Fitch Affirms Uzbekistan at ‘BB-’; Outlook Stable
Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings Fitch Ratings has affirmed Uzbekistan’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘BB-’ with a Stable Outlook.
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, high inflation and structural weaknesses in terms of low GDP per capita and weak institutional and governance levels relative to peers’.
Resilience to the Covid-19 shock reflects Uzbekistan’s reform progress in fiscal, monetary and foreign-exchange (FX) policy improvements, reduced state intervention in key sectors of the economy and financial and technical support from multilateral institutions. Government debt increased at a fast pace even prior to the Covid-19 crisis, but in light of expected policy measures and macroeconomic performance we project that debt will stabilise at a level well below the ‘BB’ median over the medium term.
Contrary to an estimated ‘BB’ median contraction of 4.4% in 2020, the Uzbek economy expanded 1.6%, supported by manufacturing on the back of the gold mining industry, construction and agriculture. Stable remittance inflows partly supported private consumption. We forecast that growth will accelerate to 5% in 2021 and 5.5% in 2022, as fiscal policy will continue to support investment and consumption, as key trading partners also recover. The evolution of the pandemic and delays in the rollout of vaccination campaigns given global supply constraints present downside risks to our growth forecast.
Uzbekistan’s overall fiscal deficit widened to 4.4% of GDP (versus the budgeted 7.5%), thus outperforming the ‘BB’ median of 7.9%. The consolidated budget deficit (general government plus the Uzbekistan Fund for Reconstruction and Development (UFRD) operations and externally financed expenditure) widened moderately to 2.9% of GDP, reflecting stronger-than-expected tax collection and gold revenues, a shorter-than-expected second lockdown in 2H20 and postponement of some investment projects.
Uzbekistan will maintain an accommodative fiscal policy in 2021 targeting a 5.4% of GDP overall deficit (3.5% consolidated) and focusing on health, education, social spending and investment. Net policy lending will increase to 2% of GDP, from 1.6% in 2020, due to the UFRD’s equity contributions to large investment projects. Fitch expects that the reduced scale of UFRD financing mitigates near-term risks to macroeconomic stability.
Authorities aim to shrink the overall deficit to 3% and 2% of GDP in 2022 and 2023, respectively, and are currently working with international financial institutions (IFIs) to develop a fiscal rule to provide a policy anchor for public finances. We expect a more gradual fiscal consolidation (4% in 2022) given our expectation of continued emphasis on investment and social spending amid the post-pandemic recovery and progress in the reform agenda.
Government debt rose to 38% of GDP (including 10.9% of GDP in external guarantees; domestic guarantees of 3.3% are not included) in 2020, from 28% in 2019 but still 20pp below the BB median. We project debt to reach 44% of GDP in 2022, still below the 59% ‘BB’ median forecast but more than double its 2018 level of 20%. The debt burden is also exposed to exchange-rate depreciation, as it is almost entirely foreign currency-denominated, closely linking macroeconomic stability and debt sustainability.
Some mitigating factors include the structure of government debt in terms of maturity and costs, with official debt accounting for 92% of the stock. The government also has high cash buffers (31% of GDP), including government deposits of 12% of GDP and UFRD liquid assets (USD10.5 billion or 19% of GDP).
The government intends to introduce a 60% of GDP debt ceiling (for public and public-guaranteed obligations) as part of the state debt law (the ceiling is already included in the 2021 budget) and has set annual borrowing limits since 2020. Post pandemic, establishing a record of adhering to borrowing targets and implementing a sustainable fiscal consolidation strategy will be important to preserve public finances as a key rating strength.
International reserves rose to USD34.9 billion (16.8 months of current external payments (CXP) vs 5.4 months for ‘BB’ peers) at end-2020 due to official and market external financing and higher gold prices. Gold currently accounts for 59% of gross international reserves. Sovereign net foreign assets reached 23% of GDP in 2020, still strong relative to ‘BB’ peers’, but Fitch expects this to deteriorate over 2021-2022 due to increased external borrowing. Uzbekistan’s net external creditor position remains robust at 51% of GDP. External debt, though, has increased rapidly, including increased borrowing from the banking sector, albeit from a low base.
