Country risk: Reform-backed policymaking puts Uzbekistan on safer ground

Uzbekistan – traditionally a riskier prospect than Azerbaijan, Kazakhstan and other central Asian republics – has shown remarkable improvement in Euromoney’s country risk survey in recent years.

Although, as with many countries, the health and economic shock has led to a deteriorating risk score, the downturn is negligible when measured against the substantial rise that has occurred during the past five years.

Uzbekistan has gained almost 16 points in Euromoney’s crowd-sourcing risk survey – where a higher score is lower risk – pushing the country up 42 places in the global risk rankings of 174 countries, to 103rd, closing in on Indonesia and similarly improving Nepal:

According to the European Bank for Reconstruction and Development (EBRD), which participates in the survey, the economy is proving resilient to the impact of Covid-19.

This is being put down to its more diversified production and export structure, including its status as a gold producer – accounting for more than half its commodity exports and acting as a hedge during periods of global volatility.

Moreover, unlike many countries, GDP continued to grow a little in real terms in the first half of 2020, with agricultural output and construction activity offsetting declines in manufacturing and gas production, suggesting only a small contraction for the year as a whole.

There have been two lockdowns, within March to May and July to August, which – with the weaker global economic environment – led to higher unemployment and falling incomes.

However, the EBRD expects real GDP to grow by 4.5% in 2021, propelled by improving domestic and external demand.

There have been upgrades to several political indicators, most notably government stability, and the regulatory and policymaking environment, partly due to an effective coronavirus response.

The authorities introduced an anti-crisis fund, backed by official creditor loans, to provide support for businesses and households, as well as fund the healthcare system, which has also improved the score for soft infrastructure.

The fiscal deficit has grown to an estimated 4.1% of GDP in 2020, according to the IMF, but the government has continued to support infrastructure projects and private-land development by low-income families, while propping up key transport companies operated by the state until the crisis is over.

Monetary policy is also following an orthodox path to reinforce confidence in the regime, with the central bank taking advantage of lower inflation to provide liquidity.

This has meant lowering its policy interest rate, while also introducing an interest-rate corridor as a step towards an inflation-targeting regime and assisting commercial banks with preferential access to targeted refinancing.

Transparency in statistics has also improved from being almost non-existent three years ago to being able to obtain most of the key data on a regular basis.

The range of reforms is unlikely to stop, with the government pressing ahead with its plans to restructure the economy. This includes modernization and efficiency programmes for the air and rail transport sectors, electricity sector reforms, and new strategic plans for the agriculture and banking sectors.

The authorities are keen on boosting agricultural yields through industrial processing and developing the infrastructure for storing farm products, as well as diversifying the economy and lessening the reliance on exports to other Commonwealth of Independent States (CIS) countries.

Although Russia and former CIS countries such as Kazakhstan, Kyrgyz Republic and Tajikistan remain important, other key markets are China, Turkey and Afghanistan.

Just as importantly, there are judicial reforms under way to improve competition and resolve investment disputes.

Survey contributor Doniyor Islamov, chief executive officer of RB Asia – a Tashkent-based investment company – notes the fact Uzbekistan’s improvement goes back to 2017 when it took the path of economic reforms aimed at developing a market economy and decreasing the role of the government.

“Since then, significant reforms have been conducted, including the liberalization of the currency, improvement of the tax system and the protection of investors’ rights, etcetera,” he says.

All of these changes are recognised by the World Bank, which has upgraded Uzbekistan’s ranking for Doing Business to 69th out of 190 countries thanks to less-bureaucratic and more investor-friendly business regulations.

While Islamov notes the fact the global crisis has weakened GDP growth and increased sovereign debt, he lists four main improvements to Uzbekistan’s country risk.

They are the establishment of an anti-corruption agency and the issuance of sovereign Eurobonds in local currency for the first time, improving capital access. Large-scale privatization has also been approved, including shares in more than 500 companies to be offered to local and international investors, and there has been improvement to investor rights and capital repatriation.

“A single law was adopted to protect investors’ rights,” says Islamov. “It guarantees the transfer of funds in foreign currency to and from Uzbekistan without any restrictions, including currency conversion for repatriation.”

There are, of course, numerous risks to be aware of. Uzbekistan is, after all, still a tier-four country risk in Euromoney’s survey, firmly within the high, but not highest (tier five) risk category.

Dmitri Fedotkin, director of research, macroeconomics and country risk, at the Russian Agency for Export Credit and Investment Insurance (EXIAR), and another of Euromoney’s survey contributors, discussed some of the many pitfalls with Euromoney.

The reformist atmosphere, for example, could disappear for whatever reason, should the top authorities decide to reverse it, or it may slow down due to the deterioration in economic activity and/or the public finances.

There are other risks to contend with, such as the fact local capital markets are almost non-existent – something that needs to develop quickly to avoid the continuation of foreign borrowing.

Meanwhile, households are not leveraged, but credit growth in newly opened countries tends to grow fast and that can represent challenges in terms of regulation for the authorities.

“The exchange rate appears to be not tightly restricted now compared to three years ago, but we don’t know how the authorities will behave should there be a currency run amid a crisis,” says Fedotkin.

“All this new exchange-rate flexibility and comparatively easy currency controls might evaporate. Maybe not, but everyone remembers how it used to be; memories are fresh.”

Despite all that, it is not often that a country the size of Uzbekistan opens up, so it is understandable it will pique investor interest.

The political change is notable in that respect, with the authority altering from 100% authoritarian to a transitional one.

“Power is still concentrated in one pair of hands, but the government and national bank are more independent and transparent,” adds Fedotkin.

“Rules governing the interaction between different branches of power are building up. All that said, Uzbekistan remains a middle-eastern country, with clans and other attached attributes. But there are plenty of examples around where such a set-up yields good results.

“I think Uzbekistan wants to follow that route.”

Fedotkin also believes the current financial state of Uzbekistan is an attraction for investors.

“It has only started to accumulate debt, and FX reserves are large and on the rise thanks to the country being a world-recognised gold-bullion producer,” he says.

“At the moment, the country can handle external shocks with relative ease and it should stay that way for the foreseeable horizon. Certainly, having the ability to pay is not the same as having a desire/will to pay, but that doesn’t seem to be on the authorities’ minds now.”

Fedotkin also notes that the authorities have a different approach to economic policies compared with previous ones, and while they openly admit they have a long way to go and lack the expertise, they pledge to gradually reform and transform themselves.

“You hear about inflation targeting and a flexible exchange range as policy agenda in Tashkent, and while I think authorities are a bit too optimistic about their ability to convert the Soviet-style machine into a market-based one so quickly, it is good to hear that sort of talk,” he says.

“And investors certainly like that a lot.”

Indeed, the new authorities are more open to outsiders and are eager to meet to talk and explain.

“On the two-to-three occasions I’ve been to Tashkent, in 2018 and 2019, I had a great experience meeting not only business/bank representatives but also the authorities from the finance ministry or national bank,” says Fedotkin.

“Yes, they are still somewhat bureaucratic at times, but quite eager to talk and share data and information, reform plans and agenda. There is also a changing team, with younger and western-educated people now working there.”