Tashkent, Uzbekistan (UzDaily.com) -- Moody’s Investors Service ("Moody’s")  has today upgraded the Government of Uzbekistan’s long-term issuer and senior unsecured ratings to Ba3 from B1 as well as the senior unsecured MTN program ratings to (P)Ba3 from (P)B1, and changed the outlook to stable from positive.

The upgrade reflects Uzbekistan’s demonstrated commitment to a comprehensive reform program in recent years that has been sustained throughout two significant, consecutive crises and which Moody’s expects to continue. Despite the coronavirus pandemic and Russia / Ukraine military conflict, real GDP growth, fiscal and external metrics have remained strong, reflecting the economy’s resilience and improved policy effectiveness in recent years. As fiscal and monetary tools continue to develop, Moody’s expects continued improvements in institutions and governance.

The stable outlook reflects risks of rising debt levels beyond Moody’s current expectations and geopolitical risks to growth. However fiscal risks are mitigated by the government’s relatively low and affordable debt burden, and substantial assets held in the Uzbekistan Fund for Reconstruction and Development (FRD).

Concurrently, Moody’s changed Uzbekistan’s local and foreign currency country ceilings to Ba1 and Ba3 from Ba2 and B1, respectively. The two-notch gap between the local currency ceiling and the sovereign rating reflects the government’s large footprint in the economy and weak policy predictability, balanced partially by moderate external vulnerability risk that reflects a persistent, though declining, current account deficit and moderate external debt stock that is on largely concessional terms. The two-notch gap between the foreign currency ceiling and the local currency ceiling incorporates Uzbekistan’s relatively weak monetary and fiscal policy frameworks, and a restricted capital account that may be prone to further transfer and convertibility restrictions in times of stress.

Moody’s expects Uzbekistan to continue implementing structural reforms, in time leading to further improvement in governance and institutions and the full realization of the economy’s growth potential. The government’s commitment to the reform agenda, despite two consecutive crises, has had broad support, although social and political risks to further reform will persist. Nevertheless, Moody’s expects the government will continue with more challenging reform, although the pace may moderate to manage social and political risks.

Uzbekistan has established a track record of effectively implementing a large part of its 2017-2021 reform agenda, significantly reducing the scope of state planning and introducing market-pricing mechanisms to a significant portion of the economy. Reforms to enhance property rights and accelerate the private sector’s development were also implemented prior to the pandemic. Since, the government implemented further price liberalization, finalized labor market and debt laws, and introduced a public procurement law.

Moody’s also expects additional progress on reforms currently in implementation (2022-2026 agenda), including large State-Owned Enterprise (SOE) IPOs and bank privatizations, which will lead to further improvements in productivity and competitiveness. These follow the privatization of smaller SOEs, and the unbundling of state gas and electricity companies. Corporate governance has also improved due to changes at the management board level of SOEs and state-owned banks.

Reforms have also translated into enhanced policy effectiveness in recent years, as illustrated by the authorities’ response to the coronavirus pandemic and Russia / Ukraine military conflict.

Following Russia’s invasion of Ukraine, the Central Bank of Uzbekistan (CBU) hiked its key policy rate by 300 basis points to 17% in March 2022 following the sharp decline of the soum against the US dollar and a rise in inflation. The refinancing rate was lowered to 15% in July 2022, and although headline inflation remains high, averaging around 12% from March 2022 to December 2022, Moody’s expects it to fall this year and next. Meanwhile the soum has remained relatively stable despite the shock.

Monetary reforms include introducing a range of soum-denominated government securities to develop Uzbekistan’s domestic capital markets. The government issued five and 10-year treasury bonds, as well as two-year inflation linked bonds in the market for the first time in 2022. Since February 2022, foreign and local retail investors are allowed to buy government securities in primary auctions. Moreover, the government plans to enhance open market operations to support the interbank repo and government securities market.

As for fiscal policy, the government established fiscal guardrails, such as a debt ceiling of 60% of GDP, annual borrowing limits, and the inclusion of more public-sector obligations on its balance sheet – enabling increased fiscal transparency and limiting the debt burden over time. As the economy opened, the government has run widening albeit still relatively small fiscal deficits in line with plans to expand social spending and invest in infrastructure to support the economic transition to a market-driven economy. Meanwhile, social security programs expanded during the pandemic have been made permanent in line with authorities’ ambitious goals of reducing poverty by half by 2026 and reaching upper-middle-income status by 2030. In response to inflationary pressures exacerbated by the Russia / Ukraine military conflict, the government also implemented targeted measures including a zero customs duty rate for key imported food items, increasing wages and pensions, one-off cash transfers, but also delaying energy reforms.

The stable outlook reflects balanced upside and downside risks. Downside risks include rising debt levels beyond Moody’s current expectations, though these risks are mitigated by the government’s relatively low and affordable debt burden, and substantial assets held in the FRD, acting as the sovereign wealth fund. Geopolitical risks also present downside risks to growth.

Moody’s expects Uzbekistan’s debt burden to stabilize below 45% of GDP within the next 3 years, lower than the Ba-rated median of 52% of GDP (2023-2025 average). Although Moody’s expects increased social spending (more than +25% per year in 2021 and 2022) and postponed energy reforms will result in delayed fiscal consolidation, widening deficits are mitigated by improved revenue collection recently due to tax reforms, as illustrated by a 33.6% and 28.4% increase in VAT and personal income tax revenues, respectively, between 2021 and 2022. Meanwhile, planned debt issuances in 2022 were delayed due to the unfavorable market environment – with the government drawing on assets instead, along with continued financing from international financial institutions. Yet FRD assets remain at $16.5 billion, with more than 50% in liquid assets that cover around 28% of general government debt in 2022.

Meanwhile, during the ongoing Russia / Ukraine military conflict, trade and remittance flows have outperformed expectations so far, with exports during January-November 2022 increasing by 12% compared with the same period in 2021, and remittances from Russia almost tripling over the same period. Concerns over mass return of migrant workers from Russia have not materialized. However, as the conflict evolves into a protracted war and sanctions on the Russian economy intensify, key risks remain, including unpredictable money flows, labor market pressures and repercussions on housing from Russian emigrants, and secondary sanctions risk. Inflation has increased and remains high, raising social risks. Yet the conflict also presents opportunities for Uzbek companies in logistics, trade and transportation, and tourism, as western companies exit the Russian market and Russians travel to the region. Moody’s expects GDP growth to moderate to 5% in 2023, due to a slowdown in remittances and inflation weighing on domestic private consumption but rebound the following year as government-backed construction and public investment projects accelerate.