Graham Stack in Minsk -

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.

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