Overview

• As remittance inflows normalize following a sharp uptick in 2022, we expect Uzbekistan’s current account deficits will widen in 2023 and exceed an average of 5% of GDP through 2026.
• We also expect growth in social spending to drive higher fiscal deficits over 2023-2026 compared to our previous estimates, while concerns over government-related entity debt and their management remain.
• However, Uzbekistan’s net general government debt remains moderate, affording the authorities temporary headroom to increase social spending, while ongoing economic and energy price reforms should support economic growth prospects over the medium term.
• We therefore affirmed our ‘BB-/B’ foreign and local currency sovereign credit ratings on Uzbekistan. The outlook is stable.

Rating Action

On Dec. 1, 2023, S&P Global Ratings affirmed its ‘BB-/B’ long- and short-term foreign and local currency sovereign credit ratings on Uzbekistan. The outlook is stable.

The transfer and convertibility (T&C) assessment remains ‘BB-‘.

Outlook

The stable outlook reflects our expectation that Uzbekistan’s comparatively strong fiscal and external stock positions and low interest burden should continue to help its economy withstand potential negative macroeconomic spillover effects from the Russia-Ukraine war. The stable outlook also incorporates our expectation of a rising government and external debt burden.

Downside scenario

We could lower the ratings if Uzbekistan’s fiscal and external positions weaken more than we currently expect, leading to faster growth in total external debt. This could, for instance, result from a more significant fallout from the Russia-Ukraine war through the channels of trade, remittances, or higher domestic social risks. In addition, the ratings could come under pressure if inadequate government oversight or administrative capacity led to payment delays by government-related entities (GREs), with possible implications for government-guaranteed debt.

Upside scenario

We could raise the ratings if Uzbekistan’s economic reforms result in stronger economic growth potential and broader diversification of export receipts and fiscal revenue, while fiscal and external metrics improved.

Rationale

Amid the ongoing Russia-Ukraine war, weaker growth outlook in China and other key trade partners, and still-high inflation, Uzbekistan is largely addressing risks to growth and social stability through fiscal stimulus and administrative price controls. We estimate a fiscal deficit of 5.5% of GDP this year relative to 3.5% in our previous forecasts, because the government increased wages and social spending. We also expect fiscal consolidation will proceed more slowly since some of the social spending will be harder to reverse.

We consider that part of the debt burden of GREs could potentially crystallize on the government’s balance sheet. The recent deterioration in the payment capacity of some GREs in the gas and agriculture sectors, due to weak corporate governance and financial profiles, could also have spillover effects on the broader economy. Nevertheless, the government has started raising tariffs for electricity and gas, while still maintaining much lower prices than several of its neighbors. Energy price liberalization and other economic reforms including privatizations should support economic growth of above 5% over the next four years.

Uzbekistan’s high development needs will keep imports and current account deficits elevated, while its commodity exports are susceptible to volatility in prices. The one-off impact from an influx of remittances and money transfers in 2022, mainly from Russia, will fade. Uzbekistan has also turned to a net gas importer from a net exporter as domestic gas consumption has spiked, while production has declined. We expect that gross external financing needs will average about 92% of current account receipts and usable reserves over the next four years.

Our ratings on Uzbekistan are supported by the economy’s overall net external asset position and the government’s moderate debt levels, although these metrics are on a weakening trajectory. Uzbekistan’s fiscal and external stock positions have historically benefitted from the policy of transferring some revenue from commodity sales to the sovereign wealth fund, the Uzbekistan Fund for Reconstruction and Development (UFRD). In addition, external borrowing was limited for many years under the previous regime of the former president, Islam Karimov, and it only began to rise in recent years.

Our ratings are constrained by Uzbekistan’s low economic wealth, measured by GDP per capita, and low–albeit improving–monetary policy flexibility. In our view, policy responses are difficult to predict, given the highly centralized decision-making process and less developed accountability and checks and balances between institutions.

Institutional and economic profile: Growth momentum to remain strong, notwithstanding significant external risks

• We estimate economic growth at 5.6% in 2023, followed by slightly lower growth of about 5.0% of GDP over 2024-2026.
• Economic and governance reforms, including plans to partially privatize several GREs, will continue at a gradual pace.
• We also believe decision-making will remain centralized and the perception of corruption high, although on an improving trend.

