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

The resilience of Uzbekistan’s ratings to the economic impact of the global health crisis reflects the sovereign’s robust external and fiscal buffers, a diversified commodity export base and access to external official financing. These factors provide Uzbekistan with the financing flexibility to respond to the COVID-19 crisis by supporting economic growth, and mitigate near-term risk related to a large current account deficit and rising government debt.

Fitch also considers that the government under President Shavkat Mirziyoyev remains committed to the reform programme initiated in 2017 to improve macroeconomic stability and growth prospects, decrease the state’s role in the economy and address institutional and governance weaknesses.

Fitch expects growth to drop markedly to 2.0% in 2020, down from 5.6% in 2019 and below the authorities’ revised projection of 4.9%, due to the combined impact of deteriorating global economic outlook and weaker remittances (9.4% of GDP in 2019) and containment measures in response to the COVID-19 outbreak. Continued financing of investment projects and the anti-crisis policy response will cushion the shock and provide the basis for higher growth at 6.8% in 2021 combined with recoveries in Russia and China. Uzbekistan’s young population, high investment rate and reforms to remove controls and distortions support a favourable growth outlook post-crisis. Nevertheless, risks to our 2020-2021 forecasts are clearly on the downside given uncertainty over the duration of the lockdown and the ultimate extent of the pandemic in Uzbekistan and globally.

The Ministry of Finance has created an externally-financed Anti-crisis Fund, (USD1 billion or 2.2% of GDP) to support employment, social spending and sustain business and investment activity. Authorities will also introduce targeted and temporary tax relief, and banks will provide a USD3 billion revolving credit line and loan repayment deferrals for impacted sectors.

Fitch forecasts Uzbekistan’s overall deficit to increase to 5% of GDP in 2020 from 4% of GDP in 2019. We expect the consolidated budget (general government plus the Uzbekistan Fund for Reconstruction and Development (UFRD) operations and externally financed expenditure) deficit will widen to 4.2% of GDP (0.2% in 2019) due to the counter-cyclical package, weaker tax performance and continued high public investment while net (policy) lending falls to 0.8% of GDP (3.5% in 2019). Fitch expects Uzbekistan to reduce the overall fiscal deficit to 2.4% of GDP in 2020 supported by recovery in revenues and removal of stimulus measures. The government targets a maximum 1.5% of GDP deficit by 2022.

Fitch expects Uzbekistan’s policy consistency to improve and reduce risks to macroeconomic stability. Starting 2020, the UFRD is included in the government budget, and is forecast to remain in balance (deficits of 3.4% and 1.8% of GDP in 2018-2019), thus reducing the scope for policy lending; a key driver of rapid credit growth in previous years. Annual limits to external borrowing and government plans to introduce a debt ceiling of 50% of GDP (for public and public-guaranteed obligations) aim to reduce the pace of debt accumulation.

The central bank has begun its official transition to inflation targeting with the objective of reaching 5% in 2023. Starting in 2020, the Central Bank of Uzbekistan’s (CBU) policy rate will set the floor for loans at preferential rates, and these will reflect market rates in 2021. However, monetary policy effectiveness remains constrained by high financial dollarisation, shallow capital markets and still high stock of loans (58% in 2019 down from 71% in 2018) on preferential terms. Fitch expects average inflation to remain high and decline to 10.5% by 2021.

Fitch forecasts that government debt will reach 34.3% of GDP (including 10.1% external guarantees) in 2020, up from 28.5% (including 8.7% in external guarantees) in 2019. While government debt remains below the current ‘BB’ median (46% of GDP), it has increased at a rapid pace and is almost entirely foreign currency-denominated, and so heavily exposed to currency risks. Mitigating factors include its structure in terms of maturity and costs (94% multilateral and bilateral). The government’s high cash buffers (28.5% of GDP in 2019) are supported by government deposits of 8.2% of GDP and UFRD liquid assets.

Gross international reserves rose to USD29.2 billion in 2019 (12 months of CXP) and we expect reserve coverage to remain strong relative to peers in 2021 (13.6 months of CXP). The external liquidity ratio, forecast at 410% in 2020, is among the strongest in the ‘BB’ category. Sovereign net foreign assets fell to 23.4% of GDP in 2019, still strong relative to ‘BB’ peers, but Fitch expects this position to deteriorate over 2020-2021 due to increased external borrowing.

