KIYAN ZANDIYEH: A lot of the old ministers have basically been fired. When you go to the country now and you meet the minister. These are Western-educated, ex-Goldman, ex-HSBC bankers.
Whilst the rest of the world has poor demographics, here you have a country with 70% of the population under the age of 35. One of the biggest reforms of the current government has done has been the liberalization of that FX rate, which for us we define as the fall of the Berlin Wall moment.
Kiyan Zandiyeh, CEO of Sturgeon Capital. We're a front-end market, asset manager. We have 13 years of investing probably in both public and private equity in Central Asia and the Caucasus.
Uzbekistan for us is a country that we consider effectively the elephant in the room in our region. It's the country with the largest population. It has 33 million people living in it. 70% of that is under the age of 35. Median age is 28. So a very young population.
One of the Soviet hangovers is obviously that they've had very high education rates. So you're talking literacy rates above 99%, 99.5%. Historically, under the previous administration, it was difficult for investors to deploy meaningful capital there.
But yet within that, you're talking about an economy that has 25 years of consistent growth. It has never had a recession. Over the past 10 years, it has been the sixth fastest growing economy.
Has a diverse resource base. It has the largest open-pit gold mine. Has copper, has zinc. Has been a very large exporter of cotton. But still has GDP per capita of $1,200.
Our view under the new administration, which I guess we'll speak about, is that this opportunity will be unlocked, and for investors will be will be a chance to deploy meaningful capital in the country.
So historically, investors haven't really been looking at Uzbekistan. And the main issue there was the repatriation of capital. So you had two FX rates, one was a subsidized government rate, and the second was let's say a black market-- free market trading rate.
Now the problem was that if you took money into the country, it was very difficult for you to get that out. One of the biggest reforms of the current government has done has been the liberalization of that FX rate, which for us we define as the fall of the Berlin Wall moment.
Effectively, there was a lot of elite in the country that were taking advantage of this differential rate. And what the government did overnight, they liberalized that and took a 50% hit on the currency. What that means today is that for any investor investing in the country, you can freely take in capital and take that back out. And that's really the main catalyst for being able to now deploy capital into the country.
If you look at what has changed basically overnight, what happened was two and 1/2 years ago the previous president, which was leading the country for about 25 years, died. And if you think of how the country was beforehand, there was a closed socialist economy, pretty much not like North Korea. It was completely isolated from the neighbors and from the broader world.
What happened then was when the president died, the prime minister became the president. And the general consensus was that it would be a continuation of what was there before. But to everyone's surprise, overnight he decided to completely reform the country, and has been quite aggressive and ambitious in the reforms that is taking place.
There are wide-ranging reforms which the government is undertaking. As I mentioned, the most significant one was the FX liberalization. What came alongside that was the capital amnesty where foreign funds could basically come back to the country at minimal tax rates.
And since then, there's been a number of reforms that have taken place. If you look on a ministerial level, a lot of the old ministers have basically been fired. When you go to the country now and you meet a minister, these are Western-educated, ex-Goldman, ex-HSBC bankers. So people that speak the same language as you.
And what they also did is-- this is a country which has total debt to GDP of 20%. So one of the catalysts for it is actually a re-leveraging in the economy.
What they did in February was their first sovereign bond issuance, which was a 10 and a five-year bond, which was four times oversubscribed. Today, trades at sub-5%. The main reason for that wasn't that the government needed capital, but it basically set a credit rating so that local corporates could now then participate in international capital markets.
Following that, one of the most significant reforms is also in tax. So historically if you were a corporate, there were 36 different tax rates you would have to calculate. And the total blended tax rate would come to about 40%. That's been slashed now down to eight different tax rates and now 12%.
Now what's ironic, if you look at that on year-on-year with the substantial fall in tax rate, the tax revenue has increased by 1.6 times. The reason for that is historically that a large part of the economy, which simply was the black economy, as much as possible they would try and not pay taxes. But now that it has been simplified, it's been reduced, you have the black economy coming to a more formal economy, the revenue base for the government is increasing. And that can be now re-injected into the economy.
One of the other reforms that has been taking place is in the capital markets. So up until now, the stock market has been very nascent. You have about 120 to 30 companies listed. This has been a legacy of the privatization programs in the mid-90s.
