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p. 16 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia Kazakhstan Kyrgyz Republic Tajikistan and Turkmenistan Uzbekistan Mongolia People’s Republic of China Southeast Asia South Asia The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : Central Asian Republics, Azerbaijan, and Mongolia

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Uzbekistan

The economy recorded its fifth year of consecutive GDP growth in 2000. This was at a slower pace than in the previous year, mainly due to a severe drought that hit agricultural production. Overall, the macroeconomic situation remains fairly stable but fragile, with the Government initiating long-awaited currency and trade liberalization reforms.

Recent Trends and Prospects

Economic growth decelerated in 2000 to 3.0 percent from 4.4 percent in 1999; the official target for the year was 4.2 percent. This was mainly the result of slower rates of expansion inagriculture and industry. A poor cotton harvest was caused by drought, while the stagnant growth in industrial output was due to the sharp drop in foreign direct investment and continuing structural problems in the economy.

The growth rate of agricultural output declined to 3.2 percent in 2000 from 5.9 percent in 1999. Grain production reached only 61 percent, and cotton 77 percent, of the target; cotton production was only 3.0 million tons compared with 3.7 million tons in 1999. Overall, the drought destroyed more than 300,000 hectares of sown land, including 50,000 hectares of rice and 30,000 hectares of cotton.

Industrial output slowed slightly to 5.8 percent in 2000 from 6.1 percent in 1999, which was attributed mainly to a lack of investment in the gold and energy sectors and a decline in the production of machinery and equipment. In contrast, ferrous metals, textiles, clothes, and footwear performed relatively well.

The services sector grew by 13.0 percent in 2000 compared with 12.6 percent in 1999 as the sector benefited from the effects of a flurry of private sector activities in wholesale and retail trading, restaurants, bars, hotels, and taxi services. The level of gross domestic investment declined to about 15.9 percent of GDP in 2000 from 17.1 percent in the previous year (see Figure 2.6). Meanwhile, the foreign share of the total volume of capital investments decreased to 22.7 percent in 2000 from 24.4 percent in 1999. Investors seem to have adopted a wait-and-see attitude ahead of the completion of the macroeconomic reform program (discussed below). In particular, very restrictive currency regulations remain a major disincentive to foreign investment.

Economic recovery since 1996 has contributed to employment growth, mainly in the private sector. Nevertheless, unemployment remains high. While the official unemployment rate was only 0.6 percent in 1999, the data mask considerable hidden unemployment in state-owned enterprises (SOEs) and in rural areas. SOEs and collective farms often retain surplus employees to avoid massive layoffs. Labor force participation rates tend to be lower in poorer regions and in rural areas.

Average annual inflation was reported at 28.2 percent in 2000 compared with 29.1 percent in 1999. The inflation target of 20 percent set by the authorities at the beginning of 2000 was exceeded due to a 51 percent increase in wages, the increase in fuel prices (which came into effect on 1 August 2000), and the depreciation of the sum (which fell by 70 percent against the dollar over the first half of 2000). Partly as a result of the government-initiated reforms, the difference between the official and curb market rates was reduced to about 2.5 times by the end of 2000, compared with about 3.5 times during certain periods of 1999.

The current account situation improved, with a surplus equivalent to 0.7 percent of GDP in 2000, compared with a 0.1 percent deficit in 1999. While export earnings declined in 2000 due to lower gold prices and falling cotton export volumes, imports fell even more due to increased import compression and intensified import-substitution policies, because of depreciation and import controls. Gross official reserves grew from $1.24 billion (5.8 months of imports) at the end of 1999 to $1.34 billion (5.2 months of imports) in 2000, while the external debt increased from 26.4 percent to 35.1 percent of GDP over the same period. Most of this debt was raised through the presale of gold and cotton. The debt-service ratio increased from 16.7 percent in 1999 to 28.7 percent in 2000.

