Commonwealth of Independent States & Mongolia

Transcription

1 Commonwealth of Independent States & Mongolia 101

2 Lazard Emerging Markets Debt Table of Contents Commonwealth of Independent States & Mongolia 101 Armenia 103 Azerbaijan 111 Belarus 119 Georgia 127 Kazakhstan 135 Mongolia 143 Russia 153 Tajikistan 165 Ukraine

3 Armenia Summary Moody s B1/ S&P NR / Fitch B+ 1 Economy: Agriculture 18%, Industry 28%, Services 55% Armenia is the least-developed country in the Caucasus region and is highly dependent on Georgia and Russia for transshipment of exports and natural gas imports. Unlike other countries in the region, Armenia is not an energy producer. The country is landlocked in a region prone to conflict, and has been engaged in an ongoing territorial dispute with Azerbaijan that occasionally results in military conflict. Armenia is vulnerable to fluctuations in global commodity prices, particularly those of minerals, which account for more than half its exports. Relations with the International Monetary Fund are good, as are relations with Russia, the European Union, and China, owing to close trading links with these countries/regions. Armenia benefits from strong remittance flows from a global diaspora that exceeds the country s domestic population. Armenia recently shifted to a parliamentary form of government, but corruption remains a problem and oligarchs are extremely powerful. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 3,686 3,856 3,519 3,541 3,644 3,798 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Armenia National Statistical Service, Bloomberg, Central Bank of Armenia, Finance Ministry, Haver Analytics, IMF 103

4 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency BB+ Local Currency BB+ BB BB BB- BB- B+ B+ B B Moody s Fitch Moody s Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Armenia 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 104

5 Armenia Strengths Key Allies Armenia maintains good relationships with Russia and Europe. Russia has traditionally been the country s most important trade partner and a key economic and military ally. Russia is the largest supplier of natural gas to Armenia and provides gas at a discount since Armenia joined the Eurasia Economic Union in Armenia s membership in this organization has strengthened the country s ties with Belarus, Kazakhstan, Kyrgyzstan, and Russia. Bilateral trade with Russia decreased in 2015 as a result of ruble depreciation, but trade flows picked up with the recovery of the Russian currency in Armenia has also been negotiating a free trade agreement with the EU, another important trade partner, and Armenia and the EU initialed the preliminary text of a partnership agreement in March 2017, with further integration expected in the coming years. 3 Strong Relationship with Russia Armenia has been the most reliable partner for Russia in the South Caucasus, and the exceptionally close political and economic ties include Armenia s membership in the Collective Security Treaty Organization with Russia and five other former Soviet states, and the presence of a Russian military base in Armenia. In addition, Russia provides protection along Armenia s Soviet-era border with Turkey and Iran, and in June 2016, Armenia s National Assembly overwhelmingly approved the creation of a joint air defense system with Russia. In November 2016, the two countries approved the creation of a joint military command. Russia has also established ballistic missile systems throughout Armenia. In exchange for this cooperation, Armenia benefits from Russia s military strength and political influence over the Nagorno Karabakh conflict with Azerbaijan, as well as overall economic and financial support. However, this close relationship has been tested by Armenian protests over Russian influence. Still, the economic and political ties with Russia are very strong for the following reasons: 4 Trade Partner: Russia purchases about one-fourth of Armenia s total exports. Foreign direct investment: Russia is the largest source of FDI, accounting for about 15% of Armenia s FDI inflows. Remittances: About 90% of Armenia s family remittances are sent from Armenians working in Russia. The World Bank points out that in 2014, 21% of the economy depended on remittances, one of the highest in the world. 5 Energy: Armenia imports about 80% of its natural gas supply, 2 billion cubic meters per year, from Russia. In addition, Armenia enjoys preferential pricing as Russia reduced the price of gas sold to Armenia to US$150 per 1,000 cubic meters in April 2016 from US$165 per 1,000 cubic meters in Assets: Russian companies own key assets in Armenia. For example, the state-owned Russian energy company owns Armenia s electricity distribution network; a Russian company owns the Armenian railway; two of the largest mobile operators, MTS and Beeline are Russian; and local banks and insurance companies have significant Russian ownership. This heavy influence stems from Armenia s 2002 agreement to swap some state-owned enterprises to repay debt to Russia. 7 Army: Russia is Armenia s principal military ally, with an agreement for the Russian military to remain in the Gyumri military base near the Turkish border until Russia maintains a base of 5,000 troops and is the chief supplier of arms for the Armenian army

6 Lazard Emerging Markets Debt IMF Armenia s good relationship with the IMF demonstrates its commitment to responsible economic management. Armenia signed a $115.6 million Extended Arrangement with the IMF in March 2014, and the Fund recently published its final review of the agreement, signing off on the country s economic program and declaring that all end-december 2016 quantitative performance criteria, indicative targets, and structural benchmarks were met. The Armenian authorities are considering the possibility of a successor arrangement with the IMF. 9 Diaspora There are more than four million Armenians living abroad, which exceeds the total domestic population of the country. About two million Armenians live in Russia and 1.2 million live in the United States. 10 Armenians living abroad represent a major source of family remittances, which is an important source of income since approximately one-third of the population lives below the poverty line and depends on remittances. 11 Most Armenians left the country during the Turkish invasion after World War I, when thousands of Armenians were killed. Economic hardship, especially during the 1980s and 1990s, also resulted in mass emigration. Political Stability Armenia is progressing toward a free democracy. Historically, elections have been found to be unfair, but there was improvement in the 2008 and 2013 presidential elections. However, more needs to be done, as the playing field was not equal in either election. In 2013, the two strongest candidates decided not to participate because they assumed the ruling party was going to commit electoral fraud, and there were protests against the re-elected president. Despite this, Armenia is one of the most politically stable countries in the region; Foreign Policy Magazine s political ranking places it ahead of Turkey, Azerbaijan, and Russia. 12 Following a December 2015 referendum on constitutional reform, Armenians voted in parliamentary elections in April 2017 that shifted the country from a presidential to a parliamentary system of government. Prime Minister Karen Karapetyan was reelected and neither the election nor the change in the governmental system, had a major impact on economic policy. The conflict with Azerbaijan over a territorial dispute in the Nagorno Karabakh region has been simmering for years, with occasional flare-ups, but Russia is attempting to mediate a resolution. Weaknesses Size and Wealth Armenia s small economy and low-income status leave the country vulnerable to economic shocks. The Armenian economy, at $11.4 billion, is the seventh-smallest of the countries we monitor, and GDP per capita amounts to only $3,798 among the lowest in the Caucasian region. Countries with small economies and low-income levels tend to default more frequently, as they tend to be less resilient to external shocks. The small size of the economy also means that benchmark-eligible bonds amount to a relatively high share of GDP. Narrow Export Base Armenia s export market is not well diversified, with precious stones and metals, mining products, and processed foods among the country s principal exports. Mining products, including copper and molybdenum, account for more than 50% of foreign shipments and are the main export-generating sector, creating vulnerability to a commodity shock

7 Armenia Tension with Neighbors Armenia s ongoing conflict with Azerbaijan over the Armenian-occupied territory of Nagorno Karabakh in Azerbaijan is continually at risk of escalation. Nagorno Karabakh is currently controlled by the ethnic Armenian majority, which has the support of the Armenian government. Tension between Azerbaijan and Armenia has continued, despite a ceasefire agreement signed in 1994 that ended the war between the two countries. Sporadic fighting and confrontation have erupted since then and could easily escalate. Armenia s relationship with Turkey has been contentious since 1920, when Turkey invaded Armenia, killed between 600,000 and 1.5 million people and forcibly deported hundreds of thousands of others. The United States and other countries have accused the Turkish government of genocide, but Turkey denies this accusation and refuses to apologize. Both countries have tried to reach a conciliatory accord, but with limited success as agreements have stalled in the parliaments of both countries due to mutual distrust. Location Armenia is a landlocked country, which presents major competitiveness problems due to trade blockages imposed by neighboring Azerbaijan and Turkey. Armenia was also prohibited from trading with neighboring Iran owing to fears of US retaliation, and renewed tensions between the U.S. and Iran could threaten Armenia s role as a bridge to the country. Most of Armenia s exports are routed through Georgia. In 2008, an armed conflict between Georgia and Russia had an adverse impact on Armenian trade flows. Although relations between Georgia and Russia have improved, the 2008 event highlights Armenia s vulnerability. Energy Dependency Unlike most countries in the region, Armenia is not an energy producer. The country imports more than 70% of its domestic gas and oil needs for transportation, cooking, and electricity generation. 14 Although the energy supply has improved and is now more stable, the World Bank notes that Armenia still faces the challenge of a supply gap and finding reliable sources of energy. 15 This dependency on energy imports also translates into costly electricity subsidies. The government attempted to reduce these subsidies in 2015 but was forced to backtrack following widespread protests, as poor households spend up to 15% of their income on energy. 16 Corruption and Power Armenia suffers from endemic corruption, a legacy of Soviet-era rule, and weak, underdeveloped institutions. Transparency International s Corruption Perception Index ranks Armenia 113th out of 176 countries, near where it was a decade ago. 17 As in other former Soviet states, this corruption is attributed to a group of oligarchs closely tied to the government who stymie government attempts to increase taxes and oppose structural reforms that might reduce their power or commercial interests. Weakening Conditions for the Banking System According to the IMF, Armenia s banking system is solid, but the weaker external environment has led to a reduction of profitability, lower credit expansion, and fewer deposits in the sector. This banking sector deterioration resulted in an increase in the nonperforming loans-to-gross loans ratio to more than 10% as of the first quarter of However, new minimum capital requirements, as well as bank mergers and new capital injections lowered this ratio to about 7% by the first quarter of High dollarization of the banking system, at more than 50% of deposits, is another vulnerability of the banking sector

8 Lazard Emerging Markets Debt Country Background Size Capital Population 29,743 KM 2 (143rd) Yerevan 3.1 Million Religion Armenian Apostolica 92.6%, Evangelical 1.0%, Other 6.4% Median Age 35.1 Years Literacy Rate 99.7% Independence 21 September 1991 Political System Government Leadership Next Elections 2022 Legislative Branch Parliamentary Democracy President Serzh Sargsyan; Prime Minister Karen Karapetyan Unicameral National Assembly Economy Agriculture 17.8%, Industry 27.5%, Services 54.7% Labor Force Agriculture 36.3%, Industry 17.0%, Services 46.7% Merchandise Exports Pig Iron, Unwrought Copper, Nonferrous Metals, Gold, Diamonds, Mineral Products, Foodstuffs Export Partners Russia 21.0%, Bulgaria 8.7%, Georgia 8.1%, Canada 7.9%, Germany 7.9%, Iraq 7.8%, China 5.7%, Iran 4.2%, Switzerland 4.2% Currency Armenian Drams (AMD) As of November 2017 Source: CIA 108

9 Armenia Country Timeline Between 600,000 and 1.5 million Armenians are massacred or deported from their homeland in ANATOlia to present-day Syria. The Ottoman government had suspected them of harbouring pro-russian sympathies Armenia is invaded by Turkey and Bolshevik Russia. An agreement with the Bolsheviks leads to Armenia proclaiming itself a socialist republic Armenia is incorporated into the Union of Soviet Socialist Republics, USSR Encouraged by the new policy of openness ("glasnost"), Armenians begin to campaign for Nagorno-Karabakh, a region with a predominantly Armenian population in the neighbouring Soviet republic of Azerbaijan, to be united with Armenia Conflict over Nagorno Karabakh begins. It lasts intermittently for five years. Many Azeri citizens are forced to flee their homes Armenian nationalists win parliamentary elections. Independence is declared, but ignored by Moscow Presidential elections. Prime Minister Serzh Sarkisian is declared winner. Thousands of opposition supporters take to the streets to protest the result The governments of Turkey and Armenia agree to normalize relations at a meeting in Switzerland, paving the way for moves to establish diplomatic ties and reopen the mutual border. Opposition protesters accuse government of failing to raise the genocide question Serge Sarkisian wins a second term as president, with official results giving him nearly 59% of the vote. His nearest rival rejects the outcome President Serge Sarkisian withdraws from parliament the landmark 2009 agreement with Turkey to restore diplomatic ties, citing the absence of political will on the Turkish side. Source: BBC 109

10 Lazard Emerging Markets Debt Notes 1 As of October Republic of Armenia: 2017 Article IV Consultation and Fifth and Final Review under the Extended Arrangement, International Monetary Fund, IMF Country Report No. 17/226, July 2017, org/en/publications/cr/issues/2017/07/19/republic-of-armenia-2017-article-iv-consultation-and-fifth-and- Final-Review-Under-the European Union, Joint Press Release by the European Union and Republic of Armenia on the initialling of the EU-Armenia Comprehensive and Enhanced Partnership Agreement, 21 March 2017, europa.eu/headquarters/headquarters-homepage/23120/joint-press-release-european-union-and-republicarmenia-initialling-eu-armenia-comprehensive_en. 4 The following points are based on the Armenia Delegation s Presentation made during their road show of the 2020 Bond issued in September Grigoryan, Marianna, Armenia Faces Cash-Crunch as Russian Remittances Slump, Eurasianet.org, 9 April 2015, accessed on November 23, 2015, 6 Gas Issue: Experts in Armenia say Russia s Price Discount Inadequate to Global Conjecture, Armenia Now, 2 May 2016, 7 Armenian Russian relations in light of electric Yerevan, TheHill.com, pundit blog, accessed on 23 November 2015, 8 Piven, Ben, Russia expands military footprint abroad with new Syria base, Al Jazeera, 18 September 2015, accessed on 23 November 2015, 9 Republic of Armenia: 2017 Article IV Consultation and Fifth and Final Review under the Extended Arrangement, International Monetary Fund, IMF Country Report No. 17/226, July 2017, org/en/publications/cr/issues/2017/07/19/republic-of-armenia-2017-article-iv-consultation-and-fifth-and- Final-Review-Under-the International Dialogue on Migration 2013, Ministry of Diaspora of Armenia, June 2013, files/live/sites/iom/files/what-we-do/idm/workshops/idm-2013-diaspora-ministerial-conference/diaspora- Ministerial-Conference-Presentation-Hakobayan.pdf. 11 Republic of Armenia: Selected Issues, International Monetary Fund, IMF Country Report No. 17/227, July 2017, 12 Bairamian, William, Mountain of Stability: Why Armenia is the Region s Most Stable Country, The Armenite, 24 March 2014, accessed on 23 November 2015, 13 Armenia: Trade Statistics, Michigan State University, Global Edge, accessed on 23 November 2015, globaledge.msu.edu/countries/armenia/tradestats. 14 Energy imports, net (% of energy use), The World Bank, CONS.ZS?locations=AM. 15 Country Program Snapshot: World Bank Group Armenia Partnership, World Bank Group, April 2015, accessed 23 November 2015, Snapshot.pdf. 16 Country Program Snapshot: World Bank Group Armenia Partnership, World Bank Group, April 2015, accessed 23 November 2015, Snapshot.pdf. 17 Transparency International, Corruption Perceptions Index: 2016, 18 Republic of Armenia: 2017 Article IV Consultation and Fifth and Final Review under the Extended Arrangement, International Monetary Fund, IMF Country Report No. 17/226, July 2017, org/en/publications/cr/issues/2017/07/19/republic-of-armenia-2017-article-iv-consultation-and-fifth-and- Final-Review-Under-the Ibid. 110

