Ben Aris in Ulaanbaatar -

Crowds of several thousand Mongolians, some on horseback, gather on the grassy plain just outside the capital Ulaanbaatar every year in the second week of June. They have come from all over the country and the police wielding high voltage cattle prods struggle to keep control.

Then, quietly at first, a rumble can be heard from over the rise in front of the crowd before the first riders appear. Brightly dressed in traditional costume, Mongolian boys, some as young as four, run towards the waiting spectators.

Soon the grassy plain is filled with more than 100 charging horses completing the 30-kilometre race. The fathers, uncles and brothers, who have been waiting impatiently on their own horses in the crowd, spring out of the line to catch the reins of the boys' horse and ride off full pelt through the crowd with the rest of the clan in tow to the family's yurt to celebrate.

This is Nadaam, the country's biggest festival and a right of passage for male Mongolians, which has changed little since the times of the country's most famous scion, Genghis Khan.

Mongolia is about as far from anywhere else in the world as it's possible to be and the worst hit of any country in the world by the fall of communism. In 1991, it was ranked bottom by the IMF in terms of development. But like the riders on the hurtling horses, inexperience and difficult conditions are minor obstacles for this hardy people. GDP growth was in excess of 10% last year as foreign investors flocked to the steppe on top of a mountain, drawn by the mineral wealth the country boasts.

Being in the middle of nowhere has its advantages. While the country being wedged in between Russia and China certainly meant it was part of the communist world - the name Ulaanbaatar means "Red Hero" in Mongolian - the nomadic lifestyle of the people and the sheer distance from Moscow or Beijing meant the strictures of the socialist model were never rigorously applied.

After a difficult start, the Mongolians grasped the nettle in about 2004 and have implemented arguably the most liberal reforms in the CIS. Commodity dollars primed the pump, but the overhaul of the bank system, a series of flat taxes on the people and business, and the simplification of regulations governing the corporate sector have allowed the country to flourish to such an extent it is now ranked just ahead of Italy in terms of development, according to the World Bank's development index.

Mongolia is a dramatic example of the band of countries that sit on the rim of Europe's emerging markets, the so-called "New Frontier" markets. Long ignored by the buccaneering investors that flocked to the obvious destinations like Russia in the 1990s, the New Frontier markets have suddenly popped up on international investors' radar screens, and-out-of-the-way capitals such as Tashkent, Tblilisi and Ulaanbaatar are now on the travel itineraries of bankers from London, New York and Vienna.

The reasons are many, but include: a hunt for the triple-digit gains that these investors used to earn in Russia; the strong 10%-plus economic growth almost all these countries are putting in driven by consumer spending; high commodity prices that make even the most remote mineral deposit viable; and probably the adventure that comes with these trips.

Transitional poverty

The emergence of the frontier markets as an investment destination should not come as a surprise - but it does nonetheless. A decade and half of reporting on the mafia, alcoholism and bucolic poverty in the hinterland of this vast region has created a stereotype of chronic poverty that is misleading. Yes, many of these countries are poor, but unlike the poverty of places like Bangladesh, India and to a lesser extent China, the poverty of Bishkek, the Transdnieper or Ulaanbaatar is transitional not chronic.

The chairman of Mongolia's fast-growing microfinance bank Xacbank explains: "The poverty in Mongolia is a transitional poverty that was cause by the collapse of the system. However, the Mongolians are well-educated and able to work. We have an urban poor who want to do something with their lives but lack the access to finance," says CEO Hutagt Ganhuyag. "They have the wherewithal to remake their lives if they can get access to the capital."

Chronic poverty is caused by poor education and a lack of infrastructure to support commerce. However, emerging Europe never lacked for the former and, flawed as the Soviet regime was, it did put in place most of the basic necessities like power stations and railways. The bottom line is that there's no real reason why the frontier markets should not eventually catch up with the West in terms of the standard of living, provided they can find the investment capital to bring their crumbling infrastructure up to scratch.

And this investment is already happening. The three big economies in the region of Russia, Ukraine and Kazakhstan - the so-called "RUK" countries - have all attracted significant investment and built up large reserves of cash. They are now acting as nodes of investment for the rest of the region as this money spills out into neighbouring countries. For example, despite the rising investment into Russia, which reached $17.3bn in the first quarter of this year, it has been a net exporter of capital for the last decade. The move out to the rim of the region began with trade, was followed by factories and now it's the turn of the investment banks to move into the New Frontier markets.

Central Asia has caught the most attention of these swashbuckling investors. Russia's Renaissance Capital moved first and opened a Ukraine office years ago, but last year the bank set up the first fully-fledged investment banking operation in the Kazakh capital of Almaty to compete with the home grown bank Visor Capital.

