Background Paper for Debt Management in Uzbekistan

8/14/2019 Background Paper for Debt Management in Uzbekistan

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External Debt Management by the Government of Uzbekistan:

Policies, Strategies, Techniques, Legal System and Institutional Set Up

And Evaluation of their Processes and Methods.

Background Note and Questionnaire

Tarun Das1 Ph.D.

Professor (Public Policy), IILM, New Delhi.

Consultant, World Bank

October 2008

1.The Author would like to express his gratitude to the World Bank HQ and the Uzbekistan Country Office,

particularly to Dr. Saumya Mitra, Lead Economist, The World Bank Country Office in Uzbekistan atTashkent for providing an opportunity to prepare this paper. The background note and the Questionnaireexpress the personal views of the author, which do not necessarily imply the views of the World Bank orthe organizations he is associated with.

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Background Note and QuestionnaireTarun Das, Consultant, World Bank

CONTENTS

ACKNOWLEDGEMENTS

1. Introduction- Scope and Objectives of the Study1.1 Debt Management Policy1.2 Debt Sustainability Analysis (DSA) by IMF Staff1.3 Legal Framework for External Debt Management in Uzbekistan1.4 Terms of Reference (TOR) for the Study

2. Basic concepts of external debt and sustainability indicators

2.1 Definition of external debt2.2 Debt Sustainability and Fiscal Deficit2.3 Debt Sustainability and Current Account Deficit2.4 Liquidity versus Solvency2.5 Debt Sustainability Measures

2.6 World Bank Classification of External debt2.7 Stress Tests, Debt Distress and Indicative Debt Service Thresholds2.8 Policy framework and Institutional Set up for External Debt Management2.9 Capacity Building for Management of Public Debt and Contingent Liability2.10 International best practices for policy framework and institutional set up

3. Current State of the Uzbekistan Economy

3.1 Economic Performance and Poverty3.2 Uzbekistan Economic Freedom Indices: The Heritage Foundation3.3 Strengths, Weakness, Opportunities and Threats (SWOT)3.4 Economic Growth and Inflation in 20073.5 External Sector Performance in 20073.6 Money Supply and Banking Operations3.7 Fiscal Situation and Reforms3.8 Medium Term Economic Forecasts3.9 Development Challenges

4. Questionnaire for All Stakeholders of External Debt in Uzbekistan

A. Debt Recording, Analysis and Debt Statistics: Coverage, Scope and Quality

B. Debt monitoring and reporting: TransparencyC. Guarantees and other Contingent LiabilitiesD. Legal System and Institutional Set Up: AccountabilityE. External Debt Management Policies, Strategies, Practices, Methods and SystemsF. Risk Management: Capacities and Systems

Annex-1: World Bank CPIA Criteria for Debt Management

Selected References

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And Evaluation of their Processes and Methods

ACKNOWLEDGEMENTS

This Report is based on mainly a review of recent studies on Uzbekistaneconomy made by the development stakeholders and the lessons andinternational best practices drawn from the authors studies on managementof external debt in selected developing countries in Africa, Asia and Pacificsuch as India, Cambodia, Gambia, Indonesia, Lao PDR, Mongolia, Nepal,Samoa, and Thailand . Most of these references are cited in the paper and

included in the selected bibliography.

The Author would like to express his gratitude to the World Bank HQ andthe Uzbekistan Country Office, particularly to Dr. Saumya Mitra, LeadEconomist, the World Bank Country Office in Uzbekistan at Tashkent for

providing an opportunity to prepare this paper.

The author is presently working as Professor (Public Policy) at the Institutefor Integrated Learning in Management, New Delhi, India. Earlier heworked as Economic Adviser in the Planning Commission and the Ministryof Finance, Government of India at New Delhi; Strategic Planning Expert inthe ADB Capacity Building Project on Governance Reforms, Ministry ofFinance, Government of Mongolia at Ulaanbaatar; CommonwealthSecretariat Consultant for Debt Sustainability Analysis for the Governmentof Gambia at Banjul; and UN-ESCAP Consultant for the Management ofExternal Debt for the Governments of Samoa, Cambodia, Lao PDR and

Nepal. The background note and the Questionnaire express the personalviews of the author, which do not necessarily imply the views of the WorldBank or the organizations he is associated with.

Tarun Das, Ph.D.

Professor (Public Policy), IILM, New Delhi, and

Consultant, World Bank.

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And Evaluation of their Processes and Methods.

1. Introduction- Scope and Objectives of the Study

This is a part of a wider study and an Economic Report being prepared under the WorldBanks Country Policy and Institutional Assessments (CPIA) for discussion betweenthe Uzbek authorities and the Bank. The main objectives of the Economic Report includethe following: (i) to develop a common understanding of the meaning of the criteria usedin the CPIA exercise and how they are applied; (ii) to obtain information and data relatingto the criteria that would enable Bank staff to make updated assessments; and (iii) todiscuss with the authorities future policy steps and reform intentions that would affectCPIA assessments. This approach would be successful only if, during its course, theauthorities presented data and information on the variables used in the CPIA exercise at asuitably disaggregated level. It is proposed that the Economic Report be based initially on

three set of questions, (i) debt policy; (ii) trade; and (iii) revenue mobilization. Thepresent Questionnaire deals with the Debt Management Policies, Strategies, Legal andInstitutional Systems, Techniques and Evaluation of their Processes and Methods.

1.1 Debt Management Policy

This chapter of the Economic Report will make an assessment of the impact of debtmanagement strategy on minimizing budgetary risks and ensuring long-term debtsustainability. Uzbekistans debt burden is manageable with favorable trends of majordebt sustainability indicators (Tables-1.1 and 1.2). The ratio of total debt stock to GDPdeclined to 17.6 percent in 2007 and further to 15.4 percent in 2008 from 42 percent in

2003. The debt service ratio (i.e. the ratio of total debt services to exports of goods andservices) declined to around 8.6 percent in 2007 after reaching the maximum at 26.7percent in 2001. The ratio of total debt stock to exports of goods and services alsodeclined to 43.5 percent in 2005 after attaining the maximum at 158 percent in 2002. Theratio of sort term debt to total debt has declined continuously from 10.4 percent in 2001to 0.9 percent in 2005. Moreover, foreign exchange reserves are being built up rapidlyand stood at $10.2 billion equivalent to 10 months of imports of goods and services at theend of 2007. But, the shares of concessional and multilateral loans are low as comparedto those for other low income and developing countries. However, the situation does not pose problems in the near and medium term. The degree and effectiveness ofcoordination between debt management and macroeconomic policies will also be

discussed. Adequate and timely information on debt stocks and flows is an importantcomponent of debt management strategy. A dedicated debt management unit should beable to plan strategy and monitor new borrowing and manage risks. Annex-1 presentsdetails related to these CPIA criteria. Present paper has four sections. Followingsection-1dealing with scope, objectives and terms of reference the study, Section-2 presents abrief note on basic concepts on external debt and debt sustainability indicators andSection-3presents a brief note on the current state of the Uzbekistan economy. Section-4presents a detailed questionnaire for all stakeholders of external debt in Uzbekistan.

