Uzbekistan Country Economic Update Summer 2019 Toward a New Economy Macroeconomics, Trade & Investment Global Practice UZBEKISTAN Toward A New Economy Country Economic Update Summer 2019 Government Fiscal Year: January 1 – December 31 Currency Equivalents: Exchange Rate Effective as of May 8, 2019 Currency Unit = Uzbekistan Som (UZS) US$1 = 8,448.89 UZS Weights and Measures: Metric System Abbreviations and Acronyms CAR Capital Adequacy Ratio CBU Central Bank of Uzbekistan CPI Consumer Price Index FDI Foreign Direct Investment FRD Fund for Reconstruction and Development GDP Gross Domestic Product IMF International Monetary Fund M2 Broad Money NPL Nonperforming Loan PEFA Public Expenditure and Financial Accountability PPPs Public-Private Partnerships PPP Purchasing Power Parity SOE State-Owned Enterprise TFP Total Factor Productivity WTO World Trade Organization ii| Table of Contents Foreword ................................................................................................................................................................................... iv Overview ..................................................................................................................................................................................... 1 A. Recent Socio-Economic Developments ..................................................................................................................... 2 B. Macroeconomic Policies and Key Structural Reforms ...................................................................................... 11 C. Economic Outlook and Risks........................................................................................................................................ 15 D. Focus Section: Growth and Job Creation ................................................................................................................ 17 Annex Table 1. Selected Macroeconomic and Social Indicators, 2016-2021………………………………….22 Figures Figure 1. Sectoral Contribution to GDP Growth ............................................................................................................ 5 Figure 2. Consumer Price Inflation .................................................................................................................................... 6 Figure 3. Key Inflation Measures ........................................................................................................................................ 6 Figure 4. Balance of Payments ............................................................................................................................................. 6 Figure 5. Export Structure ..................................................................................................................................................... 7 Figure 6. Import Structure ..................................................................................................................................................... 7 Figure 7. Selected Financial Indicators ............................................................................................................................. 8 Figure 8. Employment Structure by Sector..................................................................................................................... 9 Figure 9. GDP per Capita, Poverty, Small Business Share in GDP ........................................................................ 11 Figure 10. Consolidated Budget ........................................................................................................................................ 12 Figure 11. Debt and Debt Service...................................................................................................................................... 12 Table Table 1. Baseline Scenario: Selected Macro-Fiscal Indicators, 2018–21 ........................................................ 16 |iii Foreword This edition of the Country Economic Update is part of a semi-annual series designed to monitor recent economic developments in Uzbekistan. The report presents a broad overview of the country’s macroe- conomic, social, and structural developments in 2018. The Special Focus section discusses economic growth and job creation. This edition was authored by Eskender Trushin (Senior Economist for Uzbekistan). The analysis bene- fited greatly from comments provided by Ivailo Izvorski (Lead Economist for Central Asia), Julio Revilla (Senior Economist, Credit Risk Global Practice), and Vinayak Nagaraj (Senior Economist for Uzbekistan). Bronwen Brown edited the text. Sarah Babirye and Elena Klementyeva assisted with the production of the final draft. Sandeep Mahajan Practice Manager Macroeconomics, Trade and Investment Global Practice iv| Overview Uzbekistan’s Uzbekistan is implementing ambitious market-oriented economic reforms. The economy is reap- authorities unified the exchange rate and liberalized the foreign exchange market ing the benefits starting in September 2017, began price and trade liberalization,1 and made sig- of structural re- nificant cuts to tax rates for both firms and individuals from January 2019. The forms country’s opening to the world included elimination of entry visas to promote tourism and business and a renewed commitment to join the World Trade Organ- ization (WTO). The government has expanded social safety net coverage and sub- stantially improved the availability of economic statistics. Uzbekistan’s progress has been impressive and as a late reformer it can also benefit from the lessons learned by other transition economies. Growth has A surge in investment and a pickup in consumption boosted real GDP growth from picked up and 4.5 percent in 2017 to 5.1 percent in 2018 and further to 5.3 percent year-on-year the medium- in the first quarter of 2019. Growth is projected to rise to 6 percent in 2021, sup- term outlook is ported by market reforms to address production bottlenecks and liberalize the favorable, albeit economy. Twelve-month inflation peaked at 20 percent in early 2018 before declin- with elevated in- ing to 14.3 percent by December, resulting in an annual average rate of 17.5 percent flationary pres- for 2018. The consumer price inflation eased further to 13.7 percent year on year sures by April 2019. Inflationary pressures are likely to persist in 2019–20 due to: (i) the continued liberalization of administrative prices, including of energy and wa- ter; (ii) increased policy lending via state-owned banks to support investment growth, and (iii) public wage increases. Tightening of monetary and credit poli- cies will be required for inflation to moderate by 2021. Fiscal and cur- Imports of machinery and equipment to modernize production and imports of con- rent account def- sumer goods to meet pent-up consumer demand widened the current account defi- icits are pro- cit in 2018. The deficit is likely to narrow over the medium term but will remain jected to decline, large. The external deficit is likely to be financed by increased donor support and a and external gradual increase in inflows of foreign direct investment (FDI). External buffers are buffers remain likely to remain comfortable in the medium term, with foreign exchange reserves comfortable above 13 months of import cover. Gross external debt is projected to decline mod- estly to about 39 percent of GDP by 2020. The government budget excluding policy- based lending is forecast to shift from a surplus to a small deficit of about 1 percent of GDP over the medium term following a significant reduction in excise, income, and payroll tax rates, and increased public spending on investment, pensions, and low-income allowances. Public debt is likely to increase to about 25 percent of GDP in 2020. Steady growth of remittance inflows and the robust economic growth are expected to contribute to a modest reduction in the poverty rate. Reforms are crit- The economic liberalization measures introduced by the authorities since 2017 are ical for growth helping address important binding constraints to business, such as the lack of for- and job creation eign exchange, high import duties, and elevated tax rates. The government is advised to continue realigning the state’s role in the economy, while addressing the remain- ing constraints to private sector development. Measures to address these con- straints include: (i) increasing access to credit and improving the investment cli- 1Uzbekistan’s average import tariff was reduced from 15 percent in August 2017 to below 3 percent in June 2018. However, it was raised modestly in December 2018. |1 mate; (ii) fully implementing the tax administration reform; (iii) ensuring the trans- parency of state budget operations—particularly regarding inefficient implicit subsi- dies to state-owned enterprises (SOEs); (iv) reforming land user and ownership rights in the industry, services, and agriculture sectors; (v) restructuring monopoly SOEs and strengthening their corporate governance and financial reporting require- ments; and (vi) providing state support to export-orientation (including ISO quality certification, export risk mitigation, diversification, and WTO accession). Over the medium term, upgrading of infrastructure—in particular power and transport and improving access to quality higher education will help underpin a stronger economic potential. A. Recent Socio-Economic Developments Recent Events The government The authorities have undertaken ambitious reforms that have delivered improvements to has initiated bold Uzbekistan’s business and investment climate and are likely to boost economic growth reforms over the medium term. Reforms include changes to the currency and tax systems, the lift- ing of state monopolies in some sectors (for example, fruit and vegetable exports), and the opening of the banking sector to foreign investors2. The government has also opened the previously-closed borders with Uzbekistan's neighbors and has initiated regional transport links to foster new trade and investment opportunities in Central Asia. The gov- ernment’s medium-term economic reform priorities through 20213 include improving the business environment for the private sector; introducing public-private partnerships (PPPs)4; strengthening the corporate governance of state-owned enterprises (SOEs) and subsequently carrying out selected privatizations; reforming agriculture (reducing land under cotton cultivation, introducing direct contracts for cotton farms with textile compa- nies, prohibiting the use of forced labor); improving statistics; strengthening the inde- pendence of the central bank and implementing banking sector reforms; deepening trade liberalization and resuming efforts for Uzbekistan’s accession to the WTO; reforming tax policy and tax administration; and enacting public procurement, administrative, and so- cial service reforms. Reform imple- Significant tax reforms, which were implemented on January 1, 2019, included the es- mentation tablishment of a unified tax rate of 12 percent for personal income tax, corporate in- gained momen- come tax, and payroll tax for both large and small firms. Other changes included the tum in 2018 and reduction of the unified tax rate for small firms to 4 percent, the property tax rate from early 2019 5 percent to 2 percent and the dividend tax from 10 percent to 5 percent. 