bne:Magazine - June 2014

June 2014www.bne.eu

Inside this issue:

Spectre of Yanukovych haunts Ukraine

Will EU stand for Energy Union?

The Balkans' bear problem

Almaty in Wongaland

RISE OF THE PSEUDO-STATES

Contents I 3bne June 2014

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) +38 50 0639722 Anna Kravchenko (Moscow)

Central Europe:Jan Cienski (Warsaw) +48 604994850Mike Collier (Riga) +37 129473192Tom Nicholson (Bratislava) +42 1907732736Kester Eddy (Budapest) +36 308665550

Southeast Europe:David O'Byrne (Istanbul) +90 5359210950 Ian Bancroft (Belgrade) Bogdan Preda (Bucharest) +40 722580137Guy Norton (Zagreb) +38 513835929Andrew MacDowall (Belgrade)

Eurasia:Bureau Chief:Clare Nuttall (Almaty) +7 7073011495Molly Corso (Tbilisi)

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

Please direct comments, letters, press releases and other editorial enquires to [email protected]

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COVER STORY

The Insiders

Rise of the pseudo-states

Perspective

Chart of the month

EASTERN EUROPE

A game-changing gas deal

Russia heads toward stagnation

Keeping Gazprom in the game

Will Europe's newest state be "Novorossiya"?

Spectre of Yanukovych haunts Ukraine

Russia's regional Achilles' heel

Chocolate King wins Ukraine presidency in first round

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CENTRAL EUROPE

Preventing inertia in Poland

A more dangerous neighbourhood

Will EU stand for Energy Union?

Hungary and Croatia resume hostilities over oil firm

Poland raked over the coals

Turning the Polish plumber into the CEE investor

Estonia's Guardtime follows the data trail

Estonia's e-voting system – is it safe?

An apathetic lurch to the right

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Contents I 5bne June 2014

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SOUTHEAST EUROPE

The Balkans' bear problem

Belgrade under water

The "Putinisation" of Turkey

The Recep roadster

Flat-packing the past in Romania

The rub of the greens

Farmaggedon in Croatia

Croatia spies opportunity in crisis

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EURASIA

Almaty in Wongaland

Population control

Kazakhstan to outsource investment drive to EBRD

Arrested developments in Mongolia

Mongolia in a 100-day sprint to revive economy

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OPINION

Minimising defeat in Ukraine

Are Austrian stocks still a play on Emerging Europe?

UPCOMING EVENTS

bne June 20146 I The Insiders

was perhaps unwise for the West openly to encourage a welter of rock-throwing thugs to oust an elected president is "suspect". To call for a thorough, independent investigation into who really was behind the February sniper shootings – which killed 70 protestors, transforming Kyiv unrest into a global diplomatic crisis and "New Cold War" – is apparently "tasteless" and "insensitive". To offer factual, rational analysis of an extremely dangerous and complicated situation, while rejecting jingoism and tub-thumping, is to provoke unalloyed scorn.

The Ukrainian people as a whole should surely have ousted the incompetent and unsavoury Yanukovych via the ballot box in elections originally scheduled for March 2015. Surveys of voting intentions suggested that would happen. Ordinary Ukrainians, rightly, are sick of kleptocratic government – precisely why the unelection of Yanukovych should have gone ahead. A peaceful yet decisive removal of a discredited leader would have embedded a stronger, more durable Ukrainian democracy.

Instead, violence prevailed – violence backed and encouraged by megaphone diplomacy from Washington, London and Brussels. An "interim" government was installed, again with heavy western intervention, the composition and early actions of which seemed deliberately designed to create as much upset and insecurity as possible in Ukraine's Russian-speaking south and east.

The forceful removal of Yanukovych seriously undermined Ukrainian democracy, even before you consider its chaotic aftermath. The current unelected (nay imposed) government, lionized as "legitimate" and "courageous" in western editorials, is also clearly despised and feared by much of the population – not least as several senior members are from the openly-Russophobe Svoboda party, including the minister of justice and deputy prime minister. Svoboda's founder, Andriy Parubiy, has become National Security Secretary, no less, with Dmytro Yarosh, leader of the neo-fascist Right Sector group, as his deputy.

To write such uncomfortable truths, to observe that threatening sanctions you'll never impose is counter-

Liam Halligan in London

"That the Cold War ended in our lifetime without a general war and a nuclear exchange is the greatest shared boon, a true miracle of our own times.

Nothing beats that – it is the thing that trumps it all."

These words were uttered two years ago by Peter Hennessy, the distinguished British historian, on BBC Radio 4. It's revealing such a profoundly true observation is so infrequently made.

Far from celebrating the end of the Cold War, and its peaceful denouement, the western establishment appears to long for a return to the bad old days of east-west loathing and mutually assured destruction. Rather than building on the successful defusing of a 40-year standoff, recognising the vast benefits of cooperation and trade, politicians in Washington and London seem intent on renewed conflict with Russia. This sentiment has grown stronger, of course, since the outbreak of rhetorical hostilities over Ukraine.

When the Kyiv disturbances began in February, after then-Ukrainian President Viktor Yanukovych rejected the EU's Association Agreement, Russia instantly reverted to pariah status in the eyes of many western observers. Complex issues were reported in absolute terms, just as during the Cold War. Russia was axiomatically wrong, whatever Moscow said, with the US and UK always right.

Since then, hard facts have gone out of the window, vital shades of grey ignored. The Anglo-Saxon media has coalesced around a single "narrative" – that the Euromaidan protesters in Kyiv are brave freedom fighters, while Moscow is itching to invade eastern Ukraine and maybe Poland and the Baltic States too.

Having recently written several articles advocating mediation between Russia and the West on Ukraine, I've been receiving a slew of media abuse for my trouble. To observe that the 2010 election of Yanukovych was "fair" and "competitive", as stipulated by the Organization for Security and Co-operation in Europe, is to be labelled a "Putin apologist". To highlight that it

West needs to jaw-jaw, not war-war

bne June 2014

Most other commentators, having visited Russia only recently, if at all, seem determined to think the worst, stressing the negatives and ignoring significant gains. This is a mistake, commercially and diplomatically too – as shown during this crisis in Ukraine.

No one is saying Russia is blameless. Moscow probably exaggerated immediate safety threats in Crimea to help justify annexation of this formerly Russian territory. While preceded by a decisive referendum, this was hasty and opportunistic. Defendable on many levels, Russia's actions in Crimea still transgressed international law.

It's now clear, though, that Russians and Russian-speakers should indeed fear for their rights and safety under the new Ukrainian government. A UN report published in mid-May highlighted an "alarming" deterioration in human rights in Eastern Ukraine, with major transgressions on both sides. And the report didn't include the tragedy in Odessa's trade union headquarters, where up to 100 anti-government protesters were burnt alive by pro-Kyiv forces.

The West was surely wrong to back the violent overthrow of an elected president and woefully premature in recognising the new Ukrainian government. We should have insisted on meaningful representation from Eastern Ukraine and guarantees of minority rights.

Above all, our leaders shouldn't have tried to force Ukraine to choose. The EU's Association Agreement was an "us or them"

ultimatum. Yet it's Ukraine's destiny to be a bridge between East and West. And to thrive economically, the country must trade both ways.

Western policy should be focused on working with Russia to prevent Ukraine being torn apart. That means seriously considering Moscow's proposals – a neutral Ukraine, with semi-autonomous regions, that could join the EU but not Nato.

The West needs to get beyond Cold War distaste and start negotiating with Russia, rather than engaging in a crass public relations war. Unless we see de-escalation, and fast, this Ukrainian crisis could yet result in a major human catastrophe.

Liam Halligan is Editor-at-Large of Business New Europe and from June will write a monthly column called "The Invisible Hand".

productive, and that for all our moralising it's the "advanced" countries that, across much of the world, look marginalized and shrill, has been to endure ridicule.

The current atmosphere in the western media village reminds me of the early 2000s, prior to "regime change" in Iraq. Those of us who opposed that foreign foray, voicing concerns about self-serving western intelligence, endured ridicule then too.

The invisible handAs someone who is British, and proud to be British, I know how admirably truth-seeking my native media can be. American journalists, too, can point to a long and proud tradition. I have years of experience, though, that tell me when it comes to covering post-Soviet Russia, even the pretence of objectivity has gone.

As a rookie journalist living in Moscow in the mid-1990s, I wrote a column in the Moscow Times. Dubbed "The Invisible Hand", my weekly offering focused on the thrills and spills of Russia's early economic reforms. Like its 1990s predecessor, this column will focus on economic and business developments, not only in Russia but across the entire bne region, from Poland to Mongolia, from Estonia to Kazakhstan.

Twenty years ago, Russia's fragile "transition" economy lurched from crisis to crisis. Prices spiralled upward, the ruble see-sawed wildly and the Communists looked set to return. By the time of the 1998 collapse, the Russian economy was on its knees, with 86% annual inflation, income per head below $1,500 and government debt at 160% of national income.

Since then, Russia has staged a quite remarkable turnaround. Annual inflation is in single digits, per-capita dollar incomes are up ten-fold and state debts are miniscule at around 8% of GDP. Barely recognised by Western pundits, this transformation is among the major economic stories of our time.

Many "experts" argue that Russia remains a stagnant petro-economy. Yet energy production now accounts for just 16% of GDP, less then Norway and down from 40% in 2003. Russia's service sector, which barely existed in the late-1990s, is now three-times bigger than oil and gas.

Yes, growth has been uneven and major challenges clearly remain. But Russia is a low-tax, fiscally-sound economy with a rock-solid core banking sector – and great prospects in high-tech, pharmaceuticals and other value-add sectors. Adjusted for purchasing power, it's the sixth biggest economy on earth.

Western journalists who've followed Russia for a long time and remember the chaos of the early post-Soviet era, tend to recognise this incredible progress – not just on the economic front, but in terms of pluralism, social attitudes and freedoms too. Contemporary Russia isn't as liberal as we'd like it to be. But it's come a long way in a short time and the direction of travel is clear.

"Unless we see de-escalation, and fast, this Ukrainian crisis could yet result in a major human catastrophe"

8 I Cover story bne June 2014

David O'Byrne in Istanbul


bne June 2014 Cover Story I 9

curiously, other similar "pseudo-states", many of them formerly part of the Soviet Union.

Even before the collapse of central Soviet authority in 1991, those ethnic tensions were already boiling to the surface with Armenian groups in the majority Armenian-populated Nagorno-Karabakh enclave declaring the region independent of the then still Soviet Republic of Azerbaijan. With the breakup of the Soviet Union in 1991, this was soon followed by conflicts in Georgia and Moldova, resulting in the breakaway republics of Abkhazia and Transnistria (or Trans-Dniester – even its inhabitants don't appear to be certain).

These are territories whose legality is recognised still only by each other, Russia and a small handful of Russia's more faithful allies. Even so, they boast a national flag, national anthem and a range of at least superficially functioning administrative institutions, if not the presence of the European Commission, representation in the UN, membership of Europe's football

authority Uefa and admission to the World Cup qualifying rounds – not to mention the chance to compete in the Eurovision Song Contest.

To this list was added the Georgian breakaway region of South Ossetia, following the 2008 intervention of Russian troops and Russian trained irregulars – a common factor, as is the subsequent stationing of Russian troops.

Whether or not this extends to a Russian plan to attempt to rebuild the former Soviet Union, or at least to annex those parts between itself and the expanding

EU, is moot, but the impression is difficult to dispel.

While early secessions clearly stem from the failure of Soviet-era administrations to overcome ethnic tensions, just as clearly the more recent secessions, including those in Ukraine, are symptomatic of Russian disapproval of accession to the EU/Nato and, more broadly, "European values", as exemplified by the recent furious criticism of that most benign of European institutions, the Eurovision Song Contest, which was won by Austrian drag queen Conchita Wurst.

For the pseudo-states that have emerged, the major challenge though is not one of recognition, so much as developing their own functioning administrative institutions. "Because these entities have generally been born out of armed conflict, there tends also to be a massive displacement of persons on an ethnic basis," says Sabine Freizer, a senior fellow at the Atlantic Council, explaining that in the rare instances where communities have subsequently returned, they have faced challenges

obtaining their political, social and economic rights.

"It's a tremendous challenge for these unrecognised entities to build up their own state institutions, as they are unrecognised by international partners," she says, pointing out that despite this it is important for international donors to engage with the de-facto authorities and encourage them to develop as many democratic institutions as possible.

40 years is a long timeUltimately, the greatest risk in the creation of "pseudo-states" is that the

"Because these entities have generally been born out of armed conflict, there tends also to be a massive displacement of persons on an ethnic basis"

The 28 member states of the EU went to the polls on May 25 in the eighth Union-wide elections

for the European Parliament. However arguably the most important election on that day was further east, the presidential election in Ukraine – the first nationwide poll in the troubled state since overthrow of president Viktor Yanukovych, the subsequent Russian annexation of Crimea and the declaration of independence by the Donetsk and Lugansk regions of East Ukraine following internationally unrecognised referenda.

The Ukrainian poll is not only expected to indicate whether the country has returned to democracy, but also whether it can continue to exist as a single, united state in the face of Russian aggression. "Presumably Russia's strategy is.... to work to ensure that the vote come May 25 shows the country divided enough to then force negotiations to forge some form of federal structure," wrote Timothy Ash of Standard Bank in a note in mid-May, adding that many dispute whether Russian plans end with the federalisation of Ukraine.

The claimed pullback of Russian troops from the Ukrainian border may indicate that Russian leader Vladimir Putin has realised the limits of formal military intervention, but not necessarily that his territorial ambitions have been sated, or that successful completion of the Ukrainian poll will see the breakaway regions returned to Kyiv's control.

Rather, it appears that the self-styled "Donetsk People's Republic" and "Lugansk People's Republic" – perhaps together forming a "pseudo-state" called "Novorossiya" – are set to become for the forseeable future internationally unrecognised features on the map of Europe and Eurasia. Whatever the formation, it certainly won't want for company.

Stateless statesEurope and Eurasia already boast an impressive array of similar "pseudo-states" – de-facto functioning countries recognised only by themselves, a powerful "sponsor state" and, more


10 I Cover story bne June 2014

conflicts that create them remain frozen and unresolved.

A case in point is the "Turkish Republic of North Cyprus" (TRNC), created in the northern 37% of the island of Cyprus following the invasion of Turkish troops in 1974. That invasion came in response

to a military coup which threatened to unite the island with Greece, then ruled by a military junta, though the TRNC was only formally declared in 1983, nine years later following another coup, this time in Turkey.

Events there appear to confirm the idea that whatever the initial motivation for the creation of the "pseudo-state", ultimately it's the internal politics of the "sponsor" state or states that define whether or not the conflict can be unfrozen. "Because of the way conflicts go, you can't always say how long it's going to take," says Hugh Pope, director of the Turkey-Cyprus project at International Crisis Group, explaining that in their memoirs the Turkish generals who occupied 37% of the island in 1974 did so with the expectation that it would be handed back straight away in return for a durable settlement.

"It doesn't matter whose fault it is, things just get stuck and the cost of going through international procedures and laws can be very great for both sides," Pope argues, pointing out that high cost has been borne by the Turkish and Greek sides of the island as well as by Turkey itself, in terms of delays to its own EU accession process.

With the best chance yet of a resolution, the 2004 Annan Plan, having been accepted in a referendum by 65% of the island's Turkish population but rejected by 75% of the Greek population, the

chance of reuniting the two halves of the island had appeared unlikely until the discovery in 2011 of the giant Aphrodite gasfield. The confirmation of 200bn cubic metres of gas reserves and the possibility of much more – for which the main market would be Europe and the most logical export route via Turkey –

may yet prove sufficient incentive for a settlement to Cyprus.

Energy is also key to another long-running frozen conflict, that of the Kurdistan region of Northern Iraq, which has been a de-facto self-governing state since the international intervention of 1991 following the uprising against the Iraqi central government of Saddam Hussein. The subsequent 23 years of self-rule has resulted in an efficiently functioning democratic administration and a booming economy, thanks in no small part to the discovery of enormous reserves of both crude oil and gas.

As with Cyprus, regional politics is the main barrier to a settlement. The Kurdistan Regional Government (KRG) thus far continues to agree with

Baghdad that it is part of a federal Iraqi state, albeit with the right to arrange its own hydrocarbon exports – something which Baghdad continues to deny.

However, the seriousness of KRG's commitment to a federal Iraq is moot given that the only commercially viable

export route for its oil and gas is through neighbouring Turkey which, thanks to its own fractious Kurdish population, is unlikely to look favourably on the emergence of an internationally recognised Kurdish state. The more so given the possible emergence of a second such state in war-torn Syria.

Not that "pseudo-statehood" appears to have done the region any harm. Its enormous energy reserves and the presence of many major oil companies has ensured also a diplomatic presence by more than 20 states, including Turkey. But then, the extent to which a "pseudo-state" remains "pseudo" appears to depend largely on who its friends are.

Kosovo, for example, has been de-facto independent of Serbia since being taken under UN administration in 1999 following the end of the Kosovo War that year. And following the former Serbian province's declaration of independence in 2008, Kosovo has been recognised by 107 UN member states, including most major EU members, and accorded membership of a host of international institutions including the International Monetary Fund and World Bank – although crucially not the International Telecommunications Union, which would allow it to compete in the Eurovision Song Contest.

Serbia, somewhat understandably, does not recognise Kosovo's independence and equally understandably nor does Azerbaijan, Georgia, Moldova, Russia,

Ukraine, Iraq or Syria – and less understandably Armenia, Nagorno-Karabakh, Transnistria, Abkhazia, South Ossetia or the TRNC. Nor indeed do EU states Greece, Cyprus, Slovakia, Romania or Spain – the latter the only major European power not to have done so, presumably fearful of secession by

"The extent to which a 'pseudo-state' remains 'pseudo' appears to depend largely on who its friends are"

"It doesn't matter whose fault it is, things just get stuck"

bne June 2014 Cover story I 11

own flag, singing their own national anthem and cheering on their own national football team.

Hardly good news for an EU emerging from Europe-wide elections, in which the major issues were continuing questions over just how many former Soviet bloc states the EU can comfortably admit, as well as criticism from parties that would like to see their respective countries exit a union they no longer have any faith in. Nor is it good news for an entity that has yet to even address just what constitutes a "state" and how many new breakaway "states" it could accommodate without collapsing under the weight of its own bureaucracy – a subject it will conceivably have to address in the coming months and years.

As with the Eurovision Song Contest perhaps: it's not over until the bearded lady sings.

its own Basque and Catalan regions.

This apparent demonstration of double standards is particularly odd given that it is now 20 years since the creation of the EU's much-vaunted "Committee of the Regions." This was intended to devolve a degree of decision-making away from national governments and create a "Europe of the Regions" – a policy which looked fine on paper, but which seems to have had little effect on the secessionist tendencies of many of the regions it was intended to serve.

This September will see Scotland vote on possible secession from the UK and equally possible exclusion from automatic EU membership. This is a referendum being eyed intently by nationalist groups in Spain, Belgium, France and numerous other EU states with large regional ethnic minorities who might fancy a stab at flying their

Photo by Andres Putting (EBU)

12 I Perspective bne June 2014

redaction, with legal force, undermines the spirit of openness on which the web is based.

In reality, as Charles Arthur of The Guardian has pointed out, the provisions of the ECJ's ruling are less ominous than they might appear. The original pages describing people's nefarious or embarrassing activity will still exist; all that will be deleted as a result of successful applications will be search engines' links. It will be easy to re-expose these pages via Twitter or a social network such as Facebook; as these systems are not categorised as "data controllers", they are not affected by the Court's ruling.

A new 'black art' for PR consultants?The PR industry, now worth $100bn worldwide, has grappled with the temptation to tamper online for several years. After a few mis-steps with Wikipedia, the industry's leaders are now unanimous that interfering with online information is verboten.

Lord Chadlington, founder of Huntsworth – one of the largest international PR groups – told PR Week that: "I wouldn't advise a client to do it. But the point is now very different: it is being legally encouraged, so we can't say you shouldn't do it."

Yet he finds the ECJ ruling extraordinary. "It's unbelievable. This isn't about getting things removed that are wrong, but about getting things removed that are right." If asked, Huntsworth will advise clients to contact search engines direct.

Stephen Waddington, president of the Chartered Institute of Public Relations, sees the ECJ ruling as presenting a moral hazard to PR practitioners: "It sets the financial interests of the PR industry against notions of democracy."

Francis Ingham, CEO of the Public Relations Consultants Association, is more sanguine: "I can't imagine any of our members advising their clients to try to delete search engine links," he says. "Not only does it feel antithetical to the concepts of freedom of speech and freedom of information, but also – on a purely practical level – it is quite likely to arouse attention rather than suppress it."

"After all, Mr Gonzalez's social security debts have been unknown since 1998 but are world-famous in 2014," he adds, referring to the Spanish lawyer, Mario Costeja Gonzalez, who took the case to the ECJ after becoming angry that results from Google searches on his name included links to newspaper pages from 1998 that carried an announcement of

COMMENT: Will ECJ ruling enable the whitewashing of reputations?

A controversial ruling in May by the European Court of Justice that search engines must consider amending search results at the request of ordinary people has

given rise to worries it will be used by wealthy individuals with shady pasts to whitewash their stained reputations. But whether in reality this ruling will give such carte blanche to venal elites or create a new "black art" for PR companies is open to question.

On May 13, the ECJ ruled that search engine operators (which in Europe means Google, with 90% of the market) must consider applications from individuals to delete links to online pages that, in the individuals' view, infringe their right to privacy.

The ruling has generated a frenzy of debate and furrowed brows on both sides of the Atlantic. How is it supposed to work? Can it work? Who will benefit most from it? The consensus is that the Court concerned itself with the legal principle of individuals' right to privacy – widely accepted in Europe, not at all in the US – but left the crucial question of how the system will function for others to tackle.

Google's CEO, Eric Schmidt, admitted at the company's annual shareholder meeting on May 14 that the ruling had posed some serious questions. As things stand, it is up to Google to judge whether a take-down application has merit: they must decide if the public interest argument is stronger than that of an individual's personal right to privacy.

Up until now Google, being US-headquartered, has deliberately leant towards transparency. The ruling means they must change their ways. It also means they will need to set up a department to handle applications, but no one can tell if there will be a trickle or a flood. So far over 1,000 have been received, 50% from convicted criminals.

Some commentators, and perhaps even Google itself, question if it is right and proper for a private-sector corporation to make such intricate assessments in the realm of human rights law. It is therefore possible that search engine operators will simply accede to all requests, potentially depriving enquirers of access to vast swathes of information which belong in the public domain.