The current account deficit narrowed to 5.4% of GDP in 2020 due to high gold prices, resilient remittances and a 10% decline in goods imports. Although reviving external demand will benefit non-gold exports, we expect domestic consumption and investment recovery to push up imports leading to current account deficits of 6.3% and 5.7% of GDP in 2021 and 2022, respectively, significantly above the projected 1.7% average for the ‘BB’ median.
Uzbekistan’s average inflation slowed to 13% in 2020 but remains among the highest in the ‘BB’ rating category. In spite of higher international commodity prices, we expect average inflation to slow further to 10.6% in 2021, as electricity and gas tariff adjustments have been postponed in 2020-2021, and assuming improved policy consistency and moderate exchange-rate depreciation.
After cutting a cumulative 200bp to 14% in 2020, the central bank has indicated that intends to maintain positive real rates, as part of its transition to inflation-targeting. In Fitch’s view, monetary policy effectiveness remains constrained by still high inflation expectations, high financial dollarisation, shallow capital markets and a high share of public sector-funded credit in preferential terms.
The banking sector has preserved stability, supported by the policy response from the central bank, including liquidity injections. Capitalisation levels (total capital adequacy ratio of 18.4% at end-February with Tier-1 at 16.4%) remain above regulatory requirements. Credit growth maintained a strong pace in 2020 at 31% yoy in nominal terms. The government aims to curb credit growth to the level of nominal GDP growth to mitigate the build-up of risks to financial stability and to support the reduction of macro-economic imbalances.
Fitch’s Macro-Prudential Indicator of 2* indicates moderate vulnerability due to fast credit growth. The impact of the crisis on asset quality has been moderate but is still filtering through the numbers (non-performing loans rose to 2.8% in February from 2.1% in December). Risks to the sector originate from continued exposure to state-owned enterprises (SOEs), rapid increase in external debt to fund the domestic credit expansion, an untested loan portfolio, and a large share of foreign currency-denominated loans (50%).
In spite of the challenging economic environment due to the pandemic and 2021 presidential elections, the government intends to accelerate SOE reform through the sale of government assets, transformation of large SOEs and the privatisation of at least one large bank in 2021. Institutional capacity constraints, considerations regarding the social impact of reforms, valuation of state assets, private-investor appetite and the government’s capacity to divest assets in line with global best practices will determine the pace of SOE reform.
Presidential elections are scheduled for October 2021 and incumbent president Mirziyoyev will likely gain a second term in office. The president maintains high popularity, as he has pushed forward with economic, political and social reforms since 2017. The country, though, is still in the process of developing an institutional framework to support long-term reform efforts.
Progress on the governance front is likely to be gradual and dependent on the implementation of reforms improving the independence of the judiciary, rule of law, building an anti-corruption framework and addressing international concerns regarding human rights.
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, as is the case for all sovereigns. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Uzbekistan has a low WBGI ranking at the 19th percentile, reflecting weak rights for participation in the political process and institutional capacity, uneven application of the rule of law and a high level of corruption.
The main factors that could, individually or collectively, lead to positive rating action/upgrade are:
- Macro: Maintaining high economic growth, for example, through the implementation of structural reforms, that reduces the gap vs. peers in GDP per capita, without creating macro-economic imbalances.
- Structural: Significant improvement of governance standards including rule of law, voice and accountability, regulatory quality and control of corruption.
- External and Public Finances: Significant strengthening of the sovereign’s fiscal and external balance sheets, for example, though sustained high commodity export prices and windfall revenues.
The main factors that could, individually or collectively, lead to negative rating action/downgrade:
- Public Finances: Greater deterioration in the medium-term outlook for public finances, for example, due to weak growth, a marked worsening in the government debt-to-GDP or the erosion of the sovereign fiscal buffers that could result in the removal of the +1 qualitative overlay notch on public finances.
- External Finances: Rapid weakening of external finances, for example, through a sustained widening of the current account deficit derived from rapid credit expansion, a significant decline in FX reserves or rapid increase in external liabilities.