The UFRD (USD19.1 billion in assets) underpins the sovereign’s external and fiscal financing flexibility, in addition to supporting strategic investment projects, state-owned enterprise (SOE) financing and funding for state-owned banks. A high share of international reserves (37.7% or USD11 billion) consist of UFRD cash holdings; the CBU’s share of international reserves’ holdings consist mostly of gold (57% in February).

Fitch forecasts the current account deficit to widen to 7.6% of GDP in 2020, up from 5.6% in 2019, despite weaker import demand reflecting weaker external demand and remittances. Commodity dependence is higher than ‘BB’ peers, but Uzbekistan has a diversified commodity basket (34% gold, 17% oil and gas and food products 10% in 2019). Despite increased visitors in recent years, net travel services contribution to the current account remained negative in 2019. The current account deficit will narrow to 5.7% of GDP, still higher than ‘BB’ peers, reflecting improving export demand and remittances but also recovery in import demand. Net FDI jumped to 3.9% of GDP in 2019 covering the majority of the external deficit. Net FDI could remain close to 3.5% of GDP in 2020, reflecting lower production sharing agreements outflows in the energy sector and continued investment in areas like hydrocarbons and renewables.

The banking sector has reduced exposure to SOEs and foreign-currency risk while at the same time improving capitalisation. Close to USD4.3 billion of UFRD-funded loans to SOEs were moved from state-owned banks’ balance sheet to the UFRD, and the UFRD also swapped USD1.5 billion in loans for equity participation in state-owned banks. As a result, regulatory capital rose to 23.52% (regulatory Tier 1 19.57%) by end-2019 from 15.6% at end 2018. NPLs are low at 1.5% but could increase due to the impact of the coronavirus crisis on the economy

Fitch’s Macro-Prudential Indicator of 2*, indicates moderate vulnerability due to fast credit growth. Credit growth yoy declined to 24% in 2019 reflecting the operation in December. Nevertheless, credit had started to decelerate from a peak of 58% yoy in August to 47% in November. Tighter policy lending will moderate overall credit growth. Authorities will reduce the reliance on subsidised lending for SOEs as well as the share of the public sector (85% of assets) in the banking sector. SOE reform continues with separating regulatory and commercial functions as well as unbundling in key economic sectors, and improvements in reporting and corporate and corporate governance standards.

Institutional reforms are also delivering gradual progress in the fight against corruption and rule of law that may translate into improved governance standards, as reflected in better rankings from Transparency International Corruption Perception Index (CPI) and the rule of law Index by the World Justice Project. Uzbekistan also improved in the Doing Business ranking to 69th in 2020 from 76th.

Uzbekistan introduced a new electoral code and carried out legislative elections in December 2019. While the electoral process saw more open public debate on policies and proposals, the contest was monopolised by pro-government parties and international observers cited continued irregularities. Presidential elections are scheduled for 2021, and Fitch’s base case is that President Mirziyoyev will seek and obtain a new term, likely supporting continued reform momentum.

ESG - Governance: Uzbekistan has an ESG Relevance Score 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. Uzbekistan has a low WBGI ranking at the 19th percentile, reflecting relatively weak rights for participation in the political process, weak institutional capacity, uneven application of the rule of law and a high level of corruption.

Fitch’s proprietary SRM assigns Uzbekistan a score equivalent to a rating of ‘B+’ on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- Public Finances: +1 notch, to reflect government deposits of 8.2% of GDP (4.9% in FC) in addition to UFRD cash assets (20.4% of GDP) leading to ‘0’ net debt in addition to low refinancing risks due to the favorable cost and profile of government debt.

The removal of the -1 notch under Macro since the previous review reflects Fitch’s assessment that macroeconomic risks derived from expansionary credit and public investment policies in terms of depreciation pressures and high inflation have materialized in 2019 SRM variables; and that improvements in the consistency of fiscal, monetary and credit policies will reduce risks to macroeconomic stability.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

The main factors that could, individually or collectively, lead to positive rating action/upgrade are:

- Strengthening of the policy framework that delivers improved macroeconomic stability and slows the pace of government debt accumulation.

- Significant improvement in structural indicators including GDP per capita and institutional factors.

- A significant strengthening of the sovereign balance sheet.

The main factors that could, individually or collectively, lead to negative rating action/downgrade:

- Policy slippage or inconsistencies that lead to sustained widening of macroeconomic imbalances and increase risks for macroeconomic stability.

- Severe and sustained negative impact from the COVID-19 pandemic on medium-term GDP growth or public finances.

-A sustained fall in foreign exchange reserves or a rapid increase in external liabilities.