This possibility worries Sir Tim Berners-Lee (inventor of the worldwide web) and Jimmy Wales (founder of Wikipedia). They are also anxious that the principle of permitting

Adrian Wheeler, PR consultant in Prague

Perspective I 13bne June 2014

a real estate auction aimed at paying off his debts.

Freedom of speech, but not as we know itSupporters of the ruling say it is a step in the right direction; for the first time, a senior court has recognised that people have property rights in information about themselves. They deride existing methods of recourse as being unfit for purpose in an era of universal online communication.

My own view is that we are very happy for the right people (ourselves, for example) to enjoy the ECJ's protection, but less tolerant when it is extended to those of whom we disapprove. I expect industrial and political figures with deep pockets – including the notorious oligarchs in Central and Eastern Europe – to exploit the ruling to the hilt, just as they now succeed in expunging original web pages; the UK legal system

is famously friendly to plaintiffs with serious money to spend, regardless of their country of origin. It is estimated that more than half of cases in the London High Court’s commercial division are related to Russia or other former Soviet republics.

More significantly, I feel the ECJ's ruling is a step in the wrong direction. By granting a valuable right to ordinary people – as I'm sure they see it – the court has inadvertently handed a new weapon to those shadowy figures who have an intense and malign interest in preventing the public from knowing anything about them.

Adrian Wheeler is the former chairman of GCI Europe, and is today a partner at Agincourt Communications and a non-executive director at London Communications Agency, Westminster Advisers, Firefly Communications and Liquid PR.

Ex-Soviet sisters in charge

Vladimir Putin has been accused of wanting to rebuild the Soviet Union; women in the region might well support that dream (were it not for the high levels of domestic

violence that the Soviets also bequeathed).

As this month's chart from Grant Thornton shows, alongside Southeast Asia, the former Soviet states lead the way on women in business leadership by some margin.

Globally, Russia (43%) has the highest proportion of women in senior management, a figure that has held fairly stable since 2004, helped by a gender ratio that favours women by 6:5. Elsewhere in in Central and Eastern Europe, the Baltics (39%), Georgia and Armenia (both 35%), and Poland (34%) are all well above the global average.

"This can be traced back to the promotion of women in the former Soviet Union," the study claims. "The communist leaders promised ‘equal opportunity for all’, best demonstrated through the promotion of women in the rapidly expanding services sectors, such as health, education and accountancy."

At the same time, it seems likely that the rapid development of market economies is also a factor. The pool of capable candidates to lead businesses is simply smaller, making prejudice an unaffordable luxury, while the old boy network has never existed. In developed markets in Europe and the US the use of quotas is increasing, but it doesn't appear to be resulting in more women in boardrooms, with the global average stuck at 24%. A lack of childcare support is likely an issue here, the report suggests.

Source: Grant Thornton IBR 2014

Proportion of women in senior management

22%

20%

14%

14%

22%

13%14%

35%

14%

38%

9%

38%

41%

43%41%

40%

39%

35%

10%

37%

US

UK

Denmark

Germany

Spain

SwitzerlandUAE

Georgia

India

Thailand

Japan

China

Indonesia

RussiaLatvia

Philippines

Lithuania

Armenia

Netherlands

Estonia

Top ten

Bottom ten

bne June 201414 I Eastern Europe

Ben Aris in Moscow

A game-changing gas deal

Russia and China have closed what has been dubbed the "deal of the century" – a $400bn gas deal that

will supply energy to the burgeoning Chinese market for at least the next decade, RT reported on May 21. The agreement represents a new and deeper strategic partnership between the two biggest BRIC countries that could change the balance of power in the world.

China's economy is growing by leaps and bounds, but a quirk of geography means that, although the country is massive, it has little in the way of natural resources. It is missing all the key inputs that its factories need to make profits, with energy and minerals topping the list. Russia has the opposite problem. It has a vast and largely unpopulated territory that is home to nearly every raw material imaginable. However, its traditional customers in Western Europe for its gas have become unhappy about

Russia's reliability, so are threatening to reduce the amount of Russian gas they import as soon as they can.

"We view the deal as positive for Gazprom from a strategic point of view, as it allows it to enter the world’s fastest-growing gas market and will indirectly help in negotiations with European gas consumers," says Ildar Davletshin, an analyst with Moscow investment bank Renaissance Capital.

Together the Sino–Russian partnership has been called "the best synergy on the planet." The trouble is they don't like each other very much. Even during the Communist era, China and Russia failed to unite against the capitalist world.

Yet in the last few years the two countries have been growing together in a marriage of convenience. Chinese President Xi Jinping chose to visit Russia

first following his elevation to the post last year and Russian President Putin has thrown enormous resources into developing Russia's Far East to better tap the Chinese market.

The Socialist ideology has been discarded as the foundation of their political systems and business has taken over. The two countries have little problem trading with each other. The Chinese are nothing if they are not mercantile and the Russians are also these days most interested in making money. But their relationship will change following the gas deal.

Going into business togetherRussia's showdown with the West over Ukraine has meant that the Kremlin has swallowed its traditional misgivings about cozying up to China and decided that the two countries should go into business with each other.

bne June 2014 Eastern Europe I 15

China currently relies heavily on coal to fuel its power plants, and suffers from pollution as a result. The Chinese would love to import Russian gas, especially to its underdeveloped northwest territories.

The point with gas is that it's best suited to be sent through pipelines (though liquified natural gas shipped by tanker is growing). The point with pipelines is that once they have been built they cannot be moved. It is a binding relationship. The EU worries about Russia's power to cut off its gas supplies, though the Kremlin is as dependent on the revenues from their gas exports as the EU is dependent on Russian energy imports. And the same is true for China with knobs on.

The big difference between China and the EU is that Brussels has already built an extensive distribution network that

Russia heads toward stagnation

Ben Aris in Moscow

The Ukraine crisis has been an economic train wreck for Russia, which is bad news for Russian President Vladimir Putin.

Last year's slowdown came as a surprise, but this was supposed to be the year of recovery. Yet predictions about the economy have been steadily worsening as the year wears on: analysts began the year predicting 1.5% growth for the year, but that fell to 0.3% growth more recently. And at the end of April the International Monetary Fund (IMF) slashed its growth forecast for Russia after the economy contracted by 0.5% in the first three months of this year.

The IMF said Russia’s economy is on track to grow by just 0.2% this year, rather than the 1.3% it forecast earlier, warning that further downgrades were likely unless the Ukrainian crisis abated. "If you understand by recession two quarters of negative economic growth, then Russia is experiencing recession now," IMF mission chief Antonio Spilimbergo told reporters on April 30.

Christopher Hartwell, head of Global Markets and Institutional Research at Skolkovo Institute for Emerging Market Studies (SIEMS), is just as pessimistic. "I think Russia is already in recession and the economy will contract this year," he says in an interview with bne.

The problem for the Kremlin is there is little it can do to reverse the slide. While other governments around the world have slashed interest rates close to zero, that is not an option for Russia. "Money stimulus is suicide," says Hartwell. "Russia has got as far as it can go with the capital account or using money from the National Reserve Fund. If the central bank cuts rates, all that will happen is you'll send inflation soaring and will see the money used to buy more imports."

Capital flight is also putting pressure on Russia's banking sector, which should be one of the main sources for the badly needed investment money. The outflows have made cash scarce, so banks instead of lending are struggling to avoid a liquidity-driven crisis. "There is no investment because there is a small pool of capital and therefore the cost of the capital is high," says Hartwell. "The high interest rates represents concern, but there is also a high risk premium in Russia. The central bank can't cut interest rates, as that would just lead to inflation and growing imports."

Russia's cash pile will buy it some time, but clearly drastic action is needed to turn the situation around. With no fiscal tools to hand and the diminishing returns associated with state-funded megaprojects, the only real solution is to make deep structural reforms. "Previously, Russia was growing so fast it didn't matter how bad the government was. But now with the economic slowdown bad government makes all the difference," says Hartwell.

Shanghai, China. May 21, 2014. Russia's president Vladimir Putin (3rd L), China's president Xi Jinping (2nd R), Russia's energy minister Alexander Novak (2nd L) and China National Energy Administration chief Wu Xinxiong (R) at the signing of joint documents. (Photo ITAR-TASS/ Mikhail Metzel)

16 I Eastern Europe bne June 2014

runs throughout the Continent. As China has not until relatively recently imported gas, it doesn't have a wide pipeline distribution network. The Gazprom deal means not only will China have to spend $400bn on Russian gas imports over the next 30 years to deliver some 38bn cubic metres a year (cm/y), the real commitment is the even larger sums it will have spend on building a domestic gas distribution network. Countries don't make this sort of infrastructure investment lightly, especially if they are not sure of the continued friendship of the supplier of the gas.

The upshot is that this gas deal is a de facto strategic partnership treaty that needs to be maintained for decades and probably much longer. Ukraine's pipeline network that links Russia to Europe, for example, has been in existence for more than 50 years; even in the Soviet-era Russia continued to export gas to Western Europe despite being in a Cold War with the Nato allies.

There is no word on the all-important price of the gas. The Russian side is reportedly insisting on between $350 and $380 per 1,000 cm of gas – the same sort of price that Russia charges its European clients. The Chinese, realising they have Russia over a barrel, are asking for a discount on the order that the other countries of the Commonwealth of Independent States

(CIS) receive – somewhere between $180 and $200.

And it is a buyer's market. The Chinese did not have to do a deal with Russia. They have already done extensive gas supply deals with the countries of Central Asia. A gas supply deal signed with Turkmenistan could meet much of China's immediate needs in the short to medium term. China can afford to shop around. However, the Kremlin is showing itself to be very business-minded and driving as hard a bargain as it can.

The deal is also indicative of a shifting balance of power in the world. The emerging markets have been emerging for two decades now, but several are starting to converge rapidly with the developed world. Last year the UNDP upgraded Russia to a "high income" country – in other words it is now officially an emerged market. Likewise, China has gone from a backward bucolic economy to the powerhouse of global growth in the last two decades.

This is the emerging markets decade. The developed world should be throwing itself in to engaging with the BRIC countries, but so far have largely confined themselves to trade deals, or private enterprise building factories. By contrast the Sino-Russian deal suggests that the emerging markets are committing themselves to fully cooperate with each other.

"The deal allows Gazprom to enter the world’s fastest-growing gas market and will indirectly help in negotiations with European gas consumers"

Money cant buy you love… Money can't buy you love as the song says, though when the love is gone you might need a lot of money after all. At least that is what Russian billionaire and "fertilizer king" Dmitry Rybolovlev found out in May when a Swiss court awarded his estranged wife of 24 years a $4.5bn divorce settlement – the biggest payout on record.

The former doctor earned an $8.8bn fortune from selling his stake in Russian potash producer UralKali to Russian tycoon Suleiman Kerimov and bought, among other things, AS Monaco Football Club, where he now lives.

In addition to the cash, his ex-wife Elena will also receive a string of expensive properties, including a villa in Gstaad and two posh houses in Geneva, Switzerland, as well as properties in Florida and Hawaii. Oh, and she gets the $100m Greek island of Skorpios that used to belong to the Onassis family too.

The award is a victory for Elena who has been battling her former husband for six years, who attempted to disenfranchise her by hiding assets behind a myriad of shell companies, according to bne sources. Rybolovlev's older daughter Ekaterina made headlines two years ago by paying a record $88m for a New York City apartment just off Central Park.

Rybolovlev goes to the top of the most expensive divorces ahead of the previous record holder, Alec Wildenstein, a billionaire French businessman, art dealer and racehorse owner who was ordered to pay his ex-wife $2.5bn, and Bernie Ecclestone who coughed up $1.2bn for his divorce.

Eastern Europe I 17bne June 2014

some 40% of which is transited through Ukraine. Russia has already cut off supplies of gas twice to Ukraine in the past decade over unpaid bills and disputes about prices, which caused shortages in many parts of Europe, so it comes as little surprise the Kremlin has threatened to do so again. Gazprom warned in May that it would cut gas supplies to Kyiv in June if it does not receive overdue payment for its gas; it claims that by end-May Ukraine's debt for gas already supplied will be almost $3.5bn. "If you assume Gazprom is a political tool, then the Kremlin will use it as a political tool," says one Moscow-based analyst who declined to be named.

Thus diversification of gas supplies is high on the EU's agenda, with Europe looking to develop its own reserves of unconventional gas, like shale gas, as well as import more liquefied natural gas (LNG) from producers in the Middle East and Africa, as well as start LNG imports from the US (in March the US Energy Department conditionally approved its seventh LNG export terminal).

The EU is also getting bolder in taking on Gazprom. In September 2012, the European Commission launched a formal investigation into alleged price fixing and monopoly practices by Gazprom, which could result in

massive fines as well as subsequent lawsuits from individual countries. In March, the office of Joaquín Almunia, the European commissioner responsible for competition, said the antitrust investigation is ongoing and a completion date impossible to predict, but the timing would depend "on whether Gazprom will offer remedies that fully and effectively address the Commission's concerns," his office said in a statement.

Keeping Gazprom in the gameNicholas Watson in Prague

The May 21 gas deal struck between Russia and China has come just at the right time for Gazprom, which

is facing a series of threats to its main business in Europe.

The most immediate of these is the risk of a new round of sanctions over Russia's annexation of Crimea and continued meddling in Ukraine. Few are in any doubt, including Gazprom itself, that if the West imposes a third round of harsher economic sanctions, Russian state energy firms such as Gazprom and Rosneft will be targeted. "An expansion of the US, EU and other sanctions programmes could adversely impact operations and the financial condition of the Gazprom Group," the company warned on April 29 after the release of disappointing 2013 financial results that showed net profit fell for the second successive year by 7% to $32bn.

The bright spot in Gazprom's 2013 results was that sales rose by 10% to

RUB5.25 trillion, as it increased gas exports to European markets to a record 162.7bn cubic metres (cm), up 16% from 2012 and exceeding the previous record of 160bn cm set in 2008. Hence

the warning over any new sanctions that would hurt the mainstay of its business.

However, sanctions are only one of several threats to Gazprom's European business.

Europe is tiring of the Kremlin's perpetual use of gas as a foreign policy tool when it wants to apply pressure on Europe, which relies on Russian gas for about 30% of its annual needs,

"If you assume Gazprom is a political tool, then the Kremlin will use it as a political tool"

Igor Golovniov / Shutterstock.com


Gazprom has already been forced into making concessions to several European states over the past year, agreeing to big price cuts for countries like Lithuania and Poland, while Russian delegations have reportedly visited Brussels several times this year, though details of the talks have been kept under wraps. "Expanding exports into Europe in the future will be a harder, and possibly more expensive strategy now, in our view, with additional risks coming from the anti-trust investigation and possible fines," Renaissance Capital wrote in an April research note.

The Ukrainian crisis has also breathed new life into a pet project of Poland, which has a troubled history with Russia, to create a single EU buyer and price for Russian gas, which would get rid of the current system of bilateral contracts and improve the EU's bargaining power, hopefully leading to lower prices. "We want a uniform gas price in the European common market," EU Energy Commissioner Gunther Oettinger said in May, adding that Europe's common gas infrastructure

should be expanded to include Ukraine, Georgia and the Western Balkans.

So Gazprom is in desperate need of more leverage – which is why the gas supply deal signed between President Vladimir Putin and Chinese President Xi Jinping on May 21 is so important. "We view the deal as positive for Gazprom from a strategic point of view, as it allows it to enter the world’s fastest-growing gas market and will indirectly help in negotiations with European gas consumers," says Ildar Davletshin, an analyst with Renaissance Capital.

Feeding the dragonA decade in the making, the agreement is for Russia to supply China with 38bn cm of annual supply over a 30-year period, with a total value of $400bn, starting in 2018-2020. This deal, therefore, adds teeth to Putin's threat that while Europe talks about greater energy independence from Russia, "we begin to talk and take action towards independence from our consumers."

As a sweetener, Russia is also looking to involve China in projects that western companies wouldn't touch with a barge pole, such as Black Sea energy projects off the recently annexed Crimean peninsula, as well as a bridge across the Kerch Strait to permanently link the peninsula to Russia.

Opening up such a big new market as China comes at a crucial time for Gazprom, since it has invested billions in developing new Siberian fields that Gazprom chairman Alexey Miller said in January will have capacity to produce up to 617bn cm/y. All this gas is coming on stream just as it looks like Europe will

be reducing its imports and at the same time as Gazprom is struggling in its home market.

Talk in 2013 that the Russian government was leaning toward breaking up the inefficient and notoriously murky Gazprom appears to have dissipated, though the state company still has to deal with last year's decision to allow independent producers to export LNG (Gazprom has kept its monopoly over gas exported by pipeline), as well as much tougher competition from those independents at home. Gazprom's domestic gas sales fell

"The deal allows Gazprom to enter the world’s fastest-growing gas market and will indirectly help in negotiations with European gas consumers"

again in 2013 to 243bn cm, down 8.3% from the previous year.

As well as seeing those independents raise their share of the Russian market from less than 15% to over 25%, Gazprom has watched its best industrial customers desert it, enticed by lower tariffs, while Gazprom must adhere to government regulated prices. New legislation will allow it to sell gas to industrial consumers for up to 20% less than regulated prices.

The result of all this uncertainty for Gazprom's business, as well as a lack of dividend payments and proper governance, means investors are fleeing the company, to the extent that it trades at a price/earnings ratio of 2.2 times, compared with around 9.0 times for its domestic competitor Novatek.

Gazprom's shares rose slightly on news of the gas deal with China, giving it a market capitalisation of are down by about 15% since the crisis broke in Ukraine in mid-February when the pro-Russian former president Viktor Yanukovych fled Kyiv and Russia decided to act to preserve its interests there, giving the company a market capitalisation of around $102bn. But that's still far from the $1 trillion company that Miller promised to create in a moment of hubris in 2007.


Will Europe's newest state be "Novorossiya"?

Graham Stack in Lugansk

Pro-Russian separatist groups holding power in Lugansk and Donetsk declared independence

for these two easternmost Ukrainian regions on May 12, a move they claim was endorsed by the unofficial referenda held the previous day. There is still no clarity on what the separatists plan next, with options ranging from home rule in Ukraine to annexation by Russia. One new option that has emerged is the creation of the state of "Novorossiya".

In the park in the centre of Lugansk, a town of over 400,000 in the east of Ukraine, a couple of thousand gathered under a light spring shower to witness the self-declared birth of one of the most improbable nations – the "People's Republic of Lugansk", only half an hour after the birth of its twin, the "People's Republic of Donetsk". The birth came to the strains of Soviet war songs and a Russian-patriotic rendition by a folklore ensemble.

Then the self-proclaimed "people's governor" – an obscure and reclusive former paratrooper called Valery Bolotov, sporting body armour and flanked closely by three gun-touting guards – called out to the crowd: "Free, proud people of Lugansk. You have chosen the path that leads us to the creation of a new and independent state. We are united! We are free! We are the People's Republic of Lugansk!"

"Our young republic is only taking its first steps and those steps should be directed towards helping our brothers across the other regions," Bolotov continued. "We will never forget the dead in Odessa, the dead veterans in Sloviansk, the dead children in Mariupol," Bolotov added, referring to

the alleged victims of pro-Ukrainian forces in the weeks since the crisis began in eastern Ukraine.

"Freedom!" he cried with clenched fist, as he left the stage, with the shout taken up by the crowd.

During the ceremony, although Russian flags were few among the crowd, a giant Russian flag waved on a video

display, underlining the inspiration for the Lugansk separatists' actions.

"We have been waiting for this for so long," sobbed Ludmilla Kravchenko, a 57-year-old pensioner.

"Of course we are happy. This town is entirely dependent on Russia – the largest employer here is a Russian state-owned company," said Sergei Levchenko, a 34-year-old mechanic, referring to the locomotive producer Luganskteplovoz, with a local workforce of over 6,000.

Is Novorossiya the Kremlin plan?What the next move is for the Lugansk and Donetsk "people's republics" and who is making it are questions vexing many people locally, in Kyiv and in the world's capitals.

In March, Russia controversially annexed Ukraine's Crimean peninsula, home to Russia's Black Sea Fleet, following a referendum that directly asked locals whether they wanted to join Russia. But the May 11 separatist-

held referenda only proposed establishing something between home rule and full independence, with no mention of joining Russia. Those supporting the move did not seem to expect immediate annexation by their

"Let's call this state Novorossiya!"


giant eastern neighbour, but rather increased economic support and integration.

A clue as to the next move might be the charismatic appearance at Lugansk's May 12 "independence ceremony," immediately following Bolotov, of Ukraine's top pro-Russian politician, 44-year-old MP Oleg Tsarev. "Tsarev is the real star here," mechanic Levchenko told bne. Tsarev was slapped on the EU sanctions list on May 12 for his unwavering support for Russia's actions in Ukraine.

Tsarev has been eloquently articulating the Kremlin's line in Ukraine since the start of the tug-of-war a year ago over whether Ukraine should sign a free trade and association deal with the EU, or join the rival Russian-led

Customs Union. He created and heads the "Movement for the South and East," which is the primary political organisation backing secession for the Russian-speaking parts of Ukraine, and flags of this organisation dominated the crowd in Lugansk May 12.

Tsarev, leading the crowd in a chant of "Russia, Russia," nevertheless did not call for the region to join Russia. Instead he called for "negotiations" with the newly proclaimed People's Republic of Donetsk towards setting up a new combined East Ukrainian state. "Let's call this state Novorossiya!" Tsarev called, and the crowd responded with shouts of "All the way to the Dnipro."

Novorossiya traditionally refers to the entire Russian-speaking Black Sea coast freed from Turkish rule under Catherine the Great. Russian President

Vladimir Putin made headlines with the term when he used it during a TV Q&A session on April 18 to refer to the Russian-speaking regions of Ukraine. "Novorossiya – Kharkov, Lugansk, Donetsk, Odessa – were not part of Ukraine in Tsarist times. They were only transferred to Ukraine in the 1920s, God only knows why." Some interpreted Putin as insinuating that a partition of Ukraine could be on the cards.

For some locally, the establishment of Novorossiya is the only logical explanation for the Kremlin's gambit in the Donbass basin, which is comprised of three eastern Ukraine regions. "Why would Russia want to incorporate the Donbass alone?" asks a prominent Lugansk businessman, who spoke under condition of anonymity due

to the climate of fear in the region. "Donbass is a depressive region of 7.5m which relies on state subsidies to keep its coal mines open. The only reason for Ukraine to pay those subsidies has been to preserve the coal industry as an alternative supplier of energy to Russian gas. If Donbass joined Russia, the mines would close. Russia's move on Donbass thus only makes strategic sense if it were to seek territory all the way to Pridnestrove, and close off Ukraine's access to the Black Sea."

The Kremlin's response to the May 12 "declarations of independence" made no mention of Novorossiya, but was cautiously positive on the outcome, recognising the referenda as legitimate and calling on the "practical realisation of the results to take place in a civilised manner" via negotiations and without violence.