What they've done now to basically increase the scope, the volume, and size of the market is they've put in place a capital markets agency, which is headed up by a guy who's a previous EBRD and a Goldman banker. And by November, he's basically doing a few things. One is to take state assets, which are now being fully privatized, a portion of that to privatize through the public markets locally to increase the volume, to increase the pension funds, to basically formalize the pension fund system, increase the asset management industry. So that liquidity, both domestically and international, will be injected into the market there.
Also in terms of just ease of generally doing business, if you're an SME in the country and wanted to register your business, before it would take two to three months. Now, there's an online system. And within one day, you can register your business. So they're trying to streamline as much as possible the general business environment.
Again, when you look at customs, it's now a fully automated online system, something which was notorious for, let's say, corruption or lengthy delays of bureaucracy. Again, that's been simplified. So there's wide ranging reforms which on a broad level is trying to ease the level of doing business, make it easy for international investors to invest in the country.
And one of those intangible things is, historically, if you wanted to travel to the country, to get a visa would take you one month, two months. Overnight, they made visa free for 60 countries. So you don't even have to get it. You can fly directly from London, from New York, to the country. And what that basically shows is that it's a move from being paranoid about security to being open for international investors, for tourists, to come to the country and see what the opportunity that is there.
If you look at the industry breakdown of the economy, 28% of GDP is agriculture. Half of that is cotton. Historically, the country's been a very large exporter of cotton.
The other half is general agriculture, so vegetable and fruits. The country has an abundance of agricultural land. They have above average days of sun. And if you combine that with very low average wages, it's about $250 a month, the country has a real competitive advantage when it comes to agriculture.
The rest is predominantly industry. So they have the largest open-pit gold mine. They have copper, they have zinc. They have a lot of gas resources. And the benefit of this is that all these resources have been underutilized up until now.
The real area of focus for us, and what we believe to be a significant opportunity, is the financial sector. And if I give a breakdown, historically, a large part of the population has simply been unbanked. So, anecdotal evidence is if you look at 5% of the population has savings accounts.
Now, that is changing significantly. So historically, the average person would get their wages in cash. The government has now passed legislation whereby if you want to get paid your wages, it has to be paid by a bank account, which means that you have the unbanked economy now coming to the formal banking sector.
What that means on a high level is that obviously the deposit base of the banking sector increases. It allows for loan rates to increase substantially and of GDP growth going up, NPLs come down. And you have this positive feedback loop.
Now, if you look at the breakdown of the banking sector, 80% of banks are state banks. And effectively, they've been acting as fiscal policy tools. So, they've been lending to state or semi-state entities.
So what you're left with, which is the real opportunity, is the retail or SME side of the business, which historically have been under capitalized. So our focus there is really to focus on the private banking sector where you have this untapped retail and SME part of the economy, which are first for capital, where there's areas where to allocate capital profitably. And we believe the banking sector could benefit from that.
If you look at a broad loan growth year on year, if you look at 2019 to 2018, it's been about 150%. First half this year is about 50%. We're shareholders of a bank where year on year they've increased their loan book by about 250%. This is a bank that still has NPLs of about 2%. And we believe that can continue given that you're coming from such a low base.
From a global asset allocation perspective, the way we define investing in Uzbekistan is it's the best place to hide. Why? Because you're coming from an extremely low base. As I mentioned, GDP per capita is $1,200.
If you look at neighboring countries-- for example, take Georgia. You're talking about a country with a fifth of the population with no resources. GDP per capita there is $4,500. If you look at Kazakhstan, which from a resource base is larger, they are about $9,000.
So there's no reason in our view where over five to 10 years that Uzbekistan can't catch up with these countries. And if you look at it on a relative basis to the rest of the world, we believe it's an absolute return story. Obviously, the trajectory or the growth of that absolute return is a function of global growth because at the end of the day it's a country which exports. But you're coming from a sufficiently low base that for the foreseeable future you can have attractive absolute returns, in our view.
In terms of, let's say, international investors or multinationals looking at the country, multinationals historically have had a presence there. The benefit being that it's one of only two doubly landlocked countries. And if you look at the region, it has great transit routes to the broader countries in the region. It has very good transport infrastructure. And if you consider it as part of the Belt and Road Initiative, which has some pessimism in the West but it really has been seeing an impact locally on the ground, a lot of multinationals have been investing there to have their manufacturing base there.
