An International Monetary Fund (IMF) staff team led by Ron van Rooden conducted a remote mission from January 25 to February 16, 2021 in the context of the 2021 Article IV consultation with Uzbekistan. At the conclusion of the mission, Mr. van Rooden issued the following statement:

Recent Developments, Outlook, and Risks

1. The COVID-19 pandemic has had a marked, but so far relatively short-lived, adverse impact on Uzbekistan’s economy. Although the pandemic hit the economy hard in the first half of 2020 and inflicted considerable hardship, the recession was moderated by strong and timely containment and support measures. These included an effective public health response and the deployment of a set of fiscal, monetary, and financial measures, made possible by substantial buffers owing to prudent macro-economic policies in preceding years, and thanks also to sizable international support. This strong policy reaction allowed for a sharp rebound in activity in the second half of the year, while the agricultural and construction sectors showed resilience throughout the year. This resulted in Uzbekistan being among the few countries posting positive overall growth in 2020, at a rate of 1.6 percent, although this was still about 4 percentage points less than the growth rate projected prior to the pandemic.

2. The authorities’ large support package was timely and well-targeted . The amended 2020 budget included sizable additional spending on health care, social assistance and investment, as well as support for businesses, including through tax relief and financial support. The actual uptake was less than expected, in part reflecting the faster-than-expected turnaround in activity, as well as some delays in investment spending, resulting in an overall fiscal deficit of about 4½ percent of GDP in 2020, or some 2½ percentage points less than envisaged in the amended budget. The Central Bank of Uzbekistan (CBU) lowered its policy rate and provided additional liquidity to banks, thus supporting overall liquidity and credit. Banks were encouraged to allow firms and households to defer loan payments, providing sizable financial relief. Inflation continued to fall, although higher food prices kept overall inflation in the low double digits, ending the year at just over 11 percent.

3. Growth is expected to pick up further in 2021, but the level of uncertainty remains high and the recovery will depend especially on vaccine rollout. With the rollout of vaccines globally, the expected recovery of trading partner growth, and building on the domestic recovery in the second half of 2020, the economy is projected to grow by about 5 percent in 2021. The recovery could be delayed, however, by a resurgence of infections, a slower-than-expected rollout of vaccines, or possible new containment measures, as well as slower growth in Uzbekistan’s main trading partners and fluctuations in commodity prices, notably the price of gold. Given the current funding constraints of the World Health Organization’s COVAX program, the authorities rightly aim to secure vaccines from other sources as well.

Fiscal Policy

4. The recovery will also depend on continued economic policies to protect lives, support growth, and mitigate economic scarring from the pandemic . It is no time to let up. The 2021 budget appropriately maintains an accommodative fiscal policy stance, allowing an overall fiscal deficit of up to 5½ percent of GDP, including by ensuring that health care systems and vaccines purchases and distribution are adequately resourced, while social assistance is further expanded. Wage increases to catch up with inflation, which had been delayed in 2020, will also help support demand. Should downside risks materialize, additional support would be warranted. Notably, there is room to expand fiscal support further, by raising targeted transfers to vulnerable households and viable firms and accelerating public investment plans. As unemployment and poverty have increased due to the pandemic, there is a need to further expand the coverage of the social safety net, while improving its targeting.

5. The higher budget deficit this year can be offset by a gradual fiscal consolidation in subsequent years. Although public and publicly guaranteed debt is still at a relatively moderate level, it reached almost 38 percent of GDP at end-2020, nearly double the level of a few years ago. The government’s plan to move toward a rules-based medium-term fiscal framework is welcome. By gradually bringing the overall deficit down to around 2 percent of GDP in the years ahead, in line with the authorities’ commitments, public debt should remain sustainable. Existing international reserve buffers and low rollover risks mitigate potential risks of debt distress. As the recovery gets firmly underway, resources can be freed up to invest in human capital and infrastructure to help achieve the Sustainable Development Goals (SDGs). At the same time, the authorities should carefully manage external borrowing, especially by strengthening procedures for prioritizing capital projects, by establishing a single pipeline of appraised projects and ensuring their full integration in budget processes. Similarly, the authorities should enhance the assessment of fiscal risks, including from state-owned enterprises (SOEs) and public-private partnerships.

Monetary and Financial Policies

6. The CBU’s monetary policy stance remains appropriate. Monetary policy should continue to focus on further reducing inflation, while allowing exchange rate flexibility, to further build credibility and better anchor inflation expectations. Under current policies, inflation is projected to continue to gradually decline, to just under 10 percent by end-2021. The CBU has made substantial improvements in its monetary policy framework and its operations, but policy transmission remains constrained by a low level of financial intermediation, notably a low share of private deposits in banks’ funding, and a high degree of dollarization. Continued sound monetary policies and further financial sector reforms, while continuing to safeguard central bank independence, remain needed to strengthen confidence in the national currency and the banking system. Lending rates should be fully market-determined, with lending at preferential rates replaced by subsidies for those activities that the authorities wish to support.

7. The CBU should closely monitor the banking system, as the full impact of the pandemic on its financial health is likely yet to be observed . Banks entered the crisis with relatively strong capital buffers but the CBU rightly instructed banks to refrain from paying dividends. As the pandemic recedes and loan deferrals are phased out, comprehensive third-party asset quality reviews and stress tests will need to be conducted and loan losses recognized. Risks may also arise from the high credit growth in recent years that banks financed mainly via wholesale funding and to a large extent in foreign currency. Additionally, loan portfolios show high concentration and foreign currency risks, with the largest exposures mainly to SOEs. Supervision will need to be strengthened further, while the planned adoption of a new bank resolution law and amendments to the deposit protection law will improve the CBU’s ability to deal with any banking sector difficulties.

