, whereby the international institutions (ie. EU and IMF) "will not negotiate with the man who is capable of making commitments on the course of economic policy," ie. Matolcsy, while "the man whose words could be taken seriously, that is to say Varga, has no influence over Hungarian economic policy."

While the government has said it would be open to suggestions from the companies involved, the latest round of tax

As Rona concludes: "One wonders why the IMF or the EU would negotiate under such circumstances."

"The issue is that the man in charge of Hungarian economic policy, Matolcsy, has no credibility"

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The zloty's weakness has also been feeding through in the form of higher prices; making the central bank's job of fighting inflation more difficult. In April prices rose by an annual 4%, far above the bank's target rate of 2.5%. As a result, the bank's interest rate setting Monetary Policy Council (MPC) in May raised its headline rate for the first time in 10 months, increasing it by a quarter point to 4.75%.

arning lights in the form of persistently high inflation, a wildly fluctuating currency and gloomy industrial production numbers are flashing over the Polish economy – a sign that one of the EU's most resilient economies has not been able to completely disentangle itself from the turmoil in the Eurozone.

most liquid market. The zloty has been reacting much less to domestic factors than to external events – losing value when Hungary engages in a spat with the International Monetary Fund, rising when the European Central Bank flooded banks with liquidity, and falling again during the current crisis over the future of Greece in the Eurozone.

The MPC's step aroused a wave of opposition from senior government ministers like Waldemar Pawlak, the deputy prime minister, who called it a "dramatic mistake" and worried that it could endanger Poland's economic growth. "Unfortunately the MPC stabbed a knife into the back of our development prospects," he added.

Which is not to say that an ugly crash is looming in Poland's near future – by the standards of much of the rest of the EU the economy is still relatively solid. "Poland is a very consumption driven economy, while the rest of the region is export driven – that is what has made Poland an island of stability in Central Europe," says Mert Yildiz, emerging market economist with Renaissance Capital.

The zloty's recent weakness both hurts and helps. Many exporters are pleased at the windfall. "It's been an extra bonus for us because we had made our calculations at 4.1 to the euro [the

But despite the signs of weakness and Pawlak's outrage, the Polish economy is still performing better than just about anywhere else in the EU. The European Commission recently updated its growth

Nevertheless, there are signs of weakness. Until recently, almost every indicator released by Poland's statistical agency tended to surprise on the upside – those sorts of pleasant jolts have become much rarer in recent months. In March, industrial production slowed to its lowest rate since late 2009 – rising by an annual 0.7%, much lower than most analysts had expected. In a forward-looking indicator, Poland's purchasing manager's index slumped to 49.2% in April – anything below 50 signals the expectation of a slowdown. Retail sales, which kept the economy afloat in 2009, decelerated in March to an annual increase of 10.7%, down from 13.7% in February. Currency problems The zloty has also been gyrating wildly, more in response to wider fears over emerging markets, which has investors fleeing the region's largest and

"Until recently, almost every indicator tended to surprise on the upside – those sorts of pleasant jolts have become much rarer" currency is now above 4.30 to the euro] so the weakening has helped profits," says Roman Przybylski, sales director of Nowy Styl, a large furniture producer. But the zloty's weakness has a negative impact on the banking sector. About 700,000 Poles have mortgages denominated in foreign currency – mainly Swiss francs and euros – and a fall in the value of the zloty increases their payments. While the rate for troubled mortgages is still very low at only 2.5%, there are worries that it could rise. Strapped mortgage holders are also reluctant to spend. Real estate investors worry that retailers will have difficulty making their euro-denominated rent payments if hit both by a slumping zloty and a fall in consumer demand.

outlook for 2012, and predicted that Poland would grow by 2.7%, the fastest in the bloc. "Poland has performed even better than expected in the face of a challenging external environment. This has reflected very strong fundamentals, robust domestic demand, and sound macroeconomic management, which helped bolster confidence and sustain access to external financing," said a new report by the International Monetary Fund (IMF). However, the report went on to note that it was predicting a slowdown in economic expansion. "Risks to the outlook are on the downside, emanating mainly from external sources," said the IMF economists.


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Highway robbery in the Czech Republic

VISEGRAD:

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he construction industry is a murky business and no more so than in the Czech Republic, where the fate of Miloslava Posvarova, a former employee for the UK engineering firm Mott MacDonald in Prague, has become a matter of fierce debate. Posvarova was dismissed in early May by Mott MacDonald under circumstances that still aren't clear. People in the industry and media unambiguously link her dismissal to her sterling work highlighting the widespread dodgy practices and cost inflation in the Czech Republic's notoriously corrupt infrastructure construction sector, and that she has been sacrificed by her firm as it seeks to worm its way back into lucrative state construction contracts from which it's been frozen out. However, Mott MacDonald tells bne that contrary to press speculation, the loss of her job was part of a general downsizing of the Czech office (from 180 to 124 staff) as the UK firm exits parts of the construction business; indeed, she was one of only three people who were offered continued cooperation on a

consultancy basis. Further, Mott MacDonald complains that the company is finding itself in the midst of a political battle between the government and certain construction contractors, and this rampant speculation by the press,

Risky business The brouhaha over Posvarova began when Pavel Kohout, who heads the "Fight against corruption" working group for the National Economic Council of the Czech Government (NERV) that Posvarova voluntarily gave her time to, claimed in the Czech daily Lidove noviny on May 14 that the veteran construction engineer had been fired by Mott MacDonald because she had violated the "omerta" in the construction sector about revealing dodgy practices and was sacrificed to help the UK company regain business in the country. "[Posvarova] lost her job because she violated the 'omerta', a secret promise of silence among firms in the industry," Kohout wrote in the newspaper. "Mott MacDonald was cursed by the rest of the firms immediately after her report was published. In a small market such as the Czech Republic, even competitors cooperate. After a full dry year, the British headquarters of Mott MacDonald decided to replace the management in order to get back to the good old times of cooperation." The report Kohout is referring to is one that Posvarova authored last year as a part of Kohout's NERV working group. The report, entitled "Quality control and delivery standards for road construc-

"Posvarova lost her job because she violated the 'omerta', a secret promise of silence among firms in the construction industry"

few of which have bothered to contact the UK company to seek its comment, is part of that battle. What is clear, though, is that the notoriously corrupt construction industry in the Czech Republic is under scrutiny like never before and Mott MacDonald, long an island of probity in murky waters, is having to make changes at its Prague office to mitigate the difficulties its business has suffered over the years from its principled stance.

tion," caused a huge stink by revealing in detail how it is that constructing roads and bridges in the Czech Republic go so over budget, so past deadlines, yet are of such poor quality that roads buckle and bridges collapse, including one notorious case in 2008 that killed eight people. An illustration of the scale of the problem can be found in a survey from the Supreme Audit Office (NKU), parts of which were published by Czech Position on May 15, which showed that of 28

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projects relating to motorways and highspeed communications started after 1999, all had their deadlines extended by up to seven years and investment costs rose by a total of CZK35bn (€1.37bn), or about 68%. The key finding of Posvarova's report was that the problems of cost inflation, delays and sub-standard work in the industry began from about 2000, when the system of independent supervision of public construction works – initially set up in 1995 to comply with European Investment Bank (EIB) subsidy requirements – started to erode, then was finally removed completely when the country joined the EU in 2004. "This brought about an imbalance between the supplier and the customer (the

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MacDonald, Jiri Petrak, who told bne in an exclusive interview before he retired earlier this year that Mott MacDonald's problems operating in the Czech Republic as an engineering advisory company on construction projects began when the country joined the EU. "In the 1990s, we were well-positioned as an international independent company, we were trusted by donors to supervise funds and projects co-financed both by the EU and the EIB, and there were strict requirements for co-financed projects," he said. "Of course, for projects without cofinancing by the EU there was this corruption growing, but after joining the EU in 2004, the EU changed its approach and said, 'you handle it and we'll check later.' For those intent on

"The state is now refusing to pay the contractors and lawsuits are brewing" Road and Motorway Directorate, or RSD)," she wrote in the report. "Independent construction oversight firms hired by RSD could not withstand the pressure applied from the supplier and from its client, the RSD, which approved works despite the negative opinion of the oversight firm. Suppliers then also started to press for extra work. If the oversight firm disagreed with the extra work, it was replaced."

stealing money, this is the best way how to do it. We were pushed out totally from business – nobody wanted or needed a non-corrupt company involved. The Ministry of Transport of the government of former prime minister Mirek Topolanek issued an order that Mott MacDonald shouldn’t work for Ministry of Transport projects, as we were 'unpredictable', and I became public enemy number one," he said.

Her report also highlighted a basic conflict of interest in construction projects, in that companies that prepare plans for road construction for the Czech state often work at the same time for the winners of the said tender. This too-cosy relationship also means that the contractors often succeed in getting approval from the project coordinator for changes in the project's specifications, which causes the cost increases, delays to the project and helps avoid the contractor from being lumbered with unforeseen extra costs.

Petrak went on to detail to bne other scams by the construction business, such as those centred on land use. "The government land was first sold to someone, and this was then resold to government as a building plot, which was more expensive than if it was just a forest or a field. This 'land swapping' may have created billions for some people," he said, adding, "It is hard for you as westerner to comprehend the scale of the stealing."

The conclusions of the report were backed by her former boss at Mott

Posvarova's report for NERV also addresses the issue of construction quality, which is where, Mott MacDonald tells bne, it believes the current battle being waged through

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the press centres on. Her report says that in the absence of spot checks on construction works as they progressed, the contractors have often gotten away with using shoddy materials and products, which has had fatal consequences like the 2008 collapse of the motorway bridge near Studenka in the Moravian-Silesian region that caused a train to derail, killing eight people and injuring over 90 others. "For example, they use replicas, false crash barriers or reinforced concrete for bridges and tunnels," Posvarova wrote in the report. However, sources say there is another a fuller, unabridged version of this NERV report, not available on the NERV website, in which Posvarova details forensic evidence of negligence and failure (she is an expert in technical and measuring methods, which enables "x-rays" of any construction to reveal even its hidden defects) in construction works and ties this to specific companies, and this is being used in criminal prosecutions by the government against certain contractors. "There are ongoing problems regarding highways in North Moravia and close to Prague, and threats of lawsuits from the state against the contractors, due to technical problems. The state is now refusing to pay the contractors and lawsuits are brewing," argues Radko Bucek, the new managing director of Mott MacDonald's Prague office. "This whole story has been created by the press as part of that campaign." But while making for good headlines, none of this current spat will do much for the poor taxpayer who has had to pay for the all this rotten construction and has to travel on it. Indeed, the past misdeeds were so widespread that Petrak warns that there are likely to be more cases of bridges collapsing. "Everyone was cheating, not doing proper work. As an engineer, you can't cheat because it will come back to haunt you one day – a road becomes bumpy, a bridge collapses. I hope that things will get better because we have reached bottom."


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They ignored the restoration proposals for political reasons, they have not been looking out for the interests of all creditors," he told bne. Presiding judge Gvido Ungurs, however, agreed with counsel for KPMG, who told the court that the bank could not survive without state support, which it would not receive. KPMG now has the legal mandate to begin liquidating the bank. Assets include its large branch and ATM network, and around LVL200m in performing loans.

Bankruptcy befalls Krajbanka Ben Seeder in Riga

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court in Riga on May 8 ruled that bankruptcy proceedings can begin against Latvijas Krajbanka – the Snoras Bankas subsidiary that collapsed last winter under a cloud of fraud charges and LVL109m in missing money. The bank's administrator, KPMG, said it intends to auction Krajbanka's LVL230m loan book in the autumn. Almost a month after hearings started and a hundred hours of damaging allegations against the Baltic subsidiary of auditors KPMG, the Riga Regional Court also turned down an application seeking the removal of the accounting company from its role as administrator of the collapsed bank. Several major creditors in the insolvency process, as well as former board members and Snoras Bankas majority shareholder Vladimir Antonov, had sought to halt the bankruptcy process and remove KPMG as administrator, claiming the accountancy firm bungled the insolvency, charged too much in fees, had violated the law and was motivated by

political goals rather than maximizing returns for all creditors. Antonov, who was briefly detained by British police in December acting on a Lithuanian-issued arrest warrant, has not returned to Latvia or Lithuania. But Ivars Prieditis, the former president of Krajbanka who is now facing Latvian

Latvia's Financial Markets Commission suspended Latvijas Krajbanka on November 21, 2011, after Lithuanian regulators discovered €300m missing from parent bank AB Snoras Bankas. The suspension of the bank prompted a local run on Krajbanka ATMs around Latvia, before the government announced a deposit insurance scheme guaranteeing bank accounts for LVL70,000 or less. According to figures from KPMG, as of March 30, Latvijas Krajbanka had some LVL380m in assets and LVL560m in debt. The biggest creditors include the National Deposit Insurance Fund, which was set up by the state last year to guarantee bank deposits in Krajbanka of LVL70,000 or less. The hated beancounters Former Krajbanka director Martins Zalans told the court that KPMG had lost

"I think the Commission does not wish to see any further Russian participation in the Latvian banking sector" criminal charges in relation to the collapse, said on the sidelines of the court that the bank could have continued if it hadn't been for KPMG. "My view is that the bank was in a much better financial position in December than it is now. They should have taken an immediate decision over restoration or bankruptcy.

