Andrew MacDowall in Belgrade -

As a tiny, mountainous country with fewer than 650,000 people and scarce few natural resources in a relatively poor and troubled part of Europe, Montenegro would strike few as a natural investment magnet. But the statelet, independent only since 2006, has undertaken a concerted promotion drive across the world to raise its profile, while carrying out reforms to enhance the domestic business climate to attract new international investors like those from the Middle East and China.

While this strategy springs as much from recognition of the country's weaknesses and vulnerabilities, it has also sought to capitalise on competitive advantages, particularly in tourism. Nonetheless, the success of the coast is in contrast to relative underdevelopment in the interior. Montenegro may have one of the world's fastest-growing tourism industries, but other sectors lag behind. The lack of productive export-oriented industries is reflected in a yawning current account deficit; the International Monetary Fund (IMF) and World Bank urge further reform. Critics of the Montenegin government (and its independence from Serbia) argue that this is a luxury villa built on sand, and darkly suggest that the statelet is somewhat shady.

Over the past few years, Montenegro has emerged onto the radar as the "New Croatia", a sun-kissed Elysium with a sinuous coastline dotted with Venetian towns, with a backdrop of craggy mountains. The World Tourism and Travel Council (WTTC), a global organisation of industry leaders, forecasts that the country will have one of the world's fastest-growing tourism industries over the next decade. The sector's direct contribution to GDP is expected to rise by 16.8% in 2012, and average 11.8% annual growth to 2022; the broader "economic impact" (including indirect and "induced" effects on other areas of the economy) by 14.9% and 12.4% per annum respectively.

Montenegro is not only receiving a steady flow of visitors from former Yugoslav countries and a trickle of adventurous tourists from elsewhere, it is also now attracting some of Europe's richest and most influential people, from British financier Nathaniel Rothschild, who held his 40th birthday party in the country, to Russian billionaire Oleg Deripaska. Both have invested in the Porto Montenegro resort near the town of Tivat, which is widely regarded as Montenegro's flagship tourism investment. Porto Montenegro, majority-owned by Canadian mining magnate Peter Munk, features luxury apartments and a 185-berth marina. In January, the resort announced that ground was being broken on an 80-unit Regent Hotel while the marina was to be expanded to 370 berths.

Some of the most visible investors in Montenegrin tourism are Russian and British, both high-profile figures and individuals looking for property for investment or a holiday getaway. A drive down the coast takes one past many advertisements for coast real estate in Russian and English. But insiders tell bne that there is also growing interest from Middle Eastern investors, particularly from the Gulf. In November, developer Qatari Diar, owned by Qatar's sovereign wealth fund, announced a €250m project in a similar top-end resort in Montenegro. A high-profile visit from a Chinese delegation led by Deputy Prime Minister Hui Liangyu in March and April also bodes well for broadening the sources of investment.

The traction that Montenegro is getting is partly thanks to its natural advantages as a holiday destination. But credit also goes to the country's efforts at reform to enhance the business climate. The country now ranks 56th (from 183 countries) in the World Bank's 2012 "Doing Business" rankings published, and second only to Macedonia in the Western Balkans. "The competitiveness indicators within the Balkans region are relatively favourable, especially in the tourism sector," Anabela Abreu, World Bank country manager for Montenegro, tells bne. "The government is very committed to improving the business environment."

Abreu cites a number of major reforms, including simplifying and reducing tax and social security contributions, the establishment of a one-stop shop for business formation, and a new bankruptcy law. The country's unilateral adoption of the euro has substantially lowered currency risk - an important consideration for investors, particularly in real estate.

The government is also pursuing a number of bilateral agreements on investment, including accords with China and the United Arab Eemirates signed in April. In a recent meeting with EU representatives, Deputy Prime Minister Vujica Lazovic reiterated the government's commitment to pro-business reform.

With the global economy still sluggish and major European trading and investment partners struggling with fiscal crises and low growth, the open and heavily dependent foreign direct investment (FDI) economy of Montenegro cannot afford to rest on its laurels. "Inefficient bureaucracy has decreased gradually over the last three years, but remains one of the most challenging factors of doing business in Montenegro," Abreu says. "The high reliance of Montenegro's economy on FDI inflows makes continued reforms in this area an automatic priority."

Abreu notes that the "Doing Business" surveys have identified a number of areas in which the administration could operate more effectively, including construction permission, tax payments, contract enforcement, and property registration. Last year's assessment by the IMF also noted that "structural reforms should remain a top policy priority", citing labour market liberalisation as a particularly pressing example.

Interior problems

The glitzy success of the coastal tourism sector distracts attention from Montenegro's other challenges, including rural poverty in the interior and a struggling manufacturing sector.

The current hiatus over KAP, a heavily-indebted and loss-making aluminium plant in Podgorica, and insolvent steel mill Zeljezara Niksic does not help. KAP's future is uncertain, despite the government's announcement that it would take the plant over and pay some of its debt, while Zeljezara is being lined up for sale for the fourth time, at a significantly-reduced price. In the on-off privatisation of its metals industries, Montenegro thus lags well behind other Emerging European countries.

As recently as 2009, KAP accounted for more than half of Montenegro's exports - partly a sign of how weak other export sectors are. This much is clear from the country's current account deficit, which, while it has been significantly reduced in recent years, will still run at around 17% in 2012-13, according to the Economist Intelligence Unit.

Building up other productive sectors will be important to sustaining growth in the long term. The example of Bulgaria, which has endured a deep recession and a painfully slow recovery after the boom years of the middle of the last decade, is a warning against over-reliance on FDI in tourism and related real estate as engines of growth.

Abreu, nonetheless, takes an upbeat view. She cites energy, specifically hydroelectric power, as an area in which Montenegro has particular potential, asserting that it could become as much a success story as tourism. In her view, the country has come far, and could go much further. "Montenegro's economy has an enormous growth potential," she says. "Through the combination of further efficiency gains in key sectors of the economy and the realisation of large-scale, productivity-enhancing FDI in tourism, energy and services, Montenegro can set its economy onto a trajectory of sustained economic growth and close the per-capita income gap with the European Union within a generation."

Certainly Montenegro's small scale could stand it in good stead. There are few mouths to feed, and some of the world's most successful developed and emerging markets have diminutive but open economies. For the time being at least, the country is basking in international recognition and approval.