Republic of Uzbekistan: 2019 Article IV Consultation—Press Release and Staff Report

2019 Article IV Consultation-Press Release and Staff Report

Abstract

2019 Article IV Consultation-Press Release and Staff Report

Context

1. Reflecting a rapid demographic transition, Uzbekistan’s foremost economic challenge is to create more and better jobs. The working-age population as a share of total population has surged since the 1990s (Figure 1, Panel A). The bulge in available labor supply offers a window of opportunity for rapid and inclusive catch-up growth. In particular, following in the footsteps of other Asian countries, more job creation, higher savings, and increased human and real capital investments could generate a virtuous growth circle. Contrasting with this inclusive growth vision, over the last two decades, job creation in the formal sector fell increasingly short of the rapidly expanding labor supply (Figure 1, Panel B). Some job creation is reported to have taken place in Uzbekistan’s informal economy, where jobs tend to be less protected, less safe, and lower paid, but millions of workers had to seek jobs abroad. In 2016, President Mirziyoyev initiated ambitious economic reforms to tackle the country’s job malaise.

Figure 1.
Figure 1.

Uzbekistan: Demographics, Labor Supply, and Employment

Citation: IMF Staff Country Reports 2019, 129; 10.5089/9781498314442.002.A001

Sources: United Nations World Population Prospects 2017; country authorities; and IMF staff estimates.

2. The reform agenda aims to redress a legacy of heavily mis-allocated resources. Uzbekistan’s state-led growth model tended to direct resources to capital-intensive production by large state-owned enterprises (SOEs), favoring mining, energy, and chemicals, while agriculture continued to operate largely in Soviet planning mode. The growth model also prescribed accumulating large foreign exchange (FX) reserves, discouraged mobility of jobless workers, and was not welcoming to foreign investments. Balancing and propping up this growth model required a maze of distorting economic policies, including import substitution, FX restrictions, directed credits, and micro-managing SOEs and state banks.

3. Since taking office in 2016, the new government has completed a first wave of important economic reforms. FX liberalization came first: it not only unified the official and the parallel exchange rates at a heavily depreciated rate but also eliminated all FX restrictions subject to IMF jurisdiction. Tax reform was the next priority, foremost to foster job creation by reducing the punishing tax burden on private firms and workers. Finally, the availability and quality of economic statistics improved substantially.

4. One major theme of the Article IV discussions was the need to prioritize structural reforms. Reforms so far have rightly focused on high-impact, broadly popular, and administratively workable priorities, with FX liberalization the exemplar of this pragmatic approach. But the outstanding economic reform agenda remains vast; the authorities were therefore keen to discuss how to set priorities to address the economy’s most binding constraints on investment and entrepreneurship.

5. A second major theme was avoiding the specter of a boom-bust credit cycle. Keeping credit and investment growth in line with macroeconomic stability requirements is a new challenge for the authorities. Under the state-led growth model, a key goal was to run current account surpluses and accumulate large FX reserves, a policy objective that imposed a binding constraint on expanding credit and investment. The new policy regime has relaxed this constraint. At the same time, potential funding of credit from domestic and external financing sources is plentiful, while the country’s investment needs are massive.

6. A third major theme was reorienting policies toward more inclusive growth. While it succeeded in reducing poverty rates significantly, the state-led growth model paid scant attention to the labor market difficulties of the large numbers of unskilled and other disadvantaged workers. To remedy this, the authorities are anchoring their inclusive growth agenda on the UN’s Sustainable Development Goals (SDGs) and have started a major overhaul of their labor policies.

Outlook, Risks, and Regional Spillovers

A. Economic Developments

7. Credit and investment have surged. Nominal credit to the economy expanded by about 50 percent in 2018, financing a massive increase in imports of capital goods as well as funding investments in housing and infrastructure following decades of underinvestment (Figure 2, Table 2). The government funded and directed a large part of the credit expansion by shifting deposits to banks and through policy-based lending operations (see Annex I for details).

Figure 2.
Figure 2.

Uzbekistan: Credit and Investment, 2015–18

Citation: IMF Staff Country Reports 2019, 129; 10.5089/9781498314442.002.A001

Sources: Country authorities; and IMF staff estimates.