"Russia's move on Donbass only makes strategic sense if it were to seek territory all the way to Pridnestrove, and close off Ukraine's access to the Black Sea"

What this "practical realisation" will comprise in the coming days is an open question. Representatives of the self-proclaimed People's Republic of Donetsk said they would ask Russia to consider absorbing the region. Representatives of both the Lugansk and Donetsk people's republics have stated they might hold follow-up referenda on whether the regions should join Russia, if there was agreement from Russia.

Opinion polls held in April showed only roughly 30% of the population in Donetsk and Lugansk support the regions' being absorbed by Russia, and there has been no overt sign on the part of the Kremlin of a desire to absorb the regions. But while Russia still has major military forces amassed on the borders of the Lugansk and Donetsk regions, according to western governments, all bets are off. Russian claims it has initiated a drawdown of the forces.

Meanwhile, in Kyiv preparations are underway for the inauguration of new president Petro Poroshenko, who stormed to victory in the presidential election on May 25. This election plus the upcoming parliamentary one are vital to fill the power vacuum and solve the legitimacy problems resulting from the ousting of former president Viktor Yanukovych in February. However, with the Lugansk and Donetsk electoral infrastructure completely in the hands of the separatists, there was little to no voting in these self-proclaimed independent states compared with the 60% turnout rate elsewhere in Ukraine.


Spectre of Yanukovych haunts UkraineGraham Stack in Lugansk

Political insiders and pro-Ukrainian activists allege that the elites in the party of ousted

president Viktor Yanukovych are behind the pro-Russian separatists that have taken over the eastern region of Lugansk. And bne investigations have traced the self-proclaimed “people's governor” of Lugansk to Party of Region's structures.

Valery Bolotov, Lugansk's “people's governor”, appeared out of nowhere in early April after the successful seizure of the Lugansk headquarters of Ukraine's security service SBU. The SBU headquarters have since become the seat of Bolotov's ragtag forces that grabbed enough power to conduct a region-wide referendum on May 11 and the next day declare independence from Ukraine for the “People's Republic of Lugansk”.

According to bne enquiries, Bolotov has links to the Lugansk networks of Yanukovych's Party of Regions, which was the ruling party until the pro-European protests on Kyiv's main square, the Maidan, turned bloody in February, causing the government to collapse and the president and his cronies to flee the capital. Yanukovych himself once served

as the governor of Donetsk, another province in eastern Ukraine that has been taken over by separatists and in May held a referendum to secede.

Bolotov's only known position prior to assuming the mantle of Lugansk's “people's governor” was in 2010 when

he founded and headed the Lugansk division of the Union of Paratroopers' Veterans, in Russian Soyuz Desantnikov. The Soyuz Desantnikov is to this day registered at 22 Kherson Street in Lugansk.

bne visited the address and found that it is the business headquarters of a former Party of Regions bigwig – businessman Vladimir Landik, and his conglomerate Nord. Along with a large number of firms related to Landik's business, the address also hosts the regional section of the Party of Regions itself, and the Party of Regions' youth division.

Landik, who split with, and has been publicly feuding with, the Party of Regions since 2011, has himself alleged that the Party of Regions' old guard are the main force behind Bolotov and the pro-Russian separatists in Lugansk. Head of the Party of Regions' parliamentary group, Oleksandr Efremov, a close associate of ousted president Yanukovych, is a former Lugansk regional governor and local business magnate.

Immediately following the emergence of the separatist movement in early April, Landik suggested Efremov was the instigator: “His aides organised the seizure of the district state administration and the security service headquarters, and attacks on opposition demos: his godson Rodion Miroshnik is director of the local TV station broadcasting programmes that advocate the country's split,” Efremov said in a TV interview. “He is head of the Party of Regions parliamentary group, and yet he never says a word to condemn the situation in East Ukraine.”

Landik, who also owns a local TV station that has been critical of the separatist movement, says he has received threats since making his comments. Police reported that shots were fired at his

house on May 13. Landik declined to update his previous remarks that were critical of Efremov to bne. “I have left the region, and no longer have objective information on the situation,” he says.

Landik also tells bne that he did not know about Soyuz Desantnikov or its mysterious head Bolotov being registered at his business address. “I have a lot of companies registered there, I can't possibly remember them all,” he says.

Pro-Ukrainian activists and journalists in Lugansk also see Efremov as supporting the separatists. “If Efremov

“If Efremov was dealt with, the problem of separatism would disappear overnight”


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was dealt with, the problem of separatism would disappear overnight,” believes blogger Sergei Ivanov, who says he has seen Efremov's local political associates watching on as the separatists seize the seizures government buildings. Ivanov and most other critical voices have since fled the region due to violence, kidnapping and threats from the separatists, including the kidnapping of the 70-year-old father of journalist Vsevolod Filimomenko.

Efremov rejects the accusations that he is behind the separatists, but leads the opposition in Kyiv to the government's current “anti-terrorist operations” that are being directed against the separatists, and is calling on the government to hold talks and take heed of East Ukraine's interests. Efremov led his parliamentary group in a walkout on May 15 in protest at the ongoing anti-terrorist operation in the east of

the country. “People are currently being killed in East Ukraine. We requested a stop to the anti-terrorist operation, but you keep pretending that nothing is happening," Efremov said in parliament. He could not be reached directly for comments.

Elite supportSeparatists in Lugansk look like achieving more political institutionalisation than in neighbouring Donetsk, suggesting a greater level of local support from the Party of Regions' elite.

The Kyiv-appointed regional governor has no power on the ground across much of the region of 2.5m people, and bne sources report that the separatists are in the process of setting up a fully-fledged government for the region. The Party of Regions-dominated Lugansk regional assembly has said it will dissolve itself if Kyiv fails to allow the federalisaton of Ukraine, a key demand

of Russia and the separatists.

In Donetsk, in contrast, the separatists' power base is not in the regional capital, but in the Kramatorsk-Slovyansk-Konstantinov agglomeration closely connected to former top law enforcement officials in the ousted administration of Viktor Yanukovych, who have also since fled Ukraine for Russia.

Bolatov's spokesman Vasily Nikitin declined to provide any clarification of Bolotov's background, beyond that he had served in the army, studied at mining college and then had worked in business. Bolotov does not feature as owner or manager in any of Ukraine's corporate databases, except for founding and heading the Soyuz Desantnikov in 2010. Nikitin refused to comment to bne on Bolotov's business career, saying it was a “commercial secret.”


Russia's regional Achilles' heelBen Aris in Moscow

Russia's economy is slowing dramatically, but the pain is not evenly spread. While a

few Russian regions are making rapid progress and modernising, the bulk are getting into deep financial trouble.

"Since the 2009 financial crisis, the Kremlin has allowed Russia's regions to take the brunt of the country's economic decline in order to keep the federal government seemingly healthy, with a nominally small budget deficit and large currency reserves," US think-tank Stratfor said in a note in January. "But now most of the regional governments' debt is so high, it is becoming dangerous for the federal government and big banks and could soon become unmanageable."

Between 2010 and 2014 regional indebtedness more than doubled from $35bn to $78bn, according to the rating agency Standard & Poor's. And the size of this debt is now beginning to threaten the health of the Russian economy. If Russia was brought low during the 2008 crisis by over-borrowing amongst a few key large companies, the next crisis looks increasingly like it will be caused by the collapse of a regional debt bubble: the collective level of debt owed by Russia's far-flung regions has

risen from just until 4% of GDP in 2010 to just under 8% now, and will top 10% next year according to estimates – a far faster growth rate than the federal government's borrowing growth. Russia's total sovereign debt is currently about $300bn, or 14% of GDP.

Mixed bagThe economic performance of Russia's 83 regions is very mixed. Only about a dozen regions are actually net contributors to the federal budget; the rest live day-to-day on handouts from the central government.

The combination of a slowing economy exacerbated by the political turmoil in Ukraine has caused debt levels to

rise alarmingly in a few regions and some are now starting to look default in the eye. "The real pain resulting from Russia’s macroeconomic situation will be felt at the regional level… The deterioration in the finances of Russia’s regional governments is already visible,

even in the absence of major outside shocks," analysts at Uralsib said in a recent note.

Russian President Vladimir Putin has set regional governments ambitious development goals – laid out in a series of decrees in May 2012 – but most are struggling to meet them.

Local governments have been hoping the targets will be reduced, the deadlines extended or the central government will come up with more cash. "So far, it does not look like these hopes will materialize," says Uralsib.

Until recently the best regions have been able to finance their growth on the bond markets – both international and domestic. However as Russia slides towards pariah status, the regions have been cut off from raising debt. Analysts say most regions have turned to bank loans and budget credits for financing.

"Each region has to get federal approval to issue bonds, because regional bonds create more market competition for the federal and business bonds. Most of the banking loans to the regions carry high interest rates and are short term (mostly between two and five years). The federal loans come with much lower rates and longer repayment schedules (mostly between five and 20 years), so naturally federal credits and loans are more attractive for the local governments, though unprofitable for the federal government," Stratfor said.

The City of Moscow is by far the biggest Russian user of international bond

markets. It raised approximately $4.8bn in 2013, but has only issued $2.4bn this year due to restrictions on its own budget. The bottom line is that Russia's regions are becoming yet another mouth to feed from the slowly dwindling pot of hard currency reserves.

"Most of the regional governments' debt is so high, it is becoming dangerous"


Chocolate King wins Ukraine presidency in first roundBen Aris in Moscow

Ukraine woke up on May 26 to a totally different country; one with a legitimate president and

a chance to finally start rebuilding from the ruins left following the ouster of Viktor Yanukovych. The so-called Chocolate King, Petro Poroshenko, stormed to victory in the Ukrainian presidential elections on May 25, winning in the first round with over 50% of the vote and gaining a clear mandate to lead the country out of the political and economic morass.

Poroshenko won 54% of the vote with a turnout on the order of 60%, enough to give him a clear mandate and first-round victory. Opposition leader and former prime minister Yulia Tymoshenko got 13% of the vote, enough to keep her in the political game, but low enough to marginalise her to some extent on the national scene. Poroshenko's staff says the inauguration could be as soon as June 8-10.

The high turnout was seen as crucial to ensure that Russia had to acknowledge the legitimacy of the vote. Russia

said it is "open to dialogue" with the new president of Ukraine. However, Russian Foreign Minister Sergei Lavrov said military action must end against separatists in the east.

"Russia is likely to take a cautious approach going forward, winning time to avoid further sanctions while also gauging Poroshenko’s ability and willingness to meet Moscow's demands," says Otilia Dhand, vice president of Teneo Intelligence.

The head of the EU delegation to Ukraine, Jan Tombinski, called the elections the "most honest for the last 20 years," which is a bit of hyperbole on Europe's part because unrest in the east of the country meant that the polling was seriously disrupted there. This stands against the 2010 presidential elections that delivered Yanukovych to office that were also dubbed "free and fair" at the time (and really were). The Ukrainian Central Election Committee also passed the elections as free and fair.

The EU was fast to roll out its rewards

(and also bolster Poroshenko's legitimacy) by announcing that Ukrainians might enjoy visa-free travel to the EU before the end of this year. The European Commission will meet on June 2 to decide whether Ukraine has completed the first phase of the action plan on visa liberalisation and is able to move on to the second phase, Tombinski told reporters in Kyiv on May 25. "And after phase 2 is over, as was the case with Moldova, and this may take several months – visas will be cancelled."

Next stepsThe next major political event will be parliamentary elections, which Poroshenko said must be held this year. Fresh elections for the Rada would finish the process of legitimatising the current government and are badly needed if the political vacuum that has existed in Ukraine since November is to be finally filled.

But in the short term Poroshenko faces a number of nasty problems. He is clearly a pragmatist. An oligarch who made his money from the chocolate factory Roshen, amongst other assets, from the eastern city of Dnepropetrovsk (the same city as former president Leonid Kuchma and most of his administration), he served as a minister in the Yanukovych administration.

However, he clearly has liberal tendencies and also served in the administration of former president Viktor Yushchenko following the Orange Revolution in 2004. Moreover, amongst his media assets is Channel 5, which fearlessly broadcast scathing attacks on the Kuchma government during the attempt to hijack the elections in 2004 that led to the massive street protests and the Orange Revolution.

It is this reputation as a pragmatist and someone who has served on both sides of the house that is his main appeal. He is seen as belonging to neither the orange nor blue camp, and so is a break with the dichotomy that has become a hallmark of Ukrainian domestic politics.

He inherits a country that is on the verge of civil war and an economy in tatters.

Photo by Mykhaylo Palinchak / Shutterstock.com


Poroshenko announced that his first act as president would be to visit Donetsk, the epicentre of the protest movement, to seek a peace deal. But he also backed his works with the threat of renewed military action to bring the region back under Kyiv's thumb. Poroshenko promised the military operation in the east of the country will change: "It will be shorter and much more effective."

While overall the turnout was high at around 60%, only one in five planned polling stations in Donetsk were able to function and turnout there was estimated to be just 15%. Even oligarch Rinat Akhmetov, who lives and is registered in Donetsk, was unable to vote, according to reports.

The low turnout in Donetsk is going to be a problem for Poroshenko. The separatists are likely to reject the legitimacy of the vote. And they have guns. How he handles the situation will be a crucial first and early test for the new president.

Also a priority will be a trip to Moscow in an attempt to put relations back on a civil footing. “We cannot discuss the seriousness of security in our region without the participation of Russia," Poroshenko said at a press briefing.

Putin held out an olive branch during a question and answer session at the St Petersburg summit on May 23: “We are working with those people today who are controlling the power [in Kyiv], but after the elections, of course, we will work with the newly elected structures,” Putin said. “I hope that when the elections are over, all of these military activities will immediately stop."

Tymoshenko has called for a new Maidan protest (the third) and a referendum on Nato membership, which would be a red flag for Russia. But Poroshenko is unlikely to support Nato membership or even a referendum on the question.

The question of Ukraine's relationship with the EU is much more tricky. At a pinch the Kremlin would accept Ukraine moving closer to Europe, however Putin insists that Russia's interests must be

respected. What exactly this means is not clear. Putin has set up a rival trade club in the form of the Customs Union, which will deepen when the Eurasian Economic Union comes into existence in 2015. However, Ukraine cannot be part of both the EU and the EEU. Given that Ukraine is not going to be offered membership of the EU any time soon (if ever), there does seem to be the possibility of some sort of negotiated trade regime that would allow Ukraine to keep its piggy-in-the-middle status.

Poroshenko's rhetoric on the campaign trail has been resolutely pro-EU to ensure the Maidan protest vote, but pundits reckon he will be a lot more pragmatic now he has the country's top job, as Ukraine does not have much of a future without some sort of friendly relations with Russia. "Russia can still significantly undermine a Poroshenko presidency, and it will be waiting to see what the

president elect is going to deliver in terms of concessions, including forging a new coalition government (to include those better representing Russia's interests), commitments to no Nato membership nor EU integration, and a new Federal constitution," says Standard Bank's Tim Ash. "I am not sure that Poroshenko can or will be willing to deliver on much of this agenda, and particularly after this landslide victory."

One sticking point is that Poroshenko campaigned on a promise of never accepting the annexation of Crimea, but it looks highly unlikely that Crimea will ever be returned to Kyiv's control.

Klitschko wins mayoral electionFormer world boxing champion Vitaly Klitschko won the Kyiv mayoral election in a parallel vote on May 25. Eight parties competed for the job, with Udar, Klitschko's party, coming first with 42% of the votes.

Klitschko withdrew from the presidential race early on and threw his support behind Poroshenko, who reciprocated, supporting Klitschko's bid for mayor. It was a clever move by the former boxer. He was at the forefront of the Maidan protests, but his pragmatic deal with Yanukovych on February 21 to allow the former president to stay in office until early elections hurt his popularity with the people on the streets. That deal was overturned within 24 hours and Yanukovych fled.

The main criticism against Klitschko is that he has little administrative experience. The job of running the capital will be his first opportunity to show what he can do. He has a reputation for honesty, but will have to deliver on material improvements for the residents of the capital. If he does a good job, it will make a solid platform for his future political career. He and

his party also decided to stay outside of the current interim administration, which allows him to keep his hands clean of the dirty, but necessary, political compromises that must be made now in order to end the turmoil in the country.

"Vitali Klitschko’s Ukrainian Democratic Alliance for Reform (UDAR) may aspire to some cabinet or regional governors’ positions. Klitschko, a former boxer, had dropped out of the race in Poroshenko’s favor, raising speculations about the forging of a respective alliance on the national level going forward. UDAR’s popularity could help boost the new president’s more pragmatic course by balancing the deficiencies of Poroshenko’s own party, Solidarity, which remains a relatively marginal force," says Teneo's Dhand. "Preserving the unity of Ukraine by allowing greater decentralisation might become a more realistic option under this coalition."

"Russia can still significantly undermine a Poroshenko presidency"

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offshoring centres on the outskirts of many Polish cities.

That infusion of foreign capital and know-how, coupled with a local entrepreneurial bent, has seen Poland make startling progress in labour productivity. In 1992, the average Polish worker produced $9.90 of GDP per hour worked in constant 2005 dollars – that compared with $36.90 in Germany. By 2012 it was $23.60, just under half of the output of an average German.

But in the last few years, Poland's productivity growth has slowed, and there are fears it could follow the example of less successful EU members like Portugal, which halted its catch-up to richer parts of the Union and has stagnated for years.

communist mess into one of Europe's fastest growing economies. He predicts that the average Pole could be as rich as the average German within 20 years.

But if that is to happen, Poland will have to make some deep changes in the way its economy functions.

Labour productivityFor the last 25 years, Poland's growth has been largely built on its qualified but cheap labour force. That powered

both the hundreds of thousands of small startup businesses that have flourished since Balcerowicz's shock therapy reforms, as well as pulling in foreign investors like Volkswagen, Asian electronics makers and the dozens of companies building business process

Preventing inertia in Poland Jan Cienski in Warsaw

This year marks the 25th anniversary of the semi-democratic elections that signalled

the end of communist rule in Poland, and the country is looking back on a host of crucial anniversaries – 25 years of democracy, 15 years of membership in Nato and 10 years since joining the EU.

All in all, these have been very good years for Poland. A quarter century ago, its per-capita GDP at purchasing power parity was only about a third of Western European levels. Now it's about two-thirds, making Poland one of the world's most stunning post-communist success stories.

The trick now for the country is to look at policies that will allow it to continue catching up over the next 25 years – perhaps eventually becoming indistinguishable from the Western European countries that have been richer than Poland for more than a millennium. "If you can't prove that something is impossible, then it must be possible,” says Leszek Balcerowicz, the architect of Poland's economic reforms launched in 1990, which turned it from a dysfunctional hyper-inflationary

“We can reach the EU average, it just demands a lot of work"

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Ryszard Petru, head of the Polish Association of Economists, estimates that there are two possible variants for Poland's course over the next 25 years.

The first he dubs “inertia” and it sees Poland growing just a bit faster than the EU average, reaching about 70% of GDP per capita. Under this case, the government does little to reform, turns to populist measures to boost wages, and continues to rely heavily on the EU for investments. That would make it richer than it is today, but still not rich enough to prevent a steady outflow of migrants. It would also be too poor to be very attractive for newcomers. “Things get a bit better, but there is no breakthrough,” says Petru.

His second prediction calls for the government to undertake continual small steps to improve the business environment, to continue privatising state assets and working to boost investment in research and development. Polish companies would also shift from their current role of supplying cheap components to the German export machine to creating brands of their own and building a larger international presence. Universities would have to improve their standards and do a better job of working with the private sector. Rising wealth would pull in migrants, making up for one of the EU's lowest birth rates and for the outflow of as many as 2m people to wealthier parts of the EU over the last decade. Richer cities would also induce migrants from farms and villages to pull up stakes and move into more economically productive jobs. “We can reach the EU average, it just demands a lot of work. It's not a matter a spectacular successes. Rather, we just have to grow 1.0-1.5% faster than over the 'inertia' variant. Over time that makes an enormous difference,” says Petru.

So future governments need to continue tweaking and improving the economy. “Poland doesn't need a revolution,” says Marcin Piatkowski, a World Bank economist. “We don't need to change the model, but to gradually adapt it. It's hard to tell Europe's growth champion that its model is flawed.”

Annabelle Chapman, Bratislava

This year’s GLOBSEC security forum in Bratislava on May 14-16 took place under the shadow of the unrest in Ukraine – and its implications for the wider region. We live in a far more dangerous neighbourhood than we previously thought, said Slovakia's foreign minister, Miroslav Lajcak, opening the conference.

Despite the emphasis on European cooperation and unity in the face of the Ukrainian crisis, the rifts between different countries’ positions were easily discernable – even within the Visegrad Group (V4) of the Czech Republic, Hungary, Poland and Slovakia, which forms the centre of the event. Just before the event began, Hungarian Prime Minister Viktor Orban had called for autonomy for Ukraine’s Hungarian minority – a controversial remark which was broadly perceived as a stab in the back for the authorities in Kyiv at a difficult time.

Orban’s position is not new, said Natalia Galibarenko, Ukraine’s first deputy minister of foreign affairs, who was the Ukrainian dignitary present at the forum (Prime Minister Arseniy Yatsenyuk was unable to make it in the end – for understandable reasons). But it is especially striking in this situation, when Ukraine is counting on more constructive support from EU countries, she added coolly, speaking to an audience of European journalists including bne’s correspondent.

The Hungarian prime minister’s position seemed particularly strange when sharing a platform with Donald Tusk, his Polish counterpart, perhaps the European leader who has been most engaged in the Ukrainian crisis. Speaking to the press, Tusk acknowledged this rift, saying differences are normal but that the important thing is to build a common position.

Ukraine kept coming up at the panels over the three-day forum. In one memorable moment, Ian Brzezinski rejected his father Zbigniew Brzezinski’s controversial idea of the “Finlandization” of Ukraine, saying that would reward Russia for its aggression and betray the spirit of the Euromaidan protests that toppled the notoriously corrupt president Viktor Yanukovych in February.

Possibly one of the most interesting discussions took place at a late-night session on Russia, where one of the speakers suggested that the West had stayed with “The End of History”, whereas for Russia the world is now about “The Clash of Civilisations” - both references to two influential works of political science from the early 1990s. There was something of a consensus that “puny guy” Putin was coming out the winner, having gained the respect of some important leaders around the world.

While Orban’s unpopular stance caused a stir at the conference, the lasting sense that emerged from the conference, which kept coming up indirectly, was the question of how Germany’s – and in particular Angela Merkel’s – position on Ukraine would develop.

