TOPIC OF THE WEEK: Uzbekistan: Are we complacent about macroeconomic risks? - A slide presentation
Uzbekistan is, without a doubt, our preferred investment opportunity in the region, and we discussed in detail the reasons for that in our recent Uzbekistan Primer. In this week's report, which is a slide presentation, we discuss some emerging macro risks that could derail economic performance in the medium term.
We see growth rates being structurally supported by a combination of low per capita GDP levels and the government’s expressed desire to press ahead with reforms aimed at enhancing Uzbekistan’s production possibility frontier. In addition, favorable demographics should provide a powerful fillip to potential GDP while the 2030 Development Strategy sets ambitious goals, including doubling the share of the private sector in GDP creation to 80 percent and increasing ESG standards. As a result, while consensus forecasts see medium-term growth rates at about 5 percent, the risks are to the upside should reform fatigue not set in.
While we have always identified as the most immediate macroeconomic risk the sharp transition from robust current account surpluses to persistent ongoing and projected deficits, this challenge has now intensified. The transition was cushioned last year by excess monetary inflows from Russia, but the trend return to large CA deficits has now set in forcefully in 1H2023, with the external gap running at 7.3 percent of GDP in 1Q and 8.0 percent of GDP in 2Q. Even if current account deficits are justified by the opening of the country and the sharp increase of formerly repressed intermediate goods imports, the recorded 1H2023 gaps are larger than the sustainable (equilibrium) current account deficits that the IMF estimates to be in the range of 3.75 to 5.75 percent of GDP.
A newly emerging external headwind is related to the transition from being a (significant) net exporter of natural gas to a net importer of this commodity. This shift will create additional (and increasing) fundamental pressures on the current account position in the medium term. Indeed, Uzbekistan started importing Russian gas on October 7, 2023. This was necessary due to long-term structural considerations related to declining domestic gas production and increased domestic consumption, including because of the commissioning of Uzbekistan GTL, the largest plant in Central Asia for the production of synthetic fuels. Uzbekistan is set to become a net importer of gas by 2025.
Portfolio and other investments (loans) had been mainly financing CA deficits up until 2020/2021, but these have now declined to make space for FX reserves to fill in the significant 1H2023 gap. FX reserves have fallen by almost US$5bn since the start of the year, the most in the CCA space. To be sure, standard metrics of external vulnerability, including FX reserve import cover, are still far from flashing red, although they have also worsened the most in the region in recent years. In particular, FX reserves have declined from their peak of 34 months of imports in early 2016 to 10.9 months of imports now. Hence, there could be reasons for more concern should the trend continue. The hope is that this could be avoided by seeing a steady increase in FDI inflows to sustainably finance CA deficits in the future based on the government’s ambitious development strategy.
The more relaxed fiscal stance adds to the twin-deficit problem. For example, 1H23 budget gap has come in at almost 6 percent of GDP vs. the maximum 3 percent of GDP allowed by the budget law. While public debt levels are not excessive, servicing the negative flow fiscal position would demand an increasing share of expenditure given very high interest rates.
It would be wrong to interpret our message as sounding an undue macroeconomic alarm as existing buffers remain sufficient. Nevertheless, widening flow imbalances on the fiscal and external side warrant a more careful monitoring of the situation.
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