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Table-1.1 Uzbekistan: Trends of Selected Economic Indicators in 2002-2007Economic Indicators 2003 2004 2005 2006 2007 2008*

Growth rate of Real GDP (percent) 4.2 7.7 7.0 7.3 9.5 8.0

Growth rate of Nominal GDP (percent) 32.0 24.6 29.9 30.4 35.8 23.1

CPI inflation rate (%) official estimate 3.7 3.8 7.8 6.8 6.9 6-8

CPI inflation rate (percent) IMF estimate 7.8 9.1 12.3 11.4 11.9 11.0

Growth rate of reserve money (%) 26.7 38.7 87.5 36.5 44.9 28.4

Growth rate of broad money supply (%) 27.1 47.8 54.3 36.8 46.1 32.4

Growth rate of net foreign assets (%) 45.6 48.8 44.0 76.3 67.4 35.8

Growth rate of net domestic assets (%) -87.8 -50.5 -28.4 -148 -88.7 -38.4

Growth rate of net claims on govt (%) -1509 -114 -87.0 -145 -78.9 -56.8

Growth rate of credits to the economy (%) 6.9 10.8 15.8 4.3 16.7 30.8

Growth rate of exports of G&S (%) 28.4 28.1 12.0 18.0 40.7 22.1

Growth rate of imports of G&S (%) 8.9 26.8 4.4 13.8 44.3 28.9

As percentage of GDP at current mp

Revenue and grants (as % of GDP) 33.4 32.2 30.8 31.4 31.7 30.6

Expenditure and net lending (% of GDP) 33.9 32.1 31.1 30.9 30.2 31.1

Overall budget balance as % of GDP 0.1 0.6 1.2 2.2 2.1 -0.4Augmented budget balance as % of GDP 0.1 0.6 1.2 5.2 5.1 5.0

Total Public debt as % of GDP 41.6 35.1 28.2 21.3 15.8 13.5

Public External Debt as % of GDP 38.7 32.0 25.2 19.8 14.7 12.5

Exports of goods & services as % of GDP 37.3 40.5 38.1 37.6 40.4 41.3

Imports of goods & services as % of GDP 30.6 32.9 28.9 27.5 30.3 32.7

Current account balance as % of GDP 8.7 10.2 13.7 17.3 19.2 16.6

FDI as % of GDP 0.7 1.6 0.6 1.1 3.3 3.5

External debt (as % of GDP) 42.0 36.2 29.1 22.7 17.6 15.4

Ext. debt service (as % of exports of G&S) 20.5 17.1 14.1 12.7 8.6 7.6

Ext. debt service (as % of FE reserves) 49.7 35.6 28.0 17.3 11.3 8.1

Memo Items:

GDP in sum trillion 9.8 12.3 15.9 20.8 28.2 34.7

GDP in US$ billion 10.1 11.9 14.2 17.0 22.2 26.6

Nominal GDP per capita (US$) 396 462 543 641 827 977

Nominal GDP per capita (US$ PPP) 1654 1808 1970 2154 2388

Income velocity of money supply (level) 10.5 9.5 8.4 7.6 7.3 6.5

Foreign exchange reserves (US$ Bln) 1.66 2.15 2.90 4.45 7.41 10.1

Forgn. Exch. Reserves (Months of imports) 5.1 6.3 7.4 7.9 10.2 11.8

End-period Exchange rate (UZ Sums/US$) 979 1058 1180 1240 1290

External debt outstanding (US$ million) 4249 4322 4133 3853 3913 4095

Year-End foreign exch. reserves (US$ bln) 1.66 2.15 2.90 4.46 7.41 10.14

Foreign exch. reserves (months of imports) 5.1 6.3 7.4 7.9 10.2 11.6

Exports of goods & services (US$ billion) 3.78 4.84 5.42 5.39 9.00 10.78Imports of goods & Services (US$ billion) 3.10 3.93 4.10 4.67 6.74 8.67

External CAB (US$ Million) 861 1215 1949 2933 4267 4472

External capital balance (US$ Million) -414 -702 -1191 -1389 -2113 -1741

Population (million) 25.6 25.9 26.2 26.5 26.9 27.2* Estimated. Source: International Monetary Fund (2008b) Republic of Uzbekistan: 2008 Article IVConsultation- Staff Report; IMF, Washington, D.C., July 2008.

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Table-1.2: Trends of External Debt in Uzbekistan in 1995-2005 (US$ Million, unless otherwise specified)

Items 1995 2000 2001 2002 2003 2004 2005

Total Debt stock (EDT) 1799 4618 4855 4776 5012 5007 4225.5

Long term debt 1430 4209 4274 4383 4748 4810 4189

Public & guaranteed 1415 3764 3904 4003 4257 4302 3638.5

Private non-guaranteed 15 445 370 380 491 508 550.5

Use of IMF credit 157 127 78 62 43 19 0

Short-term debt 212 282 503 331 221 178 36.5

Principal repayments 149 646 635 581 659 700 782.2

Long term debt 149 581 590 559 636 675 782.2

IMF purchases 0 65 45 22 23 25 0

Interest payments (INT) 96 236 227 180 152 148 172

Long term debt 80 204 206 164 145 141 172

IMF charges 3 9 5 2 1 1 0

Short term debt 13 23 16 14 6 6 0

Total debt service paid (TDS) 245 882 862 761 811 848 954.2

Long term debt 229 785 796 723 781 816 954.2IMF repurchases and charges 3 74 50 24 24 26 0

Short term debt (interest only) 13 23 16 14 6 6 0

Gross national income (GNI) 13316 13541 11196 9543 10012 11912 13946

Exp.of goods and services (XGS) 3800 3400 3223 3020 3810 3890 5680

Workers remittances 0 0 0 0 0

Imp.of goods & services (MGS) 3840 3198 3379 3023 3247

International reserves (RES) 1867 1273 1215 1400 1659 2146 2895

Current account balance -21 216 -113 117 882 1215 1949

Debt Sustainability Indicators (in per cent)

Items 1995 2000 2001 2002 2003 2004 2005

Total Debt stock (EDT)/ XGS 47.3 135.8 150.6 158.1 131.5 128.7 74.4

Long term debt/ XGS 37.6 123.8 132.6 145.1 124.6 123.7 73.8

Public & guaranteed/ XGS 37.2 110.7 121.1 132.5 111.7 110.6 64.1

Private non-guaranteed/ XGS 0.4 13.1 11.5 12.6 12.9 13.1 9.7

Use of IMF credit/ XGS 4.1 3.7 2.4 2.1 1.1 0.5 0.0

Short-term debt/ XGS 5.6 8.3 15.6 11.0 5.8 4.6 0.6

Total Debt stock (EDT)/ GNI 13.5 34.1 43.4 50.0 50.1 42.0 30.3

Long term debt/ GNI 10.7 31.1 38.2 45.9 47.4 40.4 30.0

Public & guaranteed/ GNI 10.6 27.8 34.9 41.9 42.5 36.1 26.1

Private non-guaranteed/ GNI 0.1 3.3 3.3 4.0 4.9 4.3 3.9

Use of IMF credit/ GNI 1.2 0.9 0.7 0.6 0.4 0.2 0.0

Short-term debt/ GNI 1.6 2.1 4.5 3.5 2.2 1.5 0.3

TDS/ XGS 6.4 25.9 26.7 25.2 21.3 21.8 16.8

INT/ XGS 2.5 6.9 7.0 6.0 4.0 3.8 3.0

INT/ GNI 0.7 1.7 2.0 1.9 1.5 1.2 1.2

Short-term/ Total debt 11.8 6.1 10.4 6.9 4.4 3.6 0.9

Concessional/ EDT 10.4 30.4 30.1 32.7 35.6 37.6 .