With an improvement in tax collection and expenditure control, the state budget outcome was a small deficit of 1.2 percent of GDP at the end of 2000 compared with the 2.8 percent deficit targeted at the beginning of the year. The increase in revenues came from higher valued-added tax and excise tax receipts. Total government revenues remained virtually unchanged at 30.6 percent of GDP while total expenditures declined to 31.8 percent of GDP in 2000. Priority was given to expenditures relating to the development of key economic sectors and the financing of state and national programs. Additional expenditures were also made from contingency funds to help in drought relief, but at the cost of lower social safety net expenditures, which declined from 3.0 percent of GDP in 1999 to 2.4 percent in 2000.

Monetary policy remained relatively loose, with interest rates still sharply negative in real terms and growth in money supply (M2) estimated at 27.1 percent in 2000. Credit to the economy from the banking system has increased significantly in real terms over the past couple of years. Yet overall, the country's financial sector, including its equity and bond markets, is still at a very early stage of development.

Annual GDP growth is projected to remain at about 3 percent in 2001 and 2002. Development prospects for agriculture remain bleak, mainly due to the persistence of drought, the existing inefficient and inequitable state order system, and the lack of effective water management policies. Industry is likely to continue experiencing difficulties in the short to medium term, as SOE reforms will probably lead to more downsizing and closure of nonviable SOEs. On the other hand, the chemical industry is expected to grow significantly as the Government is implementing an ambitious state-led development program in the sector. The services sector is also expected to develop faster due to the almost complete privatization of SOEs in this sector and increasing demand.

The fiscal deficit is forecast to widen to more than 3 percent of GDP in 2001. While government revenues are projected to be maintained at around 30 percent of GDP, total expenditures are projected to rise to about 33 percent of GDP, as outlays on education, health, and social security increase further. Real interest rates are expected to move up in 2001 and 2002, given that the Government is slowly weakening the exchange rate as part of a painful move toward sum convertibility. However, positive real interest rates could strain the Government's fiscal stance further by increasing its cost of borrowing. In addition, a tight monetary policy might lead to bankruptcies. Therefore, over 2001-2002, the monetary stance is likely to remain loose with a targeted inflation rate of about 22 percent.

The balance-of-payments situation is projected to improve gradually over the medium term mainly because of the anticipated better export performance, caused by the depreciating sum, and greater inflows of foreign direct investment (FDI), as the Government's efforts toward unification of the multiple exchange rates (see below) gather momentum. The current account surplus is projected to improve to about 2-3 percent during 2001-2002.

The economy faces several short- and medium-term risks, namely:

1. high dependence on exports of two major products, gold and cotton, making it vulnerable to adverse movements in world prices or the vagaries in the weather, as was the case for cotton in 2000;
2. vulnerability to an increased debt-service burden as a result of the recent sharp rise in external debt; and
3. constant threats to political and territorial security from terrorist groups in the border areas, and consequent high defense spending.

Issues in Economic Management

While the economy has good long-term potential for growth (e.g., a relatively high level of human capital and rich natural resource endowments), economic performance is likely to be modest. The Government must take further steps toward exchange rate unification and trade liberalization to re-attract FDI flows and spur the growth of the economy. Existing foreign trade restrictions include the following:

1. mandatory registration of import contracts with the Ministry of Foreign Economic Relations (MFER);
2. an obligation on importing enterprises to obtain a foreign exchange license from the Central Bank ofUzbekistan;
3. an obligation on any importing enterprise to obtain a license from the MFER to conduct import operations;
4. centralized exports of gold and cotton;
5. exporters' obligation to surrender 50 percent of foreign exchange at the less preferential overvalued official exchange rate;
6. import quotas through the tender system for basic foodstuffs; and
7. import tariffs and excise duties set at high levels compared with international norms. It is crucial that economic policies and decisions are increasingly driven by price signals, and that the Government gradually moves away from being a dominant figure in all economic decisions to playing a regulatory and supportive role to growth led by the private sector.

