Uzbekistan forex reform reboots investment-hungry economy

Uzbek president Shavkat Mirziyoyev has rolled back years of tight foreign exchange controls to overcome one of the major hurdles to foreign investment into the country.

Uzbekistan’s currency regime lies at the heart of a rigid capital control structure engineered by former president Islam Karimov to promote the development of local industries over foreign competition, even at the cost of international isolation. But it has become increasingly dysfunctional in recent years, when the difference between the official rate of the Uzbek som and the street som available on the black market widened with the end of the commodity supercycle.

Mr Mirziyoyev ended this in early September when he announced the liberalisation of the exchange rate. This sent the official som rate through the floor as the divergence with the black market closed almost overnight, but stirred a rare, if cautious, agreement among foreign observers.  

“This measure clears the way from many of the fraud and corruption risks typical of a system that, at some point, [had] as many as four different exchange rates [the central bank rate, the exchange booth rate, the Uzbekistan Commodity Exchange rate and the black market rate],” said Tim Stanley, senior partner for Russia/CIS at risk consultancy Control Risks. “This was a necessary step in the right direction, but more things have to come through to liberalise the economy.”

Foreign exchange (forex) reform has featured among Mr Mirziyoyev’s priorities since his presidency began last December, when he succeeded Mr Karimov, who had ruled the country with an iron fist since independence from the Soviet Union in 1991. It took the new president about nine months to make forex reform a reality.

“One of the priority directions of the state economic policy in the area of further liberalisation of foreign exchange market is the exclusive use of market mechanisms in setting the national currency rate in relation to foreign currency,” said a note published on the governmental website on September 5.

The measure prompted an immediate 92.4% devaluation of the som as the currency quickly moved towards to its real market value, which the black market had been reflecting for months. At the same time, it allowed businesses to access foreign currency from commercial banks immediately without any restrictions, whereas individuals have to wait until October 1.

Uzbekistan’s tight foreign exchange controls have long weighed on the country’s appeal for foreign investment, alongside the scarcity of foreign currency through official banking channels. Importers have reportedly had to wait for weeks before being able to convert som into hard currency, and face rigid profit repatriation rules.

Despite its rich mineral reserves and a market of more than 30 million people, Uzbekistan’s stock of accumulated FDI stood at $9bn at the end of 2016, or 13.4% of gross domestic product, the lowest level among Commonwealth of Independent States countries, according to figures from the UN Conference on Trade and Development.

The forex reform will not change things overnight. “It’s really major reform, but it will take time for investors to overcome years of mistrust,” said Mr Stanley.

Mr Mirzoyiyev has demonstrated a commitment to follow up on his promises to modernise and liberalise the economy. He reportedly halted forced labour in cotton fields, resumed relations with international institutions such as the European Bank for Reconstruction and Development, and promised to reform the public administration while fighting endemic corruption.

Yet he remains entangled in the power struggle between reformists and conservatives that erupted as a consequence of Mr Karimov’s death. Members of the Uzbek state security services allegedly plotted to assassinate him a few days after the foreign exchange reform. Besides, he will have to handle the economic fallout from the som’s devaluation, with inflation expected to rise and the central bank having to adjust its monetary policy to the new forex course.

“Implementing monetary and fiscal policy effectively in order to restore confidence in the som’s value, contain inflation expectations and shore up the economy will be extremely challenging,” credit rating agency Moody’s said in a report on September 11.

Mr Mirzoyiyev has not balked at the challenge. After nine months in power, his presidency already hinges on the success – or failure – of his gamble.