11 Azerbaijan Summary Moody s Ba2 / S&P BB+ / Fitch BB+ 1 Economy: Agriculture 6%, Industry 52%, Services 42% Azerbaijan has abundant energy resources, low debt levels, political and social stability, and marketfriendly policies. The country has managed its natural resources well, as reflected in fiscal and current account surpluses and an accumulation of savings. However, the collapse of global oil prices has adversely affected Azerbaijan, with growth contracting in 2016 and 2017, fiscal surpluses turning into sizable deficits, and double-digit current account surpluses largely evaporating. Azerbaijan s sovereign wealth fund has reduced vulnerability to global commodity fluctuations and helped offset economic imbalances. Other vulnerabilities include a volatile relationship with Armenia, lack of diversification, and exceptionally weak institutions. Azerbaijan s oil production is likely to stagnate in the short term, making the performance of the non-oil sector vitally important, and further progress is needed to improve business conditions. It is uncertain how successful Azerbaijan will be at diversifying the economy, which is a challenge faced by other commodity-producing countries. Corruption remains another major constraint on growth. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 7,932 7,946 5,514 3,863 3,601 3,623 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Haver Analytics, IMF, NB of A, SSC of Azerbaijan 111

12 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency BBB BB+ BB B+ Local Currency BB- BBB- BBB BBB- BB+ BB BB- B B Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Azerbaijan 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 112

13 Azerbaijan Strengths Abundant Energy Resources Azerbaijan s key strength is its abundant energy resources, especially oil and gas. The country is among the 20 largest oil producers in the world and one of the largest when measuring per capita oil production. Azerbaijan produces 845,000 barrels per day (bpd), 2 and has 7 billion barrels of oil reserves that should last more than a decade. 3 About 20% of production comes from the State Oil Company of Azerbaijan Republic (SOCAR) and the remainder from a consortium of 10 companies known as the Azerbaijan International Operating Company, or AIOC, led by BP. Domestic oil consumption is around 100,000 bpd, which means most of the oil is exported, mainly through the country s Baku Tbilisi Ceyhan (BTC) pipeline. In addition, Azerbaijan has 1.1 trillion cubic meters (tcm) of natural gas reserves and produces 17.5 billion cubic meters (bcm) of gas, some of which it has recently begun to export. Gas output is expected to more than double when the Shah Deniz Stage 2 project is completed in A new pipeline, at a projected cost of more than US$11 billion, is under construction and expected to be finished by late 2018, which will allow Azerbaijan to export gas to Georgia, Turkey, and eventually Europe. 4 Strong Balance Sheet Azerbaijan has one of the strongest government balance sheets in the world. The government has managed its oil resources well, posting fiscal surpluses averaging 7.2% of GDP between 2000 and 2014, before the fiscal balance turned negative following the sharp decline in global oil prices in With the recovery of oil prices, Azerbaijan is projected to return to slight fiscal surpluses over the forecast horizon. Past fiscal surpluses allowed for the accumulation of savings in the State Oil Fund of Azerbaijan (SOFAZ) amounting to more than US$33 billion, equal to nearly 90% of current GDP. The management of SOFAZ assets has been unpredictable and subject to presidential discretion, although the government is working with the IMF on a fiscal rule that will provide greater predictability and preserve assets while allowing for countercyclical responses to oil price shocks. Meanwhile, the stock of public debt has more than tripled since 2014 following the sharp devaluation of the manat in December A debt restructuring by the International Bank of Azerbaijan in 2017 resulted in a further increase in public debt levels, since the government assumed a portion of the bank s debt. Nevertheless, Azerbaijan s total stock of public debt remains manageable, at less than 50% of GDP and it is expected to gradually decline over the forecast horizon as growth picks up again. Solid Balance of Payments Azerbaijan s balance of payments position is solid, notwithstanding a deterioration of the current account balance in recent years. The country posted large current account surpluses averaging 19.1% between 2005 and The sharp deterioration in 2015 was largely due to the collapse of global oil and gas prices, since these products account for the bulk of Azerbaijan s exports. Current account surpluses have helped offset sizable financial account deficits, allowing accumulation of a large amount of external assets totaling nearly $40.0 billion, equal to more than 100% of GDP. This is more than 2.5 times the level of external debt, which is estimated at 37% of GDP. 7 Political Stability Azerbaijan is a politically stable country because one family and one party have been in power for nearly 25 years. The current president, Ilham Aliyev, began his tenure in 2003 when he replaced his father, Heydar Aliyev, who took power in October Aliyev also won the 113

14 Lazard Emerging Markets Debt 2013 presidential election with 85% of the vote, although the international community indicated elections were unfair and rife with fraud. Aliyev s New Azerbaijan Party won the November 2015 parliamentary elections by a landslide and now holds a majority in the unicameral National Assembly, with 69 of 125 seats, owing to the opposition s boycott of the election. The next presidential election is scheduled for Social Stability Azerbaijan is a highly stable country. Social protests are rare because of strong government repression, which is not uncommon among the Commonwealth of Independent States (CIS). Azerbaijan also remains stable because the government has improved social conditions for the majority of the population. This has probably added to the president s popularity since significant progress has been made in reducing poverty, which has declined from 50% in 2001 to 6% in 2014, while extreme poverty decreased from 20% to less than 3%. 8 Nevertheless, the deterioration of economic conditions in recent years has led to occasional protests, which have been quickly suppressed. Although the government has largely maintained social stability, there is still occasional unrest in the Nagorno Karabakh region, which is occupied by an ethnic Armenian majority. Attempts at resolving tensions within the region have failed. The regional conflict led to a war between Azerbaijan and Armenia that ended with the signing of a ceasefire agreement in However, sporadic fighting and confrontation have erupted since then and could easily escalate. Armenia claims the disputed territory as its own, and Armenian leaders who have attempted to resolve the conflict have been forced to resign following domestic popular resistance. 9 Key Allies Azerbaijan has maintained a good relationship with Russia, Europe, and the United States. The US considers Azerbaijan a strategic military ally that has helped with the conflicts in Iraq and Afghanistan. The importance of ties with the European Union is measured by trade. The EU is seeking to reduce its reliance on Russian gas and looking to Azerbaijan to fill the gap. The new Trans-ANATOlian natural gas pipeline should allow Azerbaijan to increase gas exports to Europe. Weaknesses Commodity Dependence Despite the decline in oil prices in recent years, oil and gas remain the main drivers of the Azerbaijani economy, accounting for 87.4% of total exports, 27.9% of GDP, and 54% of revenues. 10 Like other commodity-dependent countries, changes in oil and gas production, and prices largely determine the direction of economic growth. However, the government has done a good job of reducing economic volatility related to the oil sector through the creation of the sovereign wealth fund. The government spends these funds when oil prices are low and accumulates savings when prices are high. 114

15 Azerbaijan Slower Economic Growth After a decade of strong economic growth, the economy has taken a sharp downturn, falling 3.1% in 2016 and a projected 0.6% in If the magnitude of this downturn is confirmed, the economy will have contracted at an average annual rate of 1.0% over the past three years, compared to average annual growth of 11.2% between 2005 and The poor performance in recent years is due to a combination of lower oil production in the Azeri, Chirag, and Guneshli oil fields, as well as the shock from lower oil prices. Gas production is expected to increase by 2018 as the Shah Deniz Stage 2 project becomes operational. Despite the sluggish oil sector, the non-energy sector is performing well, growing at a projected 2.4% in 2016 after a 3.6% contraction in Risk of War with Armenia Azerbaijan lives with the constant possibility of an intensification of its conflict with Armenia over the Armenian-occupied territory of Nagorno Karabakh, which is currently controlled by the ethnic Armenian majority with the support of the Armenian government. Tension between the two countries remains high, despite the signing of a ceasefire agreement in Since that time, there has been sporadic fighting and an increase in border tension. Azerbaijan often threatens to retake the region by force, although international organizations continue to appeal for a non-violent resolution. Weak Institutions Institutions in Azerbaijan are fragile, which adversely affects growth. The country languishes in the bottom third of many international governance and corruption indicators, such as Transparency International s Corruption Perception Index, where it ranks 123rd of 176 countries. 12 Transparency International highlights that corruption is a major problem, hindering economic development and political stability, although this is characteristic of other countries in the region, including Armenia, Kazakhstan, Moldova, and Ukraine. 115

16 Lazard Emerging Markets Debt Country Background Size Capital Population 86,600 KM 2 (113th) Baku 9.9 Million Religion Muslim 96.9%, Christian 3.0%, Other 0.1% Median Age 31.3 Years Literacy Rate 99.8% Independence 30 August 1991 Political System Government Leadership Next Election 2020 Legislative Branch Presidential Republic President Ilham Aliyev; Prime Minister Artur Rasizade Unicameral National Assembly Economy Agriculture 6.0%, Industry 51.7%, Services 42.3% Labor Force Agriculture 37.0%, Industry 14.3%, Services 48.9% Merchandise Exports Oil and Gas, Machinery, Foodstuffs, Cotton Export Partners Italy 19.9%, Germany 10.5%, France 8.0%, Czech Republic 5.2% Currency As of November 2017 Source: CIA Azerbaijanian Manat (AZN) 116

17 Azerbaijan Country Timeline 1988 Nagorno Karabakh region seeks to become part of Armenia. Ethnic Azeris begin to leave Karabakh and Armenia and ethnic Armenians leave Azerbaijan. At least 26 ethnic Armenians and six Azeris are killed in violence in Azerbaijani town of Sumqayit Ethnic strife between Armenians and Azeris escalates. Azeri nationalist Popular Front rallies support amid growing disorder After failed coup attempt in Moscow, Azerbaijani parliament votes to restore independence. In elections boycotted by opposition, Mr Mutallibov becomes president. Heydar Aliyev becomes leader of the Azerbaijani exclave of Nakhichevan. Leadership of Nagorno Karabakh declares the region an independent republic. Inter-ethnic hostilities escalate Hostilities develop into full-scale war over Karabakh. More than 600 Azeris are killed as they flee an Armenian attack on Karabakh town of Khodzhaly. Ethnic Armenian forces break through Azerbaijani territory to create a corridor linking Armenia to Karabakh. President Ayaz Mutallibov resigns. Abulfaz Elchibey, leader of nationalist People's Front, becomes president in Azerbaijan's first contested elections Armenia, Azerbaijan and Nagorno Karabakh sign a ceasefire accord. Ethnic Armenians remain in control of Karabakh and a swathe of Azerbaijani territory around it. Mr Aliyev cracks down hard on People's Front. Azerbaijani forces mount Karabakh counteroffensive. Armenia, Azerbaijan and Nagorno Karabakh sign a ceasefire. Ethnic Armenians remain in control of Karabakh and a swathe of Azerbaijani territory around it. Prime Minister Huseynov is dismissed and flees to Russia after accusations of involvement in an attempted coup. Azerbaijan signs what it calls the contract of the century with a consortium of international oil companies for the exploration and exploitation of three offshore oil fields Robert Kocharian leaves Karabakh to become prime minister in Armenia. Foreign Minister Arkadiy Gukasian is elected Karabakh president. Former PM Surat Huseynov is extradited from Russia. Following a lengthy trial for high treason he is eventually sentenced to life imprisonment. The Armenian leader is criticized at home for making too many concessions and subsequently resigns. The first oil is produced by the Azerbaijani International Operating Company under the contract of the century Azerbaijan becomes full member of Council of Europe, though council officials criticise it over human rights record. US lifts aid ban, imposed during Nagorno Karabakh conflict, after Azerbaijan provides airspace and intelligence after 11 September al-qaeda attacks in US. Azerbaijan, Georgia and Turkey reach agreement on oil and gas pipelines linking Caspian fields with Turkey. Azerbaijan officially shifts to the Latin alphabet for the Azeri language, in the fourth alphabet change in a century Construction work starts on multi-billion-dollar pipeline to carry Caspian oil from Azerbaijan to Turkey via Georgia Aliyev appoints his son, Ilham, as prime minister. Ilham Aliyev wins landslide victory in presidential poll said by observers not to reach international standards. Opposition protests met with police violence; hundreds arrested Baku-Tbilisi-Ceyhan pipeline formally opened at ceremony in Turkey after Caspian oil starts flowing along it Ilham Aliyev wins a second term as president. Western observers say conduct of the election, boycotted by the main opposition parties, was an improvement on previous votes but still fell short of democratic standards. Armenia and Azerbaijan sign a joint agreement aimed at intensifying efforts to resolve their dispute over territory of Nagorno Karabakh Azerbaijani-Armenian talks on Nagorno Karabakh end without achieving major breakthrough Presidential elections. President Aliyev wins another third five-year term Deadly clashes between troops from Azerbaijan and Armenia over the disputed enclave of Nagorno Karabakh. British Petroleum announces start of construction of Southern Gas Corridor to deliver gas to Europe directly, bypassing Russia. Pipelines scheduled for completion in

18 Lazard Emerging Markets Debt 2017 President Aliyev appoints his wife, Mehriban, as first vice-president. Fighting flares up in Nagorno Karabakh between the Azerbaijani army and ethnic Armenian troops along the line separating them. Source: BBC Notes 1 As of October As of Source: Azerbaijan, U.S. Energy Information Administration, 3 As of Source: BP Statistical Review World Energy 2017, BP, en/corporate/pdf/energy-economics/statistical-review-2017/bp-statistical-review-of-world-energy-2017-fullreport.pdf. 4 Azerbaijan, U.S. Energy Information Administration, rankings/#?prodact=53-1&cy=2016, and Shah Deniz Stage 2, BP, operationsprojects/shahdeniz/sdstage2.html. 5 Azerbaijan, International Monetary Fund, World Economic Outlook Database October 2016, accessed 14 October 2016, 6 International Monetary Fund, World Economic Outlook Database October 2017, 7 As of December 2016, Source: Lazard estimates. 8 Republic of Azerbaijan 2016 Article IV Consultation, IMF Country Report 16/296, September 2016, and World Bank Group Azerbaijan Partnership Program Snapshot, World Bank Group, April 2015, worldbank.org/content/dam/worldbank/document/azerbaijan-snapshot.pdf. 9 Armenia, Azerbaijan Move Closer To Settling Frozen Conflict, Stratfor Global Intelligence, 17 November 2015, accessed on 23 November 2015, 10 Republic of Azerbaijan 2016 Article IV Consultation, IMF Country Report 16/296, September 2016, Republic of Azerbaijan 2016 Article IV Consultation, IMF Country Report 16/296, September 2016, Transparency International, Corruption Perceptions Index: 2016, 118

19 Belarus Summary Moody s Caa1 / S&P B- / Fitch B- 1 Economy: Agriculture 8%, Industry 40%, Services 52% Belarus is a small, open economy that is very dependent on its main trade partner, Russia. The economy is recovering after a series of external shocks resulting in a major economic crisis resulting in an economic contraction of nearly 5% in The government has tightened fiscal and monetary policy and avoided a balance-of-payment crisis, but more needs to be done to tackle structural economic problems, which include a large and inefficient public sector. Real GDP grew an estimated 1% in 2017, the current account is near balance and foreign reserves have almost doubled from recent lows. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 7,977 8,316 5,941 4,989 5,585 5,745 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Central Bank, Haver Analytics, IMF 119

20 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency B+ B B- Local Currency BB- BB+ BB BB- B+ B CCC+ B- CCC+ CCC CCC Moody s S&P Moody s S&P As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Belarus 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 120