Since then, the line of bankers at the immigration desk has got steadily longer. Earlier this year, the Kremlin's favourite investment bank Troika Dialog bought a brokerage in Almaty, as did the investment-banking arm of the Bank of Georgia, Galt & Taggart. Bankers in Tashkent report that of JP Morgan and Morgan Stanley were on a fact-finding mission to Uzbekistan in June. And amongst the leading Russian banks, Alfa Bank announced in July it is raising $3bn this year for acquisitions, specifically mentioning Kazakhstan and Azerbaijan as target destinations.

More recently, Minsk has become the latest hot Frontiers market as the government appears to be opening up to foreign investment and there has been a string of bank acquisitions over the last year or so. Russia's VTB Bank, Alfa Bank has already bought a bank there, and the most recent acquisition was by the Bank of Georgia. Galt & Taggart was the first investment bank to set up in to the parochial backwater of the Belarusian capital, when it opening an office in June. But it will soon be joined by Dragon Capital, which dominates the Ukraine investment banking market, according to comments by co-founder Tomas Fiala, who says his bank is also looking at moving into Moldova.

And several funds targeting the region have been launched. Sweden-based East Capital has several funds invested into places like Uzbekistan, Kazakhstan, the Caucasus and the Balkans. Compass Capital is the biggest local fund in Kazakhstan and has been raising money abroad. And in January, the Tashkent-based Eurasia Capital Management was buying assets in Uzbekistan and has a dedicated Mongolian fund, to name a few.

Twists on the Silk Road

Uzbekistan should be the jewel in Central Asia's crown. It is the only one of the five 'Stans to have a border with all the others, which makes it the natural distribution centre for the region. And with a population of over 25m it is by far most populous country in the region, giving it a built-in consumer market. Moreover, as one of the few countries in the former Soviet Union enjoying strong birth rates, Uzbekistan expects to become the second most populous country in the CIS by about 2030, overtaking Ukraine in the process.

Yet despite the obvious attractions, the country has been a bad tempered backwater for most of the last decade and a half. President Islam Karimov's "unique path" has been little more than an excuse for oppression, which culminated in a massacre of protestors in Andizhan last year. This correspondent was snatched from the street by the Uzi-totting secret service in 1996 for simply taking a picture of the president's car, despite having interviewed Karimov for two hours a few days previously.

The country used to live off its "white gold" - huge cotton plantations set up in Soviet times. But massive mismanagement of the water resources destroyed the soil in most of the main production areas, where the salt lies so thick on the ground it looks like snow. Output plummeted from 5m tonnes a year to an average of 3.6m in recent years, taking the country's hard currency earnings with it.

In the interview, Karimov talked the talk of reform, but within a few months he gave a famous speech in which he said that the republic was not going to squander its precious hard currency reserves on, "importing chewing gum," and shuttered the foreign exchange kiosks. The onerous exchange regime killed foreign investment dead and Uzbekistan was closed to business for all of the second half of the 1990s.

Economic growth has been very slow to take off, but the state's focus on import substitution and a few key sectors like mining and automotive production are finally paying dividends. According to official statistics the pace of growth is now picking up, rising 9.5% in 2007, against the 7.3% of growth in 2006 and 7% in 2005, according to official figures.

Agriculture, and especially cotton production, remains the most important part of the real economy, but the country also has significant mineral deposits - especially gold - that Standard & Poor's estimates has a total value of over $1 trillion. However, the government scored a real coup in May 2007 by signing off on a cooperation deal with General Motors to produce cars at the UzDaewooAuto plant in Andizhan, also the scene of the shootings that year.

During his brief flirtation with capitalism in the early 1990s, Karimov personally negotiated a joint venture with the South Korean Daewoo to build a car plant that the government took over after the Korean company went bust in 2005.

Now car production is booming and more than half of the cars produced in 2005 were exported, rising to about 60% by the end of 2006 and the plant hit its production capacity of 200,000 cars a year at the end of 2007; car production now accounts for a bit less than 10% of GDP.

Industrial production over took agriculture in terms of its share of GDP in 2007 and has been increasing by 11.9% over the first half of 2007 compared with the same period a year earlier, while the rate of growth of agricultural production has been falling and increased only 3.5% over the same period, according to official statistics.

With more hard currency in its pocket the government has felt more comfortable about loosening the fetters on private business and went as far as starting to ease the currency controls in 2003. The result has been a rising tide of foreign investment. "An influx of investors is a reflection of two issues. First, the bulk of the international condemnation following the events at Andizhan has seemingly passed. While the Uzbek government might not have fully rehabilitated itself in the eyes of the West, at least potential investors may worry less about what international sanctions might be levied upon the country going forward," says Andy Birch, an analyst with Global Insight. "Second, without any hard evidence to back up this point, the Uzbek government has seemingly committed itself more to attracting foreign investment to and modernizing and expanding its production capacities."

