Georgian bank rides wave of demand for local currency debt

In a London pub quiz, the majority of teams would no doubt struggle to correctly identify the lari as the currency of Georgia.

But demand for local currency emerging market debt is such that some fund managers in London were happy buying a Georgian lari bond from the country’s largest bank this week, allowing Bank of Georgia to raise more than $200m-equivalent in its home currency.

More and more money is chasing emerging market bonds denominated in domestic currencies, with local currency EM bond funds tracked by EPFR Global seeing $10.5bn of net inflows since the start of the year.

Local currency EM became the pariah of the debt markets following the so-called “taper tantrum” of 2013, as fears over the consequences of less accommodative central bank policy in the US led to a deep sell-off. A strong dollar and a series of major emerging markets currency devaluations exacerbated this.

JPMorgan’s local currency bond index returned just shy of 10 per cent last year, however, and its total return has already topped 9 per cent since the beginning of 2017.

Jan Dehn, head of research at emerging markets debt specialist Ashmore, believes the rally has more to run, forecasting 50 per cent returns over the five-years from the start of 2016.

“Carry accounts for the first 30 per cent of that, but the other 20 per cent should come from currency appreciation — as competitiveness recovers,” he said, adding that Ashmore has increased the allocation to local currency in its multi-asset fund from around 25 per cent to just over 50 per cent over the past 18 months or so.

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For companies like Bank of Georgia, the increased demand presents a rare opportunity to fund in their domestic currency.

“Most EM borrowers would prefer to issue in local currency if possible, but there are constraints on the size and maturity of funding possible,” said Stefan Weiler, head of CEEMEA DCM at JPMorgan, a bookrunner on Bank of Georgia’s bond.

“Having a successful deal in a not very widely followed currency like lari is likely going to prompt more borrowers to reconsider it as a funding option, however.”

Bank of Georgia is not new to the international debt markets. It has issued dollar bonds previously. But asking fund managers to take exposure to a niche currency like Georgian lari is another question entirely.

“With this deal, international investors gave the vote of confidence to the country, as their willingness to take lari local currency risk shows they’re comfortable with the economic, fiscal and monetary policy of Georgia,” said the bank’s chief executive Kaha Kiknavelidze.

The deal is the first local currency bond in a decade from a former member of the Soviet Union other than Russia, which unlike Georgia has deep-pocketed domestic bond buyers. Bank of Georgia’s deal also ties into the country’s recent push for “de-dollarisation”, a series of policies aimed to reduce its reliance on foreign currency.

“We have made several steps on the de-dollarisation of the asset side of our balance sheet and this is an important step on the liability side,” added Mr Kiknavelidze.

The lender’s three-year bond priced with a coupon of 11 per cent, offering an eye-catching yield for investors with strong enough stomachs for potential risks involved.

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While the Georgian lari has stabilised this year, this is only after it went through a sharp devaluation at the end of last year. And with the US Federal Reserve in the process of raising rates, memories of taper tantrum loom large for some.

Mr Dehn said Fed rate hikes are not the primary threat to returns in local currency debt, however.

“After the taper tantrum, yields backed out so much that they began to price in a complete normalisation of Fed policy to pre-crisis levels,” he said. “The biggest single threat to the EM local currency trade is the Border Adjustment Tax, as the already overvalued dollar would surge on the back of that.”