Tajikistan debut status and EM buying spree could put benchmark issue near 7% despite fundamental questions – Deal Preview

05 September,2017 - 12:00 pm UTC

Author(s): by Tomas Cutts, Priscila Azevedo-Rocha and Laura Gardner Cuesta

Tajikistan can surprise by issuing its 8.75-year average life bond around 7% as EM investors’ indiscriminate hunt for yield shows no sign of abating, according to three buysiders and a trader. China’s infrastructure plans as well as positive government initiatives are likely to boost support for the unusual debut. But high external debt-to-GDP ratios, a highly dollarised economy and a weak banking sector in a relatively unknown sovereign means that investors could prove more wary in the long term.

 

The Central Asian state is marketing a 144A/Reg S senior unsecured benchmark-sized 10-year amortising bond with a weighted average life of 8.75 years. Proceeds will finance the costs of the Rogun Hydropower Plant Project, seen as a transformational event for an economy with just USD 796 GDP per capita, according to the World Bank. Roadshows end in the US tomorrow.

 

Several factors are likely to aid the performance of Tajikistan’s debut deal, according to one buysider. For a start, the sovereign is coming to market sooner than expected, which is unusual for emerging market borrowers.

 

“It said a few months ago that the Eurobond would be 2018’s business. By bringing the deal forward it is signalling that it is serious about the issue.”

 

Furthermore, Tajikistan will benefit from being a “new kid on the block,” as debut sovereign issuers are a rare sight, the buysider said. This effect should not be underestimated, he added.

 

Another factor ramping up interest in the deal is the strong technical factors supporting EM, the buysiders agreed. These include the hunt for yield and a lack of credit differentiation, the first buysider noted. However, Tajikistan’s newcomer status could also prove to be a hindrance.

 

“There is some scepticism because the borrower is not that well known, and has no democratic credentials so to speak,” the second buysider said.

 

Fundamental work needed

 

Tajikistan’s fundamentals still need improvement, the third buysider highlighted.

 

According to a note by Moody’s, external vulnerability risks are significant, and Tajikistan has low but rising foreign reserves relative to external debt. FX reserves reached USD 101m in March 2017. Although up from USD 34m in 2015, total short-term external debt repayments in 2016 amounted to USD 1.15bn.

 

However, Tajikistan has a good Special Drawing Rights (SDR) quota with the IMF and gold reserves totalling USD 626m as of March 2017.

 

Still, government debt to GDP has risen from 33.3% in 2015 to 44.8% in 2016, and is projected to rise to 55%-60% of GDP in 2017 and 2018. Of the 44.8% of 2016’s public debt-to-GDP, 32.7% is external, according to Tajik Ministry of Finance data.

 

Banking sector concerns

 

“The banking sector is an issue, as two banks had to be nationalised last year,” the third buysider said.

 

Over 10% of the 11.5% increase in debt-to-GDP from 2015 to 2016 was due to government support of the banking sector. As a result, NPLs rose to 40%-50% after a currency devaluation with USD 500m spent recapitalising the system, he added.

 

The banking sector is also highly dollarised, with US-dollar-denominated loans totalling 59.6% of total loans as of 2Q17, according to figures from the National Bank of Tajikistan.

 

Although the Tajik delegation has said they are working to bring down the NPL ratio to manageable levels in a couple of years, the issue is bigger than it seems, the third buysider continued.

 

But the second buysider saw the banking sector clean-up, as well as a devaluation in the national currency, as positive factors.

 

Banking sector weakness poses a risk to the government, but there has been progress on financial reforms, Moody’s noted.

 

In addition, tighter monetary policy and foreign-exchange controls are helping to de-dollarise the economy, reducing the share of foreign currency deposits from near 70% in 2015 to about 60% at the end of 2016, the note said.

 

A “transformational” bond?

 

Proceeds will be used to finance the costs of the Rogun Hydropower Plant Project, and provide energy for domestic consumption, plus generate electricity exports to Pakistan and other neighbours.

 

Following completion, the bond is scheduled to repay in six equal principal instalments starting in 2025.

 

Although the deal is structured as a project finance-type deal, it is not a project bond per se, as the sovereign is the guarantor, not the revenues from the project, said the third buysider.

 

Building the dam to export electricity to its neighbours, especially Pakistan, does not sound like a good idea to some. The bond is viable, but they will have to answer a lot of “engineering” questions regarding the viability of the project, which the government has been talking about since Soviet times, he added.

