Republic of Uzbekistan: Staff Report for 2018 Article IV Consultation
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International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
11 May 2018
eISBN:
9781484354896
Language:
English
Keywords:
ISCR; CR; fiscal policy; debt; real GDP; Uzbekistan; government; job creation; monetary policy; foreign exchange; banking system; U.S. dollar; Exchange rates; Credit; Job creation
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2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Uzbekistan

Abstract

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Uzbekistan

Context

1. Uzbekistan faces the challenges and opportunities of a rapid demographic transition. Reflecting earlier sharp downward trends in mortality and fertility rates, the share of Uzbekistan’s working-age population in total population started to rise rapidly in the 1990s, and the share of people potentially available for work will remain unusually high for the next two decades (Figure 1, Panel A). While challenging in terms of job creation needs, the demographic transition offers Uzbekistan a unique window of opportunity to realize its longer-term aspiration of achieving upper middle-income country status. If successful, Uzbekistan would follow in the footsteps of economies in East Asia that capitalized on similar demographic windows of opportunity in the past.1

Figure 1.
Figure 1.

Uzbekistan: Demographics and Living Standards

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: United Nations World Population Prospects 2017, World Development Indicators, and IMF staff calculations.

2. Uzbekistan has relied heavily on a state-driven growth model, with mixed outcomes for jobs and living standards. Policies emphasized state intervention, import substitution, and exchange restrictions, and deemphasized regional trade and cooperation. These policies effectively segmented the economy into a privileged sector that included the state and well-connected businesses, which received preferential treatment, and a disadvantaged sector that included the less-connected and informal firms. Outcomes from this growth model were decidedly mixed. Initially low living standards edged upward, but fell increasingly short of the country’s goal of reaching upper middle-income country status, although Uzbekistan outperformed some of the other regional economies (Figure 1, Panel B). And, while data on job creation in Uzbekistan tend to be scant, past employment growth was insufficient to absorb the growing labor force and was concentrated in small or informal firms. In fact, data on remittances and other labor migration indicators suggest that millions of Uzbeks were forced to seek—sometimes precarious—jobs abroad.

3. At the same time, Uzbekistan built large external buffers. The authorities targeted annual increases in foreign exchange (FX) reserves, subordinating other policy objectives, such as maintaining low and stable inflation, to this objective (Figure 2, Panel A). In line with FX accumulation targets, but at variance with the country’s Article VIII obligations, FX at the official exchange rate was allocated to preferred customers and activities, while the remainder of FX demand had to be covered in the black market, where the spread sometimes rose to over 100 percent (Figure 2, Panel B). While FX reserves of this size have significant opportunity cost, they will allow the country to implement transition reforms from a position of external strength.

Figure 2.
Figure 2.

Uzbekistan: Foreign Exchange Reserves and Exchange Rates

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities and IMF staff calculations.

4. In 2017, Uzbekistan changed course, putting the country on track toward building a more open and market-oriented economy. President Mirziyoyev’s new development strategy, which was adopted in February 2017, advocates five broad goals for reforms: (i) improving public administration and strengthening civil society; (ii) enforcing the rule of law by an independent judiciary; (iii) liberalizing and opening the economy; (iv) improving education, health care, public infrastructure, and the social safety net; and (v) promoting friendly and cooperative relationships with other countries.

5. In line with this agenda, the authorities have already introduced several important reforms. The most significant was the liberalization of the FX market in September 2017, with the official exchange rate depreciating by about 50 percent. Major revaluation gains accrued to the holders of FX assets, including holders of FX reserves, deposits, and cash; valuation losses accrued mainly in state enterprises, which have large FX exposures to state banks and external creditors. Other significant early reforms included starting to liberalize prices and reform state enterprises, cutting average customs tariffs by more than half, liberalizing visitor visa requirements, reinitiating commitment to World Trade Organization (WTO) accession, expanding coverage of the social safety net, granting the central bank more independence, and improving the quality and availability of economic statistics. Moreover, Uzbekistan has taken the initiative to improve relations and cooperation with all its neighboring countries.

6. As a late reformer, Uzbekistan can benefit from the experiences of other transition economies. Like other countries at the start of reforms, Uzbekistan faces challenges and risks due to the magnitude of needed reforms and the need to build experience and institutional capacity. Uzbekistan can benefit from the lessons accumulated during earlier transition experiences, which suggest that adhering to a reformist vision, persevering in the face of setbacks, and communicating clearly have been key attributes of successful transitions (Box 1).

Outlook, Risks, and Regional Spillovers

A. Economic Developments and Outlook

7. Since 2014, growth has slowed, while inflation has picked up (Tables 1–2). Starting in 2014, a battery of adverse external shocks—which lowered exports, commodity prices, and remittances—hit the economy. Although policies were loosened across the board, growth declined from about 8 percent to 5 percent in 2017; and domestic employment growth disappointed, averaging only ¾ percent during 2015–17. Concurrently, inflation rose, initially driven by loose monetary and credit policies, and following the policy regime switch in September 2017, increasingly reflecting pass-through from FX and price liberalization. As a result, in early-2018 inflation peaked at about 20 percent, driven mostly by a surge of prices of tradable goods (Figure 3).

Table 1.

Uzbekistan: Selected Economic Indicators, 2015–19

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Excludes registered labor migrants.

Table 2.

Uzbekistan: National Accounts, 2015–19

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Excludes registered labor migrants.

Figure 3.
Figure 3.

Uzbekistan: Inflation and Monetary Policy

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities, and IMF staff calculations.1/ Real refinancing rate deflated by the GDP deflator.

