Belarus coming in from the cold?

Graham Stack for Russia Profile

In a deep-reaching move, but still little noticed in the West, Belarus, aka ‘Europe’s last dictatorship’, has shifted the tenets of its economic strategy and is actively looking to attract foreign investment – and targeting the West.

Many analysts in Minsk see the energy dispute with Moscow at the start of 2007 over subsidized gas prices and customs-free oil exports as marking a caesura in Belarus economic strategy. In 2007, Russia put Belarus on a one way track to paying European prices for its gas by 2011, and also ended duty-free oil exports that allowed its small neighbour to earn millions by refining and exporting oil to Europe.

The booming Belarus economy, running at full capacity, with 8% annual GDP growth par for the course, was urgently demanding capital investment to stop bursting at the seams. The price rises punctured the idea the state could do it all itself.

Moreover, the Kremlin actively backed liberalization in Belarus – in the hope that Russian capital would move in powerfully.

Having learnt bitterly from the Ukrainian experience under Kutchma, where Russia subsidized Ukraine with cheap gas, but Russian companies were cut out of the privatization process, Russia has step-by-step shifted to a ‘non-ideological’ approach to dealing with its neighbours.

New president Dmitry Medvedev confirmed this shift July 15th in his first major speech on foreign policy principles:

“We are fed up with ideological investments. As you know, they were made in the previous period, and it is absolutely clear how they were paid back. And there should be no clawing at our money, which was inefficiently spent to support corrupted regimes, in the future,” Medvedev told the Russian diplomatic corps, as quoted by Interfax.

So if bumping up energy prices forced Belarus to open its economy to investors, it was a win-win game for Russia.

In fact, new head of the World Bank mission to Belarus as of July 2008, Martin Raiser, dates the Russia-prompted shift in Belarus policy even further back than January 2007.

“Key aspects of economic policy changed already a few years back. In particular, the unification of the exchange rate and the customs union with Russia meant that key market signals have already been in operation for some time,” says Raiser in emailed comments.

“With the rise in energy import prices from Russia, there has been an additional push for greater efficiency and competitiveness,” according to Raiser, “and this has led to a renewed emphasis on private investment and initiative in Belarus. This is new and it is welcome.”

Reform moves

It was in 2007 that the Belarus administration startled analysts by announcing and launching implementation of a raft of reforms aimed at improving the investment climate.

There was and is a lot to improve. Pro-private sector measures introduced in 2007 saw Belarus leap up thirteen places on the World Bank’s ‘Ease of doing business index’ – from 123rd place to an only slightly less embarrassing 110th place in the world.

But this is only the start, say analysts. According to the World Bank’s Doing Business blog, “in February 2008 the Doing Business team met with 45 government officials from 17 different agencies of the Republic of Belarus. Every single one of these representatives expressed their absolute commitment to ease business regulation in the country. Their aim is to be among the top 25 countries in the ease of doing business and top 10 reformers in the World Bank’s Doing Business 2009 report.”

In 2007, Belarus also took crucial steps such as acquiring a credit rating, and launching large-scale privatization – with the sale of second largest mobile operator, Velcom, to Telecom Austria, for over 500m euros.

An indication of the dominant state role in the Belarus economy until 2007 was that all three mobile phone operators were joint ventures with the state. But in 2008 the state is looking to sell its remaining stakes in operators MTS and BeST. Bank privatization is also in the cards, with Germany’s Commerzbank looking set to acquire fifth-largest Belinvestbank. Austria’s Raiffeisen International already owns the country’s third largest bank, Prior Bank.

This burst of reform activity in 2008 has caught many observers by surprise.
Many expected the reform drive to slow, as energy prices in 2008 have shifted back in Belarus’ favour: the country looks likely to run in a record trade surplus instead of the feared deficit this year. But, according to Dmitry Kruk of Minsk’s Institute of Privatisation and Management, the government has redoubled its liberalization efforts this year, indicating that ‘a strategic decision’ has been taken by the president.

Key challenges

World Bank’s Martin Raiser sees three key challenges facing the government:

“Belarus in some sense benefits from the fact that several of its key industrial assets are relatively new (built in the late 1980s) and that government-led efforts have achieved some success in modernizing the flagship companies.”

“But a lot of inefficient often state-owned enterprises still exist in smaller towns which will need to attract private strategic investment if they are to survive.”

“Secondly, Belarus needs to make better use of its key assets – an educated labor force and strategic location as a bridge between Russia and western Europe. For this, it needs to encourage innovation and entrepreneurship to complement the high human capital and it needs to reorient trade and transport links towards Europe and make it easier and cheaper to transit across its territory.”

“Thirdly, Belarus will need to cope with a deteriorating demographic outlook and the implications this has for the social inclusiveness of future economic growth. As the labor force declines due to aging and migration, the financing of generous social transfers through high levels of payroll taxes will come under pressure and the need to improve targeting of social assistance to the truly vulnerable and to encourage greater labor force participation will become ever more pressing.”

The question facing Belarus is whether the top-down approach pursued by the government is sufficient to master these challenges. World Bank’s Raiser notes that, while the government has “the ambition to tackle these challenges broadly”, the authorities “are aiming at efficiency improvements rather than wholehearted institutional change.”

Between Europe and a hard place

Nevertheless, the logic of reform in Belarus might yet kick-start some political liberalization, to make the country more acceptable in the West.

If economic reform in Belarus was initially prompted by relations with Russia shifting to market principles, then reforms now seem to target West European investors, according to Viktar Strachuk of Deloitte, precisely to avoid Russian capital predominating in the country.