 

However, the project could be transformational for the country, the second buysider said.

 

The first buysider said that he would consider the deal, and invest if the pricing was attractive enough. But, he added that caution is warranted with such a borrower. Macro and geopolitical risks cannot be ruled out in the medium and long-term assessment of the country, he said.

 

But, on a short-term basis, where yield-hungry investors chase EM credits on an indiscriminate basis, Tajik bonds should still offer an attractive carry and the benefits of good diversification in the broader EM sovereign debt portfolio, he concluded.

 

Lucky seven

 

Market participants see the deal launching at around 7%. EM trends and newcomer status mean that Tajikistan can get away with a relatively easy deal if it offers 6%-7% or higher, the first buysider said.

 

“With Mongolia at a z-spread of 450bps, Belarus at Z+ 425bps and Ukraine at Z+ 550bps, Tajikistan could come in at around Z+ 500bps, or 7%,” a trader noted.

 

However, 7% appears too low, the second buysider cautioned. The fairly large size (USD 1bn) and long tenor of 10-years (despite the amortisation) is a lot to ask for a debut deal.

 

The trader highlighted that, with a GDP per capita of under USD 1,000, and GDP at just under USD 7bn, a USD 1bn 10-year deal amounts to 14% of GDP.

 

A mixed bag

 

But Tajikistan may well be able to bite off more than it can chew. Other B-rated credits such as Argentina, Egypt or Pakistan, with relatively good economic development, but large medium- and long-term vulnerabilities similar to Tajikistan, continue to be well bid, the first buysider said.

 

Ecuador, Zambia and Ghana can all be seen as comparables, the second buysider said. But onlookers differed on whether other CIS names can be viewed as comps.

 

Belarus is not a good comp. It has more of a track record in the markets, and not just with the sovereign. Belarus has a history of Russia stepping in when things go wrong, added the second buysider.

 

However, the third buysider said that Belarus and Suriname can be viewed as comparables. In the case of the former, this is because it is also an energy producer.

 

He cautioned against comparing Tajikistan to a more well-known Central Asian borrower. “Do not make the mistake of comparing it to Kazakhstan,” he said.

 

The latter is investment grade, has foreign reserves and decent fiscal and current account numbers, he said. Tajikistan relies mostly on remittances from Russia.

 

Remittances as a percentage of GDP amounted to 31.4% in 2016, according to figures from the National Bank of Tajikistan.

 

“It is a very poor country under the radar from most investors,” the third buysider said. But, Tajikistan is very close to Kazakhstan, a big plus for the debut borrower, the first buysider continued.

 

“So far, Central Asia has been dominated by the debt of the Kazakh sovereign and KazMunaiGas. Kazakh debt is well liked by investors, despite the banking sector saga 10-years ago, and with Tajikistan providing another place to invest in the region, the positive sentiment surrounding Kazakhstan could easily spill over,” he said.

 

In good company

 

Tajikistan benefits from external support. There is strong Russian and Chinese influence in the country. Russia has a large military base and is economically essential through remittances. China is important to the Central Asian nation mainly through its FDI, the second buysider said.

 

The country is on the planned route for China’s huge USD 900bn “One Belt One Road” project, seen as the modern-day Silk Road, transport infrastructure initiative.

 

The percentage of Chinese foreign direct investment versus total FDI totalled 59.8% of USD 545.2m in 2015 and 73.8% of USD 436.2m in 2016, figures from the National Bank of Tajikistan show.

 

Tajikistan is effectively a first derivative of Russia, the trader noted. He highlighted the importance of Tajikistan being a member of “China’s One Belt One Road” initiative.

 

Development agencies also play an important role in Tajikistan’s funding needs. Most of the country’s foreign debt is in the form of bilateral loans from agencies such as the World Bank and the Asian Development Bank, the third buysider stated.

 

With 75% of all country-FDI coming from China, the bond will likely see demand from the Chinese, as well as retail investors, but not from big funds, he added.

 

But, “the question is, given all the Chinese FDI, support from the World Bank and all the remittances from Russia, why do a Eurobond so suddenly,” the second buysider said.

 

Tajikistan will conclude a roadshow on 6 September ahead of the issue of the 144A/Reg S senior unsecured benchmark-sized 10-year amortising bond with a weighted average life of 8.75 years. Citigroup and Raiffeisen Bank International are the joint lead managers on the issue, as reported.

 

Tajikistan is rated B- by S&P Global Ratings and B3 by Moody’s.