8. Growth in 2018–19 is projected to remain steady at about 5 percent, with continued subdued job creation. Growth will be supported by strong commodity prices and trading-partner demand, reforms that boost agriculture, and the government’s housing and infrastructure programs. Staff’s discussions with private sector representatives suggested that—for now—foreign investors remain on the sidelines, waiting to see whether reforms continue and prove irreversible. Domestic employment growth will likely pick up to only about 1 percent, with net job creation, as in the past, concentrated in small businesses.

9. Staff projects inflation to remain persistent, declining only gradually through 2018–19. The baseline scenario includes a significant tightening of the stance of monetary and credit policies. Nevertheless, the delayed effects of past expansionary policies, continued pass-through from FX depreciation, and the need to keep adjusting relative prices, especially for energy, mean that inflation will likely be more persistent than one would expect based on past inflation behavior. Moreover, delayed adjustment of non-tradable prices following the recent upsurge in tradable prices could further add to inflation persistence.

10. Authorities’ Views: The authorities thought that staff’s growth projections were on the pessimistic side as the recent improvements in the investment climate could pay off quickly. The authorities also argued that staff’s inflation outlook assumes too much persistence in the recent shocks to inflation. Based on its internal models, the Central Bank of Uzbekistan (CBU) projected consumer price inflation will decline by end-2018 to the range of 12–14 percent and decline further into single digits by end-2019.

B. External Assessment

11. Subject to several caveats, Uzbekistan’s external position in 2017 appears substantially stronger than implied by economic fundamentals and desirable policies (Figure 4 and Annex I). Given the preliminary estimate of the 2017 current account surplus of 3¾ percent of GDP, the IMF’s external balance approach (EBA) suggests that a country like Uzbekistan should have a current account deficit of 2 (±1) percent of GDP, implying a gap of 6 (±1) percent of GDP. Using standard elasticities, this would correspond to a real exchange rate undervaluation of 25–30 percent. However, as discussed in Annex I, the preliminary estimate of the 2017 current account surplus may be biased upward, and the EBA approach does not take into account the major policy regime shift that occurred in September 2017. Given the regime shift and its likely positive impact on investment and imports, staff projects that the external balance will decline significantly in 2018 and beyond, eliminating the external gap.

Figure 4.
Figure 4.

Uzbekistan: External Sector

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities and IMF staff calculations.

12. At the same time, accumulated FX reserves—at about 20 months of imports—are high and have significant opportunity costs. Thus, there is no need to accumulate additional FX reserves. However, half of FX reserves represent FX deposits of the Fund for Reconstruction and Development (FRD), which operates as a combination of a development bank that channels loans to state enterprises, a bank recapitalization fund, and a sovereign wealth fund. Moreover, some of the FRD’s assets may have to be devoted to cleaning up the balance sheets of state enterprises. On capital flows, the authorities plan to proceed cautiously on lifting present restrictions, also because reforms may create uncertainties that could lead to FX market volatility.

13. Article VIII obligations. At the time of the last Article IV consultation, Uzbekistan maintained two exchange restrictions and one multiple currency practice (MCP) subject to IMF jurisdiction. With the exchange rate unification in September 2017, as well as the adoption and implementation of regulations liberalizing the FX regime in Uzbekistan, these have been eliminated. Reports thus far indicate that market participants are now able to make payments and transfers for current transactions without impediment. Staff will continue to monitor the ongoing implementation of the new liberalized FX regime for consistency with Uzbekistan’s Article VIII obligations

14. Authorities’ Views: The authorities agreed that a developing country like Uzbekistan would normally be expected to run external deficits, although they doubted that the EBA’s current account norm captures well the fundamentals of a country that is dependent on exhaustible commodity exports. Also, the authorities acknowledged that FX reserves appear high by standard metrics, but noted that these metrics generally assume—unrealistically—that FX reserves are only used to insure against temporary shocks to output and consumption.

C. Risks to the Outlook

15. Adverse shocks to exports constitute the main external risk, while domestic risks are primarily related to transition reforms (see Risk Assessment Matrix).

  • With commodities constituting a significant share of exports and some trading partners vulnerable to commodity price shocks, Uzbekistan could again face a triple combination of adverse external shocks that lowers exports, commodity prices, and remittances at the same time. If such shocks occur, Uzbekistan has room to use fiscal stimulus to counteract a temporary decline in external demand, while allowing the exchange rate to move to maintain competitiveness and facilitate expenditure switching. Over the medium term, transition reforms should help to diversify exports and absorb labor that would otherwise migrate out.

  • Experiences with earlier transitions suggest that reforms could entail several domestic downside risks. These include: (i) reform fatigue or reversals as setbacks occur or benefits take longer than expected to materialize; (ii) faster-than-expected deterioration in banks’ asset quality or risky behavior by banks to compensate for losses; (iii) the opening of medium-term funding and capital gaps in the banking system; and (iv) a sharp decline in revenue collections from state enterprises as their privileges are withdrawn. As discussed further below, these risks can be mitigated or managed through appropriate policies.

16. Authorities’ Views: The authorities agreed with the characterization of external risks. On domestic risks, the authorities thought these were unavoidable when a country embarks on major reforms. They underscored their medium-term commitment to implementing the President’s announced development strategy. On short-term risks to banks, the authorities were confident of their ability to ensure stability and noted that there would be sufficient public resources to support banks if needed. On the risk of lower declining tax collections from state enterprises, the Ministry of Finance was keenly aware that reforms of taxes and their administration are needed to forestall this risk.