So the government wants Western investors to counterbalance Russian influence. But Western investors are still wary of Belarus, because of the stigma attached to ‘Europe’s last dictatorship.’ So ultimately, economic reform will require some degree of political liberalization at least as window-dressing. Lukashenko seems to have recognized himself that image is important: in early 2008 he hired famous British spin doctor Lord Tim Bell, who has worked for General Pinochet, Boris Berezovsky and the British Conservative Party.

Lukashenko has even promised that the upcoming parliamentary elections in September 2008 will be a ‘model of democracy.’ The claim has met with understandable skepticism from opponents. However, there is considerable room for Lukashenko to liberalise and allow opposition, without losing his iron grip on power, since he enjoys Putinesque levels of popularity, as the economy surges ahead.

On the other hand, such a move would require Belarus’ ‘Batka’ to at least allow public questioning of his infallibility – and there has been little sign that he is psychologically ready for this.

Belarus’ surprise opening gambit

Graham Stack for business new europe

For a country long regarded as a regional backwater, Belarus has been full of surprises since 2007.

First came the “gas war” with Russia in January 2007, where Russia hiked prices for gas and slapped export duties on oil – contradicting preconceptions about Russia using energy prices to punish enemies, such as Ukraine, and reward friends like Belarus. Then came a bigger surprise from the Belarusian side. After a decade of anti-Western rhetoric, the government announced a whole raft of measures to open up the economy to foreign investment and liberalise the economy. But doesn’t take much to link the two.

“For a whole decade, nothing was done to support the private sector, and no one expected these measures. Now we are hearing at a frequency of once a week cardinal measures decided on from the president or government. And all these measures are extremely positive for entrepreneurs and the private sector,” says Sergei Shaban, deputy chairman of the board of Belgazprombank.

Belgazprombank, the country’s seventh largest bank in terms of assets and third largest in terms of share capital, owned jointly by Gazprom and Gazprombank, handles the Belarus gas trade accounting for the Russian giant, while lending to Belarusian small and medium-sized enterprises. As such, it enjoys a unique insight into both state and private sectors. “Our opinion is that the measures taken by the government and president are conditioned by the need to adapt to new prices for energy,” Shaban says. “Before the price hike, there were enough resources – internal and also subsidized energy prices from Russia. This has ended, and companies need to become more competitive, to upgrade their facilities, and this requires extra capital,” says Viktar Strachuk, senior partner in the Minsk branch of Deloitte & Touche.

Dmitry Kruk of the Institute of Privatization and Management, a think-tank that drew up privatisation plans in the 1990s only to see them mothballed when Lukashenko came to power, explains that the price hike for gas and the imposition of export duties on oil shipped to Belarus threatened a lurch into the red for the trade balance, jeopardizing macroeconomic stability. The hike in energy prices also looked certain to hit enterprise profitability, making investment in upgrading facilities and making it more imperative to raise energy efficiency. But soaring world oil prices in 2008 have removed any immediate necessity to liberalise. Belarus still enjoys a “political” gas price of $128 per 1,000 cubic meters, and Belarus oil refining is still very profitable. “So it’s a paradox,” says Kruk. “This year, the trade balance will be much more favourable than last year, but the government efforts to attract investment are much more concerted that ever before.”

“It seems to be a strategic decision,” he concludes. “Everybody actually expected a slowing of reforms this year due to favourable external circumstances.”

Between Europe and a hard place

Opening up the Belarusian economy seems both a concession to Russian demands, as well as an attempt to limit Russian influence. “There is pressure from the Kremlin to open the economy. Russia understood that it’s more useful to use economic influence than political,” argues Shaban.

According to Shaban, the move to privatization was sealed by the sale to Gazprom of Belarus gas pipelines operator Beltransgaz as part of the gas deal reached in 2007. “Beltransgaz had important symbolic value in terms of privatisation. We reckoned if this deal goes ahead, privatization will continue. The Belarus government saw that nothing had changed, nothing terrible happened.”

But analysts also argue that this year’s wooing of foreign direct investment (FDI) is aimed at western investors to prevent Russian economic domination. “The priority is investment from western Europe, not Russian investment,” says Kryuk. “There’s a specific policy of restricting Russian investment proportionally, it is evident at investment forums. Russian investment is too political.”

Deloitte’s Strachuk agrees that the government is looking to balance sources of investment, because there’s already a lot of Russian capital, especially in the banking sphere. “Western countries are still wary, but Belarus’ neighbours such as Poland, Latvia and Ukraine are interested. Also Persian Gulf countries are quite active here in real estate, and there are some contacts with China and Korea. Basically, they want a mix,” he says.

Not only has juggling east and west given liberalization a momentum of its own. The very success to date of the “Belarusian economic miracle” – with regular 8%-plus GDP growth rates – means that fixed capital investment is urgently required to renew and expand capacities. This was illustrated on June 25, when the Lukomi power station, the country’s largest, suddenly packed up, causing outages across the country for both industrial and residential consumers.

Moreover, while the economy has benefited hugely from the export of goods to the booming Russian market, competitiveness in terms of market share has been falling, as Soviet-era technologies become obsolete. And with the government still the owner of most large companies, it could cash out to harvest a bonanza to finance infrastructural measures, such as constructing a nuclear power plant to reduce its energy dependence on Russia.

