Thursday, 24, June, 2021

On 4 June 2021, S&P Global Ratings revised the outlook on its long-term ratings on Uzbekistan to stable from negative. At the same time, we affirmed the ‘BB-/B’ long- and short-term foreign and local currency sovereign credit ratings.

The transfer and convertibility assessment remains ‘BB-’.

The stable outlook reflects our expectation that fiscal and external debt will continue to increase rapidly but remain at moderate levels over the next 12-24 months. We expect GDP growth to exceed 5% annually as of 2022.

We could lower the ratings if we project a faster or more significant deterioration in Uzbekistan’s fiscal and external balance sheets than we currently expect. This could happen if Uzbekistan’s economic liberalization and increasing integration with the global economy result in more elevated imports and current account deficits. Absent significant inflows of foreign direct investment (FDI), this could result in a high accumulation of debt-creating flows and external asset drawdowns.

We could also lower the ratings if dollarization levels in the economy significantly increase, or if we observe weakness in key state-owned enterprises (SOEs), leading to the realization of contingent liabilities on the government’s balance sheet.

Although unlikely in the next year, we could raise the ratings if Uzbekistan’s economic reforms and increased integration with the global economy result in stronger economic growth potential and improving fiscal and external metrics.

We revised the outlook to stable after better than expected GDP growth and fiscal and external outturns over 2020. In our view, this means near-term fiscal and external risks have decreased. Uzbekistan’s fiscal position outperformed our expectations as the government controlled COVID-19-related expenditure increases and high gold prices supported tax revenue. The 2020 deficit of 4.5% of GDP was also lower than the government originally expected. As a result, the government was able to accumulate and save some external budget-support borrowings, increasing its year-end asset position. This supported our measure of the government’s net debt to GDP ratio, which at year-end 2020 was 10% of GDP. Uncertainty remains over the trajectory of the COVID-19 pandemic, but we expect economic growth to accelerate this year. We also expect net fiscal debt to increase to 21% of GDP by 2024 from 10% in 2020. However, this remains a relatively strong fiscal stock position.

Uzbekistan’s external balance sheet performance was also better than we expected last year. At year-end 2020, liquid public and financial sector assets exceeded gross external debt by 10% of current account payments. On a gross basis, external debt increased almost US$10 billion (17% of GDP). Government external debt increased about US$4.4 billion and banking sector external debt more than doubled to US$6.7 billion from US$3.1 billion. This increase in debt was largely offset by the appreciation of monetary gold at the Central Bank of Uzbekistan (CBU), as gold prices increased significantly over 2020 and gold is the main component of the CBU’s reserve assets. However, we expect that external debt is on the path to exceed liquid public and financial sector external assets this year, taking into account increasing external debt and our assumption of gold price declines in 2021.

Although the pace of external debt accumulation is high, we expect this to moderate over the forecast period through 2024. The government has introduced into budget law a debt ceiling of 60% to GDP for total government debt and an annual signing limit in the amount of US$5 billion for government external borrowing. Also, more stringent rules around project selection were introduced into national legislation. We currently do not expect significant additional borrowing related to the COVID-19 pandemic. We expect the government’s fiscal and the economy’s external positions to remain strong relative to similarly rated peers over the period through 2024.

In our view, policy responses may be difficult to predict, given the highly centralized decision-making process and the relatively less developed accountability and checks and balances between institutions.

Our ratings are constrained by Uzbekistan’s low economic wealth, measured by GDP per capita, and low monetary policy flexibility. Our ratings are supported by the economy’s strong external balance sheet and the government’s low net debt burden. These strengths predominately arise from the government’s asset position, which stems from the policy of transferring some revenue from commodity sales to the Uzbekistan Fund for Reconstruction and Development (UFRD).

Since 2017, Uzbekistan has made strong progress on its reform and economic modernization agenda, which should improve the economy’s productive capacity and the government’s institutional strength. However, notwithstanding the positive trend in strengthening institutions, we believe Uzbekistan is starting from a low base. We believe that checks and balances between institutions remain weak and that decision-making will remain highly centralized under the president’s office, making policy responses somewhat difficult to predict. The transfer of power to President Shavkat Mirziyoyev in 2016 was relatively smooth, and we expect he will stay in power following the October 2021 election. Some uncertainty over any future succession remains.