D. Regional Spillovers

17. A reformist Uzbekistan could catalyze change and raise incomes throughout the region. Uzbekistan is by far the most populous country in Central Asia and it has historically been an economic hub for the region. Thus, successful reforms in Uzbekistan could have a powerful demonstration effect, boost trade, including by building regional supply chains, and promote regional integration, including by reconnecting regional energy and transportation networks as well as by resolving the region’s age-old disputes about water rights.

Risk Assessment Matrix 1

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1 The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within one year and three years, respectively.

Policy Discussions

A. Maintaining Prudent Fiscal Policy, Improving Fiscal Transparency, and Tackling Tax Reform

18. Uzbekistan’s fiscal policy has traditionally been prudent, although it lacked transparency, especially on-lending operations. Past prudence is reflected in low accumulated levels of public and publicly-guaranteed debt (see Debt Sustainability Analysis). In fact, the government has no outstanding domestic debt, and external debt is mostly limited to official borrowing, which, following the recent exchange rate depreciation, amounted to 24½ percent of GDP at end-2017. At the same time, the government undertook significant on-lending operations to channel credit to state enterprises.

19. The augmented fiscal deficit rose significantly in 2017, mainly due to on-lending operations. As foreseen in the 2017 budget, the consolidated fiscal position was close to balance. Higher-than-projected revenues of about 1½ percent of GDP, mainly due to the revaluation effect of FX liberalization, compensated for an increase in net lending operations of 1½ percent of GDP, which were not included in the 2017 budget (Tables 4–5). The FRD registered an unexpectedly large deficit of 3¼ percent of GDP, as its expenditures for on-lending activities for state enterprises and state bank recapitalization far exceeded budget projections. Thus, the augmented fiscal deficit, which combines the consolidated and FRD balances, and which staff considers a better measure of the government’s fiscal stance, expanded from a deficit of ½ percent of GDP to 3¼ percent of GDP in 2017.

Table 3.

Uzbekistan: Balance of Payments, 2015–19

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Projections exclude monetization of gold purchases by CBU from domestic producers.

Table 4.

Uzbekistan: General Government Budget, 2015–19 (In billions of sum)

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Augmented fiscal includes revenues and expenditures from both consolidated budget and Fund for Reconstruction and Development.

Table 5.

Uzbekistan: General Government Budget, 2015–19 (In percent of GDP)

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Augmented fiscal includes revenues and expenditures from both consolidated budget and Fund for Reconstruction and Development.

20. Staff supports the authorities’ plans to tighten fiscal policy in 2018 to reduce inflation. The tightening mainly reflects a cut in lending operations that fuel credit growth, with the FRD balancing its budget from 2018 onwards. In addition, the government envisages saving about half of the expected additional revenues in 2018 from higher-than-projected commodity prices and improved tax administration. Social safety net spending is projected to increase by about 1 percent of GDP, with targeted support reaching some 1.7 million beneficiaries, up from about 1.4 million beneficiaries in 2017. In addition, the budget envisages about ¼ percent of GDP for active labor market programs to improve the employability of the longer-term unemployed. The government will adjust social safety net spending and public wages for inflation during the first half of 2018. Staff projects that these measures, if implemented as planned, will reduce the augmented fiscal deficit to 1¼ percent of GDP. Over the medium term, the government is expected to continue to restrain on-lending operations. A medium-term fiscal deficit of 2 percent of GDP would stabilize the public debt to GDP ratio at about 25 percent (Table 8).

Table 6.

Uzbekistan: Summary Accounts of the Central Bank, 2015–19

(In billions of sum, unless otherwise indicated)

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Central Bank of Uzbekistan certificates of deposit.

Table 7.

Uzbekistan: Monetary Survey, 2015–19

(In billions of sum, unless otherwise indicated)

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Velocity is calculated using nominal GDP over end of period money supply.

Table 8.

Uzbekistan: Medium-Term Outlook, 2015–23

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

Excludes registered labor migrants.

21. Improving fiscal transparency is a priority. In the past, the use of off-budget transactions made it difficult to assess the fiscal stance, the size of fiscal operations, and their impact on the economy. The authorities have already made progress consolidating on- and off-budget transactions in their reported fiscal data. The authorities are committed to bring all fiscal operations on-budget starting in 2019.

22. Authorities’ views: The authorities were convinced that a tighter short-run fiscal stance, mainly driven by reduced on-lending operations, was needed to counter inflationary pressures. They believed that staff’s revenue projections may be conservative, especially as improvements in tax administration could pay off more than expected.

23. Comprehensive tax reform is needed, foremost to foster job creation, but should be revenue neutral and introduced gradually. The present tax system is highly complex and full of exemptions. In addition, it applies different tax regimes—standard and simplified—to firms based on the number of employees. This segmentation seems to have severe adverse consequences for job creation. First, firms exceeding the employee threshold face an excessive tax burden. Second, small firms have strong incentives to stay small, downsize, or split themselves to avoid migrating into the standard tax regime. As a result, job creation has been concentrated in small businesses. Thus, comprehensive tax reform is needed to encourage firms to expand and create jobs. Reform should be introduced gradually so that tax administration can increase its capacity to process a greater number of tax payers while improving tax payers’ ability to meet more demanding accounting standards. Perhaps even more important, tax reform should be revenue neutral to preserve a stability-oriented fiscal policy.

24. Tax reform is also needed to forestall the risk of a sharp decline in future revenue collections from state enterprises. A large share of taxes is presently collected from a relatively small number of state enterprises which greatly simplifies tax administration. But state enterprises also receive a wide range of privileges, including subsidized intermediate inputs and preferential access to credit, which enables them to carry an elevated tax burden. As Uzbekistan’s economy shifts toward marked-based principles, state enterprise privileges will erode, reducing revenue collections. Tax reform is therefore also needed to widen the tax net and forestall the risk that future revenues may be constrained just when the government may need to step up social expenditures (education, health) and spending on real capital (infrastructure) to take advantage of Uzbekistan’s demographic window over the next two decades.