LVL41m since it took over as administrator, and that the accounting firm had broken Latvian law by failing to stage a creditors' meeting. He told the court that KPMG had ignored "viable" options to keep the bank running as a going concern, includ-

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ing a proposal from Russian investment bank Otkritie Financial Corporation. The Russian group, which was barred by regulators from buying GE Money Bank Latvia last year, proposed taking over Krajbanka with a small cash injection as a direct investment, and a larger investment in the form of long-term loans. KPMG rejected the offer, claiming that any viable rescue plan would

Central Europe

Counsel for KPMG Baltics, Romualds Vosnovics, told the court that the accounting firm's fees were in line with the administrator's agreement, and would need to be approved by a court in future anyway. He said the "missing" LVL41m was in fact a writedown of the bank's loan portfolio. He denied the claim that Krajbanka's financial position had been worsened by KPMG's

"KPMG could receive up to LVL25m if bankruptcy is declared – that is why they have pushed towards the bankruptcy process"

have needed at least LVL170m in cash. "I think there is a political motivation here, that KPMG is doing what the [Latvian regulator] Financial Markets Commission wants, and I think the Commission does not wish to see any further Russian participation in the Latvian banking sector," Zalans told bne on the sidelines of the court. Counsel for creditors and former shareholder Antonov also told the court that the insolvency was illegitimate because of the participation of Aivars Jurcans, head of corporate finance at KPMG – an investment banker with no experience in insolvency matters. KPMG responded by saying Jurcans was "just crunching the numbers" and that the actual insolvency was being managed by an outside contractor who had such experience and qualifications. Janis Strencis, representing Riga City Council, which claims it is owed LVL10m from the collapsed bank, told the court that KPMG wanted only to move to bankruptcy for political and financial motivations. "Already for three months they have confirmed they received LVL600,000 in administrators' fees, and KPMG could receive up to LVL25m if bankruptcy is declared. That is why they have pushed towards the bankruptcy process and done everything they can to avoid restoration," he told the court.

actions. Instead, he told the court that the creditors "have managed to delay the bankruptcy process for a long time, and every delay means the value of the recoverable assets is deteriorating". Despite Vosnovics' courtroom charm, the accounting firm was clearly concerned over damage to its reputation. With television cameras rolling in the court room, the first few days of the hearing were dominated by a constant stream of unpleasant allegations from the halfdozen sharp-suited counsellors sitting opposite. On the third day, Oskars Firmanis, a local representative of public relations firm, Burson Marsteller, turned up at court and began pressing the flesh with local reporters. He said his firm had been contracted by KPMG to deal with the media, and that any questions from reporters to the accounting firm should go through him.

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Angry android users The Baltic states like to market themselves as edgy hi-tech innovators, yet a Latvian firm in May was fined £50,000 after nearly 1,400 people in the UK were hit by fake apps that sent out premiumrate text messages which cost them up to £15. In all, 1,391 people in the UK were affected and were falsely charged a total of £27,850 when they opened fake versions of game apps including Angry Birds, Assassin's Creed and Cut the Rope. An unknown number were affected in 17 other countries where the scam was run, including Russia, Azerbaijan, Armenia, Georgia, Czech Republic, Poland, Kazakhstan, Belarus, Latvia, Kyrgyzstan, Tajikistan, Ukraine and Estonia. PhonePayPlus, the premium-rate regulator, prevented the money being paid to the scammers, and fined a Latvian company called A1 Agregator £50,000 because it was in charge of the "shortcodes" and payment mechanisms used for the scam in the UK, though the regulator said it could not say whether the company was directly involved in the planning of the scam.


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of the roughly $3bn economy. Private Turkish associations donate more. And an estimated 35,000 Turkish troops are stationed there. Not being part of the EU, the TRNC's exports have a difficult time competing in regional markets. It does not help that there are no direct flights except from Turkey. The degree of isolation that the island suffers is such that some citizens hold four passports: that of the TRNC, Turkey, the UK and the Republic of Cyprus. The island was a colony of the UK until independence in 1960. The island split in 1974, following an attempted coup by Greek Cypriot nationalists backed by Greece and the subsequent Turkish invasion of the north of the island. Greek Cyprus, which joined the EU in May 2004, is recognized internationally as representing the entire island and some Turkish Cypriots cross the so-called Green Line to obtain passports. "When you have too many identities, you… have none," says Kemal Baykalli, director of international relations and communications at the North Cyprus Chamber of Commerce.

Island troubles Justin Vela in Lefkosa

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s the Republic of Cyprus prepares to assume the EU's rotating presidency this summer, the Turkish (and unrecognized) northern part of the island is receiving dollops of aid and unwavering support from Turkey. None of this is helping to unite the divided island, nor further Turkey's own dreams of joining the EU.

Turkey's support is crucial to the survival of the TRNC. The main components of its struggling economy are the public sector, tourism and seven private universities that aim to attract foreign students, says Dervis Besimler, president of the Turkish Cypriot investment agency (YAGA), adding that two more universities are expected to be completed soon.

Turkey has announced it will suspend political relations with the EU when the Greek half of Cyprus assumes the bloc's rotating presidency on July 1. The move is meant to show support for the Turkish Republic of Northern Cyprus (TRNC), the self-proclaimed state recognised only by Turkey that has suffered international isolation since the island split in 1974. Turkey also aims to provide water supplies to the TRNC and is financing energy exploration.

Nearly year-round warm temperatures, clean air, reasonable prices and low rates of crime make it an ideal spot

to retire, and a number of foreigners – mainly from the UK – have come to live in the TRNC, for at least part of the year. Besimler says that a northern European country is currently building a retirement community on the island. However, luring foreigners to an island life is not enough to provide jobs for the population of 290,000 and maintain territorial security. Ankara still donates about $400m-500m every year to the TRNC, directly funding a good chunk

"Luring foreigners to an island life is not enough to provide jobs for the population of 290,000 and maintain territorial security"

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Lone star Earlier this year, UN Secretary General Ban Ki-moon pushed to find a framework for settlement before the Republic of Cyprus assumed the EU's rotating presidency on July 1, but the talks failed with the two sides unable to agree on core issues. In a show of support for its Turkish brethren, Turkey has said it will follow through with threats to suspend political cooperation with the EU during Cyprus' six-month term as president. This is a symbolic move, say analysts, because economic cooperation and trade will continue as normal. However, Turkey will not be able to open any new chapters as part of its EU accession process during this time, an effort that largely stalled during the tenure of former French president Nicolas Sarkozy, a man vehemently opposed to Turkey joining the EU. The election of Francois Hollande brings fresh wings to Turkey's accession bid, but it will have

to wait until after Cyprus' term as EU president ends. Several chapters of Turkey's accession process have been frozen because of its refusal to recognise the Greek Cypriot government in Nicosia and open its ports to Greek Cypriot vessels, something Turkey says it will not do until the international isolation of the

the island, Turkey's state oil company TPAO began drilling for oil in the TRNC, at a well called "Turkish homeland." Ankara had initially insisted that any energy exploration should wait until a political settlement for island was reached, but Greek Cypriots went ahead with the drilling with only vague promises to share the gas with the north of the island in the future. Though the

"These are moves which are not helping to bridge the big gap of trust between the two communities in Cyprus"

TRNC is eased. "I believe that Turkey wants to solve the problem. On each and every international platform, Turkey faces this issue," says Baykalli. However, he adds that Turkey wants to see the end of the issue "without giving up the rights of Turkish Cypriots." Oil on troubled water In March, a groundbreaking ceremony was held to signal the start of a project that envisions Turkey providing 75m cubic meters (cm) of water per year to the TRNC. The water will be carried to the TRNC from dams currently under construction in Turkey via a 77-kilometre pipeline that will run from the coastal province of Mersin to the TRNC. The cost of the project is expected to be around $600m. With Cyprus experiencing a severe drought and the TRNC aiming to increase its population, the water is desperately needed. Turkish Prime Minister Recep Tayyip Erdogan has personally decreed that the water will begin flowing at 1:00 pm on March 7, 2014. "Erdogan is popular for keeping his word," says Besimler. Considered feasible, the water project stands to boost the TRNC's productivity. Yet other projects are considered more political than realistic. In April, in response to Greek Cypriot drilling for natural gas off the south of

odds of finding oil are slim, Turkey is financing the $600m venture and has agreed to share any proceeds 50/50 with the TRNC. Turkey is also searching for energy off the coast of northern Cyprus. However, some of the area where it will look overlaps with where Greek Cypriots are drilling, setting the stage for a potential confrontation. "Such actions as the drilling being carried out by Turkey and the Turkish Cypriot leadership show a lack of willingness on their part to achieve a solution to the Cyprus problem," Cypriot government spokesman Stefanos Stefanou announced, following the start of drilling for oil. Even so, the hard line taken is proving popular in the northern part of the island. Dr Ahmet Sozen of the Cyprus Policy Centre in the TRNC says that the realpolitik of the region means that Turkey needs to respond strongly to the Greek Cypriots' actions: "The Greek Cypriot side taking this unilateral action without consulting the Turkish Cypriots... these are moves which are not helping to bridge the big gap of trust between the two communities in Cyprus."


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The lonely life of Turkish Cypriots

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two states to reunite the island. Greek Cypriots rejected the so-called "Annan Plan" when it went to a referendum. Gungor says this is symptomatic of a Greek Cypriot strategy to prolong "open-ended negotiations that will last another 40 years."

INTERVIEW:

Southeast Europe

In Cyprus, life's a gas

David O'Byrne in Istanbul

Justin Vela in Lefkosa Hasan Gungor, TRNC Under Secretary

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he self-declared Turkish Republic of Northern Cyprus (TRNC) continues to face international isolation as the conflict that divided the island approaches its 60th anniversary. With peace negotiations in deep freeze and the Republic of Cyprus set to bask in the international limelight from the EU presidency, the TRNC is looking for ways to overcome the challenges of marginalization. "It's a critical time for the Cyprus problem, for the European Union as well," says TRNC Under Secretary Hasan Gungor. Sitting in an office that is part of the presidential compound in Lefkosa, the Turkish side of the divided city known to Greek Cypriots as Nicosia, Gungor met bne with his colleague, presidential spokesperson Osman Ertug. Both men have worked in politics long enough to have experienced first hand most of the diplomatic manoeuvring and failed talks of the past decades. The two men are keen to stress the TRNC's positive developments of late. Adopting a strategy similar to Turkey's, its great benefactor and the only country that recognises it as a state, the TRNC is trying to improve relations with the Islamic world. As Turkey looks to eastern markets as its effort to join the EU stalls, the TRNC is also looking towards the Muslim world as peace negotiations with Greek Cypriots remain unmoved. Though they do not recognize the TRNC, Muslim states may be more willing to do business in northern Cyprus than European countries.

Thus in April, the Islamic Development Bank (IDB) was in town, working together with the TRNC's foreign ministry to hold an investment forum. The IDB has already provided the TRNC with more than $3m for nine development projects in the fields of education, Islamic teachings and investment support. The conference, the second such forum held recently, was meant to introduce the TRNC's private sector to representatives from IDB member countries. "We are

competitive in European markets due to higher taxes. "The TRNC is a very small closed economy when the rest of the world is open," says Gungor. Virtually all of what it exports has to go through Turkey. Certificates to trade with Greek Cyprus can be obtained through the TRNC's Chamber of Commerce, but Ertug says Greek Cypriots can impose any price they want. "[Turkish Cypriot goods] are sold below cost

"The TRNC is a very small closed economy when the rest of the world is open" trying our best to improve our economic relationships with all," says Ertug. Ertug says the TRNC is aiming to attract students from Muslim countries to its private universities – attractive for their proximity to Europe – and businessmen to invest in everything from agriculture, to alternative energy, education and tourism. The two say they would like to see the TRNC become a Mediterranean hub for shipping and storage of merchandise. However, they admit that there are too many unresolved issues to make this possible now. Even the TRNC's few exports – halloumi cheese, potatoes, oranges, and some textiles – are difficult to sell because they are not

price," he says. The economic isolation is so severe that if a ship calls at a TRNC port and then later at a Greek Cypriot port, Greek Cypriots might impose penalties that include jail or fines. Spotlight However, the subject most pressing for the two is Greek Cypriots assuming the EU's rotating presidency this summer. "After July 1 they will not be in a compromising mood," says Gungor. "The Cyprus problem is not going away anytime soon." Indeed, the last time the Cypriots neared a settlement was in 2004, when former UN Secretary-General Kofi Annan tried to broker an agreement that would create a federation of the

Today, 68% of Greek Cypriots and 65% of Turkish Cypriots want the current negotiations to lead to a settlement, according to a survey conducted by the Cyprus Policy Centre in Turkish North Cyprus. But while the desire for settlement is there, reaching it is still far off, with 65% of Greek Cypriots and 69% of Turkish Cypriots not believing the current talks will succeed. The survey also found that a federation is not even the first choice for a solution. 93% of Greek Cypriots prefer a unitary state, in which Turks will be considered a minority; 90% of Turkish Cypriots favour two independent states. A federation comes second, with 79% of Greek Cypriots and 75% of Turkish Cypriots supporting the idea. Only 37% of those surveyed preferred the status quo among Greek Cypriots, 64% among Turkish Cypriots. Though Gungor and Ertug acknowledge that a federal solution is acceptable to the TRNC government, further negotiations are impossible until after the 2013 presidential election in Greek Cyprus. The incumbent president, Dimitris Christofias, says he will not seek reelection and therefore is not a credible interlocutor. A completely new process is necessary and a UN representative is conducting shuttle diplomacy to explore ways to find a new framework for talks. Gungor described those efforts as infrequent. "There is no substantial discussion at all. [Current talks] have been exhausted," Gungur says. Yet he still looks on the bright side. With the Republic of Cyprus assuming the presidency, at least the Cyprus issue is about to become more visible to the EU. "It will be more observable for the Europeans when they come down here."

Only a few short years ago, the prospect of finding commercial reserves of hydrocarbons in the eastern Mediterranean was, to use the inevitable pun, little short of a pipe dream. Offers of acreage were many, expressions of interest few. Now, if the results of the Republic of Cyprus' second licensing round that ended May 12 is anything to go by, that has certainly changed. Of the 12 blocks covering 45,000 square kilometres on offer, a total of 33 bids were received for nine blocks from 15 companies and consortia. Those bidding included some of the continent's biggest gas operators, Gazprom – through its subsidiary GPB Global Resources, Italy's Eni – in partnership with South Korea's Kogas, Italy's Edison, French giant Total and US independent Marathon – not to mention several UK- and Israel-based independents. The level of interest is not difficult to fathom. Just to the east in the Israeli sector of the Mediterranean lies the Leviathan gasfield, holding an estimated 450bn cubic metres (cm) of gas and 600m barrels of oil, and the Tamar gasfield holding an estimated 275bn cm of gas. And drilling late last year by US company Noble Energy in Cyprus' own block 12 struck what was announced at the time as a substantial gasfield, which the company in May confirmed to hold 991bn cm of gas. Individually, the reserves are substantial enough to ensure energy independence at current consumption levels for both countries for centuries to come – a situation which raises the opportunity of monetizing part of the reserves through export to the huge European market to the north. The discovery of more reserves in any of the 12 blocks now on offer would make turning that opportunity into an imperative. Irrespective of Israel, Cyprus' own gas demands requiring the construction of a pipeline north from the gasfield to the island. That in turn would leave the twin options of either constructing a liquefied natural gas (LNG) export plant to monetize the gas as LNG or construct a second line to Turkey from where gas could be exported via the planned TANAP pipeline. Given that an LNG plant costs around $1bn- $1.5bn to build and will use roughly half of the gas reserve in liquefying the other half, a pipeline is by far the most financially viable option. Sadly, poor relations between Turkey and the internationally unrecognized Turkish Republic of North Cyprus (TRNC), which occupies the northern third of the island, and the Greek half of the island the Republic of Cyprus, mean that option looks a very distant prospect. What is clear is that the discovery of further substantial gas reserves in the newly tendered blocks could change the picture, making export as LNG a more viable proposition or even raising the possibility of a pipeline bypassing Turkey altogether, running from Cyprus to Greece and on to Italy.