Foreign investment into the country grew by 20% year-on-year in 2006 and reached $416.7m by July of 2007 - 2.4 times the amount from a year previously over the same period, according to the State Statistics Committee of Uzbekistan. This year the government is predicting foreign investment will top $1bn, with most of it going into the fuel and energy, chemical and petrochemical, agriculture, water resources and consumer goods sectors.

There is a long way to go before Uzbekistan can be described as "open for business," but the more intrepid investors are already moving into Uzbekistan, anticipating massive returns should the door be cracked open a little wider.

The RFB Tashkent, the Uzbek stock exchange, was set up in 1994 under a presidential decree to deepen economic reforms, but has lain largely idle since then, with daily volumes of about $350,000 in 2007. However, at the start of this year, Eurasia Capital set up several funds that are investing into Uzbek stocks and more recently leading Russian investment bank Veles Capital registered a local entity and intends to make "significant investments" in equity before the end of this year.

As for the other countries in the region, the Kazakh stock market is better developed, but even this market is still in the early stages of development, where the free floats and liquidity remains small.

There is also a stock market in Kyrgyzstan that was created in the early 1990s during the country's flirtation with liberal economics before the former president Askar Akaev adopted the authoritarian ways of his neighbours. The stock market was set up in 1994 as part of the privatisation process that culminated in a voucher privatization programme in 1996. However, the main reforms to the stock market came in 2004 at the EBRD's prompting following the Rentengroup scandal: an issuer that raised $6m in 2004 and then absconded from the country with the money. However, the lack of investors means trading volumes are tiny.

Maybe the most interesting country in the region is Turkmenistan, which was run as a Stalinist police state until the former president Saparmurat Niyazov died at the end of 2006. Nevertheless, the new president, Gurbanguly Berdimuhammedow, has clearly started the process of reform and investors are sniffing around the capital of Ashgabat thanks to the country's massive natural gas deposits.

Minsk gives the green light

The first thing you notice when arriving in central Minsk is how clean it is. Outside the old Intourist hotel, where most foreigners are sent to stay, there are "keep off the grass" signs. And people do.

Like Uzbekistan, Belarus' President Aleksander Lukashenka remains an authoritarian ruler in charge of what US Secretary of State Condoleezza Rice dubbed, "the last dictatorship in Europe." It is the only one of the 15 former Republics to let the secret police keep its old name - KGB. However, unlike Karimov, Belarus has launched a real privatisation programme and is rapidly opening up to foreign investment.

Surrounded by booming economies in Central and Eastern Europe, Belarus was already drifting towards change: reform by osmosis. However, the process was catalysed by a row with Russia over gas prices in the winter of 2007. In the last six months Lukashenka has introduced a raft of reforms and Belarus' rubber stamp parliament is suddenly debating policy.

"Belarus is interesting at a lot of different levels," says Ian Hague, the co-founder of Firebird Capital, the biggest US fund working the CIS. "Because they have to pay European prices for gas now, they are no longer eager to be Russia's client state and want to encourage European investment."

The economy is already flying, putting a strong 8.1% of growth last year and is on course for 11% growth yearly over the next three years. And Belarus has the faster industrial production growth of any country in the CIS at 13.6% in the first quarter of this year against the same period a year earlier. "Given the country's geographical proximity to the European Union, investors have been waiting for the governmental green light for a long time and now they are rushing in," says Venla Sipila, who covers Belarus for Global Insight.

The next stage will be to open up the equity market to investment. The republic has already been caught up in the IPO fever that is starting to sweep the region. The largest Belarusian bank ACB Belarusbank says it plans to IPO in London this year in a listing that will be worth an estimated $0.5-1bn.

On the home front the state launched a programme to convert all its holdings into joint stock companies and legislative changes to underpin an equity market are in hand. In the middle of June the government made its plans explicit, signing off on a plan to sell stakes in 969 state-owned companies.

The moratorium on trading shares over the counter (OTC) was partially lifted on July 17 when the first batch of joint stock companies were opened to investors on the Belarusian Currency and Stock Exchange (BCSE).

Another 146 strategic companies will remain off limits to investors, but according to State Property Committee member Galina Drapeza, "starting January 1, 2011, there will be no restrictions on trade in shares of joint-stock companies."

Caucasus open for business

In the 1990s you could easily spot Tbilisi's best hotel, the Hotel Iveria. Located on the ancient city's main drag, Rustaveli Avenue, the hotel was notable not for rafts of black saloons parked outside, but because of all the washing that festooned the building's balconies.