21 Belarus Strengths Political Stability and Willingness to Adjust Belarus is a democracy, but has been ruled by the same autocrat, Alexander Lukashenko, since 1994 and has been labeled as Europe s last dictatorship. Lukashenko has used several referenda to remove term limits and remain in power and at 61, he is still young and likely to remain in power for the foreseeable future. He recently won his fifth term with 83.5% of the vote while his closest rival garnered less than 5%. However, international observers indicated that voting standards were subpar. 2 The opposition is fragmented and marginalized, with limited access to the media, and street protests are not tolerated. 3 While negative on many fronts, this political model makes economic adjustments, such as the devaluation of the ruble during the liquidity crises in 2011 and 2015, politically feasible. Relations with Russia Since its independence in 1991, Belarus has maintained strong ties with Russia, a proven ally during times of distress. For example, in June 2014, Belarus received US$2.0 billion from Russia and, more recently, Russia lent $760 million to assist Belarus s debt repayment efforts. 4 The two economies are tied through production chains and Russia supplies energy at heavily discounted prices. Estimates suggest that Russian subsidies over the past 20 years have reached 15% of Belarus s annual GDP. 5 Belarus recently had a dispute about gas prices with Russia, but this was resolved in Russia accounts for 78% of foreign direct investment (FDI) 6, more than 40% of exports, and more than half of all imports. 7 Additionally, a quarter of Belarus s banking assets belong to Russian banks. 8 As Russia continues to divert activity away from Ukraine, Belarus has become a key transit point for Russia. Along with Kazakhstan, Belarus and Russia formed the Eurasian Economic Union, which took effect in January Russia has also committed to financing a nuclear power plant for Belarus. Despite frequent and sometimes heightened periods of tension between the two countries, it seems unlikely that Russia would withdraw support. However, while this strong alliance has been a key strength, it has recently been a source of weakness due to Russia s annexation of Crimea. Belarus s government estimates a negative impact of $3 billion as a result of the incursion. 9 Relations with EU and China Belarus is looking to diversify its economic partners and improve its relationship with the European Union (EU) and China. The EU recently lifted sanctions on Belarus, which should help to unlock financing from the European Bank for Restructuring Development and the European Investment Bank. Belarus is also engaged with China on the One Belt, One Road initiative as a potential source of additional capital. Finally, Belarus is opening up to new negotiations with the World Trade Organization and improving ties with bilateral entities, including the World Bank. 10 Weaknesses Small, Vulnerable Economy Belarus is a small, open, economy with trade at 125% of GDP, making it vulnerable to the economic performance of its main trading partner, Russia. In 2015 and 2016, the economy contracted by 6.2% mainly because of the Russian recession. In 2017, we expect Belarus to benefit from the Russian economic recovery. 121

22 Lazard Emerging Markets Debt Unsustainable Macroeconomic Model Belarus has a highly centralized economic model with a large state role. Prices, production of goods and services, and lending are directed by the government. State-owned enterprises (SOE), which are much less efficient than the private sector, represent 75% of the total economy. Thus, although investment is high, it tends to be inefficient. Additionally, infrastructure is outdated and energy efficiency is low. Belarus s main policy objective has been growth via aggressive monetary and off-budget fiscal expansion, which has created large external imbalances, leading to devaluations and high inflation. The IMF noted that the combination of an ineffective economic model and low buffers makes Belarus highly vulnerable to shocks. 11 The IMF advocates a more market-oriented model including price liberalization, the elimination of tariffs, and the privatization of SOEs. Weak Public Balance Sheet The deficit of public companies has pushed public debt levels, including guaranteed debt, significantly higher to an estimated 59% of GDP in 2017, compared to around 37% of GDP in This increase is due to the sharp exchange-rate depreciation, quasi-fiscal costs, recapitalizations, and new government-guaranteed debt. The government is taking a series of measures to reduce the deficit, including quasi-fiscal costs. 12 Weak Banking System The banking system s balance sheet is weak, especially as public companies struggle to repay loans because of the recent recession and weak economic recovery. Nonperforming loans are high at 12% and continuing to rise, while capital adequacy ratios are on a downward trend and are currently close to 16%. Public banks amount to about two-thirds of the banking system assets; thus, any problem in the system will likely require some recapitalization from the central government. On a more positive note, deposit outflows have stopped. Poor External Liquidity and Recurring Balance-of- Payment Pressures Belarus remains dependent on foreign inflows despite capital controls. The country experienced two severe balance-of-payments crises in six years. The first, in 2011, followed loose fiscal and monetary policies that included wage hikes, credit growth, and negative real interest rates. This caused pressure on the exchange-rate peg, leading to depletion of foreign reserves to less than two months of imports and, eventually, a bailout from Russia. The second began in 2013 when high economic growth led to a double-digit current account deficit and a sharp decline in foreign reserves, forcing the government to move toward a more flexible exchange rate. The current account deficit has since stabilized at roughly 3% 4% of GDP and financing has picked up, helping to rebuild foreign reserves, which remain at relatively low levels. Concentration of Power President Lukashenko, dubbed Europe s last dictator, has alienated Belarus from the EU and the United States, limiting the country s funding and assistance options to Russia and, more recently, China. With the exception of some privatizations, Belarus has shown very little interest in opening up the economy, or reducing the role of the state. For example, the government used SOEs at the outset of the 2015 elections to create artificial employment and reduce social tension

23 Belarus Country Background Size Capital Population 207,595 KM 2 (86th) Minsk 9.6 Million Religion Orthodox 48.3%, Catholic 7.1%, Other 44.6% Median Age 40.0 Years Literacy Rate 99.7% Independence 25 August 1991 Political System Government Leadership Next Election 2020 Legislative Branch Presidential Republic President Alexander Lukashenko; Prime Minister Andrey Kobyakov Bicameral National Assembly Economy Agriculture 8.1%, Industry 39.6%, Services 52.3% Labor Force Agriculture 9.7%, Industry 23.4%, Services 66.8% Merchandise Exports Machinery and Equipment, Mineral Products, Chemicals, Metals, Textiles, Foodstuffs Export Partners Russia 46.3%, Ukraine 12.2%, United Kingdom 4.6%, Germany 4.0% Currency Belarus Ruble (BYR) As of November 2017 Source: CIA 123

24 Lazard Emerging Markets Debt Country Timeline 1995 Friendship and cooperation pact signed with Russia. National referenda result in a new flag almost identical to that of the former Soviet republic, and the restoration of Russian as an official language. The president's powers are also widened. There are protests on the streets, but these are broken up Council of Europe condemns human rights abuses after report accuses authorities of blocking investigation into the fate of four men with opposition links who disappeared in Minsk in 1999 and EU imposes travel restrictions on number of senior officials. Referendum backs change allowing president to serve more than previous limit of two terms. Opposition parties fail to win a single seat in parliamentary elections held at same time. Western observers say vote is neither free nor fair. Street protests ensue. Demonstrators clash with police and dozens are arrested President Lukashenko declared winner by landslide in elections condemned as unfair by Western observers. Opposition arrests reported as protesters in capital demand fresh vote. Defeated presidential election candidate Alexander Kozulin convicted of hooliganism and incitement to mass disorder. He is jailed for five and a half years Russia cuts the supply along an oil export pipeline to Europe amid a row with Belarus over taxation and allegations of siphoning. The dispute ends after Russia agrees to cut the oil duty it will charge Belarus President Lukashenko orders the shutdown of transit of Russian gas to Europe, escalating a new gas war after Moscow slashes supplies to Minsk in a debt dispute. Russia's Gazprom state gas company later resumes supplies after Belarus pays the outstanding debt. Presidential elections. President Lukashenko declared winner. Opposition and western observers allege vote rigging. Mass protests in Minsk are broken up by force, with 600 arrests President Lukashenko is inaugurated for a fourth term in office. The EU reinstates a travel ban on him and freezes his assets, while the US imposes stricter financial controls and widens its travel bans on senior officials. Belarus threatens the EU with retaliation over the sanctions and pushes ahead with plans to put more than 30 political activists, including four opposition leaders, on trial over the December protests. Belarus asks the IMF for an emergency loan of up to $8 billion over the balance of payments crisis. The government raises its main interest rate from 14% to 16% and freezes prices on a number of staple foods. Panic buying of basic goods ensues. Russia halves electricity supplies to Belarus over unpaid bills and in an effort to persuade the government to privatise lucrative assets. Belarus seeks a Russian-led $1.2 billion bailout, which is conditional on reforms. Russia agrees to sell Belarus gas at 60% below the price charged to other European countries, in return for the Russian gas monopoly Gazprom taking full ownership of the Belarussian gas pipeline firm Beltranshaz. Prominent human rights activist Ales Belyatski is found guilty of tax evasion and sentenced to four and a half years in prison. The EU says the case is politically motivated and calls for Mr Belyatski's immediate release President Lukashenko replaces longstanding foreign minister Sergei Martynov, one of the few officials that the European Union was prepared to talk to, with a close aide. Earlier in the month he sacked the air defence and border guard commanders and expelled the Swedish ambassador after human-rights activists flew into Belarusian airspace to drop teddy bears with pro-democracy messages Belarus asks Russia to deploy extra fighter jets and military transport aircraft to its territory after NATO boosts its forces in the neighboring Baltic countries. The moves come amid increasing tension caused by the crisis in Ukraine and Russia's annexation of Crimea President Lukashenko wins fifth presidential term. No significant opposition candidate was allowed to stand. Source: BBC 124

25 Belarus Notes 1 As of December Belarus election: Alexander Lukashenko wins fifth term with election landslide, The Guardian, 12 October 2015, accessed on 24 November 2015, 3 Bershidsky, Leonid, No, Lukashenko Is Not Defecting to Europe, Bloomberg View, 12 October 2015, accessed on November 24, 2015, 4 Belarus Receives $760 Million Loan From Russia, The Moscow Times, 28 July 2015, accessed on 27 November 2015, 5 lachnovic, Ales How Russia s Subsidies Save The Belarusian Economy, Belarus Digest, 25 August 2014, accessed on 24 November 2015, 6 Based on 2015 YTD data as of 24 November 2015, National Bank of the Republic of Belarus, accessed on 24 November 2015, 7 Foreign Trade of Belarus, Ministry of Foreign Affairs of the Republic of Belarus, accessed on 24 November 2015, 8 Republic of Belarus 2014 Article IV Consultation Staff Report; Press Release; and Statement by the Executive Director for the Republic of Belarus, International Monetary Fund, IMF Country Report No. 14/226, July 2014, 9 Belarus Receives $760 Million Loan From Russia, The Moscow Times, 28 July 2015, accessed on 27 November 2015, 10 Republic of Belarus, Staff Report for the 2016 Article IV Consultation, September external/pubs/ft/scr/2016/cr16298.pdf 11 Belarus: 2015 Article IV Consultation, International Monetary Fund, IMF Country Report No. 15/136, accessed on 24 November 2015, 12 Republic of Belarus, Staff Report for the 2016 Article IV Consultation, September external/pubs/ft/scr/2016/cr16298.pdf 13 Measures to support industry will not save Belarusian economy from further fall, Belarus in Focus, 24 November 2015, accessed on 24 November 2015, 125

26 Lazard Emerging Markets Debt 126

27 Georgia Summary Moody s Ba2 / S&P BB- / Fitch BB- 1 Economy: Agriculture 9%, Industry 23%, Services 67% Georgia is a small open economy with strong institutions and one of the most business-friendly environments in emerging markets. The country is an economic and financial hub in the Caucasus region, and its ease of doing business and solid banking sector have attracted large foreign investment inflows. Georgia s reforms have resulted in strong growth, which is accelerating again after a slowdown owing to the downturn in Russia and the challenging global environment. Although Georgia is an important Western ally, it maintains a delicately balanced relationship with Russia, an important trade partner that invaded the country in Key vulnerabilities include Georgia s large current account deficit, although this shortfall is nearly fully covered by foreign direct investment. Georgia is also vulnerable to external conditions due to the small size of its economy and high level of trade openness. Georgia held parliamentary elections in October 2016 and the incumbent Georgian Dream-Democratic Georgia party strengthened its majority, pointing to economic and foreign policy continuity. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 3,594 4,446 3,755 3,869 3,710 3,812 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, FM of Georgia, Bloomberg, Haver Analytics, IMF, NB of Georgia, NSO of Georgia 127

28 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency BB Local Currency BBB B+ B BB- BBB- BB+ BB BB- B B Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Georgia 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 128

29 Georgia Strengths Strong Public Sector Balance Sheet Georgia s fiscal deficit and debt levels are moderate. Although the country is a net oil importer, the fiscal accounts tend to suffer when oil prices decline, owing to fewer remittances and reduced investment from regional oil producers. The fiscal deficit rose in 2016 due to pension increases and a rise in universal healthcare costs. Although Georgia s Economic Liberty Act, which took effect in 2014, specifies that expenditures and fiscal deficits cannot exceed 30% and 3% of GDP, respectively, the government has not clarified the consequences should these targets be breached. 2 Although the fiscal deterioration of recent years raised the ratio of public debt to GDP to about 45% in 2016 from 34.7% in 2013, debt levels are projected to level off at about 43% of GDP over the forecast horizon, which is well below the legally mandated maximum of 60%. Regional Business Hub The Georgian authorities are progressing in their efforts to make Georgia the regional business hub in the Caucasus, in particular for the pharmaceutical, automotive, and mining sectors. To achieve this goal, the government has approved a series of business-friendly policies, lowered tax rates, simplified the tax system, and reduced corruption. Specifically, Georgia has signed 46 bilateral treaties to eliminate double taxation, eliminated restrictive visa requirements, and entered into trade agreements with Central Asian and Caucasus countries. 3 These efforts are reflected in the improvement Georgia is seeing in global benchmarks; in the World Bank Ease of Doing Business index, Georgia ranks 16th out of 190 countries compared to 125th in The country ranks particularly well in subcategories such as Starting a Business and Registering Properties. Efforts to improve business conditions have been recognized by the World Bank, which previously named Georgia Reformer of the Year. 5 Similarly, Transparency International s Corruption Perception Index ranks Georgia 44th of 176 countries compared to 133rd in Solid Banking System Georgia s banking system has improved substantially in recent years, and the IMF s latest Financial Sector Assessment Program notes that the sector is both sound and stable, with stress tests showing the system is able to withstand severe shocks. The banking sector s Basel I capital adequacy ratio as of the second quarter of 2017 was 25% (17.0% by local standards) and the sector s liquidity ratio is 44%. Nonperforming loans (NPLs) in the same period amounted to 4% of total gross loans according to the IMF definition; however, this rises to about 6.5% using the National Bank of Georgia s more stringent methodology. The liquid asset to total assets ratio was about 25%, while liquid assets to customer deposits were more than 40%, indicating a substantial liquidity buffer. The main weakness of the banking sector is its high level of dollarization, at 60% for assets and 70% for liabilities. 7 Notably, the depreciation of the exchange rate in 2015 did not have a major impact on the level of NPLs. Key Allies Georgia is an important ally of Western countries due to its location and because it provides a vital energy transit route to the West. As a result, Georgia has received substantial political and economic support during the past decade. A state visit by US Vice President Pence in August 2017 highlights the country s geopolitical importance. Western countries intervened to reach a peace agreement after the Russian invasion in 2008 and provided significant financial support amounting to more than $2 billion. 8 The Georgian government aims to 129