Multilateral/ Total debt 13.7 9.8 10.7 11.9 12.5 14.8

Source: (1) World Bank, Global Development Finance 2006 for the years 1995-2004 and ADB for the year 2005.

Table 1.3A External Debt: Public and Publicly Guaranteed:

Average Terms of Commitment

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Items 1995 2000 2002 2003 2004 2005

Interest (% per annum) 5.7 6.4 3.0 2.9 2.1 2.6

Maturity (years) 15.5 14.9 22.7 13.9 26.3 23.4

Grace period (years) 4.3 3.5 6.7 2.5 6.4 6.4

Grant element (%) 24 19.5 47.4 32.5 57.5 52.2

Table 1.3B External Debt: All Creditors: Average Terms of Commitment

Items 1995 2000 2001 2002 2003 2004


Maturity (years) 15.5 14.9 13.0 22.7 13.7 26.2


Grant element (%) 24 19.3 25.0 47.4 31.6 57.2

Table 1.3C External Debt: Official Creditors: Average Terms of Commitment

Items 1995 2000 2001 2002 2003 2004Interest (% per annum) 5.2 6.0 4.1 3.0 4.5 1.9

Maturity (years) 18.1 17.9 22.3 26.5 21.2 28.6


Grant element (%) 28.9 24.0 39.0 53.2 36.0 61.4

Table 1.3D External Debt: Private Creditors: Average Terms of Commitments

Items 1995 2000 2001 2002 2003 2004


Maturity (years) 9.0 6.4 6.6 7.5 9.5 7.7

Grace period (years) 2.5 1.4 1.6 2.0 1.1 2.2Grant element (%) 11.2 7.5 15.3 23.6 29.2 24.5

Table 1.3E Currency Mix of External Debt (in percentage)

Currency 1995 2000 2001 2002 2003 2004

Euro 16.0 18.2 20.7 19.6

Japanese Yen 3.1 21.2 20.7 20.7 21.1 21.4

Pound Sterling 0.0 0.0 0.0 0.0 0.0 0.0

Swiss Franc 0.1 0.0 0.0 0.0 0.0 0.1

U.S. Dollars 66.5 56.7 57.6 54.4 49.6 48.9

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1.2 Debt Sustainability Analysis (DSA) by IMF Staff

As a part of the Republic of Uzbekistan: 2008 Article IV Consultation,IMF Staff makes a Debt Sustainability Analysis (DSA) for Uzbekistan.The IMF concluded that the medium-term (2009-2013) outlook of the

Uzbekistan external debt situation is favorable under both the baselineprojections and the standard stress tests. The authorities haveambitious targets at 89 percent export-led GDP growth over themedium term, and believe that these growth rates are achievablethrough consolidating macroeconomic stability, modernizing varioussectors, improving physical and social infrastructure, enhancing therole of the private sector, and attracting FDI. They expect the externalcurrent account to continue registering relatively large surpluses.

The IMF team assessed that the recorded current account surplusshould decline as external statistics improve through proper recording

of the debit items. The IMF staffs more conservative baseline scenariobased on current policies assumes that GDP growth would slow downgradually to about 6 percent as export growth slows and the economyfaces capacity constraints, and the current account surplus woulddecline gradually to 8 percent of GDP. Then the IMF staff makes thefollowing standard two Baseline Scenarios and six Bound Tests:

Baseline:

A. Alternative ScenariosA1 = Key variables at their historical averages in 2008132A2 = New public sector loans on less favorable terms in 2008133

B Bound Tests

B1 = Real GDP growth at historical average minus one standard deviation in 200910B2 = Export value growth at historical average minus one standard deviation in 2009-104B3 = U.S. dollar GDP deflator at historical average minus one SD in 2009-10B4 = Net non-debt creating flows at historical average minus one SD in 2009-105B5 = Combination of B1-B4 using one-half standard deviation shocksB6 = One-time 30 percent nominal depreciation relative to the baseline in 20096

IMF staff concluded that under all scenarios and stress teststhe external debt situation of Uzbekistan has low and declining

external and public debt levels, and the debt outlook is2Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), noninterest current account in percent of GDP,and nondebt creating flows.3

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline, while grace and maturity

periods are the same as in the baseline.4Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to returnto its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).5Includes official and private transfers and FDI.6Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

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resilient to adverse shocks. Tables 710 from the IMF Reportare reproduced here.

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Limitations of the IMF Assessment

However, IMF Study has the following limitations:(1) It makes stress tests for only public external debt and public debt, but it does not

make sensitivity analysis for the private debt which has important impact on the

economys financial and foreign exchange situation. The Asian financial crisis inthe 1990s and the present global financial turmoil have originated not from thepublic debt rather from the private debt.

(2) It does not make Strength, Weakness, Opportunities and Threats (SWOT)Analysis for the Uzbekistan economy, which has both direct and indirect impacton debt. A tentative SWOT analysis is made by the present author in Annex-3.

(3) It does not deal with external sector related contingent liabilities, and domesticsector related off balance sheet and off budget risks of the government.

(4) It does not make in-depth analysis of the Policies, Strategies, Systems,Techniques, Legal and Institutional Set Up for the management of external debtand public debt in Uzbekistan and a critical Evaluation of their Processes and

Methods.

The present report will make an attempt to fill these gaps on the basis of desk study

as well as field surveys through interviews and designed questionnaires for all the

stakeholders of public debt and external debt.

1.3 Legal framework for External Debt Management in Uzbekistan

As per governments business rules and procedures, Ministry of Finance is in charge ofevaluation of projects being financed by external aid. It is also in charge of governmentborrowing from external sources and making payment of interest charges and repaymentof principal.

Normative - legal framework of activity

Regulations of the Ministry of Finance of the Republic of Uzbekistan have beenapproved by the Resolutions of the Cabinet of Ministers "On Approval of the Regulationsof the Ministry of Finance of the Republic of Uzbekistan" 533 dated Nov 23, 1992.

The organizational structure of the Ministry has been approved by the Resolutions of theCabinet of Ministers "On organizational structure of the Ministry of Finance of theRepublic of Uzbekistan" 59 dated February 11, 1992

According to the assigned tasks the Ministry of Finance within its competence given bylegislation performs the following main functions relating to management of externaldebt: In the framework of state debt management together with the Central Bank carriesout monitoring, counting and servicing of internal debt of the Republic of Uzbekistan,

submits suggestions to the Cabinet of Ministers of the Republic of Uzbekistan aboutimprovement of the structure of government debt, acts as a government securities issuer,

develops and approves legislative acts for securities issuance, manages external debt,

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develops top parameters of government external loans, prepares and submits guaranteesof the Government of the Republic of Uzbekistan, organizes fulfillment of loan and other

contract obligations to external creditors, carries out records and control over use and

servicing of foreign credits attracted or guaranteed by the Republic of Uzbekistan.