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Turkey's Akbank young at heart

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It's precisely this focus on new customer service models and Akbank's success in transforming its business in the wake of Turkey's 2001 crisis that attracted the Harvard University Kennedy School of Government to use the bank's story over the past decade as a case study.

INTERVIEW:

Given Akbank's success, it comes as a surprise to learn that one of the bank's main shareholders, the US' Citigroup, has just announced that it plans to sell the 20% equity stake that it bought in 2007 from the bank's main shareholder, Turkey's giant Sabanci Group. According to Citi's emerging markets president,

Hamid Bigarli, in a recent interview, it wasn't its preferred choice to sell the stake in Akbank, it was one of the technical decisions it had to make as part of the Basel III criteria. "If there had not been such a requirement, we would have had no intention of selling our shares," he told Turkish daily Hurriyet.

to look far for a buyer. Already this year, Kuwait-based Burgan Bank has agreed to buy up a 29% stake in Eurobank Tekfen, the Turkish unit of Eurobank, while the Gulf's biggest lender Qatar National Bank has confirmed that it is talks with Dexia over the possible purchase of its Turkish subsidary Deniz Bank.

What happens now is unclear. Citi is obliged to offer its shares first to Sabanci Group, which is not obliged to buy them back. However, given the high level of interest in the Turkish banking sector from cash-rich Gulfbased investors, Citi is unlikely to have

But for Binbasgil, whatever buyer materialises, business will continue as normal. "Akbank remains the flagship of Sabanci Group so there will be no change of strategy, which remains one of 'sustainable leadership' within the sector," he smiles.

David O'Byrne in Istanbul Hakan Binbasgil, CEO of Akbank

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peak to any senior Turkish banking executive about the past decade, and you should expect the odd wry smile. Little wonder. It's only 11 years since the signal failure of the state to effectively regulate the banking sector brought Turkey to the brink of collapse, necessitating an international bailout. Yet today, the situation could hardly be more different, with no Turkish banks requiring help in the 2008 financial crisis or subsequently.

successive administrations of current Prime Minister Tayip Erdogan and his Justice and Development Party has left the wider Turkish economy similarly blessed.

"2001 was a difficult year, we lost roughly 50% of our banks," smiles Hakan Binbasgil, CEO of Akbank – one of Turkey's hardiest and best managed financial institutions, which has sailed through successive crises with little difficulty.

Most importantly, with per-capita GDP now in excess of $10,000 a year, living standards have soared, leading to a steady expansion of a new welleducated, tech-savvy middle class. Coupled with Turkey's young population, it's little surprise that Akbank is at the forefront of Turkish banks aiming to

The secret of the sector's recovery, says Binbasgil, was a stiff dose of corrective measures, regulation and close supervision. "The Turkish banking sector has gone through a very successful restructuring period after 2001," he explains. "We started to manage our banks very prudently, getting the fundamentals right – no toxic products, no liquidity problems, low leverage and high capital adequacy ratios." That prudency has left Turkey's banks with high capital adequacy ratios and low leverage ratios, while the sound economic management of the three

With a sovereign debt ratio of just 40% and private sector borrowing of only 19% of GDP, Turkey has one of the fastest growing economies in the world – with GDP expected to grow 4% this year despite continuing worries over the Eurozone.

under 29," Binbasgil says. "And it's still comparatively under-banked with only a quarter of the branches per million people of the EU." i-win Addressing that young population requires the use of the latest technology and marketing strategies, explains Binbasgil, pointing out Turkey's high usage of mobile phones and social media. "In order to sustain our growth, we have to cater to the needs of the hundreds of thousands of young people who enter the job market each year and make sure that we tailor our services to meet their expectations," says Binbasgil.

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

"Our aim is to continue to be the stateof-the-art bank in terms of mobility, internet, i-pad, i-phone banking – you name it, we will continue to serve our

customers with our state-of-the-art infrastructure," he says, adding that this year will see Akbank invest a hefty $120m in yet more new technology.

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"Our aim is to continue to be the state-of-the-art bank in terms of mobility, internet, i-pad, i-phone banking – you name it"

continue its rapid expansion targeting 70 new branches this year. "Turkey is a very large and very young country – 75m population, and half of them

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uncomfortable with the direction the country has been taking. While Serbia won official EU candidate status in March, the country's economy is sluggish and lacks clear long-term direction, and the populace is disillusioned with a political elite seen as corrupt and remote. Then there is the issue of Kosovo, the region which declared independence in 2008, which both Tadic and Nikolic claim – in public at least – they see as an inalienable part of Serbia. In the first round of the election, Tadic won 25.31% of the vote and Nikolic 25.05%. Candidates from other parties took the remainder.

Shock Nikolic victory in Serbia Andrew MacDowall in Belgrade

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shock win for a former ultranationalist in Sunday, May 20's Serbian election is indicative of frustration at economic malaise and apathy among an electorate disillusioned by the political elite. Despite the hard-right background of Tomislav "Toma" Nikolic and an acrimonious campaign, the president-elect announced on May 24 that he would "insist" the country stick to its pro-European path, albeit he did this the day before heading to Russia on his first foreign trip since being elected. The bitterly-contested poll on May 20 was a run-off pitting incumbent Boris Tadic, who is seen as western-leaning and has overseen the country's progress towards EU membership status, against Nikolic, formerly a fire-breathing nationalist but now supposedly a moderate. That both candidates espoused EU accession is a sign of the changes that have taken place in Serbia since

the ouster of strongman Slobodan Milosevic in 2000. The result was a big surprise. Tadic was widely expected to win; Nikolic's confidantes were said to be sceptical of his chances. Low turnout probably helped Nikolic, who can rely on a core of enthu-

What now for the parliament? Much rests on what parliamentary government takes shape under Nikolic. Nikolic's Progressive Party narrowly won a parliamentary poll held concurrently with the first round of the presidential election, and has 73 seats in the 250-member parliament to the 67 held by Tadic's Democratic Party (DS). But the DS is thought likely to team up with its allies from the last parliament, most notably the Socialists (SPS), who performed remarkably strongly, to form a workable majority. Constitutionally, the Prime Minister has more power than the President, but Tadic has effectively taken control of the government in his eight years as President. Nikolic may have less opportunity to to do the same in a situation of cohabitation with a DS-SPS led coalition.

"Even Nikolic's confidantes were said to be sceptical of his chances"

siastic support. Many voters who leaned towards Tadic may have stayed at home due either to apathy or the expectation that he was a shoo-in. But Nikolic's win highlights once again that a substantial proportion of Serbia's population is

Headlines declaring that Tadic lost the election, rather than that his opponent won, are not far off the mark. The soon-to-be ex-president, once allegedly dubbed the "George Clooney of the Balkans" by Silvio Berlusconi, cuts an

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urbane figure, and is an energetic and telegenic campaigner. He has successfully steered a course towards the EU while maintaining Belgrade's opposition to Kosovo's independence. Many see this as a contradictory stance, given that it is unlikely that Serbia can join the EU without conceding on Kosovo's sovereignty. Tadic and his allies are widely seen as having privately given up on Kosovo while saying otherwise to the Serbian public, an impression that probably has some basis. Rather more importantly, Tadic has presided over Serbia during the ongoing economic crisis. With unemployment over 20% and meagre GDP growth of 0.5% expected this year, Serbia continues to suffer, despite successes in attracting investment such as Fiat's large and glitzy revamped plant in Kragujevac, which opened in April. Furthermore, Tadic is accused of allowing corruption and favouritism to run rampant. While his supporters strongly deny this, the impression of cronyism appears to have stuck. A Tadic victory would have meant more of the same for Serbia; the commencement of accession negotiations with the EU, a very gradual move towards conciliation with the Albanian-dominated Kosovan government in Pristina, and a broadly pro-investment economic strategy. But particularly given parliamentary arithmetic, a Nikolic presidency may differ more in style than substance from Tadic's leadership. The presidentelect was swift to reaffirm his commitment to Serbia's EU membership. In contrast to the smooth Tadic, Nikolic is seen as somewhat uninspiring, and has little talent for public speaking. A bizarre and abortive attempt at a hunger strike to call for early elections in spring last year has become something of a joke for many Serbs. But Nikolic has attempted to portray himself as a man from outside the political elite. Nikolic was defeated by Tadic at the last presidential election, in 2008, when the former was standing as the candidate

Southeast Europe

"A Nikolic presidency may differ more in style than substance from Tadic's leadership"

of the ultranationalist Serbian Radical Party, espousing a rejection of the EU, no compromise on Kosovo, and a turn towards Russia. Just four years later, having left the Radicals and founded the Progressives, Nikolic stood as a moderate conservative, supporting EU accession albeit with a harder line on Kosovo. Nikolic's volte-face, and the poor showing of the formerly powerful Radicals in the recent parliamentary poll, is indicative of the shift of Serbian politics towards a pro-European centre ground. In policy terms then, there is not a huge gulf between the two men and their parties, unlike 2008, when Serbia faced a clear choice between ultranationalism and pro-Western liberalism. Nikolic's main advantage is that he is opposing the ruling coalition and Tadic, and thus can gain support from those looking to punish the government for Serbia's economic difficulties and widespread corruption. Despite his change of heart on the EU, Nikolic also gained some support from those who disavow accession. In May, he made a pact with the Democratic Party of Serbia, which opposes EU membership, in a clear bid for Euro-sceptic votes. But the agreement merely states that the parties will work towards having a referendum on the EU. Not only is this a vague proposal, but such a referendum would be likely to support accession. While Serbia's sloughing off of its troubled past continues, the new government will face serious challenges. Much of the population continues to scrape by on low wages, which average only around €400 per month. The Kosovo issue remains unresolved, and the process of EU accession will be long and difficult – membership is not expected before 2020, and will necessitate much judicial, administrative and economic reform.

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be lower than ever. Hence, the SocialLiberal alliance will most likely attempt to focus their electoral messages on those voters they know always show up: the retirees and the rural population. Indeed, there is no better choice. Hurdles and slip-ups The biggest mistake that the governing alliance could make before the November elections would be that of acting as if it has the right to remain in power. Such an attitude will surely prompt it to make mistakes, which it has already started to do.

Dreams of longevity in Romania Bogdan Preda in Bucharest

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t would be foolish to think that the new Romanian government which took office in early May via a no-confidence vote that toppled the previous one is destined to survive after the November elections. Yet the new prime minister, Victor Ponta, who heads the former opposition party the Social Democrats which has established a political alliance with the National Liberal Party to create today's SocialLiberal Union, is already acting as though there will be no major power shifts for the next four plus years, and his government looks set to govern for years to come. The ruling coalition now behaves as if legislative elections slated for November in fact already took place at the end of April, when it managed to snatch enough votes in parliament to overthrow the 78-day-old cabinet of Mihai-Razvan Ungureanu, whom the then ruling Democratic Liberal Party had previously appointed in an effort to improve their public image before November's elections. As nearly all surveys were showing in April

that the governing coalition led by the Democratic Liberals had became wildly unpopular, Ponta and his allies took advantage of the fact that many MPs from that coalition feared they wouldn't be re-elected and promised them support in exchange for votes. However, the no-confidence vote that happened in parliament at the end

In an attempt to secure command of Romania's regions in preparation for the November elections, the second day after he became PM Ponta called for the resignation of all the prefects and subprefects in all 42 counties, saying they were serving the political and economic interests of the Democratic Liberals. The call was made despite the fact these prefects are at least formally protected by law, as well as most of them having been appointed in 2006, when his alliance's co-founders, the National Liberals, were in power. Such an aggressive action by Ponta immediately prompted eight of Romania's most prominent NGOs on May 16 to issue an "Alert from the Romanian Civil Society," which accused Ponta of "Fidesz-ization" – a reference to neighbouring Hungary's anti-democratic slide under PM Victor Orban and his

"The danger is Ponta may follow in the footsteps of his Hungarian counterpart by purging the administration and public media of independent professionals and critical voices" of April, a pre-electoral bargaining episode, will not necessarily reflect the way Romanians will vote in November. For one thing, as Romanians are overwhelmingly disappointed with the performance of most governments in the past 20 years, the turnout will likely

Fidesz party. "The danger is visible that the new Prime Minister Victor Ponta may step in the footprints of his Hungarian counterpart, Viktor Orban, by purging the administration and the public media of independent professionals and critical voices, and engi-

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neering a super-majority in the next Parliament," the statement said. In an eerie echo of the resignation of Hungary's president in April, Ponta in May had to let go his newly-appointed education minister, Ioan Mang, after he was accused by researchers from Japan, Israel and Taiwan of copying their academic work on IT in several of his papers as a faculty member at the University of Oradea. Trying to score points with the electorate, Ponta said he would change Romania's taxation system as of next year from the current flat 16% income tax to a progressive one of 8%, 12% and 16%.

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President Traian Basescu, who supported the previous governments. Indeed, the National Liberals governed together with the Democratic Liberals until 2007, and could jump ship if they get the sense they are second-class members in the current alliance. President Basescu's role should also not be underestimated. Despite the fact that quite a number of independent commentators see his importance diminishing once the party he protected lost power, Basescu's capacity to retaliate and make new political arrangements should not be discounted, especially given his last term of office will end in 2013, so he has nothing much left

"Basescu's capacity to retaliate and make new political arrangements should not be discounted"

Ponta also promised to lower the cost for employers of hiring new workers by 5 percentage points, while cutting VAT from 24% to 9% for agricultural products. The problem with such announcements is that although Ponta stated such cuts would surely work following public budget simulations by his team, he didn't say where exactly he would garner the difference of money so that he can produce enough income to keep the budget deficit in check. As such, worries are already growing that Ponta's government could resort to raising income taxes even higher once his party becomes sure about staying in power after November elections. Possible surprises Another factor that could change the political landscape before the November elections would be how the Social Democrats and National Liberals work together. While one of them is a centreleft party and the other a centre-right party, they formed an alliance mainly against the Democratic Liberals and

to lose. Allowing his loathed political opponents to cling to power is clearly irksome to Basescu, so he is expected by many to engage in political manoeuvring as the elections near. One such game could be gathering the less tainted of the Democratic Liberals and persuade the National Liberals to play ball again. All of this suggests that it's business as usual in Romania, where the politicians spend most of their time politicking instead of addressing the serious economic challenges needed to pull the country out of poverty, boost foreign investment and bring home more of the EU's funds that are available to it.