2 According to Presidential Resolution #pp-4300 dated April 29, 2019 “On measures to further improve mecha- nisms of attracting foreign direct investment into the economy of the republic”, 25 percent of state shares in each of the three commercial banks (“Alokabank”, “Turonbank”, and “Asia Alliance Bank”) and in the “Kafolat” insurance company have been put on auction for foreign investors. This resolution also put for sale to foreign investors the shares (from 35 to 100 percent of stakes) in twenty-five SOEs in chemical, oil and gas, electricity, and food pro- cessing industries. 3 In February 2017, President Mirziyoyev and the new government announced a dramatically different policy course—the “Strategy for action on five priority development areas of the Republic of Uzbekistan for 2017–21.” These five areas are governance, judicial, social safety net, security and foreign policy, and economic reforms to boost development. 4 The Law “On public-private partnerships” was approved by the Parliament of Uzbekistan on May 3, 2019. 2| New strategies The government adopted the Strategy for Innovative Development in September will guide the 2018, which includes quantitative targets for 81 indicators to be achieved through government’s 2030.5 The Strategy prioritizes human development as a key factor in competitive- priorities ness, emphasizes basic and tertiary education, and removes administrative barri- ers for business and the private sector. Recently, the government has approved the Sustainable Development Goals (SDGs) to national needs, including plans to help vulnerable groups, with 16 national SDG goals with 127 related targets, as well as the coordination council and roadmap to achieve that6. The additional spending needs for achieving SDGs are estimated by IMF at around 9 percent of GDP each year until 20307. Price liberaliza- To reduce the high cost of trading across borders, the government abolished export tion continues permit and licensing requirements for wholesale traders in October 2018. During the second half of 2018, the government liberalized bread prices and increased en- ergy prices for firms closer to cost-recovery levels. Broad-based increases were made to the country’s energy tariffs in November 2018: electricity prices were raised by 9.3 percent for individuals and by 40 percent for businesses; natural gas tariffs were increased by 10.9 percent for households and by 100 percent for busi- nesses; prices for petroleum products were also raised. The next energy price in- crease is scheduled for June 2019. Tariffs on cold water were increased in April 2019 by 23.5 percent for households with centralized supply and by 16.3 percent for households with non-centralized supply. Entry visas eased On February 1, 2019, the government introduced a visa-free regime for citizens of 45 to promote tour- economies, including many European and Western countries. On March 1, the govern- ism and business ment introduced a new type of three-year visa for investors and their family members that can be renewed without leaving Uzbekistan. Investors who invest a minimum of $3 million in Uzbekistan can obtain a 10-year residency permit.8 Strengthening of Uzbekistan’s diplomatic and economic relationships with its neighbors have im- regional eco- proved. Kazakhstan president Tokayev visited Uzbekistan in April 2019 to reaffirm nomic ties is con- Kazakhstan’s commitment to boosting bilateral trade to an annual $5 billion by 2020 tributing to en- and to set up an international center for trade and economic co-operation on the hanced regional Kazakh-Uzbek border. Kazakhstan's parliament ratified in March a bilateral agree- political stability ment whereby Uzbekistan would supply gas to southern Kazakhstan in return for oil delivery from Kazakhstan. Together with Kazakhstan, Uzbekistan launched a program dubbed the Silk Visa in February 2019, which allows foreigners with visas issued by either of the two countries to travel in both countries. Other examples of improved regional relations include Uzbekistan’s March 2018 decision to drop its 5 These targets for 2030 in the Uzbekistan Strategy for Innovative Development include all six World Bank govern- ance indicators and half of the Doing Business indicators (starting a business, getting credit, paying taxes, resolving insolvency, and protecting minority investors) as well as other useful indicators for private sector development (mar- ket capitalization, intensity of local competition) and education (government expenditure on education as percentage of GDP; expenditure on R&D; assessment of reading, math and science abilities; tertiary enrollment; firms offering formal training; females with advanced degrees). The strategy also includes measures of logistics performance, GDP per energy use, ISO environmental certificates, intellectual property protection, and ICT per capita, among others. 6 Cabinet of Ministers Resolution #841 dated October 20, 2018 “On measures to implement the nation goals and tasks on the sustainable development for the period of 2030” 7 IMF Country Report No.19/129 – Republic of Uzbekistan 2019 Article iv Consultations – Press Release and Staff Report, May 2019, p.50. 8 Furthermore, those living in Uzbekistan on an investors visa or residency permit now have the same right as Uzbek citizens to healthcare and education. |3 objections to Tajikistan’s construction of the Rogun Dam, and the 27 agreements signed during the Uzbek President’s visit to Tajikistan, including on the delimitation of the long-disputed border between the two countries, the restoration of flights be- tween Tashkent and Dushanbe, and an agreement on mutual visa-free travel for stays of up to one month. Tajikistan’s electricity exports to Uzbekistan resumed in April 2018 after a 9-year hiatus and Uzbek natural gas exports to Tajikistan rose in 2018. Bilateral trade between the two countries totaled $389 million in 2018, signif- icantly higher than the 2017 total of $238 million. Development co- Progress has been made on multiple fronts regarding development cooperation operation is with international financial institutions. In May 2018, the World Bank agreed to deepening provide Uzbekistan with loans totaling nearly $940 million for new projects in agriculture, energy efficiency, and emergency medical services, and $500 million in development policy operations (DPO) in 2018 and $500 million in 2019 as budgetary support for reforms. The Asian Development Bank (ADB) approved $300 million in policy-based loans in 2018 to help improve economic manage- ment and an additional $3 billion for the next three years to improve Uzbeki- stan’s water supply and sanitation, transport infrastructure, energy, and housing projects. In November 2018 the ADB approved a $197 million loan to expand the horticulture sector by establishing agro-logistic centers in the regions of Andijan and Samarkand. Following a 10-year break, the European Bank for Reconstruc- tion and Development (EBRD) resumed operation in Uzbekistan in 2017 with loans totaling $420 million in 2018. After launching operations in Uzbekistan a year ago, the European Investment Bank (EIB) allocated loans of €200 million ($224 million) to improve water supply, wastewater collection and treatment, as well as the energy efficiency of local enterprises. On March 1, 2019, Uzbekistan’s Senate approved the ratification of the ILO Convention №144 on trilateral con- sultations to facilitate the application of international labor norms (Geneva, 21 July 1976). The approval of the legislation should allow for the eventual end of the textile boycott of Uzbekistan. On February 25, 2019, the Uzbek President signed a decree on measures to improve the position of Uzbekistan in interna- tional ratings and indexes, including a national system for monitoring and eval- uating Uzbekistan’s position in such ratings and ongoing reforms for compliance with international standards. The Presidential resolution of April 29, 2019 of- fered 15 investment projects of US$1.7 bn for public-private partnership, includ- ing in airports and infrastructure sectors. Growth and Inflation Economic growth Real GDP growth rose to 5.3 percent year-on-year in the first quarter of 2019 increased in from 5.1 percent in the first quarter of 2018, supported by strong investment 2018 and first growth of 29.9 percent year-on-year9. On the supply side, economic activity quarter of 2019 picked up in industry by 6.8 percent, construction by 5.9 percent, services by 5 percent, and agriculture by 2.5 percent. Industrial growth came from growth in manufacturing by 7.6 percent, mining by 4.8 percent and other industries by 5.5 9 Total fixed investment grew by 29.9 percent y/y in the first quarter of 2019, including an increase in centralized investment (state budget, Uzbekistan Fund for Reconstruction and Development, government external borrowing, and Fun of water and sewage development) and in investment of population; the investment declined in such non- centralized sources as accounts of firms, domestic bank loans, and FDI. Investment in Q1 2019 was mainly in the energy, petrochemicals, and irrigation and water supply infrastructure. 