30 Lazard Emerging Markets Debt maintain this good relationship and in July 2016, an Association Agreement with the EU went into effect. The goal of this agreement is to integrate Georgia into the EU market, as nearly one-third of all Georgian exports are destined for the EU. 9 Despite the alliance and closer integration with the West, Georgia has also tried to rebuild relations with Russia, since one-third of the Georgian population supports joining the Russian-led Eurasian Union. 10 Dynamic Economy The economic reforms that Georgia has adopted since 2003 have paid off, and the economy has performed well, growing at an average rate of 4.8% between 2010 and 2016, although growth was more muted in 2015 and By signing the Deep and Comprehensive Free Trade Area (DCFTA) agreement with the EU, Georgia will facilitate access to credit for small- and medium-sized enterprises, which will likely result in a more dynamic pace of economic activity. 11 The services sector has done well, especially in sectors the government is promoting, such as communications, financial services, and tourism. Among the major constraints for higher economic growth is a shortage of skilled labor, a problem the government is trying to resolve by enhancing worker training programs. Relationship with Russia Georgia s relationship with Russia has historically been tense, especially during the short war between the two countries in August After its invasion of Georgia, the Russian government adopted import restrictions on Georgian goods, and trade between the two countries collapsed. The country s exports to Russia fell to less than 2% of total exports in 2009 from 8% in Georgia also lost control of two of its sub-regions: South Ossetia and Abkhazia. Relations with Russia are improving since a new government took power in For example, Russia has removed trade restrictions on mineral water, agricultural products, and wine, which are key export products of Georgia. Exports to Russia accounted for 14.9% of Georgia s total exports in the first half of However, there is a risk Russia will retaliate if Georgia continues to move closer to the EU. For example, Russia has issued a warning regarding the low quality of wine Georgia exported to Russia; separately, the Russian prime minister has warned of potential measures against Georgia in retaliation for supporting the EU sanctions against Russia. Weaknesses Vulnerability to External Shocks Georgia is an open economy dependent on its neighbors and thus vulnerable to external shocks. The economy is also small, with GDP of only about $14 billion, and trade openness is projected at 119.1% of 2017 GDP. In addition to Russia and China, Georgia s principal trade partners include its neighbors Turkey, Armenia, and Azerbaijan, leaving Georgia vulnerable to these countries economic performance. For example, Azerbaijan is an energy producer, leaving Georgia indirectly vulnerable to oil price fluctuations. However, this vulnerability is partly mitigated by Georgia s status as a net oil importer. External Imbalances In recent years, Georgia has registered double-digit current account deficits, and the magnitude of these shortfalls is expected to remain the same over the forecast horizon. However, Georgia s current account deficits are largely financed by foreign direct investment (FDI), and multilateral loans and bilateral donations are projected at an additional 3.4% of GDP 130

31 Georgia in FDI inflows and multilateral lending are less vulnerable to global financial conditions, reducing the risk profile of Georgia s external imbalances. Moreover, adequate levels of foreign reserves, amounting to about 20% of GDP, further reduce the risk of balanceof-payments pressures and compensate for the high levels of external debt, which have risen to more than 120% of GDP. Georgia s large current account deficits suggest underlying economic problems, mainly a lack of competitiveness, especially in the agricultural sector. Georgia imports 80% of its packaged food products. 15 The current account deficit also mirrors the small export base: Georgia s principal exports are copper ores, ferro-alloys, cars, wine, and medicine. 16 Political Differences President Giorgi Margvelashvili took office in November 2013 as a constitutional reform went into effect that transferred substantial power from the president to the prime minister. However, Georgian politics have been roiled by conflicts between Margvelashvili and former Prime Minister Irakli Garibashvili, as well as by frequent changes in government, including three prime ministers since These developments have hindered faster growth and reforms in Georgia. Garibashvili s resignation in December 2015 and replacement by the more technocratic Giorgi Kvirikashvili has helped to ease tensions. Moreover, the incumbent Georgian Dream-Democratic Georgia (GDDG) party strengthened its mandate after parliamentary elections in October 2016, clearing the way for the government to advance its reformist, pro-western agenda. 131

32 Lazard Emerging Markets Debt Country Background Size Capital Population Religion Median Age 69,700 KM 2 (121st) Tbilisi 4.9 Million Orthodox 83.4%, Muslim 10.7%, Armenian Apostolic 2.9%, Other 3.0% 38.1 Years Literacy Rate 99.8% Independence 9 April 1991 Political System Government Leadership Next Election 2020 Legislative Branch Semi-presidential Republic President Giorgi Kvirikashvili Unicameral Parliament Economy Agriculture 9.3%, Industry 22.8%, Services 67.2% Labor Force Agriculture 55.6%, Industry 8.9%, Services 35.5% Merchandise Exports Vehicles, Ferro-Alloys, Fertilizers, Nuts, Scrap Metal, Gold, Copper Ores Export Partners Russia 9.8%, Turkey 8.2%, China 8.1%, Bulgaria 7.3%, Azerbaijan 7.3%, Armenia 7.2%, Germany 4.1% Currency As of November 2017 Source: CIA Georgian Lari (GEL) 132

33 Georgia Country Timeline 1991 Georgian parliament declares secession from the Soviet Union after independence is overwhelmingly supported in a referendum. Gamsakhurdia is elected president by more than 85% of the votes cast Gamsakhurdia is deposed after fighting in central Tbilisi between government troops and opposition militias. South Ossetians vote in favour of independence in an unrecognized referendum Shevardnadze is appointed head of the newly formed State Council Fighting breaks out in Abkhazia between Georgian government troops and separatist forces Shevardnadze is directly elected chairman of parliament Georgian troops driven out of Abkhazia by separatist forces Insurrection by Gamsakhurdia supporters in western Georgia is suppressed after Georgia agrees to join the CIS and receives help from Russian troops. Georgian government and Abkhaz separatists sign a ceasefire agreement, paving the way for the deployment of a Georgian government and Abkhaz separatists sign a ceasefire agreement, paving the way for the deployment of a Russian peacekeeping force in the region. New constitution adopted which provides for a strong executive presidency. New currency, the lari, introduced Shevardnadze wins elections to the restored post of president Death penalty abolished Shevardnadze re-elected president Georgia and the separatist region of Abkhazia sign an accord pledging not to use force against each other Russia hands over Vaziani military base to Georgia. Clashes in Abkhazia between Abkhaz troops and Georgian paramilitaries backed by fighters from the North Caucasus. The tension is heightened as Russia accuses Georgia of harbouring Chechen rebels, a charge dismissed by Georgia Raid by security forces on privately-owned Rustavi-2 TV station, known for its criticism of Mr. Shevardnadze and corruption, sparks protests. Mr. Shevardnadze responds by sacking cabinet. Source: BBC 133

34 Lazard Emerging Markets Debt Notes 1 As of October Georgia: Fiscal Transparency Evaluation, International Monetary Fund, Fiscal Affairs Department, September 2017, 3 Aleksishvili, Aleksi, Why Georgia must work closely with its neighbours, World Economic Forum, agenda.weforum.org/2014/09/regional-cooperation-key-georgias-economic-growth/. 4 Economy Rankings, World Bank, DoingBusiness.org, 5 Doing Business: Georgia is This Year s Top Reformer, The World Bank, 6 December 2006, worldbank.org/wbsite/external/news/0,,contentmdk: ~pagepk:34370~pipk:34424~thesit epk:4607,00.html. 6 Corruption Perceptions Index, Transparency International, corruption_perceptions_index_ Georgia The Outlook, Ministry of Finance of Georgia, June 2017, The%20Outlook_ENG_June% pdf. 8 Nichol, Jim, Armenia, Azerbaijan, and Georgia: Political Developments and Implications for the U.S. Interests, Congressional Research Service, 25 October 2013, pdf and Donors Pledge $4.5 billion to Georgia, BBC, 22 October 2013, europe/ stm. 9 Georgia: Trade Picture, European Commission, 15 February 2017, 10 Buckley, Neil, Georgia hopes over Europe turn to disappointment, Financial Times, FT.com, 17 May 2015, accessed on 24 November 2015, html#axzz3sqirvngx. 11 EU to unlock 2 billion worth of investment for small businesses in Georgia, Moldova and Ukraine, European Commission, 21 May 2015, 12 Source: Haver Analytics. 13 Georgia The Outlook, Ministry of Finance of Georgia, June 2017, The%20Outlook_ENG_June% pdf. 14 Georgia: Request for Extended Arrangement Under the Extended Fund Facility and Cancellation of Stand-By Arrangement, International Monetary Fund, IMF Country Report No. 17/97, April 2017, Georgia Agricultural Sector, Export.gov, U.S. Department of Commerce, International Trade Administration, 19 July 2017, 16 Georgia The Outlook, Ministry of Finance of Georgia, June 2017, The%20Outlook_ENG_June% pdf. 134

35 Kazakhstan Summary Moody s Baa3 / S&P BBB- / Fitch BBB 1 Economy: Agriculture 5%, Industry 34%, Services 61% Kazakhstan has abundant oil, natural gas, and other energy resources, which have fueled growth and allowed the country to accumulate reserves while maintaining low debt levels. However, Kazakhstan has faced challenges in recent years, owing to the sharp decline in global commodity prices and geopolitical tensions involving Russia. These factors contributed to a decline in government revenues, a deterioration of the country s external balances, and pressure on the exchange rate that forced the government to devalue its currency in This helped restore competitiveness, but Kazakhstan faces longer-term challenges to reduce the role of the state in the economy, diversify the economy, and strengthen its financial system, which suffered a series of crisies in recent years. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 13,987 12,894 10,372 7,663 8,544 9,736 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Reserve data include National Oil Fund assets. Source: Lazard, Bloomberg, Haver Analytics, IMF, Ministry of National Economy National Bank of Kazakhstan 135

36 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency Local Currency A- A BBB+ BBB A- BBB+ BBB- BBB BB+ BBB- BB BB+ BB- BB B+ BB- B B Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Kazakhstan 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 136

37 Kazakhstan Strengths Energy Sector Oil and natural gas are Kazakhstan s principal sources of export earnings. The country has more than 200 oil and gas fields; it ranks 11th in the world for oil reserves and 15th for natural gas. The country was the 18th-largest oil producer in the world in 2016, pumping 1.7 million barrels per day, and the 23rd-largest natural gas producer (1.24 billion cubic feet). 2 After years of delays, the government began exporting in 2016 from the Kashagan field, considered one of the largest oil and gas discoveries in several decades, with an estimated 7 billion to 9 billion barrels of recoverable reserves. However, it may take longer to establish broader and stable production from Kashagan. Kazakhstan exports 80% of its oil, primarily to Italy, China, and The Netherlands. In addition to its oil and natural gas resources, the country has the sixth-largest reserve of coal in the world (it is the tenth-largest coal producer), and the largest stock of uranium, accounting for 41% of global uranium production. 3 International Reserves and the National Oil Fund Kazakhstan has traditionally registered trade and current account surpluses driven largely by the export of mineral products, which account for almost 80% of all foreign shipments. This positive external balance has allowed the country to accumulate sizable international reserves and oil-related assets, which nearly doubled from US$47.6 billion in 2009 to nearly US$90 billion as of September Of this total, US$32.5 billion were official international reserves held by the National Bank of Kazakhstan, and US$56.8 billion were deposits in the National Oil Fund. 4 Official reserves represent 9.1 months of imports of goods and services, but import coverage rises to 25.6 months when National Fund assets are also considered. The primary sources of income to the National Fund are taxes paid by the petroleum industry as well as revenues from privatizations in the oil and mining sectors and the sale of agricultural lands. Approximately half of Kazakhstan s oil revenues are deposited in the National Oil Fund. The Fund serves as a fiscal stabilizer, since it may transfer US$8 billion per year to the national budget. These transfers may be raised or lowered by 15% according to fiscal conditions that is, the country can draw up to US$9.2 billion per year if needed. However, the minimum required balance of the National Fund is 30% of projected GDP for the relevant budget year. 5 In recent years, discretionary transfers have depleted the National Oil Fund, and going forward the Kazakh authorities are putting in place more formal guidelines to curtail these discretionary withdrawals. Transfers will be set in the Kazakhstan tenge (KZT), and are scheduled to gradually decline to KZT2 trillion (about US$7 billion) per year by The decline in global commodity prices in recent years has eroded Kazakhstan s external balance. After years of current account surpluses, the country registered deficits in 2015 and 2016, and these shortfalls are projected to continue over the forecast horizon. These developments will also slow the accumulation of assets into the National Fund. Nevertheless, this Fund will continue to provide an important source of support to the government s fiscal accounts and the overall economy. For example, the government earmarked US$9 billion of National Fund assets to help finance a three-year US$19.3 billion economic stimulus program between 2015 and 2017 (with the balance of financing to come from multilateral organizations and state development institutions). This program helped to offset the economic impact of the 2014 oil price shock, with the economy registering slight growth of about 1% in 2015 and Growth is projected to pick up over the forecast horizon, driven largely by increased activity in the oil and gas sectors. 137

38 Lazard Emerging Markets Debt Favorable Debt Profile Kazakhstan s public sector debt profile is favorable, amounting to 25% of GDP, with public sector domestic and external debt equal to about 15% and 10% of GDP, respectively. Nearly half the country s external debt is owed to multilaterals. Kazakhstan has not tapped international capital markets since 2015, when it issued 10- and 30-year bonds. The government has no sovereign debt maturing until Kazakhstan s total external debt level is elevated at 103% of GDP, but 63% of this amount consists of long-term intercompany lending, mostly from international oil companies to their local affiliates, and this type of lending is generally less vulnerable to rapid reversals. Tradable external debt amounts to a more manageable US$18.3 billion (about 11.3% of GDP), including US$5.4 billion (market value) of sovereign debt and US$12.9 billion of corporate and quasi-sovereign (mostly the latter) debt. Political Stability Kazakhstan is one of the most politically stable countries in a region known for political turmoil. President Nursultan Nazarbayev has led the country since 1989, when Kazakhstan was still part of the Soviet Union, and he has been president since the country gained independence in The president retains control of public institutions, and family members and key allies hold senior government positions. Mr. Nazarbayev was re-elected by a landslide in April 2015 to a fifth consecutive term, and his party controls both houses of parliament by a wide margin. Although Mr. Nazarbayev s autocratic style has been criticized, his control over the country has enabled him to enact his market-friendly policies without meaningful political opposition and has contributed to a relatively stable investment environment. International Relations Kazakhstan has a good relationship with two of its principal trading partners, China and Russia, as well as with Europe and the United States. The European Union is Kazakhstan s main trade and investment partner, accounting for 53% of trade turnover and 49% of foreign inflows. 6 Kazakhstan is a founding member of the Eurasian Customs Union (along with Russia and Belarus), which was replaced by the Eurasian Economic Union (EEU) in The EEU was expanded in 2015 to include Armenia and Kyrgyzstan, creating a union of million people and a combined GDP of US$2.2 trillion. 7 Weaknesses Commodity Dependence Kazakhstan s economy is highly dependent on oil, which accounts for 24% of GDP, 50% of government revenues, and 70% of exports and foreign direct investment. 8 As a result, the 49% decline in global oil prices in the second half of 2014 had a significant impact on the Kazakh economy. The country s export earnings fell 39% in 2015 and real GDP growth slowed to 1.0% from 4.3% in The decline in oil prices pressured Kazakhstan s currency peg to the US dollar, while a loss of competitiveness resulting from the depreciation of the Russian ruble further strained Kazakhstan s currency regime. In August 2015, the Kazakh monetary authority abandoned the currency peg, causing the Kazakh tenge to depreciate more than 20%. The currency continued to weaken for the rest of the year, owing to the absence of clear policy direction from the central bank, and the depreciation caused a spike in inflation that was exacerbated by poor communication from the monetary authority. The currency has strengthened a bit and stabilized since early 2016, and the depreciation has helped to restore competitiveness, boosting exports and reducing the current account deficit. In addition, the government has adjusted its budget projections to reflect more realistic 138