1.4 Terms of Reference (TOR) for the Study

In the light of above discussions, the present study will have the following objectives:

1. To study the external debt recording and analysis system; and quality and coverage ofexternal debt statistics;

2. To study the trends of stock and composition of external debt, key external debtsustainability indicators, currency-maturity-interest mix of external debt, creditor-wiseand borrower-wise classification of external debt;

3. To review Debt Management Policies, Strategies, Processes, Legal Framework, andInstitutional Arrangements,

4. To make a Debt Sustainability Analysis (DSA) of external debt as per joint guidelinesby the World Bank and IMF;

5.To study the risk management framework, policies, strategic benchmarks andinstitutional set up;

6. To study the sovereign external debt management and the contingent liabilities relatingto external debt;

7. To recommend and suggest best practices for the following:a) Debt recording, analysis and debt statistics;b) Management of external debt and public debt;c) Institutional and operational framework;d) Legal and regulatory framework;e) Monitoring and evaluation of external debt, public debt and contingent liabilities;f) Risk management modeling and stress test;g) Monitoring debt indicators for debt sustainability analysis;h) Possibilities of debt restructuring or debt relief;

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without principal include loans with infinite maturity such as recently popularperpetual bonds as these have contractual interest payments liabilities.

Three other concepts- one relating to interest payments, another relating to currency andanother relating to short-term debt need some clarification. While calculating interest, in

general an accrual method rather than the actual cash-flow method is used. As regardscurrency, debt is made in different currencies and it is a common practice to convert alldebt in a single foreign currency, say US dollar, and also in domestic currency. In somecases, debt from non-residents could be denominated in terms of domestic currency. Asper definition of external debt, such debt should form a part of external debt, even thoughit may not be fully convertible.

In general, short-term debt is defined as debt having original maturity of less than oneyear. However, Southeast Asian crisis highlighted the necessity to monitor debt byresidual maturity. Short-term debt by residual maturity comprises all outstanding debthaving residual maturity of less than one year, irrespective of the length of the original

maturity. Residual maturity concept is distinctly superior to original maturity concept.

2.2 Debt Sustainability and Fiscal Deficit

External public debt is sustainable when debt services (repayment of principal plusinterest payments) can be paid without resort to exceptional financing (such as debtrelief) or debt restructuring or a major correction in the balance of income andexpenditures. Debt-servicing problems in low-income countries arise when the costs ofservicing public debt become very high, and official creditors (such as internationalfinancial institutions or governments, and donors) do not to provide sufficient newfinancing in terms of loans or grants for financing a countrys primary deficit. Althoughexternal official debt is the dominant source of financing, domestic debt is equallyimportant for a developing country. In general, interest rates on domestic debt are veryhigh in low-income countries and maturities tend to be short, exposing a country tosignificant roll-over and liquidity risks. Unlike external debt, which is mostlyconcessional, domestic debt is usually issued at market rates. This implies that costs ofservicing domestic debt depend on overall macroeconomic environment and fiscalsituation of a country.

Debt sustainability is closely related to the fiscal deficit, particularly to the primarydeficit (i.e. fiscal deficit less interest payments). Sustainability requires that there shouldbe a surplus on primary account. It also requires that the real economic growth should behigher than the real interest rate. Countries with high primary deficit, low growth andhigh real interest rates are likely to fall into debt trap.

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2.3 Debt Sustainability and Current Account Deficit

A current account deficit occurs if imports of goods and services (excluding interestpayments) exceed exports of goods and service plus net transfers. It is often the mostimportant factor that leads to a rise in external debt. A persistent negative current account

balance is likely to indicate that a country may face an increase in its probability of debtdistress. The standard textbook two-gap theory on the Balance of Payments also statesthat high fiscal deficit spills over current account deficit of the balance of payments. Thuspersistent and high levels of current account deficit is an indication of the balance ofpayments crisis and needs to be tackled by encouraging exports and non-debt creatingfinancial inflows.

2.4 Liquidity versus Solvency

One important conceptual issue relates to the distinction between debt service problemsdue to liquidity crunch and those due to insolvency. These concepts are borrowed fromthe financial analysis of corporate bodies, but there are distinctions between firms and

countries (Raj Kumar 1999). If a firm has positive net worth but faces difficulty to meetthe obligations of debt service, it is considered to be solvent but to have liquidityproblem. When it has negative net worth, it is insolvent.

There is difficulty to apply these concepts to a country, as it is difficult to value all theassets of a country such as natural resources, wild life, antics in museum, heritagebuildings and monuments. Besides, firms can disappear due to insolvency problems, buta country cannot become bankrupt nor disappear nor are overtaken or merged purely onaccount of financial problems. So we need to consider medium and long term prospectsof a country in terms of growth and balance of payments.

2.5 Debt Sustainability Measurements

There are broadly two approaches to determine debt sustainability of a country. One is todevelop a comprehensive macroeconomic model for the medium term particularlyemphasizing fiscal and balance of payments problems, and another is to assess variousrisks associated with debt and to monitor various debt sustainability indicators over time.These indicators express outstanding external debt and debt services as a percentage ofgross domestic product or other variables indicating the strength of the economy. Somecommonly used debt sustainability indicators are given in Table-2.1

2.6 World Bank Classification of External debt

On the basis of ratio of PV to GNI and PV to XGS (exports of goods and services), theWorld Bank in their report on Global Development Finance 2005 has classified countriesinto three categories viz. low indebted, moderately indebted, and severely indebtedcountries as indicated in Table-2.2. While PV takes into account all debt servicingobligations over the life span of debt, GNI indicates countrys total potentials and XGSindicates foreign exchange earnings reflecting debt-servicing ability. Countries are alsoclassified into low and middle income depending on the level of per capita income.

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Table-2.1: Debt Sustainability Indicators

Purpose Indicators

1. Solvency ratios (a) Interest service ratio the ratio of interest payments toexports of goods and services (XGS).

(b) External debt to GDP or XGS or Revenue ratio(c) Present value of debt services to GDP or XGS ratio

2. Liquiditymonitoring ratios

(d) Basic debt service ratio- Ratio of total debt services(interest payments plus repayments of principal) to XGS

(e) Cash-flow ratio for total debt or the total debt serviceratio (i.e. the ratio of total debt services to XGS)

(f) Interest payments to reserves ratio.(g) Ratio of short-term debt to total debt or XGS or foreign

exchange reserves(h) Import cover ratio- Ratio of total imports to total foreign

exchange reserves.

3. Debt burden ratio (i) Total external debt to GDP or GNP or XGS ratio(j) Debt services to GDP (or GNP) ratio(k) Total public debt to budget revenue ratio(l) Ratio of concessional debt to total debt

4. Debt structureindicators

(m) Rollover ratio- ratio of amortization (i.e. repayments ofprincipal) to total disbursements

(n) Ratio of interest payments to total debt services(o) Ratio of short-term debt to total debt

5. Public sectorindicators

(p) Ratio of public sector debt to total external debt or GDP(q) Public sector debt services to XGS ratio(r) Public sector debt to government revenue ratio

(s) Average maturity of non-concessional debt(t) Foreign currency debt over total debt

6. Financial sectorindicators

(u) Open foreign exchange position- Foreign currency assetsminus liabilities plus long term position in foreigncurrency stemming from off-balance sheet transactions

(v) Foreign currency maturity mismatch(w) Ratio of foreign currency loans for real estate to total

credits given by the commercial banks(x) External sector related contingent liabilities(y) Trends of share market prices(z) GDRs and Foreign Currency Convertible Bonds issued

(aa) Inflows of FDI and portfolio investment7. Corporate sectorindicators

(bb) Leverage (debt/ equity ratio)- Ratio of debt to equity(cc) Interest to cash flow ratio(dd) Short-term debt to total debt(ee) Return on assets(ff) Exports to total output ratio(gg) Net foreign currency cash flow(hh) Net foreign currency debt over equity

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8. Dynamic ratios (ii) Average interest rate/ growth rate of exports(jj) Average interest rate/ growth rate of GDP(kk) Average interest rate/ growth rate of revenue(ll) Change of PV of debt service/ change of exports(mm) Change of PV of debt service/ change of GDP

(nn) Change of PV of debt service/ change of revenueSource: Tarun Das (2006a) and IMF (2003)

Table-2.2 Cross classification of countries by income level and indebtedness

Indebtedness

Income Level

Severely IndebtedEither PV/XGS > 220% OrPV/GNP > 80%

Moderately Indebted Either132%


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(b) Indications of debt distress episodes

Debt distress is indicated by recourse to any of the following forms of exceptionalfinance:

(a) Arrears: Number of years in which principal and interest arrears to all creditorsis in excess of 5% of total debt outstanding

(b) Debt rescheduling : Year of initial debt restructuring plus two subsequent years(c) Bailoutby financial institutes / lenders(d) Normal times are non-overlapping periods of five years in which no signs of

above mentioned debt distress are observed.