4| percent. This followed 5.1 per- Figure 1. Sectoral Contribution to GDP Growth cent growth in 2018 and 4.5 percent in 2017 (Figure 1). On the demand side, while the contribution of net exports dampened GDP growth by an estimated 7.1 percent in 2018, domestic demand contributed 12.2 percent, mostly because of high fixed investment growth. The latter in turn ben- efited from substantial in- creases in government lending Source: World Bank staff calculations based on official data. to fund capital investments, mostly via SOEs. On the supply side, economic activity picked up in the industrial and construction sectors (by 10.4 percent and 9.9 percent, respectively), but de- celerated in agriculture (mainly cotton and wheat) to 0.3 percent (see Table1). Authorities attribute the slowdown in these agriculture subsectors to input bot- tlenecks, including shortages of water and unfavorable weather conditions. Inflation has Consumer price inflation has been on a downward trend. After peaking at 20.5 eased but re- percent at the beginning of 2018,10 twelve-month inflation eased to 14.3 percent mains high by December 2018 and further to 13.7 percent by April 2019 (Figures 2 and 3). Most price increases remain in low double-digits, including food (up 16 percent y/y in April 2019), services (up 13.3 percent y/y), and non-food (up 11.1 percent y/y). In services, the highest increase in April 2019 was for education (23.1 per- cent), following the 20 percent increase in contract-based tuition fees for higher education institutions in September 2018. Inflationary pressures in 2018 mainly reflected increases in administrative prices for energy and food11 and utilities, wage increases to certain public employees, and exchange rate depreciation. 10 See Uzbekistan: Staff Concluding Statement of an IMF Staff Visit, November 20, 2018, available at https://www.imf.org/en/News/Articles/2018/11/20/ms112018-uzbekistan-staff-concluding-statement-of-an- imf-staff-visit. 11 According to the Cabinet of Ministers Resolution #731 dated September 13, 2018, “On measures to reliably provide the population and the economy with grains, flour and bread on the basis of competition and the introduction of market mechanisms,” the wholesale price of grade 1 flour (UZS 1,400) was increased and free prices were introduced for bread sold to the population. |5 Figure 2. Consumer Price Inflation Figure 3. Key Inflation Measures Percent Percent 30 40 25 30 20 15 20 10 10 5 0 0 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Total Foodstuffs Non-foods GDP Deflator CPI (eop), IMF PPI Services Utilities Source: Uzbekistan authorities. Sources: Uzbekistan authorities; IMF databases. Note: CPI – consumer price index, PPI – producer price index External Sector The current ac- High investment growth supported by stepped-up directed lending and pent-up count shifted into consumer demand helped shift the current account from a surplus of 1.4 percent deficit in 2018 in 2017 to a deficit of 7.1 percent in 2018. A significant reduction in import du- ties12 in June 2018 and Octo- Figure 4. Balance of Payments ber 2017 also added to im- Percent port growth (Figure 4). Percent 50 25 Exports of goods and ser- vices increased by 14 per- 40 20 cent (led by foodstuffs, natu- 30 15 ral gas, textiles exports), 20 10 while imports rose by 42 10 5 percent. Total remittance in- 0 0 flows to Uzbekistan re- -10 -5 mained broadly stable in 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018* 2018 in nominal terms (at Exports G&S (LHS) Imports G&S (LHS) $5.7 billion) but grew as a CAB (LHS) Remittances, Net (LHS) FDI, Net (LHS) Int'l reserves (months of imports), RHS share of GDP owing to ex- Source: World Bank staff calculations based on official change rate devaluation. Re- data. mittances came mostly from tariff rates for about 8,000 of 10,800 total items were 12 In the aftermath of the exchange rate unification, import reduced (for about 5,000 items tariffs were reduced to zero) to mitigate the adverse effects on import-intensive companies (and prices) and improve the competitiveness of the economy. As a result, many tariffs on industrial inputs were lowered from about 30 percent to 10 percent, with the weighted-average import tariff falling from 15 percent in September 2017 to 5.9 percent in October 2017, and further to 3 percent in June 2018. However, from January 2019, import tariffs on 443 goods were increased from zero rate to 5-30 percent. These increases impacted utensils, furniture, office goods, household and climate equipment, and auto parts. The reduction of import duty affected only eight types of goods, including new and used tractors, yarn from silk waste, and filter fabrics. Excise taxes on tobacco and cigarettes were reduced from $60 to $40 per 1,000 pieces. Excise tax in- creased from zero to 10-20 percent on nine imported items of confectionary, four items of plastics, as well as household ovens, stoves, water heaters, washing machines, irons, vacuum cleaners, and LCD TVs. 6| Russia (77 percent of the total), Kazakhstan (6 percent), the United States (4 per- cent), Turkey (4 percent), the Republic of Korea (2 percent), and Israel (1 percent). Imports contin- Imports rose by a third from a year earlier in January-March 2019, faster ued to outpace than the one-fifth rise in exports, widening the trade deficit to 10.5 percent exports in the of GDP. 13 In the first quarter of 2019, the Central Bank of Uzbekistan sold first quarter of 6.2 tons of gold and became the world leader in gold sales. The bulk of im- 2019 ports during the period consisted of machinery and equipment, including parts and accessories (42.5 percent of the total), chemicals and related products (13 percent), and ferrous metals and related products (8 percent). Uzbekistan’s ex- The share of commodities in exports fell from about 90 percent in 1992 to 77 port structure percent in 2012 and 2018. Natural gas and gold made up about half of total has seen signifi- exports in 2012 and 2018, with more gas than gold in 2012 and more gold cant shifts in re- than gas in 2018. Cotton export fell sharply as Uzbekistan increased internal cent years processing of cotton fiber from 7 percent in 1991 to 60 percent in 2018. Trade in services (mainly transport, communications, and tourism) has ex- panded substantially in recent years, to nearly one-quarter of total exports in 2018, primarily owing to a surge in foreign visitors to the country. About 6.4 million foreigners visited Uzbekistan in 2018, up from just 2.8 million visitors in 2017. Non-commodity exports —manufacturing goods and foods (for example textiles, fertilizers, foodstuffs, cars, and home appliances) have expanded from about 10 percent of total exports in 1992 to about 23 per- cent in 2012 and 2018, evidence of export diversification in the economy (Figure 5). Uzbekistan has diversified its trade partners away from Russia (from 55 percent of trade in 1992 to 29 percent in 2012 and 17 percent in 2018) to China (19 percent in 2018) and other Commonwealth of Independ- ent States (CIS) economies (15 percent in 2018), the European Union (7 per- cent), Turkey (6 percent), and Korea (6 percent). The country’s import structure remains dominated by capital and intermediate goods, but the share of services also rose sharply in 2018 (Figure 6). Figure 5. Export Structure Figure 6. Import Structure Share of exports, % Share of imports, % Services 100 2 100 8 6 Services 13 Other (e.g. gold, textiles) 9 24.1 7 4 14 6 23 2 2 7 Other (e.g. textile) 6 Energy (e.g. gas) 19 6 9 10.9 29.4 Food 4 Energy (e.g. oil) 38 6 50 Machinery & equipment 50 Food 43 46 7 20.2 33 65 Metals (e.g. copper) 7 Machinery & equipment 8 9 1.6 Chemicals 10 9 6.8 8 9.6 Metals 8.8 7.3 10 0 1.8 Cotton fiber 15 13.3 1992 2012 2018* 0 5 Chemicals 1992 2012 2018* Sources: Uzbekistan authorities; World Bank staff calculations. Sources: Uzbekistan authorities; World Bank staff calculations. Note: * - preliminary data. Note: * - preliminary data. 13Exports of fruits and vegetables totaled $179 million (up 68.5 percent in value terms year on year). Exports on textile products totaled $369 million (up 16.5 percent in value terms year on year). |7 Ample reserves Uzbekistan’s sizeable foreign exchange reserves and low debt levels pro- provide a buffer vide a buffer against macroeconomic shocks. Reserves fell in 2018, but at against shocks US$27.1 billion (13 months of import cover) they remain adequate to en- sure sustainability and stability of external accounts. Just over half of re- serves are held in gold and the rest in convertible foreign currencies. Financial Sector Financial sector Twenty-nine commercial banks operate in Uzbekistan, including five state- indicators are owned banks, 13 partly state-owned joint-stock banks, five banks with for- sound eign capital, and six private banks. In April 2019, the value of total bank assets was equivalent to $27.6 bn. Included in this amount are the assets of the three largest state-owned banks, which together hold $15 bn. Reported financial sector indicators suggest that the banking system is sound, despite challenges related to deteriorating asset quality. Nonetheless, the dominant state-owned banks—with 85 percent of system-wide assets and 89 percent of total loans and a large amount of directed lending —distort competition and weigh on the creditworthiness of private banks. The sector has grown rapidly. Total lending by the country’s commercial banks rose by about 103 percent in 2017 and by 51 percent in 2018. A lot of the increase is due to policy lending – funds the state-owned banks receive from the government and the FRD and on-lend