25. Authorities’ views: Tax reform is a top priority, and the authorities expressed their appreciation for the detailed advice provided by a recent IMF technical assistance mission on tax policy.2 The Ministry of Finance agreed that reforms need to proceed gradually in line with improvements in tax administration; that projections of the impact of tax reform need to be realistic; and that reforms should be based on the principle of revenue neutrality.

B. Tightening Monetary Policy, Moving to Inflation Targeting, and Reducing Segmentation in the Credit Market

26. The CBU loosened monetary policy in early 2017, but started to tighten in the second half. During the first half of 2017, the CBU significantly loosened monetary policy, while the government’s on-lending operations added directly to expanding credit. As of August 2017, reserve money and credit to the economy had grown by more than 50 percent compared to a year earlier. Monetary policy was tightened prior to the FX liberalization in September, including by increasing the refinancing rate from 9 to 14 percent. After FX liberalization, the CBU maintained stable nominal exchange and refinancing rates.

27. A tighter monetary stance will help contain inflation over the next two years. Additional liberalization of prices, especially of energy prices, is planned in 2018 and there is the risk that high inflation could become hard-wired into pricing behavior and expectations. A tighter monetary stance is therefore warranted, including by increasing the nominal refinancing rate to bring it back to a positive real rate and by halting FX accumulation. To this end, staff recommended introducing a regular, pre-announced program of FX sales from the CBU’s gold purchases. The central bank should also take immediate steps to enhance its capacity for open market operations; the planned issuance of treasury bills by the government could help in this regard.

28. Staff supported the authorities’ plan to move to inflation targeting over the medium term. In the interim, the CBU should use a range of indicators, including the refinancing rate, bank liquidity, money, and the exchange rate to gauge the monetary stance and its impact on inflation. Experiences in other transition countries have demonstrated that greater degrees of de facto central bank independence have been associated with better inflation outcomes, but only after the initial price liberalization shocks had passed through the system. Other conditions that support inflation targeting include a strong transmission mechanism for monetary policy; building the central bank’s analytical capacity; and communicating policies clearly.

29. Steps should be taken to reduce the segmentation of Uzbekistan’s credit market. Currently, credits are directed via banks to support state enterprises and government programs at concessional rates (Figure 5). The FX segment of the credit market is dominated by state enterprises, which receive FX credit either directly from state banks or through on-lending operations by government entities, primarily the FRD. By contrast, the private sector is largely confined to domestic currency borrowing. As a first step, stricter limits should be put on the FRD’s on-lending activities. As a second step, FRD on-lending activities could be shifted toward domestic currency. This would make the cost of credit more transparent and reduce loan dollarization. It would also strengthen the transmission channel of monetary policy.

Figure 5.
Figure 5.

Uzbekistan: Interest Rates and Credit Market Segmentation

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities and IMF staff calculations.

30. Authorities’ views: The CBU agreed that the interim monetary framework will need to rely on multiple indicators; in particular, relying solely on monetary targets was considered as unpractical given that an unobservable, but likely large, amount of FX cash is being used as money. On the present monetary stance, the authorities noted that the refinancing rate had been hiked significantly in 2017 and that its current level may be appropriate if inflation declined rapidly during 2018. The CBU also emphasized it had adopted a neutrality principle whereby its purchases of gold would be offset by FX sales, effectively tightening monetary policy. Lastly, the CBU noted that—based on highly valued IMF technical assistance—it is examining ways to improve monetary policy operations, including via open market operations and changes to reserve requirements.

C. Safeguarding Financial Stability and Building a Growth-Promoting Financial Sector

31. Reported financial sector indicators suggest the banking system is sound, and there seems to be no evidence of withdrawal of correspondent banking relationships (CBRs). The banking system is highly concentrated (the three largest state banks account for more than half of assets), lending and other bank activities are largely state driven. Regulatory capital to risk-weighted assets—close to 19 percent as of end-2017—is relatively high (Table 9). Similarly, the non-performing loan ratio—at 1.2 percent—is relatively low, while the system’s profitability—with return on equity of about 17 percent—is high. Banks generally benefited from the September 2017 exchange rate depreciation as FX assets outweighed FX liabilities and part of their capital was denominated in foreign currency. Notwithstanding reports that other countries in the region may have experienced excessive withdrawals of CBRs, the CBU noted its survey of banks did not point to any significant difficulties.

Table 9.

Uzbekistan: Financial Soundness Indicators for the Banking Sector, 2015–2017 Q4

(In percent, unless otherwise indicated)

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Sources: Uzbekistan authorities and IMF staff estimates and projections.

32. Nonetheless, banks will likely face challenges related to deteriorating asset quality and low operational efficiency. First, banks have significant loan concentration risk, with state enterprises accounting for a high proportion of total loans (about 60 percent). Price liberalization and other economic reforms are likely to reduce the profitability of state enterprises, and banks’ asset quality could therefore deteriorate quickly. Second, loan dollarization is high, and many state enterprises with FX loans have revenues primarily in domestic currency. And third, looking ahead, state banks will need to transform their business models to operate on a more commercially oriented basis and lower cost, including through cutting staff and mergers.

33. The authorities have recently put in place several promising financial sector reforms. First, banks are no longer required to keep records unrelated to banking on behalf of the authorities. Banks report this has significantly reduced administrative costs. Second, a presidential decree has instructed officials to refrain from pressuring banks to provide credit at preferential terms to selected borrowers. Third, the CBU has addressed potential supervisory conflicts by divesting from two banks and withdrawing its officials from the supervisory boards of banks.

