Clare Nuttall in Almaty -

After two decades in the shadows, Belarus is expected to throw open its doors to large-scale international investment this year. Numerous privatisations and M&A deals, involving international as well as domestic investors, are on the cards as the country restarts its stalled reform programme.

The reasons behind this are a chain of events leading to a fundamental change in Belarus' situation. With the end of cheap Russian energy exports in sight, there is heavy pressure on Belarusian companies to modernise and become more efficient. And so on and off for the last three years Minsk has tried, with some success, to improve its business climate in a bid to attract international investments. "Belarus' economy remains largely state-owned and cash-strapped, and therefore, lacks the ability to modernise. In order for it to survive, private capital must be attracted, and there appears to be a clear realisation of this in Minsk," says Renaissance Capital in a recent report entitled, "Belarus: Possibly the last convergence opportunity in Europe."

July 2008 saw the launch of a new round of privatisations, which unlike previous privatisation drives, openly targeted foreign investors in various sectors. Plans for further reform of state-owned assets was set out in the 2008-2010 privatisation programme. Although this programme lost some its momentum in 2009 as the valuations of emerging markets assets dropped, some 150 enterprises have been selected for privatisation in 2010. While many of these are small and medium-sized enterprises, the Belarusian government is also considering the same for some large industrial assets, including the chemical plants at Homel and Grodna and a refinery at Navapolatsk. One or more of these companies is expected to be sold to a Russian investor, according to Renaissance Capital.

The government is now in the process of setting up a new national agency for investment and privatisation, which will report directly to the government, Deputy Economy Minister Andrei Tur announced on April 30. Legislation amending existing laws on state-owned assets has also been drafted.

Nonetheless, the crisis has caused government fund-raising plans to be amended somewhat. Economy Minister Nicholai Snopkov told an April investor conference that rather than the immediate mass sell-off of state-owned companies, the focus would initially be on issuing Eurobonds, BelTA reported.

Slow going

The interest in attracting foreign capital is a symptom of significant changes taking place in Belarus, which until recently was one of the slowest reformers in the post-Soviet space alongside Turkmenistan and Uzbekistan. Until recently, Belarus still had a quasi-Soviet form of centralised power, with many aspects of a command economy. State-owned enterprises still account for a large proportion of GDP.

With few natural resources of its own, Belarus' development model was highly dependent on cheap imports of oil and gas from Russia; preferential pricing for Russian energy allowed Belarus to prop up its industry and to generate export revenues by processing cheap oil and selling the output abroad. However, Belarus' relationship with its powerful eastern neighbour is starting to change. According to Renaissance Capital, the days of cheap Russian energy "appear to be coming to an end, as Russia has turned to economic pragmatism, with Belarus now receiving a far smaller proportion of its total energy imports under preferential pricing."

Renaissance Capital believes this could benefit the Belarusian economy. "Longer term, the positives outweigh the negatives," the report says. "There is an economic theory that suggests protecting industry through unfair competition... does not yield faster long-term growth; rather it simply preserves an inefficient economic structure. Belarus is a prime example of this." While Belarus has managed to achieve strong GDP growth, its economy remains very inefficient. In particular, it is one of the least energy-efficient economies in the world.

Turning to the west

At the same time, Minsk has started to look more towards the EU, which until recently has paid scant attention to Belarus. While concerns about political freedom and President Alexander Lukashenko's authoritarian leadership style remain, "Belarus and the EU are undergoing a sea change in relations as we enter the new decade," says the report.

2008 was a turning point. First, the war between Russia and Georgia in August 2008 forced the EU to engage with Belarus, to avoid losing it completely to Russia's international sphere of influence. Secondly, as demand for Belarus' main exports - potash and heavy machinery - fell, Minsk has started to seek financial inflows from Europe.

Further steps away from international isolation have followed. In January, Belarus, Russia and Kazakhstan launched a customs union - one of the largest common markets in the world. Belarus also joined the EU's Eastern Partnership programme in February 2009, and in March signed contracts with China worth $3.4bn for nuclear power construction and road upgrades.

Nevertheless, Belarus' relationship with Russia remains paramount. Lukashenko has repeatedly stressed that "Russia remains Belarus' major strategic ally," as have other top government officials. "Developing its relationship with the EU while not distancing itself from Russia will be central to Belarus' foreign policy agenda," writes Renaissance Capital.

Improvements to the investment climate and an easing of state regulation of business within Belarus started in 2007. Key reforms include streamlining the business registration process, easing taxation and creating a capital market. Today, business conditions are among the most favourable in the post-communist space. In the World Bank's "Doing Business 2010" ranking, Belarus was one of the top reformers, shooting up from 82nd to 58th place between 2009 and 2010.

The country has also "avoided the worst of the global financial crisis, largely due to strong growth in fixed investment, driven by housing construction financed under government programmes. This helped to offset weaknesses in consumption and external demand," says the report.

In addition to Russian companies, an increasing number of western investors have also entered the Belarusian market. These include TurkCell, Mobilkom Austria Group, Heineken, Generali PPF and Baltic Beverages Holding. Italian engineering firm Finmeccanica has also signed a memorandum of understanding with Belarus, following Prime Minister Silvio Berlusconi's high-profile visit in November 2009.

Today, Belarus still lags behind most countries in the region in terms of foreign direct investment (FDI) inflows. "We believe further activity by the Belarusian authorities to improve legislation and infrastructure for business in the country, together with its comparatively good performance during the crisis should attract a different type of foreign investor to Belarus in the near future," says Renaissance Capital, forecasting that FDI will resume its rapid growth path in 2010-11.