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Balkan bagpipers With the support of Indian spiritual leader Sri Sri Ravi Shankar, Bulgarian musicians put one over their more famous Scottish counterparts with a world record for the largest bagpipe ensemble, Reuters reports. The 333 Bulgarian folk musicians gathered in central Sofia late on May 16, blowing their kabagaidas - bagpipes from the Rhodope mountains in the south of the Balkan country - to set the first such Guinness world record. Dressed in traditional colourful Rhodope costumes, bagpipers started with a famous folk song "Delyu Haidutin". "You have big roots. Do not lose them, but increase old tradition and culture," Shankar told an audience of over 4,000 people who gathered to hear his advice on how to be happy and listen to the bagpipers. Happiness is an apt subject for Bulgaria, which was in the top 10 of more than 150 countries which were least satisfied with life and was the most unhappy in Europe, according to the Earth Institute's World Happiness Report released in April.


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been a growing groundswell of domestic opinion on the island that sees such events as a curse rather than a blessing. The public forum was convened by local politicians and was titled, "Novalja and Zrce two worlds – one future," where they debated the questionable merits of the island's party tourism. According to Boris Suljic, a local councillor, Pag's party scene may benefit international DJs such as Armin van Buren who can command as much as €50,000 for a night's performance, but the financial payback for the island from the hordes of clubbers that descend on Pag each year is more questionable, as the island's growing reputation for drug and drink-fuelled debauchery is destroying Pag's formerly family-oriented tourism trade. "They [clubbers] require kebab stalls, not restaurants; tents and not apartments," Suljic told local daily Slobodna Dalmacija.

Quo vadis Croatian tourism? Guy Norton in Zagreb

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recent television advertising campaign bills Croatia as "The new tourism star of the European Union." And blessed with a sun-drenched climate and stunning coastline, Croatia increasingly ranks among the go-to destinations for growing numbers of travellers from around the globe. But it's also fair to say that while tourism is a key revenue earner for Croatia, bringing in at least €6bn a year or the equivalent of 14% of GDP, the industry remains a plentiful source of controversy, with the future vision of tourism a hotly disputed topic among the local population. How the country best leverages its undisputed potential has become a matter of increasingly fierce discussion of late,

as various factions within the country contest how best to attract free-spending tourists without destroying the country's deeply-cherished natural and cultural heritage. For example, the island of Pag located in the south of the country off its Dalmatian coast, whose Zrce beach parties and festivals near the town of Novalja have earned it the moniker of the "New Ibiza", was recently the scene of a conference which debated the pros and cons of the annual invasion of hordes of nightclubbers from around the globe. While events such as the Hideout Festival have attracted widespread critical acclaim abroad, with UK daily The Guardian naming it among the best of the European festivals in 2011, there's

Ironically, 20 years ago Suljic opened the Calypso nightclub that is widely credited with propelling Pag towards party fame and resulting in the fact that the small town of Novalja, which has just 3,700 permanent residents, now boasts over 10,500 apartments. However, the noise and disturbance from landmark clubs such as Papaya and Aquarius is blamed for the fact that apartment rental levels in Pag, even in high season, can be as low as €7 per person as famously socially conservative Croatian families now shy away from the island, whose former claims to fame rested principally on it being the source for Paski Sir, a hard, salty ewes' milk cheese, and Paska Cipka, a traditional form of lacework. Rental levels in Pag are now a fraction of the price commanded in high culture-focused tourist destinations in Croatia such as Dubrovnik, whose chief tourist adviser Pave Zupan Ruskovic was sacked in January by the city's mayor, Andro Vlahusic, for speaking out about "drunken Kiwi and Aussie tourists walking naked down Stradun [Dubrovnik's central pedestrian thoroughfare]." Dubrovnik's reputation for stunning renaissance architecture combined with

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classical music concerts and theatrical festivals means that it appeals to an older, more affluent target audience than Pag. However, a planned €1bn golf development overlooking the city, which is clearly targeted at a cash-rich audience, has provoked fierce resistance from Dubrovnik residents who claim that it will enrich foreign investors, but not the local populace. Developmental pains Meanwhile, in the northern coastal of region of Istria there's an equally tempestuous debate raging over the development of a series of mega-resorts as part of the so-called Brijuni Riviera project. No sooner had Croatian tycoon Danko Koncar been awarded a 50-year concession to construct a major hotel and marina complex at Sveta KatarinaMonumenti, which is forecast to involve an investment of at least HRK225m (€30m), than the culture ministry promptly announced that there was an outstanding protection order on part of the site, which if fully enforced would require a major rethink of the proposed development. In response, Ivan Jakovcic, prefect of the Istria region and head of the IDS political party, which is a junior party in the current centre-left coalition government, called for heads to roll at the culture ministry run by Andrea Zlatar-Violic, a member of the HNS party, a fellow coalition partner. Jakovcic believes that self-serving bureaucrats at the culture ministry risk torpedoing a project he has championed for over a decade. "Such behaviour undermines the reputation of Croatia and requires urgent measures and severe sanctions," he told regional daily Glas Istre. Furthermore, Jakovcic called on investors not to participate in tenders for other tourist concessions in Istria at Hidrobaza in Pula and Pineta in Fazana, because he couldn't guarantee them legal and investment security "until all dubious relations in the relevant ministries have been cleared up." Koncar's spokesman, Goran Veljovic, told Croatian daily Vecernji List that his boss might review his participation in

Southeast Europe

the Sveta Katarina-Monumenti project. "We will not give up if the project can be realised. But if the new rules produce financial losses for us, we will abandon the project." Yet another disgruntled investor, Croatian property developer Pelagius, has appealed in an open letter to the government to intercede on its behalf with regard to its proposed HRK700m golf course and 200-bed hotel development in Istria, which has been on hold for six years because of demands from the culture ministry. The company claims it has met these demands in full, but even so it's unlikely to receive the go-ahead for its project from the local town of Umag before the end of 2013. Pelagius director Ljubica Marfan claims that bureaucratic intransigence is depriving at least a 100 local people of a job at a time of increasing unemployment in Croatia.

"Beach parties and festivals near the town of Novalja have earned it the moniker of the 'New Ibiza'"

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fell to under $1000 per tonne making the plant loss-making, according to the management at the time. At the time of its closure, the Yuzhpolymetall owed Kazakhmys an undisclosed amount. Yerzhan Ospanov, director of Metallurgic Development Complex of Kazakhmys, said in a Q&A interview in 2010 with the government news agency Kazinform that in order to recover the debt, Kazakhmys had "taken over operational management of production and financial activity in order to avoid non-productive expenses and to maximize profit." Ospanov's comments contrast with chairman Kim's comments at the AGM that its relationship with Kazakhmys is only that of a supplier.

A toxic issue Christopher Pala in Washington

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he London-listed FTSE-100 company Kazakhmys, the world's only fully integrated copper producer, has been operating since October 2010 a large lead smelter in the Kazakhstan city of Shymkent that is responsible for poisoning tens of thousands of local children, bne can reveal. While Kazakhmys executives deny the company owns the 78-year-old smelter and says it thus has no liability for the health problems that it has caused in Kazakhstan's third-largest city, taking operational control of the plant raises questions about whether the Kazakh company has properly disclosed the political and legal risks to its shareholders. There is ample evidence that the Shymkent plant is a major health problem and an environmental catastrophe. Average levels of lead oxide in the air are 22-times the international norm and have led to high lead oxide levels in the blood of an estimated 40,000 local children. Lead oxide stunts brain development in children, even in small amounts.

At Kazakhmys' annual general meeting on May 11, outgoing chairman Vladimir Kim told Tom Mayne of Global Witness, a non-governmental organisation that focuses on poor corporate governance: "The Shymkent lead plant does not belong to Kazakhmys... The only connection between Kazakhmys and this plant is that we deliver lead dust." Global Witness released a report on Kazakhmys earlier this year called "Risky Business," in which it accuses the company of failing to disclose ties to President Nursultan Nazarbayev and his closest aides. Kazakhmys has done little to assess the environmental impact of the plant on the local population and has not commissioned an independent environmental study, despite the high population density around the plant. When confronted at the AGM with details of the potential health problems that the local population faces, Kazakhmys CEO, Oleg Novachuk, told Global Witness' Mayne: "We are not aware about any potential

liability based on the information you mentioned." However, a series of interviews senior Kazakhmys gave local media at the plant's reopening in October 2010 paints a very different picture. The officials clearly state that Kazakhmys took over operational management and reopened the Shymkent plant to recover an unpaid debt. Lead levels The smelting plant was built in 1934 just outside Shymkent, near Kazakhstan's southern border with Uzbekistan. Legend has it that seven out of 10 Soviet bullets fired during World War II were made with its lead. Over the years, the city expanded and the plant is now surrounded by residential housing. The plant was privatised in 1996, becoming Yuzhpolymetall JSC, and in 2006 it began processing lead dust that's a by-product from a Kazakhmys copper smelter in Balkhash after the lead mine was exhausted. The Shymkent smelter closed in 2008 after lead prices

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The plant, Ospanov explained, is "headed by my colleague, Duisengali Baiguatov, the former director of the Balkhash smelter" and a long-time employee of Kazakhmys. Indeed, Baiguatov wears standard blue Kazakhmys overalls in a picture obtained by bne taken during the plant's inauguration attended by Ospanov, then-chairman Eduard Ogay of Kazakhmys and the governor of South Kazakhstan Region. "We sent our best managers to guarantee the best results," Ospanov says in the interview, including his brother, chief engineer Nurlan Ospanov. "The rest of the staff is made up of re-hired Yuzhpolymetall employees… Our business plan is to operate for at least three years." He made the same points to a reporter for Rabat, a local newspaper.

itself, which employs about 900 people, apparently remains the property of Yuzhpolymetall, whose director and, according to one report, owner is Tursunbek Asanbayev, and which holds the license to emit pollutants. "In any case, if it can be demonstrated that Kazakhmys controls the operation of the plant, they could be held fully liable under British law, particularly if they did not perform any prior social and environmental impact assessments," says Mayne. "If this is the case, the liabilities of Kazakhmys could be very large indeed." Neither the company's 2010 nor 2011 annual reports mention the operation, or any lead processing – a striking omission for a FTSE company given the size of the smelter. How much Kazakhmys spent to restart it, how much lead dust has been

Indeed, President Nazarbayev is often cited as having ordered an environmental clean-up as far back as 2007. None has been carried out, and last year 800 parents signed a petition calling for mass blood testing in the schools. A study performed by the Colorado-based International Task Force for Children's Environmental Health presented at the American Industrial Hygiene Association conference in 2011 found that 95% of the children tested in the city had blood levels above the legal maximum, which is 10 micrograms of lead per deciliter of blood (µg/dl). The average was 20 µg/dl. Within 1 kilometre of the plant, the average was 32 µg/dl, while the highest score for a child was 103 µg/dl. Another study by the local government found that the lead in the soil, within 0.9 km of the plant,

"The only connection between Kazakhmys and this plant is that we deliver lead dust" processed and how much revenue has been obtained remains unclear. Even the size of the debt that Shymkent owes Kazakhmys is not known. Ospanov, in his Q&A interview, declined to answer a direct question from the Kazinform reporter, Tatiana Pylayeva, saying only "the amount of the debt is not important. The fact that there is such indebtedness is important."

At the Kazakhmys AGM on May 11 in London's Lincoln Centre, Kim, the chairman who also announced he would retire within a year, volunteered that he expected the Shymkent lead smelter to close this year, without explaining why, Global Witness' Mayne tells bne. Thus, it appears clear that Kazakhmys took over operational control and financing of the smelter before reopening it, which it has said it will run long enough to recover its debts.

Clean-up calls Last July, the South Kazakhstan region's governor, Askar Myrzakhmetov, appealed to the authorities to relocate the smelter. In an official report, he wrote that the lead content of the soil at a kindergarten's playground was 24,900 milligrams (mg) of lead per cubic metre (cm), or 800-times higher than permissible. As a result of the lead pollution, "diseases have increased in the city," he reported, adding that either the plant should be closed or the people who live around it moved.

The company that manages the smelter, headed by Baiguatov, is called A-MEGA Trading, which one report on a Kazakh website last July describes as a subsidiary of Kazakhmys. However, the smelter

Myrzakhmetov's predecessor, Nurgali Ashimov, who is now minister of environmental protection, was quoted in local newspaper Rabat as saying: "The plant should install filters, or should be closed."

contained 21-times the allowable lead. The average lead content in the air was 0.0034 mg per cubic metre squared, 11 times higher than the maximum permissible average in Kazakhstan, itself twice as high as the one allowed in the US. "This is a human health disaster," says Jack Caravanos, a professor of public health at the City University of New York who studies lead poisoning around the world. "Lead in blood levels of 20 to 25 µg/dl cause serious and irreversible damage to the brain, particularly in small children." Caravanos says that even if the factory closes, the high lead content of the soil makes it mandatory for the population to move to at least 5 km from the plant. One financial analyst who tracks Kazakhmys, speaking on condition of anonymity, said he isn't surprised that this kind of liability is not reflected in the annual report. "It's not unusual around here," he says. "Investors don't care until the polluter gets punished." John Smelt, Kazakhmys' director of corporate communications, did not respond to questions from bne.


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a shorter - and cheaper - option that it hopes will secure supplies from Azerbaijan’s offshore Shah Deniz field when the second phase of production starts in 2017 or 2018. The news illustrates the growing success of the Caspian countries in their quest to export their energy to world markets without going through Russia, which retained a monopoly on regional gas transit for years after the collapse of the Soviet Union. The lack of alternative pipelines allowed Russian pipeline operators to force huge profits through their control of the route from Central Asia to Europe.