34. Staff recommended additional steps to promote financial development and help safeguard financial stability. For example, reserve requirements should include reserve averaging, allowing banks to more efficiently manage liquidity and promoting development of the interbank market. The CBU should also enhance its framework for emergency liquidity assistance, including by expanding the range of acceptable collateral. The government’s plan to restart issuing T-bills could aid this effort and jumpstart money market development.

35. Over the medium term, bank credit may be constrained by funding and capital gaps. For the next few years, the economy will continue to rely on banks for financing. To support higher growth and job creation, banks will need to raise additional funding and capital. In the past, the funding and capital gaps were largely met by mobilizing FRD funds. However, in the future banks should rely on more market-based solutions, for example attracting foreign funding and more deposits from households. To raise additional capital, banks should raise profits by better managing their credit operations and by reducing administrative costs, for example via mergers that consolidate costly branch networks. All these solutions point to similar policy requirements: creating a more stable macroeconomic environment; building the public’s trust in the banking system; allowing banks to operate in line with best business practices; and improving the country’s investment climate.

36. Authorities’ views: The authorities agreed that the banking system faces many challenges. While the CBU believes the current supervisory framework is adequate, it plans to continue upgrading its supervisory capacity and intervention tools, including by incorporating stress testing more fully in the supervisory process. Nonetheless, they emphasized the need to remain vigilant regarding near-term risks and the financial stability impact of reforms over the medium term. Attracting foreign banks and expertise was seen as important to build a financial sector that promote growth, but it was also noted that foreign banks have generally found it difficult to operate in the region. The CBU also stressed that improving the public’s financial education is a high priority.

D. Promoting Structural Reform and Sustainable Development

37. Addressing balance sheet strains and restructuring state enterprises early in the transition should be key priorities. State enterprises had large FX exposures to banks and external lenders, and dealing with their balance sheet losses has been postponed for now. The recommendations of a consulting group on state enterprise governance, expected to be available in July, should provide the basis to address the legacy issues of state enterprises.

38. Further liberalization of prices is needed, and energy prices in particular need to be brought closer to cost-recovery levels. In the past, relative price distortions were pervasive in certain sectors of the economy, particularly for energy (e.g. electricity, natural gas, and fuels) and for domestically-traded commodities (e.g. cotton, fertilizers, grains, and metals). However, many other prices (e.g. for imported or private sector-produced goods and services) were less distorted. Although energy prices have already increased significantly, they are still relatively low in international comparison (Figure 6).

Figure 6.
Figure 6.

Uzbekistan: Energy Prices

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities, World Bank Doing Business Indicators, European Bank for Reconstruction and Development, International Energy Administration, Eurostat, Globalpetrolprices.com, and IMF staff calculations.1/ The transition indicator ranges from 1 (for a centrally planned economy) to 4 (for an industrialized market economy).

39. The government should take a more active role in reducing monopolistic practices and promoting competition. In the past, notwithstanding the existence of a State Committee on Competition in charge of unfair pricing practices, de facto competition was restricted, especially in sectors dominated by state enterprises and well-connected businesses. Price liberalization by itself will not lower costs and prices if firms do not have to compete in the domestic market. More competition would also allow prices to adjust symmetrically downward if exchange rate appreciation lowers import prices, enhancing the effectiveness of a more flexible exchange rate.

40. Additional steps to liberalize trade, which does not need to be balanced or in surplus at all times, are also needed. Trade allows countries to specialize in production of goods in which they have a competitive advantage and can add the most value. To take advantage of these benefits, staff recommended further simplifying customs tariffs and streamlining customs procedures. Accession to the WTO would help Uzbekistan reach international standards and maintain access to export markets. Some officials seem to believe that only balanced trade or surpluses are beneficial for Uzbekistan. In fact, trade deficits are expected in countries with higher returns to investment and higher investment should help to achieve more job creation and higher living standards.

41. The government should seek input from the business community to identify investment bottlenecks. Studies indicate that imports and foreign direct investment help to transfer innovative technologies and facilitate job creation. Uzbekistan has already made significant progress in improving its de jure investment climate, as reflected by its improved ranking in the World Bank’s Doing Business Indicators. Nonetheless, in discussion with staff, foreign investors have expressed concerns that the de facto investment climate remains difficult.

42. The authorities have embraced the UN’s Sustainable Development Goals (SDGs) (Table 10). As key SDGs focus on promoting the accumulation of human capital (education, health) and real capital (public infrastructure), the SDG goals match well Uzbekistan’s need to create jobs for an unusually high share of the working-age population during its present demographic transition. The authorities are working with the UN and the World Bank to identify overall funding requirements to achieve the SDGs by 2030 in critical development areas and to design public and private sector approaches to close potential funding gaps.

Table 10.

Uzbekistan: Sustainable Development Goals, 2000-Latest

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Source: The World Bank

43. Authorities’ views: The authorities agreed that tackling reforms of state enterprises is important, although the current focus is on improving their operations and governance. They strongly agreed on the need to increase domestic competition. On trade, they noted efforts to promote diversification and increase value-added in exports. For example, companies were being encouraged to use domestic cotton fiber to produce and export textiles. The authorities noted that fighting corruption is a high priority under the new development strategy.

