Moody’s assigns issuer rating of B1 to the Government of Uzbekistan, outlook stable
Tashkent, Uzbekistan (UzDaily.com) -- Moody’s Investors Service assigned a first-time long-term issuer rating to the Government of Uzbekistan at B1. The outlook is stable. In addition, Moody’s has also today assigned a provisional rating of (P) B1 to Government of Uzbekistan’s forthcoming medium-term note program and a B1 rating to the planned drawdown from the program.
The ratings were initiated by Moody’s Investors Service and were not requested by the rated entity. The ratings on the medium-term note program and drawdown are being assigned ahead of planned issuance by the Uzbek government in the United States under Rule 144A.
The factors supporting the issuer rating include:
- Uzbekistan’s Economic Strength is "Moderate (-)". The economy’s shock absorption capacity is underpinned by robust growth potential supported by demographic trends, balanced by low incomes and very low competitiveness as the economy transitions from a planned, state-owned monopolistic system.
- Uzbekistan’s Institutional Strength is "Very Low" reflecting Moody’s assessment of the execution challenges involved in a very significant overhaul of the country’s institutions and design and implementation of new policy tools that would pave the way for a transition to a market-based economy, notwithstanding the authorities’ commitment to wide-ranging reforms.
- Uzbekistan’s Fiscal Strength is "Moderate (+)", supported by relatively low government debt currently financed at low costs, which provides some fiscal flexibility should financial pressure on the broader public sector rise, especially as state-owned enterprises face more competition.
- Uzbekistan’s Susceptibility to Event Risk is "Moderate", driven by political risks stemming from a potential rise in opposition to the reform program, in the face of short-term economic and social costs, that could slow its progress and impair its effectiveness.
The stable outlook reflects Moody’s expectations for balanced risks both over the near and medium term. Upside and downside risks mainly relate to the credit implications of the reforms now under way. Uzbekistan’s reform program could strengthen its credit profile if they led to a sustained increase in productivity growth and competitiveness and if they improved government and policy effectiveness. On the downside, opening state-owned enterprises and banks to more competition in a market-based environment could undermine Uzbekistan’s credit profile, at least in the near to medium term, as large financial and non-financial enterprises would potentially face significant losses in revenue, lower profitability and liquidity pressure. Such developments would weigh on Uzbekistan’s fiscal strength, external position and, potentially, on political stability particularly if related employment losses were significant.
Moody’s has also assigned a Ba3 local currency bond and bank deposit ceiling, a B1 foreign currency bond ceiling and a B2 foreign currency bank deposit ceiling. The local-currency bond ceiling reflects the maximum credit rating achievable in local currency for a debt issuer domiciled in Uzbekistan (similarly for a bank deposit). The ceilings on foreign-currency bonds and bank deposits capture foreign-currency transfer and convertibility risks. In addition, the short-term foreign-currency bond and deposit ceiling is "Not Prime.’’
Moody’s assessment of Uzbekistan’s "Moderate (-)" economic strength is underpinned by strong growth potential. Shock absorption capacity is offset by low income levels and weak competitiveness that could exacerbate and prolong an economic shock.
Over the past 10 years, Uzbekistan’s average annual GDP growth has been around 8%, partly supported by a relatively diversified export portfolio that mitigates exposure to falls in commodity prices. Uzbekistan benefits from favourable demographics, with a fast-growing young population. Moreover, Uzbekistan’s geographic position in the heart of Central Asia enhances its attractiveness to potential foreign and domestic investment. Overall, Moody’s expects GDP growth to average around 5.5% in the next five years.
However, these factors supporting economic strength are partly offset by low income levels, with GDP per capita at around $7,000 on purchasing power parity basis in 2017, which reduces households’ capacity to absorb income shocks. Moreover, at this stage, the government remains heavily involved in the economy, in particular in the banking sector and natural resources extraction and production (for example, mining, energy, and cotton). Preferential access to land, finance and the tax system favour state-owned enterprises (SOEs) and stymie the growth of private sector companies beyond a small scale, hampering productivity and competitiveness.
In particular and although Uzbekistan’s competitiveness ranking in the World Bank Ease of Doing Business indicator has improved recently, Moody’s believes that regulations that pre-date reforms, together with weak rule of law and control of corruption, continue to discourage foreign direct investment, hindering skills and productivity improvements.
The government has focused its reform program on introducing market pricing mechanisms and accelerating its industrialization program, with the aim of moving Uzbekistan’s products up the value chain. The reforms are at a very early stage, in many cases still being designed. The SOEs that dominate the economy and remain by far the main employers will face increasing financial pressure as they are exposed to more competition. Raising productivity and competitiveness would likely involve significant job losses amongst SOEs, with a negative and potentially long-lasting impact on growth.
Moody’s assessment of Uzbekistan’s "Very Low" institutional strength takes into account the authorities’ commitment to reform. This assessment also reflects the challenge involved in creating new institutions or reshaping existing ones to accompany the economy’s transition to a market-based system. This process involves designing and implementing new policy tools, the effectiveness of which is untested.
Uzbekistan scores very low, in the bottom 20% of Moody’s rated sovereigns on the Worldwide Governance Indicator’s Government Effectiveness measures, and bottom 5% on Rule of Law and Control of Corruption measures, despite some improvements in government effectiveness since 2013 following steps to improve bureaucratic skills and effectiveness.
