IFR Emerging Europe and Turkey Special Report 2014

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. “If you visit, it doesn’t feel like an economy in free-fall,” said Marcus Svedberg, chief economist at East Capital. It is a comment that strikes at the heart of the former member of the Yugoslav Republic. The first to break away from the Communist state, Slovenia then spent the 1990s successfully reinventing itself as the Austria on the other side of the Alps. Its capital Ljubljana has always felt distinctly European, and euro entry in 2007 was a foregone conclusion thanks to the fastest growth in the eurozone. But that is when the rot set in. The global debt crisis shone an unwelcome light on crony capitalism and the wild spending of its state-owned banks. Slovenia narrowly managed to avoid metamorphosing into a second Cyprus late last year. Thanks to the Herculean efforts of Prime Minister Alenka Bratusek, the country was able to avoid the stigma of a Troika bailout. In December, the country pumped in €3.3bn of government funds to save its lenders. But a huge amount of work still needs to be done. Thanks to the bailout of its own banks, the country’s debt rocketed to 71.7% of GDP at the end of last year, according to Eurostat, up from 23% in 2008. The government intends to cut the budget deficit from an eye-watering 14.7% of GDP down to 4.2% of GDP this year. And while the subject of non-performing loans is a familiar one in Central Europe, in Slovenia they stand at a hefty €11bn. That is almost a third of the annual national output. Little wonder that Bostjan Jazbec, governor of the central bank, has described the problem in several recent interviews as “worrisome”. It is true that there have been some improvements. In mid-March the Bank of Slovenia said that arrears of more than 90 days had fallen from 17.4% at the end of Q3 last year to 13.4% at the end of Q4. While a step in the right direction, the figures are something of a mirage. Fitch pointed out that Slovenian banks’ asset quality was still a risk despite the transfer of non-performing loans to a government-created “bad bank”. “Impaired loans have not reduced substantially as stricter loan classification has led to new inflows, even though official NPLs have fallen,” it noted. Privatisation issues A front-line weapon in the government’s armoury to reduce debt is privatisation. The calls for privatisation might have been rapid, but work has been slow. Half the economy still remains in state hands. So far, only two of the 15 state-controlled companies that had been earmarked for privatisation have been sold. A huge step was taken at the beginning of April with the announcement of the 75.6% sale of national telecoms Telekom Slovenije, the jewel in the country’s privatisation crown. A few weeks later, the sale of the country’s second-largest bank Nova KBM was also announced. All of this is difficult, and yet Slovenia receives little other than positive sentiment. The sovereign has had few problems raising money in the international markets. Despite €24bn of debt outstanding, with almost a third due by 2016, Slovenia has already comfortably covered its needs for this year and has stolen a march on next year too. In mid-February, it raised US$3.5bn through a dual-tranche offering of new five and 10-year notes. Admittedly, the initial premium was a generous 25bp–37.5bp, but the order book still reached a whopping US$18.5bn at its peak, and even when scaled back, books topped US$16bn. The US$1.5bn five-year was priced at US Treasuries plus 280bp while the US$2bn 10-year went at Treasuries plus 280bp. This was followed in early April by the sale of €2bn of notes, split equally between three-year and seven-year tranches. The fact that the debt is denominated in euros was deliberate – a sign that the country is pulling away from emerging market rivals and back into the eurozone fold. Even though the premium was s

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Thanks to its debt problems throughout the sovereign debt crisis, Hungary has been what Benoit Anne, head of emerging markets strategy at Societe Generale, called the “poster child of contagion”. But as he points out, that theme is three years old and it might be time to start thinking of the Central European country in a rather different way. Let’s face it, the economic news is not too shabby. After a dire fall of 1.7% in GDP in 2012, Hungary moved out of recession in Q2 last year and posted growth of 2.7% in Q4. Even if that figure is slightly distorted by the public investment that came courtesy of EU structural cohesion fund transfers of US$6.7bn last year, growth in Q1 this year was still 2.1% and economists are predicting growth figures for all 2014 of about 2.2%. The country’s debt-to-GDP figures have started to improve too, albeit slightly. From Q3 to Q4 last year the figure declined from 80.3% to 79.2%, according to Eurostat. Inflation has fallen sharply from the high levels of 2012 and is expected to stay below 3% this year. Unemployment is below the EU average at 8.6% and the forint has been resilient. Love to hate This is all a long way from the US$25bn emergency credit line Hungary needed from the EU, IMF and World Bank in 2008, so why the perennial gloom? Part of the bad reputation of Hungary comes from its politics. “Hungary is the one country in Central Europe that people like to dislike because of politics,” said Marcus Svedberg, chief economist at East Capital. At the beginning of April, incumbent Prime Minister Viktor Orban and his right-wing Fidesz party comfortably won the elections. There has been much carping from the opposition and the elections were considered free but criticised as not being fair. It is worth emphasising that Fidesz won on a landslide; taking 133 of the 199 seats. As one