E. Improving Economic Statistics

44. The authorities have taken significant steps to improve the quality and availability of economic data, but for now data provision still has shortcomings that hamper surveillance (Informational Annex). In the 1990s, the government restricted public dissemination of key economic statistics. In September 2017, the government committed to change course, starting with a Presidential decree mandating the dissemination of economic and financial data. In January 2018, the Statistics Committee began publishing a new consumer price index based on an updated methodology. And the government has agreed to participate in the IMF’s enhanced General Data Dissemination System (e-GDDS), committing to post a National Summary Data Page with key economic, financial, and social statistics starting in May 2018. Ongoing work includes efforts to improve balance of payments statistics, monetary reporting and financial soundness indicators, and to compile Uzbekistan’s International Investment Position. Moreover, the CBU, Ministry of Finance, and the Statistics Committee are preparing a roadmap for improvement of statistics which is scheduled for release in November 2018. The Statistics Committee is also working to improve the quality and range of national accounts data. Going forward, staff recommends upgrading labor market statistics, including by concentrating the collection of labor survey data at the Statistics Committee, and accelerating production of an Uzbekistan country page in the IMF’s International Finance Statistics (IFS).

Staff Appraisal

45. Uzbekistan has embarked on far-reaching reforms to achieve inclusive growth. Reflecting the country’s fast-paced demographic transition, its working-age population has surged over the last two decades, making the creation of more and better jobs an overarching policy priority. Past policies had little success in creating sufficient jobs or raising living standards in line with the country’s aspirations. In response, the President’s wide-ranging reform agenda aims at opening and liberalizing the economy. Given Uzbekistan’s sizable population and geographic location, the reforms could also have beneficial effects on regional growth and cooperation.

46. For reforms to pay off, policy makers need to adhere to their reformist vision, persevere in the face of setbacks, and communicate clearly. Major reforms are needed across policy areas and institutions. The combination of Uzbekistan’s massive reform needs and an initially low capacity to implement them may result in unavoidable setbacks. But as earlier transition experiences have demonstrated, such setbacks can be overcome, or even used as springboards to accelerate reforms.

47. In the short run, growth may not spur sufficient job creation, but tighter policies should bring down inflation gradually. While growth is expected to remain around 5 percent in 2018–19, domestic employment growth is unlikely to exceed one percent, and the number of labor migrants will likely continue to trend upward. Assuming the authorities tighten fiscal, credit, and monetary policies as envisaged, inflation—after peaking at about 20 percent—should gradually decline over the next two years. Uzbekistan starts from a strong external position, with FX reserves at 20 months of imports and a sizable current account surplus in 2017.

48. Uzbekistan’s external position is assessed as substantially stronger than indicated by fundamentals and desirable policies. Last year’s current account surplus was significantly larger than what would be predicted for a country with Uzbekistan’s characteristics. However, the large depreciation in September 2017 followed by the surge in imports following liberalization of the FX and trade regimes, suggest the external position was not as strong as suggested by the IMF EBA current account model. In addition, staff projects that the current account balance will decline significantly in 2018 and post moderate deficits in the medium term.

49. The government’s plan to consolidate its fiscal position and increase fiscal transparency is welcome. In 2017, the fiscal deficit rose to 3¼ percent of GDP, driven by lending operations—mainly through the FRD—that expanded credit to state enterprises. The government plans to reduce the deficit to 1¼ percent in 2018 by cutting back on-lending activities that have fueled credit expansion in the past. The government’s commitment to bring all fiscal operations on-budget beginning in 2019 is also welcome.

50. Tax reform is needed to spur job creation and forestall the risk of a sharp decline in revenue collections, but the government needs to reform taxes gradually and in a revenue-neutral fashion. The present tax system is not only complex and riddled with ad hoc exemptions for preferred firms and activities, it also acts as a roadblock for job creation. The tax net needs to be widened to compensate for a likely future decline in tax collections from state enterprises as reforms erode their privileges. Importantly, tax reform needs to preserve the state’s ability to pay for future investments in human and real capital through spending on education, health, and public infrastructure. At the same time, improvements in tax administration should proceed in tandem with tax reform.

51. The authorities rightly plan to tighten monetary policy to contain inflation, while taking steps to reduce segmentation of the credit market. The central bank’s shift to a tighter monetary stance is needed to ensure that inflation declines to single digits over the next two years. In this regard, the CBU should continue to develop other monetary instruments, such as open market operations. Over the medium term, a shift to inflation targeting is appropriate. In the credit market, the government should curb implicit subsidies to the state sector by limiting state enterprises preferential access to credit.

52. The two key financial sector challenges are safeguarding financial sector stability in the short term and building a growth-supporting banking system over the medium term. While reported financial soundness indicators appear strong, most credit is concentrated in state enterprises, and its quality could erode quickly. It is therefore welcome that the CBU plans to further upgrade its supervisory capacity and intervention tools. To increase growth and job creation in the medium term, the banking system will need to be able to fund credit growth without resorting to the state sector for closing its funding and capital gaps. This will require banks to become more efficient, increase the public’s trust in the stability of banks, and improve the country’s investment climate, also to attract foreign banking expertise.

53. Early restructuring of state enterprises should be a priority. While banks benefited from the revaluation of their foreign exchange assets, state enterprises incurred large balance sheet losses. The recommendations of the consulting group on governance due in July provide a first opportunity to draw up a comprehensive plan to deal with state enterprise legacy issues.

54. Uzbekistan has initiated significant structural reforms; but additional steps are needed. In 2017, Uzbekistan liberalized many prices, unified exchange rates, and eliminated measures inconsistent with Uzbekistan’s Article VIII obligations. Next steps should include additional price liberalization—especially by bringing energy prices closer to cost-recovery levels—promoting competition, and further liberalizing trade.