39 Kazakhstan assumptions about a new environment of lower growth and reduced oil-related revenues. However, sustainable longer-term growth will require deeper structural reforms to diversify the economy, reduce the role of the state in the economy, and establish more transparent rules for conducting monetary policy. Although the government is making efforts on these fronts, and it became the 162nd member of the World Trade Organization in July 2015, Kazakhstan is likely to remain an oil-based economy in the medium-to-long term. The country currently ranks 53rd of 138 countries in the World Economic Forum s competitiveness report. 9 Banking Sector Kazakhstan s banking sector has faced difficulties in the past, including a government bailout in 2009 that amounted to 6.4% of GDP, with additional periodic government support since that time. Although the financial system is healthier today, currency mismatches risk further balancesheet pressures, particularly during periods of large and abrupt currency shifts like we saw in the latter half of Dollarization of bank deposits has fallen from more than 70% in early 2016, but remains high at 55% as of July 2017, and loan growth remains moribund as households and corporates continue to adjust to the devaluation of the tenge. 10 Although official figures show nonperforming loans (NPLs) have fallen from 24% in December 2014 to less than 10%, a broader definition that includes problem loans from delicensed bank BTA, NPLs in off-balance sheet special purpose vehicles, and restructured loans suggest overall problem loans amount to more than 40% of total loans. 11 Stress tests reveal that high credit concentration, potential exchange-rate risks, and a poor regulatory environment pose ongoing risks to the banking sector. Geopolitical Risk Given its close economic ties with Russia, Kazakhstan was adversely affected by the Russia Ukraine conflict since the country was obliged to adhere to the sanctions imposed against Russia by the EU and the United States. Kazakhstan receives one-third of its imports from Russia, and 7% of its exports go to Russia, and exports to and imports from Russia declined 12% and 24%, respectively, in Trade was further undermined by the appreciation of the tenge relative to the ruble when the latter currency began weakening against the US dollar, while the former held its peg to the dollar. Moreover, four Russian banks account for 10% of banking assets in Kazakhstan, and the countries share extensive oil and natural gas pipeline linkages. Political Transition and Human Rights Although Kazakhstan s political and social stability has been attributed to President Nazarbayev s tight control over political institutions, this concentration of power has raised concerns about the country s eventual political transition. Mr. Nazarbayev has been in power since 1989 and is rumored to be in poor health, yet there are no high-profile political candidates with broad popular appeal who could readily replace him. The president appointed his daughter Dariga Nazarbayeva to the position of deputy prime minister in 2015 before transferring her to the Senate in September 2016 (the Kazakh constitution stipulates that the head of the Senate will assume power in the event of the president s death). In early 2017, Nazarbayev announced measures to devolve some of his powers to the parliament and to his cabinet. Although these changes will, in theory, decentralize economic policymaking, strengthen the parliament s legislative powers, and hasten the emergence of more prominent leaders, the President remains firmly in control of the government and there is no guarantee these changes will result in a smooth transition. Moreover, Nazarbayev has repressed any opposition, and maintains tight control over the media. In December 2011, a confrontation between police and protesting oil workers resulted in the death of more than a dozen workers. Since then, the government has increased social spending, especially in rural areas. The government is also pressuring companies to meet workers demands in an effort to curb potential unrest. Kazakhstan ranked 131st of 176 in Transparency International s 2016 Corruption Perceptions Index. 139

40 Lazard Emerging Markets Debt Country Background Size Capital Population 2,724,900 KM 2 (9th) Astana 18.6 Million Religion Muslim 70.2%, Russian Orthodox 26.2%, Other 3.6% Median Age 30.6 Years Literacy Rate 99.8% Independence 16 December 1991 Political System Government Leadership Next Election 2020 Presidential Republic President Nursultan Abishuly Nazarbayev; Prime Minister Bakytzhan Sagintayev Economy Agriculture 4.8%, Industry 33.9%, Services 61.3% Labor Force Agriculture 18.1%, Industry 20.4%, Services 61.6% Merchandise Exports Oil and Oil Products, Natural Gas, Ferrous Metals, Chemicals, Machinery, Grain, Wool, Meat, Coal Export Partners Italy 20.3%, China 11.5%, Russia 9.5%, Netherlands 8.9%, Switzerland 7.3%, France 4.9% Currency Kazakhstan Tenge (KZT) As of November 2017 Source: CIA 140

41 Kazakhstan Country Timeline 1991 Nursultan Nazarbayev wins uncontested presidential elections; Kazakhstan declares independence from the Soviet Union and joins the Commonwealth of Independent States (CIS) A new constitution increasing presidential powers is adopted; a major privatisation programme is launched; Kazakhstan ratifies the first Strategic Arms Reduction Treaty and the Treaty on the Non-Proliferation of Nuclear Weapons Kazakhstan signs economic and military cooperation pact with Russia; nuclear-free status is obtained; President Nazarbayev's term in office is extended until December 2000 and a new constitution adopted by national referendum Major oil agreements secured with China. The Kazakh capital is moved from Almaty in the south to Akmola (formerly Tselinograd) in the north Nursultan Nazarbayev re-elected president after main rival, former PM Akezhan Kazhegeldin, barred from standing. Subsequent parliamentary elections criticised by OSCE for irregularities President Nazarbayev purges government of officials accused of joining newly-formed Democratic Choice reform movement Deal signed with China on construction of oil pipeline to Chinese border Court orders dissolution of Democratic Choice, one of the country's main opposition parties. The party is accused of breaching state security by calling on supporters to protest against parliamentary election results. Opposition figure Zamanbek Nurkadilov, a vocal critic of President Nazarbayev, found shot dead at his home. Nursultan Nazarbayev returned for further term as president with more than 90% of vote. Western observers say poll flawed. President Nazarbayev inaugurates a 1,000-km (620 mile) pipeline to carry oil to western China Parliament votes to allow President Nazarbayev to stay in office for an unlimited number of terms. Mr Nazarbayev fires son-in-law Rakhat Aliyev in an apparent power struggle Chinese President Hu Jintao and President Nazarbayev unveil the Kazakh section of a natural gas pipeline joining Central Asia to China Parliament approves a bill granting more powers to President Nazarbayev, granting him the title of "leader of the nation" and immunity from prosecution President Nazarbayev calls early presidential election, after a planned referendum on allowing him to stay on unopposed until 2020 is ruled unconstitutional. President Nazarbayev wins reelection in a poll boycotted by the opposition Eurasian Economic Union between Russia, Kazahkstan and Belarus comes into force. The Eurasian Economic Union aims to create a shared market and integrate economic policy across the three former Soviet countries. President Nazarbayev is re-elected with 97.7 per cent of votes cast. Opposition parties did not field any candidates and the two other contenders were widely seen as pro-government. Kazakhstan's currency, the tenge, plunges in value by more than a third in one day precipitated by the government floating the currency after spending 28 billion US dollars propping it up. President Nazarbayev appoints his daughter, Dariga, as deputy prime minister in a move linked to possible succession planning Parliament approves constitutional reforms that will reduce the president's powers in favor of lawmakers and the cabinet. Source: BBC 141

42 Lazard Emerging Markets Debt Notes 1 As of October Kazakhstan, U.S. Energy Information Agency, 10 May 2017, 3 Kazakhstan, U.S. Energy Information Agency, 10 May 2017, country.cfm?iso=kaz and World Nuclear Association, facts-and-figures/uranium-production-figures.aspx. 4 As of September 2017, Source: National Bank of Kazakhstan. 5 Republic of Kazakhstan Bond Prospectus, 19 June Ibid. 7 Eurasian Economic Union, 8 Republic of Kazakhstan Bond Prospectus, 19 June The Global Competitiveness Report , World Economic Forum, docs/gcr /05fullreport/theglobalcompetitivenessreport _final.pdf. 10 Republic of Kazakhstan: 2017 Article IV Consultation, International Monetary Fund, IMF Country Report No. 17/108, May 2017, 11 Ibid. 142

43 Mongolia Summary Moody s Caa1 / S&P B- / Fitch B- 1 Economy: Agriculture 13%, Industry 35%, Services 51% Mongolia is a country with abundant natural resources, especially copper, gold, and coal, which it is starting to exploit. Development of large-scale mining projects such as Oyu Tolgoi are major drivers of economic growth and key to developing its wealth. However, over-dependency on commodities has led to volatile economic cycles with growth ranging from 1% to 17% over the past decade. Amid deteriorating economic conditions, Mongolia reached an agreement with the IMF and other international partners in 2017 worth more than US$5 billion on the condition that it will strengthen its banking system and implement structural reforms. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 4,366 4,168 3,947 3,660 3,553 3,721 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Gen Gov Fiscal Results Excluding Off Budget; including off budget 143

44 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency BB Local Currency BB BB- BB- B+ B+ B B B- B- CCC CCC Moody s S&P Fitch Moody s As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s S&P Fitch Bond Spreads Mongolia 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 144

45 Mongolia Strengths Abundant Natural Resources Mongolia is rich in natural resources, which remain largely unexploited and represent significant growth potential. 2 The country has some of the largest copper reserves (57.0 million tons), 3 and coal reserves (175.5 billion tons) in the world. 4 It also holds substantial amounts of other mineral deposits, including gold and fluorspar. 5 The Mongolian government has identified 15 mineral deposits that it considers of strategic importance and are the focus of developing its mining industry. Mongolia s underground resources are estimated to be worth more than US$1 trillion 6 and are, therefore, a major potential growth engine. Another important resource, though less relevant now than in the past, is agriculture, largely cereal and animal husbandry. Mongolia is the second-largest producer of cashmere in the world after China, but it produces the finest. 7 Large Scale Mining Projects The development of the Oyu Tolgoi mine will be a key driver of economic growth in the next several years as it is expected to be the third-largest copper mine in the world when it reaches full production. 8 The mine is one of the world s largest untapped copper deposits. Mining companies have already invested more than US$6.6 billion in this project, and started producing and exporting copper in June A dispute between the government and developer Rio Tinto stalled development of the project until both parties reached an agreement in May 2015, but Rio Tinto approved in May 2016 the expansion of Phase II, with an estimated investment of US$5.3 billion. 9 Oyu Tolgoi s 2016 production was 201,300 metric tons of copper and 300,000 ounces of gold. 10 The mine is expected to reach full production in 2026 producing an average of 430,000 tons of copper and 425,000 ounces of gold annually over the life of the mine. The IMF estimates that by then, Oyu Tolgoi will generate approximately one-third of Mongolia s GDP. The government owns 34% of Oyu Tolgoi. 11 Another important project is the development of the coal deposits of Tavan Tolgoi, one of the largest undeveloped coal fields in the world. Its deposits total 7.4 billion tons of coking and thermal coal resources. While the initial projection was that Tavan Tolgoi would reach million tons by 2017, 12 this project has faced significant delays as the government did not secure enough financing and decided to sell stakes to Chinese and Japanese companies. 13 The consortium is expected to invest US$4 billion in the project and is currently waiting for final approval from the Mongolian Parliament and China s State-Owned Assets Supervision and Administration Commission 14. Development of Tavan Tolgoi is an important component of the government s recently introduced Economic Stabilization Plan, with a target period of China Connection Mongolia s main trade partner, China, is a key driver behind growth. They are natural trade partners because Mongolia is a commodity producer and China is a major consumer of commodities. China accounted for nearly 90% of Mongolia s total exports and nearly a third of imports. 16,17 Trade between these two countries should continue to grow as most of the mining products of Oyu Tolgoi and Tavan Tolgoi mines will go to China. Both mines are less than 500 kilometers from the Chinese border and very close to major cities, such as Beijing. Importantly, Mongolia s ties with China go beyond trade. For example, this year the Central Bank of China renewed a swap line of RMB15 billion (US$2.2 billion) until Relations are gaining momentum, with Chinese President Xi Jinping advocating for more bilateral all-around strategic partnerships. 19 Despite government and business sector fondness 145

46 Lazard Emerging Markets Debt for closer relations with China, we note that this is not universally shared as there are also concerns among citizens that Mongolia is becoming a satellite state of China. 20 President Khaltmaagiin Battulga, who campaigned on a more nationalist platform advocating for less dependency on China, has thus far maintained a strong relationship with China. Free and Fair Elections Until the 1990s, the Mongolian People s Party (MPP) was the ruling party operating under a one-party system since the 1920s. Mongolia has since transitioned to a democracy. Mongolia has had seven consecutive successful and free democratic elections since the 1990s. The main opposition party is the Democratic Party (DP) which was founded in 2000 through a merger of five smaller parties. Since then, the DP and the MPP have been alternating power. In June 2017 the DP regained the presidency from the MPP with the victory of Khaltmaagiin Battulga. The MPP also currently controls parliament with Ukhnaagiin Khurelsukh named as prime minister in October 2017, succeeding former Jargaltulga Erdenebat following a noconfidence vote. Structural Reforms and Commitment to the IMF Program In light of the deteriorating economic conditions since 2015, the new MPP government has introduced a much-needed economic stabilization plan that aims to stabilize macroeconomic conditions in the short term while also undertaking medium-term economic reforms to ensure a more sustainable economic growth model. Some of the more immediate objectives include increasing currency reserves to reduce balance-of-payment pressures and higher levels of engagement with multilateral and bilateral organizations such as the IMF. Mongolia reached an agreement with the IMF in 2017 for a three-year Extended Fund Facility program worth US$440 million. The IMF program also opens up other forms of financing that may ultimately reach as high as US$5.5 billion of financial support. In its first review, the IMF noted that performance under the program has been good, with all quantitative targets on track and that this ambitious structural reform program will help sustain growth in the medium term. Weaknesses Commodity Dependence Mongolia s economy is highly dependent on the mining sector, which accounts for about 50% of revenues and 90% of exports. As a result, the country is vulnerable to commodity shocks that lead to boom-bust cycles. Mongolia s growth rate in the past 10 years has been relatively volatile, averaging 7.8% from , followed by a sharp contraction of -2% in 2009, and then resuming high growth rates that averaged 11.2% between , with a subsequent collapse of the economy due to the commodity shock. The IMF expects growth in of 2% 2.5%, although the outlook is rosier in the medium term as mining production is expected to increase. This highlights the volatility of the economy as a function of commodity production and prices. The structural reform program on which Mongolia has embarked should help make the economy more resilient to these shocks. 146

47 Mongolia Fast Rising Debt Levels Mongolia s debt level has risen at a rapid pace, going from 60% of GDP in 2015 to an estimated 101% of GDP by Most of the debt increase are driven by external debt, which is estimated to reach 82% of GDP in However, the debt-to-gdp ratio is expected to decline after 2018 and reach 85% of GDP by The high proportion of external debt is a vulnerability that the government is trying to address by reducing foreign currency exposure. Weak External Sector and Low Level of Reserves Mongolia s current account deficit has been high historically, at more than 25% of GDP from Although it has since fallen to about -4% of GDP in the past three years,, it is expected to increase to -9.5% in One factor contributing to the large current account deficit is the economy s small size and the large investment associated with its mining projects. While the increase in current account deficit will be driven by FDI, we note also that Mongolia s reserve levels are fairly low. Reserves peaked at US$3.8 billion at the beginning of 2013 and have fallen to US$1.25 billion as of July 2017 although the IMF expects to see reserves rebound to US$2.5 billion in Infrastructure The country s infrastructure is still underdeveloped and in need of upgrades. Less than half of the country s roads are paved, and many of the roads in the capital, Ulaanbaatar, are in need of improvements. The government is expanding its road networks to connect different regions at an estimated cost of US$5 billion. Development of a railway network is also critically important for the mining sector. Mongolia is planning to connect the large mining projects with a railway network that facilitates transportation to Russia and China. Overall investment needed to build the railways network is estimated to exceed US$8 billion. Investment in the energy sector will also be required to meet increased demand from the mining sector. The construction of a thermal plant in Tavan Tolgoi also is expected to supply electricity to Oyu Tolgoi and reduce energy imports from China. Finally, Mongolia is also part of China s ambitious One Belt One Road initiative, benefiting from a strategy of constructing roads and railways to develop a trilateral corridor between Mongolia, China, and Russia. 147