Uzbekistan’s economy continues to weather the spillover effects from the Russia-Ukraine war reasonably well, even as remittance inflows and money transfers from Russia decrease from the highs of 2022. Remittance inflows declined by one-third during the first nine months of 2023 to $8.4 billion, after almost doubling to $17 billion (21% of GDP) for full-year 2022. The decline this year likely reflects one-off transfers of savings last year after the war started, decreasing number of Uzbek workers in Russia, higher living costs in Russia, and the strengthening of the Uzbek sum (UZS) against the Russian ruble. That said, remittances are still about 45% higher than in 2021. Russia remains Uzbekistan’s largest remittance source, contributing about 80% of total remittances.

We expect real GDP growth averaging 5.2% over 2023-2026, supported by domestic demand and investment. Government stimulus in the form of tax incentives for businesses, export incentives, and social protection measures including providing subsidized mortgages and free medical services for vulnerable parts of the population, will drive consumption growth even as remittance inflows slow. The government also plans to expand the generation of electricity and volumes of gas, along with production of copper, gold, silver, and uranium, mainly through public private partnerships (PPPs) and foreign investment.

Uzbekistan’s growth has been heavily investment-led over the past five years, with one of the highest investment-to-GDP ratios globally at about 35%. The government has borrowed externally to support projects in the electricity, oil and gas, transportation, and agricultural sectors. Foreign direct investment (FDI) inflows remain relatively low and concentrated in the extractive industries. We expect that FDI inflows will increase only gradually despite the ambitious pipeline of privatizations, partially due to lower investment from Russian companies.

Uzbekistan’s broader economic reforms, including the planned transformation and privatization of GREs, and energy subsidy reforms should continue to support longer-term economic growth. In August 2023, the government consolidated the ownership of 31 key state-owned corporates and banks under the Ministry of Finance with a view to reforming them and eventually privatizing some of these entities. Authorities started to raise electricity and gas tariffs for businesses from October after several years of delays due to the pandemic and external uncertainty. We expect that energy price liberalization will be phased over several years.

Uzbekistan has made progress on the economic modernization agenda since reforms began in 2017. These have included a new privatization law, an increase in transparency regarding economic data, and the liberalization of trade and foreign exchange regimes. The government also passed laws to privatize agricultural and nonagricultural land, abolished state orders for cotton, liberalized wheat prices, and expanded the concept of private property. Fiscal transparency has increased with the government bringing significant extra-budgetary spending onto the budget.

Despite strong growth, the country’s credit quality is constrained by relatively low GDP per capita when compared globally, estimated at $2,400 in 2023. That said, Uzbekistan benefits from favorable demographics, given that its population is young. Almost 90% are at, or below, working age, which presents an opportunity for labor-supply-led growth. However, it will remain challenging for job growth to match demand, in our view. Weakness in the Russian economy, where most of Uzbekistan’s permanent and seasonal expatriates are employed, could further exacerbate this issue.

In our view, the risk of significant secondary U.S. and EU sanctions on Uzbek companies and institutions doing business with Russia remains relatively low since the government tries to remain compliant with Western-alliance-led sanction requirements. For example, in 2022 the Russian Mir card system was partially suspended and the purchase of UzAgroExportBank by Russian Sovkombank was halted due to sanctions on Russia. The bank was later sold to a local Uzbek investor. We understand that one private company, Promcomplektlogistic, reportedly breached sanctions, leading to secondary sanctions imposed by the U.S. In response, the government introduced enhanced diligence processes, automated screening measures, and stress testing.

A new constitution adopted in May 2023 lengthened the presidential term limit to seven years from five and allows the current president to remain in power until 2037. The incumbent president, Shavkat Mirziyoyev, won the election held on July 9, 2023, that followed the constitutional referendum, by securing 87% of the votes. International observers noted a lack of competition in the election. In our view, policy responses can be difficult to predict, considering the centralized decision-making process and, despite reforms, a limited number of checks and balances between institutions. Significant uncertainty over future succession remains.

