Fitch Ratings has affirmed Uzbekistan's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB-' with a Stable Outlook.
Credit Fundamentals, Geopolitical Shock: Uzbekistan's ratings balance robust external and fiscal buffers, low government debt and a record of high growth relative to 'BB' rated peers, against high commodity dependence, high inflation and structural weaknesses in terms of low GDP per capita and weak institutional and governance levels relative to peers.
The war in Ukraine and sanctions against Russia, where we forecast an 8% contraction of GDP and a 45% rouble depreciation against the US dollar in 2022, will lower Uzbekistan's growth, lead to a higher current account deficit and trigger higher inflation in 2022-2023, as reflected in our revised forecasts. Russia accounted for 70% of total migrant remittances (equivalent to 8% of GDP), 12% of total exports and 21% of imports in 2021. However, Fitch considers that Uzbekistan's robust sovereign balance sheet, improved policy framework, diverse commodity export base including gold, and availability of strong official technical and financial assistance will allow the country to preserve macroeconomic stability, the strength of external and fiscal buffers and progress achieved in the economic reform agenda.
Growth Slowdown: We forecast growth to slow to 3.1%, after a strong recovery of 7.4% in 2021, reflecting lower remittances negatively impacting private consumption, potential delay of certain investment projects, tighter external financing conditions, weaker currency and higher inflation. Our expectation is that fiscal policy and favourable prices for Uzbekistan's commodity exports (gold, copper and gas) will cushion the impact of the shock. Our baseline projects growth to recover to 4.5% in 2023, but there is a high degree of uncertainty regarding the duration of the war in Ukraine, the prospect of additional sanctions against Russia, and Uzbekistan's capacity to diversify export markets, make progress in its reform agenda and diversify financing sources for key investment projects.
Higher Inflation and External Deficits: Inflation will increase in 2022, averaging 12.7% due to the pass-through of Uzbek som depreciation, higher inflation expectations and food prices. We expect inflation to average 11.6% in 2023, although the inflation trajectory will be dependent on exchange rate volatility, potential adjustment of utility tariffs (gas and electricity) postponed during 2020-2021 and non-food and services' price stickiness. After raising its policy rate by 300bp to 17% in March, the central bank is likely to maintain a tight policy stance (positive real rates) to manage expectations and avoid pressure on the exchange rate.
We forecast that the current account deficit will widen to 9.7% of GDP in 2022, from 6.9% in 2021, reflecting a close to 50% decline in remittances in US dollar terms. Increased commodity exports, most notably gold (29% of exports in 2021) and cotton (potentially benefiting from higher prices and the end of boycott by the Cotton Campaign), combined with a lower import bill on account of slower domestic demand and the weaker som will somewhat mitigate the current account deterioration. Fitch expects higher external deficits to be financed through a combination of drawdown of international reserves, access to official financing and net FDI. A prolonged period of high current account deficits and low FDI could erode the relative strength of the sovereign external balance sheet.
Strong External Position: International reserves reached USD35.4 billion at the end of February and we expect these to decline to USD33 billion in 2022 and USD30 billion in 2023. Reserve coverage at 12 months of current external payments and external liquidity, measured by the ratio of the country's liquid external assets to its short-term external liabilities, at 284% in 2023 will remain substantially higher than peers. The share of gold in international reserves remains high at (59%), hence higher prices could also cushion the impact of higher external financing needs. Increased external financing costs and reduced risk appetite will likely slow the pace of external debt accumulation for banks and the private sector. Banks' external debt rose to 11.7% of GDP in 2021. Banking sector liabilities to Russia accounted for 10% of total sector liabilities at end-2021. The authorities are working to reduce and mitigate the risk of exposure to secondary sanctions.
Low Net Public Debt: Government debt declined to 35% of GDP in 2021 (including 9.7% of GDP in external guarantees), from 37% in 2020, reflecting high growth, a broadly stable exchange rate and reduced pace of borrowing. We project debt to increase to 42% of GDP in 2022, still below the 59% 'BB' median forecast, reflecting increased external borrowing to finance fiscal support to the economy and a weaker som. Government debt is almost entirely foreign currency-denominated (96%), closely linking macroeconomic stability and debt sustainability. Mitigating factors include the structure in terms of maturity and costs, with official debt accounting for 89% of the external stock. The government also has high liquid assets equivalent to 23.5% of GDP at end-2021.
The state debt law could be approved in second reading in the near term. The legislation will introduce a 60% of GDP debt ceiling (for public and public-guaranteed obligations), annual borrowing limits and the requirement to undertake corrective measures if debt rises above 50% of GDP. Fitch considers that the credibility of this policy anchor will depend on its capacity to slow down the pace of debt growth, manage the risk of contingent liabilities such as PPPs and preserve the relative strength of government fiscal buffers, a key supportive factor for the rating.
Asset Quality Risks, High Dollarisation: Non-performing loans (loans in the bottom three regulatory categories under local GAAP accounting) were 5.4% of total loans in February 2022, down from 6.2% in August 2021. A weaker som could lead to additional pressures on asset quality. Risks stem from exposure to SOEs and foreign-currency lending. Dollarisation remains high at 47% for loans and 41% for deposits in February, but foreign-currency lending to households is not allowed.
Annual credit growth decelerated to 18% in 2021, from 34% in 2020, and we expect credit growth to remain in line with nominal GDP growth, as part of the government's policy to prevent the build-up of risks to macro-financial stability, but also as a consequence of reduced headroom in capital buffers (capital adequacy ratio 17.4% in February 2022 with Tier 1 at 13.8%) and higher external financing costs. Fitch's Macro-Prudential Indicator of 2*, indicates moderate vulnerability due to fast credit growth in recent years.
Commitment to Reform, Diplomatic Challenges: President Mirziyoyev was re-elected in October 2021 with a mandate to continue the structural reform agenda. Despite the global and regional impact of the war in Ukraine, the government intends to accelerate the pace of reforming state-owned banks and enterprises and reducing the state's share in the economy, announcing several planned IPOs and privatisations in 2022-2023. In parallel, the government will likely maintain a strong emphasis on poverty reduction and improvement in social conditions. The war in Ukraine and sanctions will likely require a careful diplomatic balance. The Uzbek government has publicly defended Ukraine's territorial integrity, but has not joined sanctions and will maintain economic and political relations with Russia.
ESG - Governance: Uzbekistan has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Uzbekistan has a low WBGI ranking at the 19th percentile, reflecting weak rights for participation in the political process and institutional capacity, uneven application of the rule of law and a high level of corruption.
