Charlie Robertson of Renaissance Capital -

The transformation of Baku (80% of Azeri GDP) in the past decade is stunning, and the city increasingly has the appearance of a 21st-century Gulf state city (à la Kuwait or Abu Dhabi), but with the attractive renovated Tsarist architecture of Europe's first oil city. The scale of the investment makes a visitor wonder how Moscow might look if Russia chose to spend its oil wealth on investment, instead of US treasuries - but Azerbaijan has far more oil revenues than Russia on a per-capita basis, and can afford to both invest and save.

The Azeri economy expanded tenfold from $6bn in 2001 to $63bn in 2011, and it recorded the fourth-highest annual average growth rate in the world over 2000-2011, at 12.7%. Only three demographically smaller (and also resource-rich) countries did better. The expected production of massive natural gas exports from 2016 should compensate for a decline in oil production that has already begun. In the meantime, the government is keen to develop the non-oil sector.

Debt ratios are, unsurprisingly, very low, with private sector debt at just 24% of GDP (2011), government debt at 10% of GDP (2011) and external debt at 13% of GDP (2010) - the three main rating agencies have 'BBB-' equivalent investment grade-ratings on the country, and we expect these to be upgraded. As with many of our favourite emerging markets, such good debt ratios make us bullish about asset prices. Having some of the best demographics in the CIS is encouraging too.

Having said that, there are, however, few assets to buy. There is no significant listed Azeri stock. Potential plans to IPO a government stake in International Bank of Azerbaijan (like Sberbank in Russia, but with higher non-performing loans), has been put on hold since June 2012. A number of companies do, however, issue external or local-currency debt instruments. The publicly owned energy giant, Socar, issued $500m of a debut five-year 5.45% coupon Eurobond in February 2012 that was eight-times oversubscribed, according to press reports. A smaller $200m Eurobond was issued by Azerbaijan State Railways in February 2011. We believe the state-owned electricity company, Azerenerji, may be next to issue a Eurobond. On the local market, Azerbaijani manat government three-year yields recently fell to around 3.5%, while corporate yields have fallen to around 8-9%, from 9-13%.

The sustained appreciation of the manat is what makes Azeri local debt interesting, aside from the obvious (a better yield than in the West). In contrast to Russia or Kazakhstan, the manat has appreciated steadily since 2003, with no volatility when oil prices plunged during the Western financial crisis of 2008/2009. For a currency comparison, Azerbaijan is now more like a Gulf state than a CIS republic. With its current account surplus of 27% of GDP (2011) and sizeable rise in offshore assets held by the sovereign wealth fund ($33bn), and as we assume currency policy will not change before presidential elections in late-2013, stability or appreciation of the manat remains very likely, in our view. Therefore, we think manat corporate or bank bond yields should translate into dollar yields in the high single-digits.

Lacking information

What are the problems for investors? A lack of research on the local names will be a constraint for investors - even macro data is harder to compile than in neighbouring Georgia - as will the effort required to find custodians and access to the market. The authorities do have reform plans to develop the financial markets, which we believe will help over time.

Politics appear stable, again making Azerbaijan resemble the Gulf states. Presidential elections are due around October 2013, but we think incumbent President Ilham Aliyev is very likely to run for a third term, and no one we spoke to suggested any significant challenger was likely. We think it is possible that, over time, Aliyev could advance a more reformist agenda, which may face resistance from powerful ministers and their associated companies, but we do not think this is a serious issue over 2012-2013. We discussed Nagorno-Karabakh and heard that Azerbaijan's military budget is now larger than Armenia's total budget, but heard just as often that conflict is impossible to imagine while Russia maintains its strong links with Armenia. On every other issue, Azerbaijan has good relations with Russia, and indeed with Turkey and Georgia.

To conclude, Azerbaijan has decades of energy wealth to look forward to, and it represents a diversification play for international investors in local fixed income, in our view. However, equity investors will need to be patient.