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

Uzbekistan has demonstrated resilience to the initial impact of the war in Ukraine and sanctions against Russia. Nevertheless, uncertainty regarding the duration and outcome of the conflict, as well as its implications for the global economy, the likelihood of a protracted contraction in Russia, the risk of rouble volatility, vulnerability to secondary sanctions or the return of migrant workers continue to represent downside risks.

Resilient Growth: Growth continues to demonstrate resilience to external shocks. The economy expanded by 5.4% in 1H22 due to favourable export prices, a supportive fiscal stance, a significant increase in remittances and an easing of exchange rate pressures. As a result, we have revised up our 2022 growth forecast to 5.1% from 3.1%. We expect growth to ease to 4.7% in 2023 due to weaker global growth, but reach estimated potential of 5.5% in 2024 reflecting gradual fiscal consolidation and reforms that will positively affect agriculture, construction and industrial production.

Lower Current Account Deficit: The current account deficit (CAD) is likely to decline to 2.1% of GDP in 2022, its lowest level since 2017, due to strong growth in gold and non-gold exports and a large increase in personal transfers (96% yoy or USD6.5 billion in 1H22). Russia remains Uzbekistan’s second main trading partner and the majority of export and transfers are being settled in US dollars rather than roubles. Although we expect the CAD to widen to 4.1% of GDP and 5.4% in 2023 and 2024, respectively, lower fiscal deficits, moderate credit growth and tighter global financing conditions will likely mitigate upside risks to the CAD trajectory. Moreover, exports prospects are favoured by reforms in the mining, textile and agricultural sectors.

Strong External Balance Sheet: International reserves will remain robust and average USD33.5 billion in 2023-2024. Reserve coverage, at nine months of current external payments (CXP), and external liquidity, measured by the ratio of the country’s liquid external assets to its short-term external liabilities, at 219% in 2024, will remain higher than peers (five months of CXP and 176%, respectively). The share of gold in international reserves remains high at (61%). Increased external financing costs and reduced risk appetite will likely slow the pace of external debt accumulation for banks and the private sector.

Moderate Inflation Shock, Tight Monetary Stance: After a 300bp hike in mid-March, the central bank lowered its policy rate twice by 100bp to 15% due to appreciation of the Uzbek som and easing of inflation expectations in June-July. We forecast inflation to remain above peers, averaging 11.7% in 2022 and falling to 9.2% in 2024. The inflation trajectory will depend on the evolution of food prices, the timing and magnitude of adjustments to heating gas and electricity tariffs, the pace of fiscal consolidation and progress in improving competition in the domestic market.

Gradual Fiscal Consolidation: We forecast the consolidated budget deficit to decline to 4.8% of GDP in 2022, down from 5.6% in 2021 but above the government’s revised budget target of 4.1% of GDP, and Fitch expects the deficit to decline further to 4.1% of GDP in 2023, incorporating authorities’ continued emphasis on social spending, and investment. The government has announced a VAT rate cut from 15% to 12% (1.4% of GDP) in 2023. Revenue loss will be partially compensated by removal of tax exemptions, continued formalisation and improvements in tax efficiency.

Low Government Debt: We project government debt to increase to 37.3% of GDP (including 8.9% in external guarantees) in 2022, well below the 55.0% ‘BB’ median forecast, before declining to 35.3% by 2024, given our baseline of a relative stable Uzbek som, lower deficits and reduced external borrowing. Government debt is almost entirely foreign currency-denominated (93.7%), but mitigating factors include the structure in terms of maturity and costs, with official debt accounting for 89% of the external stock. The government also has high liquid assets estimated at 20% of GDP in 2022.

Parliament approved the Law of Public Debt, which introduces a 60%-of-GDP public debt ceiling, annual borrowing limits and the requirement to undertake corrective measures if debt rises above 50% of GDP. The government also intends to introduce a 3% deficit ceiling. In Fitch’s view, the credibility of these policy anchors will depend on their capacity to sustainably slow the pace of debt growth, manage the risk of contingent liabilities and preserve the relative strength of government fiscal buffers, a key supportive factor for the rating.

Continued Reform, Diplomatic Balance: Commitment to reform remains strong despite a more challenging external environment. The government liberalised the domestic price of wheat and flour, but the timing and pace of gas and electricity tariffs increases remain uncertain due to socio-political considerations. A public vote on a new constitution is likely to take place in October. Changes are likely to include the lengthening and re-set of presidential terms. Proposed changes (later discarded) regarding the status of the Karakalpakstan region led to social unrest in early July.

Uzbekistan maintains a careful diplomatic balance in the war in Ukraine, supporting Ukraine’s territorial integrity, while refraining from joining Western sanctions and maintaining a dialogue with Russia on important economic issues such as the resolution of links with the sanctioned financial institutions.

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 the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Uzbekistan has a low WBGI ranking at the 19th percentile, reflecting weak rights for participation in the political process and institutional capacity, uneven application of the rule of law and a high, albeit declining, level of corruption.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

-External Finances: Weakening of external finances, for example through a sustained widening of the current account deficit derived from a permanent decline in remittances or increase in trade deficit, resulting in a significant decline in FX reserves or rapid increase in external liabilities.

- Public Finances: A marked rise in the government debt-to-GDP ratio or the erosion of the sovereign fiscal buffers, for example due to an extended period of low growth or crystallisation of contingent liabilities, that could result in the removal of the +1 notch for this factor.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Macro: Significant narrowing of Uzbekistan’s GDP per capita gap vs. peers, for example underpinned by the implementation of structural reforms, while improving macroeconomic stability.

-Structural: Significant improvement of governance standards including rule of law, voice and accountability, regulatory quality and control of corruption.

-External and Public Finances: Significant strengthening of the sovereign’s fiscal and external balance sheets, for example, through sustained high commodity export revenues.