economist said: “The problem is that Fidesz is popular. The previous socialist government was a disaster, but Fidesz is competent. The population might be annoyed by the party’s undemocratic drive, but there is no alternative.” That is the nub of it. European commentators are vexed that Hungarians endorsed Orban’s blatant nationalism and state-centred politics. In a grandstanding speech just after the election and in front of thousands of supporters in Budapest this was put on display. Orban said he saw his job of the next four years as to protect Hungarians from “profiteers, monopolies, cartels and imperial bureaucrats” – an explicit dig at Brussels. Achille’s heel This has impacted on key aspects of Hungarian life. Last year, the domestic gas distribution business of German utility company E.ON was renationalised and given to the state-owned Hungarian Electricity Works. The prime minister has signalled his intention to increase Hungarian ownership of the banking system to 50%, made possible through a national buyout of foreign-owned banks that have suffered thanks to high taxes and non-performing loans. At 17%, according to S&P, NPLs are a distinct economic Achille’s heel. Nationalism is not just apparent at a corporate level;it is obvious at a street level too. The nationalisation of the country’s tobacco kiosks in the spring last year, for example, has had the side-effect that the word ”Nemzeti” or “National” is emblazoned on every street corner. There was a distinctly authoritarian flavour to Orban’s first term in office. Aside from a media clampdown, the government has also rewritten the country’s constitution, changed electoral rules and moved election boundaries in its favour. And with to two new nuclear generators in the central Hungarian town of Paks, which have been financed with a US$13.8bn loan from Russia, the prime minister’s eyes are increasingly turning to Moscow. It is notable that Hungary has not supported opposition or sanctio

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. When Marcus Svedberg used to visit Warsaw, he would always swing by the Treasury to discuss the latest round of sales of state-run assets. But on his latest trip to the Polish capital, in March 2014, chief economist at East Capital decided to re-jig his schedule. Poland is in the midst of a mini-economic revolution. May 1 marks the 10th year of its accession to the EU, and the advances that the largest economy in CEE have made can be seen clearly in the legacy of the nation’s highly successful privatisation programme. Since the turn of the century, the Polish government has raised US$24.9bn by shedding state assets, according to Dealogic, though earnings have slipped in recent years. The state earned US$7.6bn from asset sales in 2007, at the apogee of the privatisation process; by 2013 that number had declined to US$3.1bn. The number of sales has also fallen sharply. Between 2009 and 2011, the government divested 760 state-run assets out of a target of 802. In 2012 and 2013 combined, that number fell to just 240, from a target of 300. Paweł Tamborski, Under-Secretary of State at the Ministry of Treasury, admits that the fervour to sell state assets has waned in recent years. “Our current plan is to privatise 250 companies this year, the majority of which are rather smaller companies when compared with previous privatisation programmes”, with the aim of raising around US$1bn, said Tamborski. One-third of the total will come from the sale of small and medium-sized companies to Polish entrepreneurs, the larger of which, he added, might appeal to foreign investors. The remainder will comprise secondary sales, mainly accelerated bookbuilds – Tamborski admits there are no obvious candidates for initial public offerings in this year’s crop of assets. Poland finds itself in a strange place. Its capital markets have developed apace over the past decade, precisely because the Treasury has aggressively promoted the sale of public assets, many of which were listed on the Warsaw Stock Exchange (GPW). The development of Polish capital markets and encouraging issuance from the private sector has been high on the Treasury’s agenda. Svedberg said Poland was one of the few capital markets in emerging Europe with genuinely powerful domestic mutual and pension funds that are also leading players on the GPW, “so it is less dependent on external funds”. But in December 2013 that all changed, when the Polish parliament passed a bill requiring open pension funds (OFEs) to transfer 51.5% of their assets, mainly Treasury bonds and Treasury bills, to the state’s Social Security Institution. In a report in February titled “How the Polish pension fund reform will affect the fund’s investments” law firm Allen & Overy said: “OFEs with less money to spend mean that issuers looking for capital on the market may face more difficulties selling their securities at a satisfactory price or selling them all, which may in turn shift their attention to foreign investors with potentially deeper pockets.” Vanity exercise This creates a serious headache for the Polish Treasury. Tamborski has tried to dismiss the importance of the move to nationalise the majority of Poland’s private fund managers, saying it was little more than a vanity exercise, designed to trim the ratio of debt-to-economic output below the 50% mark. Tamborski may or may not believe his own words when he said privatisations had become “less important from a budget revenue perspective and in terms of transformation of the Polish economy”. But the government’s actions will also more than likely cut the knees off the nation’s once-vibrant securities market. “I do not expect that private issuance will immediately replace privatisations dollar for dollar,” said Karol Poltorak, director of Poland equity capital markets at Citigroup, though he