Broad-based policy reforms have included measures to increase the judiciary’s independence, remove restrictions on free expression, and increase the government’s accountability to 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 foreign exchange regimes, and planned privatizations of SOEs. The government is working on a law to privatize nonagricultural land and reforms in the agricultural sector are expected, after the abolition of state orders for cotton.

The government’s economic reform agenda is currently focused on improving the operations of SOEs and state-owned banks, with the aim to fully or partially privatize many of them by year-end 2023. Major SOEs are implementing measures to improve corporate governance and increase transparency, including by producing audited financial statements and splitting off noncore assets. The government is working to unbundle and corporatize large SOEs in the mining and energy sectors.

At year-end 2019, over US$4 billion in loans from the UFRD, previously lent through the banking sector to SOEs, were returned to the UFRD balance sheet. In addition, to improve capitalization in the system, the UFRD granted about US$1.5 billion in loans to banks to convert into equity. Along with these balance-sheet changes, the government has introduced regulations to reduce subsidized lending and encourage lending in local currency. The changes aim to help banks operate in a more commercially focused manner. The government intends to prepare several smaller companies for privatization as well, which should pave the way for the more challenging and economically rewarding prospect of privatizing larger SOEs.

We consider that continued moves away from a state-led economy could improve productivity, attract FDI, and reduce budget outflows. The IMF calculates that currently half of recorded economic output comes from SOEs. Decreasing the state’s involvement in the economy and attracting FDI are two key priorities for the government. However, FDI inflows remain low and concentrated in the extractive industries, particularly natural gas. Net FDI decreased in 2020 to US$1.7 billion, down from US$2.3 billion in 2019, but still up significantly from US$600 million in 2018.

The economy expanded 1.6% in real terms over 2020, making Uzbekistan one of the few countries to maintain positive real growth. This is because during COVID-19-related restrictions large segments of the economy remained operational including the agricultural sector and the important industrial sector--food processing, manufacturing, oil refining, and metals and mining.

Large infrastructure and investment projects also continued, but at a slower pace due to additional safety measures. In addition, the government acted quickly to introduce stimulus measures to counteract the effects of the pandemic. There was an additional US$1.3 billion (2.2% of GDP) of COVID-19-related spending in the 2020 budget to support health-related measures, infrastructure projects, employment protection, and social spending. 

We expect GDP growth will rebound in 2021 to 4.8%, led by a recovery in the services sector and economic recoveries at key trading partners. We expect real GDP growth to average about 5% annually over our 2021-2024 forecast period, supported by growth in the services, manufacturing, and natural resources sectors. The construction sector’s contribution to GDP is small but increasing. Successful SOE sector reforms, including the modernization of operations to support cost recovery, and development of the nascent private sector, could lead to increased growth potential for Uzbekistan. The country has significant 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.

Uzbekistan’s population is young. Almost 90% are 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, in our view. Despite steady growth, GDP per capita remains low, forecast at US$1,800 as of year-end 2021.

In 2021, we expect a general government deficit of 5.8% of GDP, up from 4.5% in 2020, and an average of 3.8% over 2021-2024. This comes as the government increases spending to support the economic recovery and increase the social safety net, and the pace of investment and modernization spending remains elevated. Government revenue in 2020 was heavily supported by increased gold prices. From 2021, we anticipate the government will continue increasing social spending in areas such as education and health care, and capital expenditure will remain elevated, given the government’s investment plans. Currently, social expenditure makes up over 50% of government expenditure. The government implemented tax reforms in 2019, which helped increase revenue 25% in 2019 compared with 2018. The reforms simplified the tax code and lowered some tax rates, helping expand the tax base and increase collection rates. Fiscal transparency has increased as the government brought extrabudgetary spending onto the budget, for example, with the UFRD.