Structural Reforms

8. The authorities not only face the challenge of supporting the recovery, but also continuing with Uzbekistan’s transformation to a modern market economy. Uzbekistan has made significant progress during the last few years in implementing ambitious reforms. The first phase focused mainly on improving overall macro-economic management, with price, foreign exchange, and trade liberalization, and major improvements in fiscal and monetary policy frameworks. The reform agenda is still large, however, and the pace of reforms has inevitably slowed due to the impact of the pandemic on administrative capacity.

9. Structural reform implementation needs to be accelerated to lay the basis for strong, sustainable, and more inclusive economic growth . The authorities recognize this, as highlighted also in the President’s New Year’s address to parliament. The next phase of reforms, as noted also in the President’s address, will need to focus on reducing the large role of the state in the economy and creating a vibrant and resilient private sector. These reforms will require careful preparation and sequencing, with the continued assistance from the International Financial Institutions and other advisors. The timely implementation of these reforms is important as many of these may take time to generate results.

10. Improving incentives, institutions, and inputs are key to creating a vibrant private sector and attracting more private investment:

• To strengthen incentives, the authorities should progress with opening markets, increasing competition, and allowing prices to be determined by market forces to ensure an efficient allocation of resources. These are areas where progress can be made relatively quickly and where international experience shows that results can be substantial. This includes removing remaining barriers to market entry and eliminating tariff, tax, and other privileges that notably SOEs enjoy. Open and competitive procurement markets are important for government spending efficiency. Streamlining business regulations and, importantly, enhancing their predictability and stability are necessary, as frequent and ad-hoc changes deter investors. The planned establishment of wholesale markets for natural gas and electricity will be a major step toward efficient energy pricing and eliminating large but poorly targeted implicit subsidies. To protect vulnerable households, however, raising household energy tariffs should go hand in hand with expanding the social safety net. The resumption of the WTO accession process and Uzbekistan’s increased access to EU markets will promote trade integration and benefit Uzbekistan’s businesses and consumers.
• Competition will also be enhanced by the planned reform of the large SOE sector. Last year’s presidential decree set an ambitious agenda for the reform and divestiture of nearly 3,000 SOEs. The government has already started to divest minority stakes and smaller assets via an online platform and is aiming to privatize several larger SOEs this year. Adoption of a new privatization law will help improve the legal framework for selling larger enterprises. The government should continue to hire reputable advisors to help attract strategic investors for companies that will remain (largely) in state hands and prepare other larger SOEs for sale via open and transparent processes. A new state-ownership law will help better define the ownership principles for companies that will remain in state hands. Meanwhile, the government should focus on improving the governance and financial reporting of large SOEs and place them more at arms’ length from the government. Limiting government guarantees for SOEs will help instill greater financial discipline.
• Enhancing institutions requires creating a level playing field for businesses that is well-regulated in line with international best practices and in which property rights are well protected and contracts can be enforced. The Antimonopoly Committee should further step up its efforts to break up monopolies and remove other distortions. An independent energy sector regulator will need to be established to set and adjust tariffs until these can become fully market determined. Moreover, the authorities should continue to improve governance and ensure strict adherence to the rule of law. The authorities have embarked on a far-reaching reform of the judicial system, aimed at strengthening the independence and integrity of the judiciary. Key steps will need to focus on strengthening the independence of the Supreme Judicial Council and the procedures for the selection of candidates to judicial offices, as well as the organization of courts. The Anti-Corruption Agency is tasked with investigating possible corruption, but success in tackling corruption will also depend on fair and credible prosecution and adjudication. The planned asset and income declaration scheme will help detect corruption but should be kept manageable, by focusing on senior officials, and made effective through increased transparency. Similarly, building on the increased transparency of pandemic-related spending, the planned creation of an online platform for all public procurement will also increase transparency and will be a major step in reducing opportunities for corruption. In this regard, it will be important that the portal provides key information on awarded contracts and the beneficial owners of the companies that obtained them. Business registers should be improved to ensure that they contain accurate and up-to-date information on the ultimate beneficial owners of companies. More broadly, the ongoing digitalization of government services, including tax and customs, will increase efficiency and further reduce opportunities for corruption.
• Enhancing access to inputs is important as well. Businesses have noted limited access to resources, such as finance, land, energy, and qualified labor as constraints. A key area that can contribute significantly to stronger growth is improving access to finance, by advancing financial sector reforms, including efforts to improve state-owned banks’ governance and to divest most of these. These reforms will help create a healthy and competitive banking system that can efficiently facilitate financial intermediation. Increasing land tenure rights and making them tradable are needed to help increase investment and hence productivity in agriculture. The authorities also rightly focus on investing in human capital, in health care and education, notably higher education, which, together with efforts to improve the efficiency of public spending, will improve labor skills and help achieve the SDGs. Additional investment is also needed to address bottlenecks in infrastructure and the energy sector, including to improve its efficiency.

11. The successful implementation of the reform agenda will require the steadfast determination of the authorities, but also the continued support of the international community. The IMF stands ready to continue to support Uzbekistan in these efforts with policy advice, technical assistance, and financial assistance if needed.