May 2013www.bne.eu

Inside this issue:

Russia's repo men

Putting some Polish on the portfolio

Stalemate in Sofia?

A Kazakh cattle prod

Special Report:Turkey's time

...OR ALREADY IN THE WEST AND LOOKING EAST?

IS TURKEY TO THE EAST LOOKING WEST...

Contents I 3bne May 2013

Editor-in-chief:Ben Aris (Moscow) +7 9162903400

Managing editor:Nicholas Watson (Prague) +42 0731582719

News editor: Tim Gosling (Prague) +42 0720180811

Eastern Europe:Graham Stack (Kyiv) +7 9266052742

Central Europe:Robert Smyth (Budapest) +36 19995200Jan Cienski (Warsaw) +48 604994850Mike Collier (Riga) +37 129473192Matthew Day (Warsaw) +48 607291187Tom Nicholson (Bratislava) +42 1907732736Kester Eddy (Budapest) +36 308665550Steven Roman (Tallinn) +372 56665911

Southeast Europe:Justin Vela (Istanbul) +90 5393614470David O'Byrne (Istanbul) +90 5359210950 Bernard Kennedy (Ankara) +90 535 7485120Ian Bancroft (Belgrade) Bogdan Preda (Bucharest) +40 722580137Branimir Kondov (Sofia) Guy Norton (Zagreb) +38 513835929

Eurasia:Bureau Chief:Clare Nuttall (Almaty) +7 7073011495Molly Corso (Tbilisi)Oliver Belfitt-Nash (Ulaanbaatar) +97688113149

Advertising & subscription:Elena Arbuzova +7 9160015510 Business Development Director

Tatiana Alexeeva +7 9168306850

Alec Egan +44 2030516548Business Development Director (International)

Design:Olga Gusarova-Tchalenko +44 7738783240

Cover illustration: Illarion Gordon

Please direct comments, letters, press releases and other editorial enquires to editor@bne.eu

All rights reserved. No part of this publication may be reproduced, stored in or introduced to any retrival system, or transmitted, in any form, or by any means electronic, mechanical, photocopying, recording or other means of transmission, without express written permission of the publisher. The opinions or recommendations are not necessarily those of the publisher or contributing authors, including the submissions to bne by third parties. No liability can be attached to the publisher for these comments, nor for inaccuracies, errors or omissions. Investment decisions or related actions taken on the basis of views or opinions that appear herein are the responsibility of the reader and the publisher, contributors and related parties cannot be held liable for these actions.

bne is the property of bne Media Ltd · Reg number: HE 185230 · Michalakopoulou 12, 4th floor, Suite 401, P.C 1075, Nicosia, Cyprus · Postal address: Schluterstrasse 19, Berlin 10625, Germany

COVER STORY

The Insiders

Turkey – beyond the clichés

Crashes in the making

Perspective

Chart of the month

EASTERN EUROPE

Mezzanine finance appears in Russia

Russia's repo men

Russia's internet pioneer

Ukraine's short-term fix

Ukrainians split between EU and Russia

Spreading fertilizer in Russia

6

8

10

12

13

14

16

18

20

21

22

CENTRAL EUROPE

Latvian authorities on watch for CIS money flows

A CEE stock exchange in sight

Putting some Polish on the portfolio

Palmer Capital to shop in Poland

Muck and brass in Latvia

Baltic business – singing strong or whistling in wind?

Parting shots at Fidesz

Biedronka's ladybugs swarm over Poland

24

25

27

28

29

30

31

32

Print issue: ¤68 / year Basic online package: ¤180 p/user, p/year Full subscription package: ¤500 p/user, p/year

16

27

How to invest in Eastern Europeand China

Rather than spending our time in an office, we travel around our region, meeting with over 1,200 companies a year. This tells us more about the markets than any index in the world ever could.

Read more about our award-winning funds at www.eastcapital.com.

Historic yields are no guarantee for future yields. Fund shares can go up or down in value, and investors may not get back the amount invested. Before investing, please read the prospectus carefully. Full information on East Capital’s investment funds such as the prospectus, simplifi ed prospectus and fi nancial reports can be obtained free of charge from East Capital, from our local representatives and are available on the website. Please also note that the funds, or some of the funds, may not be available for sale in your country.

EastCap_ENG_210x280_bne 2012.indd 1 2/10/2012 2:08:52 PM

Contents I 5bne May 2013

SOUTHEAST EUROPE

Finally, a deal

Serbia beyond the (negative) headlines

Stalemate in Sofia?

Electric (car) dreams in Croatia

Croatia you are the weakest link, hello

Romania reignites EU fight over jet procurement

Moldova's political crisis deepens

34

36

37

39

40

42

43

EURASIA

A "reset" in Georgia-Russian relations

Georgian water flows to Russia

Private wealth and public office in Georgia

A Kazakh cattle prod

Horsemeat on the menu

Astana Finance restructur-ing at risk of collapse

Sturgeon still swimming in Caspian region

SouthGobi crawls out of Mongolian purgatory

Foreign investors welcome Mongolia's change of tack

Southern corridor comfort

Corporate Statement: Azerbaijan stays ahead of the pack

OPINION

The US names names

SPECIAL REPORT

Turkey's financial dreams

Pegasus flies

Bringing discounts to the region

Turkey's nuclear dawn approaches

Power to the market

UPCOMING EVENTS

44

45

47

49

50

51

52

54

56

57

58

60

63

64

65

67

68

70

39

65

49Many talk about Capital Market Transactionsin Central and Eastern Europe.

We do them.

Raiffeisen Bank International has relationships in Austria and Central and Eastern Europe second to none. Close relation-ships, too, with major investors worldwide. Investors value our regional know-how and market access, giving issuers firm placement at the right price. www.rbinternational.com

RBI_AZ_Tombstones_Allg_Neu3_202x272_4c_abfall.indd 1 1/28/2013 1:46:35 PM

bne May 20136 I The Insiders bne May 2013

Inward and outward foreign direct investments of all sizes are flooding the market. At the larger end of the scale, the larger investments typically come from new or emerging jurisdictions. Russia is becoming one of the largest trading partners in Turkey, and good and improved relations between the two countries has resulted in Turkey becoming the largest foreign investor in Russia. While Russia's Rosatom is build-ing the Akkuyu nuclear power plant, Sberbank has acquired both the domestic Turkish Denizbank for over $4bn and the consumer banking division of Citibank in Turkey.

Outside the financial services sector, a significant proportion of the Turkish pharmaceutical manufacturing industry has

been acquired by global drugmakers. These companies, mainly Swiss, German, Japanese and US based, continue to compete for larger shares of Turkey’s fast growing pharmaceutical mar-ket, which expanded from $3bn in 2003 to $13bn in 2012.

There have been similar trends in many other sectors, includ-ing insurance and healthcare, as the economy expands and a fast growing population increases purchasing power, con-suming both domestic and imported production.

Turkey’s exports are on a continuous increase, with the gov-ernment taking critical steps to control the economic growth and current account deficit. The government has committed to increase its exports, currently at $150bn, to over $500bn by Turkey’s centennial celebrations in 2023. Deputy Prime

Minister Ali Babacan recently said that it would be possible to reach a GDP per capita of $25,000, provided that both judicial and educational reforms are carried out to liberalise the economy.

As part of its stated ambition to establish Istanbul as a major international financial centre appropriate to the country’s standing in the region, the government has set out its plans and construction for the premises of an international finan-cial centre (IFC) have already commenced. The intention is for the IFC to improve the Turkish economy by attracting funds, allowing Turkish businesses to obtain easier finance and for the domestic insurance sector to become closer to international financial markets.

As part of its commitment to legislative reform and to improve the climate in which to do business in Turkey, the cabinet has sent legislation to parliament on the formation of the Istanbul Arbitration Center (IAC). Turkey is aiming for the IAC to become a major dispute resolution centre for investors particularly in the IFC and a prime centre for the resolution of commercial disputes in the region. At a conference on the pro-posed IAC, convened in November 2012, the various require-ments for the development of a successful arbitration centre were discussed by a record number of 380 delegates.

As the organisers of the conference, Mehmet Gün & Partners believe that establishing the IAC alone is not enough – it must be supported by the creation of special courts and appeal chambers equipped with the state-of-the-art disclosure pro-cesses, so that the complex disputes that IFC participants may encounter can be swiftly and efficiently resolved. We will con-tinue to work to facilitate the establishment and international recognition of the IAC, of specialised IFC courts and the adop-tion of full and frank disclosure in Turkish civil procedures.

The deputy prime minister believes that Istanbul can fill the gap between the financial centres of London, Frankfurt and Dubai, and become a regional powerhouse. There is no doubt that following the Arab Spring, Istanbul benefited from its position as a strong stable economy outside the EU and its "safe haven" status for investors in the East Mediterranean, North African and Central Asian region. In Egypt, Cairo has already lost its importance to Istanbul as was shown when the Nikkei Index of Japan relocated its Middle East offices to Istanbul. With an almost bankrupt Greece and Cyprus, and an unstable Egypt, Turkey is paving the way to become the region’s major financial and commercial centre.

Mehmet Gün is one of Turkey's leading international lawyers. He is the founder and managing partner of Mehmet Gün & Partners, a leading law firm in Turkey and one of the few independent local law firms providing legal services to international standards. Mehmet Gün & Partners provides commercial, corporate, IP, competition, project finance and dispute resolution services to local and international businesses.

"With its deepening capital markets and robust growth, Turkey has caught the interest of the international investment community, particularly from the Gulf region"

"The deputy prime minister believes that Istanbul can fill the gap between the financial centres of London, Frankfurt and Dubai, and become a regional powerhouse"

Mehmet Gün of Mehmet Gün & Partners

Turkey’s strategic geographic position, at the crossroads of eastern and western cultures, historically guaranteed its political importance on the Old World

stage. Now, with its stable economic growth and a young, well-educated and highly skilled workforce, Turkey is once again rising up to become a major economic, political and financial force in the new global economy.

Turkey has been investing heavily in the development of its infrastructure, with several large projects currently underway. These include the $11bn construction of the Istanbul-Izmir motorway, the $25bn investment in the Akkuyu Nuclear Power Plant by Russia’s Rosatom and the $15bn investment in the new Istanbul Airport, which will be the world’s largest airport with an annual capacity of 150m passengers. Other major construction projects that have commenced include a high-speed rail link for Istanbul to Anmkara and a third bridge over the Bosphorus, all of which will coincide with Turkey’s bid for the 2020 Olympics.

While numerous US and European banks collapsed following the global financial and Eurozone crises, Turkey’s banking sector has been performing relatively robustly on the international stage. Turkish central bank data has revealed that portfolio inflows last year rose 60% to $35bn, with commentators describing Turkey as one of the most interesting emerging markets in the region with a diversified range of investment products. Last November, Fitch Ratings gave Turkey its first investment grade credit rating in almost 20 years, which endorses the country’s economic transformation and has been one of the main catalysts for the significant rise in demand for Turkish assets this year.

Outside interestWith its deepening capital markets and robust growth, Turkey has caught the interest of the international investment community, particularly from the Gulf region, with investors being drawn to Turkey's widening range of investment products, from a debut sovereign Sukuk bond issue last September to foreign currency-denominated Eurobonds from both banks and corporates.

Can Turkey become a major financial and commercial centre – again?

8 I Cover story bne May 2013 bne May 2013 Cover Story I 9

has fallen to around 41%, despite net exports continuing to rise. "We can talk about Turkey re-orienting itself towards the [Middle East and North Africa] region, but it will be a long time before the purchasing power of these countries reaches European levels," says Inan Demir, chief economist at Turkey's Finansbank. "There is huge growth potential, but at the same time the region is far from being stable," he explains, pointing to Syria and Iran as countries capable of destabilizing the entire region.

Oil and gas corridorExports aside, Turkey's geographical position presents Ankara with a unique opportunity to take advantage of the region's oil and gas reserves, both for its own needs and those of Europe.

The long-standing cliché of Turkey becoming the "Euro-Asian gas corridor", transiting the region's gas reserves to energy-hungry European markets may yet be realized, offering Europe both much-needed security of supply and welcome competition to the increasingly monopolistic position of Russia's Gazprom. If so, this can only help Turkey's EU accession process, cementing Turkey's position as the south-east corner of the bloc.

Turkey is already committed to constructing the joint Azerbaijan-Turkey TANAP pipeline that will carry Azeri gas from the Caspian Sea to European markets, which is expected to begin operations in 2018. The region's biggest gas reserves, though, are those in Iraq and the main factor blocking their availability being the long-running stand-off between the central government in Baghdad, and the Kurdish Regional Government (KRG) in Irbil. Acting as a de-facto national government since the early 1990s, the KRG has signed a swathe of exploration and production agreements for both oil and gas fields with developers such as Anglo-Turkish Genel, OMV, ExxonMobil, Talisman and Marathon.

An agreement with Baghdad, which remains the internationally recognized government of the whole of Iraq,

legitimizing crude exports from the region has proved unworkable, however. Reports claiming that Ankara is preparing to both allow the KRG to make its own oil and gas exports to Turkey independent of Baghdad and for Turkey's state gas importer Botas to play a role in developing the region's gas reserves remain unconfirmed by both sides. However, with no other export routes, few doubt that at some point oil and gas from the Kurdish region will be piped to Turkey – and in the case of the gas, on to Europe. All that remains is for a deal to be struck with Baghdad.

Kurdish peace dividendIf realized, such an export route would further cement Turkey's role as a vital European energy corridor and would arguably also help with the resolution of Turkey's problems with its own Kurdish minority.

A long-rumoured "peace process" has finally been confirmed, with hopes high

it can result in a settlement that will end the 30-year low level conflict with the Kurdistan Workers Party (PKK) which operates from bases in northern Iraq. Oil and gas aside, an end to the PKK conflict would offer Turkey a significant peace premium. "It would significantly reduce Turkey's risk premium, help future credit upgrades and open up the underdeveloped south east of Turkey to investment," says Finansbank's Demir, pointing out that the region's employment ratio is just 30% compared with a national average of 45%.

It would also help address the issues of human rights and free speech for Turkey's Kurdish minority, a perennial question hanging over Turkey's EU accession bid.

But Turkey's golden opportunity to realise its potential as a gas corridor

to Europe doesn't stop with Iraq. The recent discovery of sizeable gas reserves in areas of the East Mediterranean claimed by both Israel and Cyprus opens yet more possibilities, the more so since Israel has formally apologized to Turkey for the killings in 2010 on the Mavi Marmara peace ship. If the rapprochement is realized, it would open the way for the formalization of rumoured talks on a possible gas pipeline to carry Israeli gas to Turkey and on to Europe. Speaking in Ankara in April, Israeli envoy Michael Lotem highlighted Israel's interest in an export pipeline to Turkey, with the possible involvement of Cyprus.

According to Hugh Pope, the International Crisis group's project director for Turkey and Cyprus, who authored a report on East Mediterranean gas discoveries, the only economical way for Israel and Cyprus to export their gas will be via Turkey. But he cautions that economics alone are not enough,

pointing to the need for a settlement of the 39-year division of the island. The current economic crisis presents an ideal opportunity to achieve this. "Cyprus needs money and the best way to get it will be to normalize relations with Turkey," he says, explaining that Turkey has a historic chance to both secure a settlement on Cyprus and secure the transit of the island's gas reserves to Europe. "The Cypriots are traumatized, Turkey must reach out to them."

Such a settlement would offer Turkey a far greater peace dividend than the chance to transit gas to Europe, as it would at a stroke remove one of the biggest blocks between Turkey and EU membership, further cementing Turkey's place in Europe. Not to say disproving yet another regional cliché: that of Cyprus as an issue which can never be resolved.

The problem with clichés is that while glib reductionism can often result in trite or inaccurate

generalizations, they can equally as often offer a neat summary of an altogether more complex idea. So it is with Turkey, the oft-lauded "bridge between east and west", a country "at a crossroads", "with one foot on both continents", which – depending on your point of view – is either "to the east looking west", or less often "already in the west and looking east".

Geographically accurate, the cliché also continues to accurately summarise

"In the decades before World War I, Turkey was known as 'the sick man of Europe', not 'the sick man of Asia'"

Turkey's position as the largest Muslim country in Europe and the only Muslim country currently in the accession process to the EU. But while Turkey's EU membership has long been opposed by those who consider the country more a part of the Middle East than Europe, the question has increasingly become, where does Turkey view itself as belonging?

A question which Turkey's minister for EU accession, Egemen Bagis, has traditionally answered by unequivocally restating his government's commitment to joining the EU, and by turning another

well-worn cliché on its head and pointing out that even at the lowest point in its history in the decades before World War I, Turkey was known as "the sick man of Europe", not "the sick man of Asia".

In purely economic terms, since Turkey's accession into the European customs union in 1995, Europe has been Turkey's main export market, taking as much as 60% of the country's manufactured exports. However with the global economic crisis reducing Europe's spending power and high oil prices increasing that of much of the Middle East, Europe's share of Turkey's exports

Turkey – beyond the clichés David O'Byrne in Istanbul

10 I Cover story bne May 2013 bne May 2013 Cover story I 11

Even before the dust from the crisis in Cyprus had settled, attention was turning to which European

country is likely to crash next. Slovenia's name came up almost immediately because its banking sector is saddled with bad loans worth about 20% of annual GDP, but Ukraine, Belarus and Moldova also look increasingly shaky.

Slovenia's government, backed by European officials, have rushed to assure the rest of Europe that a good dose of reform plus a restructuring at the banks would enable the country to cope. The size of the Slovenian bank sector is much smaller, only about 50% of GDP against the 800% in Cyprus, and Ljubljana insists it can come up with the financing necessary to keep the economy afloat.

The Organisation for Economic Co-operation and Development (OECD) is not so sure. It warned in a report in April that the government had "significantly" underestimated the level of bad loans and may be the next Eurozone country to ask for a bailout. The OECD says the stress tests that the central bank has already carried out were far too lenient and the central bank’s refusal to publish the results is only adding to the uncertainty. The size of the bad debts hidden in bank balance sheets could be a lot bigger than that

€7bn that the central bank is willing to 'fess up to.

The true situation should become clear over the next few months. The country on April 16 managed a successful treasury bond sale – selling €1.1bn, more than twice as much as hoped – which will get it over the debt hump in June. This has given the government a bit more confidence, and it mandated three international banks to start sounding out investors about another Eurobond, the sale of which would give the government even more of a financial buffer. However, analysts say the government needs to put more of a concrete reform plan together, which would help to convince investors that it is dealing with the root causes of the unfolding crisis there. "It's positive that Slovenia is able to sell T-bills, but I would be hesitant to lend them more money until they show progress on reforms, including privatisation and the bad debt situation," Sam Finkelstein, a bond fund manager at Goldman Sachs Asset Management, told Bloomberg.

So far the population is remaining calm. And that is important, as it is they who decide when any bank runs will start. A survey at the end of March found that 51% of Slovenes have less than €100,000 on their bank account and think deposits are safe.

A poor corner of EuropeOne name that is high on the list to suffer a banking crash has barely been mentioned – and that's because the small, backward and desperately poor Moldova rarely figures much in European affairs.

Back in the 1990s, the Russian authorities were desperate to raise revenues from taxes, but the country was bleeding cash to offshore banking havens. Thus the Central Bank of Russia blacklisted Latvia, Montenegro and Moldova, which were operating as little more than money chutes out of Russia. Latvia and Montenegro subsequently cleaned up their act to a certain extent, but Moldova continues to be a festering sore on the rump of the Russian banking system.

Several of Moldova's leading banks have already been caught up in money-laundering scandals involving Russian money. Embezzlement on a massive scale was uncovered at Moldova's state-owned savings bank, Banca de Economii a Moldovei (BEM), earlier this year and there is convincing evidence it was used to launder funds embezzled from the Russian budget in the so-called "Magnitsky case".

According to a leaked International Monetary Fund (IMF) report earlier this year, BEM is heading rapidly to insolvency as bad loans, most resulting from corruption and embezzlement, mount. Although BEM is only Moldova's sixth largest bank by assets, with around 13% of total deposits, it holds a key position in the country's banking system because of its monopoly on paying out pensions and other social payments, thanks to its majority state ownership and extensive network of branches, particularly those in villages where a majority of inhabitants live. BEM also holds the deposits of almost all public agencies and institutions, such as hospitals and schools, with a total of MDL707m (€43.65m) in insured deposits, while the state's deposit guarantee fund contains a total of only MDL134m, read the leaked IMF report.

The country's banking sector ratio of assets/GDP was a moderate 58.1% in

Crashes in the makingBen Aris in Moscow

2012, although the system would quickly be overwhelmed if all the loose Russian money trying to escape from Cyprus headed to Chisinau. The tax regime is not as favourable as that of Latvia, but the system is so corrupt this is unlikely to be a major obstacle. Moldova has a double taxation treaty with Russia, dividends are taxed at 10-15%, but there are no taxes on interest or royalties. Corporate taxes are charged at 18%. It would be an ideal candidate for the new Cyprus, except it is not in the EU.

More than one way to bake a cakeSlovenia caught the headlines because of the similar problems to Cyprus that it has with its banking sector – the en vogue way to get into trouble this season. However, as Carmen Reinhart and Kenneth Rogoff showed in their book, "This Time is Different", there are many ways to bake a cake: banking crises are only symptoms of deeper underlying economic problems and at least two other Eastern European states are a lot closer to full-scale economic meltdowns than Slovenia is to having the banking variety.

The economic consultancy Capital Economics said in March that while most attention focused on the impact that the Cypriot bailout could have on Russian depositors, the deal thrashed out with the "troika" (European Commission, European Central Bank and IMF) could pose much bigger risks for Ukraine, which is already on the brink of a balance of payments crisis.

"Tiny Cyprus is the main source of [foreign direct investment] into Ukraine, accounting for around 30% of the total. The introduction of capital controls in Cyprus risks disrupting these flows, which may ultimately affect business activity and hit vital capital inflows into Ukraine... Wider vulnerabilities mean that the Cypriot crisis may still be enough to tip Ukraine into a financial crisis of its own."

Ukraine is running out of money fast. At the start of April its international reserves fell to $24.7bn, or enough to pay for just over two and a half months of imports. This puts Ukraine well into the red zone, as it is not enough to ensure the stability of the currency, say economists.

Luckily for Ukraine interest rates around the world are near zero and international bond investors are desperately casting about to find yield of any kind. When Kyiv's latest talks to restart its stand-by agreement with the IMF failed on April 12, the finance ministry rushed out a $1.25bn, 10-year Eurobond the same day, which has staved off disaster again – for now. However, with the economy slowing, tax revenues falling and government paralysed by infighting, the prospects for Ukraine's recovery are not good.

Belarus is in the same leaky boat. The country needs $3.1bn to repay its earlier loans and sovereign Eurobonds coming due, which is a lot given that foreign

exchange reserves stood at just $8.1bn in April. The Eurasian Development Bank was due to pay out the next tranche of $440m from its anti-crisis fund in April, but Russia has been dragging its heels on another $2bn loan that Minsk desperately needs.

The World Bank arrived in Minsk in April to restart talks about financing options, and the government has tried to start negotiations on a new bail-out programme with the IMF, but so far without success. The IMF says any new programme would depend on the degree to which the government is committed to structural reforms like privatisation – something President Alexander Lukashenko's administration appears unwilling to commit to. Thus no one is seriously expecting the World Bank or the IMF to come to Minsk's rescue, leaving borrowing on the international market as the only real option left.

Like Kyiv, Minsk is pinning its hopes on issuing another Eurobond. In other words, it remains extremely vulnerable to international sentiment, and both countries are sailing very close to the wind, according to Moody's Investors Service. "There are no external liquidity constraints among investment-grade countries [in the CIS]… but [the situation is] critical in B-rated countries, in particular in Belarus and Ukraine… Belarus and Ukraine face a high risk of a multi-notch downgrade, which is mainly related to external liquidity shortages,” the agency said in a recent report.