55. The authorities’ strong efforts to improve statistics are particularly welcome. In the past, non-transparent official statistics hampered surveillance, hindered effective policy making, and undermined public trust. The decision to join the Fund’s enhanced General Data Dissemination Standard is especially noteworthy and will increase data transparency, but a reform road map is needed to cement and extend progress achieved so far.

56. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Seven Lessons from Earlier Transitions

Uzbekistan is a relative late-comer to the transition from a state-led to a more market-oriented economic system. This box summarizes a few reform lessons relevant for Uzbekistan:1

Lesson #1: Macroeconomic forecasts, especially for growth, were often too optimistic in the early phase of transition reforms. However, in the case of Uzbekistan this risk is mitigated by the fact that the state sector’s share of employment and output has already been reduced by earlier reforms.

Lesson #2: Reforms liberalizing FX markets, prices, and trade were introduced first and generally welcomed by the public. After these reforms, other reforms—such as restructuring state enterprises, strengthening competition, and improving governance—faced more opposition, especially if the oligarchs and insiders that had benefited from early reforms stood to gain from stopping or slowing reforms.

Lesson #3: Economists and reformers overestimated their ability to sequence reforms, fine tune tactics, and control outcomes. The lesson from this seems to be that reformers should not over-strategize reforms, but also not delay reforms because the perfect moment has not arrived yet.

Lesson #4: Transition countries were often effective at improving legislation, rules, and institutions on paper, but implementation was haphazard or policy makers later even subverted earlier reforms. For example, some countries adopted modern, rules-based tax system, but then governments made deals with powerful, individual taxpayers.

Lesson #5: External advice was most effective when the political leadership was committed to a reformist vision. External advice can be helpful in advancing the reform agenda, but it cannot substitute for consistent, patient leadership and clear communication.

Lesson #6: The quality of human capital driving reforms was important for transition success, both at the firm and policy making levels. Generally, designing and implementing transition reforms worked better when new people open to transition ideas were in charge.

Lesson #7: Macroeconomic disruptions do happen during transitions, but they tended to be surprisingly short-lived, and, in some countries, even helped catalyze deeper reforms.

1 This summary reflects inter alia lessons drawn in: World Bank (2002) Transition: The First Ten Years; Aslund (2007) How Capitalism was Built; Shleifer (2012) Seven Things I Learned about Transition from Communism; and IMF (2014) 25 Years of Transition: Post-Communist Europe and the IMF.

Annex I. External Assessment

Overall Assessment

Background. The IMF’s current account, real exchange rate, and FX reserve methodologies suggest Uzbekistan’s 2017 external position was substantially stronger than implied by fundamentals and desired policies. However, data for 2017 mostly reflect the previous policy and data measurement regimes. Trade data for January-February 2018 already suggest that the current account surplus could shrink significantly in 2018.

Policy Advice: To boost economic efficiency and growth, the authorities should continue efforts to liberalize Uzbekistan’s trade regime, including via accession to the WTO. As FX reserves are sufficient for operational purposes and to insure against foreseeable external shock, the authorities’ policy of limiting reserve accumulation is appropriate. Thus, monetary policy should focus on bringing down inflation over the medium term while allowing the exchange rate to adjust in line with fundamentals.

Current Account

Background. According to the IMF’s EBA-Lite methodology, a country with Uzbekistan’s characteristics would be expected to have a current account balance of −2¼ (±1) percent of GDP.1 Given an estimated current account surplus of 3¾ percent of GDP in 2017, 2 this would point to a substantial gap of +6 (±1) percent of GDP. However, policy gaps explain very little of the overall gap.

Short-Term Outlook. The 2017 estimate likely overestimates future current account gaps following the policy regime switch in September 2017. Indeed, trade data for the first two months of 2018 show exports and imports rising more than 50 percent compared to a year earlier, with imports outpacing exports by a large margin. If this recent trend continues, the estimated current account gap would largely disappear by 2019.

Medium-Term Outlook. The current account is projected to register moderate deficits (on the order of 2–3 percent of GDP) over the medium term, in line with expectations for a developing economy. The balance of payments is expected to be in overall balance, but staff projects modest accumulation of foreign exchange reserves as domestically produced gold is added reserves.

  • Staff projects healthy external demand. Key trading partner import demand has recovered, with import growth in China and Russia projected at 5–6 percent in US dollars over the medium term.

  • The IMF forecasts the price of gold will rise on average by 3–4 percent per year, while the prices of cotton and natural gas will remain stable.

  • Imports are projected to remain in line with GDP growth, with the lifting of import restrictions and exchange rate depreciation have offsetting effects.

  • Labor income and remittances are expected to remain strong. In 2016 they amounted to 7¼ percent of GDP, mostly in the form of employee compensation from migrants working abroad.

  • Risks to the outlook include policy uncertainty in advanced economies and financial risks in China. On the upside, global growth momentum could turn out to be stronger than expected.

uA01fig01

Uzbekistan: Current Account

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Source: Uzbekistan authorities, and IMF staff calculations.

Assessment. Subject to considerable data uncertainties, Uzbekistan’s current account position in 2017 is assessed to have been substantially stronger than implied by fundamentals and desirable policies. This is reflected in the sizable current account surplus, although policy gaps do not seem to explain the surplus. The gap is likely to fall significantly over the next few years, as opening of the trade regimes results in strong imports that offset the effects of exchange rate depreciation and growth in trading-partner demand. The outturn will, however, depend sensitively on developments in commodity prices and the extent to which the Uzbekistan sum depreciates.

Real Exchange Rate

Background. In September 2017, Uzbekistan unified its exchange rates and liberalized access to foreign exchange. As a result, the official exchange rate fell from 4,250 to 8,100 UZS/USD.