8. Despite investment booming, growth and job creation have picked up only moderately. The response of the economy’s supply side was muted by the absence of significant cyclical slack and by the presence of binding intermediate input bottlenecks, such as energy and water shortages. In addition, production in agriculture was adversely affected by bad weather conditions. With rapid nominal domestic demand growth in 2018 mainly absorbed by higher imports and inflation, real GDP expanded by 5 percent, following 4½ percent growth in 2017 (Table 2). Available labor market data suggest that the pickup in activity has so far made little dent in the pool of unused labor resources, while, based on remittances data, the number of workers abroad continued to expand.

Figure 3.
Figure 3.

Uzbekistan: Growth and Labor Market, 2015–18

Citation: IMF Staff Country Reports 2019, 129; 10.5089/9781498314442.002.A001

Sources: Country authorities; and IMF staff estimates.

9. While consumer inflation declined during 2018, several factors coalesced to keep inflation pressures elevated. FX liberalization, first steps at liberalizing prices, relative public wage adjustments, and rapid credit and domestic demand growth have acted as potent push and pull factors on inflation since reforms started in 2017. Reflecting the dominance of the exchange rate depreciation effect, consumer price index (CPI) inflation peaked at 20½ percent at the beginning of 2018 but receded to 14½ percent by year end (Figure 4). Expectations of high inflation remain well entrenched, and alternative inflation indicators, especially the GDP deflator, indicate high underlying price pressures, with tradable goods prices still rising at rates well above the CPI.

Figure 4.
Figure 4.

Uzbekistan: Inflation, 2015–18

Citation: IMF Staff Country Reports 2019, 129; 10.5089/9781498314442.002.A001

Sources: Country authorities; and IMF staff estimates.

B. External Sector Assessment

10. The external position has deteriorated significantly, reflecting several structural and policy shifts (Table 3, Figure 5). First, FX and trade liberalization constituted a regime change, removing policy props that had repressed imports in the past. Second, the real exchange rate depreciated by about 50 percent, improving external cost competitiveness and compensating for Uzbekistan’s heavily distorted economy. Third, FX reserve accumulation policy switched to a broadly neutral stance, halting the relentless buildup of FX reserves, while the Central Bank of Uzbekistan (CBU) allowed some nominal exchange rate flexibility in response to shifts in fundamentals. And fourth, the shift toward expansionary credit policies pulled in additional imports, especially capital goods needed to modernize the economy. The combination of these changes increased the current account deficit in 2018 to 7 percent of GDP, after a surplus of 2¼ percent of GDP in 2017. The Fund’s revised external balance approach (EBA) suggests that the 2018 external deficit norm for Uzbekistan is centered on 4½ percent of GDP, compared with an underlying current account deficit of 5½ percent of GDP (Annex II). Thus, and the authorities agreed, Uzbekistan’s external position is presently moderately weaker than implied by economic fundamentals and desirable policies.

11. External stability risks remain low. Risks are contained by large FX reserves, a strong international investment position, and external debt levels projected to remain moderate over the medium term (Table 7).1 The discussions also suggested that FX market participants continue to be able to make payments and transfers for current transactions without impediments. On capital flow liberalization, the authorities rightly plan to proceed cautiously with removing strict outflow controls.

Figure 5.
Figure 5.

Uzbekistan: External Sector

Citation: IMF Staff Country Reports 2019, 129; 10.5089/9781498314442.002.A001

Sources: Country authorities; and IMF staff estimates.

C. Outlook and Risks

12. Staff’s economic outlook is predicated on the following assumptions:

  • External demand and prices: Trading partners’ import demand and relevant commodity prices, except gold, are projected to temporarily soften in 2019. The external assumptions are subject to significant downside risks, a concern shared by the authorities.

  • Monetary policy: The CBU maintains its neutral FX reserve accumulation policy, i.e. it sterilizes domestic purchases of gold with matching FX sales, allows the nominal exchange rate to move in line with fundamentals, and adjusts its refinancing rate in response to changes in prospective inflation pressures.

  • Credit policy: Credit growth in 2019 is assumed to be brought back in line with nominal GDP growth in the 25–30 percent range, mainly by scaling back directed and preferential lending. A large upward deviation from this credit growth benchmark is a key short-term stabilization risk.