External liquidity risk very high for B3 rated CIS countries

Source: Moody's, IMF, National Sources, Haver. *External liquidity indicator; (Short-term external debt + currently maturing long-term external debt + total non-resident deposits over 1 year) / (Official foreign exchange reserves)

50

100

150

200

250

300

350

400

Russia Kazakhstan Azerbaijan Armenia Georgia Belarus Moldova Ukraine0

2007 2013F Baa median Ba median B median

12 I Perspective bne May 2013 Perspective I 13bne May 2013

Russia clowns about

CHART: Economic centre of gravity shifts east again

"There is no competition in Russia. The revenues are fake. You have to control the whole sector to make money."

This comment was made by Oleg Tinkoff on one of the panels at Sberbank’s recent investment conference, "The Russia Forum", yet this highly successful Russian serial entrepreneur's entire career is testament to the opposite.

Tinkoff began his career in the 1990s setting up an enormously successful bar-cum-microbrewery in St Petersburg, which is still packed to the gills today. From that he launched his own eponymous beer brand – a light lager and Russia’s answer to the Mexican brand Corona – which he eventually sold to one of the big beer companies for squillions of dollars. Then he went into banking and more recently set up Russia’s first entirely virtual bank. Next up will be his own budget airline, which is coming, though no one is quite sure when.

Thus Tinkoff has created competition in several sectors himself. He controls none of them. And he has clearly made a lot of money. So what is he talking about?

There was a lot of irony in him making this comment from the stage of the Sberbank event. Until last year, this conference was known as the "Troika Dialog Russia Forum" – named after one of two vibrant and active local investment banks that did a brilliant job of selling Russia to the international investment community. It was one of my favourite events on the calendar. The halls were packed with fund managers and top-level businessmen from all over the world, who had to come to check up on how Russia was faring. There were entertaining sessions chaired by the likes of Marc Faber, the celebrity editor of the "Gloom Boom & Doom Report", together with fund managers such as "Black

seen at the end of 2009 at the time of writing. The price/earning ratios of stocks are similarly depressed to crisis levels. Russian stocks have always been cheaper than their emerging market peers, but now they are ridiculously cheap even by Russia’s own modest standards. The same is true for foreign investment. Usually Russia can manage to attract a couple of tens of billions of dollars a year, but last year the net FDI was a pathetic $358m, according to central bank data – enough to buy, say, one moderately sized retail chain.

At the moment, Russia is about as popular with international investors as a skunk in a banya. Things are so bad that President Vladimir Putin felt forced to urge Russian companies to switch their privatisation plans from listing on international markets to floating on the local exchanges instead. VTB bank dutifully announced it would offer a secondary public offering of 10-15% of its shares, worth about $3bn on the Moscow Exchange, some time very soon. And the state followed up increasing the value of state assets to be sold to investors this year from RUB300bn ($10bn) to RUB1.2 trillion.

But Russia can put as many companies on the list as it likes – no one came to its investment conference. Like Tinkoff is suggesting to the powers that be: if you really want to attract investors, you have to learn to share your toys with the other children and not just hire a bunch of expensive clowns to entertain your classmates.

The chart this month comes from McKinsey Global Institute, which has developed a novel way to look at the changing landscape of the global economy.

The institute calculates the global centre of economic gravity over the past 2,000 years or so: take the size of an economy and place it at the centre of the country then do the same for all the countries in the world and work out where the sum of all these points is.

The fascinating result is that for most of the past two millennia the centre of the world's business was moving westwards and nearly crossed into US territory in 1950. However, then it reversed course and has been steadily moving east again until it crossed into Russian territory in about 2010.

That move to the east is set to continue, nearing the point of origin in AD1 close to Babylon (today's Iraq) sometime in the next 20 years thanks to China's revival.

Swan" author and fund manger Nassim Nicholas Taleb or junk bond king Michael Milkin.

And this year? "Welcome back to the Sberbank snoozefest," tweeted one well-known correspondent as the next session started. The first panel contained the former UK premier Tony Blair, secretary of defence Colin Powell and Czech president Vaclav Klaus. Perhaps with the exception of former Russian finance minister Alexei Kudrin, all on the panel were very famous, very eloquent, very expensive to book – but none know that much about Russia when it comes to the nitty-gritty of investing.

Sberbank is the epitome of Tinkoff’s complaint. The state is engineering a concentration of power in the economy that is crushing the life out of competition and innovation. Following Sberbank's acquisition of Troika Dialog and the rescue of the failing Renaissance Capital last summer (it is still functioning but in a reduced form), Russia’s entire investment banking system is now controlled by two state-owned giants – Sberbank CIB and VTB Capital.

This is not a return to the command economy, but the result of bad policy. You can see what the Kremlin is trying to do. It wants to keep control over key strategic sectors, but it also sees the need for competition. So it has set up a hybrid system where it has two big state-owned organizations that compete against one another. And it does work – to an extent. Sberbank is now a much, much better bank than it was a decade ago.

But the trouble is that this hybrid-market model is not enough to coax investors into Russia. It doesn’t matter if the state-owned companies are more efficient and profitable, as all foreign

investors see is the dominance of "state-owned companies" that they don’t trust. The upshot is that "The Russia Forum 2013" was a disaster because there were no foreign investors there. The event used to be awash with them, but the crushing boot of state arrogance has killed off its mojo. The only people that bothered to turn up were the old guard of local funds (and even some of these people who live in Moscow skipped it), companies that are reliant on the state for their business (the biggest group), and Sberbank’s own employees.

Russia is making itself an irrelevance. It has been the fastest growing major economy in Europe and has none of the huge macroeconomic problems almost all the other countries on the Continent face, yet the stock market is down by nearly 10% this year already and was trading at the levels last

Ben Aris in Moscow

"This hybrid-market model is not enough to coax investors into Russia"

"At the moment, Russia is about as popular with international investors as a skunk in a banya"

Evolution of the earth's economic centre of gravity: by far the most rapid shift happened in the 10 years to 2010, reversing previous decades of development

bne May 201314 I Eastern Europe bne May 2013 Eastern Europe I 15

hold on to the equity kicker, sometimes for years, until it can be sold at an ultimate IPO. But in Russia part of the deal is a buy-back option signed by the owners, which can be exercised after the transaction that the money is raised for has been completed. "Really it is a bit confusing to call this mezzanine finance, as there are several subtle differences to those deals in the West," says NRG's Abolmasov. "It is better to think of this as structured subordinated financing, but this may change over time."

Part of the reason that company owners are willing to sign off on these buy-back options is because once their risky deal has been completed with

the mezzanine financing, the company can immediately go to one of the big Russian banks and refinance the whole deal with much cheaper and more traditional borrowing or through the sale of assets.

Last year, Hi Capital organized a deal for A5, a Russian pharmacy, which wanted to buy Mospharm, a state competitor that the government was privatising. A fast growing company, A5 was still a second-tier player and struggled to raise the government's $135m asking price for Mospharm from the obvious state-owned banks. Hi Capital lent them $95m and helped the company structure the deal to sell most of Mospharm's valuable real estate that came as part of the privatisation. "We closed the deal to take over Mospharm and on the same day sold the real estate," says Yashunsky. "The beneficial owners of A5 bought back the equity kicker from us as well and the total return on investment for the deal was 45%."

Ben Aris in Moscow

Mezzanine finance appears in Russia

With Russian banks reluctant to lend and equity markets moribund, would-be

borrowers have turned to increasingly sophisticated, albeit expensive, ways of raising capital to grow their businesses in Russia.

Over the last 18 months, Russian companies have struck a series of mezzanine financing deals that have raised several billions dollars needed to acquire rivals, to buy out the shareholders, or simply to buy new machines to make these firms more profitable.

Mezzanine financing is a halfway house between raising debt and selling equity as the deal uses a bit of both. Typically, a company asks one of the handful of specialist mezzanine lenders for credit and puts up a little equity as well to sweeten the pot. "Mezzanine finance has taken off in Russia, but there are still

very few people offering sophisticated finance products. We have raised half a billion dollars each year for the last two years for 11 deals," says the frenetic Andrey Yashunsky, managing partner of Hi Capital.

Currently, Russian banks are only willing to lend companies money for working capital purposes and are

especially reluctant to lend for the far riskier takeover or leveraged buyout deals. As such, companies are willing to pay much higher rates for short-term money to complete those kind of transactions.

At the same time, banks often ask for exorbitant amounts of collateral on loans, like a controlling share in the company, which opens the owner up to the risk of a hostile takeover if the bank makes repaying the loan difficult (a favoured tactic of Alfa Bank in the 1990s). The appeal of mezzanine financing is that companies can use equity to raise money – typically a

5-15% stake – but remain in corporate control come what may.

Niche playersCurrently, Hi Capital and New Russia Growth (NRG) are dominating the

business in Russia, but demand is rising fast and other banks are interested in developing these products.

Hi Capital's Yashunsky says he has done a dozen deals worth a total of $1bn since he started two years ago when the mezzanine market appeared, often financed by Russian banks and high net worth individuals. Likewise, NRG has raised a fund of $150m that includes the European Bank for Reconstruction and Development (EBRD) as one of its investors. "Russian banks don't know how to do [mezzanine financing] and the companies need to be educated as to how mezzanine finance works," says Yashunsky. "The first two hours of any meeting I have with a target company is usually just explaining what we are offering."

In the last 18 months about a dozen mezzanine deals have been struck and tend to be with fast-growing second-tier companies. "We did one deal to finance a banking acquisition, as the client had raised a loan from one of the big state-owned banks, but it was demanding a controlling stake in the target in exchange," says Andrei Abolmasov, managing partner of NRG, the second largest mezzanine player in the country. "Our deal allowed the acquisition to happen and once it was completed, the client could easily refinance the debt from a bank at a better rate."

But these deals come at a price – a relatively steep one. In the West, mezzanine financing is used as part of a mix of options to diversify a credit portfolio. Typically, debt is cheap and long term, but hard to get. Equity is expensive, quickly releasing cash to shareholders, but can only be used a limited number of times. Mezzanine lies in the middle of these two options, returning as much as 25% for the organizer of the deal. In Russia, however, the percentage return on the debt part is in the 30s while selling back the equity kicker to shareholders or ultimate beneficial owners returns something in the 40s.

Another difference is that in the West the mezzanine organizer will typically

"We have raised half a billion dollars each year for the last two years for 11 deals"

"We closed the deal to take over Mospharm and on the same day sold the real estate"

16 I Eastern Europe bne May 2013 Eastern Europe I 17bne May 2013

said there was a woman in Novosibirsk who can pay for me if I strike my name off my residency registration and sign in hers instead," wrote one blogger in February last year.

Sequoia Credit Consolidation, part of Adela Financial Retail Group, is probably the market leader. The company is very public, speaking at conferences and cooperates with the Russian authorities

in efforts to develop legislation covering the sector. However, even Sequoia is not without its problems and Rospotrebnadzor has at least one legal suit against the company for alleged abuse of debtors' rights.

The government is not sitting on its hands when it comes to setting up some rules for the sector, but it's going slowly and confusion reigns. In 2012, the Supreme Court of Russia resolved that debt may only be sold on with the borrower's consent, but the court failed to define what sort of loans it was talking about and most banks have simply ignored the rule. Russia's chief bailiff, Artur Parfenchikov, told a press conference in February that the Federal Bailiff Service actively supports the development of the collection market, but the bias is in favour of helping banks collect bad debts rather than protecting the interests of citizens. "We support the encouragement of the collection market. We have developed a draft law, which was passed to the Ministry of Justice. This is a very important step. We need a law that clearly defines the issues, which the legislative and regulatory compliance practices of collection agencies do not touch upon," Parfenchikov said. "We in no way oppose such activities, and in fact seek to encourage them. Collection activity must be fully self-regulated, and does not need to be licenced centrally."

Russia's repo menBen Aris in Moscow

With consumer lending booming even as the economy slows, Russia's level of bad debt is

creeping up. And banks anticipating trouble are increasingly passing on their problem loans to dodgy credit collection agencies.

Express loans to consumers were rising by just under 40% last year and keeping Russian consumption afloat. But as the economy stalls, loans are starting to go bad. While data on the true level of non-performing loans (NPLs) are sketchy (the official numbers are certainly an understatement), experts believe the level of bad debt has doubled this year from about 4% of total loans to around 8%. This is not a huge level, but worried about a new crisis, the Central Bank of Russia has already moved to tighten rules around lending by accelerating the implementation of the Basel III rules that force retail lenders to hold much larger reserves against problem credits.

Bad loans caused much of the pain in the 2008 crisis and threatened to bring some banks down, so managements

have prophylactically been cleaning out the worst offenders and selling these debts on to the dozens of debt collection agencies that have sprung up. The problem is that, as is usual in Russia, business is running far ahead

of legislation and the rules to regulate these operations are not well defined, which has led to a lot of complaints and some abuses.

Inexperienced, inexcusableIn December, VTB24, the retail arm of state-owned VTB Bank, invited eight debt collection agencies to bid for its portfolio of an unspecified volume of bad loans, including market leaders Morgan & Stout and Sequoia Credit Consolidation. The tender was won by Rusdolg, part of the Russian Debt

Corporation, which bought the troubled loans portfolio for RUB4bn (€97m), although the value of the underlying credits was not disclosed. According to market insiders, the small agency has never worked with individual debts before, but won the tender by offering an unreasonably high collection rate.

The collection agencies are getting ready for not only for an influx of overdue loans, but for deterioration in their quality as well. In 2012, the agency collection market increased 10% to RUB14bn ($467m), according to the Sequoia Credit Consolidation Agency. The National Recovery Service puts the volume of bad debt sold by banks far higher at $3.2bn last year.

Mikhail Zadornov, the head of VTB24, said at the start of April that he plans to increase the amount of bad debts handed over to collection agencies by a third this year. GE Money Bank, the Russian affiliate of the US financial group, put RUB380m of NPLs up for sale in January, MDM-Bank sold on RUB4bn in March, as have Home Credit Finance and Renaissance Credit. Even the state-owned Agency for Housing Mortgage Lending (AHML) put up a tender for the collection of RUB1.30bn ($42.27m) unsecured mortgage debts to debt collectors.

UniCredit Bank in Moscow is going in the other direction and is offering to buy other credit institutions' of pools of debt in the amounts of RUB10bn-40bn as a way of beefing up its retail business.

And the largest Russian lender Sberbank said from June 1 its own debt collection subsidiary, ActiveBusinessCollection, will be up and running. At first, the subsidiary will acquire 120,000 cases of credit cards and old loans overdue by more than 360 days to the tune of RUB1bn. Retail loans in arrears at

"One common tactic is to send burly collectors to a debtor's home at unusual hours of the day"

"Russian social media is awash with complaints"

Sberbank were a total of RUB54.2bn by March. The business model chosen by Sberbank is solely a matter of reputation, says a manager of a bank possessing a similar business unit. Probably, Sberbank wants to be sure that debts are collected correctly and debtors are not harassed more than is needed, he said.

A good bad businessBad debt collection is clearly a profitable business. Officially, the bidders for VTB24’s debt demanded a 25%-28.6% premium on the collected sum, however Sequoia Credit Consolidation demanded a whopping 47% on top of the debt as its payments for collecting a bad debt. But that is only what the companies admit to. In reality, according to Igor Kostikov, a former stock market regulator and now the head of the Financial Services Consumers' Union (Finpotrebsouz), a consumer protection agency dealing with debt collection, the companies will multiply the sum several times over and intimidate the debtor into paying more, often with the complicity of the authorities.

Russian social media is awash with complaints. "My son took a RUB112,000 loan in 2008. Then he was arrested and went to prison for five years. Nobody paid anything to the bank. Then the credit was passed to [one of the major credit collection agencies]. Today I got an SMS message: Regional representative of [agency] sent to you to revise your property and check your income. And the number 8-800-100-XXXX. When I called, a woman said that if we can’t pay, they will go to court. The sum now is about RUB1.4m," according to one post on March 13.

There is already a federal bailiffs service, but these rules regulate officials appointed by the court to recover assets and cash once someone has been declared in default or bankrupt. However, banks rarely take their bad debtors to court and hand their debts over to the debt collectors before a court case, leaving the whole issue in a legal limbo. As a result, collection agencies resort to a variety of tactics to get their money.

One common tactic is to send burly collectors to a debtor's home at unusual hours of the day. Another common complaint is the collector's threats to seize a debtor’s property despite the fact there has been no court case (something they have no power to do). Almost all of the collection agencies sail close to the wind. According to bne enquiries, two companies admitted to making use of stolen databases of

personal information – mostly from mobile phone operators – to get phone numbers and addresses of debtors, but even in Russia this is illegal.

It is a fast growing business. LLC MBA Finance is a Czech company that is expanding rapidly in Russia and the rest of Emerging Europe. Creditexpress International was set up in 1999 and has large offices in Bulgaria, Romania, Ukraine and Russia, and also offers high interest rates to distressed borrowers.

Morgan & Stout is one of the most respectable agencies and has attracted Swedish investment firm East Capital as a minority shareholder in 2008. It was established in 2007 by a group of Russians with experience in the financial sector and now has offices in 16 Russian cities covering 46 Russian regions. However, like all the companies researched for this piece, Morgan & Stout also had a slew of complaints against its tactics. "I took a RUB100,000 loan for developing my business. It didn't work out, debts grew. I didn't pay for a year. Then the bank security service started to call. Later, guys from Morgan & Stout started to call saying they represent the bank now. At first there were SMS messages, then calls up to eight a day. The call went like this: Our brigade is on the way to your flat. No one showed up. Then they started to threaten me with jail, they could make my boss fire me etc. The new trick – they called and

18 I Eastern Europe bne May 2013 Eastern Europe I 19bne May 2013

Russia's internet pioneer

Ben Aris in Moscow

Leonid Boguslavsky is by far the most successful investor in Russia's internet sector, but

you wouldn't know it to look at him. A former Soviet-era computer science professor at the prestigious Academy of Sciences, he now heads ru-Net Limited, an investment company with over 40 companies in its portfolio worth $700m, whose tentacles stretch around the world but remain rooted in Russia.

Boguslavsky seems to have the Midas touch with start-ups. Going down the list of firms in which he was either a co-founder or early partner reads like a who's who of the Russian internet. He was one of the driving forces behind Yandex, Russia's answer to Google (and still twice the size of Google in the Russian-speaking corner of the internet). Yandex floated in New York in 2010 with an $11.2bn market capitalization, making it the largest online concern in Europe. He was an early investor into EPAM Systems, which in February 2012 went public on Nasdaq in a placement that raised $72m, or 14.7% of share capital. Only about 1.52m of the 7.4m shares sold came from the company, while the remainder were offered by selling shareholders. And he was also an early co-investor into Ozon Group, Russia's answer to Amazon, which will probably be Russia's next billion-dollar internet IPO. Ozon saw sales rise 55% last year to reach $250m, Ozon's CEO Maelle Gavet told bne in a recent interview.But little of this success is visible in

ru-Net's modest offices tucked away in the upper floors of a hard-to-find shopping centre on the unfashionable side of the Moscow river. Boguslavsky is likewise understated; he enters the small meeting room where the interview is held dressed in jeans and a sweat top, a few days of stubble on his chin, and speaks with the relaxed but authoritative air of the academic he once was.

The early yearsAs former president Mikhail Gorbachev's reforms unwound restrictions on foreign investment, one of the things to arrive in the Soviet Union were computers. The Russian state had been run on pieces of paper, but as the economy began to commercialise at the end of the 1980s everyone wanted to move into the 20th century.

Specialising in mathematical models of protocols – a precursor to the software that drives the internet – the arrival of the PC transformed computing from an arcane academic discipline into a business. Boguslavsky set up a company and won commissions from the Russian and Czech governments to build integrated IT systems. Working on Oracle machines, Boguslavsky quickly established himself as the go-to man in Eastern Europe and was soon hired by the US technology company in 1990 to represent its business in the Soviet Union.

The next decade saw a lot of change. The Soviet Union collapsed the following year, but that only increased

the demand for IT services and he spent another decade as the exclusive distributor for the US technology firm in Russia and its former Soviet Republics. Finally, after completing a job for PwC, the consulting company bought Boguslavsky's company in 1997 in Russia's first big tech acquisition and retained him as a consultant.

However, things in Russia began to change fast in 2000 after Russian President Vladimir Putin took over from the ailing Boris Yeltsin as the economic chaos of the 1990s gave way to an economic boom. "We wanted to become more professional, so we were joined by some US citizens in 2000 who had the same sorts of ideas and set up ru-Net Holdings – an investment company with an initial capital of $20m," says Boguslavsky.

The growth yearsThe dot.com enthusiasm spread to Russia, but as the country was still so backward and essential pieces of infrastructure like widespread credit card usage were simply missing, building up companies remained a largely academic exercise. Nevertheless, ru-Net Holdings began establishing obvious companies that it assumed one day they would come into their own.

Among the early ventures was Yandex, which has been a runaway success. "Our strength is that we support business development. Our team is full of professionals and we can offer

both technical expertise, as well as management skills and finance," says Boguslavsky. "Yandex and Ozon are examples of when we invested in the people. In some cases companies – I prefer to think of them as 'projects' – come to us, but in most we go to them."

Over the last decade he has been involved in dozens of firms. Of course, access to capital was an important factor, but as Russia's first successful tech entrepreneur the combination of technical expertise with proven management experience made Ru-Net Holdings unique in Russia.

The first half of the naughties was also about building up businesses, but by the middle of the last decade Russia's stock market was increasing in value by 50% a year and the sector was starting to attract outside attention. On top of that, a middle class was emerging which made e-commerce a viable business for the first time.

In 2006, the company restructured again, placing its existing assets into a special purpose vehicle and ru-Net Ltd was formed to invest into new businesses, this time with $700m of capital available. "Now ru-Net Ltd has over 40 companies in its portfolio, half of which are in Russia and the rest in the international markets," says Boguslavsky. "We have 13 investments in the USA – more technology companies and not aimed at the consumer. Things like big data, cloud computing and security companies… It is important to be in the US, as it is the kitchen and they are cooking up new technologies. It helps with all our other investments in Russia, India everywhere. In the emerging markets it's more about consumers and all the models are the same."

As the decade wore on, Boguslavsky became increasingly proactive, seeking out good ideas and getting involved very quickly, investing and advising on the best start-ups that were moving into some of the more obvious niches. "We were the first investors into Big Lion," says Boguslavsky, naming Russia's biggest daily coupon company. "We approached

them a few weeks after they had launched the site. It was profitable and bigger than [US rival] Groupon. Now it has got to the scale where its business model doesn't only depend on group buying."

Another example is the movie streaming site ivi.ru, which is partly owned by a rising star of the Russian internet, Dmitri Alimov, whom Boguslavsky spotted at a very early stage. Boguslavsky approached ivi.ru shortly after the site was launched and it is now the premier movie-streaming site in Russia. In its first serious round of capital raising in September 2012, the company attracted Barings Vostok Capital, Russia's most successful private equity investor, among others.

Russia's internet sector has now moved into a fast growth phase. The country's consumers are now as wealthy on a purchasing power parity basis as the poorer countries in the EU and things like consumer credit and credit cards are growing at an exponential rate. While there are enough people and money about to set up a profitable business with millions of dollars in turnover, most companies are focused on what is the electronic version of a land rush – to grab as much market share as possible from what largely

remains virgin territory. Slugging it out in the market place will come later once all Russians have been exposed to the different services on offer.

"Most of the companies we got into in the last three to four years are still in the growth stage," says Boguslavsky. "The dilemma is always how fast you want to grow: e-commerce you could earn a profit now but at the cost of growth. If the company grows 50% in under two years, it will build up some sizeable revenues, but if you grow at

only 20-25%, then you can earn profits. However, at the moment everyone is in competition to grab the market share and make sure their company is in the top one to three. It is very costly."

What's nextWhile Russia's e-commerce and internet industry is still growing up, it is already starting to attract international interest. ru-Net started to go international about three years ago. The motive was less about the problems or uncertainties of working in Russia and more to do with keeping in touch with what is going on in the investor. "Russia has come out of the blue and no one understands how to do business here and our experience is a competitive advantage," says Boguslavsky. "We are recognised as the same animal as the other foreign tech funds and not just some crazy Russian guys with a bit of money. It is good for us too, as we learn new tricks and ideas that we can use in our other businesses."

ru-Net faces a bright future. Russia's online industry is growing fast, and rising incomes and increasing broadband penetration is only going to make doing business easier. Added to that is Russia's vast size, which makes it ideally suited to e-commerce as retailers struggle to figure out a way of covering

a market that literally extends halfway round the world: the e-commerce industry was worth $25bn in 2012 and that should grow to between $90bn-130bn by 2020.