Belarus simply has everything to gain from opening up, as Shaban argues: it is slap in the heart of Europe, with an educated workforce, social stability, and good production capacities. And, despite the conflict in 2007, “Belarus still has a huge price advantage in energy relative to other European countries, and the government can exploit this to attract extra capital,” according to Shaban.

Targets for investment

“Every ministry and every authority now has a major priority to attract foreign investments, having all been assigned certain targets in terms of millions of dollars of FDI to be attracted. Now a major part of their day is spent meeting with foreign investors to achieve these targets,” says Strachuk.

As evidence of the government’s reform efforts, it has publicly committed itself to leapfrogging up the World Bank’s ease-of-doing-business ranking from its current 110th position to a top-25 place by 2011. The most telling proof is that the privatisation of major companies is back on the agenda. That includes the imminent privatization of the two remaining state-owned mobile operators to Russia’s MTS and Turkey’s Turkcell; of fourth-largest Belinvest bank to Germany’s Commerzbank; and of giant truck builder MAZ to Oleg Deripaska’s Russian Machines. Michelin is also known to be interested in tyre producer Belshina. “There is an ambiguous logic about privatization,” says Kruk. “Enterprises that are currently profitable but facing an uncertain future will be sold, as companies in a tight situation will also be sold.” According to Kruk, companies with stable profits such as Minsk Tractor Factory, potash giant Belaruskali, and the largest oil refineries will remain in state ownership.

Crucial to stimulating investor interest in privatisation was the abolition in February of the notorious golden share rule, which gave the government the right to intervene in the running of a privatised company in the event of layoffs or losses.

Parallel to case-by-case privatization, as part of an institutional shift towards an investment-friendly economy, government unitary enterprises are to be transformed en masse into joint stock companies (JSC): 30% this year, and the remaining 70%, around 500 companies, through 2010. Government plans then envisage IPOs for the new JSCs, but current market conditions, and also the need to establish credit histories and introduce international accounting standards, make such ambitious claims seem unrealistic for the immediate future, according to most analysts

Besides attracting strategic investors, the privatization of majority and minority stakes is intended to stimulate the development of a stock market. To support this, earlier this year the tax on securities trading was slashed from a prohibitive 40% to a profit tax level of 24%. A moratorium imposed in the 1990s on trading shares in privatized companies was also lifted, and the government passed an umbrella programme on “corporate securities market expansion program for 2008-2010″ in January, envisaging 25% free float of total shares by 2010. However, considering the current embryonic state of the Belarus stock market, in conjunction with the disarray on the global capital markets, most analysts agree it will be a long time before things really start to take off here.

More significant in the short term are moves to streamline the tortuous tax system. With 42 different taxes, compliance is currently a nightmare, and the overall take high in comparison to neighbouring countries. But in 2009, the government will introduce a flat rate income tax of 12%, and reduce turnover tax, a major burden, by 2% to 1%, and possible phase it out entirely in 2010.

And it’s not just taxes. “Worse than taxes themselves are the many mandatory payments that are not taxes, but contributions to sector support funds not covered by tax law, but only by the budget law,” Deloitte’s Strachuk says.

Too much bureaucracy, not enough democracy

Nevertheless, a poll taken of foreign investors at the recent Minsk Investment Forum showed that taxes were not the main obstacle to investment. “More serious was a general lack of transparency, difficulties with regulations regarding pricing, and regulations regarding accounting in general, which is very formalistic,” Strachuk says. “The basic problem is bureaucracy and slow decision-making.”

Belgazprombank’s Shaban agrees: “In Belarus, corruption, for example, is significantly lower than in Ukraine and Russia. The problem lies in the speed of taking decisions.”

The government has a number of programmes that provide tax incentives for investors, such as a development programme for small and midsize towns, for “agricultural cities,” and for technology parks. However, some of these programmes also include administrative measures compelling companies to contribute. There is still a mix of policies being applied.

An excess of bureaucracy is twinned with a dearth of democracy. It’s still too early to say whether the Belarusian economic liberalization could prompt political liberalization. To secure the foreign investment from Western Europe needed to balance Russian money, President Alexander Lukashenko has to do something about his image – and he promptly took first steps in this direction in 2007, hiring Tim Bell, legendary British spin doctor for late Chilean dictator Augusto Pinochet, Russian oligarch Boris Berezovsky and the McCanns, among others. The upcoming parliamentary elections in September will be a litmus test of how far the administration is prepared to put substance behind spin.

Minsk cabbies

Moving from the “Batka” of Belarus, as Lukashenko is referred to, to the Minsk cabby for a view from the grassroots, Svetlana, one of Mink’s few female taxi drivers, told bne that government regulations forced her to change jobs. “Previously, I had a stall trading textiles,” she says, but new government regulations now forbid the self-employed from hiring additional workers, demanding they re-register as firms, with all the accompanying costs and hassle. “There were demonstrations against the regulations on the part of small-scale entrepreneurs in the centre of Minsk, but nothing appeared about them on TV, it was all hushed up and then they were dispersed by force.”

Another Minsk cabby, Grigory, a Hare Krishna acolyte, says he earns enough as a taxi driver, without a family to support, to have visited India for six weeks this spring. Freedom to travel is one thing. “But Hare Krishna are not allowed to celebrate on the streets in Minsk – in Moscow, yes, but not in Minsk,” he complains.

However, as a taxi driver in Moscow, he could hardly afford a six-week trip to India. This is one of the paradoxes of Belarus. In Moscow, “official” cabs are rare; instead there are myriad of gypsy cabs driven by migrant workers. In Minsk, the iron grip of Lukashenko means there is an organized, competitive and efficient taxi market. Late night revellers debate which taxi service is cheaper, much as they might discuss which mobile operator gives the best deal.