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. The CEE high-yield market is gaining momentum as banks scale back their balance sheets, forcing companies to look elsewhere for cash. The phenomenon is well under way in the West, but has been steadily spreading east. In 2012, the CEE region, excluding Russia and Turkey, saw US$4.3bn in issuance. That figure more than doubled to US$8.7bn in 2013, implying that high-yield issuance grew considerably faster than DCM issuance. Although this was skewed by a number of very large deals, such as Play’s €900m debut bond deal in January, it is still an encouraging trend for the market. Polish TV broadcaster TVN was credited with kicking off a flurry of high-yield deals in the region in September when it issued €430m of bonds to refinance existing debt. The deal was priced at 7.378%, its lowest coupon ever, an indication of things to come in later months. Play was one of the stand-out deals of the past 12 months in terms of size and the excitement generated among investors. A strong growth story, the Polish telecoms company has established an 18% market share, despite only entering the market in 2007. The bond issue was split into €630m of senior secured debt, rated B1/B+/B+, with five-year euro and zloty tranches, and a €240m 5.5-year non-call 2.5 senior unsecured tranche, rated B2/B–/B–. The senior euro tranche was priced at 5.25%, with the unsecured euro tranche at 6.5%, while the senior zloty tranche, a mere Z130m (€30m), was priced a little wider at 350bp. However, the smaller economies in the region are increasingly turning to the capital markets as well. RCS & RDS, the Romanian and Hungarian cable group, issued a €450m seven-year non-call three senior secured bond offering in October that experienced incredible demand, allowing it to be both accelerated and upsized by €100m, and being priced to yield 7.5%. In Bulgaria, Vivacom’s €400m five-year non-call two senior secured issue was priced at 6.625% in November, the same month in which SBB-Telemach, or Serbia Broadband, issued its own deal backing an acquisition by KKR. It priced a €475m senior secured bond issue at 7.785%, despite concerns about a loose covenant package. Evidently, investors did not take too much persuading to consider deals on the other side of the former Iron Curtain. The development of the high-yield market in CEE promises to make financing available for companies for which the bank market has become a much harder sell. Under new owners and having gone through a restructuring, Vivacom had reached its limits in the bank market but was looking for a capital injection to give it breathing space for the next five or six years without necessarily making any covenant adjustments, said Tanneguy de Carne, head of high-yield at SG. The bond market provided this where it is unlikely the bank market would have, he said. The growing influence of the high-yield market owes much to the technology, media and telecommunications sector, from which all the examples cited so far are taken. It is the same sector that nurtured the growth of high-yield in the US. TMT has always been the stronghold for the high-yield market and still provides a large number of deals coming through the pipeline globally. But this is especially true in CEE. It is easier for investors to make investments outside their geographical comfort zone if they are in sectors with which they are intimately familiar. Evidence can be found in CEE TMT names currently trading on Nasdaq. A TMT credit in Germany is broadly comparable to one in Romania or Bulgaria, said De Carne. Widening the scope But as CEE matures, the high-yield market should attract more names from other sectors. “This is already starting to happen, we have seen deals from other sectors like health and services,” said De Carne. “We need to see more deals from energy, capital goods a

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Despite political and social upheaval in Turkey, most view it as strategically vital, with huge long-term growth potential. Since the financial crisis, Western banks have been busily selling off non-core businesses to focus on their core markets. This phenomenon has been evident around the world, especially in emerging markets. “International banks are under pressure to optimise returns as capital remains a scarce commodity,” said Guy Stevens, managing director in the EMEA financial institutions group at UBS. “In many international markets where institutions do not possess critical mass or have a niche business model, they are struggling to do this.” It is not just a commercial decision. “We have seen European banks that have been recipients of state aid being forced to divest by the European Commission,” said Stevens. “The problem in those situations is that it is difficult to achieve the value you are looking for.” Yet relatively few banks have divested their Turkish assets. One exception was Dexia selling DenizBank to Sberbank in 2012. But that was less a strategic decision than part of the dismantling of a failed institution. Examples of banks taking a strategic decision to exit Turkey to focus on other businesses are hard to come by. There may soon be a few more examples to choose from. Rumours have been circulating that the National Bank of Greece, which has a large stake in Finansbank, may be considering divesting its asset. The bank had been found wanting in a stress test but, unlike three of its Greek peers, it indicated it would not be raising money in the capital markets. That has triggered speculation about other ways it might strengthen its capital base, with stake sales in foreign banks seen as one viable option. Yet there has been no concrete indication from NBG’s management that it is planning such a sale, and there is a