In the meantime, ru-Net has all its ducks lined up to be at the leading edge of this transformation. "In the last 18 months we had four exits and we have several other companies we could exit from now if we wanted to," says Boguslavsky. "They are at a late stage and if we need more liquidity we can sell them."

"In the last 18 months we had four exits and we have several other companies we could exit from now if we wanted to"

20 I Eastern Europe bne May 2013 Eastern Europe I 21bne May 2013

Ukraine's short-term fixbne

Ukraine spent March and April trying to stitch together a patchwork of agreements on

energy, finance, politics and reform that would allow the government to put off hard decisions and avoid having to address any of the festering problems it is facing.

The most obvious example was the failure in mid-April of a second round of talks with the International Monetary Fund (IMF) on restarting the country’s stalled $15bn stand-by agreement. Increasingly strapped for cash, Kyiv could really do with borrowing a couple of billion cheaply at the moment. Hard currency reserves have fallen to 2.8 months' worth of import coverage, which puts the stability of the hryvna at risk, and a blowout in budget spending in February saw the federal budget deficit increase four-fold to UAH2.3bn (€216m). Another sharp devaluation of the hryvna is looming.

Kyiv is living off its luck at the moment. Happily for Ukraine, the markets are awash with money these days due to quantitative easing by central banks

around the world and with interest rates close to zero in most countries, bond investors are willing to buy any old rubbish these days provided it comes with a decent yield. The same day that the IMF talks ended without agreement, the government tapped

the international capital markets for a €1.25bn, 10-year Eurobond at an interest rate of 7.625% – a lot more than it would have paid the IMF. Raising another bond keeps the wheels turning – analysts say the government needs to raise about $500,000 a month to function – but this is not a long-term strategy.

Gas leaksKyiv has made a bit more progress undoing one of its knottiest problems –

finding new sources of gas to replace the cripplingly expensive Russian imports. The amount it imports has been cut dramatically, falling by 17.4% between January and March from the year-earlier period. At the same time, Ukraine has started to import much cheaper gas from Germany and Poland. Hungary is expected to join the party later this year.

While the new imports are a tactical victory, Russia has accelerated its construction plans for the South Stream gas pipeline that will bypass Ukraine altogether. While Kyiv is keen to reduce the amount of gas its imports from Russia, it cannot do without Russian gas entirely so the South Stream pipeline leaves it in the nasty position of being cut out of the loop entirely – or being forced to pay through the nose for what it has to buy. Again, the new imports are a short-term victory, but at some point Ukraine is going to have to come to a fresh long-term agreement with Russia on gas.

While the administration of President Viktor Yanukovych wheels and deals, the basic reforms the country so badly needs are being ignored. The economy is in a mess and other than dealing with the energy bill, nothing is being done to solve the problems. Reaching for a Eurobond issue to finance government

spending is the national equivalent of a household putting its running costs on a credit card rather than economising and looking for a new job.

The economic indicators are all plummeting and the outlook is becoming bleaker. Growth stalled at the end of the first quarter and while the government insists Ukraine can put in 3-4% growth this year, the IMF cut its outlook from 3.5% to zero growth at the start of April. Hard currency reserves

that support the value of the currency were flat in March at $24.7bn, or 2.8 months of import cover, which is not quite enough to support the currency. April's Eurobond issue has staved off devaluation fears for the moment, but the government was forced to spend $827m to prop the currency up in the first quarter of this year so has bought itself maybe another four months before it will need another big dollop of cash. Prices for goods are falling, down by 0.8% in March year on year – continuing the longest period of deflation in Ukraine’s modern history – and will crush growth and investment. And tax collection is falling while spending increased four-fold in the first quarter on year.

In the face of all these problems, First Deputy Prime Minister and the former governor of the National Bank of Ukraine Serhiy Arbuzov has suggested that things will be okay because Ukrainians have an estimated $100bn in hard currency savings stashed under their beds. "We have a deep domestic market, the public has over $100bn in hand. The money is exposed to risks – from being eaten by mice to crime," Arbuzov said in an interview. This is an asinine economic argument and even if true, then while it might cushion the population from some of the pain in a crisis, it will do little to prevent an economic crash as by definition the government has no access to this money.

The state needs to be using this time to restructure the economy and put it back on the path to sustainable growth. However, since the opposition has blocked the Rada from carrying out its duties for most of the time since October’s election, work has come to a standstill. In April, the ruling Party of Regions simply moved next door and threatened to pass laws on its own, in a move of questionable constitutionality, which has broken the impasse. However, as the two sides of the house are at each other’s throats, the chances of getting anything done are next to nil.

"The government insists Ukraine can put in 3-4% growth this year, but the IMF cut its outlook from 3.5% to zero"

Ukrainians split between EU and Russia

bne

Reflecting the deep divide between the east and west of the country, Ukraine's population is split evenly in its opinion of which way the country should head,. According to a recent poll, half of Ukrainians would support the country's accession to the EU, but nearly as many say they'd like to see Ukraine join a sort of rump Soviet Union in a single state with Russia and Belarus.

According to a survey conducted by the Rating Group, some 50% of citizens are in favour of Ukraine's accession to the EU, 37% are against it and 13% undecided. Asked about the creation of a single state of Ukraine, Russia and Belarus, 42% of respondents supported this idea, 47% rejected it and 11% failed to answer.

However, rather bizarrely not every Ukrainian sees the ideas as mutually exclusive. "Interestingly, one in four Ukrainians who supports the creation of a single state with Russia simultaneously supports Ukraine's accession to the EU," says the study.

In addition, the survey showed that 41% of respondents believe that the signing of the EU Association Agreement and the creation of a free trade area with the EU are more advantageous than joining the Customs Union of Russia, Belarus and Kazakhstan. Another 38% are in favour of Ukraine's accession to the Customs Union and 20% undecided.

22 I Eastern Europe bne May 2013 Eastern Europe I 23bne May 2013

Spreading fertilizer in RussiaBen Aris in Moscow

In a grey, dusty field three hours drive from the "hero" city of Volgograd, better known by its old

wartime name of Stalingrad, a brand new derrick rises above the melting snow that marks the site of the biggest investment in Russia outside of the oil and gas sector.

The derrick is the entrance to the VolgaKaliy mine shaft, which will drop more than a kilometre below the surface to one of the richest potash deposits in the world. EuroChem Mineral and Chemical Company, a Russian fertiliser maker, is in the midst of investing $7bn into a brand new mine in Volgograd and at a second site in Perm, that once operational in 2017 will make the company the world's fourth biggest player in the business.

All around the entrance to the mine are pens filled with sections of cast iron wall cladding and other equipment at the ready. The shaft is already over 500 metres deep and is sinking by another two to three metres a day as the small team of miners work three shifts around the clock.

EuroChem was founded in 2001 and is Russia's largest mineral fertilizer producer by profitability. The company bought the VolgaKaliy licences in 2005 for $106m together with the rights to a second site at Perm in 2008, which is shallower and is being developed in parallel. When both these sites are at full

production – sometime after 2020 – they could double the company's output.

But it is still early stages for VolgaKaliy and sinking the shaft to the deposit is the riskiest part of the operation. At VolgaKaliy two storage buildings are already mostly completed, while the foundations for a processing plant have already been set and await their walls and equipment that will be arriving in the next two years.

EuroChem is owned by legendary Russian banker Andrey Melnichenko

(92%) and EuroChem’s CEO Dmitry Strezhnev (8%), who have already invested $1.1bn out of the estimated $2.6bn needed to complete the first phase of the mine. Melnichenko is better known for founding MDM Bank, which became Russia's most successful commercial bank after surviving the 1998 crisis, but in 2007 he switched out of banking and into industry with what in retrospect was immaculate timing.

Russia is nothing if not a cornucopia of mineral resources, which is wealth simply waiting to be dug out of the ground. But the VolgaKaliy project is unusual even by Russian standards in a number of ways.

The established potash producers, including the Russian rival UralKali, pooh-poohed Melnichenko when he first floated the idea of the Volgograd mine, as he had little experience in the business. But Melnichenko has gone at the project like he does everything else – at 100%. He has assembled an experienced team headed by veteran US miner Clark Bailey, who has worked all over the world. Melnichenko persuaded Bailey to come out of retirement to take this job, and the consummate miner seems as at home on the edge of the tundra struggling with the Russian language as he would on his porch back in Austin, Texas. "One of the most attractive things about VolgaKaliy

is at its 39.7% ore grade, this deposit is of exceptionally high quality, which will adds to the mine's profitability once it is in production," says Bailey in his Texan drawl.

And finally, while most mining operations in Russia are brownfield deals where the game is to upgrade Soviet-era equipment and techniques, VolgaKaliy is a greenfield project, a mine built from scratch to the highest international environmental and safety standards. EuroChem is sparing no expense on equipment and has even

begun construction of an entire town at the cost of $300m to house some 4,500 workers plus their families for the 46-year lifetime that the mine is expected to have. "EuroChem's VolgaKaliy is recognised as the most advanced greenfield potash project globally," Bailey says.

Water worksSo far there is not much to see other than the derrick and the foundations of the storage and processing building that will surround the mine when the first potash sees daylight. A giant metal bucket is lowered into the shaft and descends rapidly to the floor 570 metres below. The walls are lined by curved iron panels bolted together to hold back the sandy soil and then has concrete pumped in behind them to make the shaft permanent.

The main problem is water, which can build up against the side of the shaft and either blow it inwards or at least cause flooding at the bottom of the mine. The company has adopted a technique first developed in Poland: smaller holes are bored in parallel around the shaft and four giant refrigeration units close to the mine head pump coolant down to form a wall of ice around the shaft before the iron panels and concrete are put in place. The inside of the shaft is covered with brilliant white ice until you get to the bottom where hot fresh air is pumped down to where the digging into the floor of the shaft is going on.

The two deposits in Volgograd and Perm hold a total of 1.613bn tonnes of potash and VolgaKaliy will be able to produce 2.3m tonnes a year in the first phase and 4.6m tonnes in the second when a second shaft is sunk sometime after 2017. The second phase of work is due to be finished in 2020 and the mines will be working at full capacity from 2022. The total investment of $7bn will be financed out of EuroChem's cash flow from its other business lines.

And the company will be producing into a rising market. The first 1.4m tonnes a year will be used internally by EuroChem; last year it bought a fertiliser

plant in Antwerp that processes potash, but EuroChem currently buys all of the potash it needs on the open market. However, the mine is also playing into a global mega-trend of rising demand for agricultural products. The advent of bio-fuels has put pressure on agro-producers and the governments around the world have seen their stocks/demand ratios plummet to multi-year lows. The rest of VolgaKaliy's production will go into a global market where demand is currently running at 55-56m tonnes a year and rising by about 2% a year, according to experts. "Eventually we want to start

processing the potash and producing speciality products," says Bailey.

But even without the rising demand VolgaKaliy should be a money-spinner. "VolgaKaliy is cheap. Part of our advantage comes from the very high quality of the ore, but another important part is the very short link to the port. We are going to be hard to beat on price," reckons Bailey.

The mine is only 500km from the Black Sea where EuroChem has already built a port terminal at Tuapse that can handle 2.5m tonnes a year of potash and the company owns a small fleet of ships that can deliver it to customers around the world, including the traditional buyers in Brazil and India. The nearness of the port means EuroChem's potash could be the cheapest on the international market.

Although the financing and profitability of the project has never been an issue, the company clearly has its eye on an eventual IPO. The attention to international best practices of the mine facilities and accommodation for the workers has also been applied to the plant's environmental impact and finances. "Safety is a core value for our company. I don't say a 'priority' as

priorities in companies tend to change over time, but our attitude to safety will not," says Bailey. "We want to be the 'best in class' for the entire mining business."

The same is true for the company's corporate governance. Despite it being a privately held company with only one bond issued last December for $750m, it reports its international audited financials quarterly and publishes them on its website. The senior management also regularly meet with investors and speak at conferences. In

short, the company runs a very open and transparent ship. All of this will play well with investors in a sector that is usually marred by opacity and dependence on government ties.

An IPO is not possible until the shaft is sunk. Then EuroChem expects to float, probably on the London Stock Exchange, and should be able to raise several billion dollars.

"VolgaKaliy is cheap. We are going to be hard to beat on price"

"This deposit is of exceptionally high quality"

Clark Bailey

bne May 201324 I Central Europe bne May 2013 bne May 2013bne May 2013 Central Europe I 25

Latvian authorities on watch for CIS money flows

Listen to the words of Latvia's policymakers and the Cyprus financial crisis gives the Baltic

state nothing to worry about. But look into their eyes while they are saying it, and you sense a certain desperation mixed with fear.

The reason is simple: with Russian cash certain to leave Cyprus at the earliest opportunity – thanks to the anti-Russian rhetoric deployed by the EU as much as the financial hit that Russian depositors are being forced to take – everyone is wondering where the money will head to.

The destination could be Switzerland, the US or Cyprus-like offshores in the Caymans or Virgin Islands. EU destinations London, Luxembourg and Latvia look just as likely – the latter

Mike Collier in Riga

thanks to its large Russian-speaking population, wide range of boutique banks specialising in non-resident deposits and the simple fact that, as the hundreds of Russian-registered cars cruising the Vidzeme highway from

Pskov each day prove, these days it feels safer having your money close at hand.

Until recently, attracting Russian cash was all wine and roses; now it is rapidly

becoming the government's worst nightmare.

Speaking to bne on March 28, the country's financial regulator, Kristaps Zakulis, said Latvia had nothing to

worry about and even blamed the media for not properly understanding the situation. "There is too much speculation and too little statistics to prove such speculation," Zakulis said,

"Until recently, attracting Russian cash was all wine and roses; now it is rapidly becoming the government's worst nightmare"

insisting that the level of non-resident deposits (NRDs) in the Latvian banking system had only increased in February due to exchange rate fluctuations.

"In Latvia we are talking about tens of millions [of euros]. In Cyprus we are talking about tens of billions – they are not comparable things," Zakulis said.

Latvian banks have noticed an increased interest from overseas depositors in the wake of the Cyprus crisis, Zakulis admitted, but said it was "the same as the increased interest from journalists and the media," and had not yet resulted in substantial amounts of cash flooding into Latvia.

"We are looking at the statistics and we do not see any movements right now," Zakulis said. "If money is attracted, it should be clean money and it should meet the requirements regarding liquidity and so on."

Resident deposits in Latvian banks decreased by 0.1%, or LVL4.7m, in February from the previous month, while NRDs rose by 0.4% or LVL26.9m. During the same period, loans worth LVL13.4m were issued to residents, while LVL86.3m in loans went to non-residents.

About half the €17bn deposited at Latvian banks are in NRDs. As Zakulis says, that is chicken-feed in global terms. But the Latvian NRD sector grew by 20% last year, and the International Monetary Fund (IMF) estimates that 80-90% of NRDs come from former Soviet states (even if channelled through offshores like Cyprus). And Zakulis has written to banks warning them to be careful about "the quality of their financial flows", though the precise contents of the letter have not been made public.

Latvian Finance Minister Andris Vilks was also in lockdown mode on March 28, reassuring his Lithuanian and Estonian counterparts in Vilnius that only around 10-15% of Latvian NRDs come from Cyprus. Prime Minister Valdis Dombrovskis and central bank governor Ilmars Rimsevics were

bne

Talk of a Central and Eastern Europe stock market has been going on for years, but on April 12 that outcome looked a step closer.

In a statement, the Warsaw Stock Exchange (WSE) – the biggest player in Central Europe – and the owner of the Vienna Stock Exchange (VSE) – the second biggest, which has consolidated several Emerging European bourses over the years – said they are in "preliminary discussions with a view to consider potential ways of strengthening mutual cooperation." At this stage all strategic options and cooperation routes are being reviewed, it added.

Bringing together Central Europe's two biggest exchanges would bring huge benefits for investors, by increasing liquidity on exchanges not always best known for that and cutting trading costs.

The WSE, for many years the underdog to the VSE, has succeeded in the last few years in attracting listings from across CEE. It has been particularly successful in grabbing business from the likes of Ukraine, where companies are eager to attract international capital without opening themselves up to Russian control by heading to Moscow.

On top of a series of floats from Polish state companies, that tactic has seen the WSE maintain a steady stream of new listings over the last few years, and it's now the biggest bourse in CEE – home to 438 companies with a total market capitalisation of nearly PLN700bn (¤170bn). CEE Stock Exchange Group – parent of the VSE – also controls the Hungarian, Czech and Slovenian bourses. It hosts companies with a combined market value of ¤129bn across the four exchanges.

Speaking at a conference on April 9, WSE board member Beata Jarosz said: "We are ready to seriously consider joining with a pan-European consolidation process. In the future we want to have a partner from the region, from Europe. As far as today's information [is concerned] I am not in a position to comment on it." A spokeswoman for the Austrian operator said the bourse was interested in some form of co-operation, but declined to elaborate.

The WSE is 35% owned by the Polish government, which has said it plans to unload that stake. However, while Warsaw is still in the drawn-out process of privatising several state giants, it's likely to want to keep control of the bourse. "At some time in the future... we will sell. We will fully privatise the Warsaw Stock Exchange," Deputy Treasury Minister Pawel Tamborski said at the same event as Jarosz. "When? How? These are very good questions, we still have all options open."

Tamborski added that Warsaw also wants to retain influence on the WSE to oversee the development of both the bourse and the country's capital markets. "The development of the capital markets in Poland is very high on the agenda of the government."

A CEE stock exchange in sight

26 I Central Europe bne May 2013 Central Europe I 27bne May 2013

media no-shows the same day and bne only collared Zakulis for a chat in the cloakroom following a meeting between the three of them plus representatives of the banking sector.

For the question is not what the level of NRDs is now, but what it will be when the EU decides to return to the principle of free flow of capital and let the money run.

Rietumu bank, one of the most successful banks catering to the NRD sector, said on March 20 that it was extending its opening hours at its overseas branches to cope with "a large number of enquiries related to the situation regarding the financial system in Cyprus."

One of Rietumu's analysts, Igor Zuyev, also produced one of the most entertaining commentaries on Cyprus, referencing the classic Russian comedy film "Island of Bad Luck". "It is obvious to everyone that as soon as foreign

depositors get access to their accounts, the majority will try to withdraw their money from the island to play it safe," says Zuyev. "At present no assets can be considered as risk free, especially in countries with weak state and banking institutions. Under the oppression of the crisis, governments can resort to the maddest and the most unfair measures which often contradict both their pre-election promises and common sense."

Yet the constant refrain of the Latvian authorities is that their banks are strongly regulated (notwithstanding the fact that half a dozen of them have been named in connection with the Magnitsky money-laundering affair and other scandals), so wouldn't Latvia be a great place to put Russian cash?

Until recently, yes – but with Latvia expecting a team from the European Commission in Riga any day to draw up a verdict on its application to join the Eurozone, officials are somewhat belatedly terrified that all this talk of dodgy Russian cash might queer their pitch.

Yet perhaps the Latvian authorities should worry more about Ukrainian money than Russian.

In a March 28 note, Capital Economics said: "Most attention has focused on the impact that the Cypriot bail-out could have on Russian depositors, but the deal may pose much bigger risks for Ukraine, which is already on the brink of a balance of payments crisis."

The economic consultancy goes on: "Tiny Cyprus is the main source of FDI into Ukraine, accounting for around 30% of the total. The introduction of capital controls in Cyprus risks disrupting these flows, which may

ultimately affect business activity and hit vital capital inflows into Ukraine... wider vulnerabilities mean that the Cypriot crisis may still be enough to tip Ukraine into a financial crisis of its own."

Given the strong and well-documented connections between the elite in Ukraine and Latvia's Trasta Komercbanka (which even Zakulis admitted to bne was one of the banks "more often involved in big scandals") and PrivatBank, a Ukrainian crisis might cause unpredictable knock-on effects in Latvia – the worst of which would be to prompt all those crooked Ukrainian oligarchs to open Latvian bank accounts and blow euro accession to kingdom come.

"The Cyprus deal may pose much bigger risks for Ukraine"

to just €3.7bn, but of that Poland accounted for €2.8bn, increasing its dominance. "Poland has worked very hard to separate itself from the rest of the region," says Miroslaw Januszko of Peakside Polonia Management, a real estate investment company. "Poland is supported by strong internal demand and there is no political turmoil like in Hungary. Prague is a bit similar but much smaller, while the rest of the region is simply for opportunistic investors… Over the next 10 years we should think only of Poland."

Joining the eliteIn a new survey of investors' perceptions by CBRE, the real estate firm, Warsaw now ranks in the top five among European cities, following London, Munich, Berlin and Paris. The reason for that is yields in the Polish capital are around 6.5%, about double what is achievable in Western Europe. Although returns are much higher, risk is falling; Poland is the only EU country not to have fallen into a recession in 2009 and, despite a recent slowdown in the economy, is still one of the EU's best performers. Investors also have the security of a politically calm country where the centrist government seems to be in no danger of being ousted, and where the legal code and issues like corruption fit EU norms. "Over the last years, investors have perceived Poland not as part of the CEE but as a core European market," says Maciej Zajdel of IVG Poland, the Polish office of the German property fund.

Investor interest has focused on the core of downtown Warsaw, the Central Business District, chosen by growing

numbers of international companies for their regional headquarters. There the rents are about €25 per square metre, almost double what they are

Europe as an investment destination, in large part because the Warsaw market is large and deep. That allows investors the security of being able to find a buyer for their property in the event they want to exit the country.

In 2011, Poland pulled in €2.6bn in new real estate investment, out of €6.1bn for

the whole of Central Europe, according to Cushman & Wakefield, the real estate firm. Last year was grimmer for the region, with CEE investment falling

BRICKS & MORTAR: Putting some Polish on the portfolioJan Cienski in Warsaw

The idea that Poland could be a safe haven would have been laughable for the past few

turbulent and war-torn centuries, but growing numbers of real estate investors are not smirking as they plough money into Poland – and particularly into Warsaw – seeking higher returns than those available in Western Europe at similar levels of risk.

"Investors are saying that the supply of core product is drying up," says Brian Burgess, Poland managing director of Savills, the real estate consultancy. "The UK is very expensive, Italy and Spain don't have the climate to invest, and there is a lack of product in Scandinavia. Where is the next market? Poland."

Over the last few years Poland has pulled away from the rest of Central

bne:infrastructure

The economic crisis has hurt all the economies of the world, but now governments across the Central and Eastern European region are planning to spend trillions of dollars on infrastructure investment as the most effective form of economic stimulus to put their economies back on a sustainable growth path. This investment was badly needed even before the crisis hit 18 months ago. Decades of work lie ahead, which presents a unique opportunity for investors of all kinds. Every two weeks, bne will publish an online a round-up of the main investment projects, analysis, commentary, regulatory changes, investment plans, and funding news in bne:infrastructure.

Register and sign up for the list here: www.businessneweurope.eu/users/register.php

"Over the last years, investors have perceived Poland not as part of the CEE but as a core European market"

28 I Central Europe bne May 2013 Central Europe I 29bne May 2013

in suburban Warsaw and higher than in Polish secondary cities and in the capitals of the rest of Central Europe, except for Prague. "Our favourite asset class is offices in the Warsaw CBD and other secondary city CBDs. Cities we like are Krakow, Wroclaw, possibly Szczecin, Gdansk and Lublin," says Ben Habib, CEO of First Property Group, which invests in UK and CEE real estate.

Two big office transactions last year included the €210m sale of the Warsaw Financial Center to Allianz Real Estate and Tristan Capital Partners and the €148m sale of Warsaw's International Business Center to Germany's Deka.

There was also appetite for retail properties – even those outside of Warsaw were snatched up, as long as they had a solid market position and a good list of tenants. ING sold its 77% stake worth about €475m in the Zloty Tarasy shopping mall in central Warsaw, while the Manufaktura shopping mall in the city of Lodz changed hands for an estimated €350m-400m.

