Fitch Ratings has assigned Uzbekistan Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of 'BB-'. The Outlooks are Stable, the agency said.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR assigned at 'BB-'; Outlook Stable
Long-Term Local-Currency IDR assigned at 'BB-'; Outlook Stable
Short-Term Foreign-Currency IDR assigned at 'B'
Short-Term Local-Currency IDR assigned at 'B'
Country Ceiling assigned at 'BB-'
KEY RATING DRIVERS
Uzbekistan's ratings balance a robust sovereign balance sheet, low government debt and a record of high growth relative to rating 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 rating peers.
Uzbekistan has embarked on an ambitious and comprehensive reform programme that seeks to improve macroeconomic stability and growth prospects, as well as addressing institutional and governance weaknesses in what was a heavily state-controlled economy. The process is taking place from a position of relative strength given a robust sovereign balance sheet, stable financial sector and low indebtedness.
The external balance sheet is a key rating strength. Sovereign net foreign assets are forecast at 46% of GDP at end-2018, compared with -23% and 0.7% for the current 'B' and 'BB' medians, respectively. Foreign exchange reserves are forecast at USD26.9 billion at end-2018, equivalent to 14.8 months of current external payment (CXP), almost three times the current 'BB' median, and are expected to remain high (12.5 months at end-2020). The external liquidity ratio, forecast at 625% in 2019, is the highest in the 'BB' category.
Uzbekistan Fund for Reconstruction and Development (UFRD), the sovereign wealth fund, underpins the sovereign's external and fiscal financing flexibility, in addition to supporting strategic investment projects, state-owned enterprise (SOE) financing and funding for state-owned banks. Total assets of the UFRD were USD18 billion in 2017, and a high share of international reserves (43% or USD11.5 billion) consist of UFRD cash holdings; the CBU's share of international reserves' holdings consist mostly of gold (97%).
Fitch expects that the recent liberalisation of the foreign exchange market, combined with strong domestic demand, public sector investment projects with a high import component and likely slower demand from key trade partners will pull the current account to a deficit of 2.7% of GDP in 2018 and an average of 3.2% in 2019-2020, after an extended period of surpluses. The current account deficit will be financed mostly by FDI, but there could be a lag between the announcement and execution of reforms and foreign investment increasing above historical levels. Uzbekistan is a solid net external creditor at 49% of GDP.
Commodity dependence is high, but the export base is not dominated by one product. Gold, natural gas, metals and cotton account for 60% of total exports. External buffers are strong but exposed to commodity price volatility as 55% of international reserves are gold holdings. Russia remains a key trading partner (especially in terms of non-mineral exports), the source of 80% of migrant remittances and the main foreign investor in the country.
The liberalisation of the FX market in September 2017 is playing a key role in reducing macroeconomic distortions and improving the business environment and economic policy framework. After a 50% depreciation on liberalisation, and some appreciation pressures in 1H18, the soum has slipped by 6% against the US dollar since July, reflecting the weaker rouble and rapid import demand. Fitch expects the authorities to maintain increased exchange rate flexibility, supporting the economy's capacity to absorb shocks and moderating the build-up of external imbalances. Central bank FX intervention will be aimed at smoothing exchange rate volatility and absorbing local currency liquidity derived from gold purchases.
Monetary policy is currently focused on addressing persistently high inflation, but effectiveness is hampered by still developing transmission channels. Fitch expects inflation to average 17.9% in 2018 and decline gradually to 16.8% and 14% in 2019-2020, significantly above the projected 4% 'BB' median due to the ongoing process of adjustments to utility and other regulated prices, public sector wage increases, a weaker soum, and demand pressures from rapid (directed) credit growth.
The Uzbek banking sector poses limited near-term risks to financial stability and the sovereign balance sheet. The sector is dominated by state-owned banks (83% of assets), concentrated, and largely exposed to public sector entities. Government entities such as UFRD provide funding to banks to channel lending to SOEs and strategic projects. Capitalisation levels are adequate, as the sovereign recapitalised state banks in 2017 (USD670 million). NPLs are low compared with regional and rating peers (1.33% in 3Q18), as foreign currency loans to SOEs were restructured in 2017 after FX liberalisation. Rapid growth in credit to the economy (45% yoy in October and mostly supporting state directed investment) creates moderate macroprudential risks. Loan and deposit dollarisation is high, increasing in 2017 driven by the soum depreciation.