Flexibility and performance profile: Government and external debt levels to continue rising

• We expect net general government debt will reach about 28.5% of GDP by 2026, compared to a net asset position in 2017.
• After a temporary dip in 2022, we forecast Uzbekistan’s current account deficits will average nearly 5.3% of GDP through 2026. These will be funded through a combination of net FDI and debt.
• Despite improvements in monetary policy in recent years, we still view the central bank’s operational independence as constrained, while loan dollarization remains elevated at about 43%.

To mitigate the fallout from the Russia-Ukraine war and high food prices, the government has further increased wages and social spending this year. Authorities increased allocations for health spending, tax incentives for businesses and importers of food, food price controls, and financial resources for exporters. We expect the fiscal deficit will reach 5.5% of GDP in 2023, significantly higher than the budgeted 3.0%. From 2024, we expect gradual fiscal consolidation on the back of electricity and gas tariff reforms, moderating capital expenditure, and better targeted social spending, along with improvements in tax collection. As the government works to reduce the gray economy and improve operations at GREs, we expect the tax base will gradually increase.

The government expects the fiscal deficit to drop to 4% in 2024 and 3% in 2025. We expect slower fiscal consolidation over the coming years, with the deficit projected to reach 3.7% of GDP by 2026 because of potentially higher expenditure on social protection, such as medical services, pensions, and targeted support to vulnerable populations. Further risks to our fiscal projections remain, including from reliance on the sale of commodities, such as gold, the prices of which can be volatile. Social spending, including wages, makes up about 50% of government expenditure and can be difficult to adjust for political reasons.

As a result of higher-than-anticipated fiscal deficits, we expect gross government and government-guaranteed debt will increase to 42% of GDP in 2026, from 37% in 2022. We include government-guaranteed debt in government debt because of the close links with GREs. The state debt law approved by the president in April sets a permanent debt ceiling at 60% of GDP. There are also limits on annual borrowing, PPP debt levels, and state guarantees. The state is allowed to borrow external debt of up to $5 billion in 2024.

We think there is also a risk that the relatively large nonguaranteed GRE and PPP debt materializes on the government’s balance sheet. GREs have significantly increased borrowings in recent years, particularly in foreign currency, to finance energy and infrastructure projects. Notwithstanding limits on new external debt, GREs could face challenges in repaying this debt if some of the projects fare worse than expected, or if there are lapses in management or supervision.

To reduce external risks and exposure to fluctuations in currency movements and build domestic capital markets, the government is increasing domestic borrowing. The proportion of domestic debt to total debt increased to 18% as of June 30, 2023, from 11% at year-end 2022. Slightly more than half of domestic debt is in short-term treasury bonds and bills. The government also issued U.S.-dollar-denominated Eurobonds in October 2023 of $660 million, and sum-denominated green bonds worth UZS4.25 trillion (about $349 million). The green bonds were placed for three years at an annual rate of 16.25%, while the five-year Eurobonds were priced at 7.85%. The government is looking to introduce the participation of nonresidents in local currency debt.

As the proportion of domestic and commercial debt increases, borrowing costs will also rise from a low base. Currently, about 90% of external debt is on concessional terms. The weighted-average interest rate is about 17% for short-term treasury bills and the 10-year government bonds. The government plans to continue raising concessional debt in parallel from the World Bank, Asian Infrastructure Bank, and Asian Development Bank to finance its developmental needs.

The government’s liquid assets, estimated at 17% of GDP in 2023, are mostly kept at the UFRD. Founded in 2006, and initially funded with capital injections from the government, the UFRD receives revenue from gold, copper, and gas sales above certain cutoff prices. We include only the external portion of UFRD assets in our estimate of the government’s net asset position because we view the domestic portion, which consists of loans to GREs and capital injections to banks, as largely illiquid and unlikely to be available for debt-servicing if needed.

