On Valentine’s Day, Uzbekistan celebrated its budding love affair with global financial markets with the sale of $1 billion in dollar-denominated five- and 10-year bonds.
This would have been unthinkable in the days of the late president and arch-isolationist Islam Karimov. But Uzbekistan’s incumbent leader, Shavkat Mirziyoyev, who came to power in 2016, is determined to show that his country is open for business.
At first glance, Uzbekistan makes for an enticing investment prospect. External public debt amounts to 19.8 percent of gross domestic product, or GDP. Official reserves are nearly 183 percent of public debt, something all but unheard of among frontier markets – even the most developed ones.
That cash pile is a legacy of the closed nature of the economy presided over by Karimov. It was only in September 2017 that the government tentatively liberalized its currency regime, finally granting domestic businesses access to foreign exchange.
Impracticality was at the heart of the policy agenda. Until the summer of 2017, the largest available cash denomination was the 10,000 sum bill, worth around $1. And even that was not widely available. The simplest transactions involved the rapid counting of overflowing handfuls of banknotes. Even as the government was touting historic Bukhara and Samarkand as unmissable Silk Road destinations, there were barely any ATMs that took foreign cards.
Foreign investors largely shunned Uzbekistan.
Mirziyoyev has spent the almost 30 months he has been in power trying to pry open the economy. To that end, he invited international organizations like the European Bank for Reconstruction and Development to return. The government has taken another bash at reinvigorating inward investment through the formation of free economic zones. Suspicion of foreign expertise has been ditched. When it came to reforming the tax system, Uzbekistan turned to the International Monetary Fund and even figures like ex-Georgian Prime Minister Nika Gilauri.
This process has not been without stops and starts. Monetary liberalization spurred a spike in inflation, which Renaissance Capital analyst Gregory Smith told Eurasianet represented “one of the weaker areas of the scorecard" in terms of Uzbekistan's balance sheet. This should, however, be mitigated by “the Central Bank's move to an inflation-targeting regime and plans to introduce policy rate bands at the end of 2019,” Smith said.
But the challenge posed by these technical issues pale in comparison to the systemic roadblocks of corruption and the still-prevalent disregard for many basic rights.
On rights, international monitors have acknowledged that the government is taking positive steps by releasing political prisoners, tweaking the justice system and taking its boot off the neck of civil society. Routine stumbles, such as when security service officers harass local activists, make this a mixed picture, however.
And while media has some more space in which to operate, that freedom is still limited and conditional. This hardly augurs well for efforts to root out graft.
In any event, what measures the government has taken to address these issues appears to have been more than enough to reassure investors.
“The marketing of the bonds was highly professional,” Lutz Röhmeyer, head of Capitulum Asset Management in Hamburg, told Eurasianet. “Building big demand and communicating that pricing was more crucial than raising big amounts of fresh cash.” Röhmeyer said the main goal of the bond sale "was to build a benchmark curve that serves as a reference for local corporates.”
In other words, the government was primarily concerned with securing a low yield – the 10-year bond pays just 5.375 percent per annum – that would serve as a benchmark for other financing. This should, in theory, help further efforts to open up the economy.
The sale pitch seems to have worked. Demand for the bonds reportedly exceeded $8.5 billion, meaning many who wanted to invest were unable to do so.
Eva Bochorishvili, head of research at Georgian investment bank Galt & Taggart, noted that "there was significant oversubscription for these bonds, which might be a temporary effect and the price on the secondary market can drop."
Others voiced further concerns. Despite Uzbekistan’s ostensibly healthy credit metrics, Paul McNamara, investment director at Swiss investment group GAM, warned that “countries with awful economic structures and endemic corruption tend to default at much lower debt levels than other markets.” McNamara warned that “even by CIS standards, the Uzbek government is bent.”
Elite factionalism and cronyism are arguably no less prominent features of the system today than they were under Karimov, as very recent developments demonstrate.
Just three days before the bond sale, the head of the State Security Service, Ikhtiyor Abdullayev, was removed from a post he had held for only one year. While the government cited alleged ill health, unnamed sources told RFE/RL’s Uzbek Service, Ozodlik, that he was under criminal investigation on suspicion of corruption. What apparently really set off the rift, however, was that Abdullayev reportedly ordered Mirziyoyev's phones to be tapped and placed his family under surveillance.
And then there is the closeness between Mirziyoyev and Alisher Usmanov, an Uzbek-born billionaire with close ties to the Kremlin.
Usmanov has long had interests in Uzbekistan, but these appeared to have intensified under Mirziyoyev, to whom he is loosely related by marriage.
An investigation by Scotland's Herald newspaper revealed just how pervasive Usmanov’s Uzbek investments have become over the last two years. He has taken over Uzbekistan’s largest copper mine as well as its most famous football club. He is pursuing new investments as well, such as building a new metallurgical plant outside Tashkent. Although Usmanov is not explicitly named, the bond prospectus implies that were the United States to sanction Usmanov – in the same way it targeted other major Russian billionaires in recent years – it would potentially have a material impact on Uzbekistan’s credit standing.
Situations like these mean that the recent talk of competitive privatization should be taken with a grain of salt.
“The problem is that the economic structure of Uzbekistan has not changed. It is still controlled by elites. Bank loans based on foreign bond issues will still go to these elites and will not necessarily lead to great returns or have a broad social impact,” Neil Robinson of the University of Limerick told Eurasianet.
Yet the fact remains that Uzbekistan’s story is still a positive one because it was starting from such a dismally low baseline. Investors appreciate that trajectory.
As Will Slaughter of Northwest Passage Capital Advisors pointed out, the bond's initial yield is lower than other sovereigns and yet with arguably better fundamentals than places like Turkey, Argentina and Oman.
This bond issue is intended as the first of many.
Finance Minister Jamshid Kuchkarov told the Financial Times that two major banks will likely issue dollar bonds as well. And according to Reuters, state energy firm Uzbekneftegaz may follow suit. These entities are all state-owned, so Uzbekistan's state debts will grow but Tashkent is reportedly comfortable with a 50 percent increase on its current external public debt levels.
Maximilian Hess is a London-based political risk analyst and writer.
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Maximilian Hess is a London-based political risk analyst and writer.