The agency said that Uzbekistan has embarked on a rapid process of economic modernization and integration with the rest of the world, utilizing its strong net external and fiscal asset positions in the process.
“We expect both positions to weaken through to 2022, but remain relatively strong in a global context. During the same period, we forecast continued progress with institutional and economic reforms, which should ultimately strengthen governance and expand the production capacity of the economy. We are affirming our ‘BB-’ long-term and ‘B’ short-term issuer credit ratings with a stable outlook,” the agency noted.
“The stable outlook reflects our expectation that, over the next year, Uzbekistan’s fiscal and external positions will remain strong but decline slightly, due to current account deficits and government borrowing,” S&P Global added.
“We could raise the ratings if Uzbekistan’s increased integration with the global economy and government reforms of state-owned enterprises (SOEs) result in increased growth potential and resiliency for the economy. We could also raise the ratings if monetary policy effectiveness were to improve, for example through a decline in dollarization of the economy. Further diversification of the government’s revenue base or the composition of the economy’s exports would also be supportive of the ratings,” the agency said in a statement.
“We could lower the ratings if Uzbekistan’s integration with the world economy were to result in a significant deterioration in the fiscal and external balance sheets. This could be due to imports remaining elevated and current account deficits continuing to be funded by debt-creating flows and asset drawdowns. We could also lower the ratings if we observed increasing weakness in key SOEs, leading to growing contingent liabilities for the government,” S&P Global underlined.
“Our ratings on Uzbekistan are supported by the external creditor position of the economy and the government’s low debt burden. These strengths predominately arise from the government’s net asset position, which stems from the policy of transferring some revenue from commodity sales to the Uzbekistan Fund for Reconstruction and Development (UFRD),” the agency said.
“Our ratings are constrained by Uzbekistan’s low economic wealth, as measured by GDP per capita. In our view, future policy responses may be difficult to predict, given the highly centralized decision-making process and the relatively undeveloped accountability and checks and balances between institutions. Our ratings are also constrained by low monetary policy flexibility,” it noted.
Institutional and economic profile: Broad-based policy reforms have improved institutions and opened up the economy, but from a low base.
The authorities began a process of economic reforms in 2017 aimed at modernizing the economy, but challenges--such as SOE sector reforms and increasing foreign direct investment--remain. Progress with institutional reforms is also continuing but we expect decision-making to remain centralized despite improvements to governance.
GDP per capita remains low, at an estimated $1,800 in 2019, but we expect real GDP growth to remain relatively strong, averaging just over 5% over our forecast period to 2022, S&P Global stated.
“The government of Uzbekistan has initiated a series of broad-based policy reforms, including attempts to increase the independence of the judiciary, remove some restrictions on free expression, and increase the government’s accountability to its citizens. Changes have also included the implementation of an anti-corruption law, an increase in transparency regarding economic data, and the liberalization of trade and the foreign exchange regimes. Relationships with neighbors have also greatly improved, shown by increased co-operation in border demarcation with Kyrgyzstan and improvements in transportation links with Kazakhstan and Tajikistan,” the agency underlined.
“Notwithstanding the positive trend in strengthening institutions, in our view, Uzbekistan is starting from a low base. We believe that decision-making will remain highly centralized in the hands of the president, making future policy responses more difficult to predict. We observe that checks and balances between institutions remain weak. In addition, uncertainty over any future succession remains, despite the relatively smooth transfer of power to President Mirziyoyev,” S&P Global said.
“Further reforms began recently in the SOE, minerals, and utilities sectors, notably with the creation of the Ministry of Energy, which will have regulatory purview over the oil, gas, and electricity sectors. We believe reforms in the SOE sector could coincide with reforms in the banking sector, given their interconnected nature. At the beginning of 2019, the simplified tax system went into effect and in December 2018 the government issued local currency treasury bonds for fiscal purposes and to develop the nascent domestic financial markets,” S&P Global added.
“Over our forecast period through 2022, we expect real GDP growth to average just over 5%, supported by growth in the services, manufacturing, and natural resources sectors. The construction sector is a small but growing part of GDP. The economy has been government-led for many years, and is still dependent on SOEs, which contribute a large share of GDP,” S&P Global stated.
“Nevertheless, successful reforms of the SOE sectors, including modernizing their operations and bringing them to cost recovery levels, could lead to increased growth potential for Uzbekistan. The country has a significant endowment of natural resources, including large reserves of diverse commodities, the export of which has supported past current account surpluses. Globally, the country is one of the top 20 producers of natural gas, gold, copper, and uranium,” it said.
“Attracting foreign direct investment (FDI) is a priority for the government. Currently, FDI inflows are low and concentrated in the extractive industries, particularly natural gas. If government reforms attract more FDI, this would reduce the debt-financing of the current account balance and help to preserve the government’s large external asset position,” S&P Global underlined.
“In 2018, credit to the economy expanded by about 50%, well above nominal GDP growth. Although we expect elevated credit growth due to the pent-up investment needs of the economy, sustained high credit growth can result in asset bubbles and less conservative bank lending practices. Such outcomes could weaken our long-term assessment of the economy,” the agency said.
“Uzbekistan’s population is young, with almost 90% at or below working age, which presents an opportunity for labor supply-led growth. However, it will remain a challenge for job growth to match demand. Despite steady growth, GDP per capita remains low, at about $1,800 at year-end 2019, but is higher when measured on a purchasing-power-parity basis,” S&P Global added.