Under Lukashenko, Belarus identity is openly Soviet-rooted. Independence Day is no longer July 27, the declaration of sovereignty from the Soviet Union in 1991, but July 3, the liberation of Minsk by Soviet troops in 1944.

But this is not the same as subservience to modern Russia. In some ways it’s the opposite. Belarus is proud of the “Soviet virtues” abandoned by Russia for “corruption and low morals.” Ordinary people often echo Lukashenko’s boasts that he has prevented the appearance of oligarchs, bandits, graft and ethnic strife – the plagues of modern Russia. As a visitor to Minsk watches diners in Macdonald’s actually clear their tables after eating, something unheard of in Moscow, there’s a possibility that this proud Soviet vestige might yet take on a European tinge.

Raiffeisen plays pioneering role with Priorbank

Graham Stack for business new europe

Austria’s Raiffeisen International is the Indiana Jones of the banking world. Even after Eastern Europe became fashionable amongst international financiers in about 2004, the idea of buying into Belarus crossed few people’s minds. Now that Belarus has thrown open its doors and is quickly becoming the hottest bank market in the region, banks arriving in the country will arrive to find Raiffeisen has already been there for five years.

Priorbank was founded as an innovation in 1989 during the first wave of private bank start-ups by a group of the county’s largest manufacturing concerns, including truck makers MAZ. Oil paintings of the banks’ industrial founders still adorn the walls of Priorbank’s headquarters, but the bank was never reduced to a pocket bank: at the same time as serving large corporate clients, as early as 1995 Prior was a partner of the European Bank for Reconstruction and Development’s Small and Medium Enterprise (SME) programme, and in 1997 the EBRD took a 27% stake.

Vladimir Dedioul, member of the Priorbank board responsible for investment banking, says Priorbank was then the country’s third-largest bank, and its largest private bank. A greenfield development in Belarus would have been difficult, but Priorbank was looking for a buyer. “So Priorbank followed the typical East European pattern of taking on first a financial investor, then a strategic investor,” explains Dedioul, who has worked in the bank since it’s founding.

The strategic investor came in the shape of Raiffeisen in 2003, which too first took a 50% stake and subsequently increased it to 63.1%. “Our purpose was to find a source of long-term money for the clients we knew well. Raiffeisen gave us know-how, technologies, finance,” says Dedioul.

Austrian Bernd Rosenberg, originally from Raiffeisen International, now a member of the Priorbank board responsible for risk management, jokes that “White Russia” was literally a blank on the map. But precisely this fact attracted Raiffeisen: “It’s always better to be first in the market and here as well we saw considerable potential for the future. We wanted to cover the whole region.”

All about timing

Raiffeisen chose the perfect moment to enter the market. From 2002-2007, Priorbank grew explosively along with the Belarusian banking sector. Priorbank’s loans to customers grew more than eightfold, assets more than five times, equity trebled, and retail deposits rocketed four and half times.

It’s testament to the strength of Priorbank’s position that, unusually for Raiffeisen, the bank still uses the Prior brand, with the Raiffeisen emblem adjoined. “We were also lucky in that Priorbank has always used yellow for it logo, like Raiffeisen,” jokes Dedioul.

The Priorbank deal was pioneering for Belarus – and is seen as having kick-started a process. “The Priorbank deal showed the government that foreign investors would act perfectly normally, on the one hand, pay taxes, pay their employees, and also introduce much needed technologies and improvement,” a source at a competitor bank tells bne. “But Prior and Raiffeisen have had to adapt a bit to realities. There was an initial euphoria in terms of public relations and openness, but recently they have become more closed. They serve a number of state-owned companies.”

Dedioul admits it has not been all plain sailing. However, he points out that the government has been so convinced of the benefits from foreign investors, that it has moved from tolerating them to actively seeking them – with a far-reaching privatization of the bank sector in the pipeline for 2008.

Dedioul claims the banking sector could go private “virtually overnight.” The share of foreign capital is currently just under 10% and there is a 25% cap on foreign bank ownership, but it is widely believed that this will be changed. “People often imagine the Belarusian banking system totally belongs to the government. However, that’s simply not the case: 23 of the 27 banks in Belarus are already private.” Admittedly, of the six largest banks, with about 80% of the total assets, only Priorbank, the third largest, is currently private. “But the fourth, fifth and sixth largest are all about to be privatised in the immediate future, and the two largest, Belarusbank and Belagrobank, will hold IPOs.”

Rosenberg says Priorbank is not worried about competition heating up. “We have first-comer’s advantages,” he says. “And we have done a lot of work over the past five years. Since we arrived, we have changed structures and approaches, switched from a three-tier to a one-tier structure, made large investments in IT and personnel. These are changes that the banks that are going to be privatised still have ahead of them. That will take time, and so we are far ahead of the field.”

Rosenberg explains Priorbank strategy as being Raiffeisen’s general approach tailored to suit local conditions. “The Raiffeisen strategy is to be a universal bank strong in corporative banking, where we are traditionally good, and to build up the retail area for private individuals and micro-crediting. We have a very clear focus on SMEs and retail.”

As an example of Raiffeisen’s approach, Rosenberg points to the introduction of standardized products for SMEs as being a general tendency – but “standardized products tailored to the Belarusian market, not imported from Vienna.”

IPOs postponed?

