Clare Nuttall in Almaty -

Mongolia's mineral wealth and open economy has established it as a rising star among the world's frontier markets, though the post-Soviet republics of Central Asia and the Caucasus, while also rich in resources, have never quite captured investor interest to the same extent. As well as the specific challenges of investing in the region, the current uncertainty that's rife among global investors has made it even more difficult for these countries to attract the long-term commitments they need to develop.

Kazakhstan set itself apart from the rest of Central Asia with several billion-dollar listings on the London Stock Exchange. Mongolia has since burst onto the international scene, with the $650m Mongolia Mining Company IPO on the Hong Kong Stock Exchange in October 2010.

At the other end of the spectrum, the four resource rich but under-developed markets of south Central Asia are characterised by high political risk and low transparency. Opportunities for exposure via public markets are rare.

The three Caucasian republics fall somewhere between these extremes. Oil-rich Azerbaijan is gradually diversifying and political reforms are in progress. Armenia's economy made a remarkable recovery from its contraction during the recent crisis. Georgia has a developed local capital market with a number of liquid stocks, and President Mikheil Saakashvili's efforts to eradicate corruption have boosted Georgia from 130th place in 2006 to 68th place in 2010 on Transparency International's Corruption Perceptions Index.

"The mistake made by some investors from outside is to think of the region as homogenous. Each republic is different and some of the differences are quite significant," says Talgat Kukenov, managing partner of Aureos Central Asia Fund.

Milena Ivanova-Venturini, deputy head of equity research at Renaissance Capital, bemoans the lack of investment opportunities in public markets outside of Russia and Kazakhstan. "Mongolia is the only other place with publicly listed equities of meaningful size," she says. "There have been talk about potential listings out of this part of the world, but nothing has so far come out."

Renaissance Capital's Rencasia index, which tracks listed equities across the region (though it is dominated by Kazakh equities), shows that "Central Asian indices are among the worst performers at present not only in [emerging markets], but in a global context as well," says Ivanova-Venturini.

Despite the challenges, the handful of investors focused on the region remain confident in its long-term potential. "Overall, we are quite bullish about the whole region. The main risk is if China slows down substantially," says Clemente Cappello, chief investment officer at Sturgeon Capital. "The economies are doing well and pricing is attractive, although there is still substantial political risk. In the current environment, everyone is uncertain, which does not encourage long-term investments in the region. When everyone is scared about what will happen in the next hour, they are less willing to commit to a frontier market."

Steppe up

Mongolia has become an exception to this rule thanks to its vast and mostly untapped natural resources, its strategic location between China and Russia, and - unusual in this part of the world - its relatively open economy. "Mongolia is an open country to investors, especially compared to some of the Central Asian republics," says Alisher Ali, chairman of investment bank Eurasia Capital, pointing to the country's "rave reviews" from institutions including the European Bank for Reconstruction and Development, the International Monetary Fund (IMF) and the World Bank. "True democracy is a big plus, but this alone is not enough. Mongolia's mineral wealth has really driven the interest of international investors."

Plans to exploit the country's resources are progressing fast. Rio Tinto and Ivanhoe Mines' $6bn development of Oyu Tolgoi, the world's largest untapped copper-gold deposit, is ahead of schedule. Production is expected to start in late 2012. According to Ali, this will be a "transformative event" for Mongolia, generating billions of dollars for the state.

Another milestone for Mongolia will be the much-anticipated IPO of Erdenes Tavan Tolgoi, owner of the Tavan Tolgoi coal deposit, with estimated reserves of around 6bn tonnes of coal. The IPO, which is likely to be in the range of $5bn-5.5bn, is expected to take place late this year or early 2012. Spurred on by these and other smaller projects, Mongolia is expected to be one of the fastest growing economies this year, with the IMF forecasting growth of 9.8% in 2011.

The Mongolian government, however, is struggling to expand road and rail infrastructure to keep pace with the development of the country's natural resources. As Ivanova-Venturini points out, "monetizing on a lot of the resources is going to be a long-term prospect, with execution risk and raising the necessary investments for infrastructure being the main tension points."

Not only has Mongolia tapped international markets with the Mongolia Mining Company, but the domestic stock exchange is becoming increasingly active and has signed a three-year development programme with the London Stock Exchange. Although still small by international standards, with a market capitalisation of just $1.6bn, the exchange was the world's best performer in 2010. This is expected to continue, with a wave of IPOs expected on the local stock exchange, predicts Ali.