general suspicion that NBG’s management would hate to lose Finansbank. Elsewhere, some have speculated that ING might not be committed to its Turkish business. With a mere 1.9% of banking sector assets at the end of 2012, the business is not seen as particularly profitable. If it cannot generate a better return on equity from its Turkish business, the argument runs, perhaps it would be better off exiting the business. But a spokesperson for ING, while declining to comment on rumours, pointed to comments by its CEO to analysts in March that identified Turkey as a growth market for the bank. Whatever the truth of all the speculation, on the whole Western banks clearly see Turkey, along with Poland, as important growth markets. Those that have a foothold in the country are therefore likely to hold on to those assets, whether that is through a direct stake in a local banks, such as BBVA’s stake in Garanti, or through joint ventures, such as UniCredit’s JV with Koc Group, Yapi Kredi. “While we saw massive deleveraging across CEE after the financial crisis, we saw it less in Turkey,” said Abbas Ameli-Renani, emerging markets analyst at RBS. “Turkey is a very big market with favourable demographics; it can’t be ignored,” he said. “It is profitable and has better growth dynamics than most countries in the region, with credit growth coming from a relatively low level.” Scope for growth Far from scaling back, there is, if anything, the prospect of greater foreign participation in the Turkish banking sector. By regional standards, foreign bank ownership in Turkey is relatively modest, with most of the big Turkish banks domestically owned. In Hungary, by contrast, 90% of the bank sector is in foreign hands. “Turkey is in the rather unique situation of seeing interest from both the West and the East, in most markets you see interest predominantly coming from one side or the other,” said Stevens. In Russia, Renaissance Capital has been beefing up

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. When Ludwik Sobolewski became CEO of the Bucharest Stock Exchange (BVB) in July 2013, few could deny he had the chops for the job. The bourse’s president, Lucian Anghel, was quick to underline his new hire’s credentials. Sobolewski ran the Warsaw Stock Exchange (GPW) for seven years with great aplomb, turning it into the largest independent bourse in Central and Eastern Europe. Listing candidates from across the region flocked to Warsaw from the early 2000s, some bypassing Vienna, home to a much larger, CEE-focused bourse, as well as the likes of Paris, Frankfurt, Moscow, and London. Withering But since Sobolewski left under a cloud in late 2012, Warsaw has lost much of its once considerable allure. Initial public offering issuance totalled just €18m (US$24.9m) in the first three months of 2014, said PricewaterhouseCoopers in its quarterly IPO Watch Europe report, against €58m the previous year. Strengths are being perceived as weaknesses. And the government is not helping much.The rush of privatisations that opened up key sectors from banking to telecoms to energy in the 1990s and 2000s is now virtually over: the Polish state has sold, and listed, virtually every monetisable asset. Even current GPW chief executive Adam Maciejewski admitted in April this year that the privatisation process, “which for many years spurred on the growth dynamics of the capital market’s development … is coming to an end”. The decision this year by Polish authorities to seize US$51bn worth of privately run pension funds, previously controlled by institutions that held 43% of the GPW’s free-float assets, and transfer them back into state control, will further weaken its position as a regional magnet for IPOs, by making it harder for issuers to find buyers. Warsaw won’t shed all of its regional influence overnight, but recent events have unsettled investors and would-be issuers. The GPW has never been a particularly deep or liquid market, at least compared with the Wiener Boerse in Vienna. It needs fresh IPO blood to keep the oxygen circulating, and in recent quarters new listings have been become both smaller and thinner on the ground. Modelling Warsaw That throws the BVB’s smart decision to snap up Sobolewski last year into sharp relief. Romania is clearly attempting to follow the model that proved so successful for Poland for nearly two decades. Bucharest is pushing through an aggressive, Warsaw-esque privatisation programme. The November 2013 IPO of Romgaz raised US$530m, while total domestic equity capital market issuance reached US$1bn in 2013, up from US$76m in 2012. Sobolewski points to a host of forthcoming IPOs this year, from the initial stock sale of power distributor Electrica, set to raise up to US$700m, to the second-half IPO of coal power generator Oltenia. Such sales are vital for Romania’s drive to create a regional securities trading hub. “Privatisations are extremely important for the development of the local capital markets, because the positive experience of more developed economies showed that the competition for foreign investments was directly influenced by the IPOs of large state-owned enterprises,” Sobolewski said. They also suck in foreign capital, giving local pension funds and insurers the chance to expand and grow into the market they know best. Next on the tick-list: a push to complete more corporate bond sales, while listing more smaller Romanian enterprises on the BVB. Bucharest’s determination to walk in its peer’s considerable footsteps has been made publicly and regularly clear by leading BVB officials. “In Warsaw, we attracted issuers to increase the size of the market,” Sobolewski said. “Does the BVB need issuers? Yes. In Warsaw, privatisations grew the market and liquidity. Does BVB need privatisations of SOEs? Yes. In Warsaw we built out our market