Investors also woke up to the potential of Polish logistics as the country finally moved forward on completing its highway system, which made it possible for retailers and shippers to build centralised warehouses serving the whole country. Last year, investment in logistics and industrial properties came to €460m, accounting for more than 16% of overall investment, the highest level in years.

While Poland is riding high, there are hopes that the rest of the region will start to catch up if and when the Eurozone crisis starts to abate and growth returns. In the first quarter of this year, the region attracted €958m in investment, of which the Czech Republic accounted for €237m and Hungary for €159m, significantly more than in the same period a year earlier. "I don't share the view that core central Warsaw is the only way to go," says Eric Assimakopoulos of Revetas Capital, a regional real estate investor.

Nicholas Watson in Prague

One of those investors attracted by Poland's newfound quality as a bustling island of real estate opportunities in a becalmed sea is Palmer Capital.

The UK-based real estate fund manager, which beefed up its continental European business in 2012 by acquiring Middle Europe Investments, a struggling Dutch real estate fund manager with ¤232m of assets under management in Central and Eastern Europe, is planning a new fund that will target Polish retail properties in the country's regional cities.

"We are trying to play on our regional knowledge and coverage, and what we like are the dominant shopping centres and retail property investments in Poland's regional centres – we're not trying to buy class-A properties in Warsaw," says Ben Maudling, the regional managing director of Palmer Capital and a longtime resident of the Czech Republic.

The targeted investors for the planned fund are German institutions, which prefer lower risk property investments, such as well-located regional retail properties that can be purchased with debt financing. "There's less investment risk in Czech and Poland compared to somewhere like Ukraine, and we are looking to offer an income return of 8% net of tax," says Maudling.

Palmer Capital has had an instant impact on the funds it acquired as part of that deal in 2012. The Emerging Europe Property Fund for example, which has six Czech properties and 11 Slovak ones, mostly class-B and class-C office buildings, was the best performing real estate fund on the Amsterdam NYSE Euronext exchange (and the fourth-best performer among NYSE Euronext funds of all kinds) in 2012, with its share price rising 42% from ¤6.70 to ¤10.00 during the calendar year.

Maudling says they undertook a number of asset management initiatives to improve the performance of the property funds they took over from Middle Europe Investments last year. Many of these such as cost cutting were not rocket science and led to quick improvements in portfolio performance. "The current share price of our listed Palmer Capital Emerging Europe Fund still, however, reflects a 50% discount on NAV [net asset value]. We hope to further reduce this by continued restructuring including renegotiating leases and rents, moving tenancies and improving the financing of the portfolio, which includes bank debt and mezzanine financing," says Maudling.

Palmer is in the process of "pruning" the fund's portfolio – it recently sold one building in the Czech town of Zlin and plans to sell another two this year, something that testifies to the relatively high liquidity that exists in the Czech market, a stark contrast to the moribund markets further west.

Maudling says Palmer Capital would like to double its assets under management in the region from the current ¤300m. "We want to expand our Central European fund management business. At the moment, for us, Poland and Czech Republic offer better investment opportunities than Hungary."

FUNDS: Palmer Capital to shop in Poland

Muck and brass in LatviaMike Collier in Riga

If the ability to attract the attention of real decision-makers is key to a successful international business, then

Greenworld Fuels is a company to watch.

"We had President Putin on our stand at a trade fair in Russia," says Paul Barratt, chief executive and one of the main shareholders of the UK-registered but Latvian-based company. "Of course we were delighted, but we were even more amazed that he stayed for 20 minutes and asked a lot of detailed questions. He was very well informed."

Barratt repeated the trick at the Northern Future Forum in Riga in February when, after giving a five-minute presentation to a variety of prime ministers and other bigwigs, he was then grilled for a good 20 minutes by British Prime Minister David Cameron, suddenly rediscovering his former interest in the green economy.

Barratt is no novice when it comes to Baltic business, having previously developed a company called Blue Mountain Peat before selling it for a tidy profit to the Germans.

Greenworld consists of several companies from R&D to manufacturing with offices in London, Sao Paulo, Moscow and St Petersburg, but is

essentially divided in two parts: one dealing with waste collection and logistics (featuring ingenious underground communal garbage dumps that can hydraulically emerge from beneath Scandinavian streets like the base of a small-scale James Bond villain), and the other processing the captured waste and turning it into fuel-grade ethanol.

The production facility is in Bolderaja, a small town near Riga whose past as a Soviet submarine base means there are still a fair number of skilled engineers and scientists available to recruit to help the company become a major player in waste disposal – an industry that clearly is only going to grow and grow. "We decided to start with a clean

sheet. Most existing waste management systems just concentrate on small facets looking for revenues from different waste streams. We thought the only real way to approach it is to look at the end-to-end system from waste collection all the way to energy," Barratt tells bne.

Not causing a stinkThe centrepiece of that desire is the company's unique 6-hectare ethanol production plant, which sees raw household trash arriving at one end and fuel-grade ethanol emerging at the other, having been transformed into pulp biomass in between. According to the company, it can already work at around 94% efficiency (ie. only 6% going to landfill) with a near-100% figure possible within three years.

The amount of ethanol produced varies according to the nature of the waste going in, but output would typically be around 250-350 litres per tonne of waste. Incredibly, in just 72 hours a bag of trash can be transformed into bioethanol.

Greenworld has already signed orders for three facilities in the South Korean capital of Seoul and another in Smolensk, with Russia clearly a target market. A feasibility study has identified that 25 such plants would be enough to service a city "the size of St Petersburg" and a smaller metropolis of 2-3m – the type of city that abounds in Russia – would need around 15 plants.

Backing up its potential for Russian expansion, Greenworld has won the backing of the Academy of Science in Moscow, which carried out due diligence on the production process and gave it the thumbs up. "Our target is that the waste never moves more than 10 kilometres from its point of collection. Rather than have very big landfill sites or huge factories we have small, compact systems," Barratt says.

"That means waste moves in a sort of spoke and wheels system. Our optimum size is something between a 180,000- to 250,000-tonne-per-year plant. It gives us a very small ground space located on the edge of urban areas and means we can continually receive waste. We

"We had President Putin on our stand at a trade fair in Russia – he was very well informed"

30 I Central Europe bne May 2013 Central Europe I 31bne May 2013

aggressively control odours and the most important factor is that there is no external waste storage – everything comes straight in."

So no stinking, rotting piles of waste blighting the lives of nearby residential districts and causing other health hazards – which also makes planning applications easier once people are convinced that waste treatment plant around the corner is actually rather pretty and doesn't stink to high heaven. "The key is to get a pure biomass stream without releasing toxins. We've spent the last two to three years developing this separation system and we then use best available technology to complete the process using other partners such as the Danish enzyme company Novozymes who have supported us with their own R&D," says Barratt.

Once the ethanol is produced, it can be de-natured for blending into the fuels of local retailers or it can be shipped to other markets. The potential for such a product is immense, regardless of the additional green benefits of the production method. It is estimated that EU countries alone will use around 325bn litres of transport fuel per year by 2020, with ethanol consumption reaching 12bn litres.

EU regulations stipulate that 10% of automotive fuel must be biofuel by 2020. Unlike biofuel produced from crops such as rape, cellulosic ethanol of the type produced by Greenworld does not require increasing areas of land to be given over to fuel crops. "Market potential is huge and will grow progressively with added value over time as demand outstrips supply," Barratt says.

The eastward orientation of the company is mainly down to the short-term nature of waste contracts in the west – a point Barratt made strongly to the British prime minister. "It's impossible to attract the investment to build a facility like this with a five-year waste model," he says. "Generally we would be looking for at least a ten-year contract to make it feasible and give decent payback time to the investors."

Parting shots at Fidesz bne

It took the new governor of the Hungarian central bank just a month to oust the last remaining member of

its monetary policy council that was not appointed by the ruling Fidesz party. As Julia Kiraly resigned her post on April 8, the departing deputy governor gave the new regime both barrels.

Kiraly's resignation letter to President Janos Ader was sent just two working days after she complained of being rushed into a decision on the Magyar Nemzeti Bank's (MNB) stimulus measures, which were approved on April 4, and three months before the end of her six-year term. In a missive that blasted the central bank's new mode of operations, Kiraly said she no longer felt able to put her name to policy decisions that she believes may prompt a loss of confidence in the bank and damage the economy.

Governor Gyorgy Matolcsy, credited as the architect of much of the Fidesz government's controversial "unorthodox" economic policy, was appointed by Prime Minister Viktor Orban to succeed arch-enemy Andras Simor in March. While the previous governor had been latterly hamstrung by Orban's expansion of the MPC earlier – leading to a six-month easing cycle despite his warnings

on currency and inflation risk – fears of more unconventional actions from the new governor have dominated the market, and depressed the forint since the start of the new year.

Restrained by the large volume of foreign currency debt that's held by Hungarian institutions and households, Matolcsy has been relatively conservative in terms of policy thus far, fearing a fall in the currency would put

unsustainable pressure on their already stretched finances. However, he almost appears to be willfully trying to disturb investors via his internal administration of the MNB.

Worrying changes Some complaints of the old guard at the central bank look like standard responses to change at the top, magnified by a media corps happy to hammer Orban & Co to fill their pages.

That has seen unnamed staff moaning of office moves and the like. However, other moves appear more of a concern. Power has been concentrated in the governor's hands, while several senior economists were released instantly. Meanwhile, the traditional news conferences given by the governor and designed to help clarify policy for investors (a central plank for any central bank) have been stopped.

Adding to the concern, Kiraly's resignation came four days after she abstained from a vote on economic stimulus measures. She complained on April 6 that she was given a 40-page document on the issue just 35 minutes before it was put to a vote. The scheme to offer cheap credit to small business was met with relief by the market, who are on tenterhooks over Matolcsy's moves. The fact that the meeting on the issue was sprung on it at the last minute didn't help calm those nerves.

It was enough to push the last of the eight-member MPC not appointed by the current government to jump. "Decisions have been made that could cause serious damage not only to the National Bank of Hungary but in the longer term also to the Hungarian economy… I can see an increasing likelihood that the central bank's decisions may become not necessarily

well-founded and mistaken, for which I don't wish to take any responsibility, neither as a deputy governor, nor as a member of the monetary policy council," Kiraly wrote in her resignation letter.

Heading for the exitBut it's not just central bankers who are getting out. April saw the first foreign bank to exit the Hungarian "nightmare" as Italy's Banco Popolare agreed to sell

'Decisions have been made that could cause serious damage to the Hungarian economy'

Mike Collier in Riga

The outlook for businesses in the Baltic states is positive, according to a survey released by KPMG on April 9 titled, "Pulse of Economy" [sic] - and perhaps more significantly sub-titled, "Confidence prevails in the Baltics".

After speaking to 260 business leaders in the region, KPMG says: "The results of the survey indicate ongoing trust in the solid performance of the economies. GDP growth expectations in all three countries fall between two and four percent with 80% of the Estonian, 79% of the Lithuanian and 75% of the Latvian respondents opting for this range, whereas about 9% of the Latvians think the economy could grow even more than 4% in 2013. Interestingly, respondents in all three countries agreed that Estonia is the most attractive investment destination - an opinion that Lithuanians (87%) hold even more strongly that Latvians and Estonians themselves (both 63%).

Regarding investment plans over the next three years, 19% of all the Estonian companies polled intend to invest in Latvia, 14% in Lithuania and 9% in Russia. Latvian companies plan to invest most actively in Russia (10%), Lithuania (8%) and Estonia (7%). Lithuanian companies see Estonia and Belarus (8%) as their likely targets followed closely by Latvia (7%). The share of the companies not planning any investments abroad is 50% in Lithuania and 35% in both other countries.

The period of austerity seems to be over with pay rises rather than cuts expected in all three Baltic states. "There are obvious signs of confidence among the top players of Estonian, Latvian and Lithuanian businesses, indicated either by further expectations of a sound GDP growth ranging from two to four percent, or by an intention to raise salaries and hire more staff," concludes KPMG's senior partner in the region, Stephen Young.

But are such levels of confidence realistic? While the Baltics look set to perform better than most of Europe in the next year or so, there are several worrying factors waiting in the wings, the most important of which is clearly the unending ructions in the Eurozone - which will become even more crucial if, as expected, Latvia next year joins Estonia within the zone (and possibly Lithuania in 2015).

The way things are lining up there is a possibility Latvia may get its membership card just in time to help bail out Italy, which would be a typically Baltic case of success being more costly than failure. Speaking of which, one of the country's biggest businesses, the Liepajas Metalurgs steelworks, looks like it could go bust any day, providing a serious drag on GDP growth.

It also looks as if the Baltics' post-crisis rebounds may be drawing to a close, with even bulletproof Estonia affected. GDP growth expected to be only marginally better at 3.3% than last year's level of 3.2%, according to Swedbank. The Swedish bank sees Latvia's economy growing 4.3% (5.6% last year) and Lithuania's by 4.0% (3.6%) and advises that the breathing space the Baltics have earned should not be wasted.

Baltic business – singing strong or whistling in wind?

www.fidesz.hu

32 I Central Europe bne May 2013 Central Europe I 33bne May 2013

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

What you need to know

Sign up today for a free month trial of all our services www.bne.eu

| Eastern Europe | Russia | Belarus | Ukraine || Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

its small subsidiary to Hungary's MagNet Bank for just €500,000.

Dominated by Eurozone groups, Hungary's banking sector has been hit hard since the Fidesz government came to power in 2010. High windfall taxes, one-off schemes to reduce foreign-currency debt in the country and a new financial transaction tax drove the sector to its first loss in 13 years in 2011, a situation that continued last year.

Banco Popolare Hungary, which was founded through the acquisition of IC Bank during an expansion push by the Italian lender in 2007, is the first foreign bank to pull out of Hungary since PM Orban recently appeared to call for denationalization of the country's lenders. Although they've pulled back heavily on investment and lending, the foreign banks have insisted throughout the past three years that they remain committed to the Hungarian market.

That determination looks to be weakening.

And it's not just the banks. The Italian bank was quickly followed out the door by German utility RWE, which said it is to slash its investment in Hungary by 50% this year, citing the government's "completely unacceptable" policy moves that amount to "virtual expropriation".

Biedronka's ladybugs swarm over PolandJan Cienski in Warsaw

The bright yellow building adorned with a smiling ladybug is the most common retail sight

in Poland, and will be even thicker on the ground as Jeronimo Martins, the Portuguese parent of Poland's Biedronka discount grocery chain, announces that it plans to add almost a thousand new shops by 2015.

Biedronka was founded in the 1995 by Polish retail genius Mariusz Switalski (who went on to found the highly successful Zabka convenience shop chain), and was bought by the Portuguese retailer in 1998. At the time, the chain had 243 shops; it now has more than 2,100 and has become

the main earner for Jeronimo Martins, accounting for almost two-thirds of the company's total turnover.

Biedronka racked up €6.7bn in sales last year, an increase of 16% over a year earlier – this at a time when Polish retail sales have slumped as the economy slows. "We started to prepare for a possible slowdown in the growth of the economy a year ago and are now completing the process," Pedro Pereira da Silva, Poland country manager for Jeronimo Martins, told the Rzeczpospolita newspaper. "We increased our offering of fresh produce and changed the look and redesigned all of our shops."

Wood & Company, a Central European investment bank, notes that while Polish food retail grew by only 1.3% in the final quarter of last year, Biedronka grew its market share by almost 19% – as of the end of 2012 it controlled almost 15% of the Polish retail market. "Notwithstanding the challenging competitive environment, we see reasons to be sanguine," wrote Wood in a research note, adding that it foresees that Biedronka's like-for-like sales – the most fundamental measure of retail success – will grow by about 10% this year, a far higher figure than for retail overall.

The reason is that the chain has hit a sweet spot in Polish retailing – first aiming at poorer consumers in small and medium-sized towns, and then moving to larger cities and going upmarket as the country has become wealthier. While a few years ago Biedronka was the kind of the place where people who had any money would steer clear of, now the chain features fresh produce and a growing selection of wines and even the occasional lobster, aiming at a more status-conscious but still price-sensitive shopper.

The inside of a typical shop is a mix of cheap and cheerful products – most still packed in original shopping boxes – mixed with quite good produce. Cashiers only take cash, as the chain refuses to deal with the credit card companies.

As a sign of its new aspirations, its latest advertising campaign uses Daniel Olbrychski, one of Poland's best-known actors, who stands in a sun-dappled farm kitchen extolling the virtues of Polish produce.

Biedronka, which has become Poland's largest private sector employer with almost 40,000 workers, has also sought to go slightly upmarket in terms of labour relations. A few years ago it was hit with a lawsuit filed by disgruntled workers claiming they had been forced to work unpaid hours. It now says that

it pays about a fifth more than the minimum wage, and problems with workers have subsided.

Biedronka's dominance of Poland's retail landscape looks like it will continue to grow. The firm plans to invest almost €390m this year to open 290 new shops, and by 2015 it hopes to have 3,000 shops.

While there are few additional possibilities of expanding in small towns of about 20,000 people because the market is pretty well saturated – Market Side, a retail analysis company, finds that such towns average about one discount grocery shop per 5,000 inhabitants – there is still scope for

growth by either going smaller and moving into villages or by continuing to grow in larger towns and cities.

Market Side finds that half of all Poles live within 1 kilometre of a discount shop, and the penetration is likely to increase, with the company predicting that the total carrying capacity for such shops in Poland is about 5,000 stores –

of which the lion's share will belong to Biedronka. Biedronka is also using its market heft to open a network of cafés and pharmacies.

As Biedronka becomes more urban and goes upmarket, big-city hypermarket chains are bearing the brunt of the growing competition. In recent months big Polish supermarket chains like Tesco and Real have reacted by launching advertising campaigns stressing their low costs. "We are determined, if Biedronka decides to lower their prices, then we will do the same," Jaroslaw Moc, sales director at Real, a German chain, told the Gazeta Wyborcza newspaper.

But Biedronka's agility and market power make it a formidable foe. "It appears that the discounters have won the war for clients… they have been able to attract not only the customers from large hypermarkets but above all those shopping in small neighbourhood convenience shops," says Tomasz Starzyk, retail expert at Bisonde Polska, an analysis firm.

"As Biedronka becomes more urban and goes upmarket, big-city hypermarket chains are bearing the brunt of the growing competition"

34 I Southeast Europe bne May 2013 bne May 2013 Southeast Europe I 35

Finally, a dealNicholas Watson in Prague

Defying the cynics, Kosovan and Serbian leaders managed to stitch together an 11th hour,

EU-brokered deal on April 19 over normalizing relations between the two foes – a breakthrough that will have far-reaching implications for both countries' EU hopes. There are still considerable hurdles ahead, though.

The deal after ten tough rounds of negotiations between the prime ministers of the two countries under the supervision of Baroness Ashton, the EU's foreign policy chief, is a major success for the bloc, which had made progress between Serbia and its erstwhile province Kosovo a key condition before it would start membership talks with Belgrade. The European Commission duly recommended the EU open EU

membership talks with Serbia a few days later on April 22.

After the eighth round of talks broke up without agreement on April 8, there were worries that a deal was beyond the two. Kosovo unilaterally declared independence in 2008 after Nato helped stopped a civil war several years before between the ethnic Albanian and Serbian populations. And while many countries recognise Kosovo as an independent country, Serbia still does not and has been holding on through various means to the Serb-dominated north of the country. About 140,000 ethnic Serbs live in Kosovo out of a total population of 1.7m; about a third of them live in the north. And it's the fate of those Serbs in the north that proved the main sticking point in the talks.

Serbia had offered in the talks to recognise the authority of Pristina over the north, but was pushing for broad autonomy for the Serbs living in the Serb-dominated north. The Kosovans were holding out against this, and Serbs felt that Pristina was not interested in compromising because the EU was not putting any pressure on them to do so.

That appeared to have changed over the subsequent weeks. The 15-point treaty that was negotiated says that while Serbia does not recognise Kosovo as a state, it concedes its legal authority over the whole territory. In exchange, the Kosovo authorities concede a level of autonomy to four Serb-controlled areas of northern Kosovo, which will form one large community. This region will then receive broad rights and

authority in issues pertaining to police, justice, education, health care and culture.

That this Serbian community in Kosovo will still be financed by Pristina, and the police and courts in the northern region must be part of the Kosovan judicial system, was taken by opponents of the Serbian government as "recognition of the Kosovar state," according to former Serbian PM Vojislav Kostunica and his opposition party, the Democratic Party of Serbia.

Kostunica's scepticism over the deal is mirrored by Kosovan Serbs and hardline nationalists on both sides. Serbian nationalists say the treaty is a "betrayal of Serbian interests in Kosovo," while government officials say they have had death threats pouring in "every second". Protests in the north of Kosovo were inevitable.

Implementation is key. It won't be straightforward mainly because of the resistance of Serbs in Kosovo's north, who have a habit of setting up roadblocks and indulging in violent flare-ups. "The Nato-led KFOR [peacekeeping] mission, Eulex [the EU's police mission to Kosovo] and the Kosovar government will be responsible for supporting the agreement," said Hashim Thaci, the prime minister of Kosovo, who is a former leader of the Kosovo Liberation Army, guerrillas who fought the Serbs in 1998-1999. "We also expect facilitating measures from Serbia."

Both parties agreed that they will not "hinder or disturb each other in the process of approaching the European Union," which is key for the wider investment community. The Commission a few days after the deal recommended to the EU member states that accession talks with Serbia should be started, probably in June, and Kosovo got a formal commitment to negotiating an earlier step in the process, known as a Stabilisation and Association Agreement.

What that means more than anything else is money – something both

"Implementation is key, but won't be straightforward because of the resistance of Serbs in Kosovo's north, who have a habit of setting up roadblocks"

countries' economies are in dire need of. That means EU aid as well as private sector portfolio and direct investment.

"[The EU's] move should see a confidence boost to Serbia, and to investment into Serbia," says Tim Ash of Standard Bank. "That said, as the process with Turkey has proven, the process can be very, very long, and individual member states can stall/delay the process, and the longer term issue over the future state of Kosovo remains as an impediment still to actual Serbian EU accession. Serbia will not get the final sign off for EU accession until the issue of Kosovo is permanently resolved to the satisfaction of both sides."

Stefan Lehne of the Carnegie Europe think-tank says the agreement also vindicates the EU's overall policy toward the Western Balkans. "Resolving the region's remaining political and security problems and supporting the Western Balkan countries on their way to the EU are mutually reinforcing processes... If the people of the region

are confident that they will eventually join the European mainstream, they have a good chance of settling their differences. If they lose faith in a better future in the EU, they are likely to preserve their grudges and divisions."

The EU is hoping for positive knock-on effects, particularly in the ethnically split Bosnia-Herzegovina, which might now feel more able to make similar necessary compromises.

36 I Southeast Europe bne May 2013 bne May 2013 Southeast Europe I 37

You never have to look very hard to find negative headlines about Serbia, the delay to EU talks being

just the latest example. But behind the bad press there have been several notable positive developments on the economic front.

In April, agreement was finally reached on a new $500m loan from Russia to help shore up Serbia's weak budget posi-tion. There had been talk of a $0.7bn-1bn loan in the works, but that anything was agreed at all at such a perilous time for the Serbian and the wider European economy has to be a plus.

Serbian Finance Minister Mladan Dinkic said April 16 that the Russian loan would be used for repayment of old loans that were taken out under less favourable conditions. Serbia will repay $400m to the London Club as soon as April, and the next installment of the same amount will be paid off in the autumn, Dinkic told local media provider B92. "It is important that we stopped the public debt increase," the minister said, noting that the public debt "will remain" at 59% of GDP by the end of this year.

Serbia has been casting around for investment from other parts of the world, particularly the Middle East and China. Belgrade this year has already secured a

$400m sovereign loan from Abu Dhabi for investment in its agriculture sector and agreed more than $400m in invest-ment by the Al Dahra agricultural firm.