According to Uzbekistan’s authorities, the de jure exchange arrangement is floating, with the exchange rate is determined based on the supply and demand for foreign currency established on Uzbekistan’s currency exchange. Since September 2017, the sum has stabilized against the U.S. dollar within a 2 percent band. Accordingly, the IMF classifies the de facto exchange rate as a stabilized arrangement (see the Informational Annex for additional detail).

Based on the current account gap and standard elasticities, staff estimates the average REER was 25–30 percent undervalued in 2017.

uA01fig02

Uzbekistan: Exchange Rate Developments

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities and IMF staff calculations.

Outlook. Following depreciation of 50 percent in September 2017 and with average inflation projected at 20 percent in 2018, staff projects the average real exchange rate will be about 30 percent lower in 2018 than in 2017.

Assessment. Subject to the already-mentioned data uncertainties, staff assesses the 2017 average REER was undervalued relative to the value implied by fundamentals and desirable policies. However, the surge in imports in early 2018 suggests that imports before the switch in policy regime were repressed. Thus, notwithstanding the further decline in the real exchange in 2018, the trade balance is projected to decline significantly in 2018.

Capital and Financial Accounts

Background. Capital and financial flows are relatively limited, with the financial account close to balance. FDI inflows and government borrowing have each been on the order of 1–2 percent of GDP in recent years, with outflows on other investment largely offsetting these inflows.

Assessment. In the near term, FDI inflows are expected to remain modest. A pick-up in official external borrowing in 2018 would be partially offset by an increase in private sector FX deposits, in part as the authorities allow individuals to sell FX cash holdings. Financial flows could deviate from the baseline if FDI picks up faster than expected following economic liberalization. Similarly, financial outflows could be higher than expected to the extent investors decide to repatriate accumulated domestic currency holdings.

FX Reserves

Background. Uzbekistan’s FX reserves are large by all metrics. At $28 billion at end-2017, they were equivalent to about 60 percent of GDP, 20 months of imports of goods and services, and considerably above the IMF’s reserve adequacy metrics for emerging markets or developing countries. As a commodity exporter, Uzbekistan is also at risk of shocks arising from declines in its major exports. For example, a one standard deviation decline in prices would be equivalent to $0.8 billion (or 1¾ percent of 2017 GDP) for gold, $0.7 billion (1 ½ percent of GDP) for fuels, and $0.3 billion (¼ percent of GDP) for cotton. Commodity shocks are also correlated (e.g. 61 percent for cotton & natural gas prices and 81 percent for gold & natural gas prices over the last 30 years).

About half of reserves represent deposits by the Fund for Reconstruction for Development (FRD), reducing the reserves available to insure against external shocks or for central bank FX operations. However, even if FRD deposits are excluded Uzbekistan’s reserves remain significantly above standard reserve metrics.

Assuming a marginal return on capital equal to the regional average of about 7 percent, the opportunity cost of FX reserves would be around $1–2 billion annually, depending on whether FRD resources are included in FX reserves.

Assessment. As Uzbekistan lacks access to external commercial borrowing, FX reserves help ensure access to needed imports, insure against external shocks, and support the transition to a more flexible exchange rate. They are also needed for operational purposes (e.g. to smooth volatility in the FX market). At the same time, staff assesses Uzbekistan’s FX reserves to be substantially higher than necessary for precautionary or operational purposes. Moreover, the opportunity costs are significant.

uA01fig03

Uzbekistan: Gross International Reserves and Reserve Metrics

Citation: IMF Staff Country Reports 2018, 117; 10.5089/9781484354896.002.A001

Sources: Uzbekistan authorities and IMF staff calculations.The reserve adequacy metric with commodity shocks takes the largest metric (3 months of imports of goods and services) and adds a combined shock due to one standard deviation declines in the prices of gold, fuel, & cotton.

Annex II. Recommendations of the 2015 Article IV Consultation

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1

Bloom and Williamson (1998), Demographic Transitions and Economic Miracles in Emerging Asia, World Bank Economic Review, pp. 419–455.

2

The authorities have published the technical assistance report on the government’s website.

1

The largest factors raising Uzbekistan’s current account norm are a low dependency ratio, which reduces the need to spend and import (adding +5 percent of GDP to the norm), and a lower institutional rating, which boosts savings (raising the norm by 1¾ percent of GDP). The largest factors contributing to a lower norm are lower income/higher productivity which should make import of investment goods attractive (lowering the norm by 2½ percent of GDP) and a lower dependency ratio and slower aging speed that raise consumption (lowering the norm by 2 percent of GDP).

2

This estimate could be subject to significant upward bias as reported “other capital” outflows in 2017, which includes the statistical discrepancy, reached an unusually high level, and may reflect under-estimation of imports (Table 3).

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Cover IMF Staff Country Reports
Republic of Uzbekistan: 2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Uzbekistan
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2018: Issue 117
Publisher:
International Monetary Fund
ISBN:
9781484354896
ISSN:
1934-7685
Pages:
70
DOI:
https://doi.org/10.5089/9781484354896.002
Figure 1.

Uzbekistan: Demographics and Living Standards
Figure 2.

Uzbekistan: Foreign Exchange Reserves and Exchange Rates
Figure 3.

Uzbekistan: Inflation and Monetary Policy
Figure 4.

Uzbekistan: External Sector
Figure 5.

Uzbekistan: Interest Rates and Credit Market Segmentation
Figure 6.

Uzbekistan: Energy Prices

Uzbekistan: Current Account

Uzbekistan: Exchange Rate Developments

Uzbekistan: Gross International Reserves and Reserve Metrics