Flights to Kazakhstan, Uzbekistan, Moldova, and Kyrgyzstan used to be sparsely filled by mining engineers or backpacking tourists. Since the start of this year, the passengers have been just as likely to include hedge fund analysts in red braces checking out what they have identified as the next hot opportunity in emerging markets.
Their attention has shifted from eastern Europe, where fixed-income yields have been narrowing across almost all the region's debt markets. Even Russian GKOs, one of the world's best-kept secrets last year when their yields topped 200%, now pay under 20% in rouble terms. Dollar-hedged GKO structured products - which take care of currency, custody, clearing and foreign ownership restrictions all in one - are barely showing a double-digit yield. Bulgarian T-bills and zunk bonds, the best performers in the emerging-market universe in the second quarter of 1997, are now so over-priced that some speculators have begun to short-sell them. So the party is moving on to countries that would send most traders searching for a post-Soviet atlas.
A strong indication of the trend came in June, when Hong Kong-based Regent Pacific, which has a record of digging up hidden lucrative investments ahead of the pack, successfully launched a $70 million Central Asia Fund. The first of its kind, this is spreading its net to Mongolia, Transcaucasia and the Irkutsk region of Russia in addition to the central Asian republics. Here are some of the countries where investors have found the most lucrative investments.
Kazakhstan
Almaty, the capital, has been the first stop for speculators to pick up mekams, the Kazakh local-currency T-bills. Mekams are discounted zero-coupon bonds redeemable at par and maturing after 91, 182, or 364 days. In June and August a two-year T-bill was issued for the first time.
Mekams are issued by the finance ministry and traded through the National Bank of Kazakhstan, which also acts as custodian. The bonds are dematerialized in a registered, screen-based form and are not physical certificates. There is no capital gains tax and profits can be fully repatriated by foreign, non-resident investors. This absence of foreign ownership restrictions compares favourably with the early days of the Russian GKO market, which was so wrapped in ownership and repatriation controls that initially it was accessible only to well-connected niche players. The one restriction for Kazakh mekams is that the finance ministry limits foreign purchases to 25% to 30% of the entire lot in each auction.
After each auction, all mekams are kept in deposit accounts opened by the primary dealers at the National Bank. Primary auctions for 91-day mekams are held each Tuesday; 182-day mekams are auctioned on the first and third Thursday of each month and 364-day bills are re-auctioned once a month, usually in the third week. In total, seven auctions are held each month. To date, approximately $750 million of three-, six- and 12-month mekams have been issued and about $200 million are outstanding.
During 1996, annualized yields in US dollars averaged 25.5% for six-month mekams and 22% for three-month bills. Twelve-month bills have averaged a 38.6% yield in local currency terms. It is possible to hedge against depreciation in the tenge, the local currency, through the Kazakh Currency Exchange where foreign-exchange futures are traded on a margined basis. The exchange began trading in April 1996, volumes are still low and there remains a less-than-Chicago-Board-of-Trade certainty of risk-free settlement.
At the macroeconomic level, Kazakhstan holds the same credit rating as Russia. Gross national debt of $3.77 billion in 1996 was 18.26% of GDP. In November last year, Standard & Poor's, Moody's and IBCA assigned a BB minus rating for long-term foreign currency debt and S&P additionally assigned a BB plus for long-term local currency debt.
So much foreign capital has flooded into the Kazakh fixed-income markets in recent months that prices may have hit their peak. The spread to US treasuries on the sovereign Eurobond fell to 200 basis points in August after exceeding 300 last January. Three-month mekam, starting 1997 at a 26% yield, recently yielded 12.2% after falling to 10.3% in June. Deutsche Morgan Grenfell (DMG) predicts the mekam annual yield will fall to 10% over the next 12 months. The tenge started 1997 at 73.6 to the dollar and, although in steady depreciation during the first half, it has stabilized in recent months and recently was trading at 78.
"We see foreign investors starting to back out when the three-month bills hit the 13% level," explains Michiel de Bruijin, general manager in Almaty of ABN Amro, one of the top three primary mekam dealers. "Expectations on the tenge remain strong. The only concern is the resolution of the pension issue - the government has pledged to pay off all of its pension arrears and that has created some uncertainty about inflation which may limit any further price increases. Nonetheless, we still expect prices to remain at this level and possibly go a bit higher."
Uzbekistan
The nation is still emerging from the recession which hit all former Soviet republics after independence but recently the economy has accelerated, and the government forecasts 5% GDP growth in 1997.
Uzbekistan is beginning to develop a fixed-income market after the introduction last year of som-denominated three- and six-month T-bills trading at a local-currency yield of 40%. The country has neither credit rating nor any outstanding Eurobonds though the government is holding preliminary discussions with S&P and investment banks. A sovereign Eurobond issue could be issued in 1998.
In early 1996 the Central Bank of Uzbekistan began a monthly auction of three- and six- month bills. Outside the primary auction, where total sales could be anywhere from $500,000 to $6 million, there is a secondary auction four times per week. In July, $165 million in T-bills was outstanding; rates were 25% on the three-month and 26% on the six-month bills.
The bills are dematerialized and exist only on the register of the Central Bank. There is no continuous pricing nor screen-based system of monitoring the market. However, as there are few market participants, precise two-way prices are easily obtained by telephoning around during the four weekly secondary auctions, which last about an hour each. There have been no reports of difficulties in registration, custody and settlement of trades.