Ryskeldi Satke in Bishkek and Naubet Bisenov in Almaty -

With a mining venture with a foreign investor going sour and continued worries about stability in this Central Asian state, Kyrgyzstan is struggling to attract the kind of investment needed to get its economy moving. The answer it seems is to turn to Russia, though local industry players worry that subsequent murky deals will do little for the country's embattled mining sector.

The longstanding battle the Kyrgyz government has been engaged in to win an increase in the country's share of the flagship gold mine Kumtor, which accounted for 7.4% of GDP and nearly a quarter of industrial output in 2014, has tarnished Kyrgyzstan's image as a reliable partner for foreign investors.

Via the state-run mining firm Kyrgyzaltyn, the government holds a 32.7% stake in Kumtor's developer Centerra Gold, a Canadian company. In an effort to renegotiate the joint venture to turn it into a 50-50 deal, it has used environmental, health and safety, and other legislation to hinder the mine's operations. The failure to reach a deal brought down the government of Djoomart Otorbayev in April, the third to fall since 2010, raising concerns over the political stability in the country.

The mess has contributed to the complicated situation regarding the mining sector, turning Western investors away from the country. According to the Kyrgyz economy ministry, foreign direct investment in the country’s mining sector was down by around 90% on year to $1.7mn in January-September 2014. “The government's negotiations with Centerra have very badly damaged the flow of foreign investments in the mining sector,” Valentin Bogdetskiy, a board member of the independent Kyrgyz Mining Association, tells bne IntelliNews. “All companies present have mothballed their investment programmes and are hardly making any investment in exploration and the development of mines.”

The government's attempt to amend legislation to extract more taxes from the rapidly diminishing tax base in the mining sector is not helping either, Bogdetskiy explains. In 2013, the government replaced profit tax with income tax for mining companies and imposed a 10% levy on the export of concentrates.

As a result, when the authorities announced in early May the result of a tender for the development of the country's second biggest gold mine Jerooy, which is also embroiled in $549mn litigation between the government and former owners Consolidated Exploration Holdings, part of Kazakhstan's Visor Holding, the only other bidder to state-run Kyrgyzaltyn was a Russian outfit, which ended up winning. Explaining why Vostok-Geoldobycha, a firm owned by Russian businessman Musa Bazhayev, had won the tender, the State Geology and Mineral Resources Agency said the Russian firm had better an investment programme and technology, even though it offered $100mn versus Kyrgyzaltyn's $111mn. Kyrgyz media have linked the Russian businessman to Omurbek Babanov, who was Kyrgyzstan's prime minister between December 2011 and September 2012.

Going cheap

The price at which the authorities sold the Jerooy licence points to the extreme undervaluation of Kyrgyzstan’s mines. With estimated reserves of 97 tonnes of gold, Bogdetskiy values the mine at $450mn. “I believe it does not make sense for the new investor to invest in and develop Jerooy, but it will make sense to resell it,” he says.

The problem with the Jerooy tender was that the commission who awarded the licence “didn't have a single specialist” and the tendering process was “appalling”, Bogdetskiy claims. One of the conditions set by the authorities is that any winner would have to defend the interests of the country and government in international and local courts, and cover all costs and any damages awarded to the previous licence holders, Visor Holding (60%) and Kyrgyzaltyn (40%), whose licence to develop the mine was revoked in 2010.

Bogdetskiy believes the government’s decision to dump the winner with the problem of solving Visor Holding's claims means the Kazakh company was involved in deciding the winner. In May, the 24.kg news agency cited the Kyrgyz geology agency as saying that the Kazakh and Russian companies could have settled the dispute, as the Washington-based International Centre for Settlement of Investment Disputes suspended proceedings in the case, which was expected to be heard in November.

Orozbek Duisheyev, president of the Association of Miners and Geologists, a mediator between mining companies and the Kyrgyz government, believes the Jerooy tender was “much worse” than the sale of Kumtor over which it is fighting. “Kyrgyzstan has now got not a single percent of shares in Jerooy despite it being the most valuable mine,” he tells bne IntelliNews. “We are categorically against the deal.”

Duisheyev also blames the ownership dispute between the government and foreign investors at Kumtor for the lack of any interest in Jerooy among Western investors, which is “very bad” for Kyrgyz mining in general. “There has been nothing but disputes at Kumtor in the past three years. In this situation and with such uncertainty, what good investor will come to Kyrgyzstan?” he asked.

He also does not believe the arrival of the Russian firm in Kyrgyzstan will benefit the mining sector. “This [Vostok-Geoldobycha] is not a serious company,” Duisheyev says, pointing to suspicions over the former prime minister’s role after he admitted in the Talas Region where the mine is located that he had helped to bring in the Russian company.