A more dangerous neighbourhood

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Will EU stand for Energy Union?Annabelle Chapman in Warsaw

With tensions rising to Poland's east, Prime Minister Donald Tusk has been calling for the

creation of a European energy union that would boost the EU's energy security by giving the member states more clout when dealing with powerful suppliers like Russia's Gazprom. Many at home and in Europe's capitals remain sceptical, however.

Tusk revealed the six "pillars" to his planned energy union on March 29, shortly after the Crimean "referendum" that led up to the Ukrainian peninsula's annexation by Russia. The initiative has since become Tusk's pet project and is part of his emphasis on security, which he put at the heart of his Civic Platform party's campaign in May 25 elections to the European Parliament. Tusk's project also comes ahead of an eagerly awaited decision by the European Commission on the future of the bloc's gas imports, to be announced in June. Tough situations on the gas market are ahead of us, Tusk told the press at the

GLOBSEC security forum in Bratislava on May 15.

The EU is creating a banking union and its member states buy uranium together through the EU's atomic energy agency

– so why shouldn't it have an energy union too, Tusk argues. "It will return the European project to its roots," he wrote in an article published in the Financial Times on April 21, referring to the European Coal and Steel Community representing the start of European integration in the early 1950s. "Whether in coal, steel, uranium, credit or gas, the principal idea of the EU has always been to bring Europe together, deepening our security."

The six pillars include a gas solidarity mechanism and diversification of gas supply to the EU. Shale gas also gets a mention, as does the "rehabilitation of coal" as a source of energy, part of an attempt to boost Poland's ailing coalmining industry. It is no coincidence that Tusk presented his plan's outlines during a visit to Silesia, an industrial region in south-western Poland and a key constituency in the elections to the European Parliament.

But Tusk's attempt to save coal has not gone down well with those in Europe who are emphasising the need for more energy from renewable sources. Polish news agency PAP quoted Claude Turmes, vice president of the Greens in the European Parliament, calling Tusk's idea "purely opportunistic", as it "instrumentalises the conflict between Ukraine and Russia to defend something that cannot be defended – more coal."

The most revolutionary proposal in Tusk's initiative is the idea of joint gas purchases, says Robert Tomaszewski, an energy specialist at Polityka Insight, a think-tank in Warsaw. Orders would be supervised by an agency modelled on the Euratom Supply Agency, or else by a consortium that would buy gas on behalf of companies. "This would strengthen EU countries' position in negotiations with Gazprom, which would lose its ability to give different

prices for its European customers," he explains.

Lukewarm responseSo far, Tusk's idea has won the backing of several European politicians, including François Hollande, France's president, and Jean-Claude Juncker, a former Luxembourg prime minister and the European centre-right nominee for president of the European Commission. German Chancellor Angela Merkel said

"The EU is creating a banking union – so why shouldn't it have an energy union too?"

Central Europe I 29bne June 2014

that "in principle" she supports Poland's idea of closer EU energy cooperation, though she was less sure about the details.

But Günther Oettinger, the EU's Energy Commissioner, remains unconvinced. "Gas is a product, not a policy weapon for the EU," he told German daily Frankfurter Allgemeine Zeitung on May 15, in the context of Tusk's proposal. Meanwhile, Oettinger has expressed his desire to play a mediating role in the gas row between Russia and Ukraine, which he hopes to resolve by June 1.

The Polish prime minister's idea has also been greeted with some degree of scepticism at home – not least because of the heated political atmosphere ahead of the elections to the European Parliament, with his centre-right Civic Platform and the conservative Law and Justice party battling for first place in the polls. The Russophobic leader of Law and Justice, Jaroslaw Kaczynski, has criticised the idea because it still entails buying Russian oil and gas. Poland could become independent from Russian gas "in a short time," he claims unconvincingly.

Although the energy union is unlikely to be adopted in its original form, Tusk's idea looks set to provide the basis for the EU debate as it considers how to reduce its dependence on Russian gas – a process that's become more urgent since Russia's meddling in Ukraine. Even if the idea of joint gas purchases remains far off, Tusk's efforts could at least lead to greater transparency in gas contracts. "Poland's proposal of an energy union is above all a way of putting pressure on the European Commission," Tomaszewski points out.

The Polish government has sent out a "non-paper" outlining Tusk's project to the other EU member states, in the hope that his idea will provide the basis for the discussions in June after the Commission releases its paper on the bloc's gas markets. This means that some of the ideas in Tusk's project could outlast his election campaign in Poland – in some form or other.

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A resumption of hostilities between Hungary and Croatia suggests a deal to end the long war for control of INA is still some way off, even though alternatives to the present tie-up are thin on the ground.

The Hungarian state energy firm MOL hit back on May 13 at claims by Zagreb that it has overseen the destruction of Croatian oil and gas company INA. Croatian Economy Minister Ivan Vrdoljak alleged the previous day that since MOL took management control of INA in 2009, it has lost billions as targets have been missed and production dwindled. He cited a study by A.T. Kearney and Oil & Gas Consulting, which was commissioned by Zagreb, that found that after taking over INA, MOL defrauded Croatia of $6.2bn by failing to abide by agreements.

MOL disputes that, claiming it has invested a total of ¤1.4bn directly into the Croatian economy and accusing the Croatian minister of harming the reputation of INA. "After finally having accepted MOL Group's appeal for the acceleration of the negotiations, MOL Group was encouraged that the Ministry of Economy would at last come up with proposals regarding the future development of INA," vice president of MOL's corporate communications, Dominic Koefner, said in a statement. "Unfortunately, the [Croatian Economy] Ministry once again raised issues of the past, which will be anyway clarified by on-going arbitration processes, whereas no reasonable forward-looking ideas have been presented. Therefore the Minister's recent media approach can only be understood as an attempt to deflect attention from his recent regulations, which caused over HRK 1 billion damage to INA."

The sniping comes as the pair enter yet another round of negotiations over control of INA. The long-standing battle has been going on for years. Zagreb claims MOL gained management control illegally in 2009. Last year, former Croat prime minister Ivo Sanader was jailed for taking a bribe from MOL in return for handing over control in 2009 as it raised its stake to just below 49.1%. Croatia also insists the Hungarian company is failing to live up to its investment commitments. For its part, MOL claims Croatia – which holds 44.8% of INA – has breached its contractual agreements and is hampering its investments.

Late last year, the pair looked prepared to sell a majority stake in INA as the only way out of the mess. However, the only viable suitors are understood to be Russian oil and gas companies, and given Moscow's role in the Ukraine crisis that has made such a sale highly unlikely.

Without the option of finding a new partner, Croatia has little choice but to resume its bid to win back control of INA. Recently, it has made several moves designed to force such a solution, including stripping INA of its role in domestic gas distribution and forcing it to sell gas to its successor at regulated prices. The ongoing spat does little for the investment story of the struggling economy.

Hungary and Croatia resume hostilities over oil firm


per tonne. Unsurprising then that last year about 15% of the coal used in Poland was imported. That has left the sector with 15m tonnes of expensively mined coal sitting unsold in storage dumps, at a time when the global coal price is falling. This means the Polish sector's problems are only going to get worse. “This year is going to be a minus and maybe the next two years after that,” says Miroslaw Taras, the CEO of Kompania Weglowa, Poland's largest coal miner. “The key is to restore liquidity and to gain markets. If we can do that the situation may improve.”

Past gloriesThe coal sector's woes are not just a problem for Taras. With more than 100,000 people employed in Europe's largest coal industry, the politically powerful sector is also a headache for Polish politicians.

The coal industry was a mainstay of communist Poland, employing about 400,000 people a quarter century ago.

Since then, several rounds of layoffs and restructuring – at a cost of about €100bn – have closed many unprofitable mines and dramatically reduced the head-count. However, there are still many mines which barely turn a profit. “If there was a sensible way to end the exploitation of mines which have large problems and leave those deposits for future generations, while investing in deposits which are more profitable, then the Kompania Weglowa could become a remarkable company,” Taras says.

Poland raked over the coalsJan Cienski in Warsaw

When a country's prime minister says that a sector's profits aren't important compared

to its social and political benefits, you know that you are in deep economic trouble.

That is the message Poland's Donald Tusk recently gave to his country's troubled coal industry, which in total lost €65m last year and faces a predicted eye-watering loss of €846m this year. “Efficiency in the energy sector does not mean being exclusively concentrated on maximising profits,” Tusk said recently. “In addition to profits there are also social and political aspects.”

The problem for the coal sector is that most of Poland's mines are old and deep. That means that coal is expensive to dig out, and the mines need massive investment to keep them running. Costs and investments also steadily grow as miners tunnel further down to extract coal. “The coal companies are fighting with costs,” Roman Loj, CEO of Katowicki Holding Weglowy, Poland's second largest coal miner, said at a recent industrial conference. “Those costs, as we descend ever lower with extraction, are going to grow.”

That cost structure has made Polish coal increasingly uncompetitive compared with foreign coal from countries like Russia, Chile and South Africa, where much of the coal is dug out in much cheaper open pit mines. Although about 85% of Poland's electricity is generated by coal, and the fuel accounts for about 55% of the country's overall energy mix, power and heating plants are increasingly turning to imports for supply.

European thermal coal prices are now about €57 a tonne, while in Poland unit production costs are almost €72

Even the normally more profitable hard coal and coking coal sector is in trouble. Jastrzebska Spolka Weglowa eked out a €19.6m profit in 2013 after posting a €235m profit in 2012 and a €500m profit in 2011.

As well as closing unprofitable mines, the coal industry also wants to rework labour contracts, among the most expensive in Polish industry thanks to the sector's powerful unions. While the unions are talking to coal company bosses, there is little sign of a breakthrough in talks.

The coal industry would also like the government to loosen some of the regulations governing mineral extraction and to set clear targets for future coal use, so that mines can tailor their production to actual demand and not overproduce, as happens now.

As Poland is an EU member, that limits the government's ability to subsidise the coal industry, although there may be some sort of an informal approach to repair the sector's balance sheets. “We believe the current problem is very serious and, without support coming from a recovery in global coal prices, the 'fix' is not easy. Assuming that current low coal prices stay with us for the next two years, we see the following potential solutions: i) closing

high production cost mines (high political damage and very difficult to conduct), ii) “ask” the power sector to keep buying domestic coal with a large premium to global prices, iii) consolidate coal mines with the power sector,” wrote Rafal Wiatr of Citigroup Research.

The problem is that coal is an emotional and political subject, not just an economic one.

“In addition to profits there are also social and political aspects”


Republic. "The new EU states account for more UK exports than China, but we still don’t really punch our weight. There's much more we can be doing."

British exports to CEE have more than doubled in the last 10 years to £16bn (€19.4bn), but that still represents no more than 3% of the region's imports. Germany, meanwhile, exports almost 15-times more to the region, while Italy

outstrips the UK four-to-one, and France has doubled its performance.

Still, Paul Taylor, regional director for CEE with investment agency UK Trade & Investment (UKTI), notes export growth for the region is at the same rate as for the larger emerging markets. To that end, London has been doing the rounds,

Turning the Polish plumber into the CEE investorTim Gosling in Prague

The BRICS are the biggest and most lucrative emerging markets, but the UK is eyeing opportunities

closer to home.

Immigration from the east end of the EU may be a hot political potato in the UK right now, but London apparently hopes to replace the image trumpeted by eurosceptics of the Polish plumber nicking jobs from locals with the Polish, Czech or even Slovene investor creating employment.

Investment links between "old" Europe and the emerging economies of CEE have generally followed an expected pattern based on regional centres of gravity and historic ties. Therefore, Germany and Austria loom large in investment into the region, as well as what outflows exist. Russia has also begun to increase its activity.

However, the UK says it sees growing potential, and wants to get in on the act. "[CEE is] a high growth region with increasing spending power," says Jan Thompson, UK ambassador to the Czech

sending a major trade mission around the region in March in a bid to raise trade and encourage British investment into CEE.

Better than BRICS?"We went to Whitehall and told them that there's opportunities [in CEE], and that they're closer to home than the BRICS (Brazil, Russia, India, China) that we've been concentrating on," Taylor explains. "Therefore, it's natural to look at the outwards investment to match."

The programme formally targets the Visegrad Four (Czech Republic, Hungary, Poland and Slovakia), as well as Romania, Bulgaria, Croatia and Slovenia. It will kick off in the more developed north, however, says Taylor. "Inevitably we'll see more [investment] coming from the likes of Poland and the Czech Republic than Slovenia," he admits.

According to data from global consultancy A.T. Kearney, which has teamed up with UKTI on the drive, Polish net outflows have generally sat at $4bn-5bn (€2.9bn-3.6bn) since 2008. However, they dropped to just $1.4bn in 2012. The Czech Republic recorded around the same volume, but that made it the country's second biggest year in the last five.

However, the data includes repatriation of profits by foreign investors, making it tricky to gauge the true depth of CEE outflows. The same issue makes it unsurprising that popular offshore and tax haven destinations accounted for

around half of all outflows in both cases in 2010-12.

Elsewhere, the horizons are closer to home. A whopping 61% of Slovakia's $1.2bn outflows in 2010 hopped across the border to the Czech Republic.

In reality, investment outflows from

"CEE is a high growth region with increasing spending power"


CEE remain extremely limited. The European Bank for Reconstruction and Development reported in March that, "outward FDI from the EU-10 countries remains very small. The weighted average of total outward FDI stocks to GDP of the ten new EU countries is only about 8.7%, far less than of such established investor countries such as Germany or the UK, where it is 36% and 74% respectively."

Ground floorYet the UK ambassador says that just means her country has a good opportunity to get in early on a developing trend. "Outward foreign direct investment by the EU-10 countries is a relatively recent phenomenon," the EBRD notes. "The experience of other emerging markets suggests that a significant potential for growth of outward FDI still remains."

Taylor picks up the theme, insisting London needs to move quickly. "UKTI research says the likes of Poland and the Czech Republic are already investing. However, those flows are going to Europe and perhaps Russia. We need to respond or China and others will." Similar initiatives are underway to tap outflows in Latin America and the Gulf, he points out. "It's a competitive world in terms of attracting investment."

Although the UK is number one in Europe for overall FDI, Germany takes the biggest slice of emerging market inflows. Wresting CEE investments from Berlin will surely only be made harder due to geographic location, established trade links and the German economy's leading role in the Eurozone.

Meanwhile, the trends that have marked the last 20 years in Emerging Europe continue to push away from the likes of the UK. "Low production costs and growing market potential continue to drive significant investment east," UKTI admits in a statement launching the drive. "Light manufacturing, the energy and heavy industries, the automotive sector and the food and drink industries are all currently considering investment in the emerging markets of Bulgaria, Russia, China and Vietnam.

However, UKTI Managing Director Michael Boyd insists there's plenty of room for manoeuvre. “While low-cost production and accelerating growth means emerging markets are still attractive, we’ve seen a boom in Czech business coming to the UK," he says. "It’s a real vote of confidence in the enduring value of investments in established markets.”

Launch padSeeking to differentiate itself from the Eurozone's larger economies, the UK drive pushes the country's ties outside Europe to the wider global economy.

Taylor, who says the target is to have 15 "quality successful investments" and at least 100 in the pipeline within 18 months, says that the mid-sized companies that UKTI is eyeing can use the country as a "launch pad". The UK's global ties offer prospects to expand to the US, Middle East or Southeast Asia, he claims.

Petr Sedmihradsky, managing partner at Czech data centre company Greenhousing, which opened a unit in the UK last year, says his company is already witnessing the effect. "We are now seeing some global clients, from Australia for example. The UK investment was crucial for attracting those clients."

IT is one of the six sectors that UKTI has earmarked as offering the most potential. Energy, heavy industry, light manufacturing, food and drink, and financial services complete the list, alongside the auto industry, which has become increasingly vital for CEE's macroeconomic performance over the past couple of decades.

"There are great opportunities in the auto sector," suggests Thompson. "The UK needs over £3bn worth of auto components in the next decade, and there's no spare capacity in the supply chain currently." Taylor adds that life sciences and other high-tech companies are also needed in the UK market.

Whether such opportunities will also attract UK banks is another question.

However, although Taylor admits that the lack of UK banks on the CEE markets means they won't know most potential investors coming out of the region, he appears unconcerned that funding will be an issue.

He points out that London's role as a global financial centre is part of the campaign. The ambassador insists UK banks are ready to play their part, and notes government funding schemes – particularly for innovative firms – will help. "The UK offers significant incentives for innovation, with generous R&D credits and a Patent Box offering a 10% rate of tax on profits attributable to patents and other forms of IP,” points out Boyd.

Non-cash benefitsSedmihradsky says that the Innovation Voucher scheme, which offers funding for UK-based businesses running R&D with outside agencies, was important for Greenhousing. But he insists that issues outside hard cash are just as important a benefit to investing in developed markets.

Thanks to exposure to the advanced UK market, he says the investment has raised the company's profits in its home market. "Everyday we find new technology, new approaches to customers, that we can monetise at home," he claims.

Boyd takes up the theme, stating there are plenty of advantages on offer for the right investor. “While some business leaders are held back by concerns that the UK market is already dominated by big players, its financial transparency and quality legal environment encourages long-term secure investments and an alternative to the high-risk high-reward lottery of emerging markets," he claims.

The EBRD, which would clearly like to see more intra-regional FDI within CEE, evidently agrees, suggesting "old" Europe can still offer significant advantages to CEE businesses that are starting to find their home markets a little snug for further growth.


happy, but you don't need to trust us."

Speaking to bne at Tallinn's ultra-modern Ulemiste technology park, Ruubel is one chip in the grand hard drive of Estonia's remarkable mastery of ICT. Everyone seems to have at least one online start-up to their name and some – most famously Skype – have gone on to become household names. Relaxed and

witty, Ruubel speaks English with the barest hint of an accent and has a talent for explaining technical complexities in straightforward language that even dim-witted reporters can comprehend.

"Most cybercrime is really committed by insiders, like Snowden," Ruubel explains. "He was the system administrator and he actually erased his own traces. He did that for a year and a half, quite a long period for a system breach to exist. And the only reason we know about it is because he went public.

Estonia's Guardtime follows the data trailMike Collier in Tallinn

We all know the feeling of waking up and thinking: "I really need an exabtye-scale

digital asset authentication service. But where to get one?" The answer: Estonia.

While the description of Estonian firm Guardtime's core product may be meaningless to anyone not familiar with the in-house language of the cyber-set, a simpler rendition would be something like this: "We can tell you if your data has been changed."

In a world where the computing "cloud" becomes mightier by the moment and everyone from cyberwarriors to whistleblowers is trying to gain access to private and secret information, the ability to state with absolute certainty that data has not been compromised should be worth billions.

"Our clients don't need to trust us – it's mathematics," smiles Martin Ruubel, one of Guardtime's directors. "It's like a law of nature. You may disagree with gravity, but gravity doesn't care. Guardtime is completely irrelevant. We came up with the algorithm and the infrastructure. We patented it and we're

"When you consider there is no security that cannot be breached by insiders, you have a problem. In the Estonian system you have medical records, police records, everything there. Even if no one wants to change that information, the privacy concern is huge. Administrators can go look at the data, erase the log files and you have a problem. Guardtime's point is that they cannot do all of the above and get away with that. They mathematically, logically cannot erase their trail."

"Guardtime's system doesn't have any secrets. It's an open algorithm that starts from the data, goes through several rounds of cryptographic hashing and ends with a publication code physically printed in a Financial Times magazine that everyone is able to use to verify the data Guardtime technology has secured.

"Basically it gives equal opportunity for governments, businesses and citizens to verify whether the information – be it log files or documents or whatever – is authentic or has been tampered with."

Government approvedPerhaps the most striking testimony to Guardtime's effectiveness comes in the fact that the company, founded in 2007, already counts both the US and Chinese governments among its clients – a remarkable feat in itself. Last year gross profits were in the black for the

first time at around €5m and that figure is expected to leap to at least €20m in 2014, signalling that the company is on the cusp of major expansion. Ruubel says the company "expects to post the first meaningful net profit this year."

Ironically enough, Guardtime partially owes its existence to inter-governmental cyber espionage. After suffering a massive cyberattack in 2007 that no one has officially been blamed for (but which everyone knows Russia was behind), Estonia recognized

"We can tell you if your data has been changed"


that it needed IT infrastructure that could provide security verification. With government support, a team of cryptographers, network architects, software developers and security specialists was assembled to design the aforementioned "exabyte-scale authentication and real-time alerting system for networked digital assets".

Thankfully they named their invention simply KSI (Keyless Signature Infrastructure) and the technology is available for all the government branches through the famous X-Road digital information system to provide the backbone of what has become "E-stonia".

"In the Estonian registries, all the files are verified every five minutes, including the log files in order to know whether unauthorised changes have been made. It creates an end-to-end independently verifiable audit trail meaning that the government registry is not a black box any more – you don't need to trust anybody. You don't need

to trust the system, you don't need to trust the president or the government. And our clients don't even need to trust Guardtime," says Ruubel.

If the technology progresses as expected, Guardtime's potential could be every bit as big as Skype's.

On April 28, Guardtime launched a strategic partnership with Authentise, a leading provider of authentication services for 3D printing. While everyone agrees 3D printing will be the next big thing, there are worries that it could also introduce bootlegging and intellectual copyright theft on an unprecedented scale. Gartner estimates that by 2018, 3D printing will result in the loss of at least $10bn per year in intellectual property globally. Guardtime's

technology could help reduce such a loss.

Ruubel sees great growth potential in the Far East, partly as a result of ongoing globalisation processes. "One client group we have is medical organisations who do medical diagnosis. For example, you take an X-ray image in the US, send it to the Philippines for diagnosis – because apparently there is a shortage of doctors in the US – and they send back the diagnosis. That's fine until something goes wrong. Then we have an argument – was the wrong X-ray sent, was it a misdiagnosis? When Guardtime technology is involved, you can take it step by step: this was the image that was sent, this was the diagnosis that was written and so on. You can establish exactly what happened without anybody having the possibility to change anything."

But perhaps the most striking use of Guardtime's technology comes when Ruubel casually remarks that it is used

in drones, though he prefers not to mention exactly whose. "Our technology is used to validate the software inside the drones. It is impossible to inject malicious code into the drone software. It's kind of important that the software inside the drone is correct, that nobody hacks into it and takes over..."

He's similarly guarded about what will be a "big" announcement about another use of Guardtime technology in the next few months. "Everybody needs exabyte-scale digital asset authentication, it turns out," Ruubel laughs.

On the wall behind him, the list of major ICT companies with offices at Ulemiste reads like a shopping list of possibilities: Microsoft, Cisco, Ericsson, Skype, Hewlett Packard, Nasdaq OMX...

"The ability to state with absolute certainty that data has not been compromised should be worth billions"

Voting for office flings It may be one of the oddest political campaigns ever, but the youth wing of the Czech Social Democratic party (CSSD) put out a video for the European elections whose basic message was that "unemployment is depriving people of the joys of an office fling."