Under President Shavkat Mirziyoyev, the country has embarked on a number of economic, trade, and foreign policy reforms, with the aim of liberalizing prices and introducing competition in a number of sectors. However, Uzbekistan lacks a full range of monetary and fiscal policy tools to preserve macroeconomic stability and offset potential shocks to the economy during the reform process. The transmission mechanism for monetary policy is weak as a significant share of bank lending remains directed by the government and credit risk is not priced. Fiscal policy has no track record of adjusting expenditure and planning revenue measures in response to the economic cycle and in adherence to long-term fiscal and social objectives.
The spate of economic and political reforms that followed in the wake of President Mirziyoyev’s election has been supported by the authorities’ strong commitment to transparency, with indications of allowance for greater freedom of expression and broader-based engagement in policy decisions. If sustained, greater transparency and accountability would enhance the effectiveness of policy.
Historically, Uzbekistan’s fiscal performance has been solid. Authorities ran fiscal surpluses from 2006, with an annual average surplus of 3.9% of GDP between 2006-2016. The fiscal policy response to the 2014-15 regional shock, when the Russian economy suffered a recession, shifted the budget balance from a surplus of 3.0% of GDP in 2014 to a deficit of around 1.8% of GDP in 2017 according to Moody’s estimates.
Moody’s estimates that the budget deficit will remain around 1.5% of GDP in the next few years. In part this reflects the likelihood that, in common with other transition economies, public investment will be a key element of the authorities’ development plans. Furthermore, government spending will increase to offset the negative effects of transition on specific segments of the population, similar to the subsidies currently directed at low income earners following removal of bread price controls which began in 2018. Moody’s also expects the government to support some SOEs with on- or off-budget transfers, as they face financial pressure in a more competitive environment.
Following Uzbekistan’s liberalization of the som exchange rate in September 2017, and a nearly 50% depreciation of the currency, general government debt increased significantly, though it remains low at around 24% of GDP in 2017. Modest deficits and strong nominal GDP growth point to broadly stable government debt. Further currency depreciation would lead to a more rapid increase in the debt burden. Over time, potentially more significant financial support to SOEs and state-owned banks than Moody’s currently assumes, also poses a risk to Uzbekistan’s fiscal outlook.
The Uzbekistan Fund for Reconstruction and Development (UFRD) provides a source of funding to smooth the economic shocks through the country’s transition. However, the UFRD also pursues an economic development objective through a portfolio of investments in infrastructure and development projects. As a result, roughly one third of the UFRD’s total assets are currently in the form of investments or loans, and not liquid or available for buffering economic shocks.
While the transition of political power following the election of the President Shavkat Mirziyoyev has been smooth, the reforms currently designed and implemented will potentially come at some economic and social costs which in Moody’s view could, over time, fuel opposition to them. So far, the government has offset the negative effects of reform on certain segments of the population. As the reforms broaden, such offsetting measures will become increasingly complex to design and financially costly to implement. Increasing opposition to reforms could lead to delays and raise uncertainty about the business environment, hampering investment.
For example, liberalising prices of staple foods such as bread or energy will have a significant impact on low-income households. Similarly, reforms of SOEs may cause significant job losses, just as large numbers of young people are entering the job market. Other countries implementing similar measures have seen reform fatigue evolve into resistance to reform.
Besides political risk, Uzbekistan’s susceptibility to event risk is determined by its liquidity risk, banking sector risk and external vulnerability risk.
Banking sector risk is "Low". The small size of the banking system with assets worth around 30% of GDP limits the potential contingent liquidity risks posed by banks to the government. Nonetheless, the banking system is highly dollarized and the government has in the past provided capital injections to support its banks, most recently just before the liberalisation of the exchange rate. The banking system also remains exposed to financial pressures building up amongst SOEs, who represent a substantial portion of total banking system loans.
Uzbekistan’s government liquidity risk is "Low". While the government’s gross borrowing requirements are at around 1.5% of GDP in 2018, reflecting a low debt burden financed at low costs, Uzbekistan’s access to funding should the need arise is untested.
Uzbekistan’s External Vulnerability Risk is "Very Low (-)". This reflects Moody’s view that while Uzbekistan will likely move from current account surpluses to modest current account deficits over time, this is likely to reflect an improvement in the business climate that would foster an increase in foreign direct investment flows. At $11.5 billion in October 2018, foreign exchange reserves are large and adequate to cover Uzbekistan’s imports and external debt payments.
The stable outlook on Uzbekistan’s rating reflects Moody’s expectations for balanced risks both over the near and medium term. Upside and downside risks mainly relate to the credit implications of the nascent reform program.
Uzbekistan’s reforms could strengthen its credit profile if they led to a sustained increase in productivity growth and competitiveness by improving the allocation of resources in the economy and focusing on the country’s areas of competitive advantage. If these reforms involved improvements in government and policy effectiveness and a strengthening of the implementation of the rule of law and corruption control, they would further support the credit profile.
On the downside, opening SOEs and banks to more competition in a market-based environment could undermine Uzbekistan’s credit profile, at least in the near to medium term, as large financial and non-financial enterprises would potentially face significant losses in revenue, lower profitability and liquidity pressure. Such developments would weigh on Uzbekistan’s fiscal strength and external position as well, potentially, on political stability particularly if related employment losses were significant and social stability was threatened.
Implementation of reforms that achieved higher productivity growth and competitiveness and demonstrated improved government and policy effectiveness would likely lead to an upgrade of the rating. Such reforms would entail measures that enhance the productivity and financial health of state-owned enterprises while fostering the development of private companies, and preserving financial and macroeconomic stability.
Indications that the policy measures being implemented would raise risks to financial and macroeconomic stability would likely lead to a downgrade. This could result from financial pressure rising for state-owned enterprises and banks as increased competition makes some business models unviable.