at below-market rates to SOEs. Overall, the banking sector appears to be well capitalized, with a capital adequacy ratio (CAR) of 15.4 percent in the first quarter of 2019 (Figure 8). Banks reported an average return on assets of 2.1 percent in 2018 and 2 percent in Q1 2019 and return on equity of 16.2 per- cent in 2018 and 16.4 percent in Q1 2019 (down from 17.9 percent in 2016). Reported NPLs Nonperforming loans (NPLs) increased from 0.4 percent of total loans in are low, but may 2015–16 to 1.3 percent at end-2018, according to central bank data. Capital trend higher support from the state in late 2017 and early 2018 provided robust loss ab- sorption capacity for 2018 and the first half of 2019 Vulnerabilities Uzbekistan’s banking sys- Figure 7. Selected Financial Indicators warrant moni- tem has been rated ‘stable’ Percent toring by Moody’s since 2010. The 30 rating was again retained in 25 2018, reflecting robust eco- 20 nomic growth, stabilizing 15 problem-loan trends, the 10 earnings performance of Uzbek banks, and signifi- 5 cant foreign currency re- 0 2015 2016 2017 2018 2019Q1 serves to cushion against external shocks. Neverthe- Regulatory capital to risk-weighted assets Non-performing loans to total loans Return on assets Return on equity less, loans held by banks Liquid assets to total assets Capital to assets with state shares are highly Source: World Bank staff calculations based on official data. concentrated in single bor- 8| rowers —SOEs, in particular—as their credit risk is mitigated either by min- istry of finance guarantees or anticipated state support owing to their sys- temic importance to the economy. Employment, Job Creation, and Poverty Job demand Robust economic growth has not translated into substantial employment gen- greatly exceeds eration. The total number of jobs offered on the domestic labor market in 2018 supply was estimated at 1,061,100.14 However, this is well below the number of jobs needed (more than 1.3 million).15 Formal job crea- Uzbekistan's labor force was 18.8 million in 2018, consisting of an econom- tion is moderate ically-active population of 14.6 million and an economically-inactive popu- lation of 4.2 million. A total of 13.2 million people was employed, of which 5.3 million held jobs in the formal sector and 7.9 million (or 59.3 percent of total employment) were employed informally. Of the 7.9 million jobs in the informal sector, the number of workers employed in seasonal and tempo- rary informal jobs was 1.6 million; labor migrants finding jobs abroad to- taled 2.6 million in 2018. 16 Unemployment Uzbekistan’s sectoral employ- Figure 8. Employment Structure by Sector stood at 9.3 per- ment structure has remained Percent cent at end-2018 relatively unchanged in the last 100 decade (Figure 8). Under a re- vised official methodology, the 75 50.5 52.2 50.7 50.5 51.1 52.0 52.8 50.0 49.9 49.7 49.9 unemployment rate stood at 9.3 percent at end-2018, down from 50 8.6 8.9 9.2 9.2 9.2 9.3 9.3 9.6 9.7 9.5 9.5 9.7 percent in the first quarter.17 Unemployment is highest in the 25 27.5 25.6 26.9 27.2 26.7 25.8 25.1 27.7 27.7 27.3 27.2 provinces of Ferghana (10 per- 13.5 13.4 13.2 13.1 13.0 13.0 12.8 12.8 12.7 13.5 13.4 cent), Andijan (9.9 percent), and 0 Surkhandarya (9.9 percent), and 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018* lowest in Tashkent city (7.8 per- Industry Agriculture Construction Services cent). At end-2018 the youth un- employment rate (16-25 years Source: World Bank staff calculations based on the official data. of age) was 17 percent, and un- employment among women was 12.9 percent. 14 This includes about 152,500 job vacancies, 188,000 vacancies owing to death or illness, 169,500 seasonal or part- time job vacancies, 48,000 jobs reserved for socially-vulnerable workers, and 155,800 opportunities for self-employ- ment in small-holder land plots and dehqan farms. 15 There were an estimated 484,500 graduates from all educational institutions in 2018 looking for work; also, an estimated 851,900 working-age people were unemployed, and 26,100 people classified as socially-vulnerable were seeking jobs. 16 These data are from Uzbekistan’s Ministry of Employment and Labor Relations. 17 The rise compared to previous years is due to the methodological change and does not suggest an actual increase in unemployment. |9 The poverty rate Although lack of access to official microdata since 2003 makes it difficult to con- has fallen sub- firm the poverty trend, it is estimated that the national poverty rate declined stantially from 27.5 percent in 2001 to 11.5 percent in 2018 (Figure 9).18 Estimates of the PPP-adjusted poverty rate (at the lower-middle income countries’ line) was 9.6 percent in 2018. Poverty is higher than the national average in eight of Uzbeki- stan’s provinces,19 especially in the remote and sparsely populated rural prov- inces of Karakalpakstan, Khorazm, Jizzakh, Namangan, and Surkhandarya, where most households are employed in agriculture, and few receive remittances. Meanwhile, densely populated urban areas with remittance-receiving house- holds—such as Tashkent city and Tashkent, Fergana, Bukhara, Samarkand, and Andijon provinces—have poverty rates below the national average. Income dis- tribution has become more equitable over time in recent years—the official Gini coefficient fell from 0.39 in 2001 to 0.29 in 2013. School enrollment is universal, and electricity and natural gas networks reach households nationwide. Safe drinking water is available to 100 percent of the urban population and 85 per- cent of the rural population. Expansion of mi- The trend of poverty reduction reflects robust GDP growth, rising incomes of micro- cro- and small and small businesses, regular minimum wage increases (above inflation in 2004–14 business played and in-line with inflation in 2015–18), remittance inflows during the commodity a key role in pov- boom episode, and the government’s targeted safety net programs. In particular, the erty reduction, expansion of micro- and small businesses seems to have played a central role in among other fac- these dynamics. According to official data, these entities accounted for 59.4 percent tors of GDP and 78 percent of total jobs (both formal and informal) in 2018.20 Net remit- tance inflows—averaging $4.3 billion in 2016 and $5.7 billion in both 2017 and 2018—also contributed to falling poverty rates. Based on the government’s house- hold budget survey, remittances accounted for 7 percent of household income among the bottom 40 percent of the income distribution in 2013, and 12 percent of household income in the top 60 percent. However, the elasticity of poverty reduction to GDP growth in Uzbekistan has been low: a 1 percent increase in per 18 As estimated and measured by the Uzbek national poverty line of minimum food consumption equivalent to 2,100 calories per person per day. The household budget surveys are conducted every year by the national sta- tistics agency, but not published and not available to the general public or donors. The Bank team believes that Uzbekistan’s official poverty estimate does not take into account non -food items and the use value of assets. In 2000–01 the World Bank recommended a methodology of measuring poverty and computing a poverty line in Uzbekistan using 2,100 calories per person per day given the multiple exchange rates at that time; however, in order to obtain robust poverty estimates the application of this methodology to Uzbekistan (now a lower-mid- dle-income country) needs to be updated by correcting for spatial and time price differences, and including non- food expenditures. 19 Chepel, S. 2014. Systemic Analysis and Modeling of Prospects for Sustainable Development of the National Economy of Uzbekistan. Tashkent: Institute of Forecasting and Macroeconomic Research. 20 The official statistics estimated the size of informal employment (defined as those working without official labor contracts) at about 38 percent of total employment in 2013, including 46.2 percent in services, 41.4 per- cent in industry and 3.5 percent in agriculture. In recent years, the government took efforts to formalize some of informal sector employment. 10| capita GDP is associated Figure 9. GDP per Capita, Poverty, Small Business with a 0.5 percent de- Share in GDP crease in the poverty GDP per capita, US$ Percent rate—below the average 3,500 60 for developing econo- 3,000 mies.21 Reasons for this 2,500 50 could include a relatively 2,000 40 small number of working 1,500 30 adults per family, insuffi- 20 1,000 cient job creation, re- 500 10 gional disparities, and low 0 0 productivity growth in ag- 2006 2008 2010 2012 2014 2016 2018 riculture (which employs Small business, % of GDP one-quarter of total labor GDP per capita, US$, lhs National poverty rate, % of population, rhs and most of the poor but is subject to implicit taxes Sources: Ministry of Economy, World Bank staff estimates. and restrictions on exports). B. Macroeconomic Policies and Key Structural Reforms Fiscal and Debt Policies Budget deficit is With a planned decline in policy lending, the overall fiscal deficit (including set to narrow in policy-based lending) is projected to tighten to 1.6 percent of GDP in 2019. Part 2019 of the tightening would come from capital spending, which is forecast at $2.2 billion in 2019 (down from $3.5 billion in 2018). This follows overall general government deficit of 2.1 percent of GDP in 2018 and 1.9 percent of GDP in 2017. Policy lending rose to 3.6 percent of GDP in 2017 and further to 4.3 per- cent of GDP in 2018 because of rising lending to SOEs, debt write-offs, and state bank recapitalization (Figure 10). New public works programs were also in- cluded in the budget. Total debt was 34.5 percent of GDP (Figure 11) and public debt remained low at 20.6 percent of GDP in 2018. As such, debt sustainability is not an immediate concern. Tax cuts are ex- The government's 2019 budget, which the cabinet approved in November pected to stimu- 2018, projects a significant tax cuts which took effect in January 2019 that are late consumption expected to boost consumption and investment. 