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Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : Central Asia
Uzbekistan Even though currency convertibility was announced and fiscal and monetary targets were met, the economy continued to perform below potential in 2003-growth was sluggish and investment modest. The key for immediate improvement lies in expansion in agriculture and the small enterprise sector, while implementation of already announced policies and a concerted withdrawal of government participation in the economy could lift the country toward its long-term potential. Economic Assessment In 2003, officially reported GDP growth remained at its 2002 rate of about 4%, as slower growth in private consumption expenditures mirrored noticeable weakness in retail trade and a slowdown in industry. IMF’s growth projections were lower. Government-directed investment in hydrocarbons and construction continued, but overall government investment spending fell sharply as part of austerity measures aimed at reducing inflation and stabilizing the exchange rate. Exports gained ground but private domestic and foreign direct investment stayed modest. In the agriculture sector, growth in 2003 was again about 6%, with a good grain harvest offset by lower cotton production, and though productivity of large farms has risen since privatization, small household plots were the major contributors to the expansion. A 20% depreciation of the exchange rate bolstered export competitiveness, and some machinery enterprises boosted production and exports. Most industries, especially those favored by the Government in its import-substituting industrialization drive, continued to underperform. The Government reported that industrial growth was 6.2% in 2003. Services sector growth was only 2.5% as retail trade in particular continued its struggle to adjust to government regulations intended to suppress demand for foreign exchange. As sluggish economic growth negatively affected social welfare, the Government made efforts to provide social support. State procurement prices remained below world market levels and, combined with state production targets hindering optimal crop choices, kept incomes below potential, though agricultural families supplemented incomes through production on household plots. The slow entry of private operators into the cotton-ginning sector maintained high processing margins and contributed to keeping farm incomes relatively depressed. Enterprise restructuring, farm privatization, and the muted economic growth hit employment even as the Government declared jobs a top priority. Incomes of small businesses and retailers fell, as they were unable to adjust to trade restrictions and regulations. The Government increased salaries of employees at budgetary institutions, pensions, social allowances, and scholarships, but payments were delayed and arrears accumulated. The Government managed to restrict the state budget deficit in the first 9 months of 2003 to 0.1% of GDP, largely through its austere fiscal stance and partly by delaying spending and payments. More detailed budget figures released for the first half of 2003 indicate a marked decline in budgetary investment and reduced spending on social services compared with budget targets. Collection of indirect taxes improved but direct tax collection deteriorated because of rate reductions in profit and individual income taxes intended to spur economic activity. The tight credit policy of the Central Bank of Uzbekistan (CBU) over 2003 as well as the fiscal squeeze lowered inflation from about 27% in 2002 to about 10% in 2003. The Government reported inflation nearly eliminated for the year, but ADO 2004 has made some adjustment as the official index excludes many items bought in private markets where shortages put upward pressure on prices. Broad money (M2), which was sharply reduced in 2002, appears to have been relatively stable over the year but cash restrictions and difficulties experienced by commercial banks in accessing their reserve accounts at CBU restricted money availability, even though the traditional cash budget mechanism was formally abolished in February. As a result, the premium on cash over noncash payments for transactions more than doubled to 30-40% from the rate at end-2002 as businesses tried to keep their sales receipts out of the officially controlled banking channels. Interenterprise arrears probably rose. With inflation apparently waning, CBU cut its monthly refinancing rate twice, from 2.5% to 2.0% in August 2003 and to 1.7% (22.4% annualized) in September. The balance-of-payments situation improved in 2003 although available data, as with other macroeconomic statistics, are sparse and lack detail. Imports and exports both increased according to official sources. Capital goods imports for the hydrocarbons sector were largely responsible for import growth, since private sector and consumer goods imports were compressed by restrictions. Higher international prices for cotton and gold, the main exports, aided by somewhat stronger energy and machinery exports, underpinned higher earnings for the year. These gains, plus a step-up in antiterrorism assistance transfers from the US, appear to be the main elements in the current account surplus reported at 6% of GDP. External debt repayments continued to exceed loan