The video shows a young woman working at a computer in an office. After looking at the clock, she sneaks off to the next room and in silhouette can be seen passionately embracing a male colleague behind the adjoining door. "Everybody who wants to should be able to enjoy something a bit different during breaks. It is a shame there are half a million people who don't have jobs," intones a voice-over.

Prime Minister Bohuslav Sobotka, who heads the CSSD-led coalition government, downplayed the campaign video as a bit of fun that makes a serious point. "I take the video of the Young Social Democrats with a pinch of salt; no need to be overly prudish about it. It points out the chillingly real problem of high unemployment."

Did it do his party any good? In a record low turnout of below 20%, CSSD suffered a drubbing, coming in in third place behind coalition partner Ano and the liberal-conservative opposition party TOP09.


laboratory testing – revealed "a series of alarming problems," the researchers claimed. "Operational security is lax and inconsistent, transparency measures are insufficient to prove an honest count, and the software design is highly vulnerable to attack from foreign powers."

Such criticism has particular force in Estonia, which has pioneered the use of e-voting since 2005 and remains the only country in the world where a significant portion of votes are cast online. In the 2011 parliamentary elections, around one in four Estonian voters cast their ballots via electronic means and Estonia makes a great play

of showcasing its e-voting solutions to other states as part of its "E-stonia" publicity machine. "Estonia's Internet voting system blindly trusts the election servers and the voters' computers," Halderman said. "Either of these would

"Estonia's Internet voting system should be immediately discontinued"

Estonia's e-voting system – is it safe?Mike Collier in Riga

In the classic 1976 thriller "Marathon Man" the most memorable scene features a Nazi war criminal played

by Laurence Olivier repeatedly asking Dustin Hoffman's character "Is it safe?" with the aid of a dental drill and an unpleasant lack of anaesthetic. Estonia's National Electoral Committee must know how he feels after the appearance of an academic report that appeared to drill numerous holes in the country's much-vaunted electronic voting system and called for it to cancel e-voting.

On May 12, just two weeks before the continent-wide European elections, a team of researchers including assistant professor J. Alex Halderman of the University of Michigan announced on a newly created website called "Independent Report on E-voting in Estonia" that it had found "major risks" in the security of Estonia's Internet voting system. "Estonia's Internet voting system has such serious security vulnerabilities that... it should be immediately discontinued," the researchers baldly stated.

The research team members had been accredited to observe the Estonian e-voting system during the October 2013 municipal elections. Their observations – and subsequent security analysis and

be an attractive target for state-level attackers."

Meanwhile another member of the team, Finnish researcher Harri Hursti, pointed out the role that human error could also play in potential security breaches. "We didn't see a polished, fully documented procedural approach of maintaining the back-end systems for these online elections," said Hursti.

Videos published by election officials showed them downloading essential software over unsecured internet connections, typing secret passwords and PINs in full view of the camera, and preparing the election software for distribution on insecure personal computers, Hursti claimed. "These computers could have easily been compromised by criminals or foreign hackers, undermining the security of the whole system," he said. "With today's security technology, no country in the world is able to provide a secure Internet voting system. I would recommend that Estonia return to a paper ballot only system."

Defence of the e-realmPredictably, the Estonian authorities leapt to the defence of their flagship system, pointing out that it "has been used in six elections without a single incident which has influenced the outcome" and questioning the methods used by the research team. "The researchers met with officials from the electoral committee in October 2013, and could have contacted us at any point in the last six months to share the initial findings of their research.

In reality, the only advance information we received was notification, on Saturday evening [May 10], of a press conference on Monday. The researchers' website went up on Monday morning," the Committee said in a statement.


Kristi Kirsberg, a spokeswoman for the National Electoral Committee tells bne: "It was strange that these proposals were distributed first to the media, only four days before the beginning of online balloting, when it would have been appropriate to address these allegations directly to the National Electoral Committee. Also, the detailed analysis was released a week later, during the elections."

"The work released by the researchers has not identified of any novel attack vectors that are not already accounted for in the overall design of the system. Practical implementation of these potential attacks is either impossible or highly complicated. To date, no attacks have been identified. We have numerous tools, methods and safeguards to identify attacks," Kirsberg says.

With Estonian media picking up on the story and e-voting returning to the fore during the election period, each side has been posting commentaries on their websites debunking the others' claims. And as with "Marathon Man", the plot

of this particular thriller gets more intriguing by the minute.

Centre of the controversyEstonia's Twitter-addicted president, Toomas Hendrik Ilves, (whose tweets have even inspired an opera) was soon drawn into the action, tweeting on May 16: "This alas is NOT an independent report but rather orchestrated and funded by one political party. Real reports are not done as PR."

"Take party money for talk 'Satan votes on the internet', do PR show, provide no findings, ignore the responsible agency, claim independence," he tweeted later.

In the opinion of Anto Veldre of the

Computer Emergency Response Team for Estonia (CERT-EE), the national agency responsible for the management of security incidents in .ee computer networks, "it looks more like an attempt to rig the elections by scaremongering than a piece of research or responsible disclosure of an actual security hole."

As Veldre points out, it's not as if Estonians – or for that matter anyone in Eastern Europe – have particular reverence for paper voting. "The Communist Party always received 97-99% of votes in all polling stations. How? Well, the memories of that voting process could be rather traumatic for 'the voters,' featuring free vodka, bribery, broken fingers, swollen testicles or even some cold years in Siberia. Point being, we have very real memories of the practices used to falsify the 'paper voting'. That's opposed to the fact that it's rather difficult to bribe a computer," Veldre says.

Jason Kitcat is the public face of the research team behind the "Independent Report on E-voting in Estonia". The

leader of Brighton and Hove city council in the UK, representing the Green Party, Kitcat has been a long-time and prominent opponent of e-voting – a reputation that has earned him invitations to visit and speak from Tallinn's controversial mayor and Centre Party major domo Edgar Savisaar on two occasions, and which formed the basis of Ilves' blistering attack.

Kitcat's friend and fellow e-voting critic Barbara Simons has also enjoyed Savisaar's hospitality. Both insist they do not get involved in Estonian domestic politics, though Kitcat tells bne, "the issue of online voting has been politicised by parties and mixed in with issues about whether certain ethnic

groups in Estonia are entitled to vote."

Savisaar's Centre Party draws most of its support from Estonia's ethnic Russians, thousands of whom remain classed as "non-citizens" through their refusal to undergo naturalisation tests. And Harri Hursti, one of the report's researchers, has twice taken part in seminars sponsored by Tallinn City Council titled "Satan Votes Online" (cited by Ilves), hosted by none other than Edgar Savisaar.

The researchers' website says their material is "based upon work supported by the U.S. National Science Foundation... and by the National Science Foundation Graduate Research Fellowship", but admits its October 2013 election observing visit was paid for by Tallinn City Council, run by Mayor Savisaar. "We were very clear on all visits, that we were attending in a non-political way... I understand that [you] may be trying to spin that into something more significant, but if you look at our personal histories and the diversity of our team, then it is clear we cannot be bought by Estonian interests," Kitcat tells bne.

"We strongly felt that professional ethics bound us to inform people of our findings before another election was run using the system. I don't think it would have been acceptable for us to sit on those findings," Kitcat insists. "Online voting is part of Estonia's global marketing as 'E-stonia', a country that leads in all things digital. Any analysis which finds flaws is seen by some as an attack on that global reputation."

At the end of "Marathon Man", the bad guy winds up impaled on his own dagger as he lunges for priceless diamonds. Whether a similar fate awaits either the reputation of the research team or Estonia's online voting system remains to be seen, but for now the best response to the question "Is it safe?" is probably Dustin Hoffman's first answer: "I don't know what you mean. I can't tell you something's safe or not, unless I know specifically what you're talking about."

"We were very clear on all visits, that we were attending in a non-political way"

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UK. Right-wing parties, many of them campaigning on anti-immigration platforms, also did well in Austria, Finland and Sweden, while Greek voters, fed up with the government's austerity programme, turned to the far left Syriza party.

However, Commerzbank analysts note that while "the weekend's European parliament elections show[ed] that the electorates are unhappy with the way things are going... yet again the 30% threshold [was] not yet overcome by any far-right or far-left parties (or combination of the two)."

Rock bottomScepticism about the EU was evident across CEE, with turnouts at rock bottom in several countries, despite the economic recovery that has taken root over the past few months. As elsewhere, in many ways the results produced by the few that did vote only magnified just how jaded is the electorate.

Although the momentum has been slowing in recent weeks, the gains from Warsaw's leading role in the EU response to the crisis in Ukraine was enough to push Poland's ruling Civic Platform (PO) party across the line. The

An apathetic lurch to the rightTim Gosling in Prague

With trust in both the EU and national politics at record lows, Eurosceptic parties made

strong gains – including in Central and Eastern Europe – in the May 22-25 elections for the European Parliament. However, the poor turnout is the biggest blow to the bloc.

It's testament to the pressures across the EU that mainstream party leaders in Brussels leapt to acclaim the fact that at just over 43% the turnout at the 2014 election avoided a meltdown, and was just above the record low at the 2009 polls. Hannes Swoboda, the leader of the Socialists & Democrats (S&D), insisted the forecasted disastrous turnout had not materialised. Liberal leader Guy Verhofstadt said, "we have finally broken the downward trend of falling participation," according to EurActiv.

Early results show that the conservative European People's Party is expected to remain the largest group in the Brussels parliament, with the EPP in the lead with 28.23% of the vote, which would give it 212 seats. S&D looks set for 24.77%, or 186 seats.

However, extremists pushed the mainstream aside in France and the

ruling centre-right party has spent much of the past two years scrambling to catch up with the populist conservative opposition Law and Justice (PiS), and scraped just one point ahead with 32.8%. The Democratic Left Alliance (SLD) were in third place on 9.6%, while the anti-EU 'New Right', under the leadership of the political maverick Janusz Korwin-Mikke, provided the major shock of the night when it gained 7.2% of the vote.

Despite the enormous benefits flowing from EU membership, largely because of billions in EU structural and agricultural funds that have transformed Poland since it joined the EU a decade ago, participation in elections to the parliament was lacklustre. Turnout was 22.7%, two percentage points down on 2009.

The elections were crucial for Prime Minister Donald Tusk, as they marked the start of a long series of votes over the coming months. Starting with regional elections, 2015 will see parliamentary and presidential races.

In the run-up to the election, Tusk sought to link the European vote to larger questions of national security. "We are really standing before a fundamental problem, that eurosceptics and the European extreme right not gain such strength in the European parliament... that it does not lead to the creation of something that could objectively be called Putin's Fifth Column in Europe," Tusk said recently.

While the Ukraine crisis helped Tusk's party across the line, the emergence of Korwin-Mikke's New Right party suggests the PM could face bigger tests next year. Korwin-Mikke, a perennial political gadfly, has grabbed the attention of younger voters with his flamboyant pro-business and anti-EU message. He has even promised sell the European Parliament building and turn it into a bordello. However, recent comments saying that women are less intelligent than men, and that women have to be “raped a bit” because they “pretend to resist”, hurt him with female voters.


Incumbent Dalia Grybauskaite has declared victory over her Social Democrat rival in the runoff, as she sits on around 58%. An outspoken hawk on Russia and its recent aggression in Ukraine, the president called her victory "historic" because "Lithuania has never elected a president for a second term before".

As you wereHungarian Prime Minister Viktor Orban promised more fights with Brussels on the cusp of the election, and his Fidesz party followed up its landslide re-election into government in April with an equally impressive margin in the European vote. The party won 51.5% to secure 12 of Hungary's 21 seats. Meanwhile, the far right Jobbik beat the opposition Socialist Party into third, winning 14.7%.

As in Poland and Hungary, Romania's ruling coalition maintained its lead in the European elections, taking over 40% of the vote, exit polls showed. The bloc composed of the Social Democratic Party (PSD), the Conservatory Party

(PC) and the National Union for Romania's Progress (UNPR) is expected to take around half of Romania's 32 parliament seats.

The National Liberal Party and Liberal Democratic Party also did well, taking (PNL) 14.9% and 12.4% of the vote respectively. The main surprise in Romania was the showing for independent candidate Mircea Diaconu, who attracted 6.9% of the vote, the best result ever received by an independent in Romania.

More elections?In contrast, ruling parties received a blow in Bulgaria, Croatia and Slovenia.

Slovak shrugsNext door, with just 13% of voters bothering, Slovakia took the honour of having the lowest turnout in any country – a record it has held persistently since joining the bloc in 2004. The country's EU commissioner Maros Sefcovic said politicians need to seriously think about how to tackle the "Slovak paradox", reports EU Observer. People are generally supportive of EU membership and integration, but show an unprecedented lack of interest in the EP vote.

However, the low turnout did little for the extremists, with mainstream parties taking all of the seats. The left-leaning ruling party Smer took the biggest slice with 24.09%, but lost one of its five seats at the same time.

The Czechs also struggled to whip up much enthusiasm. The 18.2% turnout was the lowest of any national vote held in the country – and 8.7 percentage points lower than in 2009 – with the electorate having illustrated its frustration with the established political class when it voted ANO into a powerful role in the governing coalition in October.

The new political project of billionaire, and now finance minister, Andrej Babis went one better on May 23 when it took the most votes in the European Parliament election with 16.1%. The second place secured by the conservative Top 09 (15.9%) marked something of a revival for the right, which was decimated at the last national election.

The Baltics are traditionally far keener to wear their EU badges, but despite the nervous glances being cast towards Russia, turnouts were still disappointing. Overall, Estonia saw numbers drop by 7.5 percentage points to 36.4%, while Latvia saw the biggest fall in the bloc, with its 30% turnout a whopping 23.7% lower than in 2009.

Lithuania, by way of contrast, saw the biggest rise – up 16.3pp to 37.3% – of any state. However, that was thanks to the fact that the European election was run concurrently with the second round of the presidential vote.

Croatia's centre-right opposition coalition led by the Croatian Democratic Union (HDZ) is expected to take six of the country's European Parliament seats, with just four going to the ruling Social Democratic Party and its coalition partners.

In Bulgaria, the centre-right Citizens for European Development of Bulgaria (GERB) is in the lead with around 28.4% of the vote, beating Prime Minister Plamen Oresharski's Socialist Party into second place. Gallup analyst Dimitar Ganev suggested the result is likely to encourage calls from the opposition for early elections, Novinite reported. However, the vote has been marred by accusations of vote buying.

In Slovenia, just over 20% of the electorate turned out to vote, despite the European elections being seen as a dress rehearsal for domestic elections expected to take place the coming months. The results, therefore, likely spell bad news for the ruling Positive Slovenia. Opposition centre right

parties are expected to take around five of the country's eight seats.

Early elections have been on the cards since Prime Minister Alenka Bratusek resigned earlier this month, after she was ousted from the leadership of Positive Slovenia. Bratusek, whose government launched wide-reaching reforms and escaped an international bailout by the skin of its teeth, said a snap vote is needed to avoid a lengthy period of political turmoil. A date has not yet been set, but an election is expected by September at the latest.

"The European Parliament elections showed that electorates are unhappy with the way things are going"

40 I Southeast Europe bne June 2014

The Balkans' bear problemPhil Cain in Graz, Austria

The standoff between Russia and the West since Moscow's annexation of Crimea and

continued meddling in eastern Ukraine promises to complicate the already painfully slow and rocky process of the Balkans' journey towards the EU.

"Russia has huge potential for creating disturbances [in the region]," says Tobias Flessenkemper of the European Institute CIFE in Nice. "The challenge for the EU is to stick to the enlargement process."

However, that's a process under scrutiny like never before, Flessenkemper points out. European citizens, already disgruntled at the Eurozone crisis, the bailouts, immigration and the admission of new members with dubious records on aspects like corruption, registered their disapproval at the polls with a

eurosceptic swing in May's European elections.

The past few weeks have shown that traditionally Russophile Balkan nations that cling to their European aspirations

can expect a tongue-lashing at the very least from Moscow.

Montenegro would be a “legitimate target of Russian missiles” if it joins Nato, blustered nationalist Russian deputy Mikhail Degtyarev in May, according to Montenegrin website IN4S. Montenegro's stubborn refusal

to bow to Russian invective may yet be rewarded with Nato entry in September.

Montenegro's crime in Russian eyes was its March decision to go along with

imposing EU sanctions on 33 Ukrainian and Russian officials, some close to Russian President Vladimir Putin. A month later Montenegro's perpetual leader Milo Djukanovic visited Washington and called for a "bold start" on the further expansion of the Euro-Atlantic security zone. He pointed to an "interdependence between the crisis

"Russia has huge potential for creating disturbances in the region"

bne June 2014 Southeast Europe I 41

in Ukraine and efforts to destabilise the Balkans". The region is “like vacant ground, where pro-Nato and anti-Nato policies are also coming into strong conflict”.

The Russian foreign ministry said it saw Prime Minister Djukanovic’s characterisation of the situation as “hostile” to Russia. Russian daily Rossiyskaya Gazeta, a mouthpiece of the Kremlin, then weighed in, accusing Montenegro of mistreating Russian compatriots and rumbling on about Russian plans to settle the score by ending a visa-free regime and trade preferences. Such threats have so far proved empty. Neighbouring Albania, a Nato member since 2009, which also agreed to impose EU sanctions, has been spared such bombast.

On the surface Montenegro, with a population of just 600,000, seems in no position to stand up to Russia, especially given its heavy dependence on it economically. As many as 7,000 Russians are permanent residents, while 40% of real estate is in Russian hands and 300,000 Russians a year holiday there. Russians are reckoned to own as much as a third of foreign-owned businesses; setting up a business is one of the key steps for gaining residency.

But Russia may not have the whip hand that these figures suggest. "Djukanovic has been around forever. He is a sly fox. He was around during [Serbian strongman Slobodan] Milosevic's time," says Flessenkemper. "When he has a problem he gets rid of them."

Sanctions against Russia may in fact be a blessing in this, helping to impede any Russian bid to withdraw investment from the country. A tussle over the proceeds from the sale of a bankrupt aluminium smelting plant, co-owned by Montenegro's government and Russian tycoon Oleg Deripaska, has already been in full swing for months.

Slavic brothersBeyond Montenegro, Serbs feel the closest emotional bond with Russia among the people of the five Balkan EU-outsiders. The Serbian government

bne

In typical Slav black humour, at the height of the floods in Serbia people were heard to mutter that the prime minister's pet project, a massive redevelopment of the Belgrade docks, known as "Belgrade on the Water", had been completed well ahead of schedule.

But humour can't cover the pain of what's being referred to as the biggest catastrophe to hit the Western Balkans since the violent breakup of Yugoslavia in the 1990s. In mid-May the worst rainfall in over 120 years caused rivers to burst their banks and triggered thousands of landslides across Serbia and next-door Bosnia-Herzegovina and into parts of Croatia.

By the end of May, the death toll had climbed above 50, though the UN was warning it could rise further once the waters subside and the scale of the destruction becomes clear.

Bosnia said that more than a quarter of its 4m people had been affected by the floods, with more than 100,000 houses and other buildings in Bosnia no longer fit to use. "The consequences... are terrifying," Bosnian Foreign Minister Zlatko Lagumdžija told a news conference at the height of the floods. "The physical destruction is not less than the destruction caused by the war."

Many have been cut off from clean water supplies; there are now fears of disease spreading. And then there is the ordinance left over from those 1990s wars; some of the 2,000 landslides in Bosnia occurred on minefields left over from the war. Nearly 120,000 unexploded landmines remain in more than 9,400 carefully marked minefields.

The cost of the clean-up will be immense and could prove devastating in the short term for three of the region's most fragile economies that only recently began clambering out of a hole. Estimates are certainly over ¤1bn; the damage to Serbia's mines and power stations alone is above $100m. "(It is) perhaps too early to count the costs, but the devastation caused will no doubt serve as a big hit to the economy, with some reports suggesting that as much as 10% of all businesses have been affected,” Abbas Ameli-Renani, an emerging-market strategist at RBS, told the FT.

The EU is stepping in with assistance, which it has promised to provide speedily. As an EU candidate nation, Serbia can tap into a ¤500m fund when natural disasters strike. Bosnia, which isn't an EU candidate country, doesn't qualify for the fund, but the EU commissioner responsible for regional policy, Johannes Hahn, noted that the EU is looking into a reallocation of EU funds to aid Sarajevo.

The worry is that more floods could be on the way.

Belgrade under water


has maintained a studied silence on Crimea's independence, ruling out sanctions. Any pro-western statement would mean trouble for newly-elected EU convert Aleksandar Vucic, particularly among the prime minister's own Serbian Progressive Party, which was formed out of a split from the ultra-nationalists.

Milorad Dodik, president of the Bosnian Serb Republic (Republika Srpska) has had no such qualms, hailing Crimea's snap referendum split from Ukraine as a triumph of democracy, and threatening to hold a similar one in Republika Srpska to cede from the hated multi-ethnic state of Bosnia-Herzegovina.

But Serbian-Russian ties may not be all they seem. "Russia does not care about Serbs – they just use them," says Flessenkemper, adding that on the flip side "Serbs do not want to join Russia."

Serbia, he argues, hopes to leverage its diplomatic predicament to "increase the price" when dealing with the EU, which is keen to bring Serbia into the European fold. However, this approach carries the risk of Serbia "derailing" the EU course it has just achieved after making a historic breakthrough over Kosovo, he says. Dodik meanwhile, has applauded independence votes for many years irrespective of Russian backing.

Perpetual EU candidate Macedonia, locked out of the EU for the foreseeable future due to a tedious dispute with neighbouring Greece over its name, could be a long time waiting yet. It is debatable whether or not its leaders are even seriously looking to join the bloc anymore. Recently re-elected Prime Minister Nikola Gruevski has held his tongue on Crimea, but appears to be taking Putin's authoritarian, anti-gay model of governing as a template for exercising power outside the EU.

Paper tigerFor all the diplomatic tiptoeing around and Putin-like political overtones growing in European spots like Macedonia, Turkey and Hungary, some doubt Russia can or will carry much sway in the Balkans. "Yes, Russia can occasionally annoy the EU, but only if the EU is not united itself," says Gerald Knaus of the European Stability Initiative, a think-tank focused on Southeast Europe.

In Kosovo, Russian interference is not necessary when five EU members do not even recognise it. And EU divisions over Bosnia's future are also causing enough problems without Russia having to lift a finger. "I do not think Russia has the ability to disrupt EU plans in the long term, but it certainly is able to disrupt," says Florian Bieber, Professor of Southeast European Studies at Graz University in Austria.

A policy study published in May argues the ability of Russia to disrupt Balkan affairs will depend, not only on Russia, but also on the degree to which the EU re-engages in the region.