22 A reduction in the maximum and investment 21 Ravallion M. (2001, Growth, Inequality and Poverty: Looking Beyond Averages, Policy Research Working Pa- per #2558, World Bank, Washington, DC.) found that a 1 percent increase in average household income or con- sumption will cause the poverty rate to decline by between 0.6 and 4.3 percent, depending on inequality. World Bank (2005, Pro-Poor Growth in the 90s: Lessons and Insights from 14 Countries. Washington, DC) found that in countries that experienced economic growth between 1990 and 2003, a 1 percent increase in GDP per capita re- duced the poverty headcount rate by an average of 1.7 percent. 22 On October 30, 2018, the President announced that in 2019 Uzbekistan would continue its policy of raising wages, pensions and benefits at a rate no lower than inflation. He indicated his administration’s plans to raise the pay of social workers in 2019, including raising the salaries of medical workers by 26.5 percent and employees of institutions of higher education and science by 150 percent. Furthermore, spending on social benefits is set to rise by 20 percent and the share of wages and payments in the State budget will increase from 49 percent to 54 percent. |11 personal income tax rate and the abolition of the 8 percent employee contribu- tion to Pension Fund will boost household income. Because of lower corporate property tax rates and corporate income tax rates, the single tax payment for small firms, and payroll taxes, an additional 2 trillion som are projected to re- main at the disposal of entrepreneurs. Lower labor taxes are likely to increase formalization of jobs. With the fiscal revenue loss in mind, the government is taking measures to reduce the budget deficit and increase revenues in 2019. In particular, the implementation of systematic work on the legalization of the number of employees and wages. Future tax reform will also need to address the fiscal risk of an eventual decline in revenue collections from SOEs; with SOEs beginning to lose long-standing tax privileges and their profitability fall- ing, tax revenue collection from SOEs will be put under increasing pressure. The government's tax reform could lead to an expansion of the tax base. In ad- dition, rates for value added tax (and other indirect taxes) —the government's largest revenue source—remain unchanged. Figure 10. Consolidated Budget Figure 11. Debt and Debt Service Percent of GDP Percent of GDP Percent 40 12 35 34 10 40 8 30 30 6 4 20 19 19 19.5 20 15 15 15.3 2 13 13 13 13 13 12.8 0 10 10 -2 6.2 5.8 4.1 3.6 4.0 3.8 4.7 -4 0 2008 2010 2012 2014 2016 2018* 0 2008 2010 2012 2014 2016 2018* Consolidated fiscal balance, lhs Revenue, rhs Total debt-to-GDP ratio Debt service-to-export ratio Expenditure, rhs Source: Uzbekistan authorities. Source: Uzbekistan authorities, World Bank staff calculations. Note: “lhs” is left-hand side; “rhs” is right-hand side. Note: External debt includes public, publicly-guaranteed, and non-guaranteed debt. Monetary and Exchange Rate Policies Monetary tight- Consumer price inflation averaged 17.5 percent in 2018 owing to devaluation ening has been pressure on the som, the removal of price controls on food, and higher energy ongoing since prices. Following the unification and the liberalization of the exchange rate in late 2017 late 2017, the som depreciated by 58 percent in 2017, by 2.7 percent during 2018 and by 4.6 percent from January to April 2019. With average inflation at 17.5 percent in 2018, the average real effective exchange rate was about 9 per- cent lower in 2018 as compared to 2017. The central bank increased the refi- nancing rate from 14 percent to 16 percent in September 2018 to help stabilize the exchange rate and reduce inflation. The transmission mechanism from pol- icy rates to credit growth is not strong. Combined with high dollarization and a shallow capital market, the substantial policy-based lending to SOEs constrains the effectiveness of monetary policy. Credit growth to the economy slowed to 12| 50.8 percent in 2018 from 103 percent in 2017 but remained much higher than in previous years (at 27 percent on average in 2011-2016).23 Monetary policy The Central Bank of Uzbekistan (CBU) gained more powers in 2018 to conduct framework con- monetary policy and improve banking supervision. The central bank continues tinues to develop to improve its liquidity management tools. Inflation targeting is due to be for- mally introduced by 2021. Creating a strong monetary transmission mecha- nism for monetary policy, improving CBU’s analytical capacity, and communi- cating policies are essential pre-conditions for adopting inflation targeting. 24 Bringing inflation down and supporting macroeconomic stability will depend on improved policy coordination and progress on broader structural reforms to reduce the state's role in the economy and improve the quality of Uzbeki- stan’s institutions.25 First Eurobond Uzbekistan issued its first dollar-denominated bonds on February 14, 2019. successfully is- The issuance included two tranches of $500 million each, with one maturing in sued in February five years (4.75 percent yield) and the other in 10 years (5.38 percent). The 2019 bond was heavily oversubscribed, with demand from investors exceeding $8.5 billion. Most of the Uzbek Eurobonds on the London Stock Exchange were pur- chased by investors from the United Kingdom. Demand was strong despite in- ternational credit rating agencies rated the country's sovereign credit BB- (non-investment-grade speculative) in January 2019. Nevertheless, the high demand for the Eurobond suggests that there is a strong appetite among emerging-market investors for Uzbekistan which is engaged in a market re- forms program. Uzbekistan has no pressing need to raise revenue. In issuing the bond, the government is pursuing broader goals. Key Structural Reforms Reforms in key Uzbekistan relied heavily on a state-driven, import-substitution growth model areas are ongo- from the early 1990s to 2016, with mixed outcomes for job creation and living ing standards. In 2017, Uzbekistan changed course, placing the country on track to build a more open and market-oriented economy. The most notable reforms in- clude the liberalization of the foreign exchange market gradual price liberalization, reducing import tariffs and excise taxes on imports,26 reinitiating Uzbekistan’s commitment to WTO accession, liberalizing visitor visa requirements to promote openness and tourism, expanding social safety net coverage, granting the central bank more independence, improving macroeconomic statistics, and reducing tax rates for both firms and individuals. Reforms in busi- The country’s business climate for small firms has also improved. As a result, Uz- ness climate and bekistan’s position in the World Bank’s Doing Business ranking improved by 23 According to the IMF, the monetary policy in Uzbekistan is not effective . 24 See “Uzbekistan: IMF Staff Concluding Statement on the 2018 Article IV Consultations,” available at https://www.imf.org/en/News/Articles/2018/03/14/ms031418-uzbekistan-staff-concluding-statement-of- the-2018-article-iv-mission. 25 See “Uzbekistan: IMF Staff Concluding Statement of the 2019 Article IV Mission,” available from https://www.imf.org/en/News/Articles/2019/03/05/msc030519-uzbekistan-staff-concluding-statement-of- the-2019-article-iv-mission. 26 The average import tariff was cut from 15 percent in August 2017 to below 3 percent in June 2018; it was increased in December 2018. |13 SOEs maintain nearly 80 positions in five years, to 76 of 190 economies in Doing Business 2019. reform momen- Improvements were made in the indicators measuring starting a business, regis- tum tering property, paying taxes, protecting minority investors, getting credit, and trading across borders. In March 2019, Uzbekistan transferred the state-owned shares of 13 banks to the State Assets Management Agency, which was recently established within the finance ministry. Uzbekistan also established the Economic Council (with international experts) to ensure the implementation of the country’s structural reform roadmap in 2019–21.27 The tax code has also been revamped, and state-owned enterprises are being restructured with a view to eventual pri- vatization. The management of Uzbekistan’s airports and the state-owned airline is being separated, for example, as are the generation, transmission, and distribu- tion of electricity. The reform Key immediate reform priorities include further price liberalization, competition Roadmap was policy, land reform for both agricultural and non-agricultural land, ensuring better approved in access to credit and raw materials, and strengthening trade liberalization. With 2019 World Bank support, the government approved the Reform Roadmap in January 2019 that focused on (i) maintaining macroeconomic stability, through better data quality, institutional coordination, fiscal policy, tax administration reform; (ii) im- proving the efficiency of land and capital, by removing restrictions on land use in agriculture, more flexibility and transparency in land allocation, and strengthening property rights, deepening financial markets, and connecting to global markets (WTO accession), ICT sector reform, aviation sector; (iii) removing constraints to private sector development by adopting a competition law, regulating anticompet- itive firm behavior, strengthening commercial dispute resolution, reducing the cost of doing business, improving energy efficiency, and expanding utility services; (iv) enhancing social protection, including pension reform, social safety nets, labor market reforms, health, education, and the justice system; and (v) strengthening the state for its new role in a market economy, including SOE reform, public-pri- vate partnerships, public administration reform, strengthening local governance, anti-corruption, better reform coordination, citizen engagement; and (vi) strengthening environmental sustainability, via water resources and irrigation, environmental fees and fines management, and so on. Public finance On January 28, 2019, the President strengthened parliamentary control over the and governance Cabinet of Ministers28 prescribing that from April 1, 2019, Parliament must pro- reforms are key vide approval for candidates for the posts of deputy prime minister, ministers, and chairpersons of state committees. Under the legislation, candidates will now be required to present action plans to Parliament; the prime minister and govern- ment members are required to submit quarterly progress updates on the imple- mentation of the state program. Other newly-enacted reforms are designed to im- prove the quality of government services for firms and citizens, enhance public accountability, and strengthen transparency through more comprehensive disclo- sure requirements.29 New laws expanded the legislature’s control over the execu- tive branch allowing legislative review of the resolutions issued by the President, 27 Presidential Decree #up-5614 of January 8, 2019,"On additional measures to ensure the further development of the economy and increase the effectiveness of economic policy." 