The hotel was given over to refugees pouring out of the breakaway region of Abkhazia, some of whom lived there for years. The refugees are gone now but the strife over Abkhazia has, if anything, become worse. A violent showdown with Russia, which backs the regime in the capital Sukhumi, is possible and relations between Moscow and Tbilisi continue to deteriorate; in July Georgia recalled its Russian ambassador in a move that is tantamount to breaking off diplomatic relations with its larger northern neighbour.

Georgian President Mikheil Saakashvili has taken an inflammatory line in his foreign policy but he has also implemented some of the most radical and far-reaching economic reforms in the CIS.

In just over a year Georgia jumped from rank 100 out of 155 countries in the World Bank's Ease of Doing Business index of 2006 to number 18, just behind former Soviet Union leader Estonia. It was also named as the world's fastest reforming country in 2007 according to the World Bank.

CALL OUT: Georgia was fastest reforming country in the world in 2007 according to the World Bank. END

As a result economic growth soared to 12.4% in 2007, making Georgia the second fastest growing country in the CIS after oil-rich Azerbaijan, driven by, what prime minister Lado Gurgenidze calls "off the chart" in-flows of foreign direct investment.

Georgia's growth is impressive as unlike countries like Kazakhstan or Russia it doesn't sport any particular mineral riches, and with a population of 4.4m, nor does it have the appeal of a large consumer market like Ukraine or Uzbekistan. Yet the success of the reforms means that it is joining the RUK countries as a regional investment node.

The pre-eminent Bank of Georgia (which Gurgenidze built up before being appointed prime minister at the start of this year) is spearheading this charge and has already set up operations in Kyiv, Almaty and Minsk, positioning itself as a New Frontiers specialist.

The bank has also played a big role in developing the local bourse, where Bank of Georgia's own shares account for over three quarters of all the average trading volume. In 2007 the bank carried out Georgia's first IPO of winemaker Teliani Valley and has also set up galt & Taggart Capital, a fund to invest into domestic consumer story plays. The only really liquid shares on the Gerogian Stock Exchange (GSE) are Bank of Georgia, VTB Bank of Georgia, Teliani Valley and Galt & Taggart Capital.

"In general the liquidity of Georgian stocks still remains low in comparison with larger and more developed CIS markets, such as Ukraine and Kazakhstan," Galt & Taggart says. "Of 243 stocks admitted to trading on the GSE, only 58 stocks were traded in 2007, and only four of them were relatively liquid."

Ever since Bank of Georgia became the only Georgian company to list in London with a milestone $160m IPO in November 2006 it has become role model for small banks and companies in the New Frontier markets. The management of AUB Bank in Kyrgyzstan, the fastest growing bank in the country, say they were inspired by the Georgian bank and now have their sights firmly fixed on an IPO in the next few years.

The bank has also raised awareness of other opportunities in the financial sector in region. Neighbouring Armenia boasts what RusRatings, the leading regional bank ratings agency, calls "the best regulated bank sector in the region. Russia's Ruben Vardanyan, the found of Troika Dialog, bought a bank there last year and the ubiquitous Russian state-owned VTB Bank has also moved in.

However, it is Azerbaijan that has pique curiosities the most. The Azerbaijan session at this year's EBRD annual meeting Kyiv was so packed that the organisers had to close the doors and literally left some investors in the corridor listening at the keyhole.

Its the combination of 24.7% GDP growth in 2007 on the back of a record 35% growth in 2006, plus copious amounts of oil that has everyone so excited. Of all the New Frontier markets Azerbaijan is the best example of a country that was an economic basket case in 1990s now reaching critical mass and putting extraordinarily fast growth as it races to catch up with its peers. However, all the countries in the Caucasus - bar Georgia - are still stepping off square one.

But making money in the New Frontier markets is not going to be easy. True, the returns could be astronomical, but investing in the New Frontier is also like taking a step back five-years in time to deal with the problems that places like Russia used to offer. Returns are high because business is so hard to do.

Then why bother? There are two forces at work in the region at the moment. The first is the short- to medium-term repercussions of the US subprime debacle last year, which has cut most of these countries off from access to international debt and will slow growth. The second is the long-term historical convergence process of emerging markets with the industrialised countries of the west. These two forces are pulling in opposite directions at the moment and could produce some unpleasant surprises.

"The current problems in the international capital markets are going to impact the entire region and a new equilibrium needs to be found. We are not there yet and if the adjustment is rapid then we are talking about some sort of crisis," says Hague.

"However, the problems will probably force faster development of the financial markets within the region and also we should see more inter regional lending: Kazakh banks lending to Armenian companies and the like. But this needs real arms-length relations and these don't really exist yet. The upshot is most business deals will be private for the foreseeable future and investing in New Frontier public markets is still somewhere over the horizon."

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