Asian plays Clare Nuttall in Almaty

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he energy-rich Caspian countries made further progress in May in their attempts to satisfy the immense appetite of Asia for oil and gas, and end the post-Soviet region’s dependence on Russia. Uzbekistan announced on May 17 that it expects to start exporting gas through

the Central Asia-China pipeline by the end of the year, while the following day the Indian government approved a deal on Turkmen gas imports, bringing the planned Turkmenistan-AfghanistanPakistan-India (TAPI) pipeline a step closer to realisation. Meanwhile, the consortium developing the EU's pet gas pipeline project Nabucco proposed

However, the boom in oil and gas prices during the last decade, and growing demand from developing Asia, in particular India and China, has encouraged Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan to look for direct access to these markets. Most of the forecast increase in global oil and gas consumption in 2012 is expected to come from Asia, and by 2035 China is expected to consume almost 70% more energy than the US, according to the International Energy Agency (IEA). Tapping the TAPI Since 2009, Kazakhstan has been able to export oil directly from its western

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oilfields to the Chinese border through its own pipeline network. The Central Asia-China gas pipeline opened the same year, running 1,833 km from Turkmenistan – estimated to have the world’s fourth largest gas reserves – via Uzbekistan and Kazakhstan, to the Khorgos crossing on the KazakhstanChina border. Until now, only Turkmen gas has been pumped through the pipeline. However, Uzbektransgas director Tulagan Zhurayev announced on May 17 that Uzbekistan expects to start exporting its gas through the pipeline by the end of this year. In an interview with Reuters, Zhurayev said: "We can start shipping our gas right now, but there are some legal issues which need to be settled... We plan this year to supply… 2bn-4bn cubic metres (cm). We have the gas and everything is ready." Even before the Central Asia-China pipeline opened, the Turkmen government began exploring options to export its oil and gas to the energyhungry markets of India and Pakistan. The TAPI pipeline has long been under consideration, but the continuing violence in Afghanistan has put the project’s viability in doubt and sent the estimated cost spiraling up to $7bn.

Eurasia

The four participating governments have (somewhat unusually) been in negotiations over the price of the gas even before the first metre of piping has been laid. On May 17, the Indian cabinet approved state-owned GAIL’s gas purchase agreement with Turkmenistan for exports via TAPI. The deal is due to be signed during Indian Petroleum Minister Jaipal Reddy’s visit to Ashgabat on May 23-24. According to a statement from Delhi, the pipeline is now due to be operating by 2018, and will export 90m cm of gas per day for the following 30 years. India and Pakistan will each receive 38m cm a day, with the remaining 14m cm to be sold to Afghanistan.

"Lack of alternative pipelines allowed Russian pipeline operators to make huge profits"

Nabucco is dead; long live Nabucco West

Tim Gosling in Prague Some five months since bne declared the EU's grand dream to build a 4,000-kilometre gas pipeline bringing Caspian and Central Asian gas into the heart of Europe was dead and buried, the consortium behind the Nabucco pipeline have now officially killed the project.

the Turkish border up to Baumgarten in Austria. "We are convinced that we have submitted a competitive and comprehensive proposal to the Shah Deniz 2 Consortium, and that this proposal represents a win-win situation for our shareholders and for suppliers alike," Reinhard Mitschek, managing director of Nabucco Gas Pipeline International, told Reuters.

Meeting the May 16 deadline set by the BP-led Shah Deniz consortium for proposals to ship 16bn cubic metres of its gas to Europe, the Vienna-based Nabucco Consortium announced that it has pitched a scaled-down version called Nabucco West, which is set to run just 1,300 km from the planned Trans-Anatolian (Tanap) pipeline on

Mitschek was quick to stress that the scaled-down project could still source other gas from other countries. "The pipeline is designed to transport gas initially from Azerbaijan and is fully scalable to meet future gas transport demand from the Caspian Region and Middle East to the European markets," he claimed. Austria's

OMV – a member of the Nabucco constorium – has said recently that Nabucco will be vital for its JV with Exxon Mobil in the Black Sea.

the table," stated Al Cook, a BP vice president who heads the field's pipeline negotiations, at the Second Annual Azerbaijan Investment Summit in April.

Beset by problems – not least of which has been a failure to secure any of the 31bn cm of gas needed to fill it annually – the original Nabucco had been faltering for years as it strove to provide an alternative to Russian-routed supplies. The European companies behind it have been warding off suggestions that they have abandoned the grand scheme since late last year. BP and its partners in the consortium developing the Shah Deniz gasfield made no bones about their view ahead of the May 16 deadline. "Nabucco classic is dead. That option is now clearly off

The Azeris, together with their increasingly good friends in Georgia, will build a pipeline known as SCPX to the Turkish border, where Tanap will take over. Shah Deniz now has to choose between two potential routes as the gas reaches Europe: a southern pipeline running across the Balkans and under the sea to Italy, or a northern route across Bulgaria, Romania and Hungary to dock in Austria. Shah Deniz is expected to announce the winning pipeline in 2013.

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"This contract should be terminated immediately," said Jargalsaikhan Dambadarjaa, economist and local talk show host. "If someone doesn't disrupt the SouthGobi Sands deal, it will become Chinese property." Such rhetoric has had politicians scrabbling to outdo each other in proving to the electorate who is best placed to protect the Mongolian people's interests. "It does seem that it was the introduction of Chalco that began the uproar in large part because, as Mongolia develops, foreign ownership and extraction of resources is a sensitive issue, particular at the height of election season. But it's important to remember that Mongolians do not look at all foreign actors in the same way," says Chris Ackerman, investor relations manager for Prophecy Coal Corp., a Canadian firm developing a 4,200-megawatt power plant project in Mongolia.

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une promises to be a crucial month for the country that has become the darling of the emerging market investment community, as Mongolia goes to the polls and the parliament looks to pass a bill that will limit foreign investment in the booming mining industry. The two are of course related. In the run-up to the June 28 parliamentary elections, Mongolian politicians have indulged themselves in a bout of resource nationalism that always goes down well in this country of 2.8m people, especially if it involves bashing China, the country's giant neighbour that Mongolians regard with some suspicion for historical reasons. Plans to develop Mongolia’s Tavan Tolgoi coal deposit, one of the world’s largest, have stalled ahead of the June elections. Prime Minister Sukhbaatar Batbold said in March that talks with companies including Peabody Energy Corp., Russian Railways, and China’s

Shenhua Group to develop the West Tsankhi part of Tavan Tolgoi had "stopped." Jitters over Mongolia's path picked up in April when former Mongolian president and current opposition leader, Enkhbayar Nambar,

Billed as restrictive The main fallout will come in the form of new legislation governing the country's ample mineral resources, the production of which is bringing in a flood of investment and fuelling economic growth in the double digits. On May 10, the stats office revealed that Mongolia enjoyed its best quarter in a decade when first-quarter GDP growth came in at 16.7% on year. In nominal terms, GDP growth rate stood

"I expect the law will not be retroactive and will not be able to affect Chalco's bid on SouthGobi, but may create an extra step for similar deals in the future"

was arrested on corruption charges. Three days later, on April 16, the Mineral Resource Authority of Mongolia suspended the mining licenses of SouthGobi Resources after learning that the Chinese state-run Chalco had agreed with majority owner Ivanhoe Mines to buy a 58% stake in the company.

at 30.2% on year in the quarter. Mining sector output, the largest component in industrial output, grew 10.1% on year, with coal output up 10.3% to almost 10m tonnes, crude oil up 59.8% to 1.1m barrels, iron ore up 44% to 1.5m tonnes, and zinc concentrate up 24.6% to 43,100 tonnes.

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The new resources bill, on course to be passed by parliament in June, is designed to limit foreign companies from controlling key assets. It will obligate international players to request permission from the Mongolian government before acquiring majority stakes in

Eurasia

In general, though, most expect things to calm down once the election passes, with the politicians getting back down to trying to make Mongolia a good place to do business and attract the level of investment needed to revamp the country's sclerotic and in many cases

"The big unknown is what will be defined as a strategic asset"

"strategic" companies. Analysts say that the latest draft of the law states that if a foreign entity wants over 49% of one of these assets, they must ask permission first. But if that foreign entity is state owned, they must ask permission when acquiring more than 1%. The big unknown is what will be defined as "a strategic asset". Analysts say this has always been unclear in Mongolia, often making this a significant risk on prospectuses and due diligence reports for investors in the country, and this draft bill gives no further clarity on the definition, but may broaden it to include companies of a certain size in more sectors. The latest draft of the law is a significantly softened version of the first, deleting a clause that grouped any company over MNT100bn (€59m) into the "strategic" column, and removing some of the "strategic" sectors from the list. "The final draft may relax these conditions further before being passed," says Oliver Belfitt-Nash, head of research at Monet Capital in Ulaanbaatar. While not as aggressive as it once was, even so the bill continues to raise the hairs on the back of investors' necks. "I expect the law will not be retroactive and will not be able to affect Chalco's bid on SouthGobi, but may create an extra step for similar deals in the future," says Belfitt-Nash.

simply absent transport, energy and social infrastructure. "An election cycle tends to lead to a significant amount of polarisation and political posturing, as evidenced recently in France and as the US presidential elections draw closer," says Prophecy Coal's Ackerman. "In the case of Mongolia, once the dust settles, I think its leaders will get back to the business of running a country experiencing dramatic growth and really on the verge of becoming a very significant regional player." Ackerman goes on to say that it's important to bear in mind that there are fundamental differences among foreign investment projects in that country. "In the case of Prophecy, for example, all the country's coal riches are being harnessed to create energy for domestic consumption," he says. "In other words, rather than extracting resources for export, we are focused on facilitating the development of those resources purely for the benefit and use of Mongolian residents."

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Saakashvili to create holographic government The Georgian leader Mikheil Saakashvili has a new initiative to turn the whole government into a digital world, where citizens will be able to speak with 3D images of the ministers. Saakashvili says all citizens should have the opportunity to talk to the ministers they want. “Let’s say you want to immediately speak with a minister, to open heat to them. You push a button and the minister will occur with a 3D image, on a very large scale. For example large [Justice Minister] Zurab Adeishvili. I don’t know what will be added to scales how larger you make them, but no matter how it will be, he will appear in front of you. This is not fantasy,” the president said. The president noted that Georgia is making use of high technology in the country’s governing, and the country has a new government which cannot stay at one place all the time, but is always on the move. But it cannot always stay like this, he said. “In the end, we will become calm and possibly don’t be like this again. So there is only one way out: to create a digital government,” he said. The president appeared in Kvareli, in the Kakheti region in eastern Georgia, where a document was signed to set up a society for spreading computer knowledge. Society will provide various services for the population like obtaining special skills, state and private sector services; society will play the role of communicator, which will organize meetings in different regions and villages; they will provide everyday service for the village population, like typing, finding information through the Internet and copying documents.


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EDB a catalyst in the Eurasian economic space

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s Russia, Belarus and Kazakhstan move closer towards a fully functioning Eurasian economic space, the Eurasian Development Bank (EDB) has become a key institution in building the ties between the member countries, and improving the business climate within them. Established in 2006 by the governments of Russia and Kazakhstan, the EDB is a development bank designed to finance big cross-border projects that integrate the economies of the member states more closely. And other countries from the region are queueing up to join: first Belarus and more recently Kyrgyzstan. "The investment portfolio is up to $3.6bn that we have invested into 49 projects. And we are continuing to move forward. We have been especially active in Belarus more than previously, where we have several important projects especially in the power, potash, rail wagon production sectors, amongst others," says EDB's Chairman of the Executive Board Igor Finogenov in an exclusive interview with bne. The EDB is a development bank, but unlike its western cousin the European Bank for Reconstruction and Development, it also explicitly invests in projects that are designed to increase trade within the region, thus binding the region closer together. "We focus on big projects so they take time to develop and bring to fruition. The goal is to improve the local economies, but

In the next circle out, the EDB is promoting better ties with Asian countries, especially China, which has also emerged as one of the Customs Union's major trading partners. In parallel, the bank is working to deepen ties with the EU. "We have no bias between EU and Asia," says Finogenov. "If the EU has the best technological solution, then we will work with them."

Igor Finogenov, The Chairman of the Executive Board, EDB

also to promote trade between the member countries to promote mutual cooperation is also very important," says Finogenov. The trade aspect is of particular interest following the launch of the Customs Union on January 1, 2010, which some have seen as a rival to the EU, but Finogenov argues that the common economic space is complementary to the EU rather than a rival. "It's not a competitive relation but an additional one, as growth in our region will benefit the growth of the continent overall," says Finogenov. However, the development of the Eurasian common economic space is a work in progress and there are some

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neighbours, such as electricity production and transmission that will help both Kyrgyzstan and those across the border," says Finogenov.

INTERVIEW:

Ben Aris in London

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Union and the EU, unless the members of the Customs Union enter collectively into a free trade agreement with the EU – something that is possible but is not yet being discussed. Join the club Kyrgyzstan is the most recent addition to the club, but new members are admitted on the basis of mutual benefit. As Finogenov pointed out on the panel discussion at the EBRD's annual meeting on the Eurasian common economic Space, the free trade agreement is not accepting new members simply to increase the numbers, but only if the participation of a country brings real economic benefits to all the members. "There are a lot of opportunities to help

But the main thrust of the Union is to improve the business climate within the member countries and Finogenov hopes that closer integration will help promote a leveling of conditions between the countries. "The three countries have very different conditions of business and all have different rankings on the World Bank's Doing Business survey. If

we remove the barriers between these markets, then in a few years the competition will drive the conditions of doing business to converge. It will create new opportunities and the transfer of technology and know-how," says Finogenov. The EDB estimates the impact of further integration will benefit Belarus the most, where the per-capita increase in GDP will be 6.5% through to 2019. The improvement to Ukraine would be 3.5%, and Russia and Kazakhstan would also get a 2% fillip over seven

"The goal is to improve the local economies, but also to promote trade between the member countries"

tricky issues to resolve. One of the most fraught is what to do with Ukraine. Already one of Russia's most important trade partners, Ukraine has also negotiated (but not signed) a free trade agreement with the EU; Ukraine cannot be a member of both the Customs

Kyrgyzstan and the country is facing a lot of problems that can't all be solved by the EDB. It is going to need help from regional and international community through a donors club. But here too the projects we are doing in the country are also benefiting the

years. The Union should also prove to be a boon to other countries in Europe by creating a large and more integrated market on their doorstep at a time when Western Europe is once again staring into the abyss. "The problems the EU is experiencing is a useful lesson for us and we are going carefully step by step. The main advantage in our region is the fact that we don't have shared currencies and this gives the member countries a lot more flexibility in dealing with external shocks," says Finogenov.