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Grin and bear it. It’s been that sort of year for the Central Bank of the Republic of Turkey, which has suffered the sort of torrid time usually reserved for panic-stricken African or Latin American markets. The US Federal Reserve’s decision to begin tapering its QE programme put the lira into a tailspin against the dollar. Branded one of the “fragile five” emerging nations due to its yawning current and fiscal deficits – both of which remain a concern – investors fled, crimping growth and driving up inflation. Yet the central bank has fought back hard this year, impressing investors with aggressive decision-making and a willingness to stand up to Recep Tayyip Erdogan’s administration. Turkey’s prime minister reacted with barely concealed fury after the central bank, refusing to bow to political pressure, raised interest rates by a hefty 500bp on January 28, after the lira hit a record low of TL2.39 against the US dollar. A fortnight earlier, it increased the marginal funding rate to 12%, from 7.75%. And there, barring a slight trimming of the liquidity lending rate on April 24, to 13.5% from 15%, borrowing and lending rates remained through the first four months of the year. It’s a situation that is far from ideal for anyone apart from yield-hungry global investors – barring Brazil, Turkey’s central bank oversees the tightest monetary policy rate of any major emerging market. But after a hard year, there appears to be light at the end of the tunnel for the beleaguered institution. “Global and domestic financial conditions have improved significantly, so the need for much tighter policy is disappearing. Improvements in risk indicators put us in a better position in regard to key interest rates going forward,” said Turalay Kenc, Deputy Central Bank Governor, in an interview with IFR. Laying the groundwork The former Imperial College London academic is not ready to pledge the return of looser monetary conditions just yet. Inflation, for decades the bane of Turkish political and economic leaders, remains a key concern; according to the state-run Turkish Statistical Institute, consumer prices rose by 8.39% year on year in March 2014, the fastest rate of increase in 20 months. Yet the CBRT tips consumer and producer prices to peak in May before declining; Kenc said that while inflation “will worsen for a month or two, prices will come down in the second half of the year, and when they do, the economic picture will look much better”. Only then will the central bank, which fears a negative reaction from investors in the event of a “premature cut in interest rates”, said William Jackson, emerging market economist at London-based Capital Economics, consider a looser policy framework. But the groundwork is clearly being prepared. CBRT governor Erdem Basci has hinted at the possibility of cutting rates; in the medium term, the monetary policy committee he oversees is likely to pursue more modest measures, such as cuts in required reserve ratios. Deputy governor Kenc flagged up this likelihood, noting that front-loaded monetary tightening adopted in January “will ease off as the inflation outlook improves. This puts us in a better position in regard to key interest rates”. The central bank’s second inflation report of the year, published on April 30, provided investors with a more refined outlook on Turkish consumer and producer prices. Some critics believe the only difference, other than vastly higher interest rates, between the Turkeys of 2014 and 2013 is that investors have a better mental grasp of the speed and scale of the Fed’s tapering process. Officials in Ankara still face many of the challenges that last year so enfeebled the economy: a yawning current account deficit, running at about 7% of output; inflationary pressures; and GDP likely, said governor Basci, to come

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Real estate group Emlak Konut defied the markets with its revived US$1.6bn follow-on share issue last November. Some investors, however, were stung when a corruption scandal forced them to dump their stock only weeks later, which, coupled with political instability, has left many issuers and investors waiting in the wings. Emlak, whose biggest shareholder is state housing authority TOKI, first sold shares to the public in November 2010. The REIT has privileged access to state-owned land, which it auctions to real estate developers for a share in the revenue generated. In June last year, the state-owned property developer postponed a 1.3bn-share follow-on offer set to raise more than US$2bn as civil unrest in Turkey knocked nearly 13% off the BIST 100 Index. Though the market recovered a little ground and Emlak was suspended during the deal, it was hard to find a price to suit new and existing shareholders. It finally sold 1.3bn shares at TL2.5 each in a secondary share sale in November. Lessons were learnt from the previous aborted attempt in June, when the US was left until last on the roadshow and the deal coincided with protests on the streets in Turkey. With US funds driving the rally in Turkish stocks since then, the decision was taken to split management, with one team starting in New York and then Boston, and also to accelerate the sale with just three days of bookbuilding. As a result, the US dominated the book, with more than 40% of orders, followed by the UK with 20% and the rest of world also with 20%. Domestic institutions took 10%, with the remaining 10% going to retail. “As a huge secondary public offering, it was a success at that time. But of course, after the secondary public offering, the corruption probe devastated the [company’s] reputation,” said Kurthan Atmaca, equity analyst at Deniz Invest. Shares in the property developer