Page 59 - bne_August 2020_20200810

bne August 2020
Opinion 59
2021. Foreign direct investment (FDI) jumped from a mere $1.9bn in 2016 to $9.3bn in 2019.
Our economy is comparatively well diversified, albeit the state still maintains a large role in key industries (banking, natural resources, telecommunications, transportation, etc.), but privatization continues to be a key reform agenda. Inflation was consistent recently (ranging14-15%), which I believe is imported, partly as a result of the continuing trade deficit (reduced import tariffs), that continuously puts devaluation pressure on our exchange rate (the som lost 31% of its value against the dollar in just two years). However, despite these structural imbalances the outlook has remained positive as the country was preparing for a period of sustained and robust economic growth.
The danger of foreign currency debt
One of the biggest potential threats to Uzbekistan’s economic success in the years to come is over-leveraging, particularly hard currency denominated borrowing. Changes to the Securities Market Law in early 2019 made it possible for both the state and companies to issue international bonds denominated in foreign currencies. I’m calling for those changes to be repealed.
As an economy, Uzbekistan is currently running a reasonable amount of leverage, many cynics would argue, with debt to GDP of approximately 50%, discounting the fact that almost all of it is owed by the state and state owned/controlled banks and companies.
External debt, almost all of it in foreign currency, increased by 43% in just 15 months (from $17.3 to $25.1bn). If dollar- denominated external debt continues to rise, Uzbekistan’s economy (still largely dependent on export of volatile commodities and remittances from abroad for supply of hard currency) and its businesses will ultimately encounter higher debt service costs (hard currency loans services by local currency revenues). This is inevitable because of further natural devaluation of the local currency, expected from factors such as: (1) continuing trade deficit, (2) servicing
FX debt will require purchase of hard currency on the local market, (3) likely reduction in future worker remittances from abroad, and (4) perception by the population of dollars as the ‘safe haven’ savings currency.
To counter significant devaluation of the local currency and its unintended consequences of causing higher prices (inflation), resulting from higher local currency cost of imported finished goods, equipment and raw materials, the Central Bank will be forced to keep high interest rates (15% at the moment) and maintain tight supply of local currency in the financial system. Note that current total money supply indicator M2 to GDP decreased, standing at 17%, and if we exclude foreign currency deposits, money supply as a percentage of GDP is even lower, at 12%. And if we try to throw in the size of the grey economy, then M2 to total GDP would probably fall into single digits!
This demonstrated significant dollarization of the money supply in the economy, and very little local currency available in the market required to support the economic activity. Note that this indicator with our largest trading partners is substantially larger, in China it is around 200% and in Russia around 48%.
As local currency remains a scarce commodity, this will make it more expensive for businesses to borrow in local currency, hampering growth of the real sectors of the economy, and facilitating further dollarization, as a financing alternative.
If dollar borrowing accelerates, we risk ending up in a debt trap: the borrowing doesn’t lead to the hoped-for economic growth, we’re constantly borrowing more to repay previous loans. Meanwhile, the interest is adding up.
This is a sad cycle that has been repeated in emerging markets around the world again and again over the last 40 years. It’s the number one reason Uzbekistan should put a freeze on foreign currency borrowing.
Building the local market
And yet there is another reason why dollar borrowing is
a bad idea. Reliance on foreign currency-denominated borrowing from the international financial institutions undermines our efforts to build a domestic capital market and fully functional financial market.
Uzbekistan – spearheaded by the agency I lead – is in the early stages of implementing a program to build a robust local capital market. The som-denominated bond market is beginning to emerge. We are pushing the government to use local equity market to implement some privatization transactions. It is a must, so that we can gain confidence with local investors, and invite foreign investors to invest
“One of the biggest potential threats to Uzbekistan’s economic success in the years to come is over-leveraging, particularly hard currency denominated borrowing”
with us in Uzbekistan. And domestic retail investors are beginning to dip their toes into the market. We were able to develop a comprehensive and detailed capital market/ financial market development strategy, with assistance from EBRD and ADB, a detailed road map was prepared, solutions and structural reforms recommended; it now needs to be approved by the government.
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