The heart of the New Silk Road

GlobalMarkets

May 08, 2019 02:00 PM

After decades of self-imposed isolation, Uzbekistan is embarking on a range of projects with the help of Chinese assistance — and finance — to slowly start to stitch a recently remote country back into the global economy

When talk turns to cities or states that lie at the heart of regional or global trade, certain names and places spring inexorably to mind. In the late 20th Century, Germany, Japan and the United States dominated global trade. Before that, it was the turn of the commercially oriented British Empire. Receding further into antiquity the names of Athens and Aden, Calicut and Colombo, Siraf and Singapore spring to mind. Then of course there is China, the sovereign giant that dominated global trade until the 18th Century and looks ready to do so again.

Yet such lists tend to overlook a region and more specifically a country that for more than 16 centuries lay at the crossroads of commerce. Between 130 BCE, when China’s Han Dynasty formally opened trade routes to the West, and 1453 AD, when the Ottoman Empire closed them, the Silk Road was the greatest trading network the world had ever seen. Paper, spices, gunpowder and, naturally, silk, flowed west from China and the littoral states of the Pacific, while new technologies like glass-making, invented in the Islamic world, spread east. The old Silk Road wasn’t a point-to-point affair: it ruptured and reconnected multiple times along its route, interconnecting with key rivers: the Indus in modern-day Pakistan, and the Tigris and Euphrates, which empty into the Persian Gulf. But at the heart of the Silk Road stood a handful of trading hubs, rich oasis-cities like Bukhara, Samarkand, Fergana and Andijan, all located in modern-day Uzbekistan, a country with a troubled and turbulent past that, if all goes to plan, it hopes to transform into a bright and brilliant future.

Hermit state

To understand how far Uzbekistan had fallen off the trade map, it is important to understand its recent history. After the dissolution of the Soviet Union in 1991, it declared independence but, unlike some regional sovereigns, notably the more external-facing Kazakhstan, it shrank into itself, choosing to fear rather than embrace the outside world. Under Islam Karimov, a tyrant-president who ruled with an iron fist, it became Central Asia’s hermit state, regularly ranked low by democracy watchdog Freedom House alongside North Korea on issues such as political freedoms and civil rights.

Most foreign investors wisely gave it a wide berth, and Uzbekistan slowly and systematically fell behind its regional peers. According to data from Unctad, foreign direct investment as a share of gross fixed capital was 6.8% in the three full years before the global financial crisis of 2008 — a time when the price of everything from coal to copper to oil and gas, resources found in abundant supply beneath Uzbekistan’s rich soil, were going through the roof. Compare that with Kazakhstan, where FDI as a share of gross fixed capital, during the same pre-crisis period, came in at 26.9%.

Yet for a long time, that was as good as it got for political leaders in Tashkent. Inward investment fell steadily through the post-crisis era, hitting a nadir in 2017, when Uzbekistan attracted just $96m in foreign capital. The same year, just shy of $40bn worth of total FDI flowed into the five nation states that make up Central Asia. In the quarter-century to the end of 2016, according to World Bank data, Kazakhstan attracted $52bn in total FDI, against just $9.6bn for Uzbekistan.

A new dawn

Perceptions began to change in 2016. In September of that year, Karimov died and was replaced by long-standing prime minister Shavkat Mirziyoyev. The new president quickly got to work, pushing through reforms that included easing visa requirements and making the Uzbek som fully convertible. Azim Akhmedkhadjaev, chair of the state committee for investments, said it promised to usher in a “new epoch… of intense development”.

In the wake of the presidential elections of December 2018, Mirziyoyev worked hard to burnish Uzbekistan’s badly tarnished image, meeting corporates and investors, and leading policymakers in Delhi and Beijing, Tokyo and Washington. He applied to restart talks to join the World Trade Organisation, stalled for a decade, and embarked on lucrative investment trips to Russia, India, China and the United Arab Emirates. Seven special economic zones were created, offering favourable tax breaks to investors.

The EBRD re-opened its office in Tashkent after a decade’s absence from the country. Since September 2017, the European multilateral has signed and started 23 onshore projects, financing hotels, power stations and wastewater facilities, and extending credit to local lenders including Ipak Yuli Bank, Ipoteka Bank and Davr Bank.

Mirziyoyev is peering east and west in his quest for everything from working capital to institutional and geopolitical support. This makes good sense. To the east stands China, whose Belt & Road Initiative (BRI), also known as the New Silk Road, aims in the long-term to convey billions of dollars of goods a year (priced, China hopes, in its currency, the renminbi) overland by road and rail between East Asia and Europe.