48 Lazard Emerging Markets Debt Country Background Size 1,564,115 KM 2 (19th) Capital Ulan Bator Population 3.1 Million Religion Buddhist 53.0%, Muslim 3.0%, Shamanist 2.9%, Christian 2.2%, Other 38.9% Median Age 28.3 Years Literacy Rate 98.4% Independence 11 July 1921 Political System Semi-Presidential Republic Government Leadership President Khaltmaagiin Battulga; Prime Minister Ukhnaagiin Khürelsükh Next Election 2021 Legislative Branch Unicameral State Great Hural Economy Agriculture 13.3%, Industry 35.3%, Services 51.4% Labor Force Agriculture 31.1%, Industry 18.5%, Services 50.5% Merchandise Exports Copper, Apparel, Livestock, Animal Products, Cashmere, Wool, Hires, Nonferrous Metals, Coal, Crude Oil Export Partners China 84.1%, United Kingdom 6.8% Currency As of November 2017 Source: CIA Togrog/Tugriks (MNT) 148

49 Mongolia Country Timeline 1924 The People s Party chooses Lenin s road to socialism bypassing capitalism and renames itself the Mongolian People's Revolutionary Party (MPRP). The Mongolian People s Republic is proclaimed Yalta conference agrees to preserve the status quo Soviet control in Mongolia. Mongolians vote for independence in a UN plebiscite. Mongolia is recognized by the Republic of China Relations established with the People s Republic of China. Railway built across Mongolia linking Russia and China UN Security Council approves Mongolia's UN membership. Diplomatic relations established with the UK Soviet Communist Party General-Secretary Brezhnev signs a friendship treaty in Ulan Bator allowing secret stationing of Soviet troops in Mongolia Gorbachev's Vladivostok speech opens the way to detente with China and the withdrawal of Soviet troops from Mongolia Street demonstrations force resignation of the MPRP Politburo. Political parties are legalised. Elections to the Great Hural (parliament) are won by the MPRP, but 19 of the 50 seats in a new standing legislature go to non-communists The first direct presidential elections are won by Ochirbat, nominated by the National and Social Democrats MPRP candidate Bagabandi wins presidential election IMF approves nearly $40 million in low-interest loans over next three years to help tackle poverty and boost economic growth Dalai Lama visits. China denounces trip and warns Mongolian leaders not to meet the Tibetan spiritual leader Russia writes off all but $300 million of Mongolia s debts. Parliamentary elections, in which the opposition performs strongly, result in political deadlock over contested results. Tsakhiagiin Elbegdorj is eventually appointed as prime minister following power-sharing deal MPRP candidate Nambaryn Enkhbayar wins presidential election Former Prime Minister and candidate of the opposition Democratic Party, Tsakhiagiin Elbegdorj, wins presidential election, defeating incumbent Nambaryn Enkhbayar by a narrow margin. Governing MPRP says it accepts the result Controversy as Mongolian People's Revolutionary Party reverts to Communist-era name of Mongolian People's Party. Ex-President Nambaryn Enkhbayar sets up small breakaway Mongolian People's Revolutionary Party Mongolia and Rio Tinto-owned Ivanhoe Mines reach agreement on stakeholding in the massive Oyu Tolgoi copper mine. Mongolia settles for a 34% share, as previously agreed, dropping demands for parity Mongolia puts Tavan Tolgoi coal mine deal on hold while it decides whether to go it alone on developing the project. It had earlier agreed to work with a group of US, Chinese and Russian companies Mining giant Rio Tinto says it will lay off up to 1,700 workers at the massive Oyu Tolgoi mine in Mongolia following a dispute with the government Prime Minister Norov Altankhuyag is dismissed by a vote of parliament. He had been under fire for alleged corruption and economic underperformance. Deputy Prime Minister Dendev Terbishdagva takes over as acting head of government. Parliament elects Chimed Saikhanbileg as prime minister in a vote boycotted by the opposition Mongolian People s Party Prime Minister Chimed Saikhanbileg removes the Mongolian People's Party from the coalition government by dismissing six of its ministers. 149

50 Lazard Emerging Markets Debt 2016 Mongolia says it will not allow future visits by the Dalai Lama after China opposed a visit by the Tibetan spiritual leader in November. Mongolia reaches an agreement with the IMF and other international partners worth more than five billion dollars on the proviso that it will strengthen its banking system and implement fiscal reforms Khaltmaagiin Battulga is elected president. Ukhnaagiin Khurelsukh succeeds ousted Jargaltulga Erdenebat as prime minister. Source: BBC 150

51 Mongolia Notes 1 As of December Wacaster, Susan, 2011 Mineral Yearbook Mongolia, US Geological Survey, December 2012, as of December 2013, Source: Lazard. 3 Government of Mongolia Offering Memorandum, October Ibid. 5 World Economic Outlook Database, International Monetary Fund, accessed on 20 December 2013, and as of December 2013, Source: Lazard. 6 Rio Tinto and Mongolia sign multibillion dollar deal on mine expansion, The Guardian, 19 May 2015, accessed on 30 November 2015, 7 Cashmere, NaturalFibres.org, accessed on 20 November 2015, fibres/cashmere.html. 8 Oyu Tolgoi, Turquoise Hill, August 2015, accessed on 20 November 2015, pdf/ppt/trq-sitevisit-aug2015.pdf. 9 accessed 22 October Government of Mongolia Offering Memorandum, October Oyu Tolgoi, Rio Tinto, accessed on 20 November 2015, 12 Mongolia: 2012 Article IV Consultation and Third Post Program Monitoring, IMF Country Report No.12/320, November 2012, and Mongolia Bond Prospectus, BofA Merrill Lynch, Deutchse Bank, HSBC, and J.P. Morgan, November Brletich, Samantha, Mongolia struggles to develop Tavan Tolgoi coal mine, Mining.com, 21 September 2015, accessed on 20 November 2015, 14 Government of Mongolia Offering Memorandum, October Government of Mongolia Investor Presentation, October Government of Mongolia Offering Memorandum, October Han, Bochen, The Trouble With China-Mongolia Relations, The Diplomat.com, 18 November 2015, accessed on November November 20, 2015, accessed 18 October accessed 22 October Hornby, Lucy, Lunch with the FT: Saikhanbileg Chimed, The Financial Times, FT.com, 15 May 2015, accessed on 8 November 2015, html accessed 18 October accessed 18 October accessed 18 October Mongolia: 2017 Article VI Consultation, International Monetary Fund, IMF Country Report: 17/140, May 2017, Request-for-an-Extended-Arrangement-Under-the Mongolia, International Monetary Fund, World Economic Outlook 2017, October 2017, accessed on 18 October Request-for-an-Extended-Arrangement-Under-the accessed 23 October Government of Mongolia Offering Memorandum, October IMF WEO Data October IMF WEO Data October As of October 2017, Source: Bloomberg Request-for-an-Extended-Arrangement-Under-the accessed 23 October Government of Mongolia Offering Memorandum, October Mongolia Bond Prospectus, BofA Merrill Lynch, Deutchse Bank, HSBC, and J.P. Morgan, November 2012 and as of December 2013, Source: Lazard. 34 China s Belt and Road Initiatives: Credit Implications for Mongolia, September 2015, ww.frontier-conference. com%2findex.php%2fen%2fdownload%2fcategory%2f43-sept-9th%3fdownload%3d277%3a1125- moody-s&usg=aovvaw0s7lsjezu_f1orrw2eyscu 151

52 Lazard Emerging Markets Debt 152

53 Russia Summary Moody s Ba1 / S&P BB+ / Fitch BBB- 1 Economy: Agriculture 5%, Industry 33%, Services 62% Russia is one of the wealthiest countries in emerging markets, with abundant natural resources such as energy, mining, and agriculture, and a highly educated labor force. The Russian economy is large, with a sizable population and domestic market. The economy is performing relatively well considering the sanctions imposed by the United States and the European Union as well as the collapse in oil prices. Because of the country s low leverage both public and external ample external liquidity, and flexible exchange rate, Russia has been relatively resilient. The economy recovered in 2017 and it is likely improve in 2018 on the back of higher oil prices. The economy s main constraint is the country s weak rule of law, unfriendly business conditions, and large, inefficient public entities, which will potentially pose major growth constraints. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 14,525 14,295 11,339 8,957 10,631 11,385 Nominal GDP (USD Billions) 2, , , , , ,631.1 Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Central Bank of Russia, Haver Analytics, IMF, Ministry of Finance 153

54 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency Local Currency A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Local Yield Russia EMBIGD Russia GBI-EM Global Div As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 154

55 Russia Strengths Solid Fiscal Position Russia s key economic strength remains its balance sheet, with a small fiscal deficit, low debt levels, and substantial government savings. The economy posted fiscal surpluses from 2000 to 2008, leading to large savings and low debt levels and allowing the country to withstand the sharp decline in oil prices. In 2017 fiscal deficit peaked at 3.7% of GDP and in 2018 will likely be below 2.0% of GDP, which is manageable and expected to improve going forward. The government announced budget targets, which are very conservative with the deficit expected to fall to 1.3% of GDP in 2018 and 0.8% in based on an oil price of $40 42/bbl. Low deficits have helped maintain public debt levels around 15% of GDP, among the lowest in the world and primarily denominated in local currency. Government savings totals around US$90 billion, equivalent to about 6% of GDP as of August Russia currently has two funds, the Reserves Fund, totaling US$17 billion, and the National Welfare Fund, totaling US$73 billion. The main weakness of Russia s public balance sheet is the pension system. We estimate pension expenditures are around 10% of GDP or about one-third of government expenditures. Solid External Position Russia s external position remains solid despite low energy prices and economic sanctions. In the past decade, the country has posted large current account surpluses averaging more than 10% of GDP since 2000, totaling an estimated 2.2% of GDP in Current account surpluses in were the result of economic contraction and exchange-rate depreciation, which has resulted in lower imports, more than offsetting the decline in oil exports. The current account surplus partially helped to cover capital outflows and the repayment of external debt, although foreign reserves are below recent peaks. After declining for most of mid-2013 to mid 2015, foreign reserves are recovering, totaling US$425 billion in September 2017, higher than the US$356 billion reported in mid-april but down from US$524 billion in October External debt has substantially declined as sanctions imposed by the United States and the European Union following Russia s annexation of Crimea have made it nearly impossible for some corporates to roll over their external debt. As a result, the stock of external debt has declined from US$732.8 billion in the second quarter of 2014 to US$533 billion in the second quarter of Interestingly, the decline in debt stock has been sharper than the decline in the foreign reserves, which partly explains why the country s external international investment position remains positive at US$290 billion in the second quarter of Natural Resources Russia is rich in natural resources, with the world s largest gas reserves, second-largest coal reserves, and eighth-largest crude oil reserves. 3 It is also the third-largest producer of oil and second-largest producer of gas in the world. The country s proven oil reserves total 80 billion barrels. Oil production is around 10.5 million barrels per day, of which about one-third is consumed domestically. 4 In the mining sector, Russia is one of the most important producers of several products, including aluminum, copper, diamonds, gold, iron ore, etc. 5 Russia is also rich in other natural resources; however, most of these resources are located in remote places that are difficult to develop. The public sector essentially has a monopoly in key companies involved in the exploration and production of natural resources. Private investment could be more involved in the oil sector or in other natural resources if business conditions improve and Russia adopts fair rules. 155

56 Lazard Emerging Markets Debt Domestic Political Stability Vladimir Putin has controlled Russia for over a decade. He was president from May 2000 to May 2008 and prime minister from May 2008 to May Putin was re-elected president in 2012 and will be in office until the elections scheduled for While prime minister from May 2008 to May 2012, his protégé and ally, Dmitry Medvedev, was the president, but Putin maintained close supervision over economic and political policies. As president, Putin retains strong control over most important public institutions and is quick to arrest, or remove from office, anyone that opposes him, whether politician or oligarch. Street protests are too small and ineffective to pose any risk to Putin and no serious challengers have appeared. He won the May 2012 presidential election with 64% of the votes, which reflects his high overall popularity. 6 His party, United Russia, won 105 seats in the 2016 Duma elections and maintains a majority, holding 343 out of the 450 seats. 7 He is likely to win comfortably the March 2018 elections and thus will remain in power for another six years. Weaknesses Geopolitical Tensions and Sanctions The political crisis in Ukraine during February 2014 sparked major tensions between pro- Western and pro-russian forces within Ukraine and Russia. The secession of Crimea via referendum in mid-march 2014 was the catalyst for a standoff between the West and Russia, with periodic flare-ups of violence, as pro-russian separatists in the eastern province rely on Russia s support. Pro-Russian separatists in the eastern provinces of Donetsk and Luhansk declared independence via referendums recognized only by Russia. A wave of sanctions progressively intensified in March 2014, starting with individuals associated with the Crimea issue and extending to vital sectors of the economy, such as financial services, defense, and energy. In 2017 the US imposed new sanctions on Russia for its interference in the 2016 presidential election. Western banks are now banned from financing Russian state-owned entities with securities longer than 90 days. This has impacted entities with large external financing requirements, which will need to request the support of the government to roll over obligations. A number of Western firms have also reduced operations in Russia. In addition, many European countries are taking action to reduce their dependence on Russian gas imports. As a result, Russia is increasingly isolated. Low Economic Growth Russia s economic growth is increasingly weak. According to the International Monetary Fund s forecast, Russia is expected to grow 1.5% per year over the next five years, compared to 1.9% for Brazil, 2.6% for Mexico, 3.5% for Turkey, 7.9% for India, and 5.9% for China. 8 Even before the sanctions, Russia s growth was being hindered by a lack of investment, a large, inefficient public sector, unfriendly business conditions, and unfavorable demographics. The impact of sanctions will significantly exacerbate these trends. Commodity Dependence Russia is highly dependent on oil, similar to other countries in the Commonwealth of Independent States (CIS), which makes the economy vulnerable to fluctuations in oil prices. The government has tried to diversify the economy for over the past couple of years with little success. Oil accounts for about two-thirds of exports and half of government revenues, 9 and serves as Russia s economic growth engine, with important spillover effects on the rest of the economy. The economy tends to perform very well during times of high oil prices and tends 156

57 Russia to contract when oil prices are low. The collapse in oil prices has been one of the main factors behind Russia s economic contraction in Weak of Rule of Law Historically, Russia has been a corrupt country with very weak institutions. This could be an underlying cause of its unexceptional economic performance. As a result, private sector investment in Russia s frail institutions remains very limited. The dearth of private investment explains the low level of fixed investment and foreign direct investment inflows. The country s weak institutions, absence of rule of law, and widespread corruption also explain large amounts of capital outflows. 10 Monetary and Exchange-Rate Policy Inflation and Monetary Policy The Central Bank of Russia (CBR) has a single mandate: to maintain Russian ruble (RUB) stability. To meet this mandate, the CBR operates under an inflation-targeting regime. The inflation objective is to maintain headline inflation, on average, around the 4% target. Monetary policy decisions are made by the board of directors, which consists of the governor and 14 board members who each serve a five-year term. The board members are nominated by the governor, in consultation with the Russian Federation president, and must be confirmed by parliament. In addition to its monetary policy objective, the CBR is tasked with maintaining financial stability and managing foreign exchange. The CBR has several tools to implement monetary policy, but relies predominantly on the policy rate the 1-week repurchase (repo) rate which is relevant for open-market operations carried out by the CBR. Since late 2016, the CBR has included short-term forward guidance for the policy rate as an additional monetary policy tool. While the CBR has a poor record of meeting its inflation target in the past, its track record is likely to improve considerably in the years ahead. Since 2004, when the inflation-targeting regime was first introduced, the CBR has met its inflation target in only two years: 2010 and Indeed, in the past 10 years, Russian inflation has averaged around 9% 9.5% while the average inflation target over the same period was 5.6%. However, since recovering from the economic shock stemming from the collapse of oil prices in late 2014 the CBR has been focused on building its credibility as an independent inflation-targeting central bank and has had some success. Since peaking at 15.5% in 2015, inflation has declined steadily towards 4%. Inflation averaged 7.1% in 2016 and is expected to average 3.8% in In 2017, inflation continued to decline and was consistently lower than the CBR or market projections while monetary policy was further eased, albeit at a gradual pace. Headline inflation declined from 5.4% at the end of 2016 to around 3.0% in September, while core inflation fell from 6.0% to 2.8% over the same period. Excluding base effects, in the three months through September 2017, core inflation was consistent with a 4.0% annualized pace. The main drivers of disinflation have been tight monetary policy (with high real interest rates), a relatively strong RUB and fiscal consolidation. Monetary policy easing has proceeded cautiously, with the CBR cutting rates by 175 basis points to 8.25%, leading to an increase in the real policy rate from around 4% at the start of the year to closer to 5.5% 6% in the fourth quarter. 157