  • Fiscal policy: The overall fiscal stance remains broadly unchanged in 2019 and beyond. Given the country’s hard-wired fiscal conservatism, there is little risk of significant deviations from official budget targets. However, there is a risk that fiscal policy could behave pro-cyclically and that policy-based lending and off-budget operations, which are not captured by the official budget targets, could be scaled up.

  • Structural reforms: The government maintains reform momentum across a wide range of policies; slowing reform momentum is a key medium-term domestic policy risk.

13. Staff projects continued high growth with modest job creation, persistent but sustainable external deficits, and significant but contained inflation pressures (Tables 13):

  • Growth is projected to pick up to 5½ percent in 2019 and to 6 percent in 2020, reflecting mainly higher investment and normalization of agricultural production growth.

  • Job creation, formal sector employment is projected to pick up to about 1½ percent, supported by lower labor taxes but also formalization of jobs as more firms are brought into the tax net.

  • The external position is expected to stay in deficits of about 6 percent of GDP during 2019–20, but external debt levels will remain moderate and decline over the medium term.

  • And CPI inflation is projected to decline only gradually to low double-digits by end-2020, as CPI inflation is likely to remain highly persistent, and there will be continued pressures from price liberalization and relative wage adjustments.

Authorities’ views

14. Their projections largely coincided with staff projections. They saw, however, the possibility of higher growth as some investments may boost growth only with a delay. The authorities also argued that pass-through to consumer prices of energy price increases for businesses and the expansion of VAT to more firms would be less than assumed in staff’s inflation projections.

D. Regional Spillovers

15. Uzbekistan has taken the lead on improving regional cooperation. The previous state-led growth model sought to minimize regional trade and infrastructure interdependencies. Given Uzbekistan’s central geographic location and large population size, this stance cast a pall over regional trade and cooperation. Since the start of reforms, significant progress has already been made in boosting regional trade and promoting regional integration, including by reconnecting regional energy and transportation networks as well as by defusing the region’s age-old disputes about water rights.

Policy Discussions

A. Maintaining a Prudent Fiscal Policy

16. The fiscal stance in 2018 remained prudent. The official budget balance reported by the government yielded a surplus of ½ percent of GDP, an over-performance of ¾ percent of GDP relative to the budget (Table 4). Additional revenue from FX liberalization, favorable commodity prices, and improvements in tax collections was partly saved, providing counter-cyclical support to the economy. Staff’s preferred measure to gauge the impact of fiscal policy on the economy—the overall fiscal balance—adjusts the government’s reported revenue and expenditure for off-budget transactions and includes an estimate of policy-based lending operations. In 2018, with policy-based lending the main deficit driver, the overall fiscal deficit amounted to 2 percent of GDP, the same overall fiscal deficit as in 2017.

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.

17. The planned fiscal stance in 2019 will continue to support macroeconomic stability. The official budget balance is projected to shift from a surplus to a deficit of ½ percent of GDP, mainly reflecting the cost of the 2019 tax reform (Table 4). But with policy-based lending projected to decline significantly, in line with the need to curb credit growth, the overall fiscal deficit is expected to decline to 1½ percent of GDP. If revenue over-performs again in 2019, as is likely given fast nominal wage growth, staff recommends resisting pressures for pro-cyclical spending increases. The recent US$1 billion Eurobond will add to already ample available external financing available from official creditors at concessional terms. As in 2018, the authorities plan to deposit part of excess financing in banks. Domestic debt issuance is planned to be limited and designed primarily to support financial sector development. The government should resist potential pressures to use excess financing to scale up policy-based lending or off-budget operations.

18. Public debt is projected to remain moderate over the medium term, but additional spending needs will likely have to be accommodated. Overall fiscal deficits of close to 2 percent of GDP would stabilize the public debt at about 25 percent of GDP, providing an appropriate fiscal anchor in a lower-income country accustomed to fiscal prudence (Table 7).1 However, preliminary staff estimates of additional spending needed to achieve the UN’s Sustainable Development Goals (SDGs) on health, education, and selected public infrastructure point to significant future spending pressures (see Annex III). Phasing out policy-based lending would open up some fiscal space; there would also seem to be significant scope for mobilizing additional revenue given that Uzbekistan’s revenue-to-GDP ratio (25 percent of GDP) is presently well below CIS peers (34 percent of GDP).