For Uzbekistan’s president, the initiative could not have arrived at a better time. China’s desire for the bulk of its trade to bypass the US-controlled Strait of Malacca works to Uzbekistan’s favour. The New Eurasian Land Bridge and the China-Central Asia-West Asia Economic Corridor, two of the BRI’s chief trade routes, pass through Uzbekistan: the former officially terminates at the Dutch seaport of Rotterdam, while the latter comes to a full stop on the shores of the Mediterranean. For both routes to operate at full capacity, China knows there cannot be any missing links.

That explains its drive to channel capital into a host of key infrastructure projects across the country. A new and fully electrified $5bn rail line linking western China with Tashkent is already underway, the first phase of which is funded by a $400m loan from the Export-Import Bank of China (Chexim). The two countries are working on a host of other projects, ranging from water management to logistics to astronomy.

In June, Mirziyoyev is slated to attend the next Shanghai Cooperation Organisation summit, which brings together the leaders of China, Russia and the Central Asian states, and is set to take place in Tashkent for the first time.

Some nation states, fearing the consequences of rising levels of national debt, are reluctant to accept funding from Chexim and China’s other big development lender, China Development Bank, but so far at least, Uzbekistan, a country long on ambition and short on high quality infrastructure and investment partners, is not one of them.

Looking west

Then there is the vast single market at the western end of the Belt & Road. In February, Uzbekistan and the European Union held the first round of talks on an Enhanced Partnership and Cooperation Agreement, which aims to boost two-way trade with the EU.

Later this year, Mirziyoyev is scheduled to visit Belgium and Switzerland. His administration continues to ease travel restrictions on tourists and business travellers. In February 2019, Uzbekistan said it would allow visa-free travel to the country for visitors from 45 countries, including the UK, Italy, France, Germany, Singapore, Japan, and Austria.

Zones of influence

China, history tell us, is one of the most inventive of countries. Over the centuries, it has given us everything from paper to gunpowder, tea to silk, and the compass to movable type printing. But perhaps no invention is more relevant in the modern economic and financial world than the special economic zone (SEZ).

The secret to their success lies in context. China was judicious from the outset, setting out a master plan but infusing it with enough institutional flexibility. Its more advanced cities (Shenzhen, Shanghai) started the ball rolling, focusing on heavy manufacturing (clothes, shoes, plastics).

As these SEZs moved upstream into higher-margin goods and services (robotics, AI, biotechnology), old-style manufacturing moved inland, to second or third-tier cities, or, increasingly, overseas. China was careful not to build too many SEZs, thus avoiding a surfeit of price competition, but it promised to move heaven and earth to keep its key investors happy, and usually delivered.

Foreign corporates set down productive roots, often for decades. Developed and developing nations, recognising the model’s simple, elegant effectiveness, sought to replicate it.

Now, Uzbekistan, a fast-growing country rapidly opening up to the outside world, has jumped on board. SEZs of all types and sizes are springing up across the Central Asian state, with the aim of sucking in foreign capital and giving the country’s 33m people a better and richer life. In October 2018, president Shavkat Mirziyoyev set out plans to build seven special zones dotted around the country, including an SEZ in Sirdrayo, an area located between Tashkent and Samarkand, that will offer corporate tax breaks, and free investors from the cost of paying a land tax. Other special zones, in Tashkent, Samarkand, Bukhara and the eastern Fergana valley, are springing up, focusing on industries including logistics, agribusiness, light industry, pharmaceutical production and tourism.

An e-visa scheme introduced in 2018 will be extended in the second half of the year to cover nationals from 76 countries and will permit double and multiple entries — a boon for regular business travellers. It seems to be working: according to data from the foreign affairs ministry, 5.3m people visited the country in 2018, more than double the previous year’s figure of 2.6m.

Air travel, once costly and rare, is booming as the sector opens up. Uzbekistan Airways, the national flag carrier, is adding new routes to Europe and Asia, and expanding its roster of Airbus A320s and Boeing 787 Dreamliners.

In 2017, the president inked a $250m loan from Export-Import Bank of Korea, to finance the construction of a new terminal at Islam Karimov Tashkent International Airport. Set to open in 2021, it will be able to process 3m-4m passengers a year and accommodate up to 36 aircraft. Plans are also under way to convert Tashkent-Vostochny Airport, a military-and-cargo facility to the east of the capital, into a business aviation hub by 2020, a project slated to cost $150m.

Thanks to projects like these, and dozens of others either planned or pending, a once-isolated country is slowly being stitched together. Global mining and energy firms from Europe, Asia and the Americas are engaging with the government, with the aim of forging joint ventures with leading corporates, and of exploiting vast reserves of energy, metals and cotton. Better infrastructure, again, is key to its success.