slumped by 14% when its chief executive officer Murat Kurum and two board members were called in for questioning amid scores of arrests tied to an investigation into allegations of graft involving government officials and public tenders. They were released after questioning, the company said, on December 22. But for many investors, particularly US funds, selling off their shares was the only option. “For most of the American-based funds, if there is any risk of corruption, even if there is speculation, they prefer not to invest,” Kurum added. Lined up Turkey is home to the cancelled ECM trade due to local market volatility often killing off trades. The country lumbers at the lower end of market cap to GDP ratios versus other emerging markets. In total last year, TL4.6bn was raised on the equity markets through IPOs and SPOs, compared with TL5.1bn of funds raised on the equity markets in 2012, with the lion’s share coming from Emlak’s secondary public offering (about TL3.25bn), according to data from Borsa Istanbul. However, in the long term, Turkey’s capital markets are expected to pick up speed, with more companies opting to turn to the equity markets. “The speed of IPOs has declined over the last year or so, but looking forward, I think more companies will be inclined to open to the public in order to tap into an equity investor base. I can see that happening, especially when your cost of financing increases… We’ve started to have a positive change and corporate culture in favour of capital markets, also evidenced by the increasing number of corporate bond issuances,” said Didem Gordon, CEO of Ashmore Turkey. For now, political instability and the corruption scandal have stoked high levels of volatility across the financial markets in Turkey, scuppering hopes of any large IPOs in the near term. Local election results on March 30 prompted a strong rally on markets, with the outcome viewed as reducing political uncertai

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Thanks to the double whammy of the tapering of quantitative easing in the US and political instability, which have rocked asset prices, investors in Turkey have been on a roller-coaster ride in the past year. Many, however, see little damage to Turkey’s long-term emerging market growth story, despite the headlines. Last year, Turkey particularly bore the brunt of the US Federal Reserve’s announcement that it would begin winding down quantitative easing. Turkey is particularly vulnerable to any pulling back of foreign investment in emerging markets due to its huge current account deficit and its reliance on external financing. Just over a week after the Fed’s surprise announcement on May 22 last year, a police crackdown on a small demonstration based in Gezi Park in Istanbul swelled into widespread anti-government protests that raged across the country. The lira and shares dropped further. “You have tapering coming to the global emerging markets and then you have a period of political instability. It was a very bad combination for Turkey. Not only was the market coming down but the currency was also extremely volatile,” said Emre Akcakmak, portfolio manager at East Capital. The political instability did not end there. Turkish assets came under further pressure at the end of the year when a wide-ranging graft probe began with a series of dawn raids and arrests that led to the resignation of three ministers and the dismissal of dozens of police officers. It revealed fractures within the AK Party and unnerved investors in the run-up to local elections this year. Emerging market currencies also came under fire as China’s growth slowed and the Turkish lira fell to record lows in January, prompting the central bank to implement massive rate hikes at an emergency meeting to protect its currency. However, a decisive win by Prime Minister Recep Tayyip Erdogan’s AK Party in the local elections on March 30, which retained its control of the two biggest cities, Istanbul and Ankara, and raised its share of the national vote assuaged some of the fears of the markets. “At least in the very short term, much of the uncertainties are removed from the market; now we need to see a bit of stability,” said Akcakmak. “We need to see if we’ve already hit the bottom.” The long game Turkey has been the darling of emerging markets investors after notching up 9% growth in 2010 and 2011. Since then, growth has not exceeded 4% and is now predicted to slow down further. In April, Moody’s cut Turkey’s outlook to negative, saying the political uncertainty in the country would weigh on weak points in its economy, notably its high external financing needs, damaging its growth prospects. The ratings agency also cut its forecast to 2.5% growth this year, citing political and financing concerns. “Moody’s expects a cyclical slowdown due to lower global capital flows, which will dampen consumption and investment… While these near-term projections partly reflect the dampening impact of a higher interest rate environment on domestic demand, they are a reflection of the long-standing volatility that has characterised Turkey’s growth model,” the agency said. Market volatility and the glare of the global media spotlight have also dented confidence in Turkey, with the BIST National 100 Index losing a third of its value since the Fed’s announcement last May to its lowest point in early March this year. “Following Gezi park protests, all of a sudden you have huge coverage from the international media, and then you have the corruption scandal … it’s usually not as easy as it sounds to repair that kind of damage,” said Akcakmak. An international capital flight that accelerated in the wake of the corruption scandals has raised concerns in the West. In the context of heightened political risk, it is potential new inv