58 Lazard Emerging Markets Debt Looking ahead to 2018, we expect the CBR to continue easing monetary policy as inflation stabilizes near the target. We expect inflation to stabilize at 3.5% 4% in 2018, driven by relatively tight monetary policy, continued fiscal consolidation, and currency stability (with risk of mild depreciation). This should clear the way for the CBR to cut rates further, to around 6.5% 7%, in line with their guidance for a neutral real policy rate of 2.5% 3%. This is somewhat more than current market expectations. We see Russian rates as an attractive investment opportunity. Exchange Rate Policy and Outlook The RUB is a fully convertible currency operated under a managed floating regime. Since November 2014, the RUB has been a free-floating currency where the CBR stands ready to intervene to smooth volatility. Prior to that, between 2005 and November 2014, the RUB was actively managed against a basket of the euro and the US dollar. The RUB can be traded both onshore and offshore on either a deliverable or non-deliverable forwards basis. The RUB exchange rate is most closely linked to the price of oil. Given the importance of oil to Russia s exports and fiscal accounts oil and gas exports represent more than half of all Russian exports the exchange rate has been highly correlated with the price of crude oil. Looking ahead to 2018, we expect modest RUB depreciation. We believe that the three most important factors that will determine the currency s outlook will be (i) the path of global oil prices; (ii) the monetary policy stance; and (iii) the intervention policy determined by the new budget rule which is aimed at stabilizing the real exchange rate by smoothing out commodity price shocks. Under a baseline scenario where oil prices are in the $50 $60/barrel and the sanctions regime remains intact, we expect to see modest RUB depreciation in The real effective exchange rate deflated by terms of trade (to adjust for the close link to oil prices) is now about 15% stronger than the 10-year average, suggesting there are downside risks to the RUB. 158

59 Russia Inflation USD/RUB Inflation Policy Rate As of December 2017 Source: Bloomberg REER REER Median since Dec 1999 Median last 10 yrs Median last 5 yrs As of December 2017 Source: Lazard, JP Morgan 159

60 Lazard Emerging Markets Debt Country Background Size 17,098,242 KM 2 (1st) Capital Moscow Population Million Religion Russian Orthodox 20.0%, Muslim 15.0%, Christian 2.0%, Other 63.0% Median Age 39.6 Years Literacy Rate 99.7% Independence 25 December 1991 Political System Semi-Presidential Federation Government Leadership President Vladimir Putin; Premier Dmitry Medvedev Next Election 2018 Economy Agriculture 4.7%, Industry 32.5%, Services 62.1% Labor Force Agriculture 9.4%, Industry 27.6%, Services 63.0% Merchandise Exports Petroleum and Petroleum Products, Natural Gas, Metals, Wood, Chemicals Export Partners Netherlands 10.5%, China 10.3%, Germany 7.8%, Turkey 5.0%, Italy 4.4%, Belarus 4.3% Currency Ruble (RUB) As of November 2017 Source: CIA 160

61 Russia Country Timeline Russia part of the Union of Soviet Socialist Republics Russia becomes independent as the Soviet Union collapses and, together with Ukraine and Belarus, forms the Commonwealth of Independent States, which is eventually joined by all former Soviet republics except the Baltic states. Chechnya declares unilateral independence Yeltsin orders the army to attack parliament, which is recaptured following a bloody battle. Russians approve a new constitution which gives the president sweeping powers. Communists and ultra-nationalists make large gains in elections to the new legislature, the State Duma, which replaces the former parliament, the Supreme Soviet Duma pardons participants in anti-gorbachev coup of August 1991 and parliamentary rebellion of Russia joins NATO s Partnership for Peace programme. Russian troops invade the breakaway republic of Chechnya Communist Party wins largest share of vote in parliamentary elections, giving it more than one-third of seats in Duma Yeltsin re-elected for another term. Yeltsin signs a peace treaty with Chechnya and agreement on cooperation with NATO. Russia admitted to the G-7 group of industrialised countries Ruble collapses and government gives notice of intention to default on foreign debts. Kiriyenko sacked. Parliament rejects Yeltsin s nomination of Mr Chernomyrdin for prime minister Militants from Chechnya invade the neighboring Russian republic of Dagestan. Yeltsin sacks Mr Stephashin and replaces him with ex-kgb officer Vladimir Putin. Putin sends Russian troops back into Chechnya in the wake of a series of bomb explosions in Russia which are blamed on Chechen extremists. His tough line increases his popularity among Russians Putin elected president Russia and the USA announce a new agreement on strategic nuclear weapons reduction. The two sides are to cut their nuclear arsenals from over 6,000 missiles apiece to about 2,000 each in the next 10 years. Russian and NATO foreign ministers agree on the establishment of the NATO-Russia Council in which Russia and the 19 NATO countries will have an equal role in decision-making on policy to counter terrorism and other security threats Chechen conflict President Putin gains almost total control over parliament after elections in which Putinbacked United Russia wins landslide Mikhail Fradkov replaces Mikhail Kasyanov as prime minister as Mr. Putin wins second term as president by landslide. Mr Kasyanov moves steadily into the liberal opposition camp. Chechen President Akhmad Kadyrov killed in a bomb blast in Grozny. Russian authorities seize assets of Yuganskneftegaz, the key production unit of oil giant Yukos, to offset the latter's reported tax debts State gains control of Gazprom gas giant by increasing its stake in the company to over 50%. Russia and Germany sign major deal to build gas pipeline under the Baltic Sea between the two countries. Gazprom gains overwhelming control of Sibneft oil company by buying out businessman Roman Abramovich for 13 billion dollars. 161

62 Lazard Emerging Markets Debt 2006 Russia briefly cuts supply of gas for Ukrainian use in row over prices. Moscow says its reasons are purely economic but Kiev says they are political. Putin signs controversial law giving authorities extensive new powers to monitor the activities of non-governmental organisations and suspend them if they are found to pose a threat. President Putin visits Beijing and signs range of economic agreements, including deal on future supply of Russian gas to China. Ruble becomes convertible currency. Amid tension over Georgia's breakaway regions and its ties with NATO, Moscow's relations with Tbilisi deteriorate sharply when four Russian army officers are briefly detained there on spying charges. Russia imposes sanctions and expels hundreds of Georgians whom it accuses of being illegal immigrants Russia test fires a long-distance missile. President Putin talks of a new arms race, with the US planning to expand its missile defences into Eastern Europe. President Putin's United Russia party wins a landslide victory in parliamentary elections, which critics describe as neither free nor democratic Putin ally Dmitry Medvedev wins presidential elections as Mr. Putin cannot serve a third consecutive term. Putin becomes PM. Tensions between Russia and Georgia escalate into a full-blown military conflict after Georgian troops mount an attack on separatist forces in South Ossetia. Russia drives Georgian forces from South Ossetia and Abkhazia, then recognizes them both as independent states, drawing further protests from the West and Georgia. The Russian parliament approves a $68bn package of measures to help banks hit by the global credit crunch. Parliament votes overwhelmingly in favour of a bill that would extend the next president's term of office from four to six years Russia stops gas supplies to Ukraine after the collapse of talks to resolve a row over unpaid bills and gas prices. Supplies to southeastern Europe are disrupted for several weeks as a result of the dispute. Russia ends counterterrorism operation against separatist rebels in Chechnya, one month after President Medvedev said life in the republic had normalized to a large degree. President Medvedev and Barack Obama, on his first official visit to Moscow, reach an outline agreement to cut back their countries' stockpiles of nuclear weapons, in a move aimed at replacing the 1991 Start I treaty. Opposition parties accuse the authorities of rigging local elections as the governing United Russia party wins every poll by a wide margin Presidents Medvedev and Obama mark warming in ties on the Russian leader s first visit to the White House. Obama says the US will back Russia's World Trade Organisation accession, and Russia will allow the US to resume poultry exports. Arrests of 10 low-level Russian spies in the United States Vladimir Putin is confirmed as the ruling United Russia party's candidate in the March 2012 presidential election, making his return to the Kremlin highly likely. Georgia and Russia sign a Swiss-brokered trade deal which allows Russia to join the World Trade Organization (WTO), ending Georgia s blockade of Russian membership since the 2008 war Vladimir Putin wins presidential elections. Opponents take to the streets of several major cities to protest at the conduct of the election, and the police arrest hundreds. Russia formally joins the World Trade Organization (WTO) after 18 years of negotiations. 162

63 Russia 2014 After flight from Ukraine of pro-moscow president Viktor Yanukovych, Russian forces take over Crimea and hold referendum to secede and join Russia. This sparks biggest East-West showdown since Cold War, with the US and its European allies imposing sanctions and accusing Russia of stoking separatism in eastern Ukraine. Russia s Gazprom sign 30-year deal to supply the China National Petroleum Corp with gas, estimated to be worth over $400bn. It is major boost for Moscow's plan to find alternative energy market in face of possible European sanctions over Ukraine crisis. Following the downing of a Malaysian Airlines passenger plane over eastern Ukraine in a suspected missile strike, Russia comes in for international criticism amid claims denied by Moscow - that it supplied rebels with heavy weaponry. The EU and US announce new sanctions against Russia. The IMF says Russian growth is slowing down to zero. Russia agrees to resume gas supplies to Ukraine over the winter in a deal brokered by the EU The Russian ruble begins to drop rapidly against the US dollar, losing about half its value in the next two months. Russia carries out first air strikes in Syria, saying it targets the Islamic State group. But West and Syrian opposition say it overwhelmingly targets anti-assad rebels instead. Turkey shoots down Russian warplane on Syria bombing mission. Russia, Turkey's secondlargest trading partner, imposes economic sanctions. Source: BBC Notes 1 As of December Haver Analytics, accessed on 9 October Russia, US Energy Information Administration, 26 November 2013, and Statistical Review of World Energy 2013, BP, 2013, en/global/corporate/about-bp/statistical-review-of-world-energy-2013.html. 4 Russia, US Energy Information Administration, 26 November 2013, 5 Afirova, Elena, The Mineral Industry of Russia U.S. Geological Survey, July 2013, minerals/pubs/country/2011/myb rs.pdf. 6 Profile: Vladimir Putin, BBC, 7 June 2013, 7 The Duma Election 2011, Russia Votes, accessed on 20 December 2013, duma/duma_today.php. 8 World Economic Outlook Database, International Monetary Fund, October 2015, accessed on 6 December 2015, 9 EMEA EM: Expanding Amid Global Fixed Income and EM FX Wariness, J.P Morgan, November In the World Bank s Rule of Law Index, Russia ranks 162 out of 212 countries. In the World Bank s Control of Corruption Index, Russia ranks 176 out of 212 countries. Worldwide Governance Indicators, World Bank, accessed on 20 December 2013, 163

64 Lazard Emerging Markets Debt 164

65 Tajikistan Summary Moody s B3/ S&P B- / Fitch NR Economy: Agriculture 28%, Industry 26%, Services 46% Tajikistan is a landlocked CIS country with very high growth rates but also the lowest GDP per capita in the region. This relatively high poverty level increases the importance of remittances from Tajik citizens abroad, particularly in Russia, who in the past sent remittances that amounted to 50% of GDP before the oil shock. The slowdown in the Russian economy and devaluation of the somoni led to a banking crisis that ultimately forced the government to recapitalize four banks at a cost of 6% of GDP. One of the country s greatest potential sources of wealth is its dense river network, which could be used for hydroelectricity production. Despite this potential, Tajikistan currently suffers from energy deficiency. The government restarted a megaproject, the Rogun dam, which once completed in 2021 is expected to not only provide energy independence but also allow Tajikistan to export energy to Afghanistan and Pakistan. While geopolitics and security challenges are a concern, this is offset by the support it receives from China. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 1,046 1, Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Haver Analytics, IMF 165

66 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency B Local Currency B B- B- CCC CCC Moody s S&P Moody s S&P As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s 166

67 Tajikistan Strengths High Growth Rate One of Tajikistan s key strengths is its historically solid GDP growth rate, which is among the highest in the region. The country s 2016 growth rate was 6.9%, and its average annual growth rate in was 8.1%. 1 Agriculture is the largest sector in the economy, accounting for 20.6% of GDP, although its share has been declining as other sectors such as mining, manufacturing, and construction expand. The restarting of large-scale projects such as the construction of the Rogun dam, which will cost an estimated $3.9 billion, will be an important driver of economic growth. Over the medium term ( ), average annual growth is expected to decelerate to 4.0%, but despite this, Tajikistan s growth rate will still be the second highest among CIS countries. Hydroelectric Power Potential Tajikistan s most tangible natural resource is water from its dense river network, supplied mainly by the Amu Darya and the Syr Darya rivers, which offers potential for electricity generation. In 2015, the International Hydropower Association estimated the country s hydropower potential to be 527,000 gigawatts hours, ranking eighth in the world. The Eurasian Development Bank estimates that Tajikistan s commercially available and economically viable hydropower to be 317,000 gigawatts hours. 2 The country s current installed capacity as of 2016 is 17,200 gigawatts hours, but the Rogun dam, which is scheduled for completion in 2021, is expected to supply energy to neighboring South Asian countries such as Pakistan and Afghanistan. The Rogun dam is expected to be the tallest in the world at 335 meters. Tajikistan s Nurek dam, which was built in the 1970s, is the world s tallest at 300 meters and is currently the country s main source of energy. China Support Tajikistan has solid economic and geopolitical ties with China, a relationship that is growing increasingly stronger. Geographically, Tajikistan is located within the scope of China s One Belt One Road strategy and stands to benefit from infrastructure projects such as a transportation network connecting Central Asia. The countries militaries cooperate as Tajikistan is part of an alliance to fight regional terrorism. China is expected to build four border checkpoints and a new military training center 3 in the southern part of Tajikistan along the Afghanistan border. Commercially, Tajikistan s largest source of imports is China, surpassing traditional suppliers such as Russia and Kazakhstan, although it exports very little to China. More importantly, China is the single-largest investor in Tajikistan. From 2012 to June 2017, total FDI from China has amounted to $1 billion, or 50% of all FDI during the period. China is the largest foreign investor in the country by a significant margin. Of the $436 million of FDI received in 2016, China accounted for about $322 million, while the next-largest investor was Russia at $35 million