disbursements in 2003, and outstanding debt was about $3.8 billion, or 38% of GDP. FDI, at about $40 million, is now the lowest on a per capita basis among the Central Asian republics. Gross international reserves in excess of $1.5 billion at year-end provided about 6 months of import cover. Policy Developments In 2003, policy measures, including tight monetary and fiscal policies, were directed mainly toward formally establishing current account convertibility. This has been a long-standing goal of the authorities as part of their efforts to attract greater FDI. The Government made its announcement in October 2003, followed by an IMF statement, that Uzbekistan had accepted its Article VIII obligations for current account convertibility. Uzbekistan has maintained a managed floating exchange rate. However, in addition to the official main reference rate, prior to October 2003 and exchange rate unification, the exchange rate system had included an official depreciated secondary market rate for certain transactions as well as various restrictions on making current payments and transfers. Black-market transactions had been made at spreads generally well above both official rates. The Government’s financial policies, combined with intensified trade restrictions and procedural barriers to accessing cash and foreign currency, exerted downward pressure on the demand for foreign exchange. These actions, begun the previous year, induced a convergence of the two official rates and the black-market rate to around Som975/$1 by September 2003. This was maintained for the rest of the year. Attaining Article VIII status was an important milestone, but the Government nevertheless faces major challenges in making current account convertibility work in practice to achieve the economic efficiencies underlying the concept. Significant imbalances have been built up in the economy, including fiscal arrears, while trade restrictions have been raised to the point where they are stunting economic activity. Unwinding these imbalances will be difficult and requires careful management, but will likely entail the release of pent-up price pressures involving some adjustment in the exchange rate as the economy moves to greater market orientation, which is an aim of government policy. The Government has stated that its medium-term objective is to liberalize trade, attract foreign investment, and realize the benefits of currency convertibility. It views the intensified trade and procedural restrictions as temporary actions. Moreover, it has stated its intention to concentrate future public spending on social welfare and to reduce its participation in the economy. The Government has also said that it will maintain a tight monetary policy to facilitate a smooth transition to its convertibility obligations and has indicated that the cash restrictions were an administrative problem. Since 2002, the Government has maintained a conservative external borrowing stance and has set stringent requirements for government guarantees of external borrowing by enterprises. Progress was made in some areas of structural reform. For example, farm privatization targets were met. The Government has stressed the centrality of agriculture to its development vision and announced wide-ranging agricultural reforms. State procurement prices for grain and cotton were raised closer to world market prices, and regulations according greater control to farmers over their production of cotton and grain were passed. Marketing reform in the grain sector saw some success with increased private participation in grain trade and processing, though the transition in the cotton sector has been slower. While the Government declared an end to its monopoly on cotton exports, adequate private marketing channels have yet to emerge and procedural bottlenecks remain. Moreover, some local authorities continue to control farmers’ production decisions in contravention of government resolutions. The Government has begun the process of formulating a new strategy for improving living standards. The strategy foresees more broad-based links between poverty reduction goals, economic growth, and sector-specific interventions. This is the first time that steps toward a comprehensive strategy aimed at poverty reduction have been made, and more important, if the strategy is completed as planned, the first time that poverty reduction will be looked upon as an allocative rather than purely redistributive function, i.e., to be addressed within larger growth initiatives and not merely through social assistance. If resource allocations in agriculture and industry follow market signals and trade is freed from restrictions, the economy has the potential to attain long-term growth rates of 7-8%. Agriculture could be the primary driver of any initial expansion, with small industry development playing a complementary role as direct controls over economic decision making are replaced by indirect macroeconomic management. In addition to headway made in farm privatization, complementary progress on reforming the state procurement system, trade liberalization, and private sector development in agricultural support services and processing could quickly induce agricultural growth of 2-3 percentage points over its current level. Trade liberalization has the potential to raise services sector