Reform-hungry Uzbekistan tests markets with ‘Samarkand bond’ debut

The World Bank’s International Finance Corporation (IFC) has issued the first ever som-denominated Samarkand bond on the London Stock Exchange (LSE), raising the profile of the Uzbek currency and bringing the government led by president Shavkat Mirziyoyev a step closer to pulling off a sovereign bond debut.

The IFC issued two, two-year so-called ‘Samarkand bonds’ worth UZS80bn each (a total of about $20.3m) that were placed “with European asset managers dedicated to emerging markets”, according to the World Bank’s private sector arm. The proceeds of the bonds, listed on the LSE on June 20, will be used to expand lending for micro, small and medium-sized companies in Uzbekistan through local bank Hamkorbank.

“For Uzbekistan it’s a first, very symbolic step,” says Shukhrat Vafaev, deputy chairman of the country’s state committee for investments.

Out of isolation

The country was largely isolated for years under strongman leader Islam Karimov, who ruled the country with an iron fist from independence in 1991 until his death in September 2016. Since then, Mr Mirziyoyev has established several major reforms aimed at breaking through the isolation of the previous decades and gradually opening up the resource-rich central Asian economy of about 32 million people.

Mr Mirziyoyev even surprised many observers by rapidly jettisoning the draconian controls on the foreign exchange and capital repatriation typical of the Karimov era, leaving the som free to float in the currency market. This prompted an expected depreciation after years of manipulation of the official exchange rate – black market rates had largely anticipated this drop.

Combined with a wide set of other reforms, the overhaul of the foreign exchange regime put Uzbekistan on the radar of investors across the board, including financial investors. The government is now willing to capitalise on the current reform momentum by issuing a first ever sovereign bond in hard currency in the international markets to establish a sovereign yield curve and pave the way for Uzbek companies to access the international bond market.

“Our government is seriously working on preparing the process of getting a sovereign rating. We haven’t asked credit rating agencies to issue a rating yet, but we are working with our financial advisor [Citigroup] to start approaching international rating agencies on that issue. As soon as we receive the rating, we will follow up with a sovereign bond issuance in foreign currency,” says Mr Vafaev.

Appetite sparks action

Even though market momentum has been shifting in recent weeks, investors’ appetite for emerging market notes has allowed countries such as Tajikistan, Uzbekistan’s impoverished and troubled neighbour, Iraq or Ecuador to successfully place their Eurobonds among international investors in the past couple of years.

“They could issue a Eurobond tomorrow if they wanted,” says Stephen Bailey-Smith, senior economist and investment strategist at Denmark-based Global Evolution emerging and frontier investment manager.

“A credit rating would help, but that’s not necessary as long as they come up with a decent story around what they are doing and how they are going to pay back. Two to three months ago it would have been a bit early in terms of market appetite though.”

There is still no timeline for the project though, causing some investors to raise an eyebrow. “I don’t see why it would take so long to issue a credit rating,” says one portfolio manager, who preferred to remain anonymous.

Why the delay?

Several factors may explain the delay, including state bureaucracy and distribution of powers that typically requires a green light for the project on many different levels – including from the president – and a lack of financial urgency. The operation would first aim to build a sovereign curve as a reference for possible semi-public or private companies to follow suit and issue their notes in the international markets. “We have the privilege to be a resource-rich country, we are not in a rush,” Mr Vafaev says.

The ambition of issuing an international bond marks the pace of change in Uzbekistan, where only a couple of years ago the whole operation would have been unthinkable. And it would open new financing sources for public, semi-public and private institution to raise financing, perhaps also domestically, where the capital market still lies in a very embryonic stage.  

“The changes happening in Uzbekistan are extremely exciting as they open up their economy,” says Georgina Baker, vice-president for central Asia at the IFC. “This international issuance is one of the supporting steps [in this process]. Eventually we would like to issue locally as well. [For this to happen] they need to open up their local capital market and have local companies issuing corporate bonds and the government issuing sovereign bonds.”

Sarmarkand bonds will have to fend off doubts over the value of their promised return though. Both bonds have been issued at par with a 9.5% coupon. In a country with expected inflation of 16% and 14% in 2018 and 2019, respectively, according to Asian Development Bank (ADB) estimates, that means that real returns will be in negative territory should the ADB estimates prove correct. Yet, they remain a way for the government to test the appetite of the international market ahead of a Eurobond debut that might happen once everyone in Tashkent gives greenlight, first and foremost Mr Mirziyoyev.