(c) Determinants of debt distress

Traditional Debt Sustainability Indicators include the following: Present value of debt/exports ratio Present value of debt/revenues ratio Present value of debt/assets ratio Debt service/exports ratio Debt service/revenues ratio Debt service/assets ratio

Shocks can arise as significant fall or volatility of the following: Real revenue growth Real depreciations Assets value growth

(d) Quality of institutions and policies

1. There could be substantial value-added in looking at the role of organizational

quality, good governance, policies and shocks in addition to traditional debtburden indicators when assessing probability of debt distress.

2. Using a common debt-burden threshold to assess sustainability for all companiesis unlikely to be appropriate.

3. There is a strong tradeoffs between quality of institutions, policies, systems ofauditing and sustainable level of debt.

(e) Indicative Debt and Debt-Service Thresholds (%)

To assess debt sustainability, debt burden indicators are compared to indicative debt-

burden thresholds. If a debt-burden indicator exceeds its indicative threshold, then acountry is at a higher probability of debt distress. The basic assumption is that a countrywith a high debt service burden relative to its repayment capacity is more likely to runinto debt-servicing difficulties. As per joint Fund-Bank empirical studies (IMF 2006)low-income countries with weaker policies and institutions tend to face debt-servicing problems at lower levels of debt than countries with sound fundamentals and stronginstitutions, because governments with weak institutions and inadequate macroeconomicpolicies tend to misuse and mismanage public funds. These countries are also more

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vulnerable to exogenous shocks, such as declines in the international prices of the majorexports or a natural disaster at home, since they lack adequate preemptive measures fordisaster management and mitigation.

Thus, the indicative debt-burden thresholds8 depend on a countrys quality of policies and

institutions, measured by the Country Policy and Institutional Assessment (CPIA) indexof the World Bank (see Table 2.3). The CPIA grades countries according to theireconomic management, structural and social policies as well as public sectormanagement and institutions. The index is updated annually.

Table 2.3 Indicative Thresholds for Debt Sustainability Indicators

(in percent)

Indicators Quality of Debt Management Policies and Institutions

Poor Medium Strong

NPV debt/GDP ratio (%) 30 44 50NPV debt/XGS ratio (%) 100 150 200

NPV debt/Revenue ratio (%) 200 250 300

Debt service/XGS ratio (%) 15 20 25

Debt service/Revenue ratio (%) 25 30 35

Source: IMF (2006)

For example, if the policy regime and institutions of a country is assessed as Poor by the WorldBank CPIA, then the debt service to exports ratio for this country should be kept below 15percent. If debt service ratio exceeds 15 percent, the country would face problems for servicingdebt. If the policy regime of a country is considered to be Medium, the country can have debt

service ratio up to 20 percent. If the policy regime for a country is assessed as Strong, thecountrys debt/service ratio can go up to 25 per cent. Other indicators have similar interpretations.

However, IMF concludes that the indicative debt burden thresholds are indicative benchmarks for making a debt sustainability assessment based on a forward-lookinganalysis of debt and debt-service trends, and not intended to be rigid ceilings. In a similarvein, it is neither expected nor suggested, that countries with low debt ratios borrow up totheir thresholds.

(f) Debt Distress Classifications

A country faces an episode of debt distress if it cannot service its debt without resort toexceptional financing (such as debt relief) or a major future correction in the balance ofincome and expenditures. The joint WB/IMF DSA framework classifies countriesaccording to their probability of debt distress into four broad categories:

(1) Low risk

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All debt indicators are well below the relevant indicative debt burden thresholds.Alternative scenarios and stress tests do not result in indicators breaching thresholds inany significant way.

(2) Moderate risk

The baseline scenario does not indicate a breach of thresholds. Alternative scenarios andstress tests show a substantial rise in the debt-service ratio over the projection period. Asa consequence, the debt-service ratio may reach its indicative threshold, while debt-stockratios may breach them.

(3) High risk

The baseline scenario indicates a breach of debt stock and/or service ratios over the

projection period. This is exacerbated by the alternative scenarios/stress tests.

(4) In debt distress

Current debt stock and service ratios are in significant and/or sustained breach ofthresholds.

2.8 Policy framework and Institutional Set up for External Debt Management

International experiences and practices of management of external debt, public debt andassociated contingent liabilities by leading public debt offices bear many valuable lessonsfor developing countries in the process of strengthening their debt management capacity.Many countries - mainly advanced and some emerging market economies - have set upintegrated public debt offices and are successfully managing their sovereign debts. Inmost countries where debt offices have been set up, there is clear evidence of movingtowards fiscal consolidation. There has also been a significant change since late 1980s inthe institutional structure, the role and style of functions of public debt managementtowards risk management. This has been enabled by institutionalization of the debt officewith an in-house risk management culture, as a specialized institution, staffed withprofessionals and market specialists. The role of such debt offices, in many instances,gradually transformed into treasury operations on the lines of those performed byinvestment banks, corporate houses and foreign exchange management by central banks.Within the debt office, middle office emerges as the risk manager, which formulates and

advises on the debt management strategy and also develops benchmarks for assessing therisk-cost trade off of the portfolio.

The primary requirement for a debt office is to bring the size of public debt at sustainablelevels. Without sustainability of debt, risk management would not have much impacttowards insulating the debt portfolio from systemic risks. The main risks that need to bemanaged for the sovereign debt portfolio are foreign currency risk, interest rate risk,credit risk, liquidity risk, refinancing risk, operational risk and payments and settlement

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risk. Many debt offices have addressed management of market risks like currency andinterest rate risk by establishing a risk management framework for the sovereign debt inan asset-liability management framework.

A prudential risk management framework is essential for reducing uncertainty among

sovereign debt managers as to the governments tolerance for risk, its willingness to tradeoff cost and risk objectives. Once the risks are identified, risks and costs for alternativedebt strategies are measured in a scenario-based model under a base case scenario anddifferent market rate scenarios; or in a simulation-based model under value-at-risk, cost-at-risk or budget-at-risk approach. The government then chooses the strategy that bestrepresents the governments preferences for managing the risk/cost trade-off, andgenerally tends to choose a policy framework along an efficient frontier, which entailsminimum risk. The debt managers may also use various derivatives such as buybackoperations, currency and interest swaps and other hedging activities.

