The Central Asian republic of Uzbekistan is set to overtake Ukraine to become the largest consumer market in the Commonwealth of Independent States within the next decade. Little more than a basket case economy since President Islam Karimov clamped down on foreign exchange in 1996, the source of most of the Soviet Union’s cotton has begun to flourish.

The only one of the five so-called ’stans’ to share a border with all the others, its 27m strong population is the largest in the region, making it a natural production and distribution centre. An increase in real disposable income in recent years, albeit from a low base, has stimulated consumer markets across the board. Official data shows that real disposable income increased by 20% in 2006 and by the same amount in 2007: Gross domestic product per capita is now US$2,300 on a purchasing power parity basis and is fuelling a shopping binge. Car sales doubled between 2005 and 2007. Mobile penetration is the fastest growing in the CIS growing from just 1.5% in 2005 to more than 35% in August 2008. And the 20% increase in imports in 2007 was in part due to rising imports of consumer products.

“Pretty much anything related to consumption - shops, banking and insurance, mobile phones, for example - is doing well,” says Akmal Mirsadikov, deputy general director of Ansher Capital, a local fund.

Still, given the country’s poor reputation, foreign investment has been patchy. Several successful local chains of eight to 10 shops have emerged in the retail sector, but the market is as yet too small to attract big international operators. However, it is a different story in other consumer-related markets.

In October 2007, General Motors announced a joint venture with state holding company Uzavtosanat, which has run the UzDaewoo auto factory since Daewoo’s bankruptcy in 2005. GM has a 25% stake in the joint venture, with the potential to increase this to 40%. At full capacity, the former UzDaewoo plant, in Asaka in Andizhan province, will produce 250,000 Chevrolets a year, to be sold in locally and in other CIS countries. As a sign of the deal’s importance, President Islam Karimov attended the signing.

Foreign telecoms companies such as MTS and Vimpelcom from Russia and the Nordic region’s TeliaSonera have bought into the fast-growing mobile telecoms industry. In the insurance sector, Russia’s Ingosstrakh bought up 76% of Tashkent-based Standard Investment Group as part of the government’s 2007-2010 development programme for the sector. “Uzbekistan is much more open, even compared with two or three years ago. Most of the laws were always there, but policy has changed a lot,” says Komil Ruzaev, managing partner of Essential Investments, a local brokerage.

Rather than the “shock therapy” and mass privatisations pursued in other countries, Mr Karimov followed his “unique way”, which involved gradual change, keeping taxes, subsidies and state spending high, and only gradually releasing control of major companies to the private sector.

The state remains heavily involved in the economy, but in the current turbulent climate, the country’s relative isolation has played to its advantage. “Recent supercharged high-flyers Russia, Ukraine and Kazakhstan have now found themselves at the epicentre of the ongoing crisis in the region,” says Alisher Ali Djumanov, managing partner of Eurasia Capital Management and believed to be the only alumnus of France’s Insead business school in the country.

“Uzbekistan, the fourth largest economy in the CIS, is in better shape because of government policies which at the time were considered to be too rigid and less pro-market. There is still a question of whether this policy will be better for the economy in the long term but, in the current environment, the conservative approach will benefit Uzbekistan. We believe the long-term investment story for Uzbekistan is intact.”

Eurasia launched Uzbekistan Growth Fund, the first Uzbekistan-dedicated hedge fund, in September. Its initial capital was US$5m but, according to Mr Djumanov it could grow substantially as the economy expands. “Uzbekistan has a centuries-long tradition of entrepreneurship and commerce. The ancient cities of Samarkand, Bukhara and Khiva were key trading outposts along the Silk Road. That talent is still there,” he says.

Abandoning its traditional job of growing cotton, over the past decade the government has been encouraging large-scale private investors to move into sectors such as manufacturing, mining, textiles and food processing. In the oil and gas sector, foreign investors include Russia’s Gazprom and Lukoil, China National Petroleum Company, Malaysia-based Petronas and Korea Gas. Europe has also been keen to secure supplies of Uzbek gas.

As well as its oil and gas reserves, Uzbekistan is the world’s ninth largest producer of gold, and has significant reserves of coal, phosphate and tungsten under the deserts in the west of the country. The Uzbek State Committee of Geology estimates total mineral potential to at about US$3,5000bn. Ratings agency Standard & Poor’s has independently estimated the value at close to US$1,000bn.

However, a dispute between US gold miner Newmont and the Tashkent government highlights the risks of doing business in Uzbekistan. One of the few large investments in the republic in the 1990s, relations turned sour last year. The dispute was settled by international arbitration in mid-2007. But, since then, new government regulation has tried to set clear rules on licences for exploration and mining.

Under the government’s 2007-2010 privatisation programme, opportunities to invest in large state-owned companies are also appearing. The most attractive are plans to sell a 49% stake in the national energy companies Uzbekneftegaz, the world’s 12th largest gas producer, and 35.55% of Uzbekugol, the largest coal miner in central Asia. Other companies to go under the gavel include Uzbekistan Airways, electricity company UzbekEnergo and two big banks - Asaka Bank and National Bank of Uzbekistan.

Source: Financial Times (UK)