Priorbank recently qualified as an IPO partner for the Warsaw stock exchange – again, the first bank in Belarus to do so. With the government announcing upwards of 75 IPOs of state-owned companies to take place in the immediate future, this looks like a wise move to get a slice of the action.

Dedioul says, however, it is unclear how fast this can be achieved, giving the current international market conditions.

Rosenberg agrees: “It is very difficult to jump from isolation to integration in one go, in one year,” he argues. “There’s a whole science of how to do it: building up a credit history, working with international institutions, with private placements, sovereign borrowings, country ratings. To do it in one year is basically impossible.”

The private sector in Belarus, Dedioul and Rosenberg agree, appreciate the recent moves towards liberalisation, while emphasizing the importance of correct timing and consistency in implementation.

Belarus takes big step with Velcom privatization

Graham Stack for business new europe

Velcom’s new Austrian CEO Helmut Duhs does not hesitate to call the privatization of Belarus’ second-largest mobile operator by Telecom Austria, “the biggest step in privatisation for Belarus.” The 37-year-old Duhs hardly anticipated Minsk as a future posting, but since he took over in November, Velcom has become a flagship for Belarus’ new economic policy of openness.

The privatization has been a feather in the cap for President Alexander Lukashenko’s privatization programme, but the deal was mired in scandal to start with. Only a year ago, the Belarusian government suddenly announced that its second-largest mobile telecom asset, then called Mobile Digital Communications (MDC), had been clandestinely privatized for an undisclosed sum to a shadowy Syrian investor called Ead Samawi, bringing with it accusations of insider dealing.

Samawi’s business interests in Belarus allegedly originated with arms trading, and he was one of the few foreigners in the country said to be close to the president. Ead Samawi also surfaced in public shortly after the Syrian foreign minister visited Minsk on a state visit about two years ago. Analysts point out that the state arms exporter Beltekhexport held 20% of the government’s total 51% in MDC. Relationships between the Belarus administration and Samawi have had their ups and downs since MDC was founded in 1998: Samawi even spent a night in a KGB detention cell in 2003. But 2008 saw a number of televised love-ins between Samawi and Lukashenko, which seemed to pave the way for the behind-the-scenes privatization. With a decade’s delay, Belarus seemed to be making the same transition from state-ownership to crony capitalism that Russia and Ukraine had done in the 1990s.

This initial apprehension made the cheer greeting the Telekom Austria deal weeks later all the louder: the Austria firm bought 70% of Samawi’s holding company SB Telecom for €730m, with a call option agreement for the remaining 30% exercisable in the fourth quarter 2010, valued at approximately €320m. Suddenly a new optimism was in the air: Belarus seemed to be skipping over the crony capitalism stage and looking instead to attract foreign investors – from the West.

The shift was a big surprise apparently for Telekom Austria itself, which first made contact with the Belarusian government in 2007. The sum Telekom Austria paid SB Telecom, Duhs told bne, was only a slightly higher valuation than the €550m the government belatedly this year said it had received from SB Telekom for its 51% stake.

And now the government has said it intends to privatize the other two mobile phone companies as soon as possible. The Belarusian market leader, MTS, a joint venture between Russian mobile giant MTS (49%) and Belarus fixed-line monopolist Beltelecom (51%), looks set to see the Russian company acquire an extra 2% for around $27m, according to the telecommunications ministry. The third-placed BeST is likely to be acquired by Turkey’s Turkcell when a price has been agreed upon.

So what only a year ago would have seemed fantasy, is now nearing reality: the complete privatization of a key sector to foreign investors.

Duhs himself disputes that there has been any u-turn in government policy, arguing the development is entirely logical. “Velcom was the first GSM operator in Belarus and Samawi was always the driving force behind the company. The digital mobile industry was from day one, competitive and liberalized. It simply made sense for the state to sell its stake when the market had matured and the entrepreneurial stage completed. It made sense that the existing partner make a deal, and then negotiate with an international investor.”

President Lukashenko himself boasted to students at Belarus State University in February about how profitable this strategy had been for the state: “We invested nothing at all [in Velcom] and got around $600m for our stake,” he said, adding that “billions” were being offered the state for MTS, and for BeST even “with all its debts.”

Growth potential

From the point of view of Telekom Austria, the attraction of the Belarus market lies in its great potential for growth. “It is the only market we have with less than 100% penetration, in fact around 70%, and currently our tariffs are 70% lower than in the next lowest market,” explains Duhs.

Velcom’s monthly ARPU in the first quarter was €6.5, compared with Telekom Austria’s ARPU of €28.7 in Austria for the same period. In the Belarusian context, however, Velcom boasts the country’s highest ARPU due to its traditional focus on better-off users: market leader MTS reported only €6.25 of ARPU in 2007.

Part of the reason for such low tariffs, besides competition, has been government involvement in the branch, admits Duhs, and the ideology of a “socially-oriented economy.”

“This is a country-specific approach,” shrugs Duhs, “which requires a commitment from large companies. You have to know and accept it before you enter the market.”

One such commitment is for mobile operators to provide equal quality to all inhabitants, ie. to ensure coverage of unprofitable rural areas. The rural population is an important government constituency, and because Belarus is sparsely populated, operators have to invest a lot in their networks relative to subscribers. In addition, the fixed-line operator Beltelekom is a state monopoly offering the lowest call tariffs in Europe. “Mobile phone operators subsidise the fixed-line operators,” says Duhs.