S&P Global expects the current account to remain in deficit, averaging about 6% of GDP over the forecast period, to meet the consumption and investment demands of the more outward-facing economy.
The government’s debt burden will remain low despite ongoing fiscal deficits, averaging about 3.5% of GDP over the forecast period.
“High dollarization, which may only decrease as confidence in the domestic currency increases, continues to hamper monetary policy effectiveness. We do not expect single-digit inflation within our forecast horizon through to 2022,” S&P Global said.
“The current account opened up more than anticipated in 2018, with a deficit of about 7% of GDP. This was the result of increased capital goods imports and wider statistical coverage of previously informal sectors of the economy. We expect the current account balance to average a deficit of about 6% over our forecast period to fulfill the economy’s need for the capital goods and high technology goods required to modernize. Additionally, consumer goods imports should remain elevated, given the increased ease of trade,” the agency underlined.
“Better trade relations with neighbors should boost Uzbekistan’s exports, especially agricultural goods. However, exports remain heavily dependent on commodities, with gold, other metals, and natural gas making up approximately 50%. Remittances and income from abroad are an important component of Uzbekistan’s current account, given the large number of Uzbeks working abroad, particularly in Russia,” the agency added.
S&P Global expects sustained current account deficits to mean liquid external assets exceed external debt by about 6% of current account payments on average over the forecast period, compared with 28% in 2017.
“In our view, the economy’s external balance sheet will remain strong. We estimate our measure of external liquidity (gross external financing needs to current account receipts, plus usable reserves) to be relatively modest at 97%, because of the long-dated nature of the economy’s external debt and high level of reserves,” S&P Global added.
“We include in our estimate of the central bank’s reserve assets its significant holdings of monetary gold. The central bank is the sole purchaser of gold mined in Uzbekistan. It purchases the gold with local currency then sells dollars in the local market to offset the increase in reserves from the gold. We do not include UFRD assets in the central bank’s reserve assets but instead consider them government external assets, because we view them as fiscal reserves,” the agency said.
“We expect the government’s fiscal balance to remain in a deficit of about 2% of GDP over the forecast period. We anticipate the government will increase social spending on areas such as education and health care, but we also expect an increase in capital expenditure, given the economy’s infrastructure needs. Currently, wages make up the largest component of expenditure, at over 50%. The government implemented tax reforms in 2019. The reforms simplified the tax code and lowered some tax rates. Although this may help expand the tax base and increase collection rates, we believe initially it could lead to weaker revenue,” S&P Global underlined.
“We estimate the general government sector will be in a net debt position by year-end 2020. Government assets, used for both domestic fiscal and external purposes declined in 2018. We estimate government assets will average about 18% of GDP over our forecast period. The government’s assets are mostly kept in the UFRD. Founded in 2006, and initially funded with capital injections from the government, the UFRD has received revenue from gold, copper, and gas sales above certain cut-off prices. We include only the external portion of UFRD assets in our estimate of the government’s net asset position because we view the domestic portion--which consists of loans to SOEs and capital injections to banks--as largely illiquid,” the statement reads.
“The government issued a $1 billion eurobond in February 2019 and issued its first local currency treasury bonds since 2012 in December 2018. We estimate general government debt at $13.6 billion (22% of GDP) at year-end 2019. Besides the eurobond, most debt is split roughly equally between official bilateral and multilateral creditors. General government debt is almost all external and denominated in foreign currency, making it susceptible to exchange rate movements. In our estimate of general government debt, we include external debt of SOEs guaranteed by the government, due to the closeness of the government to the SOEs and the ongoing support for the SOEs from the government. General government debt service is low, due to its concessional nature. We estimate interest payments at 1% of revenue on average over our forecast period,” it underlined.
“In addition to the SOE’s external debt that we include in our definition of general government debt, the government also guarantees about $4.5 billion (11.5% of GDP) of foreign-currency-denominated but domestically-held debt of SOEs. These loans are from the UFRD and we consider this government expenditure. As reforms on SOEs begin, if it becomes apparent that sizable government financial support will be necessary, we could reconsider our assessment of contingent liabilities,” S&P Global said.
“One of the most significant economic reforms that Uzbekistan has made was the liberalization of the exchange rate regime in September 2017 from a crawling peg, over-valued in comparison with the black market rate, to a managed float. Although we believe the central bank initially intervened heavily in the foreign exchange market, it now only intervenes intermittently to smooth volatility. The relatively short track record of the float constrains our assessment of monetary flexibility, as does our perception of the potential for political interference in the central bank’s decision-making. Our assessment of monetary policy is also constrained by high inflation and the high dollarization of the economy, which limits the effectiveness of monetary policy transmission mechanisms. Positively, the central bank is moving toward inflation targeting, but we expect this transition will take a few years,” the agency said.
“We expect inflation to remain above 10% for our forecast period and to average 15% over 2019. Despite the effects of the September 2017 currency devaluation having mostly worked through the economy, inflation should remain high. More open trade policies have allowed domestic prices to move toward regional and international prices, putting inflationary pressure on domestic goods. Growth in public sector wages and the liberalization of regulated prices should also add to inflationary pressure over the forecast period. We note that in September 2018, in response to these inflationary pressures, the central bank raised its refinancing rate to 16%. We expect monetary policy to remain tight,” the agency concluded.
