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p. 50 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia East Asia Southeast Asia South Asia Central Asia Azerbaijan Kazakhstan Kyrgyz Republic Tajikistan Turkmenistan Uzbekistan The Pacific III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : Central Asia

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Uzbekistan

Tight economic policies in 2004 resulted in further macroeconomic adjustment, but progress on structural reforms was uneven. Accelerated GDP growth, a balanced budget, a sizable current account surplus, and the maintenance of current account convertibility must be set against the continuance of trade restrictions and the imposition of further impediments in the internal market. A reinvigorated approach to structural reform is needed to speed development and poverty reduction.

Macroeconomic assessment of 2004

Recording the highest rate since independence, GDP growth in Uzbekistan accelerated to 7.7% in 2004, according to official estimates. Growth was led by the agriculture sector but the other major sectors all played their part. Favorable climatic conditions contributed to agriculture�s strong performance, with the cotton crop showing a recovery after a poor harvest in 2003. Grain production in 2004 was lower though than in 2003, in part due to a reduction in the land area sown. Notably, the contribution of private farms to crop production doubled in 2004. The acceleration in industrial growth was driven by the resource sectors, particularly fuel and ferrous metals, and machine building, especially the automotive and aircraft industries.

Economic assessments based on official data need to consider the following two factors. First, in the past, official real GDP growth estimates were higher than other estimates partly because of differences in GDP deflators. For 2004, while there was a significant drop in the official GDP deflator, other official inflation estimates, such as producer prices, stayed high. Second, in past years, the official growth numbers based on the production side of the national accounts were inconsistent with GDP by expenditure category. For 2004, even taking into account the significant contribution of net exports of goods and services, the officially estimated 7.7% growth would require unrealistically sharp growth in domestic consumption and/or investment. Preliminary unofficial estimates put GDP growth for 2004 at 5.5%.

Limited employment opportunities and low returns to labor have perpetuated poverty levels at more than a quarter of the population. Poverty data based on a household budget survey updated in 2003 show a marginal decline in poverty incidence from 27.5% in 2000 to 26.2% in 2003. Surprisingly, the latest results also indicate a very sharp decline in poverty incidence in the southern region, hitherto the poorest in the country, from 47.4% to 26.4% in the period. The official reported unemployment rate is 3.1%, but alternative sources suggest that the actual rate is about 6%. While this figure appears relatively low by international standards, the significant informal sector (estimated at between a third and a half of the economy) engaged in less productive activities suggests that there are bottlenecks in labor absorption, including impediments to private sector development. Employment growth during 2004 remained stagnant.

The authorities maintained a tight fiscal stance in 2004 with the budget balance (excluding extrabudgetary funds) posting a small surplus. The revenue-to-GDP ratio decreased to 23.7% in 2004 from 24.2% in 2003, due in part to cuts in certain tax rates. Budget expenditures as a share of GDP declined to 22.9% in 2004 from 24.6% in the previous year. The burden of the expenditure cuts has fallen on centralized investment financing and �other expenditures.� The share of social sector spending has been maintained, but spending on social protection continued to decline.

Inflation in 2004 remained subdued and virtually unchanged as per the official estimates, with the year-on-year end-period change in the CPI at 3.7%. (Alternative estimates suggest an inflation rate of around 15%. These estimates are based on the consideration that the basket used to compute the official estimates does not adequately represent goods and services actually consumed by the public.) Higher nonfood prices, led by utility price increases, partially offset the fall in food price inflation. Broad money grew rapidly during the latter half of 2004, reflecting mainly the accelerated growth in net foreign assets prompted by the balance-of-payments surplus.

Strong export growth of goods and services in 2004 of 30% contributed to a current account surplus estimated at 8.4% of GDP, the third consecutive year of surplus. Higher world prices for gold and an expansion in energy exports were the main drivers, since cotton export earnings increased only modestly due to the poor harvest in the previous year. Consistent with the reported pickup in investment, import growth accelerated to 28.2%, with higher imports of machinery and equipment, as well as metals. The deficit on the capital account is estimated to have widened as higher FDI inflows were counterbalanced by other capital outflows. Overall, the large current account surplus outweighed the capital account deficit. Foreign exchange reserves were about $2.1 billion at end-2004, providing over 6 months of import cover.

Macroeconomic policy developments

Macroeconomic management has tended to have a short-term focus of addressing individual problems, such as containing the fiscal deficit and reducing inflation, in ways that could generate longer-term problems. In 2004, the authorities further reduced the base rate of the profit tax on enterprises to 18%; effective 1 January 2005, it was brought down further, to 15%. Also, preferential rates and other tax incentives are applied to enterprises included under the revitalized localization program. Consequently, tax revenues from this source fell sharply in 2004. The Government has often equated fiscal reform with tax rate cuts, with insufficient regard to ensuring an adequate tax base and a tax administration system that are capable of sustaining pro-poor spending. It is essential to strengthen the revenue effort and improve revenue buoyancy by keeping exemptions and discretionary rates to a minimum and by improving tax administration.

In order to contain inflation and maintain stability of the exchange rate, cash circulation restrictions remained in force in 2004, a mechanism that raises the risk of liquidity shortages for enterprises and a buildup of arrears (as occurred in 2003). With the pilot phase of the �plastic card� (a type of bank debit card) system of payments ending in 2004, a nationwide rollout is planned in 2005. The Central Bank of Uzbekistan (CBU) has given a commitment that the system will be implemented on a purely voluntary basis, though some in the private sector fear that the system could be used for further restricting cash transactions. CBU cut its refinancing rate twice in 2004, bringing it down to 16% to align it with inflation.