"We focus on big projects so they take time to develop and bring to fruition"

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be hard to find, and cost well above the national norm. In a bid to entice shoppers, boards outside stores in Zhezkazgan boast: "Everything at Almaty prices".

Carrots and sticks in Kazakhstan Clare Nuttall in Almaty

K

araganda, in central Kazakhstan, used to be a byword for remoteness, the Soviet equivalent of Timbuktoo. However, the city is now very much on the map compared to other towns in the region thanks to the nearby copper mining towns of Zhezkazgan, and Temirtau – the location of the steelworks where President Nursultan Nazarbayev worked as a young man before turning to politics. At the end of a branch line, an overnight journey southwest of Karaganda arrives in the copper mining town of Zhezkazgan. This was where one of the spurs of the Soviet rail network ended, and the town's main attraction is a row of trees planted by Yuri Gagarin and other cosmonauts who got off the train from Moscow to head even further out into the steppe to the Baikonur cosmodrome. Starting out as the Kengir gulag, Zhezkazgan is today where the headquarters of Kazakhmys, the London-listed mining giant that now operates the town's massive mining complex, is located. Kazakhmys dominates life in the town: residents go to work on Kazakhmys buses, study at Kazakhmys-sponsored schools, get treated at the Kazakhmys

medical centre, and support the FC Kazakhmys football team. While based on mining rather than oil, the living situation in central Kazakhstan's mining towns is not dissimilar to that in Zhanaozen, a town that hit the

Such are the parallels between Zhanozen and these other mono-industry towns, which were born during Soviet times, that the government is now watching for any hint of discontent. Even in the remotest corners of Kazakhstan, residents have become increasingly aware of the difference between their own lives and those of the business and political elite in Astana and Almaty. In recent weeks, there have been incidents in both Zhezkazgan and Temirtau. A three-day strike started on May 5 at the former's Annenskiy mine, where 98 workers refused to return to the surface after their shift. They were later joined by workers from the Vostochnyy, Zhezkazgan and Yuzhnyy mines, with a total of 250 people sitting in underground and around 2,000 supporters above. The dispute was resolved on May 8, when Kazakhmys management agreed to higher pay and better working conditions. In a statement issued on May 8, Kazakhmys CEO Eduard Ogay said that the dispute had been resolved using a model developed after the Zhanaozen tragedy. However,

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to appease angry workers by promising generous financial assistance to help diversify single-industry towns, while at the same time sacking officials who either didn't see the storm coming or failed to deal with it adequately. But it is also making clear it will clamp down hard on any subversive activity that threatens to destabilise the country. Out of Steppe At a meeting on May 21, the Kazakh government approved proposals by the Ministry of Economic Development and Trade (MINT) for a $900m financial package to support the single-industry towns between 2013 and 2015, with additional funding promised in the following five years. The "Single-Industry Cities Development Programme" for 2012-2020 will support 27 settlements across the country. Most are small, with populations of under 50,000, but collectively they add up to a total of 1.5m people, or almost 10% of the population. The government will allocate KZT38.2bn ($258m) for the development of the towns in 2013, with a further KZT43.2bn to be spent in 2014, and KZT53.9bn in 2015, Kazakhstan's

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"Even in the remotest corners of Kazakhstan, residents are aware of the difference between their own lives and those of the elite in Astana and Almaty" Minister of Economic Development and Trade Bakytzhan Sagintayev told a government session. Regional akims (governors) have been given until July 1 to submit proposals to the central government. Each akim has been instructed to prepare at least three proposals for projects to diversify the economy of each town, Kazinform reports. Astana plans to increase development funding for Zhanaozen with several new funds for the town established, whilst the Zhezkazgan region will receive KZT130bn under the new plan for socioeconomic development. At the same time, following the line that television is the 21st century opiate of the people, the communications ministry has put Zhanaozen and Zhezkazgan at the very top of the list to receive digital TV when the national roll out starts this year.

Although salaries are decent by Kazakh standards, the cost of living in these mining towns is also high. Given Kazakhstan's poor distribution networks, consumer goods and fresh fruit and vegetables can

Astana is taking a three-pronged approach in the aftermath of Zhanaozen. The government has sought

The government has also sacked the Zhanaozen mayor and other officials connected to the riots, with the highest profile casualty being Nazarbayev's son-in-law Timur Kulibayev, who was sacked from his position as head of sovereign wealth fund Samruk-Kazyna, the main shareholder in KazMunaiGas E&P which operates the Uzen field. At the same time, however, there has been a severe clampdown on opposition activity, with several opposition leaders and journalists arrested in January.

D

From rubble to rubles in Georgia

Since Georgian President Mikheil Saakashvili launched a visa-free policy for Russians in February with the undisputed logic that "Russia is and always will be Georgia’s neighbour", a growing number are visiting. According to the national tourism agency, some 50,000 Russians crossed into Georgia during the first three months of the year, which was three times the number for the same period last year. They are also investing: Shota Abkhazava, a Russian businessman of Georgian descent, funded the new $20m racetrack in Rustavi.

Molly Corso in Tbilisi

For Georgia, attracting foreign direct investment is more important

the promised pay rise does not solve the long-term doom facing Zhezkazgan when its ore deposits are eventually exhausted. Two weeks later, on May 19, around 3,000 workers from the ArcelorMittal Temirtau (AMT) steelworks demonstrated to demand higher pay. A company official met trade union leaders, but AMT is understood to be unwilling to pay the 30% pay rise demanded by workers.

Other towns expected to benefit include Balkhash; Karatau, the site of phosphate deposits in south Kazakhstan; and Arkalyk, a bauxite mining town in Kostanai region, Kazakhstanskaya Pravda reports.

espite a Russian embargo and the 2008 war with its overbearing neighbour, Georgia wants Russians to know their business – and their rubles – are still welcome.

"Although salaries are decent by Kazakh standards, the cost of living in these mining towns is also high" international headlines in December last year when a seven-month strike by oil workers at the Uzen oilfield ended with clashes between strikers and police that left 16 dead, an incident that threatened to spread to other parts of Kazakhstan and unravel the fabric of stability the authorities have carefully woven over the past two decades.

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than politics, according to Interior Minister Vano Merabishvili. During a question and answer period in front of parliament on April 26, Merabishvili said that, "despite the fact we expect

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Investment consultant Stephanie Komsa explains that one of the hardest parts about attracting American investment to Georgia is familiarizing US companies about Georgia; with

Russians that is not necessary. "Historically, [Russians] have always seen Georgia as an attractive place and a place for opportunities... I think Georgians are also really comfortable with Russians, in terms of personally and as tourists and as business partners. There is just a historical understanding and connection with each other," she says. "In that sense, Russian [investment] is very, very practical."

Komsa notes that proper tenders and open processes are making investments from Russia – or anywhere – more transparent. Also, Russia's 2006 embargo on Georgian goods forced Tbilisi to diversify its trade partners, a development that puts the economy in a much stronger position to be more choosy about which companies it chooses as business partners. "Georgia can be a little bit picky about who invests because there are such a diverse set of investors. There are not a lot of investors yet, but it's not going to be stuck in a situation where it will be at the mercy of a situation in one country," she says. "So now it seems to be a good time to embrace Russian trade and Russian investment and Russian tourism, because it is not the only thing."

Tvalchrelidze, agrees that historic relations play an "essential" role in business relations between the two countries, but warns that while western businesses are legally required to be transparent due to the laws in their

Komsa, who works with Georgian businesses who are looking for investment partners, noted that while money has no scent, acquiring a good investment partner still requires a strong nose. "Investment always

"Russia is and always will be Georgia's neighbour"

a threat from Russia on a daily basis" and "80%" of the Russian businesses in Georgia are owned by the Kremlin, "money has no smell – any investment in Georgia is welcomed." While Russia might not be the largest investor in Georgia, it is in the top 10, notes economist Davit Narmania. Russian investment in Georgia has even increased since the war, according to GeoStat, the official statistics body: investments doubled from 2008 to 2011, from $26.2m to $52.3m. Narmania, executive director for the Caucasian Institute for Economic and Social Research, says that the Georgian authorities are focused on attracting investment even at the cost of dealing with a political enemy, pointing out that the government has traditionally drawn a line between political policy and economic policy. While relations with Moscow are tense politically, there is no problem with dealing with Russian business to help the Georgian economy. Familiar territory Professor Alexander Tvalchrelidze, executive director of the International Foundation for Sustainable Development who works with Russian investors as well as investors those from the West, says the country's natural resources are particularly attractive to Russian investors, such as hydroelectric power and mining – anything that can be extracted and manufactured because that is the sector where they are "internationally competitive," he says.

Today, however, for several those concerns have fallen second to the government's priority to increase economic growth and decrease unemployment.

"Money has no smell but you need a nose for investment to sniff out everything"

home countries, Russian businesses are allowed to be more "flexible." In 2005, when Georgia started its radical privatisation process, that "flexibility" was at the core of concerns about Russian investment. Civil society protested the possible sales of strategic assets to Russian companies with opaque ownership. There were also concerns that Moscow would try to control the country economically, if not politically.

requires analysis and consideration of every factor. Who the person is, whether they are trustworthy, what their personality is, whether they are a good manager, whether they think strategically, what their financial situation is," she says. "Money has no smell but you need a nose for investment... to sniff out everything."


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Opinion

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Essential kit for the emerging market explorer Derek Weaving of Renaissance Capital

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eaders may be familiar with an advertisement for a financial institution, widely featured on London’s black taxis, that praises a stout pair of shoes as an essential piece of kit for their investment managers. Another advertisement, for a different investment institution, features a hand compass – presumably used to navigate difficult terrain while seeking out hidden corporate treasures. My own piece of advice to investors venturing into unfamiliar emerging market territory would be to arm themselves with a report on the state of the local electricity system. To get the idea, try to imagine your world without electricity. Too tiresome? As a shortcut, think of life in Europe or the US in the early 19th century, before Faraday discovered that moving a magnet could induce an electric current in a coil of wire. No electric lights, no phones, no computers. Without power, Western Europe and the US could not have achieved the high levels of output and efficiency that now define them as developed markets. The steam engine may have kicked-off the industrial revolution, but it was sustained by electric power. It requires no great level of sophistication to buy a diesel generator and order-up a supply of fuel to be delivered by lorry. This is standard operating procedure for mining enterprises located in some of the earth’s most remote and inhospitable regions. If crime is a problem, build a fence around the installation and hire guards. Electricity produced in this way is expensive, but the cost can be offset against the high gross margins characteristic of extraction businesses. However, almost every other type of investible economic activity needs to be connected to a grid if it is to be competitive in the global marketplace. And this is a very much more complex undertaking. That Europe and the US were able to harness Faraday’s discovery to drive their economies was largely due to their relatively high levels of political and social development. Electricity is a capital-intensive, long-term business and not

susceptible to quick-fixes. A government with vision, longterm commitment and concern for the next generation is essential, both to see plans through to fruition and to create a financial environment that achieves the low cost of capital needed to make electricity affordable. Leaders should also have a broad mandate that does not leave them reliant on the support of self-serving lobbies. All nations have suffered at some time during their histories from the consequences of unbridled political patronage, but the form is important. Dispensing largesse from the public power sector must surely be one of the most injurious.

"To get the idea, try to imagine your world without electricity"

The Rule of Law is needed to safeguard the electricity sector’s assets and, once they are built, the cash flows. A competent, committed government is certainly a good start, but it won’t achieve much if grids are pilfered as soon as they are built. And neither will a sparkling, new public power network be viable for very long if users by-pass their meters, or don’t pay economic rates for their supplies. Many governments favour subsidising energy supplies for the socially-disadvantaged, but funding the subsidies from within the power sector is a fast route to a dilapidated electricity system. The message for investors is that the condition of a nation’s public electricity system is an accurate and robust indicator of a nation’s economic, social and political sophistication.


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It is an indicator that is impervious to short-term oil price fluctuations, to exchange rates and even to the latest data on the level of consumer confidence in the state of Minnesota. Few economic activities and no economies can flourish without access to reliable and affordable supplies of electricity. My piece of advice to an investor exploring new horizons would be to ask three questions. 1. How much electricity does the local economy have? 2. What is being done to develop what they have? 3. What is the probability of success? If the answer to question 1 is “not much”, the answer to question 2 is “quite a lot” and the answer to 3 is “quite high”, you may have the beginnings of an investment opportunity. Conversely, if the answer to 1 is “quite a lot”, to 2 is “not much” and to 3 is quite low, it may be wise to pack away the walking shoes and compass for another day.

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"The condition of a nation’s electricity system is a robust indicator of a nation’s economic, social and political sophistication"

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top dog Igor Sechin from government is another big shakeup in the structure of control over energy, with him moving sideways to head up Rosneftegaz, the holding company that owns the state's stake in national oil company Rosneft. This appointment has been widely taken to mean that Sechin will remain de facto in charge of energy. However, all this talk of power is to miss the point of Putin's government. In Yeltsin's day, running the Kremlin was all about brokering power, but under Putin Russian politics has increasingly become about policy. Of course, power still counts for a lot, but to understand where Russia will go under this new cabinet it makes more sense to look at what sort of policy changes the new government will pursue. Take the Dvorkovich-Novak-Sechin troika. The first thing is that Sechin will clearly be responsible for operational issues pertaining to developing the energy sector. Massive amounts of investment are needed and deals galore will have to be cut with foreigners to develop the Arctic, the Barents Sea gas deposits and open up Eastern Siberia.

Derek Weaving is Head of Utilities Research at Renaissance Capital

On the other hand, Novak is not an oil man and comes to the job from the Finance Ministry where he worked under Alexei "Mr Prudence" Kudrin. Together with Dvorkovich's interest and academic qualifications in economics, it seems this formal control over the sector will be more about investment and collecting taxes from the natural resources sector in general.

Russia's new government

This change in policy – or at least an extension of existing policy – is bolstered by the appointment of Belousov as head of Economic Development. A well-respected economist, Belousov is close to Putin, but also supports the president's preferences for big state spending. In other words, the plan seems to be to extract more revenue from the natural resources sector and spend it on big state initiatives to promote diversification and growth. The massive RUB20 trillion spending programme on the military-industrial sector will be one of the main beneficiaries here and Putin is committing himself to this plan and hiring people to make it work.

