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

Credit Fundamentals: Uzbekistan’s ratings balance robust external and fiscal buffers, low government debt and a record of high growth relative to ‘BB’ rated peers’, against high commodity dependence and structural weaknesses in terms of low GDP per capita, an uncompetitive and large, albeit reducing, state presence in the economy, and weak, but improving, governance levels.

Strong Commitment to Reforms: Uzbekistan’s government is progressing with key structural economic reforms, including privatisation of state-owned enterprises and a continued reduction in preferential lending to stimulate competition in the economy. The government plans to revive its energy tariff reform, after putting off implementation in May 2023. Successful implementation will benefit long-term public finances and reduce contingent liability risks from state-owned electricity distribution companies.

Political and Geopolitical Risks: President Shavkat Mirziyoyev won snap presidential elections in July under a new constitution that extends presidential terms to seven from five years. Uzbekistan’s World Bank Worldwide Governance Indicators (WBGI) improved by 9pp in the 2021 ranking to the 29th percentile overall (current BB median: 50th percentile), driven particularly by the Regulatory Quality Index (+17pp) and Government Effectiveness Index (+11pp).

The economy has proved resilient to spillovers from the Ukraine war and Russia sanctions so far, with Uzbek banks implementing controls to comply with western sanctions. Commercial ties with Russia will remain deep, and the government will continue balancing this with strong ties with western countries as it seeks to avoid becoming subject to secondary sanctions.

Strong External Finances: Uzbekistan’s external balance sheet is a key credit strength, with foreign-exchange (FX) reserves equivalent to 9.4 months of current account payables as of July 2023, and the economy in a net external creditor position. A very sharp increase in remittances, coupled with solid export growth (mainly to Russia), resulted in a near-balance on the current account in 2022. Rouble volatility contributed to a 25% drop in remittances in 1H23, although they are still high by historical standards.

Fitch expects the current account deficit to widen to 4.8% in 2023 - as remittances normalise and the trade deficit worsens - and to average 4.7% in 2024-2025 (projected BB median: deficit of 2.8%). The external liquidity ratio will average around 400% over 2023-2025 (current BB median: 144%).

Low Public Debt Levels: Fitch expects gross general government debt (including external state guarantees) to stabilise at just over 37% of GDP in 2023-2025 (1H23: 33.4%; current BB median: 54.1%). While 91.3% of government debt is FX-denominated as of 1H23, risks are mitigated by the high share of concessional debt (88.8% of external debt) and fairly long maturities (1Q23: 9.3 years) for external debt. Assets of the Uzbekistan Fund for Reconstruction and Development, a source of deficit financing, were 20% of GDP as of 1Q23, 50% of which were denominated in FX.

Widening Fiscal Deficit: Fiscal performance deteriorated in 1H23 due to a reduction in VAT receipts, higher social spending and postponement of planned energy tariff reforms. Fitch now expects a full-year worsened budget deficit of 5.1% (original budget target of 3%) for 2023, before it tightens to 4.3% in 2024 and 3.4% in 2025 given our expectation of rationalisation of subsidies, and more targeted social spending. Delays to full implementation of energy subsidy reforms would slow deficit shrinkage (to reach the medium-term fiscal deficit target of 3% of GDP).

Robust Growth Prospects: Uzbekistan recorded real annual economic growth of 5.6% in 1H23, following 5.7% growth in 2022. Household consumption was robust, while investments and exports also performed strongly. Fitch expects growth to reach 5.9% in 2023, before stabilising at around 5.7%, just above potential (estimated by authorities at 5.5%) in 2024-2025.

Dollarisation, Subsidised Lending: Dollarisation of bank deposits and loans is fairly high in Uzbekistan, at 44% and 28.7%, respectively, as of end-1H23, albeit down from early 2023. Directed lending has fallen substantially to 18% of new loans as of 1H23 (2017: 51%). Retail credit annual growth surged to 54% in June, but was well below the pace seen in 2018-2019 and largely reflects financial deepening, while household credit/GDP is low at 12.4%. Banks are well-capitalised and profitable, with improving asset quality (the NPL ratio fell to 3.4% as of 1H23 from a peak of 5.8% in 3Q21) but we see risks from the seasoning of loans issued at the start of the reform period (from 2017).

Inflation Pressures: Inflation has historically been high relative to peers in Uzbekistan, highlighting weak monetary policy transmission. While inflation fell to 8.6% in July from a peak of 11.9% in January-February, energy tariff hikes will result in a marked increase in inflation in 2024 to 13% on average, before falling to 6.5% in 2025 (inflation target: 5%). Fitch expects real interest rates to remain positive over the forecast horizon.

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 World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Uzbekistan has a low WBGI ranking at the 29th percentile, reflecting weak rights for participation in the political process, weak institutional capacity, uneven application of the rule of law and a high level of corruption.