The institutional structure for public debt management, world wide, could be broadly

characterized into two categories setting up of a centralized public debt office andscattered debt management responsibilities. The former category of a centralized debtoffice, which has been the showcase for countries currently strengthening their debtmanagement capacity, is mainly found in advanced countries and a few emerging marketeconomies. For these countries, there has been a preference to locate the debt office as aseparate entity under the Ministry of Finance or within the mainstream Ministry. Thereare also some instances of locating the debt office outside the Ministry as an autonomousagency, but with a Memorandum of Understanding (MOU) signed between the Ministryof Finance and the Public Debt Office. This institutional mechanism is usually,safeguarded, by public debt legislation or legal statutes.

The second category of institutional structure reflects dispersed debt managementresponsibility, either within the Ministry of Finance (for most emerging marketeconomies) or scattered between the Ministry of Finance (responsible for external publicdebt management) and the central bank (responsible for the internal public debtmanagement). A World Bank survey of about 50 developing economies showed that inabout 11 per cent of these countries, central bank manages domestic debt. Some of theemerging market economies, with dispersed debt management responsibilities betweenthe Ministry of Finance and the central bank (Hungary, Colombia, and South Africa) havealready separated debt management responsibility from their central banks. Moreover,some emerging market economies with debt management responsibility within theMinistry of Finance (China, India, Thailand, South Korea, Brazil, and Mexico) have setup a middle office under the Ministry of Finance as a first step towards strengtheningtheir debt management capacity.

Although, independent set-up for the Public Debt Office and the Ministry of Finance areregarded as somewhat separate watertight compartments for locating the debt office, inreality, however, there is a very thin dividing line between the two. The Ministry ofFinance always exercises some measure of control over the operations of the debt office,irrespective of its location. This is unavoidable because it is the liability of the

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Government that is to be managed by the debt office. Therefore, even among the mostindependent set-ups like National Treasury Management Agency of Ireland and theSwedish National Debt Office which are entrusted with day-to-day managementresponsibilities, the Ministry of Finance determines the policy, sets the operationalguidelines and the benchmarks under which the debt office is required to operate.

Governance issues promoting sound and professional approach towards debtmanagement, required debt offices to clearly define and disclose its objectives for debtmanagement, establishing an organizational structure that ensures clear accountabilityand transparency of responsibilities with appropriate internal controls, and establishmentof a legal framework wherever possible. For enabling sound risk management practices,most debt offices established prudent risk management strategy and policy, strengthenedmiddle office analytical capability, and defined a framework for risk managementensuring consistency with other macroeconomic policies and objectives. Debt offices alsoaccorded priority to recruitment of trained staff, and selection and implementation ofeffective management information systems.

2.9 Capability Building for Management of Public Debt and Contingent Liability

Continual upgrading of the information and communications technology (ICT) and the professionals engaged in the management of public debt and contingent liabilities isessential for maintaining debt sustainability over time. Once the public debt managementresponsibility is centralized and a computerized debt recording system functionsefficiently, the main challenge is to develop a risk management office (or middle office).Building a sound risk management capability within a sovereign debt managementoperation can take several years given the experiences of even the developed countrieslike Belgium, Colombia, Ireland, New Zealand and Sweden. However, there is nouniform model which holds good for all countries and at all times. The system needs tobe country-specific and owned by the respective government and cannot be importeddirectly from other countries.

Given that risk management skills are a scarce resource and training staff in this area isvery expensive, a strategy needs to be developed to hire new staff with these skills and tohave an intensive training program for existing staff. Appropriate wage-income policiesand succession plan also need to be formulated to retain these staff given their obviousmarketability or to replace a staff in the case of need. The manager or the head of themiddle office should also have strong technical and public policy skills.

A decision on whether to introduce specialist risk management software should bedeferred until risk management skills and a sound technical knowledge have beenbuilt up within the debt offices. Rushing into these decisions may lead to theestablishment of a risk management framework without full understanding of thealternative strategies or an understanding of how the designated software actuallyworks. There is also the question of compatibility of this software with themanagement information systems.

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2.10 International Best Practices for Policy Framework and Institutional Set Upfor External Debt Management

As regards policy framework, international best practices for the management of externaldebt leads to the following broad conclusions:

(a) Management of external debt is closely related to the management of domesticdebt, which in turn depends on the management of overall fiscal deficit.

(b) Debt management strategy is an integral part of the wider macro economicpolicies that act as the first line of defense against any external financial shocks.So debt management policies need to be well coordinated with fiscal policies,monetary policies, financial and capital market policies and overall macro-economic policies.

(c) As regards institutional set up, nearly all of the autonomous debt management

offices have adopted an organizational structure similar to that in leadingcorporate treasury and investment banks. They divide functional responsibilitiesfor managing transactions into different offices within the debt managementorganization and established procedures to ensure internal control, accountability,checks and balances. Usual practice is to establish separate front offices, middleoffice, back office and head office, as explained earlier.

(d) International best practices also indicate that debt management offices generallyform a part of the Ministry of Finance, although the management of externalassistance from the IMF is the joint responsibility of the Ministry of Finance andthe Central Bank. A few developed countries have set up independent debt officesoutside the Ministry of Finance for management of both domestic and externaldebt. However, a developing country will need a number of years beforemigrating to such an independent system.

(e) Almost all the developing countries donot allow sub-national governments (states, provinces, corporations, municipalities etc.) to borrow directly from externalsources, although public sector enterprises are allowed to borrow directly fromexternal sources, preferably without government guarantees.

(g)

(f) There is need to have a cautious approach on external short-term credit. In manydeveloping countries, like India, government does not resort to any short termborrowing from external sources, although the public sector enterprises and the private sector companies are allowed to borrow short-term credit externallysubject to certain conditions and prudential limits.

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(g) For an emerging economy like Uzbekistan, it is better to put a limit on privatecommercial borrowing with short and medium maturity.

(h)

(h) Big bullet loans are bad for small economies like Uzbekistan as these can createrefinancing risk and roll over problems in future.

(i) It is not enough to manage the government balance sheet well, it is also necessaryto monitor and make an integrated assessment of national balance sheet and to putmore attention on surveillance of overall debt- both internal and external, privateand public. During the last financial and foreign exchange crisis towards the endof the last decade, in each of the major Asian crisis economies, viz. Indonesia,Korea and Thailand, weakness in the government balance sheet was not thesource of vulnerability, rather vulnerability stemmed from the un-hedged sort-term foreign currency debt of the private sector comprising commercial banks,finance companies and corporate sector.

(j) It is not sufficient to manage the balance sheet exposures, it is equally important

to manage off-balance sheet exposures and contingent liabilities.(k)

(l) It is necessary to adopt suitable policies for enhancing exports and other currentaccount receipts (tourism earnings and remittances) that provide natural hedgeand the means for financing imports and debt services.

(l)(m)Detailed data recording and dissemination are pre-requisites for an effective

management and monitoring of external debt and formulation of appropriate debt

management policies.

(m)It is vital that external contingent liabilities and short-term debt are kept withinprudential limits.

(n) It is important to strengthen public and corporate governance and enhancetransparency and accountability by strengthening internal and external audit.

(o) It is also necessary to strengthen the legal, regulatory and institutional set up formanagement of both internal and external debt.

(p) A sound financial system with well developed debt, money and capital markets isan integral part of a countrys debt management strategy.