The authorities have ensured a gradual depreciation of the exchange rate in nominal terms (0.7% per month). The track record on currency convertibility remains good according to the findings of a recent IMF review mission, but progress on complementary structural reforms has been slow.

Banks have seen a deceleration in net income growth over the past few years, largely due to the sizable level of NPLs of the large state-owned banks. CBU set up a national institute of credit monitoring in 2004 to improve this area. Despite recent growth of small and medium private banks, the state-owned banks remain dominant. Privatization of Asaka Bank, the second-largest state-owned bank, originally scheduled for 2004, appears stalled for the present. Economy wide, the authorities reported that 966 enterprises were privatized in the first 3 quarters of 2004 but only one large privatization deal was brought to closure.

A presidential decree on the creation of a chamber of commerce and industry was issued in July 2004 that could pave the way for a dialogue between representatives of the private sector and the Government on measures to improve the business environment.

Uzbekistan�s foreign trade regime is characterized by a moderate average unweighted tariff rate (lowered in 2004 to 14.6%), but the four-band system of tariff escalation based on stages of production is geared toward protecting selected domestic industries. Numerous nontariff barriers restricting trade also remain in place, presenting a risk that the efficiency gains from the introduction of currency convertibility may not be realized. Indeed, the regulatory burden on �shuttle� trade was intensified in 2004.

Restructuring loss-incurring cooperative farms (or shirkats) into private farms continued in 2004, with the latter increasing to over 100,000 toward the end of the year. Most private farms are required to produce cotton and wheat on 85% of their leased land but have freedom to make their own farming decisions on the remaining 15%. The Government has credited its policy of restructuring shirkats with giving a major boost to the efficiency of the rural economy. It does indeed seem that private farms have lower production costs than shirkats, as the incentives to divert resources that are common in shirkats are absent in private farms. In other respects however, the profitability of private farms is held down by shared disincentives inherent in the state procurement system for cotton and wheat.

The Government recognizes that if it is to make a dent in the poverty incidence, it will need to sustain high rates of growth through structural reform with complementary changes to the provision of human development and social protection services. Its Living Standards Improvement Strategy, completed in June 2004, is now being further developed into an Interim Welfare Improvement Strategy Paper (I-WISP), a framework that sets out the following targets: reduction in poverty incidence from 26.2% in 2003 to 20% in 2010; annual GDP growth of 8.0-8.5% over 2007-2010; inflation in the range of 4-5%; investment growth accelerated to 12% a year with the incremental capital output ratio (ICOR) falling from 5.8 to 3.2; export growth maintained at 10-12%; the share of industry in GDP increased to 20%; the number of employed increased to 13.2 million; and unemployment brought down to 2%. Additional work is required to develop the draft strategy into a coherent and consistent economic program.

Outlook for 2005-2007 and medium-term trends

Sustaining the growth rate achieved in 2004 will not be easy. Some of the key sources of recent growth have an uncertain future, including strong prices for commodity exports--in particular cotton where prices have weakened--but also gold and energy. Key to the medium-term outlook will be the extent to which the Government adopts an accelerated reform program. In the near term however, the growth dividend from an accelerated reform scenario could be small.

In 2005, the external environment is seen as being less favorable. World cotton oversupply is likely to depress demand for cotton fiber exports, gold prices are expected to decline from the record high seen during 2004, and while the outlook for energy prices is positive, it is uncertain. Officially reported consumer inflation is set to remain in the 6-8% range but actual inflation (factoring in prices in markets where consumer goods are traded) is likely to be higher at 12-15%. Adherence to the Government�s commitment to assuring enterprises� access to cash will be essential for ensuring that wages are paid and that the purchasing power of the poorer sections of society is maintained. Overall, a moderate deceleration in GDP growth to around 5.0% in 2005 may be expected.

Over 2006-2007, the acceleration in GDP growth to 8.5% envisaged in the I-WISP appears ambitious, but an improvement to around 6.5% is possible if some pickup in structural reforms and a positive global environment are seen.

Currently, the investment rate is around 22% of GDP. To achieve a growth rate of 6.5% and assuming an ICOR of 4.4 will require an investment rate of 28-30% of GDP. In the past, the government budget funded investment of around 6% of GDP a year. The ability of the budget to finance higher levels of public investment appears constrained by the anemic revenue mobilization effort. FDI inflows account for less than 1% of GDP, and while the energy sector has good prospects for FDI projects financed by the Russian Federation, other foreign investors appear lukewarm because of the investment climate in the country. This leaves domestic private investment to fill the gap, which would need to improve from its current level of about 14%.

The current investment climate for both domestic and foreign enterprises makes achievement of this investment target challenging. A lower investment rate with higher investment efficiency could achieve the 6.5% growth target, but the prevailing strategy of import-substituting industrialization would have to be reoriented.

Under this policy, large sectors of the economy are subordinated to the promotion of selected industrial activities--at considerable cost to overall economic efficiency. Moving toward and sustaining the GDP growth target will therefore require a refocus of the development strategy to enable both a higher level of investment and an improvement in its quality.

Assuming acceleration in structural reforms, growth could pick up to around 6.0% and 6.5%, respectively, in 2006 and 2007. The impetus for this growth is expected to come from private investment and exports. The balance-of-payments outlook for 2006-2007 under an accelerated reform scenario is one where both exports and imports are likely to rise to fuel higher investment and growth. The emerging current account deficit of the scenario is likely to be readily financed with additional official development inflows and FDI inflows accompanying reforms. In short, growth over the medium term will depend on whether the authorities adopt a substantially reinvigorated structural reform program or continue with the current direction and pace of reform.

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