Back to Baku

Azerbaijan is also known for its natural resources, particularly oil and gas. In 1994, Baku signed the deal dubbed the "Sale of the Century" with a consortium of international oil companies led by BP to develop the Azeri-Chirag-Guneshli oilfield. Until recently, the economy has been unhealthily dependent on hydrocarbons and distinguished by its high corruption level. But the process of change that started with the infrastructure investments during the economic crisis has been accelerated by recent government reforms.

This spring saw a series of hastily suppressed protests inspired by the "Arab Spring". It was no coincidence that in January, the Azeri government announced new anti-corruption measures. Observers on the ground say that concrete changes have been made, with investigations leading to dozens of dismissals among state employees. This was accompanied by a gradual diversification of the economy. "In Azerbaijan, revenues from oil and gas are trickling through society. The interesting sectors are those that give exposure to the emerging middle class," says Cappello, citing sectors such as financial services and retail.

Until recently, investment in Azerbaijan was further complicated by the lack of a local capital market, but the government is also making a concerted effort to develop the stock exchange. Azeri companies may also decide to tap international markets in the near future - state oil and gas company Socar has already indicated that it will. Cappello forecasts Socar will issue a Eurobond in the near future. "Once one large state-owned enterprise sets a benchmark, other companies will follow," he says, adding, however, that private equity is still needed to access most investment opportunities in Azerbaijan.

Also possessing large endowments of oil and gas and minerals, Central Asia's second-largest economy Uzbekistan has the potential to become a dynamic frontier market, but it needs even bigger reforms than Azerbaijan. Tashkent's recent record is ambivalent: Islam Karimov's November 2010 speech outlined wide-reaching reforms to the business environment and some steps towards liberalisation were made, but they have been accompanied by a clampdown on foreign investors.

Lawyers acting for Oxus Gold say the company is being forced out of the Amantayau Goldfields joint venture by its state-owned partners, while investors from Germany, South Korea and Turkey have also experienced difficulties. This is a pity because Uzbekistan has the largest gold reserves in Central Asia, as well as substantial deposits of uranium, copper, zinc and other metals, in addition to oil and gas. "If there is to be another internationally listed major mining company from Central Asia, on the scale of Kazakhmys or ENRC, it will come out of Uzbekistan," reckons Askar Yelemessov, chairman of Troika Dialog Kazakhstan.

"Not only does Uzbekistan have more gold than Kazakhstan, it also has some large mines and a very substantial mining complex that it inherited from the Soviet Union," Yelemessov tells bne. "Unfortunately, the large companies such as Navoi Mining and Metallurgical Combinat that are exploiting its resources are not listed, and Uzbekistan does not yet have an international rating. For Uzbekistan to list companies internationally would be major departure from the existing model of building the economy based heavily on their own resources."

Until then, investors are looking for alternative targets in the smaller, but more open, republics of Kyrgyzstan and Tajikistan.

Niche markets

Small mountainous republics, with populations of 5.3m and 6.9m respectively, Kyrgyzstan and Tajikistan have substantial mineral reserves that are largely untapped, and have attracted a handful of investments despite the problems of poverty, instability and corruption.

But a high level of political risk remains. Kyrgyzstan has seen two revolutions in six years and the threat of a resurgence of the deadly ethnic clashes seen in June 2010 remains. As recently as July, several hundred police were deployed to end a standoff between Kyrgyz and Uzbeks in the southern town of Aravan. Meanwhile, President Emomali Rakhmon of Tajikistan, the former Soviet Union's poorest republic, has maintained a precarious stability since the end of the civil war in 1997, but there is a constant threat of insurgency from neighbouring Afghanistan.

Although there are similarities between the two, Kyrgyzstan is considerably ahead of Tajikistan. It has close economic ties to Kazakhstan, is a member of the World Trade Oragnization and is set to join the Customs Union (with Russia and Kazakhtsan) possibly as soon as next year. "We are confident in Kyrgyzstan, despite the political turmoil, and to some extent in Tajikistan, even though this is the poorest Central Asian republic," says Aureos' Kukenov, who backed Kyrgyz cable company Ala TV in 2008. "This is mainly because the private sector in these countries is much less controlled by the government than in Turkmenistan or Uzbekistan, where it is very difficult to do private equity deals."

However, both markets still have a long way to go. Tajikistan does not have a stock market, while in Kyrgyzstan the main domestic market, the Kyrgyzstan Stock Exchange, merged with its rival in March in the hope of boosting turnover. This fell from a high of $130m in 2008, to just $10m in 2010 due to a combination of the international economic crisis and the local political turmoil. Further growth of these potentially attractive markets will depend on political stability and progress in building infrastructure and fighting corruption.