Aegon AM: Central Asia, a landlocked premium

December 19, 2023

Some countries must pay bondholders additional premium to compensate for the risks stemming from their geographic constraints. This applies especially to those landlocked countries who must rely on their neighbours for access to international trading markets or valuable resources. The economic resilience of these countries can be heavily dependent on diplomacy. Central Asia’s 'Stans', as the post-Soviet states are known, are a prime example of why additional spread is warranted.

November's historic storm in the Black Sea, which brought flooding to coastal areas of Southern Ukraine and Russia, served as a reminder of how vulnerable Central Asia's landlocked countries can be to events far from their own borders.

In this case, it was Kazakhstan. The oil exporter is heavily reliant on access to Russia’s Black Sea oil terminals for export of its product. Oil accounts for ~60% of the country’s export revenue and nearly a fifth of its GDP.^[1] The suspension of oil loadings at the terminals in response to the storm led to Kazakhstan's largest oilfields cutting combined daily oil output by 56% from 27th November.^[2]

Although this was a temporary disruption, it highlights how much Kazakhstan’s oil revenues depend on amicable relations with its warring neighbour, as did the recent tanker ban following Russia’s concerns over the targeting of its Black Sea naval vessels.^[3]

There will be a non-immaterial tail risk of disruption so long as the Ukraine War persists. President Tokayev’s increasingly assertive efforts to position his country as an important transit route for trade between East Asian and European economies also risks testing relations with Putin’s regime.

Neighbouring Uzbekistan – which lack’s Kazakhstan’s oil wealth – hopes to benefit from similar new economic ties, as evidenced by President Mirziyoyev's recent engagement with European leaders to secure investment commitments.^[4] Yet, like Kazakhstan, the country is constrained by its geographical position.

To address an energy deficit caused by a growing middle class and industrial base, this double landlocked country has no option but to turn to Russia for gas imports through existing pipeline infrastructure.^[5]

Such trade itself is not controversial but, while the Stans increasingly make overtures to the West and China, a few - alongside those in the Caucasus - are facing allegations of being a hub for re-export of foreign goods to Russia, with Kyrgyzstan being a particular standout given its simultaneous growth in imports from Europe and  exports to Russia.^[6]

Lastly, historic economic ties make it difficult for the Stans to avoid any economic fallout. The former Soviet countries have long had large numbers of nationals working in Russia which provide a valuable transfer of earnings home. A fall in these transfers would weigh on currencies.^[7] 

Given the clear geographic constraints and historic economic ties with Russia, Central Asian countries are having to manoeuvre themselves pragmatically between the interests of the West, Russia and China while attending to their own internal affairs.

There are many factors for bondholders to be vigilant of, and several reasons for specific securities to offer ongoing spread premium. For example, the long-dated bonds of Kazakhstan's national oil company do offer compelling yields to investors for a BBB-rated credit, but they are unlikely to offer material spread compression from current post-war levels while such geopolitical risks persist.

Longer-term, the issue that poses an existential threat to the region's economic development and to its population is that of water scarcity. President Mirziyoyev took the opportunity to express his concern when taking to the podium at this month’s UN Climate Change Conference in Dubai.

Central Asian countries are profoundly dependent on neighbouring water resources given their predominantly arid climates. In June, Kazakhstan declared a state of emergency as the declining water level of the Caspian Sea threatens its maritime industry.^[8] Uzbekistan's cotton industry, a legacy from the Soviet Union's strive for self-sufficiency which effectively drained the Aral Sea, urgently needs modern irrigation technology.^[9]

 This has been an increasing area of focus for the current regime since it came to power in 2016, with 2024 a 'transition to an emergency mode of work to save water.'^[10] Afghanistan's construction of a canal to divert water from the Amu Darya, one of two key rivers in Central Asia, for its own agriculture is likely to exacerbate the regional water stress.

This serves as another example of Central Asian countries’ requiring to cooperate on the management of scarce water resources among themselves and with countries further afield^[11], something which becomes acutely relevant given that the region's population is expected to grow 37% between 2019 and 2050.^[12]

^{[1] https://www.fitchratings.com/research/sovereigns/fitch-ratings-sees-risks-to-kazakhstans-oil-exports-from-dependency-on-russia-20-02-2023}

^{[2] https://www.reuters.com/markets/commodities/black-sea-storm-disrupts-russian-kazakh-oil-exports-2023-11-28/}

^{[3] https://www.upstreamonline.com/production/russia-lifts-oil-tanker-ban-after-sea-drone-attacks-in-black-sea/2-1-1496472}

^{[4] https://www.eureporter.co/uncategorized/2023/11/01/uzbekistan-france-the-course-towards-rapprochement/}

^{[5] https://eurasianet.org/uzbekistan-reaches-deal-to-buy-gas-from-russia}

^{[6] https://english.nv.ua/nation/how-kyrgyzstan-and-other-central-asian-countries-help-russia-import-sanctioned-goods-50372790.html}

^{[7] Remittances to Europe and Central Asia post a strong growth (worldbank.org)}

^{[8] https://eurasianet.org/kazakhstan-authorities-declare-state-of-emergency-over-caspian} 

^{[9] https://www.un.org/en/chronicle/article/dry-tears-aral}

^{[10] https://www.gazeta.uz/ru/2023/11/30/water/}

^{[11] https://thediplomat.com/2023/07/the-talibans-new-canal-threatens-water-security-in-uzbekistan-and-turkmenistan/}