68 Lazard Emerging Markets Debt Weaknesses Energy Deficiency Energy deficiency is one of the country s major weaknesses. Blackouts are frequent, which in turn hinders economic productivity. Part of the problem is the predominance of hydropower. This leads to an electricity surplus in the summer, when demand is low as glacial melt is high, but results in an electricity deficit in the winter when energy is needed most but energy generation depends on water reservoir capacity. 5 Extensive electricity shortages in winter affects about 70% of population, and has an estimated cost of 3% of GDP. 6 To achieve energy independence, the government is building the Rogun dam, which is expected to double electricity production capacity and allow for exports to Pakistan and Afghanistan. Low GDP per Capita Despite its fast economic growth rate, Tajikistan had the lowest GDP per capita in the CIS region at US$800 in Moreover, other countries such as Kyrgyz Republic, which in 2010 had a GDP per capita of US$875 compared to US$740 for Tajikistan, reached US$1,072 per capita by 2016, leaving Tajikistan as the only country in the CIS with a GDP per capita below US$1,000. External Dependency on Remittances From Russia Tajikistan s economic performance is influenced significantly by developments in Russia via two main channels: trade (mostly imports), and, more importantly, remittances from Tajik citizens residing in Russia, of which there are at least an estimated 870,000 7 (10% of Tajikistan s population). Tajikistan had one of the highest remittances dependency in the world at 50% GDP in before the oil shock and geopolitical tensions led to a sharp slowdown in the Russian economy in Since then, remittances as a percentage of GDP has fallen significantly to 31.4% in Remittances are important not only for balance of payments but also as a growth engine of the economy as it helps fuel domestic consumption. Geopolitics and Security Challenges Security along the Tajikistan-Afghanistan border is a top priority for the country s national security, particularly after the withdrawal of international forces in Geographically, Tajikistan shares a 1,400-kilometer border with Afghanistan, where militant violence is increasing and security deteriorating. In addition, domestic repression of opposition parties, including the Islamic Renaissance Party of Tajikistan, has led to resentment that has driven some believers to join the Islamic State. 10 Relationships with another large neighbor, Uzbekistan, has been tense in the past due to disputes over gas supply, commercial flights, and water resources. 11 Uzbekistan, for example, had traditionally opposed the construction of the Rogun dam and only withdrew its public opposition in July Low Level of Reserves Low levels of foreign currency reserves is a major credit weakness for Tajikistan as it is not large enough to buffer a potential external shock. As of June 2017, the level of foreign reserves was $74.1 million (about 1% of GDP), a significant decrease from the $261 million Tajikistan had at the end of However, Tajikistan s gold holdings are more significant, with a reported value of US$658.9 million (about 9.5% of GDP). 168

69 Tajikistan Corruption Corruption remains a major issue in Tajikistan despite some important reforms. The OECD notes that the country needs to step up its fight against corruption and turn political declarations of commitment into action, 12 and Tajikistan currently reports twice per year to the OECD on its progress. Tajikistan considers that it has implemented 80% of the OECD anticorruption measures. The remaining items require parliamentary approvals, which are being obtained. 13 Despite these efforts, Tajikistan s ranking in the Transparency International s Corruption Perception Index has deteriorated. Tajikistan ranked 136th out of 167 countries 14 in the 2015 Corruption Perception Index, but Tajikistan slipped in 2016 to 151 out of 176 countries, placing it also as the third-lowest ranked among the CIS. 15 Weak Banking Sector Tajikistan s banking sector has been impacted negatively by a combination of: the slowdown in the Russian economy following the oil shock of 2014; the sharp depreciation of the somoni in , which made it more difficult for borrowers to repay US dollardenominated loans; and a slowdown in remittances. These events led to a considerable deterioration of banking assets quality as NPLs jumped from 13.7% of total assets in 2013 to 47.6% by 2016, although it has since declined to 44.0% as of June Banking sector assets were close to 39% of 2016 GDP. During the banking crisis, the government recapitalized four local banks, two of which were considered systemically important, at a cost of 6% of GDP. Natural Disaster According to the Asian Development Bank, Tajikistan is one of the most vulnerable countries in the world to climate change and rising temperatures as it is a country with mountainous terrain and extreme weather that causes frequent flooding. 16 In addition to the human casualty risk and displacement that any major natural disaster can cause, the economic impact is relatively significant for Tajikistan as approximately two-thirds of the population lives in rural areas and depends on agriculture, 17 a sector that accounts for 20% of the economy. Earthquakes are another risk, with the World Bank indicating that earthquakes could have a higher impact, though their probability is much lower. For instance, the World Bank model shows that a catastrophic earthquake once every 250 years would cause capital loss of about 30% of GDP

70 Lazard Emerging Markets Debt Country Background Size Capital Population 144,110 KM 2 (97th) Dushanbe 8.5 Million Religion Sunni Muslim 85.0%, Shia Muslim 5.0%, Other 10.0% Median Age 24.5 Years Literacy Rate 99.8% Independence 9 September 1991 Political System Government Leadership Next Election 2019 Presidential Republic President Emomali Rahmon; Prime Minister Kokhir Rasulzoda Economy Agriculture 27.8%, Industry 25.9%, Services 46.3% Labor Force Agriculture 43.0%, Industry 10.6%, Services 46.4% Merchandise Exports Export Partners Currency As of November 2017 Source: CIA Aluminum, Electricity, Cotton, Fruits, Vegetable Oil, Textiles Turkey 27.8%, Russia 15.6%, China 14.7%, Switzerland 9.8%, Iran 6.5%, Algeria 6.5%, Italy 5.8% Tajikistani Somoni (TJS) 170

71 Tajikistan Country Timeline 1991 Supreme Soviet declares Tajikistan independent from the Soviet Union; Rahmon Nabiyev, Communist leader during , wins Tajikistan's first direct presidential election with 57% of the vote Anti-government demonstrations in Dushanbe escalate into civil war between pro-government forces and Islamist and pro-democracy groups which eventually claims 20,000 lives, displaces 600,000 and devastates the economy Islamist rebels capture towns in southwestern Tajikistan; UN-sponsored cease-fire between government and rebels comes into effect Last meeting of the National Reconciliation Commission held and a new bicameral parliament set up in March; a new national currency, the somoni, introduced; visas introduced for travel between Tajikistan and Uzbekistan Tajikistan is quick to offer support to the US-led anti-terror coalition, set up after the 11 September attacks on the US Tajikistan doubles the number of border guards along its 1,300-km (800-mi) frontier with Afghanistan to prevent al-qaeda members from entering the country to escape US forces Russia formally opens military base and takes back control over former Soviet space monitoring center International Monetary Fund (IMF) orders the return of loan of $47M after it finds Tajikistan submitted false data. Russia agrees to write off Tajikistan s $240M debt in return for cession of a Soviet-designed space tracking station Agreement signed with US military allowing it to transport non-military supplies to Afghanistan over Tajik territory President Rakhmon's People s Democratic Party wins an overwhelming majority in parliamentary elections. International monitors say widespread fraud took place Tajikistan settles a century-old border dispute with China by agreeing to cede some land Tajikistan accuses Uzbekistan of an economic blockade, citing gas supply cuts and rail freight curbs. Tensions are high over a Tajik dam that Uzbekistan fears will restrict irrigation water supplies President Rakhmon wins another seven years in office The head of Tajikistan s Special Forces, Gulmurod Khalimov, claims in a newly released video that he has joined the jihadist group Islamic State in protest at what he calls the government's anti-islamic policies Work begins on the controversial Rogun hydroelectric dam on the Vakhsh river. Downstream neighbor Uzbekistan has strongly opposed the dam, fearing the impact on its agriculture. Source: BBC 171

72 Lazard Emerging Markets Debt Notes 1 IMF World Economic Outlook, October Republic of Tajikistan Offering Circular, 29 August Republic of Tajikistan Offering Circular, 29 August Republic of Tajikistan Offering Circular, 29 August accessed WHEN? 6 accessed 11 October accessed 17 October Republic of Tajikistan Offering Circular, 29 August Republic of Tajikistan Offering Circular, 29 August and accessed 16 October Republic of Tajikistan Offering Circular, 29 August accessed 11 October Republic of Tajikistan Offering Circular, 29 August accessed 11 October accessed 11 October accessed 11 October Republic of Tajikistan Offering Circular, 29 August accessed 11 October

73 Ukraine Summary Moody s Caa2 / S&P B- / Fitch B- 1 Economy: Agriculture 14%, Industry 27%, Services 60% Ukraine is in a difficult economic, social, and political situation that has been exacerbated by the conflicts in Eastern Ukraine, although conditions stabilized in 2016 and improved in The economy contracted 15.8% in , but posted positive growth of 2.3% in 2016 and is expected to grow 1.9% in Inflation is on a downward trend, after surpassing 60% in March 2015, while the exchange rate has stabilized and foreign reserves have close to tripled to US$16 billion. The fiscal deficit is improving, but debt levels remain high, close to 85%. The government remains committed to the International Monetary Fund s (IMF) program and integrating into the European Union (EU), although the population is losing patience as economic conditions remain difficult, corruption remains high, and the popularity of the government is low. The two-party coalition has a small majority in the parliament; thus, there is a risk that elections are moved forward. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 3,941 3,088 2,129 2,195 2,478 2,364 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Central Bank, Haver Analytics, IMF 173

74 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency Local Currency BB- BB+ B+ B B- BB BB- B+ B CCC+ CCC CCC- B- CCC+ CCC CCC- CC CC Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Ukraine 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 174

75 Ukraine Strengths Positive Reform Momentum Despite internal struggles, the government that replaced President Viktor Yanukovych has made major reforms in a short period of time, although it is hard to measure how much more political capital remains to continue with these long-overdue reforms. Among the most important measures already adopted by the current government are a gas price increase, exchange-rate devaluation, and the approval of the pension reform in These measures were taken without triggering major protests, which is a positive surprise as the population is giving the government some room to maneuver. The government does not have much choice in continuing to move forward with reforms, as otherwise it might compromise the agreements reached with the IMF and bilateral entities, such as the World Bank. Uncertainty remains as to whether the population and the political class will continue to support the government in moving forward with its economic agenda. Multilateral/Bilateral Support One of Ukraine s key strengths is its good relationship with the international community and the support of the EU and the United States. The country was able to avoid a complete economic collapse in 2014 and 2015 thanks to multilateral and bilateral lending, which provided well over US$10 billion in financial assistance. The last agreement with the IMF in March 2015 was for a four-year program totaling US$17.5 billion. 2 The government is moving forward with the IMF agreement but at a slower pace than anticipated, with the approval of the second disbursement in September 2016, almost one year behind schedule. The government will need to tackle corruption and privatize some of the state-owned enterprises, which are all necessary to move forward with the IMF program. Economic Potential Ukraine has a large domestic market that makes it a potentially attractive place to invest. The economy is large at US$105 billion, and the population is sizable, totaling 42.4 million. 3 Ukraine s population is well educated as indicated by its high rank across a number of indices. For example, in the UNESCO Education for All Development Index, Ukraine ranks 14th out of 113 countries. 4 In the World Economic Forum s Higher Education and Training Index, it ranks 40th out of 144 countries. 5 Labor costs in Ukraine are relatively low when compared to other countries in the region, such as Bulgaria, Romania, Croatia, and Russia. 6 These factors have helped some high-tech industries, such as defense, to prosper. In different education indices, Ukraine ranks relatively high. The country also has abundant fertile land that can be used for agriculture. Ukraine is currently among the top 10 agricultural producers in the world, and it ranks among the top five countries in the world in share of arable land. 7 Ukraine is currently an important producer of sunflower oil, grain, and sugar. Finally, the country has the fourth-largest shale gas reserves in Europe. 8 Improving Economic Growth Ukraine s economic performance is expected to improve substantially in the medium term as it emerges from crisis. The economy is estimated to have contracted 15.8% in , but it posted a small growth rate of 2.3% in 2016 and 1.9% in Inflation is on a downward trend after peaking at 60.9% in April 2015 and falling to 16.4% in September The exchange rate has stabilized allowing the government to begin gradually removing capital controls. On the external front, the current account deficit is around 4% of GDP after posting a deficit close to 10% of GDP in On the fiscal side, the government aims 175

76 Lazard Emerging Markets Debt to significantly reduce the deficit to 2.4% of GDP, once transfers from national oil and gas company Naftogaz are included. Weaknesses Internal Division The internal conflict between the East and West of Ukraine has major social, economic, and political impacts on the country. Historically, the eastern part of the country has been in favor of closer ties with Russia and the western part in favor of closer ties with the EU. This tension escalated in late 2013 when then-president Yanukovych, signed an economic agreement with Russia, which included a US$15 billion aid package while abandoning talks of a free-trade agreement with the EU. This was a source of discontent in Kiev, where the population is more pro-european, and triggered social unrest that ultimately led to the removal of Yanukovych in early 2014, and his replacement with a pro-european government. Russia, fearing the new government was moving closer to Europe, decided to retaliate by annexing Crimea in eastern Ukraine; Russia also removed some of the economic benefits it provided Ukraine, such as low gas prices; and provided support for some of the Eastern cities to rise up against the government. This eventually resulted in an armed conflict and the deaths of hundreds. Both sides reached a peace agreement in September 2014, giving more autonomy to some eastern cities, including Donetsk and Luhansk. 9 However, the armed conflict resumed a couple weeks later until a new peace agreement was reached in February Since then, the violence has declined but has the potential to again escalate. Geopolitical Risks The recent conflict in Ukraine was not only fomented internally, but also by other countries. Ukraine is in a strategic location, with both Russia and the EU jockeying for economic and political influence. Russia fears the expansion of the EU and NATO into neighboring countries. On the other hand, since the fall of the Soviet Union, the EU has expanded gradually toward the east with the support of the United States. Both sides have supported their interests in Ukraine, although Russia has been more actively involved as it has significant leverage over Ukraine, given its close economic ties. Europe and the United States have tried to counter-balance Russia s influence mainly by providing financial support to the government. Oligarchs Oligarchs have dominated both the political and economic arenas in Ukraine. Their popularity is low as most are considered corrupt and contributors to the economic and political crisis. After the protests in early 2014, the oligarchs kept a lower profile as they feared they could be the focus of an attack by the population. However, the oligarchs are now attempting to re-establish their power which could pose challenges for the government to move forward with muchneeded reforms, as the oligarchs may seek to maintain economic control of key industries. Corruption Ukraine has high levels of corruption within its institutions. The government has passed anti-corruption laws, but enforcement remains a challenge. The laws seek to improve transparency, especially with respect to the sources of politicians wealth. International agencies note that one of the major economic constraints is the high corruption level, especially in the judiciary system, where judges are often bribed. In the Corruption Perception Index: 2015, Ukraine ranked 131th out of 176 countries

77 Ukraine Country Background Size Capital Population 603,550 KM 2 (46th) Kiev 44.0 Million Religion Ukranian Orthodox 66.7%, Catholic 10.0%, Other 23.3% Median Age 40.6 Years Literacy Rate 99.8% Independence 24 August 1991 Political System Government Leadership Next Election 2019 Legislative Branch Semi-Presidential Republic President Petro Poroshenko; Prime Minister Volodymyr Groysman Unicameral Supreme Council Economy Agriculture 13.8%, Industry 27.3%, Services 59.5% Labor Force Agriculture 5.8%, Industry 26.5%, Services 67.8% Merchandise Exports Export Partners Currency As of November 2017 Source: CIA Ferrous and Nonferrous Metals, Fuel and Petroleum Products, Chemicals, Machinery and Transport Equipment, Foodstuffs Russia 9.9%, Egypt 6.2%, Poland 6.1%, Turkey 5.7%, Italy 5.3%, India 5.2%, China 5.1% Ukrainian Hryvnia (UAH) 177