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he reaction to the new government has largely been neutral to negative. Perennial hopes that Russia was finally going to embark upon a radical and rapid course of economic reform and political liberalisation failed to materialise – but then they never have. That is not how Russia works. The Kremlin doesn't do radical. Business leaders are happy at least and praised the "stability" that the new cabinet brings. Policy will be rejigged and some good things added, but for most existing investors the continuity is as important, because they have learnt how to operate in this environment and don't want radical changes – let alone an Arab Spring-style revolution. No one wants that; not even the protestors.

But it is just as clear that Russia needs change. A couple of appointments were singled out by the steady-as-she-goes crowd for upbeat comment and optimism. The promotion of former presidential economic advisor Arkady Dvorkovich to the post of deputy prime minister for industrial and energy policy is seen as a big step forward for the liberal camp, as Dvorkovich, like his former boss German Gref, only talks sense. Part of his brief will be to oversee the energy sector, which seems to be in the crosshairs. One surprise was the appointment of relative unknown Alexander Novak to oversee the energy portfolio. At the same time, the departure of Siloviki

The wisdom of this policy is questionable to say the least. Kudrin quit over the issue, but while the economics of it might be doubtful, you can see why Putin wants to do it: the negotiations over the West's missile shield are ongoing and from the Kremlin's windows looks like a very belligerent threat to Russian national security. Apart from energy and defence, the other appointments are a mixed bag. We can expect what we have had for most of the last decade: ongoing and steady progress with reforms, but nothing to catch the banner headlines and plenty of screw-ups in the implementation. While dramatic change would be exciting, as long as Putin continues to deliver on improving the quality of life then, for the business community at least, steady-as-she-goes will do.

"Business leaders are happy at least and praised the "stability" that the new cabinet brings"


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he size of a recent press conference is indicative or how far Russia's e-commerce business has to go.

In the US, if you got together one of the biggest e-commerce companies in the country to sign off on an investment deal with one of the biggest private equity funds in the country, the blogosphere would be alight with comment and the 24/7 news programmes would be running retrospective specials in a blitz of media coverage. Think Morgan Stanley and its efforts to organise the IPO for Facebook. Yet just a handful of journalists turned up at the iconic Hotel Ukraina (now the Radisson Royal Hotel) in central Moscow on April 24 to eat canapés and drink champagne (which was actually Prosecco) at the signing ceremony that saw VTB Capital Venture Business spend $18m to take an undisclosed stake in Fast Lane Ventures (FLV), probably Russia's most successful e-commerce company with 17 websites in its portfolio. "There were 6m people online when we started the company 10 years ago," says Pascal Lament, president of Direct Group Holding and co-founder of FLV, who made his first money in the catalogue business with PPE and then founded Rusfinance that he later sold to French bank Société Générale. "Twelve years on there are already many websites, but there is still not a lot. There is a window to create new and very professional websites that are not just for Russia as websites are by definition international."

Special Report: Private equity in CEE/CIS

FLV is not an incubator in the traditional sense, as it carries its companies much further. Setting up one new company every two months or so and investing in other people's start-ups too, after ten years of work FLV is only just starting to find buyers for some of its babies. The whole internet sector is only now starting to mature and the going is still very tough.

More funds required Ben Aris in Moscow

In February, FLV sold Sapato.ru, Russia's principal online shoe and accessories retailer, to Russian online store OZON Group, and at the start of April it completed its second deal by selling


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the mail-order company Shopping Live to the German-based Home Shopping Europe. FLV CEO Marina Treshchova said Shopping Live was one of the first of its portfolio companies launched and

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The FLV deal is testimony to the dearth of more institutional-sized deals. While there is plenty of money floating about in Russia, despite the best efforts of President Vladimir Putin there is a pau-

"There is radical growth in investing into start-ups but finding the second round of funds and an exit is hard" was a very successful investment both in terms of profitability and also demonstrating FLV's unique ability to achieve rapid growth. Major market Russia, or more accurately the Russianspeaking world, is a huge market of some 250m people. Internet penetration has been soaring and currently stands at 43%, half the European level, but growing very fast, which is sucking in investment. Treshchova estimates there was a total of $1.3bn invested in Russian internet companies in 2010 in a total of 59 deals, which rose to $2.15bn in 2011 in a total of 213 deals. And no one is expecting the pace of growth to slow. "Now there is a radical growth in interest in investing into start-ups and at the seed capital stage or grant funds," says Clement, "but finding the second round of funds and finding an exit is hard." That's where VTB Capital Venture Business comes in. Russia's oligarchs have become very interested in the internet – especially after Alisher Usmanov, who Forbes listed as Russia's richest man in April, made a fortune investing in Digital Sky Technologies in 2005, which has since bought, among other things, a 2.28% stake in Facebook that has risen five-fold in value. "Raising $100,000 to $1m from angels and funds for an online company in Russia is easy," says Aidar Kaliev, global head of VTB Capital Venture Business, who will get a seat on FLV's board. "The trouble is raising the second-stage investment."

city of private equity and venture capital funds. In effect, FLV has been forced to tie up with Russia's second largest stateowned bank to help it tap big investors and bigger sums, because the state-connected bank is one of the few big players at the party. Clearly, in the short term the cooperation is a savvy move. VTB Capital Venture Business's average ticket size is just what is needed: $2m-5m up to a maximum of $15m. And tickets can get even bigger if VTB

State of play The development of the online investment business is following a similar pattern to what happened in the rest of the economy. In the early stages of transition, the state played a key economic roll because it was the one with resources and so could choose to get strategically important sectors moving. The private sector simply didn't exist at the start of the process. The problem that Russian online ventures face today is they are in competition with simpler, more obvious investments that still pay extremely high and much more predictable returns. However, Putin said in 2006 there was a need to create a venture capital industry to tap into Russia's enormous, world-renowned intellectual resources. VTB Capital Venture Business is one manifestation of this desire by the state to bootstrap this sector into existence. "We spend all our time in the private equity sector talking about the government, but that only shows how bad things are when it comes to raising funds in Russia. The government is not a sustainable source of finance," Henry

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private equity projects, just behind the Middle East and North Africa region, which has been destabilised by the Arab Spring during the last year. "It means investors see the risks in Russia as higher than those in the Middle East, but those of us who have made investments in Russia know this is not true and the returns in Russia are amongst the best in the world," says Potter. "What can the government do, as clearly it needs to improve its image? But I have been waiting for 18 years for that to happen." The lack of institutional interest in Russia will stymie the government's muchhyped plans to modernise Russia. The job of Rusnano, the state agency tasked with the job of bringing in investors

into the hi-tech sector, has been made harder because of the lack of funds. Flush with cash, Rusnano can match investors' capital dollar for dollar, but a spokesman for Rusnano said: "We have some projects where co-financing is already approved, but they have stalled because our partners have been unable to raise the money they promised." The lack of interest is making the whole business of raising money for private equity funds hard, as international investors will not invest into local teams until they have a track record of proven outperformance, but the local teams can't prove themselves until they have raised some funds. Currently, there is only one fund in Russia that has

Potter goes on to cite another recent industry survey that found Russia ranks last amongst the emerging markets in terms of capital raised for

Still, the FLV-VTB Capital Venture Business tie-up is a landmark deal, as it means the whole sector has moved off square one. VTB Capital Venture Business won't bring hordes of blushing western brides to the altar of investment anytime soon, but it can play the very useful role of matchmaker.

are being lured by the high returns made in the likes of Asia and Latin America.

The main reason behind this performance in CEE is that all the ingredients necessary for an attractive private equity market – structured business environment, a pool of local managers, capital markets, trade sale opportunities, and a private equity "midwife" in the form of the EBRD – already existed 10 years ago when the economies of the region were just about to take off. "If you look at other private equity markets such as the BRIC [Brazil, Russia, India and China] ones outside of Russia, many didn't have these same ingredients," says Richard Seewald, a partner at Alpha Associates, a Swiss-based private equity fund manager. "That doesn't mean going forward they won't, but over the last 10 years the 'infrastructure' for private equity wasn't in place like it was for CEE."

Yet this state of affairs seems strange if you consider what the European Bank for Reconstruction and Development

The extent to which the CEE private equity market has matured over the past decade was illustrated in February this

Potter, managing partner at Alpha Associates, complained at a private equity conference a few days after the FLV presser. But it is all Russia has at the moment. Russia is badly underperforming the other BRICs when it comes to attracting private equity capital: a mere $1.5bn of funds in 2011, according to Emerging Markets Portfolio Investor, against the $5.0bn for Brazil, $15.0bn for India and $28.6bn for China.

escaped this chicken-vs-egg trap and that is Barings Vostok Capital Partners (BVCP), run by Michael Calvary. "But even BVCP's success causes problems," says Christopher Rose from C5 conferences, who is trying to create an industry lobby group. "When it goes to market to raise fresh funds, it sucks up all the money that is currently available for Russian investments and leaves very little for anyone else."

(EBRD) is saying, which is that private equity in the former Eastern Bloc has outperformed all other markets globally over the last 10 years, yielding returns of between 15% (CEE ex-Russia) and 24% (Russia and the CIS region). This compares favourably with the approximately 13% returns seen in Asia, 9% in the US and 5% in Western Europe (see graph).

"It means investors see the risks in Russia as higher than those in the Middle East"

Capital Venture Business takes the deal to its sister institution VTB Capital, Russia's leading investment bank, which has access to serious money – its own and other people's; VTB counts six out of 10 companies in Russia as clients. Currently, the bank's private equity division is investing the bank's own money, but can also match this one-to-four with clients' investment for the right project. "We bring a lot to the party, as in addition to financing we can provide loans, organise IPOs, syndications amongst big investors, debt – the full spectrum of investment possibilities," says Kaliev. "Now with Fast Lane as a partner, we can provide the full cycle and international investment."

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High performance Nicholas Watson in Prague

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s our special report lays out, a lack of funds is stymieing the development of Russia's private equity industry, while Central and Eastern Europe in general has fallen out of favour with private equity investors who


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year by the twin IPOs from technology companies AVG Technologies and EPAM Systems on the New York Stock Exchange. While neither of these CEE companies enjoyed the smoothest of

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Amazon.com, along with several other international investors in a $100m round of financing to further strengthen the company’s position as the country's largest online retailer. And Alpha

capital deployed in the region the figure jumps to over half of respondents. "We can clearly see that the overall pool of capital for CEE has significantly shrunk compared with the boom years of 20062007, when €6bn-7bn was targeting the region," Szczepanski says. "That won't come back, but it will be good if it stabilizes around €3bn-4bn."

"Private equity in the former Eastern Bloc has outperformed all other markets globally over the last 10 years"

debuts (AVG fell 19% on the first day of trading, while EPAM priced below its indicative pricing range), their ability to raise a combined $200m in tricky market conditions underlined how global investors are paying more attention to the technology and media businesses that have grown up and proven themselves in Russia and the wider CEE market, and can now realistically offer a significant IPO exit for investors – something that has traditionally proved a problem.

CEE/CIS outperform 30%

25%

20%

15%

10%

5%

0% 10Yr

EBRD Russia/CIS EBRD CEE EVCA Western Europe Source: EBRD

CA US Private Equity CA Latin America CA Asia (ex Japan)

Power to attract Going forward, private equity investors are particularly looking to the new generation of companies that are serving Russia's promising online consumer and business-to-business markets, many of which have either become or are set to become Europe's largest over the next few years. With 50.8m internet users registered in September 2011, Russia has overtaken Germany to become the largest internet market in Europe. This is driving the 17% annual growth in its e-commerce market, worth just $20bn-22bn in 2010, which analysts believe will accelerate further to about 30% a year to top $100bn as soon as 2019. Private equity funds invested $4.2bn into Russia in 2011, double the $2.2bn invested in 2010, with the average deal size increasing to $80m against $50m over the same period, according to Ernst & Young. Alpha was one of those, investing in September in Ozon.ru, Russia's

was close to announcing another deal in Russia's e-commerce market at the time bne went to press. There are other Russian sectors private equity is looking at. On May 14, an international private equity consortium comprised of the Russian Direct Investment Fund (RDIF), Xenon Capital Partners' Rusenergo Fund, the Middle East's AGC Equity Partners, and the Macquarie Renaissance Infrastructure Fund (MRIF) announced it had completed the purchase of a 26.43% stake in Russian power producer Enel OGK-5 from Inter Rao UES, becoming a partner of Italian energy company Enel, the controlling shareholder in Enel OGK-5. Rusenergo Fund and AGC Equity Partners have each invested $175m in the transaction, while the RDIF and MRIF invested $137.5m each for a total deal value of $625m. This was the largestever private equity deal in the Russian power sector. "We are delighted that this complicated transaction has now completed. This closing cements our partnership with such high quality investors as RDIF, MRIF and AGC, a private equity firm which represents a consortium of Gulf and Middle East institutional investors. All together, we now look forward to working closely with the management of Enel OGK-5, who we rate very highly," said Natasha Tsukanova, founder and managing director of Xenon Capital Partners.