19. At the same time, declining future fiscal collections from SOEs pose a significant risk. SOEs—which account for only 13 percent of formal sector employment—currently provide a large share of revenues, and experiences in other transition economies demonstrate that SOE reforms could crimp these collections significantly. Improving corporate governance in SOEs and continued tax reform efforts should go a long way toward forestalling this risk.

Authorities’ views

20. The authorities agreed that fiscal risks will need be monitored carefully to avoid destabilizing shifts in future fiscal policies.

B. Continuing a Tight Monetary Policy and Reducing Credit Growth

21. Given persistent inflationary pressures, the authorities agreed the monetary stance should remain relatively tight. The Central Bank of Uzbekistan (CBU) aims to gradually bring CPI inflation back to single digits. After increasing the refinancing rate last year from 14 to 16 percent, the CBU is aiming at keeping liquidity in line with the tighter monetary stance, even if such operations are costly (Figure 6). However, at this point, the CBU’s policy tools have only limited impact on monetary and credit conditions due to the heavy segmentation of the credit market. Credit growth will need to be contained by reducing policy-based lending and other directed credit operations outside the budget. The nominal exchange rate has moved broadly in line with underlying fundamentals, especially depreciations in key trading partners. However, staff recommends that CBU FX interventions to sterilize liquidity generated by purchases of domestic gold—which amounted to 7¼ percent of GDP in 2018—become gradually more regular and predictable. The mission also noted that for the central bank to conduct monetary policy and financial oversight effectively, the proposed new CBU law needs to provide the CBU with sufficient independence.

Figure 6.
Figure 6.

Uzbekistan: Monetary Policy and Exchange Rate

Citation: IMF Staff Country Reports 2019, 129; 10.5089/9781498314442.002.A001

Sources: Country authorities; and IMF staff estimates.

Authorities’ views

22. The CBU argued that the FX market remains shallow and is prone to high volatility without market-smoothing interventions, and significant changes to the FX market structure may have to await the emergence of a more market-oriented banking system. Moreover, the CBU noted it had largely followed its pre-announced FX “neutrality rule” to sterilize liquidity injected through its gold purchases.

23. There was also agreement that the rapid expansion of credit—both in quantity and quality—needs to be contained with three objectives in mind:

Ensuring macroeconomic stability: A continued credit boom could turn into a credit bust, with adverse implications for growth and stability (see Annex I for an illustrative simulation). There was broad agreement that bringing credit growth closer to projected nominal GDP growth during 2019–20 would not unduly constrain growth and job creation but could reduce the risk of excessive inflation and external imbalances.

Reducing credit misallocation: Directing credit to fund low-return investments in capital-intensive sectors is not an effective way to create jobs. The authorities should phase out directed credit over the next few years to improve credit allocation.

Increasing transparency of preferential credit: Where there is a good public policy rationale for extending preferential credit, the subsidy component of preferential credit should be reported in the budget, as is already the case for credit subsidies covered by the Fund to Support Entrepreneurship.

Authorities’ views

24. Regarding macroeconomic stability, they noted that Presidential Decree No. 4141 dated January 31, 2019, mandates the government and the CBU to develop a proposal by May to contain future credit growth in line with internal and external stability objectives.

C. Building a Growth-Promoting Financial Sector

25. The banking system remains heavily shaped and directed by the state, limiting the effectiveness of macroprudential policies. State banks account for about 85 percent of the banking system’s assets. The banks’ main function remains to support the country’s investment and development plan by extending credit, with the government providing directives, funding, capital, and guarantees as needed. Against this backdrop, unsurprisingly, reported bank soundness indicators continue to look reassuring, although liquidity indicators have tightened due to rapid credit growth (Table 8). But, following FX liberalization, several large unhedged SOEs suspended servicing some of their FX credits, signaling there are bank balance sheet issues that will need to be addressed as part of a restructuring of state banks. Notwithstanding the state’s continued large influence on bank decisions, the CBU has started to more actively use macroprudential tools to contain risks, including by introducing a capital conservation buffer and higher risk weights for specific household loans. The CBU also continued to upgrade its supervisory capacity and intervention tools. At the same time, notwithstanding growing concerns in other countries in the region, there is no evidence of significant withdrawals of correspondent banking relationships in Uzbekistan.