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. For all the talk in recent years of “core” and “periphery” European nations, it’s easy to overlook the fact that the Continent has two sets of both. The first group roughly hews the eurozone in half, separating the “good” or fiscally upright nations of the north from the “bad” sweep of largely southern states. But look east and you see the same phenomenon at work, writ small. Central and Eastern Europe, much like the eurozone, remains a region split between countries that “work”, largely by cleaving to investor ideals such as fiscal probity, strong manufacturing bases, and low debt and labour costs, and those that for reasons both within (a lack of reformist zeal) and beyond their control (geography, conflict, irascible neighbours) don’t. This divide has created not just a two-speed region, but, said Gautam Kalani, Central European economist at Deutsche Bank, also “a two-speed recovery that divides countries with strong fundamentals from countries that are either struggling, or which rely more on external conditions being supportive”. Kalani points to successful core CEE nations such as Poland and the Czech Republic, whose manufacturing and export-led economies are bound tightly to the resurgent German growth engine; and nations whose stock with global investors has either risen (Romania) or remained stable (Hungary). GDP in 2014 is set to expand by 3.2% in Poland, and by 1.6% in the Czech Republic, according to the Economist Intelligence Unit, with industrial output having risen by 5.3% and 6.8% respectively year on year in February. Compare that with Ukraine, whose indebted, conflict-wracked economy is set to shrink by 2.3% this year, according to the EIU, or Slovenia, another contracting economy that utterly failed, in the post-Soviet era, to impose a reformist agenda. (See Slovenia.) Vienna-based Erste Group, a key player in the region’s banking sector, tips the economies of regional laggards such as Serbia to grow by just 1% in 2014, with Croatia only just breaking par. Geography matters Geography either aids or hinders a sovereign’s prospects. It can hardly be happen-stance that Poland and the Czech Republic, countries whose supply chains, said William Jackson, an emerging market economist at Capital Economics, are “inextricably intertwined with Germany’s”, are recovering fastest from Europe’s half-decade of malaise. It is no surprise that the likes of Croatia and Bulgaria “are struggling because their economies are more closely tied to Italy’s economy”, which grew by just 0.3% year on year in the final three months of 2013. But reform matters too. Take Bulgaria and Romania. Both, squeezed between the Balkans, Ukraine, and the Black Sea, suffer from topography and geography, but the two nations’ fortunes have diverged wildly in recent years. Romania, whose economy expanded by 3.5% in 2013, has visited the sovereign debt market four times in 15 months, raising US$5.5bn from a blend of seven, 10 and 20-year notes. A raft of regional peers, including Hungary and Slovakia, followed suit, printing well-received bonds. Meanwhile, Bulgaria, which saw its economy grow by just 0.9% last year, remains conspicuous by its absence, despite the clear hunger among global investors for higher-yielding CEE sovereign debt. The underlying reason – why global investors like Romania but shy away from Bulgaria – comes down to the former’s ongoing desire to reform, which trumps (though often only just) the yearning to remain within its comfort zone. Investors are keenly awaiting a trio of initial public offerings expected in the second and third quarters, from state-run power producers Hidroelectrica and Oltenia, and power distributor Electrica, set to net the state up to US$1.5bn. David Smart, global head, sovereign funds and supranationals at Franklin Templeton Investments, which

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Alisa Maric embodies the intimate relationship that exists in the Balkans between economics, politics – and chess. An economist by training, the former Serbian sports minister and one of the country’s most popular celebrities is also a woman grandmaster – the world’s highest-ranking chess title restricted to her gender. Any observer will tell you that in this part of the world outcomes in both economics and politics are determined like moves in a chess game – and when the pieces are positioned correctly, the result is assured. For Serbia and its otherwise troubled economy – like a chess stratagem that was failing badly – those pieces may just have fallen into place. A landslide victory for the ruling party in the March elections has provided an iron-clad mandate for sweeping economic reforms just as the country begins negotiations to join the EU that are likely to ensure that its government makes exactly the right moves. “This really is an opportunity for Serbia to push ahead because until now, ruling coalitions have typically been more fragmented and have not had the same level of power that this government will have,” said Peter Sanfey, deputy director for country strategy and policy at the European Bank for Reconstruction and Development and a specialist on South-Eastern Europe. “The EU accession process is going to take some years but the negotiations are likely to advance relatively quickly and will be very important for the overall reform mood in Serbia. They can really lock in some of the legislative changes and some of the administrative changes that are under way.” Daunting challenge On paper, Serbia’s economic challenges look daunting. It is running Europe’s highest budget deficit at 7.1% of GDP, public debt stands at 60% of GDP and rising, and the EBRD’s latest revision to its outlook suggests growth this year could undershoot the 1.3% it was