Tashkent, Uzbekistan (UzDaily.com) -- Rating-Agentur Expert RA confirmed the sovereign government credit rating (SGC) of Uzbekistan at ‘BB-’ (Sufficient level of creditworthiness of the government) and at ‘BB-’ (Sufficient level of creditworthiness of the government) in foreign currency.

The rating outlook is stable which means that in the mid-term perspective there is a high probability of maintaining the rating score.

Overall government debt of the Republic of Uzbekistan keeps increasing and estimated to reach 36% of GDP and 142% of budget revenues due to active borrowing on international markets (including an issuance of US$1 bn Eurobonds in February 2019), as well as issuance of local UZS-denominated bonds and an increase in guarantees for national projects.

The agency expects the debt load to increase by end-2020, but at a slower pace. “In our view, the current and forecast debt load remains at acceptable levels. In addition, maturity and repayment conditions remain favorable, with around 32% of overall debt owed to foreign governments and public institutions, and 33% to international financial institutions on concessional terms, it added.

According to preliminary data from the MFRU the consolidated budget in 2019 was executed with a deficit of 1,5% to GDP, while the overall budget deficit3 could reach around 1,6% of GDP by the end of 2019 according to the IMF’s latest estimates. In order to increase transparency and accountability of public finances, as well as to be in line with international standards, the MFRU introduced the official “overall fiscal balance”4 with targets of -2,7% and -2,1% of GDP for 2020 and 2021, respectively. Our assessment of the overall fiscal balance is close to the mentioned indicator, and does not pose substantial risks to the government’s creditworthiness.

Preliminary data for 2019 shows an accelerated growth of the Uzbek economy at 5,6% in real terms, as compared to 5,4% in 2018, supported by significant growth in construction, manufacturing and service industries. Such growth remains one of the highest in the region and we expect the metric to be in the range between 5,5% and 6% in 2020-2021, while the long-term growth rates will depend on the privatization of SOEs as well as the overall effectiveness of structural reforms.

As a result of the Central Bank of Uzbekistan’s (CBU) policy, regarding the capitalization of state-owned banks, the overall regulatory capital increased by 2,2x by the end of 4Q 2019 y-o-y, with capital adequacy and capital to assets ratios reaching 23,5% and 18,7% respectively. Asset quality and profitability metrics also remained at positive levels, with an officially recorded NPLs to total loans ratio at 1,5% and ROA at 2,2% as of the same date. At the same time, we still see potential risks in the system related to the high concentration (around 85% of assets) of state-owned banks, strong government influence and partly controlled distribution of credit resources at preferential rates. There are elevated risks of materialization of contingent liabilities, taking into account financial position of some large SOEs and expected decrease of the scale of preferential lending.

Due to the dominance of FX-denominated obligations in the structure of public debt (more than 97% of internal debt and 100% of external debt) and high volatility of the national currency, the debt position remains vulnerable to exchange rate fluctuations. In 2019, the national currency depreciated by 14% against the USD, which led to an increase in the debt burden. The government is diversifying the debt structure by launching from December 2018 the issuance of UZS-denominated domestic bonds, but the share of such obligations remains insignificant, around 1% at the end of 2019.

According to the preliminary data, the trade deficit in Uzbekistan in 2019 reached 11% of GDP as compared to 10% in 2018, mostly due to the growth of imports of machinery and equipment for the modernization of local enterprises, while exports increased at a slower pace. We expect the current trend in foreign trade to continue in 2020 as export demand weakens and imports are stably high, nevertheless the external position of Uzbekistan is supported by a moderate debt level and its favorable maturity, as well as sound foreign exchange reserves covering 13 months of imports by end-2019.

After a rapid growth over the last several years the ratio of banking system assets and domestic loans to GDP is expected to stabilize by the end of 2019 at 52,1% and 40,4% respectively (as compared to 52,6% and 41,4% in 2018) mostly due to the restructuring of the banking system balance-sheet5. Although these indicators are still at a moderate level, a significant share of loans is still directed lending to SOEs, which limits the effectiveness of the market role of the banking sector.

The officially reported unemployment rate slightly decreased to 9% in 2019 from 9,3% a year before. This level is considered as elevated according to our internal benchmarks. In addition, the local labor force market is heavily exposed to the economic situation in Russia and Kazakhstan, and therefore the unemployment level can deteriorate in case of significant economic distress of these economies.