Uzbekistan’s exports remain reliant on commodities, which comprise about 40% of goods exports, particularly gold. The current account deficit surged during first-half 2023 to 7.7% of GDP, largely due to a drop in remittances and strong import growth. Higher global commodity prices and gold sales helped exports increase significantly in 2022. However, we expect gold prices to decline gradually over our forecast period from $1,850 per ounce (/oz) in 2023, to $1,500/oz in 2024 and $1,400 in 2025 (see “S&P Global Ratings Metal Price Assumptions: Holding Higher For Longer,” published Oct. 17, 2023, on RatingsDirect). Conversely, increasing copper prices could offset part of the decline.

We project that current account deficits will average 5.3% over 2023-2026, fueled by imports of capital and high-tech goods. Uzbekistan became a net importer of gas in October 2023 after it started importing Russian gas via a pipeline through Kazakhstan. Along with increasing household consumption, large projects like the Gas to Liquids Plant, Shurtan Gas Chemical Complex, and Gas Chemical Complex MTO (methanol to olefin) will add to gas consumption and imports over our forecast period.

Uzbekistan remains in a net external asset position vis-à-vis the rest of the world. However, the country’s gross external debt has been rising in recent years, particularly within the public and financial sectors. In our view, this increase primarily reflects the opening of the economy and its sizable investment and development needs. A large proportion of the rise is attributed to official rather than commercial creditors. Our current external forecasts are based on the expectation of a moderation in the pace of foreign debt accumulation over the forecast horizon.

We estimate that Uzbekistan’s usable foreign exchange reserves will marginally decline through 2026 due to lower gold prices and ongoing current account deficits. The Central Bank of Uzbekistan’s (CBU’s) holdings of monetary gold comprise nearly 80% of total usable reserves. The CBU is the sole purchaser of gold mined in Uzbekistan. It purchases the gold with local currency, then sells U.S. dollars in the local market to offset the effect of its intervention on the Uzbek sum. We exclude UFRD assets from the CBU’s reserve assets because we consider them as fiscal assets. Our view is supported by the budgetary use of external UFRD assets in the domestic economy over the past four years. The UFRD’s total assets were $16.7 billion as of Oct. 31, 2023, with the liquid portion at $6.5 billion.

Uzbekistan’s monetary policy effectiveness has been improving in recent years. One of the most significant reforms in that regard was the liberalization of the exchange rate regime in September 2017 to a managed float from a crawling peg, which was heavily overvalued compared with the parallel-market rate. The CBU intervenes in the foreign exchange market intermittently to smooth volatility and mitigate the increase in local currency from its large gold purchases.

In 2020, the CBU adopted measures to transition to an inflation-targeting mechanism. Inflation remains high due to elevated energy and food prices, averaging 10.4% in the first nine months of 2023. The CBU expects it to fall to about 5% by second-half 2025, a delay from its earlier projection of 2024. We forecast inflation will remain near 11.0% this year, then average 7.7% in 2024-2026. The CBU maintained its policy rates at 14% at an October 2023 meeting, after reducing them 100 basis points in March 2023 following earlier rounds of tightening.

In our view, the large footprint of state-owned banks in the sector, at about 70% of total assets, and preferential government lending programs reduce the effectiveness of the monetary transmission mechanism. However, we note that directed lending at preferential rates has been gradually diminishing. Dollarization, although declining, also remains high at about 45% of loans and 32% of deposits as of October 2023. We expect local currency deposit growth will outpace that in foreign currency because of interest rate variances and differences in the reserve requirement for banks.

In our view, Uzbekistan’s banking sector will continue to show resilience. We consider that the economic recovery and low penetration of retail lending in Uzbekistan (with household debt to GDP at below 10%) will remain among the key factors contributing to lending demand growth in the next few years. However, we think credit costs will remain elevated at about 2.0%-2.2% in 2023-2024. The funding profiles of Uzbek banks are largely stable, supported by sizable funding from the state and international financial institutions and growth in corporate and retail deposits. Nevertheless, access to long-term funding remains scarce in the domestic market. While the license withdrawals affecting Turkiston Bank and Hi-Tech Bank in 2022 suggest a clean-up of weaker institutions, they also underpin our view of a less predictable and transparent approach to regulatory actions.

Selected Indicators

Table 1

Uzbekistan Selected Indicators

Source: S&P Global Ratings