Then there has been a marked improve-ment in inflation. In March, Serbian inflation fell to 11.2% from 12.4% in February, and the recent peak of 12.9% in October. The National Bank of Serbia (NBS) and International Monetary Fund have both indicated that inflation could fall to 6-7% by year-end. "The decline largely follows the script of the NBS, which has argued that a combination of tight monetary policy (the central bank hiked its main policy rate by 225bp over the past year)… forex strength/stability and favourable base period effects par-ticularly stemming from the poor harvest in 2012 will force inflation sharply lower over the course of 2013," says Tim Ash of Standard Bank.

Ash also notes a big improvement in the country's trade and current account position in the first few months of 2013. In January-February, the trade deficit fell by 23.4% on year, with exports rising by over 30% as investments in the auto sector finally begin to bear fruit. The cur-rent account deficit narrowed by around 30% on year in January to just €176m, with exports growing by over 20%. Helping to finance that deficit will be the

rising foreign direct investment, which totalled €78m for the month, close to double the year earlier level, and around one quarter of the full-year total received in 2012. "Net FDI thus looks well on track to meeting the NBS/government prediction of over €1bn in inflows, perhaps reflecting more stability on the political front, relative policy orthodoxy, and rigorous efforts by the government to attract FDI inflows," says Ash.

A big drag on the economy remains Serbia's loss-making state enterprises. The government is trying to offload JAT Airways, RTB Bor copper mines, JAT Tehnika aircraft maintenance company and the indebted Galenika pharmaceuti-cals, but a combination of a weak global economy, a blighted history of failed privatisations, and Serbia's unhappy past relationships with foreign investors is making these a hard sell.

Serbia was hoping Abu Dhabi's Etihad Airways would be the white knight to rescue the loss-making JAT, but despite positive comments from the government over the past few months the Gulf airline on April 15 stopped short of taking a direct stake in the loss-making airline, agreeing for the moment only to share route-booking codes.

A few days earlier on April 12, the finance ministry revealed that the US-based unit of Canada's Valeant Pharmaceuticals International was the only bidder for Galenika that met all the conditions of a tender.

A running sore is the fate of the Zelezara Smederevo steel mill, which was "returned" to Serbia by US Steel in 2012 for the token amount of $1, the Pittsburgh-based giant bidding farewell with the words: "We will miss the people of Serbia."

Finance Minister Dinkic said talks are underway with "one major European company," though a tender for a strategic partner for the steelmaker has been extended four times now. The last deadline expired on February 28, and the only potential buyer, Uralvagonzavod from Russia, did not submit an offer.

Serbia beyond the (negative) headlinesbne It's not been an auspicious start to

the election campaign for the just-resigned governing party. With par-

liamentary polls scheduled for May 12, Citizens for the European Development of Bulgaria – GERB is its Bulgarian acro-nym – is trying to engineer what would be a first in post-communist politics in the Balkan state: a second term as the dominant force in government.

That would be quite a feat, considering that GERB, in government since 2009, stepped down on February 21 in the face of mass protests at high electricity bills that went broadly political (and very slightly violent), with its mouthy and popularity-hungry premier Boiko Borisov falling into uncharacteristic near-silence for more than a month thereafter. But Borisov has become talkative again and, with opinion polls unexpectedly favourable for him, the election campaign kicked off formally on Friday, April 12.

Things haven't gone too well for GERB so far. Over the first weekend of the campaign, attempting simultaneously to emphasise his government's welfare achievements and the erosion of the country's reserve position, Borisov con-trived to remark that "pensioners had eaten up the fiscal reserve" – a formula-tion gleefully pounced on by opponents.

And on April 12 came news from the prosecution affecting Borisov's key

henchman Tsvetan Tsvetanov, interior minister in Borisov's cabinet and now head of GERB's election campaign staff. Tipped off at the end of March – with information routed through (and well publicised by) Socialist opposition leader Sergei Stanishev – chief prosecu-tor Sotir Tsatsarov let loose a team of prosecutors to look into allegations of illegal phone-tapping by the interior ministry of a bewildering range of busi-ness figures and politicians (including some of GERB's own ministers).

Tsvetanov dismissed the allegations as nonsense, promising to resign if they proved true. Opposition figures duly called for him to make good on his promise when on April 12 the prosecu-tion announced that charges would

be filed against four interior ministry officials – three for failing to lay down proper surveillance guidelines and one for destroying evidence. These officials were Tsvetanov's responsibility, argue the opposition, though there's no sign so far of him doing the honourable thing. But the affair – inevitably dubbed

"Bulgarian Watergate" – will add heat to what already promises to be, well, quite a vigorous election campaign.

Feisty campaignStanishev's Bulgarian Socialist Party (BSP) and the Movement for Rights and Freedoms (MRF) – a formation that mainly represents the country's ethnic Turks – had been crying "foul" almost before the game began, doubting the neutrality of the presidentially-appointed caretaker government tasked with hold-ing elections and, in particular, predicting that the interior ministry, still headed by a "Tsvetanov insider", would exercise a baleful influence on the polls. The pros-ecutor's latest moves won't do much for the ministry's credibility. Add this to poli-ticians' desperation to blame each other for the public grievances so spectacu-larly aired in February, and you've got a formula for a month-long slanging match.

The outcome could be complicated. One complication, admittedly, seems to be absent. February's protest movement was radical and diverse in the demands it threw up: these included not just lower power prices and the renationalisation of Bulgaria's foreign-owned power distribu-tion companies, but also a new constitu-tion, recallable MPs, public representa-tion on regulatory bodies – and even, briefly and in isolated quarters, abolition of parliament and/or political parties. And opinion polls in late March suggest-ed that 14% of Bulgarians would vote for a "protest party" if there were one. As it turns out, there are six running in the

elections, with the protest movement divided in terms of aims and personali-ties – and by very Bulgarian suspicious about what interests are behind whom. Long term, one or more of them could be important and popular radicalism could revive. Short term, it's unlikely that any will end up in the next parliament

Stalemate in Sofia?Sandy Gill in Sofia

"Borisov is less of an asset than he used to be: his earthy charisma has been eroded by years in government and over-exposure"

38 I Southeast Europe bne May 2013 bne May 2013 Southeast Europe I 39

by achieving the 4% share of the vote required for entry.

So the contest is, for now, still mainly between established political forces. And, though Bulgarians don't trust opinion polls, those polls have recently – apart from one derided outlier in March that showed GERB at almost double the BSP's level of support – been reasonably consistent. Above all, no one is heading for anything like a majority in Bulgaria's 240-seat parliament. GERB has been appreciably, though not dramatically, ahead of the BSP, with the MRF and the extreme Bulgarian nationalist Ataka certainly heading for parliament, and former EU Commissioner Meglena Kuneva's Bulgaria for its Citizens (BfC) probably doing so.Thus, a poll conducted by the Medi-ana agency April 4-9 showed GERB at 26.4% of respondents, BSP at 23.7%, Ataka at 6.2%, MRF at 5.8% and CfB at 4.5%. That would give GERB around 95 MPs in Bulgaria's 240-seat parliament, the BSP 85, with Ataka and MRF above 20 seats apiece and Kuneva's party with around 16.

With the 4% barrier applying to votes cast, rather than to the entire electorate, election of a sixth force would seem not to be inconceivable: according to Medi-ana, Democrats for a Strong Bulgaria (DSB) – the party of late-1990s right-ist premier Ivan Kostov – is at 2.4% of respondents. Failure to unite with other factions of the "conventional right" limits Kostov's chances, however, while the sort of free market policies Kostov has traditionally backed aren't necessarily big vote winners in the current populist climate.

All this needs to be qualified by reference to statistical margins of error and to the fact that a month is a very long time in politics. For instance, GERB – so Mediana's Kolyo Kolev told the press – had surged five percentage points in the previous month, apparently benefitting from a strategy of concentrating its rhetoric on the idea that it was the only party that could stop "former communists" from getting back into power, a reference to Stanishev's BSP. One might add that, now out of

government – in what some saw as an irresponsible resignation – GERB doesn't have to deal with the considerable flak being suffered by the caretaker cabinet over a crisis situation in Bulgarian energy, which has cut the country's coal production drastically and angered its miners. But it's doubtful whether anti-communism alone will get GERB through the election campaign, while there's plenty of ammunition for the opposition to use about electricity – and indeed phone-tapping. Meanwhile, Borisov is less of an asset than he used to be: his earthy charisma has been eroded by years in government and over-exposure.

As to the BSP, it might well gain from the campaign. A somewhat hesitant figure as prime minister between 2005 and 2009, Stanishev has developed politi-cally in opposition into a formidable predator with a keen instinct for his opponent's jugular. Last year, he deci-sively saw off an intra-party challenge from Georgi Parvanov, whose term as state president had ended early in 2012. More recently he's improved the party's image – and electoral chances – by excluding some senior BSP figures from the party's election lists. It remains to be seen what further revelations he has to embarrass Borisov and friends in the coming weeks. And, "former commu-nists" or not, the BSP's left-leaning poli-cies – including, ironically, abolition of a flat-rate income tax that the party itself introduced in government – will give it some credibility in the wake of the protests. At the same time, Stanishev's choice for prime minister is, not himself, but former finance minister Plamen Ore-sharski, an ostensibly non-party figure with a right-of-centre background and a (possibly deserved) reputation for fiscal probity. Which both reassures financially and absolves Stanishev from charges of being power-hungry.

Outside of the main two parties, the core ethnic Turkish support means the MRF isn't likely to suffer serious losses. And the party should benefit, perhaps electorally and certainly in terms of possible alliances, from the apparently genuine departure of its widely dis-trusted long-term leader Ahmed Dogan earlier this year.

Looking set for electoral extinction at the beginning of this year, Ataka's rid-ing high – and might ride still higher – on the populist mood that underlay February's protests: its mercurial leader Volen Siderov has developed a fine line in rhetoric against "colonial slavery" and domination by foreign firms, and seems to have no compunction about disco re-nationalisations that most other politicians would privately recognise as a can of worms.

As to Kuneva's BfC, don't count on it. Ructions between the central leader-ship and local chapters over election lists have already led to mass defections in several towns, and probably betoken quite a potential for implosion. Voters may draw conclusions before the elec-tion.

Coalition confusionThe parliamentary arithmetic could be complicated – and will be much influ-enced by turnout and precisely who clears that 4% barrier. It's pretty clear that no party will be able to form a gov-ernment by itself. However, coalitions might be hard to form.

Asked last week about possible coali-tions, Tsvetanov replied that GERB would "never" form one with the BSP, Ataka, or the MRF. Further questioned about BfC, he replied: "Let's wait and see who will win seats in parliament." Kuneva has recently ruled out any coali-tions – though she's not been widely believed. Meanwhile, MRF leader Lyutfi Mestan has urged politicians to get real: coalitions are inevitable, he's argued.

The smart money at present is probably on a BSP-MRF-BfC coalition, but it's hardly a foregone conclusion. A parliament in which Ataka holds the balance isn't to be ruled out. Nor is prolonged haggling, ending in some kind of national unity government – or new elections. Meanwhile, there's a medium-term question of whether the protest movement could be revived.

The spectacle of politicians failing to reach agreement might do it. So might next winter.

Electric car dreams in CroatiaGuy Norton in Zagreb

Croatians may be bitterly divided over many issues – politics, economics, religion and football

are just a few of the subjects they love to argue about – but there's one thing that unites them: they're absolutely mad about cars. And if the long-cherished plans of a couple of Croatian companies come to fruition, the country may soon become known as the home of an innovative, high-tech automotive industry that builds on the proud legacy of one of its most famous sons, electrical engineering genius Nikola Tesla.

Since independence from the former Yugolsavia, Croatians have proved to be total "petrolheads", willingly mortgaging themselves up to the hilt just so they can acquire the biggest, fastest, most luxurious vehicle that they can possibly afford. To date, Croatia has proved to be an absolute boon for foreign car manufacturers, who have been more than happy to feed Croatians' automotive addiction.

The country's banks have also earned handsome returns on the hefty fees and interest that they levy on loans so that the average Croatian can drive at breakneck speed along the country’s

expensively built motorways in the vehicle of their dreams. Until recently, however, the country's obsession with all things automotive has done little for the real sector of the economy in Croatia. While western neighbour Slovenia boasts a Renault plant and eastern neighbour Serbia is home to a Fiat factory, Croatia has until recently only played host to a number of relatively small-scale domestic

enterprises that supply automotive parts to foreign manufacturers.

That may be about to change if Rimac Automobil and Dok-Ing Automotive, after several years of research and development, can move beyond the concept model stage of electric cars to full-scale production, and in doing so help reverse – albeit on a relatively minor scale – the steep decline in the fortunes of Croatian industry.

Made in CroatiaSince declaring independence in 1991, Croatia has lost a staggering 80% of its manufacturing base – a fact that goes a long way to explaining why unemployment is now approaching the 400,000 mark in a country of just 4.3m people. Although neither of Rimac Automobil or Dok-Ing Automotive claim that their respective cars will ever be manufactured in the type

of volumes achieved by the global automotive giants, the hope is that if successful the firms will support the ambitions of future generations of product designers, engineers and manufacturing entrepreneurs.

The first of the two models to hit the market has been Rimac Automobil's Concept One, a true electric supercar which can reach a top speed of 305 kilometres per hour (km/h), making

"We started out to make the best and are not interested in how much it will cost"

40 I Southeast Europe bne May 2013 bne May 2013 Southeast Europe I 41

it the fastest electric car currently in production. Powered by four specially developed electric motors, the 1088-horsepower vehicle can travel from 0-100 km/h in just 2.8 seconds and can drive for up to 600 kilometres on a single charge.

Developed at a purpose-built facility in Sveta Nedelja near the Croatian capital Zagreb, the Concept One, which has a million dollar price tag, is now being actively marketed to the expanding class of the global super-rich looking for the latest plaything to brighten up their lives. At this stage, annual production is unlikely to exceed 15 cars a year, but it is hoped that the Concept One will eventually attract a fan base that will help position the Rimac Automobil marque alongside the likes of traditional supercar manufacturers such as Bugatti, Ferrari and Lamborghini.

Almost as extraordinary as the Concept One's performance is the fact that Rimac Automobil was only founded in 2009 by a fresh-faced inventor, Mate Rimac, who is still aged just 24. Rimac has successfully transformed his one-time automotive dream into physical reality – a remarkable achievement that has earned Rimac widespread global media coverage. Bloomberg for example included him among its "Best of 2012" list, while Wired magazine, the UK bible for high-tech gadget freaks recently dispatched a team of journalists and photographers to Croatia to report on the backstory to the Concept One's development.

As he makes clear in the Wired report, Rimac says the thinking behind Concept One is firmly based on a no-expense-spared approach. "We started out to make the best and are not interested in how much it will cost," he says.

He adds that he's only interested in manufacturing the Concept One in Croatia, or not at all – a stance that meant two years of negotiations over venture capital support from investors from Abu Dhabi broke down after the potential backers insisted Rimac relocate his factory to the Gulf region, which he refused to do. "It is a matter

of patriotism. In Croatia, we don't have any manufacturing industry any more. I want to establish a technology business that produces real products. I want…. to be the best in the industry. And stay in Croatia."

Priced to sellCroatia's other wannabe electric carmaker, Dok-Ing Automotive, is conducting final tests on its XD prototype, a much more modest vehicle than the Concept One, which it hopes to start producing by the end of the year. "It's a luxurious, fast, small urban electric car made of sophisticated materials, first in its niche, and despite a price of €50,000 already has interested buyers," says Dok-Ing owner Vjekoslav Majetic, a 57-year-old engineer who began developing his idea five years ago and presented the first prototype at the Geneva Auto Show in 2010 to rave reviews from the motoring press.

Featuring three seats configured in Y-formation like the Maclaren F1 supercar that places the driver in the middle of the car, the XD has a futuristic body shell made from a pioneering mix of carbon fibre and Kevlar, and features a touchscreen dashboard and electrically operated gullwing doors. With a top speed of 140km/h, the XD can accelerate from 0-100km/h in

bne:infrastructure

The economic crisis has hurt all the economies of the world, but now governments across the Central and Eastern European region are planning to spend trillions of dollars on infrastructure investment as the most effective form of economic stimulus to put their economies back on a sustainable growth path. This investment was badly needed even before the crisis hit 18 months ago. Decades of work lie ahead, which presents a unique opportunity for investors of all kinds. Every two weeks, bne will publish an online a round-up of the main investment projects, analysis, commentary, regulatory changes, investment plans, and funding news in bne:infrastructure.

Register and sign up for the list here: www.businessneweurope.eu/users/register.php

7.5 seconds and will have maximum driving range of 250 kilometres on a single charge.

Founded in 1991, Dok-Ing has traditionally manufactured robotic vehicles for unexploded ordnance removal, firefighting and underground mining, but Majetic, a self-confessed car buff, admits that he has always had a burning ambition since a child to design and produce cars. "When I realised that we had the knowledge, I decided to do it. I'm not motivated by profit, it was more like a game, I wanted to prove that I could do it," he says.

At present, the company is reported to have 50 pre-orders for the XD from Croatian customers, the first being placed by Croatia's richest businessman Ivica Todoric. Majetic says he's hoping for tap foreign investors for development capital that would help the company hire 200-300 additional workers and upgrade its production facilities in Zagreb. If it can source the required additional funding, Dok-Ing eventually hopes to produce 1,000 units a year. Increased production volumes could mean that the XD could eventually retail for as little as €30,000, opening it up to a potentially much wider global market.

bne

In one respect, Croatians have got right into the EU swing of things by largely ignoring the elections for the European Parliament – just 21% turned out to vote in the April 14 polls. Yet in another respect the country will be an outlier, in that when it joins the EU on July 1 it will be the first new member ever to do so while mired in recession.

According to an April 9 report from the Croatian National Bank (HNB), in comparison to ten new EU member states form Central and Southeast Europe, Croatia posted the weakest economic growth in 2012, the third year in a row.

In 2012, Croatia's economy contracted 2%, which was in line with Slovenia (-2%), and worse than Hungary (-1.7%) and the Czech Republic (-1.1%). On the other hand, both Poland and Slovakia experienced a rise of 2% in GDP, while newest member states Bulgaria (+0.8%) and Romania (+0.2%) also managed to eke out some growth. The best performers were the Baltic states: Latvia (+5.3%), Lithuania (+3.6%) and Estonia (+3.2%).

That dismal 2012 performance means that Croatia’s cumulative GDP contraction has extended to 10.9% since the crisis struck in 2008.

The HNB survey also found that Croatia had the highest unemployment rate, at 15.8% according to the International Labour Organisation's methodology; 18% according to Eurostat statistics. The next highest jobless rates were reported in Latvia, 14.3%, and in Slovakia, 14.5%, while the Czech Republic had the lowest rate of 7.2%, according to Eurostat.

The outlook for 2013 is for another bad year as Croatian household consumption, investment and industrial production continue to decline amid Europe’s sovereign debt crisis.

Indeed, Erste Bank notes that the outlook for 2013 has actually deteriorated since the fourth quarter of 2012, when the economy shrank 2.3% from the year-earlier period. The bank now expects the economy to contract 0.8% in 2013, with the risks on the downside to that. "Negative risks [are] materializing on the investments side, where we are expecting stagnation at best, amid a slashed public investments pipeline and the private sector remaining on the sidelines," says Alen Kovac of Erste. "We are also more conservative on the private consumption side, given the deteriorating labor market outlook and ongoing consumer pessimism. Public consumption, given the fiscal constraints, should remain unsupportive. Exports are expected to post only marginal growth, as a result of still weak growth momentum in key export markets and supportive tourism performance."

Further out, there might a bit more to cheer about. "[We] are expecting a modest positive growth rate in 2014, supported by a pickup in investments and more supportive external demand. In the medium term, growth figures are expected to remain well below pre-crisis levels (4.0-4.5% on average in 2000-08) and to stabilize in the region of 2-2.5% in the medium term," says Kovac.

Croatia you are the weakest link, hello

"Despite a price of ¤50,000, it already has interested buyers"

42 I Southeast Europe bne May 2013 bne May 2013 Southeast Europe I 43

Romanian Defence Minister Mircea Dusa reignited a fight with the EU over defence procurement

when he announced in April that Bucharest intends to go ahead with a plan to buy a 12-strong squadron of F-16 multi-role fighters from Portugal.

Romania has been at loggerheads with the EU for several years over its intention to buy the second-hand US jets made by made by Lockheed Martin to replace its aging Soviet-built MIG-21 Lancers rather than hold a transparent tender in which other manufacturers like Saab Gripen would compete. bne revealed in September that the European Commission had sent letters to the governments of Romania, Bulgaria and the Czech Republic to highlight EU laws concerning procurement, after it became concerned about possible moves by those member states to conclude major defence deals to buy supersonic fighter jets without holding an open tender.

Following a meeting with his Portuguese counterpart Jose Pedro Aguiar-Branco on April 22, Dusa was quoted by Xinhua as saying: "By the

end of May, we will probably finalize documents with the Portuguese party and subsequently, until September, with the American party, so that we resume the multi-role aircraft equipping program at the scale of a squadron, ie. 12 planes."

Dusa's predecessor Corneliu Dobritoiu announced last autumn that Romania would pay around €670m over five years for the fighters. Romania and Portugal

have a deadline of June to complete negotiations, Dusa said, adding that the package includes everything neces-sary for the operation of the planes: the training of the pilots, maintenance, and upgrading.

According to local news reports, the fighters are among 25 F-16s delivered to Portugal in 1999 under the Peace Atlantis II Program. Prior to that, they had been used by the US Air Force since 1984. The aircraft are in "very good" condition, according to Romanian expert teams.

The latest move continues a three-year battle by Romania to try to avoid clear EU procurement rules, raising suspicions of corruption in a country that is riddled with it. The brouhaha began in March 2010 when the Romanian president's office announced that after a meeting of the Supreme Defence Council – an unelected advisory board that has no executive powers but is very influential by dint of its appointment by the president – it had been decided to send a proposal to parliament to acquire 24 used F-16 fighters from the US Air Force. President Traian Basescu in subsequent interviews said it was purely an economic decision, yet that didn't stand up to much scrutiny. Saab Gripen quickly released its proposal, showing

it would offer 24 brand new multi-role jets, for the same price of around €1bn.

Saab Gripen was joined at the time by Eurofighter in stressing the need for a transparent tender under EU rules. Following heated debates in the Romanian parliament and the media, the decision was shelved a few months later, with the president citing a lack of funds. However, over the subsequent years several Romanian officials

Romania reignites EU fight over jet procurement

bne

"By the end of May, we will probably finalize documents with the Portuguese party"

indicated that the plan to buy the F-16s was still alive.

The latest announcement by Dusa is sure to infuriate Brussels. EU Commissioner for Internal Market and Services Michel Barnier, who oversees public procurement in the 27-member bloc, wrote a letter, dated May 15, 2012, to the defence ministers of Bulgaria, Romania, Slovakia and the Czech Republic to remind them about EU directives concerning tenders for public procurement and the need for transparency in such procurement.

"The decision to acquire combat aircraft is a sovereign decision of your country. However, since combat aircraft are military equipment in the meaning of Directive 2009/81/EC, Member States have to abide to the rules of this Directive when they purchase such aircraft," Barnier wrote in the letter, a copy of which was obtained by bne last year. "This means in particular that they have to publish a contract notice in the Official Journal of the European Union and open the procurement procedure must be open to all potential suppliers in the EU."

A spokesman told bne then that the Commission had received "positive" replies from Bulgaria and the Czech Republic, but pointedly omitted to mention Romania. Now we know why.

bne

Moldova's political crisis deepened as the country's president was forced to appoint acting Deputy Prime Minister Iurie Leanca as interim PM on April 23 following the Constitutional Court's stunning decision the day before to declare unconstitutional the presidential decree that designated Vlad Filat as PM.

Moldova's latest bout of political chaos began when Filat's government resigned on March 5 after losing a confidence vote following months of feuding among leaders of the pro-European coalition that has run the country since 2009. Filat, who heads the Liberal Democratic party, has since served in an interim capacity and earlier in April President Nicolae Timofti asked him to try to form a new government. He appeared to have secured the necessary 51 votes in the 101-seat parliament to give him a majority, but in a stunning decision the Constitutional Court ruled that his nomination was illegal. The court argued that because Filat was dismissed over corruption suspicions, Timofti had to choose another candidate. The court's decisions are final and irreversible.