Overall, however, the issue of current account convertibility is the main item on the economic reform agenda for 2001. Despite the first steps taken by merging the official and commercial bank exchange rates in May 2000, the unified official exchange rate remained substantially overvalued, administratively determined, and accessible to the same limited set of economic agents. Exchange rate unification by itself is not sufficient to achieve current account convertibility. Real liberalization of access to foreign exchange for all current account transactions as well as lifting exchange restrictions on current account transactions should accompany the process. Concessionary and commercial foreign capital inflows are likely to increase if the Government commits itself to a genuine liberalization policy. Any such policy should include:

1. implementing current account convertibility;
2. lifting foreign trade restrictions;
3. reforming the banking sector;
4. developing a market infrastructure for capital, commodity, and real estate markets;
5. eliminating bureaucratic obstacles to establishing and operating private businesses;
6. removing the state order system for cotton and wheat that will improve incentives in the agriculture sector; and
7. switching from an import substitution to an export promotion policy that will build on the country's dynamic comparative advantage.

Unemployment and poverty also present important concerns over the medium term. Currently, there is considerable hidden unemployment and underemployment in SOEs and collective farms. Deepening of SOE and agricultural reforms will lead to downsizing or closing of inefficient industrial units and collective farms, and the resulting surplus labor will pose a major challenge to policymakers. Possible responses include initiating wide-ranging reforms that will attract private sector investment for creating new employment opportunities and further developing small and medium-sized enterprises so as to help absorb redundant workers and new entrants to the labor force. Currently, there is a mismatch between the supply and demand for various skills in the labor market. One of the impeding factors is the slow pace of reform. Additional steps have to be taken to increase labor mobility, which has traditionally been very low, but which is crucial due to the seasonal factor in labor demand.

Policy and Development Issues

One of the priority reforms in the short and medium term is the restructuring of the financial sector, currently dominated by a few large banks. The Government recognizes the importance of having a strong financial sector to ensure sustained growth, an orderly transition to a market economy, and efficient delivery of credit to small and medium-sized enterprises. The banking system is highly concentrated, with five major state banks controlling 90 percent of total banking assets in the country. Banks do not compete with each other but maintain their sectoral focus, as in the early post-independence years. The most important commercial banks are still state owned and follow credit policies set by the Republican Monetary Policy Commission, in pursuance of the Government's agricultural and industrial strategies. Banks also facilitate revenue collection for the Government. In the transition toward a market economy, the banks have helped the Government fund its budget through timely collection and transfer of taxpayers' funds. To improve public trust in banks and to allow their proper functioning as financial intermediaries, the institutional basis for tax collection as a government function should be strengthened, and kept distinct from the responsibilities of a commercial bank.

Some major steps in banking sector reforms have already been taken. Recognizing the need for better depositor protection and confidentiality, and for increased interbank competition, the Government passed a resolution in January 1999 to regulate the use of bank accounts for tax purposes and gradually phase out restrictions pertaining to the number of bank accounts used by a legal entity. Further, to extend efficient banking services to small depositors and small private entrepreneurs, it has attached high priority to developing efficient and stable privately owned banks: so far, 10 fully privately owned banks have been established. The Government has also moved to restrict the issue of guarantees for bank lending to public investments refinanced by foreign multilateral or bilateral lenders and to priority production activities in sectors such as agriculture and pharmaceuticals. To facilitate these reforms, it is strengthening banking regulation and supervision, providing training for financial sector personnel to improve their managerial and technical capabilities, restructuring banks with poor loan portfolios, and developing other capital market institutions. The Government has a stated policy objective to move the banking sector into a market-oriented environment, to allow the banks independence in banking activities, and to diversify their corporate sector activities. Therefore, it has placed a high priority on speeding up the processes of financial sector liberalization, restructuring, and privatization. To initiate the privatization process, it has created a bank privatization agency and nominated five banks (National Bank of Uzbekistan, Asaka Bank, Uzjilsberbank, Tadbirkorbank, and Zamin Bank) for the first round of privatization.

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