28 Presidential Decree of January 28, 2019, “On priority measures to increase accountability of the Cabinet of Min- isters on the effectiveness of implementation of strategic tasks of social and economic development of the country.” 29 Law of March 29, 2018, “On State Procurement” and regulations of September 27, 2018, to enact this Law; Law of January 3, 2017: “On combating corruption”; Law of December 9, 2015: “On e-Government”; Cabinet resolution #320 of November 6, 2015: “On implementation of measures on enacting the Law on transparency of state bodies.” 14| the prime minister, and the cabinet of ministers, as well as the introduction of par- liamentary investigations.30 Furthermore, all draft laws and presidential and cab- inet resolutions since 2017 are now available to the public on the government’s website.31 Uzbekistan has also implemented the recommendations of the En- hanced General Data Dissemination System (e-GDDS) by publishing critical mac- roeconomic and financial data through the National Summary Data Page (NSDP)32 that serves as a one-stop publication vehicle for essential macroeconomic data. The NSDP is posted on the website of the State Statistics Committee and is accessi- ble on the IMF’s Dissemination Standards Bulletin Board.33 The NSDP page contains links to statistics published by official data producers, namely the State Statistics Committee, the central bank (monetary statistics and balance of payments), and the finance ministry (state budget statistics). The finance ministry also completed its transition to modern Debt Management and Financial Analysis System (“DMFAS 6.0”) so that Uzbekistan became one of 57 developing economies—and one of only six countries in the Europe and Central Asia region—with this software in 2018.34 In January 2019 the finance ministry also introduced three-year budgeting for the period 2019–21. In May 2019 the government decided that the public investment program is to be prepared for three years starting from 202035. A Single Treasury Account has been effective since 2012, and two consecutive Public Expenditure and Financial Accountability (PEFA) reports36 have confirmed that the budget is com- prehensive and good monitoring mechanisms are in place to ensure budgetary con- trol and fiscal stability. Since 2015, all firms submit their tax, customs, and statistical reports online, and all public procurement is executed through a computerized sys- tem. The finance ministry updated its public financial management reform program through 2020 in November 2016. C. Economic Outlook and Risks The economic Despite a slowdown relative to historical averages, Uzbekistan’s economic out- outlook is gener- look remains positive, with real GDP growth projected at 5.3 percent in 2019, ally favorable 5.5 percent in 2020, and 6 percent in 2021 (Table1). Market reforms are ex- pected to address production bottlenecks and liberalize high-potential growth sectors of the economy, such as horticulture, tourism, food processing, textile, and chemicals. These reforms will be supported by a significant reduction in the business tax burden. Inflationary pressures would persist in 2019 –20 due to further price liberalization and wage increases, but the effects are expected to moderate by 2021. The current account deficit is expected to narrow from its 2018 level but remain in deficit as the economy continues to import signifi- cant levels of capital and machinery to modernize production. Increased donor support and a gradual increase in FDI would finance the deficit. External buff- ers are projected to remain comfortable over the medium term, with foreign 30 Law “On Parliament Control” of April 11, 2016. 31 See https://regulation.gov.uz/. 32 See https://nsdp.stat.uz/. 33 See http://dsbb.imf.org. 34 These six economies are Albania, Armenia, Georgia, Moldova, Romania, and Uzbekistan. 35 Presidential Decree of May 14, 2019 #5717 “ On measures to transit to a new system of preparation and imple- mentation of the Investment Program of the Republic of Uzbekistan”. 36 Uzbekistan’s first PEFA assessment was completed in 2012; a second PEFA report was published in January 2019. |15 exchange reserves remaining above 13 months of import cover. Gross external debt is expected to decline modestly by 2020, to about 34 percent of GDP, while total public debt is expected to increase to near 25 percent of GDP. Excessive credit The main risk to macroeconomic stability is that a prolonged credit boom growth may could aggravate inflationary pressures and feed into a higher external def- threaten stability icit. The government is expected to curtail directed lending to maintain fiscal discipline. The central government balance (excluding policy-based lending) is expected to remain in a lower surplus of about 0.5 percent of GDP over the medium term due to significant reductions in excise, income, and payroll tax rates, and increased spending to maintain public investment, pen- sions, and low-income allowances. However, with policy-based lending (which is projected to decline) the overall state budget deficit would decline to about 1.7 percent of GDP on average in the medium-term. Steady economic growth and remittance income are expected to contribute to a modest pace of poverty reduc- tion. Changes in government policies may further expand support programs to poor and vulnerable households and reduce poverty. For 2019, the government has increased the budget allocation for social protection by 50 percent. Table 1. Baseline Scenario: Selected Macro-Fiscal Indicators, 2018–21 (In percent, unless otherwise indicated) 2018e 2019f 2020f 2021f GDP, at constant market prices 5.1 5.3 5.5 6.0 Private Consumption 3.8 3.9 4.0 4.2 Government Consumption 1.4 1.4 2.3 2.6 Gross Fixed Capital Investment 18.1 15.2 10.2 10.1 Exports, Goods and Services 10.7 8.2 2.2 2.5 Imports, Goods and Services 25.8 18.4 7.1 6.8 GDP, at constant factor prices 5.1 5.3 5.5 6.0 Agriculture 0.3 2.9 3.2 3.4 Industry and construction 10.4 6.4 6.3 6.7 Services 4.7 5.9 6.3 7.0 Inflation (Private Consumption Deflator) 17.5 14.8 14.1 11.0 Current-Account Balance (% of GDP) -7.1 -6.6 -5.6 -4.7 Overall Fiscal Balance, incl. UFRD (% of GDP) -2.1 -1.6 -1.8 -1.8 Debt (public, % of GDP) 20.6 23.2 24.7 24.6 Primary Balance (% of GDP) -1.7 -1.2 -1.4 -1.4 Source: World Bank staff calculations based on official data and IMF calculations. Risks are Prospects are favorable for higher commodity prices and accelerated private in- weighted to the vestment (including FDI) owing to Uzbekistan’s bold reform agenda. Overall, downside however, risks are tilted to the downside. These risks include weaker-than-fore- cast economic growth in Uzbekistan’s main trading partners—Russia, China, and Kazakhstan—potential delays in additional structural reforms to reduce the State’s role in the economy, and rising inflation. The risk to the domestic econ- omy of external instability is modest due to a comfortable cushion of foreign ex- change reserves and low levels of external (mostly concessional) public debt. While market reforms have begun to address the role of the State in the economy, the next phase of reforms aims to tackle more complex issues such as SOEs and the financial sector, agricultural reforms, and the privatization of non-agricul- 16| tural land. These reforms are critical to economic transformation and to sustain- ing economic growth and job creation. They also carry significant economic and social risks that will need to be carefully monitored and managed. In addition, the reform agenda is expanding rapidly, and the authorities recognize the need to prioritize reforms that address the economy’s most acute distortions first. D. Focus Section: Growth and Job Creation37 Significant chal- The Uzbek economy creates about 280,000 new jobs per year on average (on a lenges exist in net basis) compared to the 600,000 jobs demanded each year for demographic the labor market reasons alone. The economy needs to double the number of jobs created each year only to absorb new entrants. Most jobs will have to be created by estab- lishing new firms, with some created by expanding existing firms. Other struc- tural weaknesses in Uzbekistan’s labor market include d isincentives to work, skills gaps and a limited supply of training in technical skills, high youth unem- ployment, high economic inactivity and long-term unemployment, and limited labor mobility. Economic growth Creating productive jobs is the key to economic growth and improvement in liv- drives job crea- ing standards. The two key factors contributing to growth in GDP per capita in tion Uzbekistan are growth in labor productivity and growth in employment. The economies that today have the highest incomes per capita are also those that have shown the most impressive increases in labor productivity growth over the past two centuries. This increase in productivity has led