Croatian Foreign Minister Vesna Pusic has called for EU re-engagement, proposing a loosening of the conditions for future EU candidates. Croatia finally joined the EU in July last year, a decade after it applied, principally because of deep concerns over its record on combating corruption.

Unsurprisingly, Pusic's view has found little support among her peers, who are battling growing disillusionment amongst their populations about the whole European project, particularly letting in new members in Southeast Europe like Bulgaria, Romania and Croatia.

That, say some, provides Russia with fertile ground for sowing its seeds of distrust.

"Russia does not care about Serbs – they just use them"

The undead news story Like vampires themselves, the subject of Count Dracula is an undead news story. In the same month that the Romanian-born historian who wrote a cult book linking the fictional Dracula to the 15th-century Romanian prince Vlad the Impaler died, it turns out that the Transylvanian castle once reputed to be the count's abode is now "for sale."

Radu Florescu co-authored with Raymond T. McNally a book called "In Search of Dracula" in 1972, in which he asserted that Irish author Bram Stoker based the vampire character in his 1897 novel on Vlad the Impaler. Vlad III, Prince of Wallachia (1431–1477), a member of the House of Draculesti, became feared for his practice of impaling his enemies – a reputation for excessive cruelty that spread across Europe. As many as 80,000 people died under his bloodthirsty seven-year reign. Florescu's work was translated into 15 languages. He died at the age 88 in Mougins, France on May 18.

Meanwhile, Bran Castle in Transylvania is reportedly up for sale by its Habsburg owners. The Romanian government has reportedly lodged an $80m bid for the gothic pile that's become a popular tourist destination for those seeking Dracula thrills. The fortress dates to the 13th century and images of it supposedly reached Bram Stoker in Ireland, who drew inspiration for his famous work from travelogues and sketches by British diplomats.


As a country permanently on the edge of Europe, both geographically and

metaphorically, Turkey has a tendency to invite hyperbole. And, it has to be said, Turkish politicians are no strangers to embroidering fact in the search for votes, with the latest example being warnings from the opposition about a rush toward totalitarianism.

Statements made by Kemal Kilicdaroglu, leader of Turkey's main opposition Republican Peoples' Party (CHP), at a recent meeting with a group of international journalists went some way beyond the normal level of criticism levelled by opposition leaders at an incumbent government, even that of Turkish Prime Minister Recep Tayyip Erdogan and his Justice and Development Party (AKP). "Turkey cannot be described as a healthy democracy, we are rushing towards totalitarianism," he warned.

"If a country has no freedom of expression, how can you call it a democracy," he added, pointing to the short-lived ban on Twitter, the continuing ban on YouTube, and the perennial issue of media ownership and partiality.

These are strong words that Kilicdaroglu justified by pointing to events of the past year. This has seen the routine use of riot police and tear gas to suppress anti-government protests, resulting in the deaths of six protestors, as well as a surprise police probe into corruption that saw dozens of arrests and forced the removal of four senior cabinet ministers and the head of a state bank,

but which itself was suppressed through the removal and transfer of dozens of senior police and prosecutors. These events were followed by an even more unprecedented series of leaks onto the internet of telephone conversations involving Prime Minister Erdogan, senior ministers, businessmen and bureaucrats.

But while the police investigation may have been stalled, the Turkish parliament on May 5 voted to establish a special parliamentary commission to

investigate the allegations against the four former ministers, albeit one which will be dominated by MPs from the AKP, which holds an overall majority in parliament.

According to Kilicdaroglu, the protests indicate just how much importance Turkey's young population gives to freedom of thought, while the question of corruption is symptomatic of the way Turkey has changed over the 12 years of AKP rule. "Today we have an AKP state: the courts, the prosecutors, the governors, the police – they're all part of an AKP construction," he said, enquiring what kind of state is it where a prosecutor cannot act on a complaint against the prime minister.

No to Putin modelIt was for the coming presidential elections in August that Kilicdaroglu reserved his strongest comments, pointing out that media speculation was focusing on whether the AKP would put forward the current President Abdullah Gul as a candidate for a second term, or Erdogan. "This is just the 'Putin model'," he said, noting that while the president is nominally independent from the political process, Gul has simply approved whatever the AKP government passes through parliament. "First we should debate what sort of president we

want. We can't have a president who is suspected of corruption."

That debate though may already be over, with the AKP voting to retain its limit of three terms for sitting MPs, which will see Erdogan and most of his cabinet unable to stand as AKP candidates in the next general election in April 2015. This move all but confirms that Erdogan will be the AKP candidate, with Gul returning to the post of prime minister that he held briefly in 2002-2003.

The "Putinisation" of TurkeyDavid O'Byrne in Istanbul

"Mr Erdogan has already become that president 'de facto', now he wants to be that president 'de jure', like Mr Putin,"


According to Kilicdaroglu, the two-round presidential poll will see every party field its own candidate in the first round, with most likely a consensus candidate emerging in the second – a process he thinks will enable his party to pick up enough votes to win. No party has yet announced its candidate for the August polls.

Kilicdaroglu is not alone in suspecting that Erdogan might be looking to emulate Vladimir Putin. Such a possibility has been discussed at length in the Turkish media ever since Erdogan first trailed the idea of changing the Turkish constitution to introduce an executive presidency.

"Mr Erdogan has already become that president 'de facto', now he wants to be that president 'de jure', like Mr Putin," says Cengiz Aktar, professor of Political Science and senior scholar at Istanbul Policy Centre, pointing out that the real subject of discussion should not be the mechanics of who gets elected or how, but who should be standing as a candidate. "It's a serious omission, that the ethical angle is not discussed enough in Turkey."

"In a civilised country, people who hold public office and who have been under suspicion of graft, corruption and embezzlement, they resign first and clear their names, then they think about running again for office," he says.

Presidential election scheduleJuly 8 – publication of preliminary candidate list. All parties expected to nominate a candidate.

July 11 – publication of final candidate list. Some parties expected to drop their own candidates.

August 10 – first round of voting. IF no candidate receives 51% or more, a second round is held

August 24 – second and final round of voting, widely expected to be a runoff between one AKP candidate and one opposition candidate. The candidate receiving the biggest share of the votes is elected.

David O'Byrne in Istanbul

The sale in May of BMC, the one-time Turkish subsidiary of the British Motor Corporation, has opened the door for the realisation of a long-term wish of Turkish Prime Minister Recep Tayyip Erdogan: the development of a "Turkish" car.

BMC was snared with a final bid of TRY751m (¤257m) from ES Mali Yatırım ve Danismanlik, whose owner Ethem Sancak is known to be close to the Turkish prime minister. Seized last year by Turkey's Savings Deposit Insurance Fund (TMSF) against $455m of debts from a bank belonging to its previous owner, Turkey's Cukurova Holding, BMC was offered for sale earlier this year with a reserve price of ¤340m.

The purchase represents a new departure for Sancak, who operates Turkey's biggest importer of drugs and medical supplies, and who last year bought newspapers Aksam and Skyturk 360 from the TMSF, after they too were seized from previous owners Cukurova.

Speaking to the media after the BMC sale announcement, Sancak confirmed his interest in building up a defence business (BMC also makes military vehicles) and that he is in talks with the Qatari government over the possible investment of TRY1bn into BMC.

Founded in 1964 as a joint venture between local partners and The British Motor Corporation (later British Leyland) from which it takes its name, BMC is the third oldest of Turkey's 15 vehicle manufacturers. Following Leyland's pullout in 1979, the company produced British-designed vehicles under licence, and over the past two decades has developed its own range of light trucks and specialist commercial and military vehicles, including the armoured "Kirpi" military transporter. But cash flow problems have seen production at BMC halted several times over the past year and the company last year failed to fulfil an order for 468 Kirpis with the Turkish defence ministry.

While the sale of BMC to a new owner should solve the short-term cash flow problems, it will also offer an opportunity for the company to fulfil a long-term ambition of Turkish Prime Minister Recep Tayyip Erdogan for the development of an all-Turkish passenger car.

While BMC and other small manufacturers have both designed and produced specialist vehicles, to date all of the passenger cars and the mass production commercial vehicles produced in Turkey have been designed my major international manufacturers.

Turkish manufacturers have been trying for over a decade to increase the level of local content in their vehicles and to boost their own R&D facilities helped by government incentive schemes, while PM Erdogan has been pushing for one or more to come up with an entirely Turkish model on the same lines as Malaysia's Proton, which can be sold both on domestic markets and internationally.

The Recep roadster


IKEA, the Swedish furniture retail giant, has launched an internal investigation into allegations that it

was involved in running hard-currency payments to a company controlled by Romania's brutal Communist-era secret police, bne can reveal.

The claims, initially made by Romanian newsportal HotNews.ro, and published internationally for the first time by bne, allege that in the 1980s IKEA ran an "overbilling" operation that channelled cash to a firm run by the Securitate, responsible at the time for torture, assassinations and the suppression of opposition for the quasi-Stalinist regime of Nicolae Ceausescu. Ex-Securitate officials and their allies are widely seen as having continued to wield influence in Romania after the revolution in 1989, and indeed to this day.

IKEA says that its arrangements in Romania in the 1980s were entirely normal for that era, and says that it has yet to find evidence that it did business

in breach of its own code of conduct. But the company is not able to deny the alleged arrangement outright.

According to HotNews.ro, for at least two years between 1985 and 1985, 6.2% was added to orders of furniture produced by Romanian export-import

company ICE Tehnoforestexport in an "overbilling" operation. IKEA was, and still is, a large puchaser or Romanian-made furniture goods. Of this, 1.85 percentage points were channelled by Tehnoforestimport to a Securitate-run and staffed firm, ICE Dunarea, with the

remaining 4.35 points sent to an IKEA account in the former East Germany (the DDR).

The details of this arrangement were uncovered by HotNews.ro correspondent Claudiu Zamfir in the archives of the National Council for Study former Securitate Archives (CNSAS). HotNews.ro admits it "did not find any document bearing signatures of both IKEA and Securitate representatives," and IKEA says that it has found no evidence of a direct link to the Securitate. But Henrik Elm, IKEA's Global Purchase Manager, was unable to refute the claims entirely in an interview with bne.

And HotNews.ro editor Dan Tapalaga is in no doubt of the Swedish firm's culpability for its involvement with the secret police, even if indirect. "ICE Dunarea was one of the most important state companies before 1989, controlled by the Securitate," he tells bne. "The Securitate spread terror among ordinary people, immediately arresting anyone attempting to protest against Ceausescu's regime. Human rights were smashed in the '80s. Doing business with such a state only to increase your profits, helping a criminal communist regime to survive by paying the Securitate, is a shame for a western company. They must be exposed at least for this hidden, shameful economic compromise 30 years ago. People have the right to know and to judge."

Hard cashExperts on Romania during and after Communism say they aren't surprised by the allegations. "Anyone familiar with the nature of the foreign intelligence operations during the Ceausescu era should know that they

Flat-packing the past in RomaniaAndrew MacDowall in Belgrade

"It is hard to believe that IKEA was altogether unaware of the ruthless Ceausescu operatives with which it was transacting business"


businesses seem relaxed about dealing with autocratic regimes however much they disrespect basic political rules."

While IKEA's Elm defended the company's Communist-era business in Romania and insisted that the company's own investigations had yet to find evidence that company officials knew it was funding the Securitate, he admits that, "the fact that the business referred to took place 30 years ago makes it difficult to get a complete picture".

"We take all matters of this kind very seriously," he tells bne. "We are trying to put the pieces together to get a better picture of how the business was running. The documents we have inside IKEA don't cover all the details that far back in time, we are trying to find out more details. In the '80s the handling of hard currency and money was not a very easy process."

Elm says that the so-called "overbilling operation" was very common in Communist-era Eastern Europe. He asserts that it was a commission paid on top of the purchase price of the Romanian furniture shared between Technoforestimport as a representative of the suppliers, and IKEA, as payment

for the latter's investment in plant and

were meant to serve the regime's voracious appetite for hard currency," Vladimir Tismaneanu, a Romanian-American professor of political science at the University of Maryland, tells bne. "This was the dark world from which many of the influential figures of the post-communist transitions (politicians as well as oligarchs) emerged in Romania and in other former Soviet Bloc countries. In the Romanian case, the Securitate was the 'sword and shield' of a particularly grotesque and murderous tyranny."

Tismaneanu cites the torture and assassination in prison of Gheorghe Ursu, an opposition activist, for the crime of keeping a diary detailing the state's failings; and the savage interrogation and long jail sentences meted out to protesting industrial workers in Brasov in 1987. "Such terrible facts were known to any decent person who cared about human rights," he says.

Tom Gallagher, an emeritus professor at the University of Bradford in the UK, tells bne that, "it is hard to believe that IKEA was altogether unaware of the ruthless Ceausescu operatives with which it was transacting business… Rather a lot of important European

"We are trying to put the pieces together to get a better picture of how the business was running"

training in Romania, bringing valuable knowledge and technology transfer to the country. "We had only one business partner, Technoforestimport, which set up the [financing] structure, a very normal commission-based structure," he says. "It is nothing confidential."

However, IKEA has come a cropper for its dealings in Communist-era Eastern Europe in the past. In 2012, the company apologised after an independent investigation that it had commissioned found that its suppliers in the DDR had used forced labour, and that IKEA representatives were probably aware that political prisoners were involved. IKEA's code of conduct has been strengthened since the fall of Communism, most recently in 2000, though Elm says that much the same rules applied in the 1980s. "We have the same demands as on every supplier, including a code of conduct – a very, very robust code of conduct – and a very good way of verifying this code of conduct and if there are any dealings that were not in line with the code of conduct," says Elm.

He also cites a list of countries that IKEA will not do business with, though many would say that Ceausescu's Romania, a notoriously egregious abuser of human rights, had as much reason to be on the blacklist as any.

Whatever more comes to light in the case, Tapalaga admits that it is unlikely to harm IKEA's operations today in Romania. IKEA is a major player in the Romanian furniture sector, purchasing €420m worth of goods from the country in 2013, and operates one store in Bucharest generating RON440m in revenue (including VAT) last year. As Elm points out, the company contributes hundreds of millions of euros to a beleaguered economy – he cites a recent €80m investment in a foam factory – supporting thousands of jobs.

For better or for worse, many Romanians would sooner forget the Securitate oppression – and consider the perceived continued influence of intelligence structures in Romania as something they can do little about.


Romania’s once booming green energy sector has been hit by the government’s decision

to slash incentives for renewable electricity generation. Both local and international investors are now drawing back from new and existing projects, citing uncertainty about the operating environment as well as lower financial returns.

A late starter compared to many European countries, Romania’s renewable energy sector took off between 2010 and 2013, with the government’s generous incentives drawing in investors from across Europe and Asia. Bucharest uses a “green certificate” incentive scheme that offers less stable but potentially higher returns than the feed-in tariff model employed in Western European countries such as Germany and Italy.

But even before many of these projects got off the ground, confidence started to falter as rumours of plans to cut incentives spread. The government acted in June 2013, announcing cuts to

the number of green certificates issued to generators of wind, solar and small hydropower plants put into operation after January 1, 2014. Some incentives for older plants were also suspended by the government’s emergency ordinance.

Renewable energy producers receive the tradable certificates for each megawatt of electricity they produce, while traditional power producers and

major industrial companies are ordered to buy the certificates. However, power generators have complained that the number of certificates they must buy is too high, resulting in higher power prices for consumers.

In a populist move in the run-up to the November 2014 presidential elections, President Traian Basescu signed off legislation approving the government’s cuts to green certificates in March. “I have passed today the law approving the ordinance and I look forward to seeing lower electricity prices,” Basescu said, according to Agerpres. “I think it is also what the population wants, they expect lower prices, according to government statements.” Bucharest has also faced pressure from the European Commission to reduce incentives in line with other countries like Germany, Spain and the UK.

Stranded assetsHowever, the cuts have been bad news for the emerging renewables sector. “Projects have been cancelled,” Ciprian Glodeanu, president of the Romanian Photovoltaic Industry Association, tells bne. “Even some projects that were close to being commissioned have been put on hold after several years and millions of euros' worth of investment. The changes have affected both small local companies and larger international investors.”

Munich-based REC Solar EMEA, which has a small solar park near Bucharest as well as selling solar panels to the Romanian market, currently has no concrete investment plans in the country “due to the many uncertainties in this market”, according to Luc Grare, senior vice president sales and marketing.

“Definitely, our plans were affected by the government’s decision to reduce

incentives for renewable energies. But even more impact have the many uncertainties and a lack of stable conditions, which are indispensable for financing long term projects like solar installations,” says Grare.

The rub of the greensClare Nuttall in Bucharest

“Even some projects close to being commissioned have been put on hold after several years and millions of euros worth of investment"


“The Romanian solar market might be nevertheless of interest... But stable conditions are indispensable to capture this potential,” he adds.

Czech power company CEZ has also announced that it is considering the sale of a minority stake in its Fantanele and Cogealac wind farms. The company did not give a reason for the planned sale, raising speculation that it is connected to the cut in incentives.

However, according to Domenico Pastia, business development director of renewable energy developer Sunshine Solar Energy, it is the smaller players that have been disproportionately affected, with many now being forced out of the market. Although projects can still be profitable, the returns have shrunk. Pastia tells bne that the “dramatic change” in incentives “also changed the return profile of investors and the investor landscape... What we see now is that the investors are usually also the providers of technology. In terms of the players that are competing

in the market, only the big guys can play a role, especially the very largest companies that can finance projects from their own balance sheets.”

This is not to say that everyone is abandoning the market. Despite the cuts, EDP Renováveis announced on March 27 that it had secured €30m of project finance to build 50 megawatts' worth of solar parks in Romania from the European Bank for Reconstruction and Development and the Black Sea Trade and Development Bank.

Meanwhile, Spain’s Iberdrola, which sold its Polish wind farms in 2013 and has been looking to sell its Romanian assets, recently indicated it is in no hurry to quit the market. A spokesperson for the company told Wind Power Monthly that it would sell its Mihai Viteazu wind farm only if it received a “good enough” offer.

Land, sea and airIn terms of terrain, Romania has high potential for renewable generation.

The 2013 ‘Eastern Wind’ report from the European Wind Energy Association notes that the Dobrogea region in particular is “ideal for large wind energy projects”. While wind was the first type of renewable energy to gather momentum, solar gained ground later, partly because lower incentives in Western Europe forced major companies to seek better returns elsewhere.

On the demand side, rising incomes are expected to drive demand for electricity, and Bucharest is also looking to become a regional exporter to markets such as Albania and Turkey.

While the incentive cuts have called a halt to the rapid expansion of the market, this may not be the end of the story. Firms and industry associations, while lacking the clout of Romania’s large industrial companies, are stepping up their lobbying efforts in the hope of either a partial reversal in the cuts or the introduction of a new incentive model acceptable to both producers and consumers.

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Once a sturdy pillar of Croatia's economy, the foundations of its agricultural sector are looking

increasingly shaky as many of the nation's farmers continue to struggle with the transition from being part of a centrally planned economy to a free market system.

The break-up of the large estates formerly controlled by the state-owned collective farms during the Yugoslav era into small, privately owned plots in post-independence Croatia in the 1990s created hundreds of thousands of family farms. But at an average size of 5.6 hectares most farms in Croatia cannot hope to compete with their much larger, more efficient equivalents in the EU and beyond.

Although in the decade-long run-up to Croatia joining the EU on July 1 last year successive administrations preached the potential benefits of Croatian farmers gaining unfettered access to the EU's single market of 500m inhabitants, in reality the uncompetitiveness of much of Croatia's farming industry has meant the country is facing a rising tide of imports and sinking exports. Consequently, in 2013 Croatia's agricultural trade deficit

widened to $1.2bn, up $250m on 2012.

No wonder, then, that farmers' representatives are concerned about the situation whereby Croatia now imports over 60% of all its food, whereas it was once self-sufficient in many areas of agricultural production. As

Mato Mlinaric, president of NHS, the independent Croatian farmers' party, notes: "It's extremely worrying the overall state of arable and livestock farming in Croatia, where the import lobby is so powerful that it threatens to completely destroy Croatian agriculture."

One of the most dramatic side effects of the decline in farming has been the rural flight phenomenon in Croatia. Whereas in 1960 around 70% of

Croats lived in rural areas, according to the 2011 population census that figure has slumped to around 40%. Furthermore, in many rural areas of Croatia unemployment is running at 50%, depressing the demand for locally produced food. According to the CIA World Factbook, agriculture in Croatia accounts for just 5% of GDP and 2.1% of the labour force, versus 6% and 7% respectively in the EU as a whole.

Making a pig's ear of itThe decline in Croatian agriculture is particularly noticeable in areas such as pig farming. Whereas pre-1991 Croatia reared over 2.1m pigs for slaughter, last year it reared fewer than around 800,000, down a third on 2012. As a result, an industry that once provided for all of Croatia's needs now covers less than 40%. The 60% balance is covered by imports, principally from the rest of the EU, which rears 10% more pigs than it requires.

Nor is there much likelihood of a reversal in the fall in pig production. According to Ernest Nad, head of the agriculture at the Croatian Chamber of Commerce in the eastern city of Osijek - the country's unofficial farming capital – the number of breeding sows has fallen more than 50% to under 100,000, from

over 200,000 a decade ago. "I think it will take a long time to get back to the scope and size of production from the 1990s when we had a positive balance of payments in terms of pig production," says Nad.

Last year pork imports were worth €300m, while exports were a measly €20m. Because of the slump in the number of pigs being raised in Croatia, producers of specialty products such as Istrian prsut (Croatia's equivalent of

Farmaggedon in Croatia Guy Norton in Zagreb

"The import lobby is so powerful it threatens to completely destroy Croatian agriculture"


Italian prosciutto) use imported pork 80% of the time to produce their prized cured meats. This not only reduces the value-added component of these products when exported, but has also complicated efforts to secure geographic protection status from the EU for such products, which would help to secure premium pricing at home and abroad.

While prsut producers in Istria are looking to boost production from 250,000 hams a year to over a million by 2020, it remains unclear what benefit, if any, local pig farmers will derive from those ambitious plans. Three large vertically-integrated producers account for 60% of pork production in Croatia, with the 40% balance produced by small-scale producers that typically

lack the economies of scale enjoyed by their European peers. For example, the typical pig farm in Croatia boasts just 10 breeding sows, while the typical pig farm elsewhere in the EU has over 100.

While some farmers have sought to concentrate their efforts on raising traditional indigenous breeds such as

"Pig farming in Croatia is being cut down right to the bone"

black Slavonian and spotted Turopolje pigs, the attempt to preserve Croatia's livestock heritage has been frustrated by misguided government policies.

