Issue 5, 2015. October-November



A 2015 study has found the Georgian economy could benefit from developing the corporate bonds market.

Sally White

Corporate bonds could provide the impetus for "substantial improvements" to access to money in Georgia, providing alternative financing sources. This was a conclusion of a critical major study- The Georgian Capital Market: Diagnostic Study & Recommendations, initiated by one of Georgia's prime backers, the Asian Development Bank (ADB) and published earlier this year. The corporate sector, including microfinance, has already begun to act on it.

The ADB made it a condition for loans that the government act on it, too. So far this year, the ADB has offered $150 million in loans, the most recent a $75 million tranche to assist government reforms aimed at "increasing savings and domestic resources." While it has announced no moves yet, the government has to deliver on the study's recommendations by next summer.

Eyeing the Bond Market

Nor is it just the corporate heavies that have their eye on a bond market for funds. Georgia's very dynamic microfinance sector (MFI) - comprising 73 companies, with 352 branches and showing 20% growth over the last six months - has, too. It has started to explore with other financial players how such a market, catering for a wide category of companies, funds, and domestic and international investors could be initiated. Given microfinance's long reach into Georgia's agriculture and SME sectors, any material increase in the funds available to it could make a huge difference to Georgia's economy.

The ADB highlighted a requirement that there should be "strong focus on building viable content (issued securities) for the system." Markets need something to trade! Bonds have already proven to be popular. Of course, the ADB stricture is that it is vital that all the right rules and regulations, conforming to international standard, be put in place to protect investors.

Archil Bakuradze, a member of the Board of Directors of Georgia Microfinance Association and Executive Chairman of JSC MFO Crystal, explained such a market's attraction. "MFIs are well positioned to become attractive issuers of bonds with a view to raise capital later down the line. We have already syndicated interest from several industry players. For MFIs, the bond market can become an important refinancing option in parallel with the current alternative, i.e. microfinance investment vehicles internationally and commercial banks at home. Another attraction is that it would provide GEL finance, so critical for our borrowers." The increased dollarization of Georgia's finance has become a severe problem for the country as the dollar has strengthened."

He expanded on his views: "MFIs see the bond market as a strategic alternative for refinancing. The intent is, of course, to keep the relationship with microfinance investment vehicles (MIVs) and commercial banks, but it is important to diversify the funding sources.

"Bonds will offer more access to GEL funding, which is critical for MFIs and their clients. Bond issuances will increase the awareness of MFI among investors, including the general public. At the moment, we are more interested in domestic investors, who would invest GEL, but in the future, foreign currency tranches can be structured to attract more portfolio investment to the sector."

"A corporate bond market will offer a new type of funding to firms and new financial instruments to Georgian investors, big and small," Bakuradze said.

An efficient and well regulated corporate bond market (which, of course, will require new rules and market procedures) would have a big ripple effect on Georgia's corporate life. He added that, in his view: "This movement will motivate companies to improve their disclosure standards and become more open enterprises. This market will offer to companies an alternative to quite rigid bank lending practices, which are overwhelmingly based on real estate guarantees. More Georgians will participate in economic life, investing their interest with Georgian corporations, which will encourage savings and investments much needed by customers and crucial for fuelling Georgia's economic growth."

Usually bonds are less flexible than loans, according to bankers, but as an alternative source of funding, bonds may not require collateral and could be slightly less expensive.

Conditions are becoming more auspicious for bonds. Pricing has become more competitive, and the leading rating agency, Fitch, has already had a meeting with some of the large companies. It seems to have made attractive offers on fees. In the study, the companies were described as being "enthusiastic about the idea of placing local bonds."

Six Offerings in 15 Months

As evidence of potential for a bond market, there were six successful offerings of corporate securities between January of last year and the end of March this year and they totalled around $50 million. There has also been an increase in the financing activity of the international financial institutions (IFIs) - ADB, the European Bank for Reconstruction and Development (EBRD) and the World Bank's International Finance Corporation (IFC), mostly in lari. These IFIs made their placings privately, but the corporate bond sales, though in dollars, were mostly public ones.

A recommendation of the study is that the IFIs as well as major corporations should use the market more. Also, it says, issues should be in lari to help reduce the dollarization of the economy.