to the creation of ‘bet- ter’, or higher-paying, jobs. GDP per capita is, in fact, a measure of the popula- tion’s productivity, and differences in GDP per capita between high-income and low-income economies largely reflect differences in their levels of labor produc- tivity. The driving force behind the rapid growth in labor productivity in ad- vanced and rapidly developing economies has been a combination of investment in the quantity and quality of human capital, physical capital, technological pro- gress, and organizational capital at the firm level, and institutions (such as mar- kets, the state, a national innovation system, and the legal framework) that de- termine the allocation of resources. Rising labor Uzbekistan recorded a cumulative increase of 165 percent in GDP (value added) productivity has per capita between 1996 and 2016, which is equivalent to an average growth driven GDP rate of 5 percent per year. Total output per worker (or labor productivity) in- growth creased by about 150 percent over this period. The growth in value added per capita can be decomposed into growth in labor productivity, growth in employ- ment, and growth in demographic factors (such as changes in the economically- active population and the working-age population) using the Shapley decompo- sition method. The growth in value added per capita over this period was driven by rising productivity (explaining 91 percent of the increase in value added per capital) and by demographic change (22 percent of the increase). These positive effects were mitigated by decreases in the labor force participation rate and in the employment rate over the same period. 37This chapter summarizes the key messages of the World Bank report “Uzbekistan Growth and Job Creation: An In- depth Diagnostics” (2019). |17 Labor productiv- Rising capital per worker and a modest increase in total factor productivity ity growth came (TFP) played a positive role in the within-sector changes in labor productivity. mainly from Due to high growth in investment, the capital in the economy increased 18-fold within sectors between 1996–2016 and the capital per worker ratio increased almost 12-fold. TFP (net of inter-sectoral shifts) rose by only 16.4 percent during the same period, and the inter-sectoral shifts, on the whole, had a slightly negative effect on growth of value added per capita in that period. This is because some inter- sectoral shifts were productivity-enhancing, whereby workers moved from below-average-productivity sectors and subsectors (for example, cotton and wheat agriculture) to above-average-productivity subsectors (for example, transport and telecommunications services, and trade and catering). However, other inter-sectoral shifts involved workers moving from above-average- productivity subsectors (such as manufacturing and mining, for example) toward below-average-productivity sectors or abroad, or from below-average- productivity subsectors (such as agriculture) to other below-average productivity subsectors (for example ‘other services’ and construction). Job creation has The ‘Uzbek model’ of economic development used between 1996 and 2016 was lagged popula- unable to ensure sufficient job creation for the rapidly-growing population. Total tion growth formal employment rose from 8.2 million in 1996 to 12.3 million in 2016 (a 50- percent increase). However, as a result of the simultaneous growth in the economically active population (and the working-age population), the employment rate declined by 0.52 percent per year on average between 1996 and 2016. Job creation in the manufacturing subsectors has been a particular challenge, especially in labor-intensive subsectors such as food processing, light industry, apparel, and other manufacturing. Manufacturing employment in Uzbekistan was only about 9 percent of total employment in 2016, having declined during 1996–2016 despite government policies to support the sector, and contrary to the government’s expectations. The industrial sector (mining and manufacturing, excluding construction and utilities) is the least-important employer in Uzbekistan’s economy, accounting for just 13 percent of total employment. This share was lower than in comparator countries in 2016—45 percent in Turkmenistan, 32 percent in Belarus, 25 percent in Ukraine, 22 percent in the Kyrgyz Republic, 21 percent in Kazakhstan, 17 percent in Tajikistan, and 14 percent in Azerbaijan. Simultaneous Many of Uzbekistan’s sectors and subsectors experienced simultaneous growth employment and in employment and labor productivity. This was the case in construction, labor productiv- chemicals and petrochemicals, wholesale and retail trade and catering services, ity growth is transport and communications, and other services subsectors. While the ideal electricity industry and two subsectors of the mining sector (the fuel industry and the metallurgical industry) created jobs, they also experienced a decline in labor productivity. Uzbekistan has a The ratio of value added to total output when calculated in international prices competitive ad- (for both inputs and outputs) is significantly higher than the same ratio vantage in food calculated in domestic prices for the food processing and textiles and apparel processing, tex- industries. For some industries (such as chemicals and petrochemicals and tiles, and apparel construction materials), however, this ratio is higher in domestic prices than in international prices—although, for some subsectors of the chemicals and petrochemicals industry the ratio is higher in international prices than in domestic prices. The large differences between domestic and international 18| prices, among other things, show the level of price distortions in Uzbekistan’s economy. In addition, there is still a large productivity gap in manufacturing between Uzbekistan and the upper-middle-income countries (by 2.2 times in manufacturing overall, including almost 6 times in the chemical industry), but only a 50-percent gap in the food processing industry, a 30 percent gap in the apparel industry, a 10 percent gap in the textile industry, and no gap in general in the machinery building industry. These gaps show untapped potential for productivity growth in Uzbekistan’s manufacturing subsectors that is possible to use by addressing the existing constraints to the business climate and productivity growth at macroeconomic, sectoral, and firm levels. Small manufac- Enterprise surveys show that small manufacturing firms in Uzbekistan are, on turing firms are average, much more productive than large firms—which are mostly state-owned more productive or state-controlled enterprises—but that large firms employ relatively more but employ employees than small firms. The average labor productivity in five fewer workers manufacturing subsectors of Uzbekistan was about twice as high in small firms ($75,000 per employee, compared to $34,000 in large firms) in 2014 and 2016. Meanwhile, the average number of jobs created per unit of capital in 2016 was higher in large manufacturing firms (35 jobs per million U.S. dollars of capital, compared to 12 jobs in small firms). In a market economy in the long-run, firms with higher productivity can pay higher wages and should attract more employees. However, until 2018, Uzbekistan experienced the opposite; perhaps because there was high inertia in the manufacturing sector owing to limited information flows on wage differences between large and small firms, and a lack of market forces in the economy38 that explains weak reallocation processes in the economy in general. The business cli- The economic literature shows that, in most economies, young firms can be a mate hinders more important source of net job creation than existing (incumbent) firms. 39 firm and job cre- However, the average number of newly-registered firms per 1,000 of the ation working-age population over the 2006–16 period indicates that Uzbekistan (with 0.72 new firms) has the second-lowest business density of all CIS countries (higher only than Tajikistan with 0.35 new firms), and less than half the CIS average (1.67 new firms). Business density is also lower than the average for the lower-middle-income group of countries to which Uzbekistan belongs (1.99 new firms per 1,000 of the working-age population), and lower than the average for Europe and Central Asia (4.63 new firms) in 2014.40 The Uzbek people are known for their entrepreneurial abilities; it is primarily business climate constraints that are restricting an increase in the rate at which new firms and jobs are created. Uzbekistan was ranked 76 of 190 economies in the World Bank’s 2019 Doing Business ranking; its most challenging areas were trading across borders, dealing with construction permits, resolving insolvency, paying taxes, getting credit, and registering property. 38 More market forces were added at the end of 2017 with the introduction of convertibility of the national cur- rency, a reduction in import tariffs, and the launch of the free trade of 27 key raw materials on the commodities exchange. 