growth by 5-6 percentage points over its presently depressed level. Rising incomes in these sectors in turn could well feed into higher industrial expansion over time as policy changes lead to enterprise restructuring and new investment. The Government’s announcement of current account convertibility is the first step in transmitting appropriate price signals to the economy. Trade liberalization, removal of price controls, rationalization of the tax regime, sustained progress on the enterprise privatization program, discontinuation of preferential treatment for favored enterprises, and a phaseout of state planning and resource allocation would work to raise industrial growth by 2.5-3.5 percentage points above the present level. While initial improvement can come about through relatively less capital-intensive supply responses in the agriculture sector and growth in the small enterprise sector, higher long-term growth will require increased domestic savings and investment as well as larger inflows of FDI. For this, the creation of a healthy business climate and banking sector reforms should be made a government priority. Legal reforms, including the protection of property rights and improvements in the enforcement of contracts, are essential to foster and sustain the needed strengthening in investment activity by both domestic and foreign investors. In addition to encouraging savings, banking sector reforms to allow banks to function as genuine financial intermediaries will be essential. The abolition of the extrafinancial roles of banks (such as tax enforcement and cash planning) and interest rate controls; banks’ freedom to manage liquidity and lend, subject only to the usual prudential regulations; and sustained progress in bank privatization will be key elements in banking reform. Outlook for 2004-2005 The economic outlook depends on progress in agricultural reforms, changes to the trade regime, follow-through with currency convertibility, and installation of a conducive environment for business development. GDP growth over the forecast period is not projected to improve significantly from the 2003 rate of about 4%, although the outturn in 2004 could be slightly higher at about 4.5% if the global recovery and buoyant import demand in Uzbekistan’s main markets are sufficiently strong. In 2004-2005, growth will be conditioned by whether farm privatization and other reforms stimulate agricultural supply responses and greater industrial capacity utilization, and by whether enterprise privatization increases productivity. The outlook for 2005 would brighten if policy reforms could be accelerated. It will be difficult for the Government to maintain high fiscal arrears without risking social unrest, and the budget deficit is projected to widen to roughly its 2002 level of about 2% of GDP as these are unwound. Despite government intentions to maintain tight monetary and fiscal policies, inflation is projected to increase to perhaps 20% in 2004 and then likely remain at around this level in 2005. The sustainability of a tight monetary policy is doubtful in the face of CBU’s reduction in the refinancing rate, budgetary financing requirements, and the need to ease the present procedural barriers to accessing cash and foreign exchange (to strengthen enterprise activity). In these circumstances the exchange rate is likely to depreciate, especially if trade restrictions are eased. Export growth and a continued strict import regime are expected to maintain the current account surplus at roughly its present level of 6% of GDP over 2004-2005. Although it is expected that the cotton harvest and exports will decline in this period, the fall will be offset by stronger global prices. If enterprises are able to respond to the likely depreciation of the currency through greater capacity utilization, machinery exports are in a favorable position to increase, with relatively little additional investment. Strong demand for energy in the Russian Federation is expected to result in moderately higher energy exports. Imports will remain concentrated in capital goods for the hydrocarbons sector, and will be partly funded by foreign investment. The compression of private sector and consumer goods imports will continue, though it will be important that restrictions ease and that the exchange rate and tariff policy come to play a greater role in controlling demand. Agricultural growth will be a primary determinant of living standards over the forecast period. It can be expected to translate into widespread income increases if land reforms and changes in the state procurement system proceed as planned and if the business environment for small enterprise development in the agriculture sector improves. Industrial growth is not expected to lead to substantial employment generation because of redundancies, while small enterprises and domestic trade are unlikely to grow rapidly without substantial policy changes. Moreover, the number of government budget-financed jobs in health, education, social protection, and administration is expected to fall as the Government streamlines budgetary expenditures. Thus the pace of longer-term improvement in living standards and poverty reduction depends on strong action to pursue wide administrative, structural, and macroeconomic reforms.
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