Filat couldn't disguise his irritation with the court, warning that the ruling was "very dangerous and may have far-reaching consequences for this state's future," though promised to abide by the decision. "The Constitutional Court ruling appeared at the moment when a new parliamentary majority was almost set up, which would have formed a government and overcome the political crisis," Filat told a news conference on April 23.

"This is an unprecedented decision, which will go down in history. Unfortunately, the Constitutional Court is talking about political responsibility and suspicions about corruption. It looks strange, though, that the Constitutional Court ignores legal concepts, including presumption of innocence. This ruling is very dangerous and may have far-reaching consequences for this state's future," Filat said.

Filat's previous three-party coalition known as the Alliance for European Integration had worked to bring Moldova closer to mainstream Europe. But the fall of the alliance has threatened to derail its course towards signing free trade agreements with the European Union by the end of the year.

If parliament fails to approve a new prime minister in three attempts, it will have to call new elections. Those could well be won by the communists, which are likely to reverse the previous coalition's moves to integrate more with the West.

Moldova's political crisis deepens

44 I Eurasia bne May 2013 bne May 2013 Eurasia I 45

Abashidze, a career diplomat who served as ambassador to Russia in 2000-2004, was tapped by incoming Prime Minister Bidzina Ivanishvili last year to restart a dialogue with Moscow. Ivanishvili had prioritised improving relations with Russia during his election campaign, and promoted a plan of reengagement that broke sharply with

President Mikheil Saakashvili's rather recalcitrant policy toward a country with which relations had been tense since the break-up of the Soviet Union, then worsened after the 2003 Rose Revolution. The 2006 Russian embargo effectively ended diplomatic and commercial relations between the two

neighbours, and Tbilisi severed all ties to Moscow after the August 2008 war.

The loss of trade with Russia, particularly for small farmers in Georgia's poorer western region, has been a blow to the economy. But re-engaging with Moscow has been a political hot potato for Georgian

politicians for the past decade, and Abashidze has repeatedly stressed that his meetings with Russian Deputy Foreign Minister Grigory Karasin are just "the first steps out of the deadlock," not a resumption of relations. "[This is] not yet a political process," he tells bne in an interview. "We started just talking

A "reset" in Georgia-Russian relationsMolly Corso in Tbilisi

The first two days in April illustrate well the huge task that Zurab Abashidze, Georgia's

Special Representative for Relations with Russia, faces as he tries to mend relations between the two neighbours.

On April 2, a Georgian delegation was due to discuss the crucial restart of agricultural exports with the leadership of the Russian Federal Service for Veterinary and Phytosanitary Surveillance (Rosselkhoznadzor) in Moscow; the day before, Russia was dismissing Georgian complaints about its Black Sea military exercises over the weekend, which involved up to 7,000 military personnel and more than 30 warships, describing Tbilisi's reaction as "the public inflation of a Russian threat to cover its own confrontational policy."

Given this backdrop, Abashidze is pushing pragmatism over emotion and "small steps" to end the political deadlock between the two countries that fought a war as recently as 2008.

Georgian water flows to Russia

Molly Corso in Tbilisi

After a six-year hiatus, Georgia's famous sparkling mineral water Borjomi is heading back onto Russian supermarket shelves. But a new tax levied by the Georgian government could make the return bittersweet.

Moscow announced it was lifting the 2006 ban on the iconic Georgian mineral water on April 11. Borjomi, long popular in the former Soviet Union as a cure-all for everything from morning sickness to a hangover, was banned when relations between Russia and Georgia deteriorated six years ago due to Tbilisi's deepening relations with Nato and a Russian spy scandal.

Russia's decision over Borjomi has been widely anticipated since billionaire Bidzina Ivanishvili came to power after Georgia's October 2012 parliamentary elections. Prime Minister Ivanishvili, who made his fortune in Russia, has prioritised normalising trade relations with Moscow and, over the past six months, Tbilisi has worked closely with the head of Russian consumer protection agency Rospotrebnadzor, Gennady Onishchenko, to end the embargo and return Georgian wine, mineral water, and other products to the Russian market.

Onishchenko has signed all the paperwork needed to allow Borjomi and three other Georgian mineral water producers to resume exports to Russia, putting an end to the "health concerns" that Russian officials claim originally led to the 2006 embargo. No proof of any health dangers presented by Georgian mineral water or other products has ever been produced by the Russian side.

In addition, the January sale of a majority share of the IDS Borjomi company to Alfa Group, an influential Russian investment holding, was also perceived as a strategic move to smooth the mineral water's return to the Russian market. Borjomi did not respond to bne's request for comment on the Alfa Group investment or the return to the Russian market. But Vladimir Ashurov, CEO of IDS Borjomi, told Russian daily Kommersant that the company plans to regain the 3.5% market share that it enjoyed before the Russian embargo. "In 2005, Borjomi held 3.5% share [of the Russian market] in volume and 13% of the monetary worth,” he was quoted as saying by Kommersant. "We plan on returning to that position."

In order to do regain its position in the Russian market, however, Borjomi has its work cut out.

Bojormi will have to compete with the full range of European mineral water – and Russian mineral water – that is now available on the Russian market. Furthermore, IDS Borjomi press warns that the Georgian government's decision to triple mineral water extraction tax could cripple Borjomi's ability to compete on the Russian market – and indeed the other 40 markets worldwide where Borjomi is sold. "IDS Borjomi has a negative position on the government's decision to triple the fee for the extraction of [mineral water]," the company said in a statement. "The increased fee will have a negative impact on production, particularly for Borjomi mineral water's competiveness in Russian, Ukraine, and other export markets."

The new fees, according to Borjomi, will make Georgian mineral water extraction the most expensive in the Commonwealth of Independent States and Europe. Prior to the increase, Borjomi paid ¤5.90 per cubic metre – reportedly at least ¤1.00 higher than its competitors in Georgia; after the increase, Borjomi will have to pay ¤13.90/cm. "We regret the decision because… [it poses] a serious threat to [Borjomi mineral water's] future development prospects,” the company said.

Regardless of its competitiveness, however, the simple return of Borjomi mineral water to the Russian market is a success for Ivanishvili and his new government. The prime minister's Georgian Dream coalition came to power on a platform of returning Georgian products to the Russian market – and thousands of farmers and manufacturers are waiting for the government to make good on their promises. After a February visit to Georgia, Rosprotrebnadzor short-listed 17 brands of Georgia wine and five brandies for import to the Russian market. Another trip to Georgia is planned in April.

"As we say in this part of the world, one speaks one thing at the beginning of the road, and one speaks another language at the top of the mountain"

46 I Eurasia bne May 2013 bne May 2013 Eurasia I 47

on certain issues like trade, transport, culture and some humanitarian issues, and we will see if there is any chance to go forward."

To date, the two men have met twice, once in Geneva and one in Prague. A third meeting in Prague is planned for May. Each meeting is low key, and Abashidze is quick to underscore the importance of "small steps" over "loud noise… without creating exaggerated illusions, expectations."

Food for thoughtTrade tops his agenda, as well as easing visa restrictions for Georgians. "There are a lot of Georgian interests in trade and commerce [in Russia]… We produce wine – they love wine. We produce fruits and vegetables – they like such products. They are fond of sun and

sea and having fun – and we intend to be such a country, a good touristic route," he says.

But Abashidze stresses that exports to Russia – including wine, mineral water, citrus fruits and greens – is just part of the potential: a better working relationship could encourage more investment. "The reduction of political tensions will also stimulate many people in Russia, many Georgians… Previously, they had political restrictions from both sides," he says. "Now this is changing and people are quite optimistic in this regard."

The dangers of high expectations and unchecked emotion are uncomfortably close, however: while Georgians overwhelmingly approve of improving relations with Moscow, the level of reengagement they support varies widely.

Even as wine producers embrace the process of reopening the Russian

market for wine and mineral water, the decision to send a national dance group to perform in the Kremlin met with public disgust and protests. "There is still a fear, this negative experience in our history… and the recent events of 2008 are unfortunately part of this very bad experience," he says. "But we cannot live always in the past, we cannot live only in the regime of full confrontation with Russia. This is not sustainable… so that is why we are speaking about pragmatism, that is why we are trying to change the current state of affairs to build upon some positive elements."

Abashidze is well suited for the challenge. He served as Georgia's top diplomat to Russia under the former Georgian president (and Soviet minister of foreign affairs) Eduard Shevardnadze. A tall and understated man prone to quoting proverbs, Abashidze is focused on concrete, achievable steps. "We are trying now to identify those common interests and trying to work on that. Afterwards we will see what is next," he says. "When we move, when we start walking maybe at some point we will see what is next, [what is] on the other side of the horizon… as we say in this part of the world one speaks one thing at the beginning of the road, and one speaks another language at the top of the mountain."

For over two centuries, relations between Georgia and Russia have fluctuated from friend to foe. But Abashidze warns against attempts to restore "friendship" with Moscow. "The [Russian] politics [concerning] Georgia are not only based on emotional values. There is pragmatism, there are principles, there are interests of course," he says. "I am not very fond of using this word friendship between two countries. There might be friendship between people, between groups of people, but states are usually linked with state interests. This is the word that links two states and not the collective friendships."

"The recent events of 2008 are unfortunately part of this very bad experience,"

Private wealth and public office in GeorgiaMolly Corso in Tbilisi

The plans of Georgia's new billionaire prime minister, Bidzina Ivanishvili, to create three new

investment funds – not to mention his former bank's multi-million-dollar donation to victims of recent storms – are raising fresh questions about the degree of separation necessary between private wealth and public office.

Conflicts of interest are nothing new in Georgian politics – several supporters of President Mikheil Saakashvili's United National Movement (UNM) party reportedly prospered by marrying politics with their business ambitions. But Ivanishvili's deep pockets have long been a pull for voters, especially since the billionaire entered Georgian politics, creating an arena where personal fortune and public largesse are often prioritized over policy and rule of law.

Ivanishvili's money loomed over the 2012 parliamentary election won by his Georgian Dream alliance. During the bitter and often ugly campaign, his wealth attracted fines from the former government desperate to hold

onto power as well being the source of promises to voters. Those promises have continued after the election: during his October 5 meeting with business leaders, Ivanishvili floated the idea of using his own money to fill budgetary gaps. He has also spoken openly about putting his own fortune in a new private equity fund that would finance investments in Georgia.

There are no restrictions in Georgian law that stop individuals from granting

funds to the state budget. However, economist Paata Sheshelidze warns that Ivanishvili's habit of speaking about his wealth and pledging to use it for various programmes or charities could technically be breaking the law, because legally he was required to separate himself from control of his

billions when he took office. "As long as he is prime minister, he is no longer part of the decision making of [his personal fortune]," Sheshenidze says. "He has no decision-making power, so if he said it publicly, he broke the law… He must say that he might advise somebody… he must not say that he will put the money [in a specific investment]."

In January, the financial group that Ivanishvili founded, Cartu Group, made good on the PM's promise to aid families in Kakheti who suffered during a series of brutal storms last summer. Cartu Group signed a contract with the Ministry of Regional Development and Infrastructure, pledging GEL95m ($57m) for the 25,800 families affected by the storm. Ivanishvili no longer owns the group; however, his son Uta owns 8.25%, according to ownership documents filed with the National Bank of Georgia. The funds are being disbursed by the Cartu Group, not the ministry, noted Minister of Regional Development and Infrastructure Davit Narmania, who dismissed charges that the aid constitutes a conflict of interest.

Blurred linesIvanishvili's plan to create a new private equity fund – and be one of its investors – is also drawing criticism. The prime minister has repeatedly announced plans for three other new government-run investment funds: a $2bn sovereign wealth fund, an agriculture fund and a venture capital fund. While the private equity fund would be separate from those planned government funds,

Ivanishvili's tendency to speak about them together has fuelled confusion and speculation that he will also finance part of the sovereign wealth fund.

Vakhtang Lejava, chancellor of the Free University and an economic advisor to former prime minister Nika Gilauri,

"Mr Ivanishvili will have nothing to do whatsoever with the sovereign wealth fund"

48 I Eurasia bne May 2013 bne May 2013 Eurasia I 49

other countries. "We have imported cattle from Australia, Canada, the US and the EU," Omarov says. "The climate in the northern plains of the US is similar to ours and in Canada it is even colder. Australia of course has a warmer climate, but cattle from all countries performed well in Kazakhstan."

The only major setback so far came when 722 heads of Austrian cattle, intended for two farms in north Kazakhstan, were discovered during their quarantine period to be carrying the agent for viral diarrhea and Shmalenberg's virus. The animals were destroyed, preventing the infection from spreading to cattle already in situ, and Kazakhstan is

seeking compensation from the supplier. However, the incident highlighted the risks of large-scale cattle imports and in future Kazakhstani inspectors will check cattle before they are imported.

Getting the numbers upUntil recently, cattle such as Angus, Charolais and Hereford were not bred

in Kazakhstan, which urgently needs to improve the gene pool of its cattle as well as simply boost numbers. Kazakhstan saw a sharp fall in the number of cattle in the years immediately following the collapse of the Soviet Union in 1991. As the collective farms broke up and the new government paid less attention to supporting agriculture than the emerging oil and gas industry, productivity slumped in areas from grain to dairy products.

Wheat production, for example, plummeted in the 1990s, but has recovered in the last decade with strong government support, and despite fluctuations from year to year achieved a record harvest in 2011. It has been a similar story for animal husbandry, where the number of animals and the quality of livestock declined sharply in the 1990s. Now both farmers and government are working to reverse the decline and bring the sector into the 21st century.

KazAgro is helping the sector to grow by providing financial support for farmers through its Sybaga programme, which enables farmers to obtain cheap credits to buy cattle and build related infrastructure. This includes improving the quality of herds by helping farmers to import high-quality breeding cattle.

According to Omarov, the programme has been popular with farmers. A total of 59,000 heads of cattle were purchased in 2012 alone, compared with a target of 42,000. Since Sybaga was launched, Kazakhstani farmers

have imported 30,000 cattle – some 8,000 more than projected – and KazAgro is aiming to support the import of 72,000 cattle by 2016.

KazAgro also supports investments into infrastructure, because of the need to build everything from feedlots to modern factories that can process

"As long as he is prime minister, he is no longer part of decision making in his personal fortune"

"Kazakhstan saw a sharp fall in the number of cattle in the years following the collapse of the Soviet Union"

notes that the financing for the $2bn sovereign wealth fund, which would control state assets like the railways and energy, is unclear. "My question is how the investment fund gets money.

We know only one, just one declared source of possible investment: the prime minister's private wealth," Lejava says. "Investing money means being a partner… Some people think this is a great thing for investors, but there can be scepticism about that as well, as to how this will be perceived."

However, Giorgi Bachiashvili, deputy CEO of Partnership Fund – an

investment fund set up by the former government to provide financing for large investments that banks were wary of underwriting – stresses that Ivanishvili's personal fortune will not

play any role in the $2bn sovereign wealth fund. Bachiashvili, who is working with the government to create the new sovereign wealth fund, says Ivanishvili is planning to invest in a private equity fund that will be funded by a group of wealthy Georgians who will be passive investors in businesses, independent of the government. "Mr Ivanishvili will have nothing to do whatsoever with the sovereign wealth

A Kazakh cattle prod Clare Nuttall in Astana

In the last three years, tens of thousands of breeding cattle have been imported to Kazakhstan from as

far away as Australia in a drive to make the country a high quality beef producer and meet the government's ambitious target of exporting 60,000 tonnes of beef a year by 2016. Restrictions on exports to Russia mean that almost all meat produced in Kazakhstan is consumed domestically, but officials at state agricultural holding company KazAgro are confident that controls will be lifted in time to meet the target.

Airlifts of pedigree cattle from the plains of North Dakota to the Kazakhstani steppe started in October 2010. Some 2,000 Angus and Hereford cattle were flown over by KazBeef, a joint venture set up by Dakota-based Global Beef Consultants and Kazakhstan's largest meat producer KazMeat. This was followed by mass airlifts from other countries, including 2,500 Angus heifers flown in from Australia by another major Kazakhstani meat producer Sever Agro N to stock a ranch in the far north of the country near the Russian border.

According to Alpamys Omarov, deputy director of KazAgro, the imported cattle have acclimatised well to Kazakhstan's extreme continental climate, helped by consultants from the US, Australia and

fund… This will be a completely private entity," he says.

If investors are concerned about a potential conflict of interest, Bachiashvili says, there are plenty of avenues for them to speak out. "Trust me, the level of transparency that the new government has, the level of freedom of press, if some investor finds himself disadvantaged because some other guy has an investment from the private equity fund, there will be a big scandal."

Ivanishvili himself has downplayed concerns over how investors will perceive the prime minister as an investor. "I will not have any connection with the funds… I am not hiding anything and there is nothing to hide," he told a press conference on February 5. "It is not important who invests how much in what… I will not have any contact" [with the investments made by the fund].

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

What you need to know

Sign up today for a free month trial of all our services www.bne.eu

| Eastern Europe | Russia | Belarus | Ukraine || Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

50 I Eurasia bne May 2013 bne May 2013 Eurasia I 51

Astana Finance restructuring at risk of collapseClare Nuttall in Astana

Astana Finance, the last Kazakh financial institution crippled by the 2008 global crisis to

complete its debt restructuring, has asked for more time as it continues to push the Kazakh government for tax breaks that would allow the $2bn restructuring to go ahead. While international creditors remain onside for the restructuring of several Kazakhstani banks – including two rounds at BTA Bank – the perceived lack of support from the government for Astana Finance's restructuring has caused creditors to lose faith in the process and they are considering taking legal action in the US and UK.

Astana Finance, the country's largest non-bank financial institution, announced on March 27 that it has asked for an extension to the deadline to complete its debt restructuring until December 31, 2013. As of mid-April, the Almaty specialised financial court had

not yet reached a decision on whether to grant the extension.

Astana Finance, which defaulted on its debt obligations in May 2009, said in a statement that it needed to extend the deadline, as it had not yet been able to secure an exemption from tax payments

on deemed income from the write-down of its liabilities, which would have allowed the restructuring deal agreed with creditors in July 2012 to go ahead. However, the deadline has already been extended once, from November 2012 to March 2013, and so far there has been no apparent progress on the tax exemption.

Astana Finance owes close to $2bn,

including over $1bn to international bondholders, around $260m to export credit agencies and up to $700m to domestic lenders. Set up initially to invest into real estate, and later branching out into banking and insurance, Astana Finance was hard hit by the crisis that started with the bursting of the country's real estate bubble in mid-2007. Around 90% of its loans are now non-performing.

Flies in the ointmentCreditors agreed to the 2012 restructuring package on the condition that Astana Finance would receive preferential tax treatment similar to that offered by the government to BTA Bank, Alliance Bank and TemirBank, which also launched debt restructurings in 2009. This would have allowed the company to avoid tax payments potentially costing up to $400m. "Writing off liabilities is a taxable event in Kazakhstan, and the amount could be considerable, so they put in the condition that this would be waived if the restructuring is to go ahead. Without this tax waiver – which was offered to the banks – the restructuring is meaningless," Andre Andrijanovs of Exotix Limited, the London-based frontier market investment bank, tells bne.

Astana Finance's management is still pushing for the waiver, saying that it is committed to the restructuring, but the process has been delayed by factors outside its control – namely the creation of the National Development Agency (NDA), which is expected to take over the management of Astana Finance

and other state-controlled financial institutions from sovereign wealth fund Samruk Kazyna. There are also plans to merge Kazakhstan's existing pension funds into a single fund under the control of the central bank, a process that has been linked to the disposal of state banking assets. Both the NDA and the state pension fund are due to be created in the first half of this year.

and package meat products to the high sanitary standards required for export. When the Sybaga programme started, Kazakhstan had feedlots with spaces for 37,500 heads of cattle; by 2016 this is set to increase to 150,000.

Interest has also been sparked among international investors, with Israel's LR Group reported in March to have signed a deal with KazAgro to set up beef production in south Kazakhstan. LR is planning to build a large-scale complex handling everything from production of fodder to meat processing.

However, it takes time to build up a herd and mature cattle for slaughter, and Kazakhstan has not yet seen an increase in beef production, which has fluctuated between 373,000 tonnes and 407,000 tonnes in the period from 2007 to 2012.

During the same period, Kazakhstan increased total meat production from 833,100 tonnes to 926,400 tonnes, with the main contributors being higher production of mutton, horsemeat and especially poultry, which almost doubled from 64,300 tonnes in 2007 to 123,100 tonnes in 2012.

With its population of just under 17m and large areas of steppe for grazing, Kazakhstan is ideally suited to ramp up meat production and increase exports to its neighbours. The creation of the Customs Union also meant that in theory Kazakhstani farmers should be able to export large volumes of meat to the Russian market.

In addition to the target of exporting 60,000 tonnes of beef a year by 2016, Astana wants to see exports of 180,000 tonnes a year by 2020. "In 1990, the final days of the Soviet Union, Kazakhstan was exporting around 200,000 tonnes of meat, so we believe the target is achievable," Omarov tells bne.

Unfortunately, in recent years Kazakhstan has been unable to export meat to Russia because of veterinary and accreditation requirements and other non-tariff barriers. As a result, Kazakhstan has made virtually no progress in boosting exports, although Omarov is optimistic that with the lifting of barriers expected before long the target is still achievable.

Although Kazakhstan also borders China and three Central Asian republics, Russia is considered the highest potential export market for Kazakhstani meat, and most large local companies are concentrating their efforts on preparing for exports to Russia. Modern meat processing and packaging factories are being built in northern cities such as Astana and Kostanai in readiness to access the market once it opens up.

"Without this tax waiver – which was offered to the banks – the restructuring is meaningless"

Horsemeat on the menu

Clare Nuttall in Astana

Ikea has not made it to Kazakhstan yet, but when it does, the Swedish company's horse-rich meatballs are likely to be as welcome as its reasonably priced flat-pack furniture. While the horsemeat scandal spreads around Europe, Kazakhs can't get enough of the meat.

Horse has been an integral part of the Kazakh diet for centuries, dating back to nomadic times, and today is prized as a delicacy. Not only is horsemeat eaten in dishes such as the traditional beshbarmak on feast days, in the 2012 London Olympics it emerged that the meat was also served up to help Kazakh athletes stay in peak physical condition. Horse sausages, known as kazi and kurta, as well as Caspian caviar, were flown to London for Kazakh wrestlers and weightlifters. Ilya Ilyin, who won gold medals at the Beijing and London Olympics, told journalists that horse meat and chicken were the "best foods for weightlifters".

But while Kazakhstan has increased production of horsemeat from 65,300 tonnes in 2007 to 85,100 tonnes in 2012, demand for the meat is so high on the domestic market that exports are not expected any time soon. "It's more expensive than other types of meat, so this is a high-end business that is financed by bank credits as well as though our programme," Alpamys Omarov, deputy director of state agricultural holding company KazAgro, tells bne. "There are no plans to export at present because there is still unmet demand on the domestic market, but we would be prepared to support exports in the future."

"It takes time to build up a herd and mature cattle for slaughter, and Kazakhstan has not yet seen an increase in beef production"

52 I Eurasia bne May 2013 bne May 2013 Eurasia I 53

Creditors are also concerned by the sale of the stake in Astana Finance's banking division, Bank Astana Finance, to three Kazakhstani investors. Kazakhstan's financial regulator published notices of central bank resolutions dated February 25, permitting Kenes Rakishev, Olzhas

Tokhtarov and Orazkhan Karsybekov to "acquire significant shareholder status" in Bank Astana Finance.

Since the restructuring of Astana Finance has dragged on for nearly four years, there is growing speculation that the firm's relatively small size and lack of systemic importance in Kazakhstan's financial system means that there is

In its March 27 statement, Astana Finance says that it "can confirm that its request for the Tax Law Amendment is now receiving consideration at high levels within the government of Kazakhstan." Astana Finance expects "significant progress" within three weeks of the

announcement. However, according to a source close to the process, many international creditors have already lost faith in the restructuring process, and the creditors' committee is considering its options to file a lawsuit against both Astana Finance and Samruk Kazyna. If this goes ahead, legal action could be taken in multiple jurisdictions including Kazakhstan, the UK and the US.