We estimate general government gross debt at US$21 billion (38% of GDP) at year-end 2020. General government debt is almost all external and denominated in foreign currency, making it susceptible to exchange rate movements. We note the Uzbekistani sum’s exchange rate with the U.S. dollar depreciated 14% in 2019 and 10% in 2020, increasing debt in local currency terms. Besides the government’s Eurobonds and local currency debt (about US$300 million at year-end 2020), debt is split roughly equally between official bilateral and multilateral creditors. In our estimate of general government debt, we include external debt of SOEs guaranteed by the government, due the ongoing support to SOEs from the government. As reforms at SOEs continue, if it becomes apparent that sizable government financial support will be necessary, we could reconsider our assessment of contingent liabilities. A large portion of general government debt is concessional, resulting in low debt-servicing costs. We estimate government interest payments at about 2% revenue on average over our forecast period.

The government debt stock crossed into a net debt position in 2019, although debt remains low relative to that of peers. We expect net general government debt will increase to 21% of GDP by 2024. The government’s assets, about 25% of GDP, are mostly kept at 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 cutoff 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 and therefore unlikely to be available for debt-servicing when needed.

We expect the current account deficit will increase to about 6.4% of GDP in 2021, up from 5.4% in 2020. Last year, the current account was supported by high gold prices, restrained imports, and stable remittances against lower gas exports and weaker tourism receipts (an increasing component of services exports). We expect the current account balance will average a deficit of about 6% of GDP over our forecast period to fulfill the economy’s need for the capital goods and high technology goods sectors to modernize. Additionally, consumer goods imports should remain elevated, given the increased ease of trade.

Exports remain heavily dependent on commodities and gold is the main export good. We expect gold prices to decline over our forecast period to US$1,700 per ounce in 2021, US$1,500 per ounce in 2022, and US$1,300 per ounce in 2023 and thereafter. Increased copper prices should support exports over the forecast period. Natural gas exports should decline as the expanding economy’s domestic needs for gas and electricity increase. 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.

We expect current account deficits will mostly be financed with debt inflows over the forecast period. This year, we forecast Uzbekistan will move to a net external debt position, when only considering liquid public and financial sector external assets. Our measure of external liquidity (gross external financing needs to current account receipts, plus usable reserves) is relatively strong at 85%, because of the long-dated nature of the economy’s external debt and the high level of reserves. We expect FDI will increase over our forecast period. The authorities have worked toward improving the external statistical capacity related to coverage, timeliness, and transparency.

We include in our estimate of the central bank’s reserve assets its significant monetary gold holdings. 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 still consider them as government external assets, because we view them as fiscal reserves.

We expect dollarization of loans in the banking system, at about 48% in April, will decline over the coming years to about 40% in 2024, due to increases in retail and commercial lending in local currency. The large drop in dollarization at year-end 2019 is from the UFRD’s removal of US$4 billion in U.S.-dollar-denominated loans from the banking sector and the conversion of US$1.5 billion in foreign currency loans to local currency. Deposit dollarization was 43% as of May, and we expect local currency deposit growth will outpace that in foreign currency because of interest rate differentials and differences in the reserve requirement. In our view, declining dollarization should help improve the effectiveness of monetary policy transmission mechanisms. However, our assessment of monetary policy is still constrained by high inflation.

Positively, the central bank is moving toward inflation targeting, but we expect this transition will take a few years. Although the effects of the September 2017 currency devaluation have mostly worked through the economy, we expect inflation will average about 10% over our forecast period.

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.

In addition, we expect a deflationary impact from slowly reducing credit to the economy over the forecast period through 2024. In response to the COVID-19 pandemic and lower inflationary expectations, the central bank lowered its refinancing rate to 14% from 16% in 2020, where it remains.

One of Uzbekistan’s most significant economic reforms was the liberalization of the exchange rate regime in September 2017 to a managed float from a crawling peg, which was heavily overvalued in comparison to the parallel-market rate. The central bank intervenes in the foreign exchange market intermittently to smooth volatility and sterilize the increase in local currency from its large gold purchases. 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.

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