In from the cold

Uzbekistan is opening up fast financially and economically, with foreign portfolio investors, notably funds that specialise in unlocking investable assets in frontier markets, taking their first, tentative onshore steps. The Tashkent stock market’s free float is a mere $300m, but it is set to grow as more firms, in the private and the public sector, sell shares to local and foreign institutional investors.

A key moment in the country’s capital markets development took place in February, when the Republic of Uzbekistan sold $1bn of Eurobonds to international investors; leading local corporates are set to follow suit, with oil and gas group Uzbekneftegas tipped to print its inaugural corporate bond by the end of 2019.

And while foreign lenders are in most cases barred from buying stakes in Uzbek banks, those restrictions are widely expected to be removed or eased in the coming years.

Looking ahead, there are many good reasons for investors to put their money to work in the Central Asian state. China is ploughing untold capital into infrastructure projects that will link Beijing with Europe via one of the youngest and fastest-growing economies anywhere in the developing world. In its latest World Economic Outlook, published in April 2019, the IMF tipped economic output to expand by between 5%-6% every year through the mid-2020s, and pointed to a host of other positive macro-economic signs, including narrowing deficits and easing inflation. It seems that after years of self-imposed isolation, Uzbekistan is finally, to the delight of global investors, corporates, lenders and policymakers, coming in from the cold.

Russia wanes, China rises

For decades after the collapse of the Soviet Union, Russia’s influence in Central Asia endured. Then as now, Russia saw the area as part of its “near-abroad”, or natural sphere of influence. It maintained a strong military presence in the likes of Uzbekistan, and financed projects aimed at, among other things, cutting poverty and fortifying society.

The Collective Security Treaty Organisation (CSTO), an intergovernmental military alliance founded in 1992, may have been regional in theory, but it was heavily reliant on Russian minds and money. In 2014, Russia unveiled the Eurasian Economic Union (EEU), in the hope of permanently binding the region together, economically and financially.

Russian influence remains, but there is little doubt it has waned sharply in recent years, across Central Asia in general, and more specifically in Uzbekistan. When Islam Karimov, a hard-line dictator, died in 2016 and was succeeded by current president Shavkat Mirziyoyev, Russia wasted little time reminding the new guy who was boss. One of Mirziyoyev’s first official trips abroad was to Moscow, where he signed a slew of energy, food and military deals worth $15bn.

Yet Mirziyoyev has been more than willing to tread his own path. His predecessor withdrew from the CSTO in 2012, and the current president has evinced no desire to re-engage militarily with Russia. Nor does he show any wish to join the dead-in-the-water EEU, a paper tiger of a multilateral project.

Russia’s dilemma is exacerbated by the fact that there is now a more powerful and ambitious superpower operating in its own backyard. Regional sovereigns that once instinctively turned to Russia for funding and protection, now court China, coveting its diplomatic strength and seemingly limitless capital reserves.

Chinese development banks, operating under the aegis of president Xi Jinping’s flagship Belt & Road Initiative, are financing and facilitating much-needed infrastructure, building airports, highways, and new rail lines. In November 2018, while attending the second Belt & Road Forum in Beijing, Mirziyoyev revived plans for a high-speed railway linking the eastern Uzbek city of Fergana, with Xinjiang in western China. A few months earlier, he returned from his maiden overland voyage to the People’s Republic, having inked dozens of deals worth $23bn, spanning sectors from oil refining to power plants, and chemicals to agriculture.

Once the region’s primary trading partner, Russia now ranks second or lower in many markets, Uzbekistan included. The country posted exports of $11.5bn in 2017, according to data from the CIA World Factbook, of which more than half, mostly in the form of energy and minerals, was shipped west to Switzerland and east to China, with Russia accounting for a tenth of the total. In 2017, China overtook Russia, to become, for the first time, Uzbekistan’s largest source of imports.

Economic winter

The long, slow decline in Russian influence is easy to explain. Russia’s economy grew by an annual average of 0.4% over the half-decade to the end of 2018. Events such as the 2014 annexation of Crimea and the subsequent rouble crisis acted as a destabilising force in a region desperate for financial, economic and political stability. Western sanctions did not fatally undermine Russia, but they did remind regional nation states like Uzbekistan that Russia would always march to the beat of its own drum.

By contrast, China, with its constant and comfortable refrain of “trade and more trade”, came to appear to be a far more reliable long-term commercial partner. “China’s Belt & Road Initiative is everywhere in Central Asia,” notes Gunter Deuber, head of economics, fixed income and foreign exchange research at Raiffeisen Bank International. “You see it in trade and cropping up in FDI data across the region, and the stark truth is that Russia has completely lost out. Central Asian states will always seek to manage the balance of their relations with both countries, but China matters far more these days and Russia matters far less.”

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