39 World Bank. 2012. World Development Report 2013: Jobs . World Bank, Washington, DC. 40 One caveat of this indicator is that it includes only businesses registered as legal entities, even though in 2016 about 210,000 individual entrepreneurs were operating in Uzbekistan without registering as legal entities and, so, were not captured by the indicator. Thus, the number of actual entities in Uzbekistan that create jobs, relative to the population, is slightly higher than this indicator would suggest. |19 Physical infra- Interruptions in physical infrastructure result in significant losses in potential structure defi- manufacturing output each year. Small firms suffer more than large firms from ciencies result in interruptions of electricity, gas, and water supply, and from a lack of territory or high losses lease rates on land for expanding output production. Total self-estimated loss from all interruptions in physical infrastructure was 42 percent of potential output in large firms in 2012, 24 percent in large firms in 2016, and 38 percent in small firms in 2016. By improving infrastructure services, the authorities can increase both output per worker and employment in firms. Authorities’ de- Firm productivity is also constrained by the authorities diverting managers’ time mands on firm and firms’ financial resources toward non-productive activities. About 31 time and re- percent of managers’ time in large firms and 26 percent in small firms is lost on sources hinder various non-productive bureaucratic activities such as dealing with central productivity government ministries, local authorities, industry parastatal associations, or former line ministries concerning tax, customs, inspections, sanitary, and environmental issues. As a result, less time is available for more important work like improving their firms’ productivity, efficiency, skills, technology, and profitability. Firms reported that 32 percent of employees in large firms and 30 percent in small firms participated in cotton picking or were distracted to other public works in 2016. About 23 percent of large firms and 11 percent of small firms said that local authorities requested “additional spending” from firms without compensation. In 2016, about 13 percent of large firms and 7 percent of small firms made unofficial payments to various authorities to get things done, and 8 percent of large firms and 6 percent of small firms knew in advance how much to reserve for illegal payments to local authorities. About 61 percent of large firms’ total output and 46 percent of small firms’ total output was subject to central distribution by a line ministry or industry association in 2016, rather than being decided by firms and the free market. Structural re- Uzbekistan needs to tap into the potential productivity gains associated with the forms must im- cross-sectoral reallocation of labor from below-average to above-average prove allocative productivity sectors. This process should be complemented by intra-sectoral re- efficiency, en- allocation from lower-productivity firms to higher-productivity firms within courage busi- each sector. In the medium term, there is strong potential for economic growth ness-to-business from accelerating shifts of labor toward economic subsectors with above-aver- spillovers, and age productivity (that would be expected to have higher wages), such as from strengthen firm agriculture to manufacturing, mining, transport, and services (financial and busi- capability ness services and telecommunications, for example) and within the agriculture sector (from cotton and wheat to horticulture). Reallocating labor from less- to more-productive subsectors of the economy will require policy interventions, in- cluding to mitigate the social impact of economic restructuring. Currently, the lack of appropriate unemployment insurance and poorly targeted social assis- tance undermine the effectiveness of existing policy instruments. Firms need re- The government has already removed two top binding constraints to business forms that elimi- by implementing two reforms: unifying exchange rates in September 2017 and nate binding con- cutting taxes in January 2019. The reforms demanded by manufacturing firms straints to busi- show that at this stage of Uzbekistan’s economic development most fi rms are ness preoccupied with resolving simple constraints related to firm survival—such as lack of access to inputs and lack of access to markets for outputs. Addressing these issues can improve allocative efficiency and firm capabilities. The next phase of reforms would, therefore, need to focus on the next set of binding 20| constraints such as (i) ensuring an uninterrupted supply of electricity and natural gas; (ii) improving access to high-quality, affordable raw materials for all; (iii) improving access to credit (lower inflation, affordable interest rates and terms, and lower collateral requirements); (iv) providing additional territory (land) to allow production to expand (for example by developing markets for land user or ownership rights in the industry and services sectors); (v) increasing the availability of skilled personnel (workers, engineers, and top managers); (vi) improving regular provision of information to all firms in all sectors about the available new technologies and equipment (to help firms with capital rehabilitation and technology upgrading) and state support for exporting (such as ISO quality certification and export risk mitigation, promoting diversification, WTO accession, organizing trade fairs, providing regular information on foreign demand for products, and so on); and (vii) reducing the degree of domestic market monopolization by state-owned enterprises (SOEs) and banks, industrial holdings, and associations. Easing business Removing barriers to market entry and exit, easing business regulations, lifting regulations, mar- remaining price controls, strengthening private property rights, and tackling ketization, and inefficiencies in the SOE sector would further improve overall productivity. A removing barri- valuable lesson for Uzbekistan41 is that reducing government participation in ers to entry and productive activity, deregulating, and removing barriers to entry and exit can exit is expected spur organizational change at the firm level (such as more efficient management to accelerate pri- and additional research and development activities) and contribute to the vate sector de- growth of GDP per capita. Competitive pressures can boost technology velopment absorption and innovation if firms have access to financial markets, raw materials, and other inputs. Business registration in Uzbekistan is relatively easy (Uzbekistan ranked 12 globally for starting a business in Doing Business 2019), but informal barriers and government failures—opaque regulations and a lack of adequate protection of property rights (for example land ownership and intellectual property)—remain significant. These constraints limit Uzbekistan’s ability to attract foreign direct investment (FDI) and absorb technology. Exiting the market is costly as bankruptcy procedures are slow or poorly developed. Measures to tackle these challenges could be accompanied by moving to international accounting and reporting standards (IFRS) in the real sector, hardening the budget constraints for SOEs, strengthening corporate governance and restructuring and privatizing SOEs and banks, further liberalizing prices and sustaining trade liberalization, enhancing competition policy and demonopolization, and improving banking competition and liberalizing interest rates. Addressing market distortions slowly and selectively could exacerbate, rather than alleviate, them. 41 India and China significantly liberalized their trade and import tariffs on manufactured goods. India halved import tariffs on most tradable goods and eliminated quantitative controls between 1990 and 1997. China has been moving away from the very restrictive regulation of 30 years ago. SOEs in China have been operating more like private sector firms following the governance reform, which expanded managerial independence and decoupled the SOE ownership function from other aspects of government policy making. |21 Annex Table 1A. Selected Macroeconomic and Social Indicators, 2016–21 2016 2017 2018 2019 2020 2021 Projections National Income and Prices Nominal GDP (LCU), UZS trillion 243 303 408 523 643 759 Nominal GDP per capita (US$) 2,568 1,828 1,532 1,805 2,067 2,370 Real GDP growth (percent) 6.1 4.5 5.1 5.3 5.5 6.0 Gross investment growth (percent) 4.1 19.4 18.1 15.2 10.2 10.1 Consumer price inflation, average 8.8 13.9 17.5 14.8 14.1 11.0 Nominal official exchange rate change, average 2,965 5,114 8,070 … … … Real effective exchange rate (2015=100) (decrease = depreciation) 84.3 65.9 60.2 … … … External Accounts Merchandise exports, USD billion 8.6 10.1 11.4 12.4 12.8 13.4 of which (percent of total merchandise exports): Cotton fiber 7.4 4.7 2.0 2.5 1.2 0.5 Energy (natural gas, electricity) 19.8 18.9 23.4 21.0 22.3 22.2 Food 8.0 8.6 9.6 11.4 12.8 13.1 Gold 32.5 32.1 25.6 30.3 30.1 29.5 Other exports of goods 32.3 35.7 39.4 34.8 33.6 34.7 Merchandise imports, USD billion 11.0 12.4 18.3 20.3 21.1 21.9 Current-account balance (percent of GDP) 0.4 2.5 -7.1 -6.6 -5.6 -4.7 Foreign direct investment, net (percent of GDP) 2.5 2.1 1.3 1.8 2.1 2.7 Total official international reserves, USD billion 26.5 28.1 27.1 27.5 27.9 27.6 Total official international reserves, months of imports 19.2 14.4 12.8 12.3 12.0 11.2 Total external debt (percent of GDP) 18.6 34.1 34.5 34.0 33.5 32.2 Consolidated Fiscal Accounts (percent of GDP) Overall fiscal balance (incl. UFRD balance) -0.5 -1.9 -2.1 -1.6 -1.8 -1.8 Pubic debt 8.6 20.2 20.6 23.2 24.7 24.6 Monetary Accounts (percent of GDP) Broad money 21.5 24.1 20.5 19.3 19.0 19.0 Credit to the economy 21.8 35.5 39.7 38.7 37.9 38.0 Policy rate (percent) 9 9 14 16 .. .. Social Indicators Population, total, mid-year (millions) 31.9 32.4 33.0 33.5 34.0 34.6 Population growth (percent) 1.8 1.6 1.8 1.6 1.6 1.6 Unemployment rate (percent of labor force)* 8.0 9.0 9.3 9.3 9.2 9.2 Poverty rate, national (percent of population)** 12.3 11.9 11.5 11.3 11.1 10.9 Inequality – Gini coefficient 0.28 0.28 0.30 0.31 0.32 0.33 Life expectancy (years) 68.5 68.5 71.3 71.3 71.3 71.4 Sources: World Bank staff calculations and estimates based on official data published and provided by the authorities and IMF data. Note: * The Ministry of Employment and Labor Relations of Uzbekistan changed its methodology for calculating unemployment in 2018. ** Estimated and measured by the Uzbek national poverty line of minimum food consumption equivalent to 2,100 calories per person per day. Household budget surveys are conducted every year by the national statistics agency, but not published and not available to the public or do- nors. The Bank team believes that Uzbekistan’s official poverty estimate does not take into account non-food items and the use value of assets. 22| Uzbekistan Country Economic Update | Summer 2019