26. A strategy for restructuring the banking system is urgently needed. The strategy—planned to be elaborated with the help of the World Bank—will at a minimum need to set directions on the future mix of public and private banks, determine the restructuring needs of banks earmarked for public or private operation, and decide on an approach to attract private participants to the sector.

27. To obtain funding in the future, a restructured banking system will need to gain the trust of the private sector. Currently, banks intermediate less than 10 percent of non-government savings, a significantly lower share than observed in more mature transition economies. As the government gradually reduces funding, banks will need alternative funding sources to support an expanding economy. This will require ensuring macroeconomic stability, especially low and stable inflation; assuring depositors that they are adequately protected; and building trust in banks’ governance. Adopting a new banking law based on international best practices would support these requirements.

Authorities’ views

28. They agreed that mobilizing domestic savings and attracting foreign bank expertise will be critical for building a financial sector that promotes growth. The CBU stressed that improving financial literacy and inclusion is a key ingredient toward building a more inclusive financial system. The Ministry of Justice noted that the new banking law would need to adhere to the country’s overall legal framework, including addressing potential concerns that the law could give too much regulatory power to the CBU.

D. Prioritizing Structural Reforms

29. Prioritizing Uzbekistan’s vast structural reform agenda is challenging. Reforms are needed across all policy areas; for example, a recent government’s economic reform roadmap lists more than 500 priorities. Given a heavily distorted economy, it is unrealistic to address all such distortions in a short time. At the same time, the authorities are keen to quickly improve Uzbekistan’s attractiveness as investment location, especially in order to attract more FDI. To deal with this challenge, the authorities have been using an eclectic mix of approaches, including international competitiveness rankings, expert road maps, and growth diagnostics to pinpoint reform priorities.

30. An investor survey pointed to a number of promising reform priorities. Staff surveyed domestic and foreign investors regarding the impact of reforms so far and the urgency of additional reform efforts in about 30 structural policy areas (Annex IV). Responses regarding the urgency of additional reforms can be grouped under three headers:

Availability of economic resources: Investors viewed tackling constraints on the availability of skilled labor, energy, land, and finance as especially urgent. These are also factors often cited as preconditions for a country’s ability to successfully absorb large FDI inflows.

Cost of doing business: Investors pointed to the cost of customs procedures, high tax rates, and tax compliance as especially binding constraints; investment incentives were also seen as in need of a major reform overhaul.

Quality of public governance: Respondents identified fighting corruption and enforcing the rule of law, especially regarding competition and contracts, as especially important. They also highlighted the need to make government policies more predictable and improve the quality of public information.

Authorities’ views

31. They welcomed staff’s attempt to add a new perspective to the reform prioritization debate. They noted that the survey results in some areas confirm their own views, especially on availability of economic resources, while other results will require more reflection.

Reforms Targeting Availability of Economic Resources1

32. SOE reform will be key to improve resource allocation. In the past, SOEs absorbed disproportionate shares of skilled labor, energy, and financial resources, while facing weak competition enforcement and enjoying a wealth of investment preferences. Staff therefore welcomed the authorities’ decision to accelerate SOE restructuring along three prongs. First, the new Agency for Management of State Assets has been given a mandate to strengthen corporate governance. Second, the government has started unbundling SOE activities in the energy and transportation sectors, and it has also made some progress on separating SOE management, supervision, and regulation. Third, the government is classifying SOEs into those that will be privatized, opened for minority stakes, or remain under full state ownership.