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Falling out of favour Tim Gosling in Prague

P

rivate equity funds in Central and Eastern Europe are struggling to keep the attention of emerging market investors dazzled by the returns made in the likes of Asia and Latin America. However, with CEE continuing to converge with Western Europe, the comparison with other emerging markets is starting to look incongruous. Either way, fund managers in CEE insist (predictably perhaps) that although they expect to see some consolidation of the private equity (PE) industry in their part of the world, there's plenty of opportunity left, with the larger funds facing little problems raising new capital. It's simply a matter of weighing risk and return as CEE assets are re-rated as simply "European". "There is an increasing move in CEE's asset class towards core Europe," points out Przemek Szczepanski of Syntaxis Capital, "and that should continue." Reflecting the views of investors and fund managers across the region, Alpha Associates partner Richard Seewald says that several of the CEE houses are due to go out to raise new funds, but it will take longer than in previous

years. "Those with performing track records should prevail," says Seewald. "Although CEE doesn't present the same high growth opportunity as some of the BRICS, it does present the opportunity for attractive risk-adjusted returns and outperformance of Western Europe." That last point is the answer of the local industry to recent reports that CEE is sliding alarmingly in terms of its attractiveness for emerging market investors. A survey by the Emerging Markets Private Equity Association (Empea) in April suggests CEE is now viewed as the least attractive of nine emerging market regions; Latin America and Southeast Asia took the top spots, with three-quarters of investors or more expecting them to produce returns of 16% or higher. To a degree, suggests Szczepanski, it's a question of fashion. "Fundraising is tougher globally now. CEE has been hit more than most, but that's partly because the hot money is looking elsewhere." That view appears to be supported by Empea's survey, which says that whilst just 15% of all investors expect CEE to offer returns of 16% or more, amongst those that already have

That change in fortune for the region suggests that some of the myriad of fund managers tempted into CEE during the boom will indeed struggle. "The returns in CEE have been excellent over the last decade, but not as high in the last four years or so," points out Brian Wardrop of Arx Equity Partners, which raised its last fund in 2009 and has around 50% of it invested. "We do hear that appetite for CEE is not especially high right now. There will be fund managers that will not be able to raise follow-on funds." That promises a rosy future for those who pull through however, with all commentators insisting that there's plenty to do in "core CEE" – meaning the EU members of the region. At the same time, Szczepanski suggests, "some more risk adverse investors, such as the large pension funds, are likely to head deeper into core CEE as convergence continues." "For the survivors," Wardrop continues, "there will be less money chasing more deals. The shakeout will probably take a couple of years, after which we should see an attractive investment market in CEE for the next decade or more." That predicted opportunity – which Wardrop suggests is particular to CEE as the masses of companies founded in the wake of communism in the early 1990s ripen for PE investment – means established fund managers plan little fundamental change in strategy. Instead, they view the investor pullback as temporary, driven by the crisis in Europe. "We won't dramatically extend our geographic base," the Arx man says. "There's lots to do in core CEE. What we aim to do is develop a deeper and increasingly systematic PE model in our core region." Szczepanski concurs that core CEE has plenty to offer, but also suggests


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"It would probably be easier right now to sell a Poland-only fund"

that interest in less explored markets in the region is also set to rise in some quarters: "There's likely to be some movement towards the more 'frontier' markets in [Southeast Europe]. When the hot money that is now going to Asia etc. returns after the European crisis, it will head to those markets." Emerging and emerged Szczepanski says that with core CEE in the midst of re-rating, it could be that the next round of fund raising will see some lines being drawn within the region. For instance, Roland Berger's "European Private Equity Outlook 2012" classifies

Poland as a separate market within CEE, with the study showing the country attracted a full 7% of total European PE investment in 2011; the remainder of the region had to make do with sharing just 6%. "It would probably be easier right now to sell a Poland-only fund," he smiles, although adds that, "Romania and Bulgaria should present attractive opportunities in a couple of years." CEE is, of course, not a homogenous market, given the different stages of development, but Seewald points out that one constant across the region is the catch-up process going on with core

Europe, meaning "it makes sense for us to cover CEE and Russia comprehensively, giving our investors exposure across the cycle." Wardrop, who picks out the Romanian retail sector as one to watch for PE deals in the medium term, says Arx also has no plans to restrict the remit of any future fund, although he acknowledges that through the crisis, that has been the de facto situation. "Since 2008, we've only made investments in Poland and the Czech Republic," he says, putting the blame firmly on the macroeconomic and banking environments in the rest of the region. "In those countries we can still leverage investments systemically, whereas finding the capital can be difficult somewhere like Hungary or Romania."

Ben Aris in Moscow Igor Agamirzian, CEO of RVC

F

Backed with $880m of state money, RVC co-invests with privately owned funds, providing half the money, but taking only 49% of the shares for the

amongst a few of the first investments we made," says Agamirzian. Still, all the effort is starting to make a difference. Economic Development Minister Elvira Nabiullina predicted at the start of April that the innovation sector is expected to gradually raise its share in the Russian economy to 12-13% from a current 11% by 2015, and to 16% by 2020. E-commerce is one of the fastest growing sectors in Russia at the moment, but RVC has invested the

"These world famous funds are starting to get really excited about the prospects of investing into Russia"

Agamirzian says he will look at anything, but the obvious sectors for the fund to target are IT, biotech, alternative energy and e-commerce. "We have another biotech company that is just about to sign a deal with [state-owned technology agency] Rusnano tech for a second round of financing that will be used to build a production facility to produce hi-tech capsules to deliver a dermatological product it has been developing," says Agamirzian.

Vladimir & Igor's excellent venture

double-digit return for doing no more than buying German equipment and putting it into a regional sausage factory. So the Russia Venture Company (RVC) was born and five years and its first projects are starting to hit the market.

specialist, RNT develops, produces and installs its GPS/GLONASS-based telematics system that allows the owners and customers of cargo ships to follow their progress. The company already has 60,000 ships in its system, or about 20% of Russia's entire merchant fleet. The technology was developed thanks to investments made by RVC and its partner VTB Venture Capital Fund, a subsidiary of the state-owned VTB Group. The company wants to use the fresh capital to expand its sales overseas.

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first money abroad and only came back to Russia once the market was ready for it," says Agamirzian. Most of the co-investors into RVC's funds have been either Russianspecialist funds or local investment banks, but Agamirzian says RVC hopes to bring in more foreign money as well. "We already have a couple of funds outside Russia that co-invest with the biggest international players in companies overseas, but have some Russian angle," says Agamirzian. "But now we are seeing the start of a much bigger interest from foreign tech funds, who are allocating part of their portfolios to emerging markets and Russia in particular. These world famous funds are starting to get really excited about the prospects of investing into Russia.

"Exits are much easier as well," he adds.

INTERVIEW:

ive years ago, then-president Vladimir Putin floated the idea of a state-backed venture capital company to "leverage Russia's intellectual capital." No one disputes the Russians are clever or have good scientists – Russia was first to put a man into space after all. The problem is that businesses see no point in investing into highly risky, long-term technology projects when they could still earn a guaranteed

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most part. And the first crop of investments are starting to mature, Igor Agamirzian, CEO of RVC, tells bne in an exclusive interview. Last year, RVC successfully listed Russian Navigation Technologies (RNT) on the RTS New Market, a special platform for smaller companies, raising $10m. RNT is exactly the sort of company RVC is always on the hunt for. A shipping

Sowing the seeds RVC officially began making its first investments in 2007, typically contributing up to $5m for early stage companies or $500,000 as seed capital, and today the company has 12 funds with RUB26bn ($867bn) invested in 104 companies. In addition to its own funds, the Ministry of Economic Development and Trade appointed RVC to oversee another $500m worth of funds that have been established by a troika between RVC and the federal and regional governments to promote projects at a regional level. Agamirzian says that Tomsk and Tatarstan already stand out as champions when it comes to regional tech funds. "Most of the companies in our portfolio are still only two to three years old, so we are only just beginning to reach maturity

largest market of its cash into biotech. "There are a lot of copy cat internet companies out there that are growing very fast and they are developing something that has proven interest in other countries. But there are also a lot of private investors interested in this sector. We are a state company with a mandate to promote development of high technology companies, so we look further afield than just the obvious projects," says Agamirzian. The most prospective companies are those that cater to either business-toconsumer demands or business-to-business, but specifically targeting the needs of the people running those companies, believes Agamirzian. Ironically, Russia's difficult business climate has proven to be an advantage for some young companies like 1C (the name is in Cyrillic and pronounced "one-s"), one of Russia's largest software developers. At home it became well known for its Russian accounting software, but abroad it is better known now as a games developer. "1C grew up meeting the needs of the domestic market and then branched out overseas, but there are other companies like Transas that produces port navigation simulators used in training around the world and other marine software. It made their

Part of this international interest may have been sparked by the IPOs of internet and software companies Mail. ru, Yandex and EPAM Systems over the last couple of years, but Agamirzian still only has a few trophies to hang on his wall. The benefits of RVC are only just starting to become apparent, but Economic Development Minister Nabiullina is very upbeat, saying that the macroeconomic effect of innovations will start to make themselves felt in 2018-2020. The current growth might seem low, but she adds: "Never before has there been this type of long-term growth in Russia amid a decreasing labour force."


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Funding small business in the Caucasus Molly Corso in Tbilisi

C

ostly bank loans and limited funding sources have stifled the growth of small business across the South Caucasus. But a new fund could change that, according to Esben Emborg, the principal partner of the Small Enterprise Assistance Funds (SEAF) in Tbilisi. The Caucasus Growth Fund, created by major international financial institutions and the US-based SEAF, is banking on a mixture of equity and debt financing – as well as new funding tools – to boost business growth and development in Armenia, Azerbaijan and Georgia. In an interview with bne, Emborg notes the secret to the fund's success could be in untapped regional partnerships and prioritising good management over any single market sector. He stresses while that the fund's key sectors are "nothing surprising" – agriculture, hydroelectric power, retail, distribution, warehouses and cold storage – a focus on good management and on new types of "synergies" between businesses could open more possibilities for investment and development. "It is not so much the sector that makes the company worth investing, it is more the management. That is obviously a finding that is important to us," Emborg says, adding that in Georgia, for example, any well-managed business "can succeed at almost everything" because of low competition and the open market. Take for instance trade. While Georgia has made efforts to model itself as a trade centre for the region, the distribution system between the three countries is unwieldy. Trade between the three is further hampered by the ongoing conflict between Armenia and Azerbaijan over the contested territory of NagornoKarabakh.

Emborg, formally the general manager for Caucasus Region for Cadbury Schweppes and Nestle, notes that the lack of a single distribution network for all three markets has been a stumbling block for consumer goods moving from warehouses in Europe to households throughout the region. Addressing gaps in the regional distribution system or other market areas would allow the fund to help business and commerce develop across Armenia, Azerbaijan and Georgia. "We are also looking at regional synergies between the three countries – I think it makes sense," he says. Financial muscle With a working budget of $42m – invested by the Black Sea Trade & Development Bank, the European Bank for Reconstruction and Development, the World Bank's International Financial Corporation, FMO Entrepreneurial Development Bank, and SEAF – the Caucasus Growth Fund will have the muscle to buy into and/or lend to a wide portfolio of businesses across several sectors. The fund will be managed by SEAF. The fund will be the first to offer a mix of equity, debt, mezzanine financing and participatory lending to companies. While large financial institutions have tried to offer small and medium-sized enterprises equity financing in the past, the format did not catch on. The new fund, notes Emborg, should help entrepreneurs receive the financing and know-how they need without restricting their cash flow. While the fund is focused on businesses in Armenia, Azerbaijan and Georgia, the companies do not have to be owned by entrepreneurs from those countries. "It does open a lot of doors and I think it opens up doors to people who had seen the potential of the Georgian, or the Caucasus markets," Emborg says. "Sure, I hope [the fund will also help with

financing]. We will be looking at new investments and we also have [funds] we can use on start-ups." But the varied business climate in all three countries could be a potential obstacle for a fund banking on building a portfolio across the region. While Georgia has earned praise for its reforms, both Armenia and Azerbaijan remain bogged down with corruption and cumbersome legislation. The World Bank's "Doing Business" annual survey of bureaucratic hurdles that obstruct business ranked Georgia as the 16th easiest place to do business of the 183 studied in 2011. Armenia and Azerbaijan ranked 55th and 66th, respectively. "The three countries are very much different in terms of how they operate, the openness, the business climate. So we are not making any illusions that we will have an easy time in Armenia or Azerbaijan," says Emborg. "Georgia is [also] still in development, obviously, but much, much further on than the other countries." "The speed that any of these countries will develop is all about how much the government in each of these countries is willing to let go and let people do their business without interference," he adds. Emborg underscores that the fund has already identified potential clients, and there are a half a dozen projects "in progressed stage" across all three countries. An additional hurdle for the fund could be the business sectors' development: the target group for the fund – enterprises with a turnover of less than $15m and fewer than 250 employees – have struggled to take hold in all three countries. "It will be a challenge, obviously, to find businesses in that middle section that has the sufficient capacity to grow in terms of management and all other things. The big businesses in Georgia and in Armenia and in Azerbaijan have a tendency to 'hoover' up the best people – they offer the best pay and it is the place you want to work, so they are much more attractive for young, smart people," Emborg said. For all that, he's optimistic. "We still believe that we can find businesses that are worth investing in and can grow."


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bne June 2012

Upcoming events 2012

Emerging Market Investments Summit 2012 (5 - 6 June) IB Centre Moscow, Russia www.ibcentre.org

LTE Forum 2012 (5 - 6 June) HanseCom Media & Communication Istanbul, TURKEY www.lteforum2012.com

Russian Securities Forum (6 - 7 June) ICBI Baltchug Kempinski, Moscow, Russia www.informaglobalevents.com

Emerging Europe Deal Forum (12 - 13 June) C5 Vienna www.c5-online.com

The 5th Annual Central Asia Mining Congress 2012 (18 - 21 June) Terrapinn Rixos Hotel, Almaty, Kazakhstan www.terrapinn.com

Private Banking (19 - 20 June) EBCG +421 2 3220 2200 Prague, Czech Republic agnes.pajorova@ebcg.biz www.ebcg.biz

Emerging Market Investments Summit 2012 (19 - 20 June) Marcus Evans Summits +357 22849 308 Radisson Blu Alcron Hotel, Prague, Czech Republic Summits-emea@marcusevans.com http://bit.ly

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

The World Banking and Finance Summit (26 - 27 June) Lafferty Group London, UK www.lafferty.com

Transport in EE (3 - 4 July) E.E.L Events

International Cash and Treasury Management (26 - 28 September) EuroFinance Monaco www.eurofinance.com

Pharma Excellence in the CEE, CIS, SEE & Turkey (4 - 5 October) Fleming Europe Budapest, Hungary http://pharma.flemingeurope.com

5th CFO Summit Emerging Europe & CIS (17 - 18 October) CFO Insight Vienna www.cfo-summit-ee.com

26th BACEE Country and Bank Conference (18 - 19 October) Banking Association for Central and Eastern Europe (BACEE) Budapest www.bacee.hu

2nd Annual CFO Forum (24 - 26 October) EBCG +421 2 3220 2200 Prague, Czech Republic event@ebcg.biz www.ebcg.biz

7th Caspian International Conference and Showcase BANKING & FINANCE (7 - 10 November) Iteca Caspian LLC +994 12 447 47 74 Baku, Azerbaijan banking@iteca.az www.banking.iteca.az

Events

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Business New Europe June 2012 edition  

The only English-language magazine that covers CEE/CIS.

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