The CBU is pursuing a tight monetary policy, keeping the refinancing rate at 16% after an increase of 2p.p. in 2018. However, from 1 January 2020 the CBU introduced the new policy rate (“key rate”), which is expected to be the main money market benchmark6, as well as implemented interest corridor of +/-1 p.p. and introduced new policy instruments, including REPO transactions, currency swaps and overnight deposits. Besides, adhering to the free float exchange rate regime, the CBU conducts neutral interventions mainly to sterilize the purchase of gold in order to contain the monetary base, smoothing out only sharp fluctuations in FX rates. In addition, the official inflation in 2019 remained within the CBU’s forecast corridor of 13,5%-15,5% and reached 15,2%. However, the efficiency of the monetary transmission mechanism is limited by the availability of preferential lending to SOEs at below-market rates (the current spread between the market and preferential rates is around 16p.p.), as well as by the lingering high dollarization, which remained elevated after a slight decrease to 47,7% for loans and 43,9% for deposits as of December 2019.

The quality of the fiscal policy in Uzbekistan has improved substantially over the last two years, including continuing tax reform, improvement of fiscal planning, accountability to the legislative body, substantial increase of transparency and consistency of all fiscal operations (especially, the implementation of the “overall fiscal balance”), as well as the introduction of borrowing limits for each year and plan for gradual reduction of deficits till 2022. However, we still observe risks of deviations from the policy in the form of directed lending to SOEs and financing of social programs, despite the fact that these risks are expected to be partly mitigated by the activation of the privatization program and the reduction of the scale of preferential lending within the next years.

Uzbekistan is one of the leading countries in the world in terms of diversity and availability of natural resources (mainly gold and natural gas), which contributes to sustainable economic growth. At the same time, the country has long been in a water crisis, the severity of which may increase with the reduction of water resources amid the melting of mountain glaciers due to global climate change. Agriculture is the most exposed to water risk, accounting for around 30% of gross value added.

GDP per capita in PPP terms over the past five years has expanded by 30% to US$8,800. However, Uzbekistan remains lagging other peers in the Central Asian region. Furthermore, the unadjusted HDI as of 2018 also remained extremely low, at 0,71 (109th place among 189 countries).

After the period of price and exchange rates liberalization, inflation remains high and volatile in Uzbekistan. Mostly triggered by the food price increase, inflation in 2019 hiked once again to 15,2% after a slowdown in 2018 (14,3% as compared to 18,8% in 2017), but remained within the CBU's forecast corridor. We expect the inflation to decrease gradually by the end of 2020 and to be close to the upper bound of the CBU’s corridor of 12-13,5%, if the macroeconomic environment remains stable.

Institutional development continues to be hampered by high level of corruption perception, moderately weak checks and balances system and rule of law indicators. According to Transparency International, the Corruption Perception Index was 25 out of 100 in 2019, while Government Effectiveness and Rule of Law Indexes stood at -0,55 and -1,1 in 2018. However, Uzbekistan reached significant progress in the World Bank's Ease of Doing Business ranking by occupying the 69th position out 190 countries in the 2020 report and it also showed a substantial increase in governance transparency.

The national capital markets remain undeveloped in global terms despite the ambitions reforms, which started in 2019. The stock market remains represented by a limited number of participants with a narrow range of financial instruments and a high concentration of trades (ten largest issuers account for about 73% of the annual trading). However, we notice substantial growth of the number of market participants, issuers, traded shares as well as new instruments, including traded UZS government bonds, which were issued in order to create a benchmark for local issuers and add more instruments for the management of liquidity in the banking system. However, despite the fact that national companies capitalization to GDP more than doubled over the last six years, it remains below 10% of GDP.

The level of financial dollarization remains elevated at 47,7% for loans and 43,9% for deposits by end-2019, showing still high demand for lending in foreign currency and not enough confidence of the population in the national currency (very weak stress factor).

The following developments could lead to an upgrade:

• Ensuring macroeconomic stability, economic growth and reduction of unemployment through a smooth continuation of the initiated reforms and restructuring of the public business sector;
• Prudent and transparent fiscal policy focused on diversifying revenue sources and significant curtailing of policy lending programs;
• Improving the efficiency of monetary policy, its consistency and providing more freedom to monetary authorities, resulting in a long-term and controlled reduction of inflation and levels of financial dollarization.

The following developments could lead to a downgrade:

• Strong growth of directed lending with concentration in state banks, which may lead to increased external imbalances, higher inflation and materialization of contingent liabilities;
• Sharp increase of dollarization levels due to adverse conditions in the FX-market;
• Elevation of the government debt load due to devaluation of UZS, taking into account the high share of FX-denominated debt.