33. Price liberalization is closely linked to SOE reform. During the second half of 2018, the government liberalized bread prices and brought energy prices for businesses closer to cost-recovery levels. But significant cost recovery gaps remain, and the mission encouraged continued price adjustments, especially in the energy sector, to reduce SOE losses, save energy, and attract foreign investors to the energy sector. To reduce policy uncertainty, future price increases should follow a pre-announced calendar. To alleviate the impact on vulnerable households, the government plans to continue to improve targeting and coverage of social benefits.2

34. Improving labor skills has been a long-standing reform concern; land right reform is underway. Private ownership of non-agricultural land will be permitted starting in July 2019, while reforming use rights for agricultural land is a priority over the medium term. The World Bank has been providing comprehensive advice on improving labor skills, especially through tertiary education.

Authorities’ views

35. They noted that SOE reform should benefit from studying earlier experiences in other transition economies. They agreed that further price liberalization is needed, but also noted the difficulty of striking the right balance between achieving cost recovery, adding to inflationary pressures, avoiding economic disruptions, and affecting the vulnerable.

Reforms Targeting Reducing Cost of Doing Business

36. Tax reform is viewed as a multi-year undertaking. The 2019 tax reform has simplified taxes, significantly reduced labor taxes in the formal private sector, and cast the VAT net much wider. In fact, the number of firms covered under the standard tax regime has expanded from 7,000 to 35,000 firms. Further reforms should prune tax and customs preferences, which are often granted to specific firms, equalize labor taxes across firms, and provide more efficient incentives for foreign investment. Regarding tax administration and compliance cost, measures are underway to reorganize the headquarters, establish a large tax-payer office, and strengthen the governance of field offices.

37. Efforts to liberalize the foreign trade regime are gathering momentum as part of the WTO accession process. As a double-landlocked country, Uzbekistan already faces high trading costs due to geographic challenges, which are further compounded by the high costs, time delays, and uncertainties imposed by present trade regulations. The authorities noted that applying WTO principles, including the Trade Facilitation Agreement, would help address regulatory weaknesses in trade facilitation and import licensing.

Authorities’ views

38. Tax reform remains a top priority to improve the attractiveness of Uzbekistan as an investment location, and the authorities are keen to take full advantage of the Fund’s and the World Bank’s comprehensive, multi-year, technical assistance package.

Reforms Targeting Strengthening Public Governance

39. Fighting corruption is a high priority. The authorities pointed out that one of the first laws adopted by the new government was Uzbekistan’s Law on Combating Corruption. The government’s anti-corruption strategy is being implemented through legal, regulatory, and institutional measures, including on procurement. At the same time, the relevant implementation agencies will need to build capacity in enforcing measures. The government is also focusing on educating citizens and officials on anti-corruption policies and stepping up prevention and enforcement efforts, especially in the socially-sensitive areas of education and health.

40. The regulatory framework is undergoing significant upgrades. The authorities noted that streamlining and rationalizing the vast number of existing regulations, even in a relatively narrow field like competition regulations, is a Herculean task. Areas that are receiving particular attention include the legal and regulatory frameworks in the airline, wholesale trade, and energy sectors. A recent Presidential decree separated Uzbekistan Airways into separate companies to manage the airline, airports, and air navigation while transferring regulatory responsibilities to the government. Regarding wholesale trade, the government recently abolished trading licenses and advance payment requirements. On energy, the government has established a new tariff commission under the Cabinet of Ministers with the goal of adjusting prices to cost recovery levels.

41. Fiscal transparency will continue to be strengthened. Since 2017, Uzbekistan has made important progress toward improving fiscal transparency, albeit starting from a lagging position. The publication of a first citizen’s budget was a major step toward strengthening fiscal transparency. The 2019 budget also included for the first time medium-term fiscal projections and a discussion of fiscal risks. The government is committed to include all fiscal operations, including off-budget spending, in the 2020 budget. It will also conduct a comprehensive assessment of fiscal risks, particularly risks related to SOEs, and establish a strong legal framework for regulating Public Private Partnerships (PPPs).

Authorities’ views

42. They noted that in some reform areas, including competition and contract enforcement, progress may appear slow because they first need to install and build implementation capacity. On public governance, they expressed some frustration that international governance and transparency rankings seem slow to respond to changes on the ground.

E. Fostering Inclusive Growth

43. The UN’s SDGs are anchoring Uzbekistan’s inclusive growth agenda. The authorities have fully embraced the SDGs to set development goals, including for education, health, gender equality, infrastructure, and financial inclusion. Moreover, achieving the SDGs would promote their key goal of creating jobs. To add specificity to the inclusive growth dialogue, staff presented preliminary staff estimates of public and private resources needed to achieve key SDG goals over the next decade (Annex III).

