We elevate Uzbekistan to our Top 5 with a Buy on UZBEK '31s at a yield of 9.0% (z-spread 617bps) as of cob 18 July on Bloomberg (US$68.6 on a mid-price basis). This follows the Buy we assigned to the bond on 22 April (when the yield was 5.9% and with a z-spread of 317bps). However, we recognise the bonds have fallen by 17pts since then (spread 300bps wider), with a total return of -20.1% ytd, roughly in line with the Bloomberg index.
Still, we think fundamentals remain strong and valuations are even more compelling now. Our view on the bonds followed the IMF’s 2022 Article IV mission in April which painted a reasonably positive picture despite the impact of the war in Ukraine (the board review was concluded in June and the staff report was published). Growth this year was revised down (from about 6% pre-war to 3-4%), primarily due to heavy dependence on remittances from Russia, and inflation (around 12%) was seen as high but stable. However, we think policy space (low public debt, strong liquidity buffers) may help to mitigate the economic impact, and is supportive of ability to pay. With four dollar bonds now, amounting to just US$2.2bn in size (only 3% of GDP), total interest payments are still only US$96mn a year, albeit with the next maturity, US$500mn, in 2024.
Uzbekistan remains at low risk of debt distress, according to the IMF assessment, with public debt projected at 38% of GDP this year, albeit some 10ppts higher than pre-Covid levels. Moreover, a high level of international reserves (over twelve months’ import cover) and long maturities further mitigate the risk of debt distress. Indeed, on our calculations, international reserves (including gold), are c50% of GDP. This makes Uzbekistan a net public external creditor.
Investors may, however, be concerned about the rising debt burden (public debt is deemed sustainable but the trajectory is upwards), high external financing needs, the risk that Uzbekistan gets drawn into Moscow's sphere of influence, as Putin seeks to re-create the Soviet bloc, domestic and regional unrest, and concerns over governance and transparency.
That said, we observe that with the Uzbekistan sovereign dollar curve pretty flat, investors are not getting paid for duration. The yield on the February ‘24s at 8.5% (that’s 8.5% for essentially 18m paper) compares to 9% on the ‘31s. Hence, the ‘24s could be an interesting short-duration trade for defensive investors (with a price of US$94.5). Still, the ‘31s are also interesting at a low cash price of US$69 (incidentally, that is virtually the same price as Mozambique but Uzbekistan has much stronger credit metrics); for a country with debt/GDP of 40% and reserves equal to 50% of GDP, Uzbekistan should not be defaulting.
For detailed profiles of the rest of our Top 5 fixed income picks for H2 2022 – Ghana, Mozambique, Nigeria and Pakistan – click here.