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3. Uzbekistan- Current Economic Performance and Outlook7

3.1 Economic Performance and Poverty

Uzbekistan economy is currently in a resilient and rebound mood. Economy performedvery well since 2004 benefiting from favorable external environment and improved

policy framework. Uzbekistan suffered less economic shock from the dissolution of theSoviet Union than did most other former Soviet republics because it avoided hastyliberalization of the economy, and relied on an import-substitution trade regime thatprevented the collapse of domestic agriculture and manufacturing, which was a widespreadoccurrence in other former Soviet Republics. It produces large amounts of cotton and gold,and commodities of value on world markets. There was also an exchange rate regime whichcomplemented the regulation of trade regime and minimized capital flight.

The country achieved an average growth rate of nearly 8 per cent during 4 years 2004-2007 with peak at 9.5 per cent recorded in 2007 (Table 3.2), compared to an averagegrowth rate of only 4.2 percent during 1999-2003. The increased productions and exportsboom of cotton, automobiles, gas, and metals served as the main drivers of growthsupported by favorable weather conditions and high world prices of cotton and metals.Uzbekistan economy usually does well when the weather conditions are favorable andinternational commodity markets are buoyant.

Higher growth coupled with a sharp decline in the population growth rate from 2% in the1996-99 to 1.2% in 2000-07, led to an increase of annual per capita GDP growth, from2% in the late 1990s to 6% in 2004-06 and 8% in 2007. Despite high economic growth,employment generation and private consumption lagged behind and the incidence ofpoverty remained wide-spread, as poverty ratio had been relatively growth-inelastic. Thisimplies that the so-called trickle down effects of high growth have been uneven, slow anddelayed in the case of Uzbekistan. A study made by Mckinley and Weeks (2007)concluded that, although the growth performance of Uzbekistan in the post-independentera was better than for similar former Soviet Union Republics (Table 3.1), there areuntapped potentials for achieving faster trend growth rates, and if more broadly based,such growth could bring dramatic gains in employment and poverty reduction.

Table 3.1: Comparative Economic Performance of Uzbekistan, Annual GDP Growth (%)

Countries 1991-1994 1995-1999 2000-2006 1991-2006

Central Europe -3.3 3.2 4.5 2.1

Baltic states -11.7 4.8 8.0 2.1

Other Soviet Republics -15.4 0.2 9.2 0.3

Uzbekistan -6.8 1.1 5.1 0.9

Source:Mckinley and Weeks (2007)

7This section is primarily based on (a) the Uzbekistan Country Brief 2008 prepared by the World Bank(July 2008); (b) the ADB Country Report on Uzbekistan prepared by Iskandar Gulamov and KiyoshiTaniguchi of the Uzbekistan Resident Mission, ADB, Tashkent, for the real sectors; and (c) InternationalMonetary Fund (2008b) Republic of Uzbekistan: 2008 Article IV Consultation- Staff Report; IMF,Washington, D.C., July 2008, for the financial and external sectors.

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Table 3.2 Uzbekistan: Trends of Selected Economic Indicators in 2002-2007

Economic Indicators 2003 2004 2005 2006 2007 2008*

Growth rate of Real GDP (percent) 4.2 7.7 7.0 7.3 9.5 8.0

Growth rate of Nominal GDP (percent) 32.0 24.6 29.9 30.4 35.8 23.1

CPI inflation rate (%) official estimate 3.7 3.8 7.8 6.8 6.9 6-8

CPI inflation rate (percent) IMF estimate 7.8 9.1 12.3 11.4 11.9 11.0

Growth rate of reserve money (%) 26.7 38.7 87.5 36.5 44.9 28.4

Growth rate of broad money supply (%) 27.1 47.8 54.3 36.8 46.1 32.4

Growth rate of net foreign assets (%) 45.6 48.8 44.0 76.3 67.4 35.8

Growth rate of net domestic assets (%) -87.8 -50.5 -28.4 -148 -88.7 -38.4

Growth rate of net claims on govt (%) -1509 -114 -87.0 -145 -78.9 -56.8

Growth rate of credits to the economy (%) 6.9 10.8 15.8 4.3 16.7 30.8

Growth rate of exports of G&S (%) 28.4 28.1 12.0 18.0 40.7 22.1

Growth rate of imports of G&S (%) 8.9 26.8 4.4 13.8 44.3 28.9

As percentage of GDP at current mp

Revenue and grants (as % of GDP) 33.4 32.2 30.8 31.4 31.7 30.6

Expenditure and net lending (% of GDP) 33.9 32.1 31.1 30.9 30.2 31.1Overall budget balance as % of GDP 0.1 0.6 1.2 2.2 2.1 -0.4

Augmented budget balance as % of GDP 0.1 0.6 1.2 5.2 5.1 5.0

Total Public debt as % of GDP 41.6 35.1 28.2 21.3 15.8 13.5

Public External Debt as % of GDP 38.7 32.0 25.2 19.8 14.7 12.5

Exports of goods & services as % of GDP 37.3 40.5 38.1 37.6 40.4 41.3

Imports of goods & services as % of GDP 30.6 32.9 28.9 27.5 30.3 32.7

Current account balance as % of GDP 8.7 10.2 13.7 17.3 19.2 16.6

FDI as % of GDP 0.7 1.6 0.6 1.1 3.3 3.5

External debt (as % of GDP) 42.0 36.2 29.1 22.7 17.6 15.4

Ext. debt service (as % of exports of G&S) 20.5 17.1 14.1 12.7 8.6 7.6

Ext. debt service (as % of FE reserves) 49.7 35.6 28.0 17.3 11.3 8.1

Memo Items:

GDP in sum trillion 9.8 12.3 15.9 20.8 28.2 34.7

GDP in US$ billion 10.1 11.9 14.2 17.0 22.2 26.6

Nominal GDP per capita (US$) 396 462 543 641 827 977

Nominal GDP per capita (US$ PPP) 1654 1808 1970 2154 2388

Income velocity of money supply (level) 10.5 9.5 8.4 7.6 7.3 6.5

Foreign exchange reserves (US$ Bln) 1.66 2.15 2.90 4.45 7.41 10.1

Forgn. Exch. Reserves (Months of imports) 5.1 6.3 7.4 7.9 10.2 11.8

End-period Exchange rate (UZ Sums/US$) 979 1058 1180 1240 1290

External debt outstanding (US$ million) 4249 4322 4133 3853 3913 4095

Year-End foreign exch. reserves (US$ bln) 1.66 2.15 2.90 4.46 7.41 10.14

Foreign exch. reserves (months of imports) 5.1 6.3 7.4 7.9 10.2 11.6Exports of goods & services (US$ billion) 3.78 4.84 5.42 5.39 9.00 10.78

Imports of goods & Services (US$ billion) 3.10 3.93 4.10 4.67 6.74 8.67

External CAB (US$ Million) 861 1215 1949 2933 4267 4472

External capital balance (US$ Million) -414 -702 -1191 -1389 -2113 -1741

Population (million) 25.6 25.9 26.2 26.5 26.9 27.2* Estimated. Source: International Monetary Fund (2008b) Republic of Uzbekistan: 2008 Article IVConsultation- Staff Report; IMF, Washington, D.C., July 2008.

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National poverty ratio (defined as percentage of persons consuming less than 2,100 kilo-calories per day) declined by only 1.7 percentage points from 27.5% in 2001 to 25.8% in2005 (Table 3.3). Poverty reduction was uneven in rural and urban areas. While urbanpoverty ratio declined from 22.5% in 2001 to 18.3% in 2005, rural poverty ratio remains

more or less invariant around 30 percent over the same period. Consequently, thedifference between the poverty ratio in urban and rural areas grew from 8% in 2001 toalmost 12% in 2005. The rural population makes up 64.4% of the total population but theproportion of the disadvantaged population living in rural areas is 74.7% .

