• Credendo’s payment experience and the political and economic situation have drastically improved.
  • The new president adopted a more cooperative attitude toward its neighbours and introduced prudent political liberalisation measures.
  • The authorities have embarked on ambitious economic reforms aimed at moving from a centralised economy to a market economy.
  • A transition towards a market economy is not without risk but the country has sufficient buffers to tackle these challenges.

Change in domestic and external political scene

Former President Islam Karimov – who had been in power since the country’s independence in 1991 – passed away in September 2016. He was smoothly replaced by Shavkat Mirziyoyev. The new President – elected in December 2016 – adopted a more cooperative attitude toward its neighbours and introduced limited political liberalisation measures such as the release of prisoners of conscience, the elimination of travel restrictions and of ‘forced’ labour for cotton harvests. He also consolidated his power as highlighted by the removal of the powerful head of the National Security Service in January 2018. In the future, the political power is likely to remain concentrated in the hands of the President and the political elites.

Uzbekistan is the most populous state in Central Asia followed by Kazakhstan – that has the largest regional economy with a nominal GDP of USD 160.8 bn in 2017 compared to a mere USD 47.9 bn for Uzbekistan – and has historically been an economic hub for the region. Former leader Karimov had long tried to turn his country into the strongest regional power. As a result, the relations with other Central Asian countries were strained, notably those with Kyrgyzstan and Tajikistan due to disputes over border delimitation and water issues and following the Uzbek withdrawal from a Soviet-era power grid on which both countries heavily relied.

Since Karimov died, the situation has significantly improved thanks to the constructive attitude of the new president who has already visited Turkmenistan, Kazakhstan, Kyrgyzstan and Tajikistan. The first results of better ties with its neighbours are already visible: additional border crossings were opened, visa restrictions were eased and a regional summit was organised. Better relations also pave the way for a more integrated approach to water issues (cf. pollution, dam and hydropower projects in Tajikistan and Kyrgyzstan) and the revival of the Soviet-era electricity network to facilitate energy sharing. In addition, better ties are also likely to boost regional trade and improve Tashkent’s access to crude oil which would benefit the Uzbek refineries which currently operate below capacity because of insufficient domestic oil production.

Ambitious economic reforms

Between its independence in 1991 and 2016, Uzbekistan relied on a development strategy anchored by a restrictive trade regime – such as its policy of import substitution and heavy control on access to foreign exchange reserves – and extensive state intervention financed by natural resource revenues (energy, cotton and gold). The state’s role in the economy was predominant. The exchange rate system was heavily controlled. As a result, the sum’s official rate depreciated less rapidly than the currency of its main trading partners and the unofficial rate in the parallel market. In the past, scarcity of foreign exchange on the official market led to undue delays in the availability of foreign exchange for payments and transfers for current international transactions.

Since 2017 the authorities have embarked on ambitious economic reforms aimed at opening and liberalising the economy to make it a market-oriented one. They already introduced several important reforms such as the liberalisation of some prices and first steps to improve the quality of data. The most significant reform was the lifting of the Soviet-era exchange restrictions for current account transactions in September 2017 and the subsequent adoption of a de jure floating exchange rate regime. As a result, the official exchange rate depreciated by around 50% vis-à-vis the US dollar. On the positive side, the exchange restrictions have been eliminated. As a result, foreign exchange is now available in a timely manner.

The authorities also announced that they are willing to further liberalise prices, restructure state-owned enterprises, and remove remaining bottlenecks to international trade and foreign direct investment. The move is very positive as it decreases credit risk in the long term. However, experiences with earlier transitions suggest that reforms could entail several risks including reform fatigue or reversals. State-owned enterprises are likely to be the most impacted by the transition as their privileges are withdrawn and competition is likely to increase.

As a result of price and exchange rate liberalisation, the inflation rate surged to 18.9% in 2017 (compared to 7.9% in 2016). In 2018 and 2019, inflation is likely to gradually decrease but to remain in the double-digit range as additional liberalisation of prices is planned. This is a positive development as in the past price controls created distortions.

Accumulation of large external buffers

The restrictive trade regime (cf. policy of import substitution and foreign exchange restrictions) helped to maintain the current account balance in surplus. As a result of the current account surpluses recorded in 2002-2017, the country accumulated large external buffers. Looking ahead, the structural reforms put further pressure on the current account surplus which has already eroded since 2014 as a result of the Russian economic crisis and the sharp drop in commodity prices. Indeed, the net fuel exporter is heavily reliant on commodities and labour income as main sources of current account receipts. Even if the current account receipts follow an upward trend (compared to their low level reached in 2016), the current account balance is expected to turn into a small deficit as of next year. The moderate deficit is likely to be financed by a decrease in foreign assets as foreign direct investments are likely to remain hindered by the difficult business environment and foreign investors’ wait-and-see approach.

Given the large current account surplus posted during the past decades but also limited access to external commercial borrowing, the external debt – which surged in 2017 – is moderate. The debt service ratios are relatively low and expected to remain stable in the coming years.

Analyst: Pascaline della Faille –P.dellaFaille@credendo.com