Vladimir Margeta, a professor at the faculty of agriculture at Osijek University, points to the contradiction that the incentives for importing foreign hybrid breeds of pigs are higher than the subsidies for raising indigenous breeds. In practice, says Margeta, the current subsidy regime favours the big three pork producers which import common, foreign hybrid breeds, while discriminating against the family farms that specialise in rare, domestic breeds. As a result there are currently just 1,000 Slavonian and Turopolje breeding sows registered in Croatia, versus 35,000 foreign hybrid

sows. "It is clear that once again so-called big farmers are being favoured at the expense of small farmers," says Margeta.

He adds that while the government professes to support family farms and rare indigenous breeds as part of preserving Croatia's rich agricultural heritage, its actions are in fact helping

to drive both small farmers and their prized animals to extinction.

Furthermore, Margeta says the costs of bureaucracy - some 25% of Croatia's agriculture budget is spent on covering the cost of the 2,300 or so officials that administer the farming industry - and the poor drafting of Croatia's 2014-2020 rural development programme under which the country is eligible for around €350m of EU funds a year means that the outlook for its agriculture sector remains poor.

Meanwhile, a lack of preparation by the agriculture ministry has frustrated the attempts to export Croatian rare breeds to the EU, with the government's failure to monitor pig herds in Croatia for Auzejsky's disease leading to a ban on the transportation of live pigs to the EU. "Although the government knew it had to conduct monitoring for Auzejsky's disease it didn't do it," says Stjepan Kusec, president of SUS, the Croatian pig breeders association. "Pig farming in Croatia is being cut down right to the bone… Such moves such as the lack of preparation for live pig exports… means that the destruction of pig farming just continues."

So it's increasingly Croatian pig farmers' heads that are on the chopping block rather than their livestock's. Welcome to the culling fields of Croatia in year zero for the country's agricultural community.


It speaks volumes about the parlous state of the Croatian economy that in May the country’s justice ministry

announced plans for investor-friendly legislative changes designed to ease the purchase of Croatian real estate by Russian citizens.

While the EU is coming under increasing pressure from the US to further tighten the existing sanctions on Russia over the Kremlin’s machinations in Ukraine, the EU’s newest member Croatia, whose economy has been mired in recession since 2009, is preparing to roll out the red carpet for cash-rich Russians looking to buy their own piece of holiday heaven on the country’s stunning Adriatic coastline.

Explaining the reasoning behind the move, Justice Minister Orsat Miljenic told Croatian daily Vecernji List on May 15 that Croatia was looking to remove an anomaly whereby an ordinary Russian citizen would in practice have faced just as many legal hurdles when buying a vacation property in Croatia as a major Russian corporate titan such as Gazprom would when mulling the theoretical takeover of its Croatian equivalent INA.

“We were an absurd country in that we were seeking foreign investors, but when they turned up and wanted to buy a vikendica [holiday home] of 50 square metres, then we wouldn’t just let them and we forced them to form a limited liability company through which to buy the property... In fact, we have been forcing them to play legal games and have made them feel unwelcome,” admitted Miljenic.

As a result of the hitherto unhelpful legal environment in Croatia, Russians have in the past often bypassed Croatia, flocking to buy properties in neighbouring Montenegro instead, where it is estimated that over 60% of all holiday

home sales have been to buyers from Russia. What’s more, when Croatia joined the EU last July it was forced to tighten its visa regime for Russian tourists, something that caused a 30% drop in the number of visitors from Russia in 2013, further narrowing the potential for holiday home sales to ordinary Russians.

Time to buyHowever, in the wake of the outbreak of violence in Ukraine and the economic backlash against by Russia the Croatian daily Novi List reported that local real estate agents have recently been receiving an increasing number of enquiries from both countries about potential buying opportunities in the residential property market in both the coastal regions of Istria in the north and Dalmatia in the south of Croatia.

Any pick-up in Russian or Ukrainian demand in the country’s moribund housing market would be hugely welcome, given that in the latest regional economic prospects report from the European Bank for Reconstruction and Development published on May 14, Croatia was highlighted as one of the countries in Emerging Europe whose economic prospects could be most damaged by financial contagion from the crisis in Ukraine. While in January the EBRD forecast that GDP in Croatia could grow by 1% this year, the London-based development bank is now predicting the country’s GDP will actually shrink by 0.5%. “Croatia is the only country in the transition region, other than crisis-hit Ukraine, that continues to remain in recession,” noted the EBRD, adding: “Croatia will continue to remain in recession on the basis of depressed investment and credit.”

Furthermore, even a relatively small number of house sales to Russian or Ukrainian clients could help boost the

headline foreign direct investment (FDI) numbers in Croatia this year. According to the Croatian National Bank, in 2013 FDI in the country fell almost 60% on year to around €436m, marking a three-year low since 2010 when Croatia attracted just €370m in FDI.

Big players arrive In May the Croatian media was abuzz with the news that Russian billionaire Viktor Vekselberg had bought Hotel Belvedere in the Croatian tourist hotspot of Dubrovnik. Destroyed in 1991 during Croatia’s battle for independence against Serbian forces, the disused property was reportedly sold to Vekselberg’s Croatian-registered Vila Larus property investment vehicle for just over €12m – a 50% discount to the starting price at a previous public auction last March that failed to attract a single bid. It is hoped that Ukrainian-born Vekselberg, whose fortune is estimated by Forbes magazine at $17bn, making him the third richest person in Russia, will now return the hotel to its former five-star glory. Vekselberg was already a well-known devotee of Dubrovnik, having previously bought the private residence Villa Lozica for a reported €5m and acquiring the luxury restaurant Labirint in the Unesco World Heritage port city.

Vekselberg may be near the top of the tree when it comes to wealthy Russians, but it is hoped that a more investor-friendly environment will enable the recession-hit Croatian residential property market to benefit from a combination of investment/flight capital from more modestly wealthy individuals and businesses from both Russia and Ukraine. According to the recently published spring economic outlook report by the European Commission, Croatian housing is among the most favourably priced in the EU relative to the country’s underlying economy, with residential property in Croatia selling for as much as 20% below the so-called equilibrium point.

That however has failed to convince cash-strapped Croatians to dip into their hard earned savings, with Croatia registering the largest fall in house prices in the EU last year, dropping by 17.8%.

BRICKS & MORTAR: Croatia spies opportunity in crisisGuy Norton in Zagreb

52 I Eurasia bne June 2014

The payday lender offers first-time loans ranging between KZT10,000 and KZT30,000 ($55-165) with interest rates of up to 2.5% a day for five to 30

days, Sidorov explains. The interest rate will fall for bona fide customers with every next loan, while the size of the loan possible will gradually increase, reaching $440 after the fifth loan, he says. The average monthly salary in Kazakhstan is about $640.

"People who use this service, as a rule, value the convenience and speed of obtaining a loan, and they save a lot of time," he says, noting the cumbersome

bureaucracy now involved in obtaining a loan from the commercial banks.

Kredit24 is targeting customers who either "don't want" or "aren't able" to go to a bank for a loan because they don't meet the new, more stringent

Almaty in WongalandNaubet Bisenov in Almaty

A Wonga-style online payday lender has opened up shop in oil-rich Kazakhstan to cater

to the aspirational middle class looking for cash to fuel their rampant consumerism. With the country's commercial banks having been badly burnt by the credit crunch that resulted in a lot of loans going bad, the first Kazakh online payday lender is set to fill a huge gap in the market.

Kredit24 started operations on May 12 and has already proven popular with the country's netizens looking for a payday loan. "This project is innovative because there was no such service in Kazakhstan until now," Aleksey Sidorov, co-founder of the company, tells bne in his first media interview since the launch of the website. "We are the first Kazakh company to do this."

"The sums people borrow from us or Wonga are small, which means they don't inflict a serious damage on the material wellbeing of a person"

bne June 2014 Eurasia I 53

requirements. "This means they are a high-risk segment and the level of defaults on loans issued by payday lenders is higher," Sidorov says. "This is one of the reasons for a higher interest rate because the risks are factored into the interest rate."

Kazakhstan's banking legislation bans financial institutions from setting interest rates on loans at more than 56%, which is expected to be reduced further in the future. For Kredit24 to charge the higher interest, it operates not as a financial institution but as a limited liability partnership whose loaning activity is not regulated by the National Bank of Kazakhstan.

The share of non-performing loans (NPL) at Kazakh banks stood at 32% in January, with the ratio reaching as high as 51% at Alliance Bank and 87% at BTA Bank. In February President Nursultan Nazarbayev ordered the government and the National Bank of Kazakhstan to get the ratio down to 15% by 2015 and to 10% by 2016, though he admitted in April that a cultural change is needed to get Kazakhs into the habit of paying back their debts on time. "Our people haven't yet learned that loans should be paid back," he said.

However, Nazarbayev also wants his country's citizens to keep spending. At the height of the financial crisis in 2008, he urged Kazakhs to spend more, especially on property and domestically assembled cars, to help stimulate economic growth. Kazakhs "should not wait and keep money in socks," Nazarbayev said.

Such appeals to profligacy have encouraged global luxury brands to flock to Kazakhstan to try to tap into the newfound oil wealth. Bentley, Maserati and Louis Vuitton have opened Central Asia's only outlets in the country's commercial capital, Almaty. So has the US department store Fifth Avenue Saks, which sells a pair of Jimmy Choo shoes for several hundred dollars to designer-obsessed Kazakhs.

Population control

Naubet Bisenov in Almaty

With a wary eye on the separatist movements in Ukraine, Kazakhstan announced on May 15 a programme to boost the ethnic Kazakh population in its northern border regions in a bid to ward off any potential risk of secessionist movements by the large Russian contingent there.

Astana announced it has revived a programme to encourage ethnic Kazakh migration to the country from abroad after a brief suspension of the strategy, which was launched after the country obtained independence in 1991. However, it added the state would provide financial support only to those ethnic Kazakhs who choose to settle in seven border regions, including the oil-rich Atyrau region on the Caspian coast.

Kazakhstan has attracted almost 1m ethnic Kazakhs from abroad since 1991. According to government estimates, over 5m still live outside the country, mainly in China, Uzbekistan, Russia, Mongolia and Turkmenistan. However, funding for the programme was suspended in 2012 following deadly clashes between protesters and security forces in the western oil town of Zhanaozen the previous year. The violence was partly blamed on unresolved social tensions involving ethnic Kazakh migrants.

Analysts link the revival of the programme to developments in Ukraine. Moscow invoked the need to protect the rights of ethnic Russians and Russian speakers when it annexed Crimea in March, and is now using the same concerns in its support for the separatist militias in the east of the country.

The events in Ukraine have rattled several former Soviet states. The Baltic states, which have spent the two decades since independence nurturing suspicions of Russian expansionism and nationalism amongst their relatively large ethnic Russian populations, have been front and centre in expressing worries. However, at the other end of the spectrum, those with the closest ties to Russia are also eyeing the situation nervously.

Russia's actions over Ukraine have notably seen enthusiasm for the Moscow-led project to build the Eurasian Economic Union wane in Belarus and Kazakhstan. Ethnic Russians accounted for 22.4% of Kazakhstan's 17.2m population at the beginning of 2012. Over 90% speak Russian.

The northern and eastern Kazakh regions on the border in particular have sizable ethnic Russians populations. In the Kostanay and North Kazakhstan regions, ethnic Russians outnumber ethnic Kazakhs, who account for just over a third of the population. Ethnic Russians constitute 42.6% and 50% respectively. In the northern Pavlodar and Akmola Regions ethnic Kazakhs account for about 50% of the population, with ethnic Russians making up 35% and 38% respectively. In East Kazakhstan Region, ethnic Kazakhs are an absolute majority at 57.5%, but the share of ethnic Russians is 39%.


services. Sidorov says the Kazakh payday loan market has great growth prospects and compares it to tiny Latvia where about 20 payday lenders serve a population of 2m people. The businessman expects Kredit24 to operate in full swing over the next year, with its loan portfolio reaching a target of $1m.

Another important reason for people seeking payday loans is the "public humiliation" they experience when they are denied a loan by the banks. "The main principle of our work is transparency, which is to show people how much they will get and how much they will have to return," Sidorov says.

The company scores potential clients' creditworthiness based on information

in their applications and in order to establish their identity the company staff call work and mobile telephone numbers provided to verify the information. Within an hour of the submission of an application during business hours, the company notifies potential clients that their applications are accepted for processing and issues a loan to creditworthy applicants within the next two hours.

Sidorov says the company is now undergoing the procedure of technical compliance for accessing credit histories of potential clients in credit bureau databases and hopes this process will be completed within the next month. However, in contrast to banks, Kredit24 will not be able to access detailed information, but will only see a credit seeker's score given by credit bureaus.

Asked whether he is aware of the bad press the UK's payday lender Wonga receives, Sidorov says that

negative publicity stems from the "misunderstanding" of its work and that his company will also face the challenge of explaining to the Kazakh public that payday lenders "are not a source of social problems". "I believe the sums people borrow from us or Wonga are small, which means they don't inflict a serious damage on the material wellbeing of a person or family," he says. "It's not a mortgage people get bogged down with for 20 years. It's not that significant a debt."

"I'm not embarrassed by parallels drawn between my company and Wonga. Moreover, I have respect for the founders of it for their project," he says, adding that he would like to learn from Wonga's experiences in the UK market.

Kredit24 shares Kazakhstan's embryonic payday loan market with the local branch of Russia's moneyman.ru, which arrived earlier this year. However, Sidorov doesn't consider it as a rival but a partner, because both companies offer a new product on the Kazakh market. "It's important for them and us to promote the new product, which is why both they and we put certain effort and money into popularising this product," Sidorov says.

He expects more payday lenders to emerge in Kazakhstan because of the "relatively low entry barriers" to the market, though his is confident about his company's ability to compete. "We can successfully compete against them because we know and understand this market better. We are local and our understanding of the local mentality is our advantage," he says.

Borrow around the clockSidorov, a former banker with 12 years experience, says he first had the idea of offering online payday loans last year and it has taken him five months to find a local investor and start the project. "We are a purely Kazakh company and we are proud of creating a product which is advanced by successful companies in the West," he notes.

This is not his first dotcom start-up: for five years he has been running the successful prodengi.kz website devoted to banks and the financial sector, and the cpc.kz website which offers online advertising services.

Kredit24, which employs eight full-time employees and about 20 freelancers at the moment, is currently operating

during normal business hours, but it plans to work round the clock. The website attracted 1,500 unique users in four days and received about 30 applications a day. It is now issuing about five loans a day on average. "We are now testing our business model in real time based on real applications," Sidorov says.

He explains that two major factors have played a crucial role in the timing of the project: the level of penetration of the internet and bank cards. He notes that today there are 9m internet users and over 13m bank cards in Kazakhstan. "The critical mass has been achieved for an online business to be feasible," Sidorov says.

A preliminary analysis conducted by the company shows that applications for and queries about payday loans have been submitted from all over Kazakhstan, including rural areas, which backs the company's expectations of high demand for its

"People who use this service, as a rule, value the convenience and speed of obtaining a loan"


managing director for Turkey, Eastern Europe, the Caucasus and Central Asia in an interview with bne. "The state then comes in as a co-financier, providing grants and technical assistance, or as a revenue back-up when it comes to PPPs [public-private partnerships]."

For investors, the key point is that the projects will be selected on the basis of their economic and commercial merits only, shorn of the oligarchic or political

considerations that often interfere with the commitment of government investment funds.

Memoranda of understanding have already been signed with the European Investment Bank and Asian Development Bank, and the EBRD expects to sign off on its leading role on

the deal before the end of May.

Perhaps one of the motivations for reaching out to the EBRD is the disaster that has been the development of the massive Kashagan oilfield. After almost a decade of delays and huge cost overruns, production was finally launched in September last year only for it to be immediately shut down again due to pipeline corrosion from hydrogen sulphur gas. A flagship project for the country, the $50bn project highlights, among other things, the operational difficulties that continue to stymie the government's ambitious plans.

The EBRD's Heckman says there are many synergies to be gained, as much of Kazakhstan's development strategy mirrors the EBRD's own goals. But until now the development bank has operated in parallel with the government's efforts to diversify the economy away from natural resources, acting more like a private equity fund and concentrating almost exclusively on the private sector.

The new deal envisages the bank working hand in glove with the state to tap international best practices to get the reforms working faster and more efficiently. "Our strategy is exactly along the lines of what the Kazakh government wants to promote and work on the most. It is an exciting development because they want to use the best experts in class globally, which is what the IFIs will be assisting them with," says Heckman, speaking on the

sidelines of the EBRD's annual general meeting in Warsaw on May 14. "What they want to do is kick-start reforms."

The idea came from the Kazakhs: after taking over as prime minister at the start of April, the first thing Karim Masimov did was go to the EBRD to suggest joining forces, according to bne sources.

"It's a totally out-of-the-box idea. It's never been done by the EBRD before"

Kazakhstan to outsource investment drive to EBRDBen Aris in Warsaw

The Kazakh government has agreed with the European Bank for Reconstruction and

Development (EBRD) on a radical deal that will see the state effectively outsource part of its diversification drive to the multilateral bank.

The plan involves a possible KZT1 trillion (€4bn) of investment being pushed into every part of the economy, with the EBRD taking charge of a significant part of the decision-making and implementation process. In the first stage of the cooperation, international financial organisations (IFIs), led by the EBRD, will be given $2.75bn to supervise of a $5bn state-run investment programme. "It's a totally out-of-the-box idea. It's never been done by the EBRD before," says Janet Heckman, director of the EBRD Kazakh office, who will be point for much of the work.

The Kazakh government will allocate the money to the EBRD-led team of IFI specialists, which will then get to "choose the projects we want, and design them," says Olivier Deschamps,


The idea is borne out of several needs. Kazakhstan has become increasingly liberal in its approach to economic reforms and focused on the need to diversify the economy, in part to provide jobs to its young population. However, the effort is going slowly.

The root problem that this new scheme is attempting to address is the lack of human resources available to the government when it's trying to push through deep, difficult and painful reforms, say the EBRD officials involved with the plan.

The Kazakh government is not intending to hand over complete control of the investment projects, as the ministries will retain an important role and oversee each project together with the IFIs. "All of the projects will be managed by a joint 'council of control' that will include the key ministers and the heads of the IFIs," says Heckman, adding that the EBRD will play a leading role in the day-to-day operations of most of the investment projects.

New modelThe Kazakh experiment could well produce a new model for cooperation between development banks and governments in Central and Eastern Europe and the Commonwealth of Independent States. Many of the countries in the CEE/CIS region suffer from the same problems: they operate largely as a closed shop; there are market practices, but there's also nepotism, insider dealing, corruption and simple inefficiency. This new model is an attempt to fling open the windows

and let the sunshine of transparency illuminate state investment projects.

"Typically many of these governments have good ideas and have adopted suitable policies, but where they all always fall down is on the implementation," says one EBRD official working in Kazakhstan. "One of the key benefits of tying up with the EBRD is the access to its sophisticated and extensive resources, making use of the EBRD's large team of expert bankers who collectively have centuries of experience. So it's not just about the money. It's about leveraging what we know to see what's needed. An important part is the increased accountability and transparency that agrees together with the government. That will give us the ability to monitor the progress of the project."

Still, there is significant money involved. In addition to the $2.75bn that the Kazakh government is committing to what is in effect a pilot programme, the EBRD says that it will commit its own money and expects to "significantly increase investments into Kazakhstan," says Heckman.

More importantly, the EBRD usually brings in private investment to match its own money, up to a ratio of 80:20 in private money-EBRD money, says Heckman. Just how the money is spent will depend on the specifics of each project. "The money can be used for project financing or for technical advisory in other key areas. The value of the projects could be anything. We work from very small projects for $10m up to $100m," says Heckman.

"What they want to do is kick-start reforms"


month later, on June 20. However, he received a second travel ban after investigators decided that after looking at SouthGobi's books the company was suspected of evading taxes and laundering billions of dollars.

Kapla denies the accusations, citing as proof internal audits as well as external audits from the "Big Four" accountants PricewaterhouseCoopers and Deloitte. He also questions the methodology of the investigators. "All they've done is shown sums of findings in reports," he

says. "They've never presented us with materials that show how they've come up with those numbers."

Kapla didn't actually learn about his second travel ban until a colleague, SouthGobi's legal advisor Sarah Armstrong, was stopped at the airport in October 2012 when flying home to Australia. Armstrong was allowed to

return home in time for Christmas that year, but she left behind three colleagues from SouthGobi who are still subject to travel bans but have not yet been formally charged of any crime.

Then there's a banking consultant for Standard Bank, Chris Bradley, who received a travel ban from November to December last year for what many regarded as only tenuous links to fraudulent documents submitted by Just Group to take out a loan from the bank. Just Group defaulted on its debt following its 2013 implosion, which brought down with it Mongolia's fourth largest bank at the time, Khadgalamj Bank.

While Bloomberg has reported that there are about 50 expats prohibited from leaving Mongolia because of alleged connections to open investigations, Kapla reckons there's tens more. Says Allyson Algeo, a spokesperson for the US Embassy in Ulaanbaatar: "We continue to raise our serious concerns regarding [Kapla's] case with Mongolian authorities and to urge them to resolve any outstanding issues through a fair and transparent process, conducted in an expeditious manner."

The reason for this worrying trend is manifold, say observers. Mongolia's police are gung-ho about rooting out graft due to the strong anti-corruption stance taken by Mongolian President Tsakhia Elbegdorj since he was elected

in 2009. Some expats attribute their problems to political motives, as many of the alleged crimes occurred during the notoriously corrupt government of former prime minister Sukhbaatar Batbold, who led the Mongolian People's Party from 2009 to 2012. Many corruption cases that involve foreign companies are related to officials who were in power during that time, as

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

Arrested developments in MongoliaTerrence Edwards in Ulaanbaatar

Mongolia's vast natural resources have enticed foreign investors to what is still very much a

frontier market. Politicians' re-writing of investment rules has been one major risk for intrepid investors, but another more worrying hazard is emerging: arrest and travel bans.

Since the 1990 Democratic Revolution in Mongolia, the country has established itself as a beacon of democracy that outshines the authoritarian neighbours of Russia and China that it is sandwiched between. However, the Mongolian authorities' increasingly liberal use of travel bans on expats is starting to concern many investors and long-time residents of the country.

Take the case of Justin Kapla, a veteran in Mongolia's mining industry with a Mongolian family. Kapla had held the post of president at SouthGobi Sands, the licence holder for the Ovoot Tolgoi coal mine in the Gobi desert, for just six months when prosecutors raided his offices on May 8, 2012, investigating illegal dealings with a former head bureaucrat at the Mineral Resources Authority, who was charged and later convicted of corruption. Kapla was banned from leaving the country, though this ban was lifted about a


was the case for SouthGobi. There is also a fair bit of mistrust among some Mongolians toward foreign investors due to the widening wealth disparity that occurred during Mongolia's mining boom, as well as a general perception that foreigners are plundering Mongolia's natural resources.