So Velcom has no worries about a price war breaking out between the newly privatized operators as happened in Ukraine 2006: “Prices are simply as low as they can get.” Instead, Duhs welcomes increased competition as stimulating market growth.

He also notes that Belarus is committed to WTO entry, which requires the liberalization of fixed-line communications. “Positive signs by the government on such issues were a condition for us entering the market.”

But for all the low ARPU and social strings attached, the 3.2m Velcom subscribers now comprise 20% of Telekom Austria’s mobile subscribers in a country with GDP growth averaging 8% per year, with the first tenders for 3G licenses likely to take place this year. And Duhs is aiming higher: for Velcom to be market leaders within five years, by providing more value-added services while diversifying its subscriber base away from business users.

Improving investment climate

Regarding the investment climate as a whole, Duhs points to the Belarusian tax system as the biggest obstacle. “It is by far the most complicated I have ever seen, with 42 taxes meaning that huge administrative efforts are needed for compliance.” And it’s not just the number of taxes: taken together, Belarus has the highest tax rates in region, says Duhs.

Duhs points out that Velcom enjoys a privileged position when it comes to dealing with government, “because the privatization is perceived by all parties as a pioneer action and supported as such.” In general, he says, since foreign investors are still a novelty, government works with them on a case-to-case basis, not yet having developed routinised procedures.

Duhs sees Velcom acting both as an “ambassador” for Belarus abroad, promoting the country as an investment location, as well as for Austrian business investing into Eastern Europe. “The Austrian approach regarding [foreign direct investment] is more flexible than in larger countries, and Austria has always been a pioneer in entering East European markets. So it’s not a coincidence that the biggest sectors in Belarus are privatized first with the help of Austrian companies.”

Duhs points to Austria’s historical links to Central and Eastern Europe. Metternich once quipped that the Balkans start on the outskirts of Vienna, and it’s no coincidence that the Austrian pioneers in Belarus, Telekom Austria and Raiffeisen International, are both headed by men with roots in the former Yugloslavia – Boris Nemsic and Herbert Stepic, respectively. Looking east comes easy to them.

That is not all the two pioneering investors share: Belarusians might well imagine that yellow and black are the Austrian national colours. Following rebranding, Velcom’s new black on yellow logo now perfectly matches the Raiffeisen emblem displayed by Priorbank. The new Velcom brand aesthetics are also pioneering: The eye candy previously smiling from billboards has now been replaced by sombre, even harsh, images of “real people,” about which even Velcom’s own sales staff openly express their puzzlement.

But this, argues Duhs, is what foreign investment can bring – new approaches, new ideas, new technologies. And thus, to explain the rebranding to staff, Duhs and his team did what few Belarusian managers do – they launched a roadshow through Belarus to convince workforce on the rebranding, explaining the concepts and answering questions openly. “There were a lot of questions,” smiles Duhs.

Russia’s private pension funds still in their infancy

Graham Stack for Russia Profile

Russia’s private pension funds have got off to a quick start after the pension reform conceived in 2002 first created accumulative pension savings accounts parallel to pay-as-you-earn.

From 2005 to 2007, the amount of accumulated pension savings – grew from 183,9 trillion rubles to 401.8 trillion. Of this, the share held by non-state private pension funds increased from 1.1% in 2005 to 10.6% in by the first quarter of 2008, according to Expert RA.

But, analysts point out, this impressive growth from nil was mostly due to pensions funds’ corporate links giving them captive customers. Now they must make the difficult switch to retail to tap the broader market. A new government measure is intended to help, but might instead hinder.

According to Irina Rudykh of rating agency Expert RA, who held a round table on private pension funds July 15th that gathered decision makers from government and private sector, “private pension funds’ main resource to date has been their corporative backing.” All of the top 6 PPFs according to pension reserves are linked to industrial holdings.

“The dynamic growth of pension reserves held by private pension funds – by 63% in 2005 and 46% in 2006 – was based on the activities of corporate funds,” says Rudykh. “Most large Russian holdings quickly created ‘pocket’ pension funds which grew quickly, because they had ‘captive’ clients – company workforces – and grew from nothing. So the first stage of growth was easy. There were hardly any infrastructural costs or marketing costs.”

Corporate funds can count on stable and guaranteed demand from workforce numbering hundreds of thousands in the case of natural monopolies.

But this demand is restricted exactly to these hundreds of thousands, and as the captive market is now largely captured, this growth model has reached its limits.

As a result, according to Alfa Bank analyst Olga Naydenova, 2007 saw a slow down in the development of Russian PPFs, with pension reserves held by PPFs growing by only 16.7%, the lowest growth rate since the reform was launched. The majority of analysts ascribe this slowdown to the limits of the corporate PPF model.

Getting blood out of a stone

According to Rudykh, for these funds to keep growing, they must switch to retail on the open market.

However, as easy as the initial phase was thanks to corporate captive markets, as difficult the switch to retail is likely to be.

“This is a huge market, a whole order larger than the corporate market,” says Rudyk. “But there exists here a striking paradox that must be overcome: despite the extremely low level of pension security, there is still practically no demand at all in Russia for the services of PPFs on the part of private individuals.”

For a whole host of reasons, Russians are extremely passive in respect to pensions saving.

According to Oksana Sinyavskaya of Russia’s leading Centre of Social Policy think-tank, there are a number of deep-rooted issues that make tapping the non-corporate retail market like getting blood out of a stone.