"If this goes ahead, legal action could be taken in multiple jurisdictions including Kazakhstan, the UK and the US"

little incentive for the government to ensure that the restructuring process is successful.

Astana is already planning to wind up its involvement in the banking sector by the end of this year. The government, through the Samruk Kazyna fund, nationalised BTA Bank (including its subsidiary TemirBank) and Alliance Bank, and took minority stakes in the other two top four banks, Halyk Bank and Kazkommertsbank, in February 2009. Since then, debt restructurings have been completed at Alliance, Temirbank and twice at BTA. At a government meeting on February 4, President Nursultan Nazarbayev told officials to dispose of government stakes in the banks by the end of 2013. There are already plans to merge and sell off Alliance and Temirbank, while shares in BTA may be offered to Halyk – which has already bought back the government's stake – in exchange for shares in Halyk's pension fund.

FUNDS: Sturgeon still swimming in Caspian regionClare Nuttall in Astana

With Central Asia under-performing other frontier markets and several asset

management groups shutting up shop, it's becoming increasingly hard to

make a case for staying in the region. But Sturgeon Capital, which launched a regional equities fund in October, expects to see its commitment pay off over the longer term.

The investment firm launched the Sturgeon Central Asia Equities Fund, the first Central Asia and Caucasus-focused UCITS hedge fund, on the back on demand for an equity-only strategy. Sturgeon's original fund is split between listed equities and fixed income, while the new fund invests into companies listed internationally that have substantial assets or operations in the region.

Despite outperforming its benchmark since the launch, the "Sturgeon Central Asia Equities Fund" has lost money, as valuations in the region have continued to lag behind other frontier markets. However, Sturgeon's founder and CEO Clemente Cappello says that the firm is confident about the longer-term prospects: "We are not doing this with a short-term horizon. The story will play out in two or three or five years' time. Markets tend to be efficient in the medium term, and we expect Central Asia to re-couple with global markets."

Globally, there are signs that investors are returning to frontier markets after

the exodus at the start of the financial crisis back in 2008. "Encouraged by central banks, we expect the search for yield to start again. People are scared, but they can't afford not to invest into frontier markets for much longer. Pensions funds and insurance companies need returns," says Sturgeon associate Paul Henderson.

Cappello points out that investors are heading to Asian countries such as Mongolia and Myanmar, there are large inflows to Africa, and generally positive sentiment about Latin America – although the stories coming out of Central Asia and the Caucasus tend to be more negative and the region has not yet seen a similar inflow of capital. This is reflected by the performance of regional indices such as Renaissance Capital's Rencasia, which are substantially under-performing other global emerging market indices. Equities valuations in the region are among the cheapest globally, a discount that Cappello says is not justified.

The low valuations continue despite the region as a whole enjoying sustained GDP growth in recent years, and a good performance from a number of companies with large market capitalisations on exchanges including London, Hong Kong and Toronto. "The companies have delivered, but the investors have not," Henderson tells bne.

Sturgeon believes that there remains a solid case for investing in the resource-rich and relatively low-cost region. Its proximity to three of the four BRICs – China, India and Russia – is a huge advantage, as is the high level of education and relatively good infrastructure. Both Cappello and Henderson also reference the region's Silk Road history, which left a legacy of a trading mentality that has persisted to this day. "People give up, but we are in this market for the longer term. I think the region is at a turning point in terms of local companies and local capital markets," says Henderson. "If you believe in emerging assets, you have to believe in Central Asia. The region provides the raw materials for most of the goods that are produced in Asia and exported to the world."

Sore pointsRisks for investors include rising resource nationalism in countries from Kyrgyzstan to Mongolia, and a range of political risks. "Central Asia is heavily biased towards natural resources, which is a highly politicised sector. Probably the biggest issue for us is political risk in the wider sense – the risk of the rules of the games being changed – and corporate governance issues. These are the same across the globe," says Cappello.

There are also wide variations in the maturity and ease of access in countries across the region, with Kazakhstan, Central Asia's largest economy, the destination for over 40% of Sturgeon's investments. Not only does Kazakhstan have substantial natural resources, it also has more companies listed internationally than its neighbours, and, unlike for example Mongolia, it has been

through a boom-and-bust cycle, leaving the market more mature.

Kazakhstan also has the region's most developed stock market, although the Kazakhstan Stock Exchange (KASE) lacks liquidity and issues such as the use of T+0 settlement need to be resolved. It is not yet clear what the impact of the consolidation of Kazakhstan's 11 pension funds into a single state-controlled fund will be, but it is likely to be negative for the exchange to some extent.

Elsewhere in the region, Sturgeon is eyeing the high potential but less accessible markets of Turkmenistan and Uzbekistan; the latter has a vibrant stock exchange though investment is hampered by issues relating to the rule of law and currency convertibility. Countries such as Azerbaijan and Georgia have also made efforts to develop their stock exchanges and encourage investment, giving hope for investors that there will be more opportunities in future.

"If you believe in emerging assets, you have to believe in Central Asia"

54 I Eurasia bne May 2013 bne May 2013 Eurasia I 55

improvement justify this restart of operations," said the Canadian-listed company in a statement about the return of operations. "The flow of coal and sales will be carefully managed in order to react quickly to any future changes in market conditions."

For many, the company's fate was sealed in January 2012 when Rio Tinto bought a controlling stake in Turquoise Hill Resources (then known as Ivanhoe Mines), the majority owner of SouthGobi. Rio made it clear that it was interested in holding on to only one of Turquoise Hill's Mongolian assets, with its eyes clearly fixed on the prized Oyu Tolgoi copper and gold mine.

The day to cut SouthGobi loose finally came in March 2012 when a deal was struck to sell Turquoise Hill's 57.6% stake in the coal miner to Aluminum Corporation of China (Chalco). Another Chinese entity, the sovereign wealth fund China Investment Corporation, already owned 14% of the SouthGobi.

Turquoise Hill had hoped to use the proceeds from the sale of the SouthGobi stake to directly fund the development of its $6.6bn Oyu Tolgoi copper/gold mine, but instead the proposed deal set alarm bells ringing in political circles already on edge about growing Chinese influence in the country. The result was the politicians dusted off a piece of draft legislation on foreign investment in the country's natural resources that until then had been languishing and rushed its passage through Mongolia's parliament, plunging SouthGobi into financial difficulties and sending shock waves rippling out through the rest of Mongolia's mining sector.

Government officials said the law was meant to create a review process for deals involving foreign investors in the country's resources that involved parliament, but without a mechanism to see the process through, it effectively killed the deal. Chalco announced last October it had given up trying to take control of SouthGobi, as well as the proposed purchase of a 29.9% interest in

Mongolian coking coal supplier Winsway Coking Coal Holdings.

Immediately following the March 2012 announcement of Chalco's proposed purchase of the stake, the government also said it would suspend SouthGobi's licences, although the company insisted its licences were in good order. But then an official at the Mineral Resources

"We are working hard to maintain good relationships with all of our stakeholders including the Mongolian government"

SouthGobi crawls out of Mongolian purgatoryTerrence Edwards in Ulaanbaatar

Though Mongolia-focused coal miner SouthGobi Resources had time for a short hooray following

the relaunch of operations at its Ovoot Tolgoi project, it still has a myriad of issues to contend with if it's to appease both investors and the Mongolian government.

Just three days after announcing the relaunch of operations on March 22, SouthGobi released an inevitable dismal annual report that included a $103m loss for 2012 – inevitable because the company became the epicentre of a fierce fight over resource nationalism in Mongolia and worries there about growing Chinese influence, and had to endure nine months of being unable to mine its coal deposits while the Mongolian government put the company's licences under a microscope. That loss compared with a $57.7m net profit for the previous year when operations went undisturbed.

"While a certain amount of volatility remains in the coal markets, signs of

Authority of Mongolia was arrested for an illegal transfer of licences, including one held by SouthGobi. Extraction halted at the end of June 2012 and SouthGobi had to start burning through its stockpiled reserves to supply customers. SouthGobi saw its share price on the Toronto Stock Exchange fall 74% from a 52-week high hit in April 2012 of $7.32 to as low as $1.84.

BellwetherAccording to Philipp Marxen, chief executive of Xacleasing, which provides the trucks and other base equipment necessary for mining operations, the ups and downs experienced by the coal miner were largely indicative of the sentiment felt throughout the industry as a whole. "In discussions with our lessees, which have been sub-contractors of SouthGobi, the importance of this mining firm's success as a bellwether of the foreign-invested mining sector has become obvious," says Marxen. "If the company can start full-scale production and increase coal exports again, this will positively affect the supply chain."

SouthGobi is likely hoping for some backing from the Mongolian government as it tries to put the incident behind it. The investigation that began last year for the alleged illegal license transfer is still ongoing

and the president of the mining unit leading the Mongolian operation, Justin Kapla, is prohibited from leaving the country while authorities continue to look into the matter. According to company spokesperson Altanbagana Bayarsaikhan, one other remaining licence requirement under question for failing to meet minimum spending was not considered "material to its business".

The company will also need the government to honour its past project approvals as it deals with a legal battle with a local citizens' council in a province called Umnugobi. The council placed some of its licenced territory for exploration under special protection. Although a local court revoked that protection, the council is appealing the decision. "We are working hard to maintain good relationships with all of our stakeholders including the Mongolian government," Ross Tromans, SouthGobi president and CEO, said in an investor call for its 2012 annual financial results.

He added, "I think that generally, we are working at improving those relationships and it's an ongoing process, whether there's been huge change, it's hard to tell but certainly the relationship is cordial and respectful."

Armenian "cognac" makers face fight over name

Yerevan is keen to achieve closer relations with the EU, but a casualty of this process could be Armenia's cognac producers, who are under pressure from France to re-label their products as mere "brandy".

France has established its right to the name "cognac", which refers to brandies produced in the region around the town of Cognac, from specific grapes and by a specific method that involves aging in French oak barrels. Like the name "champagne", France has fiercely defended its exclusive right to use the name "cognac".

This presents a particular problem for Armenian brandy producers, whose main export market is Russia, where the word "cognac" is used more generically to describe high-quality brandies such as those produced by the Caucasian country. Armenia has been producing brandy since the 19th century, and its brandies are highly rated both within the former Soviet Union and internationally. One fan of Armenian brandy was Winston Churchill, who is said to have tried Dvin cognac during the Tehran Conference and from then on drunk a bottle every day.

In an interview with ArmInfo, the managing director of Yerevan Brandy Company, Ara Grigoryan, acknowledged that international regulations state Armenia has no right to describe its products as cognac, but said he did not think this would become an issue within the next five to ten years. However, Grigoryan said he didn't expect Armenian companies to start describing their products as "brandy", suggesting that they "will have to find some alternative name for this drink."

56 I Eurasia bne May 2013 bne May 2013 Eurasia I 57

At the same time, the amendment tightens restrictions on foreign state-owned entities (SOEs) investing in Mongolian firms, by removing a 100-billion tugrik ($71m) threshold triggering government intervention. Thus, all SOE investment is now subject

to government approval, and for acquisitions by SOEs of stakes above 49%, parliamentary approval will also be required.

Tightening control of SOE investment is a sop to hardline resource nationalists, who began the push for SEFIL following last year's $926m bid from state-owned Aluminum Corporation of China

Ltd. (Chalco) for a majority stake in coalminer SouthGobi Resources. Many Mongolians saw the bid as part of a worrying trend of seeing its resources sold off to its giant southern neighbour, with whom it has a tricky historical relationship.

The wide-ranging nature and stiff penalties of SEFIL – companies found in violation of the law could even have their permission to operate revoke – ended up scaring off much foreign investment. According to the local brokerage Mongolia International Capital Corporation, the country saw its lowest monthly inflow of foreign investment since at least 2010 in February with $81m, while foreign investment in 2012 fell 17% to $3.9bn.

“I think this is the first step in Mongolia's recognition of how the law impacted private companies from completing transactions and how it has driven down investment,” says Chris MacDougall, managing director of Mongolian Investment Banking Group. “Now we can expect transactions on hold since SEFIL to be completed.”

Grey areasSome analysts caution that the law still fails to clarify key details. Although the amendment just passed by parliament has not yet been released in full, law firm Hogan Lovells told clients in a note

that the scope of what is known about the amendments are "narrow" and need further work.

"The proposed amendment has not provided sufficient clarification for the law's vagueness,” says Michael Aldrich of law firm Hogan Lovells. "In addition, the official wording of the amendment has not yet been disclosed so we do not have

“This is the first step in Mongolia's recognition of how the law impacted private companies and how it has driven down investment"

Foreign investors welcome Mongolia's change of tackTerrence Edwards in Ulaanbaatar

Mongolia's parliament, April 19 passed an amendment to its controversial foreign

investment law of last year, which should allow over 100 pending investment deals in the country to now progress.

The Strategic Entities Foreign Investment Law (SEFIL) was rushed through parliament in May 2012 as protests grew about the increasing foreign (read: Chinese) control over the country's vast mineral wealth. But the wide-ranging nature of the law caused investment to fall through the floor as international investors felt the law was designed to deter all foreign participation in the economy.

The new amendment to SEFIL exempts private sector foreign companies from the full scope of the law, which demands government approval for the purchase of any stake in a Mongolian company operating in the mining, banking and finance, communications and media sectors in Mongolia.

a clear view on the precise nature of the changes. At this juncture, it looks like some officials might be overselling the idea of a liberalisation."

From what Hogan Lovells knows about the amendment, key terms have been left vague: the mining sector could include mining service companies that assist the operators at mines and even oil extraction; there is also no mention of how pension funds and sovereign funds factor into the law; nor is there even a complete definition of a state-owned entity.

However, the law will likely be enough to allow deals involving private firms to move forward, such as an agreement by Teck Resources, a large Canadian miner, to join up with Erdene Resource Development Corporation as a partner in its mineral exploration in Mongolia. Erdene said the deal hinged specifically on clarifications to SEFIL.

Chimed Saikhanbileg, the government's cabinet secretary, told parliament that the Ministry of Economic Development is already in the process of drawing up a new law to replace SEFIL and resolve these remaining questions. The government hopes to bring greater certainty to investors that Mongolia is a home for long-term investment, he said.

Mongolia's opposition party, the Mongolian People Party (MPP), has also declared its intention to draft a competing law. The MPP, which has been the ruling party for most of Mongolia's history as a democracy, is eager to reclaim power and will likely use the law as a point of debate while highlighting perceived failures of the current ruling government. The opposition party has called for the resignation of Prime Minister Norov Altankhuyag of the government-leading Democratic Party, holding him responsible for the falling foreign investment.

Southern corridor comfort

bne

The Samsun-Ceyhan oil pipeline project looks to have been shelved, after a Russian minister told Turkish media it would be uneconomic. The move appears to be part of a push by Moscow to cement ties with Turkey – a strategic lynchpin in the tussle between the EU and Russia over oil and gas from the Eurasian region.

Russian Energy Minister Alexander Novak told Turkish newspaper Today's Zaman in April that it doesn't make economic sense to build Samsun-Ceyhan, since shipping crude via the narrow Bosphorus channel is up to 40% cheaper. "It depends on whether this project will be competitive enough to survive," Novak said. "It does not seem so at the time being."

The 550-kilometre Samsun-Ceyhan pipeline was planned to carry as much as 1.5m barrels of oil per day, primarily to ease the dangers involved in shipping crude through the congested Bosphorus. The route would run across central Turkey to link the Black Sea with the Mediterranean. However, it has been stuck on the drawing board for some time.

It returned to the front of many minds in late March, when Turkey announced it was blacklisting Italian energy major Eni – a partner in Samsun-Ceyhan alongside Turkey's Calik and Russian state-controlled giants Rosneft and Transneft. Eni's sin is its participation in exploration of offshore deposits off the Greek part of Cyprus. Turkey claims activity around the divided island, split into a Greek and a Turkish half, is illegal because the resources belong to all Cypriots. The Italian company shrugged and pointed out in response to the blacklisting that, apart from the stalled Samsun-Ceyhan, it could not see which of its projects in Turkey might be disrupted due to the strategic nature of its other interests.

Russia's Gazprom had also applied to compete in those same Cypriot exploration tenders. However, Novak said during a high-profile visit to Turkey in April that Moscow would not put its relations with Turkey at risk. The move to pull out from partnering Eni in the pipeline looks to confirm that stance. Russia is hardly known for running energy infrastructure projects on strictly economic grounds, least of all those that might challenge the EU's "southern gas corridor" – an energy route that aims to bring gas from the Caucasus and Central Asia to Europe while circumventing Russia, which currently dominates transit routes out of the region.

Turkey is key to realizing that "southern gas corridor". The plan to build the TANAP pipeline, which runs from the giant Azerbaijani Shah Deniz gasfield, through Turkey to the Bulgarian border, is the likely first route to achieve that ambition. And with Turkey the clear lynchpin in all such efforts, Russia now appears to be trying to cement relations.

58 I Eurasia bne May 2013 bne May 2013 Eurasia I 59

The International Monetary Fund's (IMF) biannual World Economic Outlook published in the middle of April gives a clear snapshot of how emerging markets are coping

with the global slowdown. The roiling crisis in Europe is weighing on economies everywhere, but Azerbaijan emerges as a clear winner. It has one of the fastest growing economies in the world, as it enters into a new phase of development.

“Azerbaijan managed to escape the worst effects of the cur-rent slowdown, like it avoided the worst of the 2008 collapse, thanks to its oil cushion and the government's ongoing efforts to diversify the economy,” says Farid Akhundov, CEO, PASHA Bank, the leading commercial bank in Azerbaijan.

Azerbaijan’s oil revenues have helped of course, but just as important is the low level of debt, the IMF points out. While many other countries are burdened with debt, the government in Baku can concentrate on putting what resources it has to work.

Part of the country’s strength has been the prudence of its banking sector, which has borrowed little from abroad and been conservative in extending loans at home. The low penetration of the banking sector in the economy with a ratio of bank assets to GDP of just 20% means the economy is not very exposed to external shocks. The silver lining of the crisis has been to refocus the government’s attention and energy on continuing the reform process.

“We should not think in terms of a start and a finish to the crisis after which we will go back to the way we were. We need a change in thinking to take in the new global realities and we have started this process,” says Akhundov.

The assets of both PASHA Bank and the sector as a whole grew by a healthy 26% in 2012. But in keeping with the changing environment, the Central Bank’s decision to firm up the stabil-ity of the banking sector by increasing the minimum capital requirement for banks from AMT10m to AMT50m this year will lead to a rapid consolidation of the sector. Currently there are 44 banks in Azerbaijan, but following the requirement of the capital increase we expect to meet the New Year with less banks, says Akhundov.

More significant is the restructuring of the Azeri economy that is now well underway. The government has been investing heavily in infrastructure and with much of this work complet-ed, the economy is moving into a new phase.

“The framework that business can operate in is being established. Now the challenge is for the private sector to take on more of the load and for banks to support them with corporate lending,” Akhundov says.

PASHA Bank is taking the initiative here. Over the next five years it is looking to increase it's lending to small and medium-sized enterprises to 60% of the total loan portfolio. Most of the growth will come in lending to mid-sized companies, which already account for 30% of its loan portfolio, but PASHA Bank wants to increase that further.

“The development of the economy is not a financial problem, but one of transparency and the quality of companies,” says Akhundov. “We can play a bigger role in the economy as banks and support clients with alternative forms of financing like bond issues or IPOs.”

As a pioneer of the domestic capital market, PASHA Bank is already developing these products for its clients.

“We just completed the launch of a $30m club loan, the first in our history,” says Akhundov. “The money was raised from a consortium of banks lead by Raiffeisen and we have plans for more issues ahead.”

The bank is also planning to raise its second syndicated loan this year, with the first ever Eurobond issue possible in 2014. Other banks have also started to issue bonds as the domestic capital market deepens.

The slowdown in the global economy has also catalysed the process of regional integration. PASHA Bank opened a subsidiary bank in neighbouring Georgia in February this year. Since busi-ness ties between the two countries are developing at a very rapid pace, it is planning to “catch this wave” and plans to increase the assets of PASHA Bank Georgia to $50m-60m by the end of 2013.

PASHA Bank operates in a dynamic economic environment, and to get the most out of that it is considering new markets, with Turkey being one of them.

“We are at the very early stage of researching the market look-ing at the sectors and structure of the economy in Turkey. There is lots to learn there both in terms of know-how and ideas that we can usefully bring back to use in Azerbaijan. This is part of the regional integration in practice,” says Akhundov.

CORPORATE STATEMENT:

Azerbaijan stays ahead of the pack

Farid Akhundov, Chief Executive Officer

bne May 201360 Opinion Opinion 61bne May 2013

Vannik Amendment during the Cold War." But he said it's unlikely there will be "a Cold War in the form that it existed during the 20th century." The new one will be "a caricature" of that and a "quite soft one."

The softer start to this Cold War is highlighted by the fact that by not including more prominent politicians on what is essen-tially a "blacklist", Washington "wussed out", according to US critics of its own law.

There were reports that up to 200 names would be placed on it, but in the end no high-ranking officials were included. The most prominent omission was the chairman of Russia’s Investigation Committee, Alexander Bastrykin – a nasty piece of work by all accounts – although his deputy was named. Lib-eral opponents of the Kremlin had been hoping for a more VIP

selection. Moreover, those on the secret list – the only name mentioned so far is Chechen President Ramzan Kadyrov, who scoffed at his inclusion – only face a visa ban and can't have their assets seized unless their names are released.

In other words, Washington realised that publishing the list was going to be very damaging and attempted to limit that damage by shying away from putting anyone really important on the list.

But at this point you have to ask whether the list has done anything to fix the problem that it was proposed to address. No one will dispute that the death of lawyer Sergei Magnitsky

bne

On April 12, the US government released its long-antic-ipated "Magnitsky list" that bans 18 people, almost all Russian officials, from entering the country and allows

the government to seize their US assets (if any). In addition, the New York Times revealed there is an additional "secret list" that apparently have an additional eight names on it and a meeting later this month could add more. So the result of put-ting this piece of legislation into effect and releasing this list is what exactly?

The first result of the list was the entirely predictable Russian government response with its own list of 18 names of US offi-cials, dubbed by some the Guantanamo list, as some are linked to the notorious prison camp in Cuba where the US is holding people indefinitely and without legal process on suspicion they are terrorists. However, most of the people on Russia's list are accused of torturing, kidnapping or otherwise abusing Russian nationals' human rights around the world.

The Russian foreign ministry is clearly irked and sent out a string of tweets following the publication of the US list: "It's time the US realise that building relations with Russia in a spirit of mentorship and outright dictate is futile… This war of lists is not our choice but we have no right to ignore outright blackmail… Our list includes those involved in legalising torture, indefinite imprisonment in Guantanamo, kidnap-ping Russians in third countries." And most pertinently: "The publication of the Magnitsky list has dealt a blow to bilateral relations and mutual trust."

Clearly, the first concrete result of the list has been to make already fraught relations between Moscow and Washington a lot worse. Indeed, bne has discussed the resumption of the Cold War, and these tit-for-tat moves the list has started is exactly the sort of point scoring that was a hallmark of the Cold War.

Over the weekend, Fyodor Lukyanov, editor of Russia in Global Affairs, caught the mood with a piece that said the Magnitsky list appears set to "play a role resembling that of the Jackson-

The US names names

in pre-detention trial in 2009 was a tragedy and a crime. Indeed, most of the names on the US list are people directly connected to either his detention and abuse, or the tax fraud that saw $230m stolen from the Russian government. All of these people should be tried and convicted – and none of them are even being investigated.

However, does releasing blacklists in this way help deal with the problem? Quite clearly, this list will not only fail to pres-sure the Kremlin into acting, but if anything it will make it even less likely the Kremlin will do anything, because to do so would risk losing face – one of Russia's very Asian traits.

Strobe Tabott, a former US deputy secretary of state and Rus-sia expert, tweeted over the weekend: “#Magnitsky law & list will not advance human rights in Russia. In fact, it's already counter-productive. That's Washingtonese for 'stupid.'"

He went on to sum up the dilemma: "2 wrongs don't make a right: #Magnitsky persecution shows dark side of #Putin's Rus-sia; #Magnitsky law shows Congress at its most hamfisted."