forecasting in January. The consensus among observers is for growth of around 1% – a fall from last year when the accounts were artificially buoyed by Fiat’s investment of €1bn in a car plant at Kragujevac. Reform has long been on the agenda, but the country’s economy has struggled to make the transition experienced elsewhere in emerging Europe. “Serbia has been undergoing a long process to clean out the imbalances both in the public finances but also in the private finances, so growth has not been very strong. It’s on the recovery path and I think it will continue to recover, but it’s taking longer here than in some other parts of emerging Europe,” said Marcus Svedberg, chief economist at emerging markets specialist East Capital. In March, the Progressive Party (SNS) of Deputy Prime Minister Aleksandar Vucic won 156 seats in the 250-member parliament in polls called by the ruling coalition to bolster its reform mandate. Popular for his high-profile anti-corruption platform, Vucic was seen by voters as someone who delivers. The new government was sworn in on April 27 and has already unveiled a string of legislative initiatives. In a key sign of continuity, the strategist of Serbia’s reform process, Lazar Krstic, remains finance minister. What makes this moment particularly important for Serbia is the way the pieces now sit on the chessboard: EU accession negotiations began in January and the Serbians have also been talking to the IMF. Turning a corner Svedberg said: “I don’t see it as a sharp turning point because they have been heading in this direction for quite some time, but it’s a take-off: they have much better possibilities now – Europe is out of recession, they are out of recession, they are starting to see foreign direct investment coming in, they have a reformist government, and they have finally started negotiations with the EU.” A key theme in talks with the IMF is likely to be downsizing the public sec

To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com. Thanks to the Vienna Initiative, set up to stem outflows of capital by Western European lenders out of the region, the Austrian capital has built on its foundations of influence in recent years. Perhaps even the Mongol warriors knew. When the armies of Ogedei, third son of Genghis Khan, reached Vienna in 1241, they were there for a reason. The Austrian capital, powerful even then, was also viewed as the entry-way to Western Europe. Destroy it, and nothing remained between Ogedei’s men and the cities of Paris, Milan and Venice. In the end, they were saved by the Khan’s death, and the overnight disappearance of his armies from the plains of Europe. But nearly nine centuries on, Vienna remains a continental clasp, drawing together the disparate economies of Western and Eastern Europe. Vienna-based lenders, led by Erste Group Bank and Raiffeisen Bank International, remain the financial powerhouses of Central and Eastern Europe. According to the Bank for International Settlements, the combined exposure of Austrian financial institutions to the CEE region at the end of 2013 was €210bn, more than any other sovereign nation. A January 2014 report issued by the National Bank of Austria described the exposure of domestic lenders to the region as “fairly large, but broadly diversified, with more than 50% [of outstanding loans] in countries rated investment grade”. The relationship is based on trade as well as finance: the flow of Austria-made goods to the largest seven CEE states in 2013 outweighed combined Austrian exports to Switzerland, Italy and the US. “Austria is definitely still the gateway to Central and Eastern Europe,” said Michael Buhl, co-chief executive officer of Vienna’s flagship stock exchange, the Wiener Boerse (WB). Austrian corporates and banks piled into the region during the boom times of the 1990s and 2000s and remained as the clouds gathered over Europe. The Vienna Initiative, formed in 2009 by Austrian lenders and a collection of multilaterals and development banks, averted a potentially catastrophic outflow of capital by Western European lenders desperate to shore up capital in core markets. A rare example of public and private sector interests working for the common good (though the latter sometimes had to be dragged kicking and screaming to the table by taxpayer-funded multilaterals), the Initiative proved that Austrian investors “weren’t just fair-weather friends, and that our financial institutions were and will remain responsible and committed long-term investors in the region,” said Gernot Mittendorfer, chief financial officer at Erste Group Bank. “The eastern expansion of the EU and a focus on infrastructure have made Vienna one of the leading business locations on the Continent. Vienna is still the gateway to CEE and the place to be when doing business in the region,” said Gianni Franco Papa, head of CEE division at UniCredit. The same is true of Erste’s big Austrian rival, Raiffeisen. “There are no signs of a retreat [by] dedicated Western banks from CEE markets,” said a Raiffeisen spokesperson. In fact, the exposure of Austrian lenders to the eastern half of Europe has, since the advent of the Vienna Initiative, remained “more or less flat”, she said, despite the vicissitudes of two crises and a deep eurozone recession. Loyalty That’s not to say Austria’s lenders have stood still over the past five years, or failed to rejig their strategies to accommodate a changing world. Both have stuck it out in struggling CEE markets held back by the still sluggish eurozone, but they are prepared to respond decisively if political or institutional issues threaten their interests or foreign investment. In April 2013, Erste Group sold its Ukrainian division for US$83m, booking a US$200m loss on the sale. Mittendorfer said Ukraine was the only country where