44. Unskilled and other disadvantaged workers could benefit from additional support. Pre-reform policies paid little attention to labor market issues, while actively discouraging internal and external labor mobility. Women and youth experienced higher unemployment, and those with lower incomes often migrated abroad in search of work. The authorities have started tackling these issues (Annex V). First, they now recognize that migration is a key coping mechanism for disadvantaged workers. They have created an agency to support migrants and allowed private employment agencies to operate. Second, some restrictions on internal migration have been lifted. Third, the 2018 and 2019 budgets have significantly increased funding for active labor market programs, including training, public works, and wage subsidies. It also would be desirable to complete already started reforms, including revisions of the outdated labor code and employment law.

Authorities’ views

45. They welcomed staff’s SDG costing framework, noting that estimates and caveats broadly match their own assessments. They saw better functioning of the labor market as key for promoting inclusive growth. They also noted, however, that job creation is a herculean task given the accumulated labor supply overhang, which could be further boosted by SOE restructuring or returning migrants if external downside risks materialize.

F. Improving Economic Statistics

46. Further steps are needed to improve statistics. Before the reforms started, available statistics were scarce and often simply confirmed achievement of economic targets. Since May 2018, key economic, financial, and social statistics can be downloaded from a National Summary Data Page. At the same time, staff’s investor survey suggests that many remain skeptical about progress so far and see an urgent need for further improvements. From staff’s perspective, surveillance work would especially benefit from improved national account and labor market statistics, including by revising past data. Two initiatives would further catalyze reforms. First, the Statistics Committee, the Ministry of Finance, the Ministry of Labor, and the CBU should agree on a roadmap to improve statistics. Second, subscribing to the IMF’s Special Data Dissemination Standard (SDDS) would confirm the authorities’ readiness to adhere to international standards and accountability.

Authorities’ views

47. They agreed that transitioning toward SDDS should be the next step to strengthen statistics. They also noted that the government is keen to correct and publish revised statistics in areas where there may have been inaccuracies in the past.

Staff Appraisal

48. Uzbekistan has successfully implemented a first wave of significant economic reforms. Reflecting the overarching need to create more and better jobs, the country has adopted a wide-ranging reform agenda to open the economy, level the economic playing field, and improve public governance. Foreign exchange liberalization, tax reform, and a major upgrade in the quality and availability of economic statistics spearheaded the early reforms. Uzbekistan is also leading efforts to improve regional cooperation, key for promoting regional trade and supply chains, while reconnecting the region’s public infrastructure networks.

49. Policymakers will need to be patient to reap the full benefits of reforms. After almost three decades of static policies, reformers face the twin challenges of redressing a legacy of mis-allocated resources while gaining the reform credibility needed to attract foreign investments. Moreover, Uzbekistan’s large reform needs combined with still low implementation capacity could result in setbacks. And looking ahead, the external environment could prove less benign that presently projected.

50. In the short run, output growth and job creation are likely to improve moderately, while tighter policies should reduce inflation gradually. Despite a less favorable external environment, buoyant investment is projected to increase GDP growth to 5½ percent in 2019 and support formal sector employment growth. CPI inflation—14¼ percent at end-2018—will likely remain elevated in 2019 before starting to gradually decline.

51. Staff assesses Uzbekistan’s external position as moderately weaker than indicated by fundamentals and desirable policies. Imports, especially capital and intermediate goods, surged in 2018, boosting the current account deficit to about 7 percent of GDP. Nevertheless, the Fund’s external balance approach and the country’s large external buffers suggest that external stability risks remain low.

52. Restraining credit growth, especially directed credit, has emerged as the main challenge to macroeconomic stability. Following decades of underinvestment, credit growth boomed in 2018, financing a surge in investment. A prolonged credit boom could exacerbate inflationary pressures, feed into excessive external deficits, and trigger a costly boom-bust cycle. With both domestic and external financing likely to remain plentiful, the authorities will need to exercise self-restraint to ensure macroeconomic stability.