Part of Russia's ire at the list is that it's so clearly designed to selectively punish Russia. Defenders of the list couch its rationale in terms of the fight for human rights and the US "value-based" system that champions individual freedoms and sanctity of life.

However, this list is exclusively aimed at Russia. If the laws it is based on were generalised to allow Congress to blacklist any country that abuses human rights, although that would be a very aggressive thing to do it would be morally acceptable. But the double standards here are blatant. Washington has almost entirely ignored a Saudi court's decision to execute some minors convicted of burglary last month, and on the same day this list was released Deputy Secretary of State Mike Hammer was starting a tour of Central Asia with trips to Tajikistan and US ally Uzbekistan. On April 9, Hammer was in the Uzbek capital of Tashkent where he participated in a conference on "government transparency and press freedoms," and during the trip will "underscore the US Government's commitment to the region," the department said in a statement.

I am sorry, but this is a complete joke if the US is position-ing itself to be the global judge that is going to hold other countries to its own high standards of human rights. Uzbek President Islam Karimov is an out-and-out dictator and a very nasty one at that – there is strong evidence his regime boiled one of his opponents alive. How can Congress reconcile con-demnation of the Kremlin for the death of Magnitsky on one hand, yet condone an official high-level visit to Uzbekistan and pledge US friendship to a regime like Karimov's?

Poor PRThese double standards are not lost on the Kremlin, which is why it is so angry. Yet they highlight a deeper and more worry-ing trend in Russian relations with the world.

Because Russia's image is poor and its economic integration in the global economy is so weak, it's increasingly seen by western politicians as an easy target. If you want to polish your image, then be tough on Russia, as it costs you nothing politically but makes you look like a strong man. The only thing that Russia exports is oil and that's a commodity, so it doesn't matter how rude you are about the Kremlin, there are few economic consequences. Gordon Brown did this after he became PM in the UK. Mitt Romney did it during the last US presidential election. Congress is doing it now with the list. And the international press does it on a daily basis, as it makes great copy.

But it is a dangerous game to play, because Russia is becom-ing a more significant country. Its economic power is growing

steadily, maybe not in the form of exported goods the West buys, but in the form of becoming an increasingly important consumer market for European firms.

Finally, the last question to raise is why if this list is clearly so useless in terms of what it purportedly is trying to achieve – force the Kremlin to improve human rights at home – was it put into law in the first place?

This raises the question about Bill Browder's role, the former head of Hermitage Capital and Magnitsky's friend and boss. Browder has campaigned tirelessly on Magnitsky’s behalf and is identified by the New York Times as a big lobbyist for the bill. Indeed, it is probably fair to say that one of main reasons for the bill's existence has been Browder’s work.

But this raises a difficult question. Browder is clearly pursuing a personal vendetta against the Kremlin – quite naturally given he regards it as being behind the murder of his friend and colleague. But without wanting to seem insensitive, does that justify a law that affects international relations between two major powers that affects the interests of some 500m people? I am not entirely sure what to think about this, but I think that at least for the sake of transparency Browder should be forced into full disclosure so the personal aspects of the case can be set against the national interest, and he should publish how much he spent in his lobbying effort and to whom in order to get this bill passed into law.

"The publication of the Magnitsky list has dealt a blow to bilateral relations and mutual trust"

"Why, if this list is clearly so useless in terms of what it purportedly is trying to achieve, did it become law in the first place?"

bne May 201362 I Special report bne May 2013 Special report I 63

Special Report: Turkey's time

for the privilege; Moscow's two major bourses – the RTS and Micex – merged last year to create the Moscow Exchange.

In the push for new listings, Turkey will solicit the help of partners to help lure companies from 45 countries, Borsa Istanbul said at its press event, admitting that the track record for overseas listings is poor. There is only one foreign compa-ny – Do & Co, a catering partner to Turk-

ish Airlines – out of a total 332 listings. "An international financial centre implies companies from other countries coming to your market as well," Borsa Istanbul's chairman, Ibrahim Turhan, said, adding that if successful, the exchange could carry out its own IPO by late 2015.

Turkey stepped up its bid to build Istanbul into a global financial centre in March and April. It

kicked off construction of its planned huge new banking district, finalized the merger of its trading exchanges, and launched a drive to lure foreign listings to the new Borsa Istanbul.

Echoing the political ambitions of Turk-ish Prime Minister Recep Tayyip Erdo-gan for the country to become a regional leader, the merged exchange is targeting a major role as a centre for emerging market companies to raise money. That saw Borsa Istanbul move swiftly to sign deals with brokerages from southeast Asia, Africa and the Caucasus on April 10 – just five days after the PM rang its debut gong – enlisting their help in attracting foreign companies to list their shares on the exchange.

Part of an initiative entitled "Listing Istan-bul," Borsa Istanbul signed agreements with eight brokerages, including the Turkish unit of Singapore's PhillipCapital

Group, Unlu Menkul Degerler – part-owned by South Africa's Standard Bank – and Invest AZ Menkul Degerler, majority-owned by Azeri businessman Elshan Guliyev. The brokerages will undertake "promotional and marketing activities" to encourage foreign companies to consider Istanbul, the exchange said.

Borsa Istanbul was launched on April 5 following the merger of the Istanbul

Stock Exchange with the Istanbul Gold Exchange and the Izmir-based Derivatives Exchange. The building of a single trading exchange is a major step in Ankara's push to fill the gap in the market between the trading time zones of London and East Asia. Turkey is racing the likes of Russia

Turkey's financial dreamsTim Gosling in Prague

"Given its assets, Istanbul has the potential to be truly international"

bne May 201364 I Special report bne May 2013 Special report I 65

BIM's Egyptian venture is not its first in the MENA region. Three years on from opening its first store in Morocco, BIM has expanded its operations to include 116 stores and aims to open a further 50 stores this year after recovering from what it regards as a slow start due to Morocco's poorly developed property leasing system.

After that experience, BIM subjected the Egyptian property market to close scrutiny before opting to start operations. "After Morocco, that was the first thing we looked at, but our research didn't identify any problem leasing outlet locations," says Dortluoglu, saying that for the first year at least BIM anticipates only opening stores in the Egyptian capital Cairo before targeting only the main population centres. "We'll focus initially on Cairo, opening at least 30 stores, and then expand into Alexandria and the Nile delta region."

With a population of over 80m, the Egyptian market should keep BIM busy for some time. "We are looking at other markets nearby, and some not so nearby, but for the short to medium term we have no plans to enter other markets," he says.

Closer to homeNot that BIM is only looking outside of Turkey for growth. Since first open-ing its doors in 1995 with just 21 stores, it today operates 3,655 stores of

which 366 were added last year alone. Turnover last year topped $5.5bn, with fourth-quarter sales up a healthy 16% to TRY2.58bn and profits up 7.6% at TRY85m. Growth in Turkey has yet to peak and it's planning on opening a further 375 stores in 2013, as part of a $270m investment and expansion plan aimed at growing sales by 17-18% this year.

The jury may still be out on whether the "Arab Spring" has actually delivered better living conditions

to the bulk of the Middle East and North African (MENA) region's formerly disen-franchised masses, but not many would argue that the resulting instability has been good for business. Which makes the recent announcement by Turkish supermarket group BIM that it plans to start operating in Egypt, opening as many as 30 new stores this year, all the more remarkable.

Despite continuing instability, BIM duly opened its first store in the Egyptian capital Cairo in early April, promising 13 more by the end of the month, having identified what it believes is a lack of sufficiently organised food retail.

Certainly, the unrest that has followed the overthrow in 2011 of former president Hosni Mubarak has been marked by shortages in some basic foodstuffs and sharp price increases in what is available. "Trouble can also be an opportunity, and at a time when [foreign direct investment] is dropping

and other retailers are withdrawing, we think our investment will be appreciated," says BIM's chief financial officer, Haluk Dortluoglu, repeating BIM's belief that democracy will eventually take root.

Sticking close to its Turkish model of offering a limited range of basic

products at heavily discounted prices, BIM's plans for Egypt currently envisage offering between five and six hun-dred mainly food lines, most of which it expects to source locally in Egypt. "Around 80% of what we sell will be sourced from local [small producers]," explains Dortluoglu, pointing out that this again should help in its adoption by the local market.

Bringing discounts to the regionDavid O'Byrne in Istanbul

Racing RussiaTurhan also discussed progress in the exchange's bid to join the Euroclear trading system, claiming that joining the world's biggest bond settlement system could increase foreign ownership of Turk-ish sovereign debt by as much as 50%. "We will be reaching as many as 200,000 new investors with Euroclear," he stated.

Turhan said in March that Borsa Istanbul hopes to reach an agreement with the clearing system by the end of 2013. He told reporters on April 10 that Euroclear representatives are currently on the ground. "Their members are in Turkey as I speak, work continues," he said.

Turkey is lagging Russia in this regard. Euroclear began direct clearing of Russian debt in February, in a move some analysts have estimated could raise fixed-income investment to the country by as much as $30bn. Turkey’s

"We'll focus initially on Cairo, opening at least 30 stores, and then expand into Alexandria and the Nile delta region"

Pegasus flies

bne

Turkey's Pegasus Airlines completed its IPO on April 22, selling a 34.5% stake on Istanbul's stock exchange that values the country's second largest airline at around $1bn.

The airline says the proceeds from the share sale will help fund its ambitious expansion programme. The carrier bought 75 planes from Airbus in December as part of a goal to triple its fleet to tap into the rapidly developing market for airline travel in both Turkey and the surrounding region. Pegasus has the option to boost the order by an additional 25 planes, which would take the full value of the deal to $10.3bn for 100 aircraft. The discount carrier has grown six-fold since its 2005 takeover by local giant Sabanci Holding. Pegasus, which flies to 61 destinations in 24 countries, increased its passenger count by about 26% between 2010 and 2012.

Revealing the pace of development in the sector, the Airbus order from Pegasus only held the title as largest ever deal in Turkish aviation history for a few months. In March, Turkish Airlines announced an order for up to 117 jets from the European aircraft maker.

It's that rapid growth that attracted investors to Pegasus' IPO to such a degree that the airline's shares enjoy a similar price/earnings ratio as the world's largest low cost carriers Ryanair, Easyjet and Jet Blue. At around 14.6-times, the airline's P/E ratio is almost double that of the country's largest carrier Turkish Airlines.

government debt market, at $295bn, is almost twice that of Russia’s already, while Ankara is pushing hard to make Turkey a major player in unleashing the huge potential of Islamic funding in its neighbourhood.

Another race in which Moscow leads is in the physical construction of a

financial district. While the Moscow City development on the edge of the Russian capital's centre is now populated with skyscrapers, the Istanbul International Financial Centre (IIFC) is still a dusty

patch of land between the suburbs of Atasehir and Umraniye on the Asian side of Turkey's second city. However, Erdogan is pushing hard to have the $2.6bn project up and running within three years, and construction officially started in March. The 4m-square-metre scheme is planned to have retail outlets and hotels, as well as host the head offices of the country's financial market governing bodies, and state-owned and private banks.

Yet while Russia is ahead in terms of tangibles, Turkey enjoys considerable advantages when it comes to sentiment. The countries are enjoying similar levels of economic growth, but worries over corruption and corporate governance mean Russian stocks are trading at levels last seen at the end of 2009. By way of contrast, the Turkish stock market spent 2012 setting new records, while bond yields plummeted. At the same time, international lenders are desperately seeking a route into the promising Turkish banking sector; Moscow has witnessed an exodus as twin state giants Sberbank and VTB increasingly dominate.

A 2010 study by Deloitte on Istanbul's prospects of turning itself into a global hub noted how those same advantages offer the city a leg-up in building the necessary "aligned political, legal, fiscal, regulatory and physical environment." The consultants rated Turkey above Russia in terms of legal and regulatory environment, political and economic stability, infrastructure and ease of doing business. "Given its assets," Deloitte's report concludes, "Istanbul has the

potential to be truly international – rising above existing centres to match the best in the world."

"An international financial centre implies companies from other countries coming to your market as well"

bne May 201366 I Special report bne May 2013 Special report I 67

BIM has grown organically without making any acquisitions, but Dortluoglu wouldn't rule out any future purchases if the right target presents itself, nor a move away from its base of "hard

discount" retailing given that Turkey's per-capita spending is expected to rise from around $7,350 this year to over $10,000 by 2015. "If there is a really good opportunity, we should consider

it, but a different format would be more appropriate to balance the market," he says, pointing out that Turkey's super-market sector is currently in a period of unparalleled change.

That would be putting it mildly. Turkey's oldest supermarket chain Migros, which operates 911 stores across a range of formats, is already formally for sale with UK-based owners BC Partners

reported to be in protracted talks with US giant Walmart, having already sold Migros' discount subsidiary Sok to Turkish food giant Ulker. Similarly, recent announcements by top Turkish combine Sabanci that it is thinking of exiting its joint venture with Carrefour suggests that the 247-store Carrefour chain could also be put on sale.

As to which of these might tempt BIM, Dortluoglu is tight lipped. "As yet we have no decision and no budget, and there is no solid proposal on the table – this is just something we're considering," he says.

Watch this space.

other opposition groups, who warn of the possible dangers of the Akkuyu site being close to areas of known seismic activity, few now seem to doubt that the plant will be built. And according to Rauf Kasumov, deputy CEO of the project company Akkuyu NGS AS, they have little to worry about. "Normally for the site of new nuclear plant, you would contract one independent company to conduct a site study, we used three," he says, explaining that in addition to a local and international company, Akkuyu NGS parent Russia's Rosatom also contracted Turkey's state seismic laboratory at Kandilli to give the Akkuyu site the once over. "All three gave the same result, the site is absolutely safe," he says.

The vetting process continues with the project company due to submit its Environmental Impact Study for assessment by the end of May, with Turkey's environment ministry obliged to respond within three months. A positive result, explains Kasumov, would allow the company to apply for both a generating licence for the plant and a construction permit to allow building to commence. "We don't expect any delays, but anyway it will be another 18 months before we pour the first concrete as we have to level the site first," he says, adding that if all goes to plan, the bulldozers should begin work in September this year.

With the first of the four 1.2GW units expected to be completed in 2019, after testing and fuelling the first power should be generated in 2020.

Following that, the company envisages commissioning a unit a year with the full 4.8GW expected on line by 2024.

Long-term solutionGiven the length of time before power

It's a well-accepted maxim among Turks, that in Turkey things take longer than they do elsewhere.

As long ago as the 1960s when Europe was investing heavily in nuclear power plants to meet fast growing demand, Turkey's top technical universities began offering courses in nuclear engineering aimed at training the engineers who would develop the country's own planned nuclear power sector. Some 45 years on and those graduates may finally have the chance to put their learning into practice as plans for a new 4.8-gigawatt (GW), Russian-designed plant in Akkuyu finally appear set to make it off the drawing board following a $20bn agreement between the Russian and Turkish governments signed in 2010.

That deal allows for the construction of four units of 1.2GW each, complete with a guaranteed offtake price of 12.35 US cents per kilowatt hour (kWh) for 70% of the power produced by the first two units

for 15 years and for 30% of the power produced by the third and fourth unit for the same period.

Although still subject to strenuous opposition from environmental and

Turkey's nuclear dawn approachesDavid O'Byrne in Istanbul

"Turkey and Russia are close neighbours – it's very fruitful to have good relations with your neighbours"

'Trouble can also be an opportunity; we think our investment will be appreciated'

bne May 201368 I Special report bne May 2013 Special report I 69

from the plant is available, Akkuyu is not intended to meet Turkey's current pressing need for either more installed capacity, or to diversify away from increasingly expensive imported natural gas, which at times of peak demand has been used to generate as much as 51% of Turkey's power and supplies of which are currently limited. Rather it is part of a long-term strategy, aimed at meeting future demand which is growing at up to 8% a year and which current projections indicate will require at least 9.5GW of installed capacity by 2021.

At the same time, Akkuyu and the two other nuclear plants that Turkey wants

to construct will provide an alternative to gas-fired plants, which are still expected to make up the bulk of the country's installed capacity as new sources of gas become available.With many analysts predicting that the huge volumes of gas expected to become available from Iraq and the Caspian Sea basin over the next decade will help reduce gas prices and make power from gas-fired plant cheaper than that from nuclear, the offtake guarantees awarded to Akkuyu have been widely criticised by opponents of the project who claim that the guarantee of 12.35 US cents is too generous. "Power prices in Turkey have

been rising steadily and we believe that the free market price will be about that level by the time we start generating," says Kasumov, pointing out that aside from guaranteeing supply of a hefty volume of power, the agreement affords other significant benefits to Turkey.

These include a 20% share of the plant's profits after the 15-year guarantee period is over and full training for over 600 engineers and bureaucrats who will operate and maintain the plant, and oversee Turkey's nascent nuclear power sector.

But the biggest benefit, he contends, is the contribution that the plant will make to long-term relations between Turkey and Russia. "We are close neighbours – it's very fruitful to have good relations with your neighbours," he smiles.

It has been a long time coming, but Turkey’s new electricity market law that was finally passed by the

Turkish parliament in March looks set to herald the creation of a fully liberalised energy market.

Power to the marketDavid O'Byrne in Istanbul

The new market will allow the trading of a range of energy products both inside Turkey and across its borders. And if successful, it should keep energy prices competitive and end the uncertainty concerning power sales, which has

slowed the pace of private sector investment in power generation to such an extent that Turkey for much of the past decade has been just a few steps away from power shortages.

Central to the new law is the creation of a new energy exchange: Enerji Piyasalari Isletme Anonim Sirketi, or EPIAS for short, which will be incorporated by the end of September. Envisaged as part of Turkey’s planned Istanbul Financial Centre, the creation of which has already seen the re-branding of the Istanbul Stock Exchange as Borsa Istanbul, EPIAS is expected to be physically located in Istanbul adjacent to the stock exchange.

The precise details of what will be traded and when trading will commence have yet to announced, though. "The energy market regulator EPDK is currently drafting EPIAS articles of association and the secondary market regulations,” explains Mustafa Karahan, head of Turkey’s Electricity Traders’ Association, who says that once these are published it will be clear what mandate the company has been given.

15% stake could be held by Botas," he suggests, referring to Turkey’s state gas importer, which currently imports 80% of Turkey’s gas and operates the country’s gas transmission network.

Also as yet unclear is how the market will be policed. "There has to be effective market surveillance to ensure the market cannot be manipulated," warns Karahan. Otherwise the new law repeats existing legislation governing the role of the existing state energy market regulator EPDK and the state grid operator TEIAS, as well as confirming the existing regulations on the issuing of licences for generation, distribution and transmission for between a minimum of 10 years and a maximum of 49 years.

Other changes included in the new market law include the introduction of

Initially at least, EPIAS is expected to take over the operation of Turkey’s existing "day ahead" power market PMUM. Eventually though, EPIAS is expected to expand operations to allow day ahead, intra-day spot and physical trading in power and possibly also natural gas, with responsibility for developing trading of futures products remaining with Borsa Istanbul.

Ownership and policing mattersThe final ownership of EPIAS is also still unclear, with the new law specifying only that it limits the participation of state companies to 15%, a figure which can be doubled to 30% by ministerial decree. According to Karahan, the initial 15% could be held by Turkey’s state power grid operator TEIAS. "If they include gas market trading in EPIAS' remit, then a second

"If all goes to plan, the bulldozers should begin work in September this year"

a new "preliminary generating licence" to be awarded to power plant projects as a first stage to allow developers to secure funding. Those projects that are able to secure funding and are ready to move to construction will then be awarded a full generating licence: This change amends a flaw in the old law, which allowed companies to apply for and be awarded licences for projects that they had no intention of developing and were intending only to sell on as off-the-peg licenced projects at a hefty mark-up. This resulted in the development of a de-facto secondary market in licenced projects, with hundreds of mainly hydroelectric power projects licenced but undeveloped as licence holders instead tried to sell them on.

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

What you need to know

Sign up today for a free month trial of all our services www.bne.eu

| Eastern Europe | Russia | Belarus | Ukraine || Central Europe | Estonia | Latvia | Lithuania | | Poland | Czech | Slovakia | Hungary | Southeast Europe | Slovenia | Croatia | Serbia | Romania | | Bulgaria | Turkey | Moldova | Albania | Bosnia | | Croatia | Macedonia | Montenegro | Kosovo | | Eurasia | Kazakhstan | Georgia | Uzbekistan | | Kyrgyzstan | Turkmenistan | Tajikistan | | Azerbaijan | Armenia | Mongolia |

70 I Events bne May 2013 bne May 2013 Events I 71

Upcoming events 2013

Staying ahead ina changing market

Note – this conference will be deliveredin Russian and English

www.eurofi nance.com/russia

Treasury Risk and Cash Managementin Russia4 – 5 June 2013Radisson Royal Hotel, Moscow, Russia

– this conference will be delivered

www.eurofi nance.com/russia

Radisson Royal Hotel, Moscow, Russia

20 %DISCOUNT

Register online and use

the booking code

BNE/20

What You do not Want to Miss from the Serving The Needs of The Wealthy:

EBCG’s 2nd Annual Private banking conference Serving the Needs of the Wealthy in CEE, SEE & CIS will bring together the most respected private banks and leading wealth managers to discuss actual trends and challenges which professionals are facing these days. The event is filled with keynote presentations, hot topics and insightful panel discussions which provide an interactive and highly practical guide for all industry peers.

1. Discussions about regulatory changes happening in Europe and beyond2. Insightful presentations into new commercial strategiesfor the region3. Strategies how top companies and industry leaders are improving their portfolio of services

4. Latest improvements to quality of services and added value for customers5. Experiences with performance levels enhancement, elevating leadership impact & accelerating business results6. Updates on wealthy clients’ interests, alternative investments and philanthropy trends

Special Discountin cooperation:

20% off!(Discount code: BNE56)

www.ebcg.biz Tel.: +421 2 3220 2200 Fax: +421 2 3220 2222event@ebcg.biz

4 Ways to contact us:

FMRS

F R E EM A R K E TR O A DS H O W

2013

www.freemarket-rs.com

"To Save or Not to Save:Will austerity programs alone save Europe?"

free markets, free people

8th May-27th June

C

M

Y

CM

MY

CY

CMY

K

TurkeyPrivate Equity & Venture Capital

Summitaccessing new markets - developing new opportunities

3rd edition

June 2013 | Turkey, venue tbc | Conference & Workshop

Official Legal Partner

Media Partners

www.eelevents.co.uk Register now!

MongoliaInvest2

13Ulaanbaatar

Mongolia

www.cbonds-congress.com

June 6, 2013

Hosted by:

Partners:

FORUM

RUSSIAN

RussianIPO Forum

Russia,Moscow,

Novotel MoscowCentre

IVExpected number of delegates – 150Participation fee – USD 600

Free Market Roadshow 2013 (8 May - 27 June) Austrian Economics Center, +43 (1) 505 1349 ext. 32 m.ristevski@austriancenter.com www.freemarket-rs.com

EBRD Annual Meeting and Business Forum (10 - 11 May)EBRDwww.ebrd.com/am

The 3rd annual International Forum Airport Development: Russia & CIS (15 - 17 May)Adam Smith Conferences, +44 20 7017 7444 World Trade Centre Moscow, Russiaevents@adamsmithconferences.com www.adamsmithconferences.com/as223bahpe

VI Astana Economic Forum (22 - 24 May)SUCCESS K media agency, +7(7172) 24 14 30 Astana, Kazakhstanpr@astanaforum.org www.2013.astanaforum.org

4th Emerging European Investment Products (23 May)EEL Events, +44 (0) 207 275 8020Warsaw, Polandstephanie.gryszan-brindley@eelevents.co.uk www.eelevents.co.uk

3rd Annual CFO Forum (27 - 28 May)EBCG, +421 2 3220 2200 Prague, Czech Republicevent@ebcg.bizwww.ebcg.biz

Russian Real Estate & Urban Development Summit 2013(3 - 6 June)Adam Smith Conference, +421 2 3220 2200 Moscow, Russiaevents@adamsmithconferences.comwww.adamsmithconferences.com

72 I Events bne May 2013