Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed Uzbekistan’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘BB-’, with a Stable Outlook.

Credit Fundamentals: Uzbekistan’s ratings balance robust external and fiscal buffers, low government debt and a record of high growth relative to ‘BB’ rated peers’, against high commodity dependence, high inflation and structural weaknesses in terms of low GDP per capita and weak, albeit improving, governance levels. While the economy has demonstrated resilience to the spillovers from the war in Ukraine and sanctions against Russia, significant uncertainty exists with regard to the evolution of these risks.

Notable Improvement in Governance Indicators: Uzbekistan jumped nine places in the latest World Bank Governance Indicators (WBGI for 2021), to the 29th percentile, reflecting an improvement in regulatory quality and government effectiveness, as well as voice and accountability, and control of corruption. However, geopolitical developments and proposed reforms to extend presidential terms raise uncertainty over whether improvements in governance will be sustained.

Economic Reform Agenda Set to Continue: Uzbekistan’s government appears willing and able to proceed with key structural economic reforms, including privatisation of state-owned enterprises (SOEs), rationalisation of the number of ministries and size of the bureaucracy, and a continued reduction in preferential lending to stimulate competition in the economy. However, developments such as political unrest in Karakalpakstan in July 2022, and energy shortages in January 2023 pose risks to the pace of sensitive reforms. We therefore view the adoption of a liberalised regime of electricity prices, scheduled for May 2023, as an important bellwether for the appetite and capacity for reforms, and reducing the role of the state in the economy.

Geopolitical Risks: Uzbekistan maintains strong commercial ties with Russia, given the latter is its largest trade partner. There are no discernible disruptions to bilateral trade settlements from sanctions, although an increasing proportion of transactions are reportedly being settled in roubles. While authorities are projecting an increase in exports to the EU to benefit from the grant of the Generalised Scheme of Preferences (GSP+) to Uzbekistan, logistical challenges associated with suitable trade routes will act as a constraint. Volatility of the rouble, vulnerability to secondary sanctions, and the potential for a large-scale return of Uzbek migrant workers from Russia pose downside risks.

We see some limited signs of Uzbekistan seeking to balance its dependence on Russia with boosting energy security. In December 2022, Uzbekistan refused a Russian proposal to form a ‘Gas Union’ with itself and Kazakhstan for creating a common market for natural gas. Additionally, Fitch expects Uzbekistan to actively work with western countries to de-escalate sanctions-related risks, particularly in the banking sector. In September, the Central Bank of Uzbekistan complied with a US demand to cut off access to the Russian Mir payment system.

Strong Growth Prospects: The Uzbek economy grew 5.7% in 2022 (2021: 7.4%), driven by strong remittances (more than double 2021 levels), which propelled private consumption, as well as a solid boost to exports (mainly to Russia) and by an increase in government spending to mitigate the inflationary shock. In Fitch’s view, energy shortages in early 2023, coupled with sluggish global demand and an expected tapering of remittances will reduce growth to a still robust 5.4% on average in 2023-2024.

Continued Fiscal Consolidation: Fitch forecasts a faster than previously expected fiscal consolidation, with the augmented general government deficit shrinking to 3.5% of GDP in 2023 and 2.3% in 2024 (current ‘BB’ median: deficit of 3.3%) from an estimated 3.9% in 2022. Strong revenue growth enabled by solid GDP growth and an expansion of the tax base, a reduction in policy lending, and a shift towards public-private partnerships that will reduce direct capex costs to the state, as envisaged under ongoing reforms, are positive for fiscal policy management.

Low Public Debt Levels: General government debt (GGD), at 34.4% of GDP at end-2022, is well below the current ‘BB’ peer medians of 55%, and we expect it to stabilise on average at 36.4% in 2023-2024. While exchange-rate risks are high (94.3% of GGD is FX-denominated), overall risks to debt dynamics are mitigated by a large share of concessional debt, as well as long maturities (3Q22: 9.5 years for state external debt). The asset base of the Uzbekistan Fund for Reconstruction and Development (UFRD), which is a source of deficit financing for the government, was large at 21% of GDP as of end-2022, although the liquid portion of this buffer (denominated in FX) has fallen by 30% over 2017-2022.

Strengthened External Finances: The current account was close to balance in 2022 (2021: deficit of 7% of GDP), driven by a doubling of secondary income inflows, and solid export growth. Remittances from Russia grew 2.6x to USD14.5 billion (18% of GDP), partly reflecting heightened demand for Uzbek workers in Russia as well as the 6.5% appreciation of the rouble against the Uzbek som in 2022. Fitch expects the current account deficit to widen to an average of 4.4% of GDP in 2023-2024 as remittance growth stabilises, and domestic demand bolsters import growth. FX reserves and international liquidity for Uzbekistan are very strong, with reserve coverage projected at about 11 months of imports over 2023-2024.

High Dollarisation, Subsidised Lending: Uzbekistan’s banking sector is marked by high deposit and loan dollarisation, of 39% and 47%, respectively, as of end-January 2023. The sector is heavily dominated by state-owned banks although as part of ongoing reforms, their share of assets has fallen to 78% in 2022 (2021: 82%), while exposure to state-owned borrowers has fallen to 15% from 18%. The sector is experiencing a slow but steady shift away from preferential/government-subsidised lending. Banks are well-capitalised (capital adequacy ratio of 17.7% as of January 2023) and highly profitable (return on equity of 10% and 37% or state-owned and private banks, respectively).

Inflationary Pressures: Inflation averaged 11.3% in 2022, above the central bank’s 10% target. Fitch expects inflation to moderate to under 9% by end-2024 (when the target will be 5%), with the trajectory dependent on the exchange rate, food price growth, fiscal consolidation and progress in improving competition in the domestic market. Fitch expects that the liberalisation of energy tariffs in mid-2023 will go ahead but with probably smaller price increases than previously envisaged. Fitch expects real interest rates to remain positive even if, as expected, the central bank demonstrates a loosening bias in 2023-2024.

ESG - Governance: Uzbekistan has an ESG Relevance Score (RS) of ‘5’ for both Political Stability and Rights, and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that WBGI have in our proprietary Sovereign Rating Model (SRM). Uzbekistan has a low WBGI ranking at the 29th percentile, reflecting the absence of a recent record of peaceful political transitions, weak rights for participation in the political process, weak institutional capacity, uneven application of the rule of law and a high level of corruption.