“I think that the main problem is in the lack of knowledge and lack of trust. Russian people do not know much about the pension reform, and there were no information campaigns about it, as there were for instance in Poland or Sweden). Most Russians do not know about private pension funds, and how to choose a private pension fund or a private managing company. And they do not trust either the state or private firms. However they trust private pension funds even less than the public pension fund.”

Secondly, according to Sinyavskaya, is the problem of low income: “Although incomes of Russian population are growing they are distributed unevenly, and they were too low over a long period of time. So, now people prefer to consume than to save. And most of them do not have enough money to save. And when they have it, they prefer to invest in more liquid instruments with guaranteed interest, like deposits, or buy housing.”

A further brake is is that the actual amounts accumulating are still small. “This is still virtual money that people do not feel, do not consider real,” says Rudykh.

Under the terms of the Russian pension reform, where contribution payers fail to specify a private pension fund or asset management company, the money is assigned by default to VneshEconomBank (VEB), a state-owned development bank.

Currently, according to Renaissance Capital analyst Katya Malofeeva, 95% of Russians are failing to specify a private pension fund – so their pensions land with VEB.

The irony, however, in 2007, according to Malofeeva, was that VEB actually achieved a higher return on its assets than the private pension fund average. So pension funds are not doing well enough for the average Russian to care whether the money stays with the state or not.

“Private pension funds do not demonstrate high yields and are themselves not too active in promoting their services,” says Sinyavskaya.

“There are three reasons for this. The first is strict regulation of instruments available for pension investments. The second is a high volatility of Russian financial markets, caused by its mostly speculative character. And the third is, to my view, inadequate qualification of managers in managing companies. But this we cannot prove.”

Reforming the reform?

As rapid as the growth of private pension funds has been, starting from nil, they are still only a drop in the ocean in terms of what is needed to shore up Russia’s shaky pension system.

Some analysts call Putin’s pension reform a failure, and demand a fresh start.

Others say that, while the coming pension crisis has not been banished, the time lapsed for judging the success of private pension funds is too small, especially given the novelty of many of the concepts for Russians used to a cradle-to-grave welfare state. According to Rudykh, “what is needed now is not a new reform, since the original reform was only decided on after a real struggle, but a reform of the reform.”

In autumn 2007, the issue of how to improve on the pension reform was addressed by a new minister of social development, Tatyana Golikova, who replaced the unpopular Mikhail Zubarov. Successive presidents and prime ministers, most of them called Vladimir Putin, called for new measures to strengthen PPFs.

As a result, one of Putin’s last measures as president was to sign into law the ‘Co-financing Act,’ popularly referred to as the ‘thousand for thousand’ programme. The act provides incentives for individuals to pay into pension savings accounts, committing the state to add a thousand rubles for every thousand rubles of voluntary contributions, up to a total of 12,000 rubles per year.

“This will make a difference in stimulating interest in voluntary pensions savings in PPFs,” says Expert’s Rudykh. “While Russians don’t like to save, they are attracted by the idea of getting something for free.”
Alfa Bank’s Naydennova, however, criticises the government for failing to launch a large advertising campaign to acquaint Russians with details of the new initiative, which will become effective in October 2008.
A more fundamental objection to the new law comes from those PPFs which have no corporate ties and thus are already working actively in retail.
According to Renaissance Capital’s Malofeeva, the law “On Cofinancing” was passed after three months of lobbying from big business resulted in a supplementary provision: allowing employers to add another 1000 rubles to the original 1000 rubles of voluntary savings. These 1000 rubles ‘donated’ by the employer are then tax exempt.
Malofeeva argues that this means that the law will directly benefit the ‘pocket’ pension funds of large corporations and disadvantage retail-oriented PPFs.

Critics allege that a corporation with a ‘pocket’ pension fund, for the price of 1000 tax-exempt rubles, will see 3000 rubles returned to its pension fund, to be managed by its own assets management company.
Malofeev says that this clause, in combination with the existing backbone of ‘pocket’ pension funds, could badly distort the new law. Instead of stimulating the development of PPFs, by privileging captive corporate pension funds with no presence in retail, it could instead damage the development of PPFs.
The new law, according to its critics, will create a doubly privileged group of pensioners: employees of large, often state-owned corporations such as Gazprom: being both better paid, they are more likely to afford the voluntary contribution and thus qualify for parity state co-financing, while their employees will add a further 1000 tax-free rubles for tax minimization, and see major assets flow into the company pension fund.
There are however also voices supporting precisely this corporation-based development, arguing that corporate pension funds such as Lukoil Garant, Norilsk Nickel’s fund, and Basel’s Sotsium, with household-name industrial concerns behind them that will presumably be around in fifty years time, are more suited to win the trust of the population. They also point to formerly “pocket” banks such as Gazprom Bank that have mutated into national players on the banking market in their own right.
So it seems creating a save-as-you-earn pension system has now been declared another field of mutually-rewarding partnership between the government and Russian big business.

Chubais has left the building

Graham Stack for business new europe

On July 1, Russia’s electricity sectoral holding RAO UES will cease to exist, replaced by a host of privatised power generation companies and state-owned grid operators – thanks to the efforts of ‘the great privatisator’ CEO Anatoly Chubais. Although the unbundling and privatization of RAO UES has been hailed as a huge success, concerns remain – not least because Chubais will no longer be there to look after his baby.

In the RAO UES offices, the last post was sounded for the former blue chip company, and CEO Anatoly Chubais lowered the company flag. In its place, a battery of new flags was hoisted: those of the 24 successor companies: 6 wholesale generation companies, 14 territorial generation companies, the hydroelectric giant RusHydro, and assorted grid and distribution operators.