In terms of international investors, we are the first, let's say, private equity investors in the country. That is not to say that international investors are not looking at it. What they're looking for most likely is more certainty as to the path of reforms. And at that point, they will start to invest.
From the public market side, it's still a bit early stages. The country has set up an agreement with a global distributor so that international investors can basically hold the local securities in their portfolios. But that is a plan that they're looking to implement within the next two to three years.
For investors looking for broader exposure to the country, there are a number of ways. Obviously, they had the debut bond issuance, which is now freely traded. There will most likely be further issues that's coming up from both state companies and the banking sector.
There are local bonds which traded about 20% to 22% in local currency. So one has to take a look at the FX side of them. But if you look at inflation differentials, on a base case one can expect 5% to 10% devaluation in a year, which still provides a healthy hard currency yield.
In terms of the local market, it's not easy to access. And investor would have to travel there. Once they're there, to open a brokerage account it's quite easy.
The difficulty really is liquidity. So the average liquidity is about $50,000 a day, which really isn't significant. Now the opportunity there is to go to the companies directly to do block trades, where you can buy large chunks of shares of listed companies directly from the company.
What is also interesting, there's a long pipeline of privatizations that will be coming to the market. And one can potentially participate in pre-IPO opportunities there.
My advice would be simply to travel to the country. Whilst it may not seem it from here as, let's say, a capitalist fever going on in the country, and there's deals happening left right and center. The benefit is that the companies there are hungry for international investments. And by virtue of not having too much competition, one can invest at very attractive valuations in companies which are already profitable and have a bright future ahead of them.
So in terms of thinking about timelines to investing in Uzbekistan, our view is it's a five to 10 year story. It's going to take a while for these reforms to meaningfully impact the economy. Having said that, they already are. As I mentioned in the banking sector, loan growth is plus-50%. The economy is now about 6% GDP growth. IMF has it forecast for 6% to 8% going forward.
The tax reforms, they've already had immediate benefits. But still a large part of the economy has to still come to the more formal side of the economy to benefit from those tax reforms.
Again, on the banking sector, still you have a large part of the population which is unbanked. So there's that transition from them moving to the unbanked economy to the formal banking sector. Again, that'll take two to three years.
But if I put it into an example of, let's say, an investment that we're looking at. It's an agricultural company we're looking at. And they simply produce corn on the cob. They vacuum package it such that it can last for a year. And they export it to Russia, Eastern, and Western Europe.
This is a company which started three years ago. It has 50% operating margins, already cash flow positive. Now, their plan is to basically quintuple capacity over the next three years and for them to meet their capacity within four years.
This is a business that one can invest in at about three, three and 1/2 times earnings. And again, if you look at it from a timeline perspective, it's up until five years where you really see the realization of an investment in terms of the gains and the potential exit that one can make.
So I want to say it's a short-term story. You're coming from a very low base. There are a lot of catalysts that are taking place that will take, let's say, five to 10 years to basically be implemented. And it's over that timeline that I think investors should be really looking at this market.
If you look at the breakdown of corporates, unlike say a country like Kazakhstan where you have very large state companies and then very small companies, Uzbekistan is slightly different. So you have a few large state companies. But then you have a large SME sector.
And if you focus on state companies, basically the government over the next five years is looking to privatize all of their stakes in state companies. And the broad idea being that the country is very young, it has a large workforce coming online every year. And they need these companies to be in private hands to basically absorb that workforce. If it continues in state hands, given the efficiency constraints, that will be difficult.
So what we'll probably see over the next five years is these companies moving into private sector hands. Predominately the hope of the government is that they're going to foreign investors or foreign multinational hands and for the efficiency there and the corporate governance to improve.
Our focus is really on purely private companies where the entrepreneurs or the founders have a large stake in the business. Their incentives are aligned with minorities. And it's where we see stability in the future business landscape.
If one was to say focus on state companies or these privatizations, you really have heavy lifting to do in terms of fixing corporate governance. And given that the future landscape is aimed to be a private sector landscape, our view now is better to start investing in the pure private companies where, again, you have governance which is more aligned with Western standards. And their incentives are for long-term profitability rather than, let's say,