The study, which is more than a touch bank-centric, sees quite a large candidate community of major players for a corporate bond market- firstly, it names the banks, then state-owned companies and at least five of the microfinance organizations. It sees the insurance funds and pension funds as unlikely candidates - at least at this stage. Others might disagree, and it will also depend on the size of acceptable issues. Anyway, as the study comments "Georgia does not know - and under the current system cannot know - the financial make-up of the JSC population."

The background is the struggling economy, as Georgia faces challenges that include falling fund inflows. This is partially because remittances from Georgians abroad in Russia and Ukraine are down, but foreign investment and export growth are also threatened by global uncertainty. The government has not chosen to support or develop the stock market (which now barely exists) as a source for funding and monitoring of the economy. However, as noted by the IMF, EBRD, World Bank and ADB, the international model is increasingly for developing countries to do so.

Any government role in the development of the market should be clearly defined, as a means of warding off over involvement.

The structure of the Georgian stock exchange has encouraged issuers in recent years to raise funds off-market and also to do so abroad.

There is a long way to go yet to get to the end of the "road-map" set out in the study. Laws and regulations protecting investors, putting exchange trading on an international basis (with information all in English), increasing transparency, leveling the taxation playing field, freeing up the market and attracting more issuers as well as investors, and so on - all and more are needed. The study found that Georgia "possesses all of the required ingredients to operate a healthy capital market. Bakuradze concludes that the government's socio-economic development strategy 2020 "is all about inclusive economic growth." At the moment, non-banks represent only about 7 percent of the Georgian financial market. Perhaps not surprisingly as he is pointing out from his end of the capital markets, funding from a healthy bond market would enable microfinance to be a more powerful driver for small entrepreneurs' participation.

The Working Group for the ADB study was chaired by the Vice Prime Minister and Minister of Economy and Sustainable Development, the President of the National Bank of Georgia, the Minister of Finance, the Secretary of the Prime Minister's Economic Council and a former Chairman of the National Securities Commission of Georgia. The study was published in May as a Discussion Draft after being commission last September, and it was supported by USAID under its Governing for Growth in Georgia project.

Georgia's Microfinance Sector - important enough to be a potential key player in Georgian capital market reforms:

In Q2 2015, 73 Micro Finance Institutions (MFS) were registered at the National Bank of Georgia. They employed total 4,729 members spread through 352 branches. Member numbers rose by 15 percent and branch numbers by 20 percent in this period.

The gross loan portfolio was 1.1 bn GEL, which was 30 per cent higher than at the end of 2014. During the same period, the loan loss reserve grew by 94 per cent, which indicates deterioration of assets quality. According to the Microfinance Association, however, Georgia has been affected much less by regional crisis in comparison to its neighbours.

Around 51 per cent of the funding to MFIs comes from international microfinance investors. Of the rest, 24 percent comes from Georgian commercial banks, 21 percent through loans from individuals and 5 percent from legal entities. The attractiveness of micro-finance to SMEs is that, according to Archil Bukaradze, a member of the Board of Directors of Georgia Microfinance Association, many specialist MFIs do not demand personal guarantees for loans. They offer non-collateralized loans. Banks, however, often do demand collateral.

Before the government's use of banks to disperse subsidies to agriculture, MFIs were the largest source of financing for Georgian farmers. While agro-financing is still an important area, it is now only accounts for around 25 percent of their loans.

MFIs are not allowed to take deposits and cannot benefit from Central Bank refinancing instruments right now, Bakuradze points out. Thus MFIs are hoping that the Georgian bond market will help them diversify funding sources and gain access to lari funds.
When analysed in May this year, the return on microfinance assets was "a reasonable 4-6 percent on average and comparable to that of commercial banks," he comments. The quality of microfinance assets "has been consistently good (impaired assets are usually within 2 percent). These are signs of a sound and competitive market with - by and large - well governed and responsible institutions." His conclusion is that they should be welcome members of any bond market.

Importantly, another reason for increasing the ability of microfinance groups to lend, he points out, is that "more than half a million Georgians are regular users of a payday loans, which is completely beyond financial regulation."