This was the culmination of a turbulent 10 years work for Anatoly Chubais. When Chubais moved from the government to UES in January 1998, his legion of enemies predicted it would be the death of the company. Ten years later, he has proved them right.

In 1998, RAO UES was in dire straits, caught at the centre of the Kafkaesque nightmare of arrears and barter payments that passed for an economy at the time. Chubais’ reputation had taken a battering due to the scandals associated with privatisation, and suffered what seemed a terminal blow during the financial meltdown of August 1998. The ensuing economic rebound and the Putin presidency gave him a new lease of life as reformer – but made him no less controversial a public figure.

Flak from all sides

Chubais’ reform proposals for the electricity sector attracted flak from all sides: from the Communists as a matter of principle, but also from Western analysts and investors who feared a repeat of the sweetheart privatization deals, and by fundamentalist liberals. His most committed opponents didn’t stop at verbal attacks – Chubais was the target of an all-out mortar and machine-gun assassination attempt in 2005.

The protracted saga of RAO UES reform repeatedly seemed bogged down in parliamentary hearings and cabinet meetings – and yet it moved. Chubais has attributed this to direct support from President Vladimir Putin, “without whom none of this would have been possible.”

The story then exploded in 2007, as the first wave of privatizations to strategic investors took place – for unexpectedly large sums and attracting major European energy concerns.

“The result of ten years of reform is a new structure based on private property and market principles,” Chubais wrote in business daily Vedomosti, June 30th. “In the place of the RAO UES holding, new dynamically developing companies gave emerged – in generation and distribution, sales and service. A competitive market in electric power has been created in the country, and many billions of dollars in investment attracted giving a powerful boost to our country’s economy.”

“In the course of one and a half years,” Chubais continued, “Russian and foreign private investors have invested almost RUB1 trillion in our power generation companies… The detailed investment plan 2008-2012 envisages RUB4.3 trillion to be invested, with 43,000MW of new capacity alone costing RUB1,798 trillion.”

But, far from being dizzy with success, Chubais is aware of the considerable risks still facing the implementation of the reform.

Until only recently, one of the most serious threats to the reform came from Gazprom buying massively into power generation capacity, and looking set to dominate the market. Especially worrying were plans for Gazprom’s power generation assets to merge with coal concern SUEK’s, giving the joint venture a 15% share of total power generation, around 40% of fossil-fuel power generation, and almost a monopoly on supplies of gas and coal. Chubais himself referred to such plans as “the rebirth of state capitalism.” Most analysts agreed with him, but viewed the development as inevitable: what Gazprom wants it gets.

Sensational

It was thus a sensation when on June 10th Gazprom recalled the deal from consideration by the Federal Anti-Monopoly Service (FAS) with woolly justification. Abstaining from the SUEK merger plan seems to show that new President Dmitry Medvedev is on the side of the liberals, and reinforces Chubais’ reputation for beating apparently impossible odds – a reputation earned masterminding Yeltsin’s reelection in 1996.

The most serious remaining risk, in Chubais’ view, is solving the problem of cross-subsidisation of household tariffs by industrial customers, which he says totals RUB120bn per year. “Not one government resolution directed at ending this practice has been implemented over the last ten years,” he complains in his article. “As a result, the structure of the retail market is inadequate. Because of artificially low rates for households, and inflated rates for industry, we had to create the institution of guaranteed supplier, which then restricts free competition… [and thus] lead to structural conflicts between distribution companies and sales companies.”

The second serious risk, according to Chubais, is that of capex inflation pushing up prices. The huge capex programme in Russian power generation, has coincided with a doubling of costs for generation capacity on the global market over the last three years, and also with the current credit crisis increasing financing costs.

“All this will lead to a significant increase in the cost of investment programs, and… in the end prices charged to consumers,” warns Chubais, who calls on the government to rely on the market and competition to keep prices as low as possible.

Both these factors highlighted by Chubais could lead to a sharp increase in prices for electricity at a time when inflation is already surging. Moreover, today’s prime minister is a holy cow rather than a potential scapegoat, meaning that there will be political pressure to delay unpopular decisions.

Chubais nonetheless argues that price liberalisation is unlikely to be postponed. Standard and Poor’s electricity analysts are less optimistic about this. “Reforms have been beset with delays and revisions that erode the nature of the ultimate plan’s clarity,” Elena Dubovitsjaya and Ekaterina Marushkevich warn in a report. “Tariff regulation, particularly in heat generation, remains opaque and politicised despite legal changes that were designed to create a more transparent regulatory framework. In this environment we consider power generation companies to be highly exposed to the risk of political interference, including implicit price controls.”

The Standard and Poor’s team, who focus on corporate governance risks, points to politically motivated decisions, inefficient government regulation and control, limited control of new owners over strategy and investment programs, and new state monopolisation in the form of Gazprom, as risks facing the new owners.

The recent departure of top management from generation companies due to generous golden parachutes has also raised questions about future managerial capacities.

Paradoxically, according to Standard and Poor’s, one of the main threats to the reform results from another departure: “the liquidation of the fundamental ideologist behind the reform – RAO UES.”

But RAO UES head Chubais feels his work has now been done – and says his future plans involve only “to sleep for six months.”

Before going home for some well-earned kip, he left a farewell note on the RAO UES website:

“Thanks to all of you who accompanied us along the way – whatever side of the barricade you were on. We are leaving now. But the lights will stay on – because the building called the Russian power sector now has new owners.”