Then there are suspicions that the travel bans are being used as leverage in contract disputes. "We are concerned by reports that the Mongolian exit visa system is being misused to pressure foreign investors to settle civil and investment disputes,” says Algeoa of the US embassy. “Such concerns could have a chilling effect on international investors considering whether Mongolia is a viable destination for foreign direct investment.”

Shaky foundationsCertainly, in many cases bne has looked into the evidence doesn't warrant such drastic action as the imposition of travel bans, lending weight to the idea that other considerations are at play here.

Nearly two years after Kapla was first prohibited from leaving Mongolia, a judge on May 12 rejected the case against SouthGobi for tax evasion, arguing it was too weak to proceed, according to a statement from the company accompnaying its first-quarter results for the year.

From the start, claims Kapla, the authorities have been bending the law to reach a specific goal – proving some kind of wrongdoing by SouthGobi's management. "Basically, all tax cases must originate from the Mongolian Tax Authority's audits," says Kapla. "In this case, it doesn't."

The figures don't add up either. SouthGobi was accused of selling twice as much coal as it reported in 2012, according to Kapla's legal defence, when it reported a loss to shareholders. They also claimed it laundered over $4.5bn during the year, or over a third of Mongolia's 2012 GDP.

But there is still the possibility of civil action, and the travel bans for Kapla and two of his former co-workers remain in

place. Meanwhile, Kapla worries about the health of his father-in-law back home and whether or not he'll ever be able to see his grandfather again. "My grandfather is going to be 102. At 102, there aren't many birthdays on the horizon for him," he says.

Australian Didi Anandakalika says she too has faced the situation of Mongolian authorities rushing to judgment against foreign residents after groundless accusations have been made. Having lived in Mongolia for 21 years – enough time to see the wild deer that once roamed the streets of Mongolia's capital pushed out by luxury Hummers and BMWs – Anandkalika has been denied an exit visa since the beginning of this year due to accusations that she embezzled funds from the orphanage to which she has dedicated her life. She denies the charges made against her by colleagues, saying she suspects the intent is a land grab against the orphanage. “I was surprised how many things I can be accused of” without any evidence from the accusers, says Anandakalika. “People can make all kinds of complaints. You have to prove yourself innocent,” she says, noting how little was required to make such a serious claim against her.

Mongolian authorities' actions also appear to be in violation of the International Covenant on Civil and Political Rights, which Mongolia signed in 1968 and ratified six years later. It states: "Everyone shall be free to leave any country, including his own," unless there are "exceptional circumstances".

Mongolia's justice minister has publicly acknowledged the circumstances surrounding the stranded foreign residents in an interview with a local Bloomberg television affiliate in Mongolia, adding that there are also many Mongolians under such restrictions. On May 13, it emerged that a former Mongolian bureaucrat involved with the petroleum sector had died in custody without ever being charged.

Temuujin told Bloomberg his ministry is looking into the issue of travel bans, and the matter would likely be discussed during the fall session of parliament, later this year.

BacklashAccording to one investor from Australia who regularly travels to Mongolia, some of his peers refuse even to make the trip on the chance that they too will be prohibited from leaving. Thus this increasing use of travel bans is inevitably taking its toll on foreign investment – something the Mongolian government is bending over backwards to attract again after inflows began drying up two years ago following some high-profile cases of foreign investors being discriminated against.

SouthGobi played a prominent role in that process. In 2012, the government blocked a proposed acquisition by state-owned Aluminum Corporation of China, or Chalco, to purchase a majority interest in SouthGobi Resources, the parent company of Kapla's organisation. The deal went sour largely because Mongolia remains wary of China exerting political or economic power over its smaller neighbour after centuries of warring between them.

Mongolian politicians responded to the Chalco bid by rushing though the notorious Strategic Entities Foreign Investment Law (SEFIL), which drastically limited the size of interest in Mongolia's mines, among other strategic assets, that foreign private and state-owned entities could buy without seeking government approval. Foreign investment in 2013 was nearly half as much as the prior year, and Mongolia has not come close to the jaw-dropping 17.5% economic growth it achieved in 2011.

Mongolia has since repealed that controversial law, and with Turquoise Hill confirming it is again considering bids for its 56% share in SouthGobi, the authorities are being given a second chance with the miner to show Mongolia is open to foreign investment. But while the government's move to repeal unfriendly laws is a welcome step, it won't much good if investors are too scared to visit.


only be revived once there are specific projects in place," says Bayanjargal Byambsaikhan, chairman of the Business Council of Mongolia and now an advisor to the prime minister for the 100-day initiative.

Poor policy decisions that restricted investment and fuelled disputes with large investors have forced

the government to watch the local currency, the tugrik, depreciate for about a year. At the end of April, the tugrik sank below 1,800 to the dollar, meaning the currency has weakened 26% from a year ago and is now the worst performer in Asia over the past 12 months, according to Bloomberg. The weak currency has made essential

imports such as petrol fuel and food staples more expensive than many in the country can bear.

Government revenues aren't anything to boast about either. Although the volume of coal exported in the first three months of the year was up 8.4% from the year before, lower prices resulted in a fall of 1.4% in revenue earned. And while revenue from copper exports grew 67%, thanks in no small part to the launch of commercial operations at Rio Tinto's Oyu Tolgoi mine, disagreements over costs between the diversified Anglo-Australian miner and the Mongolian government have held back a key expansion project that would unlock a majority of the wealth at the mine.

That's bad news all round for investment in Mongolia. The mine – which literally means "turquoise hill" due to the outcrops of oxidised copper that Mongolians have supposedly known about for centuries – is one of world's largest undeveloped copper deposits and at peak production will constitute about a third of the country's economy, so its progress is taken as a bellwether by investors for how the country is performing.

Open for business"Mongolia is open for business" is the message that the government is eager to spread. Mongolia's prime minister on April 30 called upon foreign diplomats and leading figures in business to gather for a meeting to announce his plan.

Altankhuyag and his aides explained how the government would concentrate on supporting business through tax cuts and loans, as well as help to increase production from mines and promote foreign investment.

Efforts by the Mongolian government to recapture foreign investment began

"Right now one of the key problems is the inflow of foreign capital into Mongolia"

Mongolia in a 100-day sprint to revive economyTerrence Edwards in Ulaanbaatar

I n May the Mongolian government continued its efforts to make amends with investors and restore

the lustre to its once prosperous economy. This latest legislative push will see the country roll out a new coordinated effort to settle disputes in its mining a sector and tip the balance of investment returns once more in favour of investors.

Mongolian Prime Minister Norov Altankhuyag received approval from parliament on May 7 for his 100-day economic stimulus initiative. The premier is putting his energy behind promoting private business and foreign investment to help remove some of the bitter taste left in investors' mouths from the grief that the country's politicians have caused over recent years.

"These [initiatives] are all aimed to increase foreign direct investment to Mongolia because right now one of the key problems is the inflow of foreign capital into Mongolia, and that can


in earnest last year. In November, the parliament passed a new Investment Law that threw out unpopular restrictions on foreign investment by private foreign firms. It also approved legislation that revamped Mongolia's

securities market and set the foundation for institutional investors to enter the market.

The economy minister went into greater detail on Altankhuyag's plan the next day at the Mongolian Investment Summit in London. A slideshow presented at the summit on May 1 showed government plans to invest in downstream production for the country's vast coal reserves, such as coal washing and handling. Concession agreements between the government and private investors would be a key mechanism to see such projects become a reality, according to the presentation.

Altankhuyag is dedicating a fair bit of his plan to the mining sector – which is what originally put Mongolia on investors' radars in the first place. Canada's Centerra Gold has been waiting for the go-ahead from the Mongolian government since 2010 for its Gatsuurt mine after a law aimed at

protecting the country's forests and water resources put its license in limbo.

There were also between 106 and 109 licences cancelled by the government after a judge voided every licence

approved by an official convicted of corruption. Kincora Copper, another Mongolia-focused miner based in Canada, reported a C$7m write-off because the court decision meant it could no longer explore at its North Fox and Tourmaline Hills properties. "In the previous government, some of the licences were approved in an unlawful way," said Altankhuyag. "We are committed to solving the issues. On how, we have a working group to develop the criteria."

Traversing the Turquoise HillWhile most would agree the government has ticked off many of the items on its list of issues that need to be dealt with, it is unlikely to eliminate some of the biggest drags on the economy, which the International Monetary Fund (IMF) now sees decelerating more sharply to growth of 11.7% in 2014 and 5.8% in 2015. Previously it saw growth of 12.9% in 2014 and 7.6% in 2015.

Not everything is in the government's control. One issue out of its hands is demand from China for coal and copper – Mongolia's two largest exports. However, it does have influence over the biggest factor for the economy, the relaunch of the development of the Oyu Tolgoi mine.

Statements by Rio Tinto CEO Sam Walsh and the government indicate that the company is in no rush to begin work on the underground mine shaft, even though the government is indicating that work could begin as soon as September.

According to Dale Choi, head of Independent Mongolian Metals & Mining Research, it's unlikely that Rio Tinto will move forward until it can be sure that Mongolia won't try to alter the original terms laid out in a 2009 investment agreement for the project, as it has many times attempted in the past. "Only RT [Rio Tinto] and GOM [government of Mongolia] know exactly what's going on but our understanding is that RT wants essentially sanctity of the multi-billion dollar investment agreement, not the never-ending political debate with attempts to renegotiate it," Choi said in an email note to subscribers. "Although this point is well understood by some GoM officials... at the moment there is a lack of prominent national political consensus on sanctity of the Oyu Tolgoi Investment Agreement which would be enabling for RT to proceed with underground development at OT."

"Under the previous government, some of the licenses were approved in an unlawful way"

bne June 201462 Opinion

because he claimed they were fighting for their lives. However, a more dramatic example of this lack of traction came with Putin's unexpected call for the rebels to postpone their referenda on secession from Ukraine.

Local anti-Kyiv leaderships in Donetsk, Lugansk and Slovyansk rejected his appeal and went ahead with their shambolic and illegitimate polls on May 11. Needless to say, overwhelming support for secession was reported.

Where the truth liesSo what does this mean? The Machiavellian explanation is that this is the kind of shadow play so beloved of the Kremlin's once-and-maybe-future political technologist, Vladislav Surkov; a staged manoeuvre to support Moscow's claims not to be running the rebellion.

There is much to commend this line, but it does overlook one thing: it requires Putin to be willing to make himself look weak, even irrelevant. This is not something he is generally inclined to do, especially in recent times.

So should one accept the Kremlin's narrative at face value, that it is an honest broker trying to bring peace to Ukraine despite the actions of, in Putin's words, "the people who carried out an anti-constitutional seizure of power [in Kyiv], a coup d'état"? Of course not. The Kremlin annexed Crimea and has stirred up trouble from Odessa to Kharkiv.

"Having unleashed chaos to force Ukraine back into Moscow's sphere, Putin may be having second thoughts about its implications"

Mark Galeotti of New York University

Is there any prospect that Kyiv can "win" in eastern Ukraine? The recent referenda on secession suggest not, at least for the foreseeable future. But there may be a

narrow window for, at the very least, minimising the level of defeat.

After all, who is in charge in eastern Ukraine? The West sees little ambiguity. US representative to the UN Samantha Powers, looking at the seizures of administrative buildings, feels that, "the only entity in the area capable of these coordinated, professional military actions is Russia." UK Foreign Secretary William Hague sees a campaign of destabilization "planned and brought about by Russia."

The truth on the ground is more complex. Moscow is enthusiastically supporting the uprising and providing it a formidable krysha ("roof", or protection in criminal slang) through its forces on the border and the threats to intervene if Kyiv moves too forcefully against the rebels. (Not, judging by the indifferent success of the "anti-terrorist operations", that that is any great risk to the insurgents.)

It is not just backing it politically, there are government agents on the ground coordinating and supporting the local rebels. Meanwhile, a motley collection of Russian "war tourists" – Cossack nationalists, mercenaries, adventurers – is crossing into eastern Ukraine to join the rebels, with Moscow's blessing and, often, its guns as well.

But this is certainly not a campaign carefully planned in the bowels of the General Staff building on Znamenka Street in Moscow. We saw that with the kidnap of OSCE observers in Kramatorsk, south of Slovyansk, in April. Kremlin special envoy Vladimir Lukin was able to secure their release, but Moscow was taken aback and embarrassed by the incident – and it took over a week for them to be freed.

At the time, the Kremlin tried to play down its control over the rebels. Dmitry Peskov, Putin's spokesman, said that, "Russia essentially has lost its influence over these people"

COMMENT: Minimising defeat in Ukraine

Opinion 63bne June 2014

is unavoidable: Ukraine is not going to be joining the EU or Nato in the foreseeable future, and the West is not going to bail out its economy forever.

The trouble is that no one in Kyiv – one eye on future electoral prospects, the other on the muscular ultra-nationalists – seems willing or able to offer Moscow specific, detailed proposals.

This also reflects a lack of leadership in the West, though. If Ukraine is truly the front line of a new Cold War, then let Nato tanks dig in around Kyiv, and open-ended western credit keep the economy not just afloat but buoyant. But if the West is not willing to pay the price to save Ukraine

on these terms, then the only other terms available are Moscow's, and it does no one any favours to encourage unrealistic hopes in Kyiv.

Either the West accepts Russia's challenge, and treats this as war to the knife, with a logical end-point of regime change in Moscow and a willingness to see Ukraine burn in the process, or else its best service to Kyiv is to encourage it to the negotiating table and help it secure the best surrender terms it can get. These are invidious choices, and in the long run Putin's regime will be the weaker for having forced the West to make them, but for now they are inescapable.

Mark Galeotti is Professor of Global Affairs at the SCPS Center for Global Affairs, New York University.

The truth is, as ever, somewhere in between. Moscow has opted to pressurize Kyiv, encouraging and supporting local commanders – can't we just call them warlords? – and power brokers, willing to raise hell not for Moscow's benefit but for their own. They are eastern elites terrified of the consequences of a hostile new regime emerging in Kyiv; elements of the security forces associated with former president Yanukovych who likewise fear reprisals; gangsters and opportunists spying the chance to turn muscle and bravado into economic and political power.

Give peace a chanceThere are two major implications to this. The first is that lasting peace in eastern Ukraine will require a settlement with many local interests, whose aims may well often run at cross-purposes. The militias of the east are rightly infamous. However, the ultra-nationalists who hijacked the protest movement in Kyiv's Independence Square, or Maidan, after Yanukovych's fall exercise a baleful influence on the new government's freedom of maneuver. Many have also joined the new National Guard, a hastily raised and trained force of volunteers, drawn disproportionately from nationalists from the west, which killed policemen in Mariupol on May 9 and an anti-government militant in Krasnoarmeysk.

As Igor Kolomoysky, oligarch and loyalist governor of Dnepropetrovsk, announces the creation of a special "Dneipr Battalion" and presidential contender Yulia Tymoshenko backs the creation of "territorial self-defense brigades", there does appear to be a serious risk that this conflict may devolve into a struggle between loyalist and secessionist militias and warlords.

The second is that it is dangerous not to take advantage of any opportunities for negotiation that Moscow offers.

To be sure, the Kremlin is often disingenuous, even downright mendacious. But as local leaders announce the creation of the "Donetsk People's Republic" and appeal to join Russia – contrary, according to most polls, to the general opinion of the region's population – there may actually be a window of opportunity.

Does Moscow, after all, want the Donbas? Had this been Putin's primary aim, it seems hard to understand why he waited so long, why he encouraged this rising anarchy that actually would make governing the area all the harder. Instead, he seems to be looking for a deal with Kyiv, and every escalation in the east is first and foremost to ratchet up the pressure.

Having unleashed chaos to force Ukraine back into Moscow's sphere of influence, though, Putin may be having second thoughts about its implications. Putin has put too much personal capital into the campaign to withdraw without some kind of agreement that acknowledges Russian interests. This will be a bitter pill for Kyiv to swallow, but it

"It is dangerous not to take advantage of any opportunities for negotiation that Moscow offers"

bne June 201464 Opinion

Western Europe, which mainly reflects the business focus of Austria’s financial sector. Banks, insurers and real estate companies, on average, perform more than 50% of their business in or related to CEE, while for non-financials the corresponding figure is 13%.

The overall CEE exposure is still substantial, but has come down in recent years. In a similar exercise performed at the end of 2007, the market’s CEE exposure was 37%, while the exposure to the domestic economy was 31%. In a way, the weights of the domestic and the CEE business have reversed since then, while the impact of Western Europe and the

rest of the world remained broadly unchanged. The relative decline of the market’s CEE exposure – against the author’s expectations more than six years ago – has had two main reasons: First, many companies refocused their operations during and after the financial crisis in response to economic or political developments in CEE. For example, banks started retreating from Ukraine even before the current crisis, and they also limited their Hungarian exposure in response to regulatory assaults. In addition, property companies have expanded mostly in Germany rather than in the neighbouring east as planned before the crisis. Also non-financials – eg. Wienerberger, Verbund, Voestalpine – changed their

"The Vienna bourse continues to occupy the middle ground between Western and Eastern Europe not only in geographical but also in performance terms"

Peter Szopo of Erste Asset Management

The Vienna Stock Exchange has still the highest correlation with Central and Eastern Europe (CEE) equity markets among all Western European equity

markets. This is the main explanation for the ATX’s dire performance since the beginning of 2013. The market’s overall exposure to CEE has weakened over the past seven years, but remains high. Therefore, any rebound – if there is one – will likely happen only together with a recovery in CEE equity markets.

Since the beginning of 2013, the Austrian stock market has been the worst performing among its Western European peers. The ATX gained just 6% last year, while the EuroStoxx 50 advanced 18%. This year as well the performance has been lacklustre (-2.5% to mid-May 14 versus a 3% gain of the EuroStoxx 50).

Apparently, the Vienna Stock Exchange continues occupying the middle ground between Western and Eastern Europe not only in geographical but also in performance terms. Over periods of 1, 3, 5 and 10 years, the performance figures of the ATX always came in between those of western and eastern European markets. Only over 15 years, Austrian stocks outperformed both western and eastern peers, because of the market’s resilience in 2000 to 2002, when stock indices globally almost halved.

In an attempt to quantify the market’s dependence on CEE, we looked at the exposure of Austria’s listed corporate sector to the region (incl. Russia and Turkey) in terms of their top-line (for non-financials) or assets (financials incl. property stocks). Based on company data and – where necessary – our estimates and applying market cap weights shows that 37% of the market’s total capitalization is linked to companies’ domestic business, while 29% can be attributed to business in CEE. Western Europe accounts for 24% and 11% are linked to business in the rest of the world. These figures imply that the market’s exposure to CEE is higher than to

COMMENT: Are Austrian stocks still a play on Emerging Europe?

www.wienerborse.at

Opinion 65bne June 2014

international expansion strategy and cut back their business plans in CEE. Second: Many of the companies with a high CEE exposure underperformed the broader market in recent years – most notably RBI and Wienerberger – and others like Strabag dropped from the main index. Therefore, the weight of stocks with a high ‘CEE-beta’ declined.

As a result of the fundamental links of the country’s corporate sector, the correlation between CEE stock markets and the ATX, Austria’s main equity index, has been higher than for any other Western European index. Over the past ten years, the correlation between Austrian and CEE stocks (PL, HU, CZ) of weekly returns was always in a range between 0.65 and 0.8. Across all markets, the correlation was elevated during and immediately after the financial crisis, when global top-down risks dominated all asset classes. Since 2012, the correlation between western and eastern European stock markets has been generally on a downward trend (in line with falling correlation across all asset classes), but the ATX’ correlation with CEE declined less than was the case for other indices.

Therefore, the Austrian equity market still offers the best exposure to CEE for those investors who cannot directly invest in the region, eg. fund managers who can only have euro risk. In contrast, for EM investors, there is no reason to have an Austrian allocation as such, because they can get CEE exposure directly. However, single stocks with a significant CEE business could be attractive on valuation grounds or because they offer exposure to a sector that is not well represented on local stock exchanges in the region (VIG in the insurance sector would be a case in point, because with Warsaw-listed PZU there is only one large local insurer in CEE).

"The Austrian equity market still offers the best exposure to CEE for those investors, who cannot directly invest in the region"

ATX – Regional exposure

Source: Bloomberg, GEMetrixx

AT, 37%

CEE, 29%

W. Europe, 23%

RoW, 11%

Total

AT, 37%

CEE, 52%

W. Europe, 9%

RoW, 2%

Financials

Annual stock market gains/losses*

Source: Bloomberg, GEMetrixx. *) AT: ATX; EU: EuroStoxx 50; CEE: MXMU

12%

1YR 3YR 5YR 10YR 15YR

6%

0%

-6%

-12%

-18%

AT EU CEE

66 I Events bne June 2014

Upcoming events 2014

European Bonds & Loans Forum (5 - 6 June) Global Leading ConferencesVienna, Austriahttp://globalleadingconferences.com

IV International Economic Summit of Russia and OIC Countries (5 - 6 June)KazanSummit Organizing CommitteeKazan, Russia

Global Economic Forum 2014 (16 - 18 June)IBDE, +44 (0) 20 7193 1485 Liverpool, United Kingdom

Catalyst Cap Intro: Emerging Markets Alternative Investing (23 June)+1 212 966 2993New York City, [email protected]

5th annual international Ukrainian Energy Forum(23 – 26 June)Adam Smith Conferences, +44 20 7017 7444Kyiv, [email protected]

6th annual Private Equity Emerging Markets (24 - 27 June)ICBIAmsterdam, Netherlands

CEE Energy Awards & Forum 2014 (29 May)Warsaw, Polandhttp://ceeenergyawards.com

5th International Banking and Finance Forum: Restoring Growth and Confidence in World Markets (2-3 July)IBDE, +44 (0) 20 7193 1485 Liverpool, United [email protected]

BOND CONGRESSCIS and Baltic

June 19—20, 2014, Sochi

Hosted by: Lead sponsor:

Official partners:

With contribu�on from:

Annual Cbonds Conference, which serves to discuss the development of local bond markets in Russia, Kazakhstan, Belarus and other CIS countries, as well as eurobonds emerging markets. Tradi�onally, the conference is accompanied by an interes�ng informal program.

Expected number of par�cipats: 300

www.cbonds-congress.com

Contacts:Agenda, sponsorship:Ekaterina [email protected],+7 (812) 336-97-21 *223

Participation:Elena [email protected],+7 (812) 336-97-21 *104

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

bne’s veteran team of journalists have more than 100 years of collective experience of reporting on this dynamically growing region and can explain the “why” of “what” is going on.

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