53. Staff welcomes the government’s prudent fiscal policies. The 2018 overall fiscal deficit amounted to 2 percent of GDP, driven by policy-based lending operations to state enterprises—mainly through the FRD. The government’s present fiscal plans, which include cutting back on-lending activities, are consistent with an overall deficit of 1½ percent of GDP in 2019. Staff also welcomes the government’s commitment to bring all fiscal operations on-budget in 2020.

54. Additional tax reforms are needed to spur investment and reduce risks to medium-term revenues. The 2019 tax reform appropriately focused on simplifying taxes, reducing taxes on labor, and broadening the VAT. However, investors see additional tax reforms, especially improved tax administration, as key to improving the investment climate. Moreover, the government should widen the tax base as restructuring state enterprises could cause a decline in tax collections.

55. The CBU rightly intends to maintain a tight monetary stance while allowing the exchange rate to move in line with fundamentals. The CBU has kept the refinancing rate steady since September 2018 despite declining consumer inflation, a prudent stance given that underlying inflationary pressures remain strong. Moreover, liquidity in the banking system should be kept in line with the monetary stance, even if the monetary operations needed to achieve this target are costly. The exchange rate has moved broadly in line with underlying fundamentals, including depreciations in key trading partners. However, the central bank’s FX interventions to sterilize liquidity generated by purchases of domestic gold could become more regular and predictable.

56. The main financial sector challenge is to build a banking system that can support growth over the medium term. In the future, the banking system will need to be able to fund credit growth without resorting to the government to close funding and capital gaps. This will require boosting the efficiency of banks, increasing the public’s trust in the stability and governance of banks, and improving the country’s investment climate to attract foreign banking expertise.

57. The government needs to prioritize its vast structural reform agenda. The government is rightly concerned that an unfocused, sprawling structural reform agenda could overburden its scarce implementation capacity while delaying the economic pay-offs from reforms. Liberalization of prices and steps to restructure SOEs promise to address constraints on resources for the private sector. WTO accession and reforms to the trade regime should also help reduce cost. And the authorities’ plans to improve public governance should prove especially beneficial for the investment climate.

58. The authorities’ continued efforts to improve statistics are also welcome. In the past, non-transparent official statistics hampered surveillance, hindered effective policy making, and undermined public trust. Much has been achieved already, but more work is needed, especially on improving national accounts and labor market statistics. Joining the Fund’s Special Data Dissemination Standard could underpin these efforts.

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

Table 1.

Uzbekistan: Selected Economic Indicators, 2016–21

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Sources: Country authorities; and IMF staff estimates.

In March 2019, the government revised national accounts data for 2014–2018.

Consolidated fiscal data are budget data adjusted for operations of the Fund for Reconstruction and Development (FRD), equity injections, externally financed expenditures, and policy lending.

Labor market statistics were revised starting in 2018.

Table 2.

Uzbekistan: National Accounts, 2016–21

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Sources: Country authorities; and IMF staff estimates.

Labor market statistics were revised starting in 2018.

Table 3a.

Uzbekistan: Balance of Payments1, 2016–21

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

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Sources: Country authorities; and IMF staff estimates.

The authorities revised the historical BOP statistics in March 2019.

Positive values means outflows.

Underlying current account assumes the annual gold production is exported.

Table 3b.

Uzbekistan: Balance of Payments1, 2016–21

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and IMF staff estimates.

The authorities revised the historical BOP statistics in March 2019.

Positive values means outflows.

Underlying current account assumes the annual gold production is exported.

Table 4a.

Uzbekistan: General Government¹, 2016–21

(In billions of sums)

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Sources: Country authorities; and IMF staff estimates.

As adopted by Parliament.

Consolidated fiscal data are budget data adjusted for operations of the Fund for Reconstruction and Development (FRD), equity injections, externally financed expenditures, and policy lending.

Table 4b.

Uzbekistan: General Government, 2016–21

(In percent of GDP)

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Sources: Country authorities; and IMF staff estimates.

As adopted by Parliament.

Consolidated fiscal data are budget data adjusted for operations of the Fund for Reconstruction and Development (FRD), equity injections, externally financed expenditures, and policy lending.