Uzbekistan has a track record of conservative fiscal planning and execution that has led to the accumulation of savings and low debt. General government debt is projected at 20.9% of GDP in 2018, compared to a current 'B' median of 60% and 'BB' median of 47%. All debt is external and includes 7% of GDP in government guarantees. Fitch expects debt to average 19.5% of GDP in 2019-2020.
The government is a net creditor of 17.2% of GDP owing to deposits of 8%, (including USD2.1 billion accumulated from previous surpluses of which USD850 million are in foreign currency) in addition to UFRD cash holdings. Refinancing risks are low with amortisations averaging 1.2% of GDP in 2018-2019. The structure of debt is favourable in terms of maturity and costs (51% owed to IFI creditors), but debt dynamics are highly exposed to currency risk as 100% is foreign currency-denominated.
Fitch expects the consolidated budget (including regional governments and off-budget funds such as social security) to remain in surplus in 2018-2019 and reach a balanced position in 2020, reflecting strong revenue growth in 2018, prudent expenditure execution given changes in the tax regime and strong VAT revenue growth. A comprehensive tax reform package to be introduced in 2019 to reduce the tax burden, increase formalisation and increase the efficiency of the tax system could cost 2pp of GDP, but Fitch expects this to be partly compensated by formalisation gains and improved efficiency in tax collection.
Fitch projects that off-budget spending through UFRD investment and directed credit (primarily financing for housing development, strategic infrastructure and industrialisation projects), will lead to an augmented deficit of 2.6% of GDP in 2018 and 2.9% in 2019-2020. These projected deficits will be roughly in line with the forecast 'BB' median and will be financed mostly through sovereign assets. The government has not issued domestic debt since 2012.
Fitch forecasts growth to reach 5% in 2018 and slow slightly to 4.9% in 2019 before rising to 5.3% in 2020, outperforming the forecast growth for the current 'BB' median. Growth will be driven by government investment in strategic projects, housing and infrastructure expenditure. Long-term growth potential is underpinned by favourable demographics and a rich natural resource endowment. GDP per capita forecast at USD1,188 in 2018 is less than one-fifth of the USD6,600 'BB' median.
Governance indicators, as measured by the World Bank, are well below 'BB' and 'B' medians. However, after an orderly and peaceful transition of power in 2016, the government of president Shavkat Mirziyoyev has focused on addressing institutional weaknesses in terms of rule of law, government effectiveness, control of corruption, reducing the state presence in the economy and improving the business environment. The government has improved relations with neighbouring countries, and Uzbekistan is engaging with a variety of international partners, including multilateral organisations, to attract investment, obtain financing, open new markets and received technical assistance.
A fast-moving, complex and broad reform agenda create some concerns regarding coordination and institutional capacity of the public administration to effectively plan and execute policy measures while minimising economic distortions, in Fitch's view. Despite the current strong commitment of the political leadership to the reform agenda, Fitch considers that the delay in the materialisation of its benefits in terms of higher growth, increased private investment and employment creation in combination with greater-than-expected social costs could cause reform fatigue, although this would not impact social stability.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Uzbekistan a score equivalent to a rating of 'B+' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Public Finances: +1 notch, to reflect government deposits of 8% of GDP in addition to UFRD cash assets (30% of GDP) that result in net government debt at -17% of GDP in addition to low refinancing risks due to the favourable cost and profile of government debt.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The main factors that could, individually or collectively, trigger positive rating action are:
- Progress in entrenching macroeconomic stability driven by increased credibility and consistency of Uzbekistan's policy framework
- Faster than anticipated improvement in structural indicators including GDP per capita and institutional factors
- A significant strengthening of the sovereign balance sheet
The main factors that could, individually or collectively, trigger a negative rating action are:
- Policy slippage or inconsistencies that lead to widening of macroeconomic imbalances
- A sustained fall in foreign exchange reserves
- Materialisation of contingent liabilities that lead to sustained weakening of the sovereign balance sheet
KEY ASSUMPTIONS
Fitch assumes that the Russian economy will grow 1.5% in 2019 and 1.9% in 2020, and oil prices will average USD65 and USD62.5 in 2019 and 2020, respectively.