This geographic distribution of the disadvantaged population highlights the largedifferentiation in poverty rates between the regions as well as the fundamental differencebetween Tashkent city and other regions of the country. The highest poverty rate in 2005was in Karakalpakstan (44%) and the lowest one was in Tashkent city (6.7%), with thesecond lowest being Ferghana oblast (15.8%) (Table 3.4).

Table 3.3 Poverty rate (2001 2005), in %Sectors 2001 2002 2003 2004 2005

Total 27.5 26.5 27.2 26.1 25.8

Urban 22.5 21.8 22.0 18.8 18.3

Rural 30.5 29.4 28.7 30.3 30.0Source: Family Budget Survey (2001) as reported in IMF PRSP for Uzbekistan (2008)

Table 3.4 Geographic Distribution of Poverty in 2005 (in percent)

Territory/ oblast Poverty ratio Total population Disadvantaged

population (%)

Total 25.8 100 100

Urban 18.3 35.6 25.3Rural 30.0 64.4 74.7

Karakalpaktan 44.0 5.1 8.7

Andijan 23.1 9.5 8.5

Bukhara 20.8 6.4 5.1

Jizzakh 29.6 3.7 4.3

Kashkadarya 41.0 8.5 13.5

Navoi 26.3 2.9 3.0

Namangan 33.4 7.9 10.2

Samakand 23.9 11.2 10.4

Surkhandarya 34.6 7.3 9.8

Syrdarya 32.6 2.4 3.0Tashkent oblast 20.4 10.1 8.0

Ferghana 15.8 11.6 7.1

Khorezm 31.0 5.1 6.1

Tashkent city 6.7 8.2 2.1Source: State Statistics Committee, as reported in IMF PRSP (2008)

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As judged by the World Banks poverty line of 2 USD per day, around 45% of the Uzbekpopulation lived on less than 2 USD per day. Income inequality as judged by Ginicoefficient also remained high at 36.8 percent in 2003. The share of the lowest 10 percentof the households in income or consumption was only 2.8%, while that of the highest10% of the households was 29.6%.

As in many developing states, the most vulnerable groups in terms of poverty are ruralinhabitants, families with many children, the disabled, the unemployed, people withlower level of education and households with women breadwinners. A commoncharacteristic of poor families is that the head of household is unemployed and they havemany children. Even employment does not always guarantee protection from poverty, as50% of the poor families have an employed household head. However, beingunemployed sharply increases the potential for poverty.

A recent survey further revealed that income-poor in Uzbekistan can be asset rich.For example, over 98 per cent of the population owns a house or flat, 86 per cent have

plots of land, 87 per cent have a TV set, 38 per cent have a refrigerator and 12 per centhave a car.

Despite sustained high growth since 2004, Uzbekistans economy is underperformingcompared with other CIS economies. It is still the poorest country in the region, withGDP per capita (at PPP) at only 40% of the CIS average. Its economic potential remainssignificantly underutilized. Although geographic limitations (a large distance to majormarkets) could provide a part of the explanation, major constrains for faster povertyreduction and employment generation include lack of appropriate policies for the privatesector development.

3.2 Uzbekistan Economic Freedom Indices: The Heritage Foundation

Uzbekistan's economy is 52.3 percent free, according to Heritage Foundation 2008assessment, which makes it the world's 130th freest economy. Uzbekistan is ranked 24thout of 30 countries in the AsiaPacific region, and its overall score is lower than theregional average.

Uzbekistan has relatively high levels of fiscal freedom (88%), business freedom (67.8%),and labor freedom (72.1%). The top personal income tax rate is moderate, the topcorporate tax rate is low, and overall tax revenue equals little more than 20 percent ofGDP. The labor market is flexible. Licensing and bankruptcy procedures are costly, butopening a business is easy, and the average tariff rate is moderate.

Uzbekistan is weaker in monetary freedom (57.5%), investment freedom (30%), financialfreedom (20%), property rights (30%), and freedom from corruption (21%). Inflation isdisastrous, and the government controls the prices of a variety of goods through statemonopolies. Foreign investment is officially welcome, but opaque bureaucracy andpolitical interference create disincentives. The courts are subject to political interference,and corruption is pervasive throughout the civil service.

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3.3 Strengths, Weakness, Opportunities and Threats (SWOT)

A SWOT analysis of the Uzbekistan economy is presented in Table-3.4. It is evidenced by the table that Uzbekistan has many strengths and opportunities to achieve higher

growth provided it continues with strict monetary discipline and fiscal prudence, it bringsthe structural reforms for private sector development to their logical ends, and is able totackle the risks due to variations of international prices of its major exports such ascotton, gold, copper and gas and major imports such as petroleum oil and food products.

3.4 Economic Growth and Inflation in 2007

Uzbekistan achieved a real GDP growth rate of 9.5% in 2007, supported by a growth of6.1% in agriculture value added, 12.1% in industry, and 26.6% in services. Despitedeteriorating soil quality, rising grain harvests, higher world prices for cotton, andincreasing productivity from privatization of agricultural cooperatives helped agriculture

to grow by 6.1% in 2007.

Industrial growth was aided by increased production and exports of metals, gas, andautomobiles. Metals, countrys largest single export, received significant govt. investmentin recent years. Gas export volumes increased by 18%, and secured a 40% gain in exportprices. Overall, fuel and energy sub-sector grew by 10.1%. Automotive industry outputincreased by 27%, driven by substantial government support through various taxexemptions and subsidies.

Growth in services stemmed from increased revenues from gas transit, substantialRussian-led investments in the communications, and significant construction activities inhousing and infrastructure.

High inflation remained as a major problem for both the government and the Centralbank. Although the official estimate of the Consumer Price Index (CPI) based inflation in2007 was 7%, the IMF estimated CPI inflation at 12.3%8, caused by a marked expansionin the money supply, increases in administered prices, public sector wage rises, andunproductive expenditure related to the general election. The authorities responded byfurther tightening the monetary and fiscal discipline, reducing the pace of sumdepreciation, and limiting the pass-through of higher international food prices throughadministered prices.

8The divergence between official estimate of inflation (6.8%) and the International Monetary Fund (IMF)estimate (11.4%) was almost the same in 2006. In general, IMF estimate of CPI inflation is about five percentage point higher than the official estimate of CPI inflation. IMF states that its estimates areconsistent with other available information, including producer prices, GDP deflators, wage increases,growth in monetary aggregates, and utility price increases.

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Table-3.4 SWOT Analysis of the Uzbekistan Macro-economy

Intern

alenvironment

Strengths

1. Sustained high GDP growth averaging around 8% since 2004.2. Cotton, metals, gas, construction are the leading sectors.3. Favorable fiscal situation, with overall fiscal surplus in recent years.

4. Strict monetary discipline5. Declining ratios of public debt to GDP (estimated 13.5% in 2008)6. Enabling environment for FDI and public-private partnership.7. Favorable fiscal reforms with simplified rules and tax cuts.

8. Improvement in budgeting system and planning with introduction ofmedium-term budgeting, adoption of GFSM-2001 budget classificationand switch to standard accounting and auditing rules.

9. High levels of fiscal freedom (88%), business freedom (67.8%), laborfreedom (72.1%) and flexible labor markets.

10. Moderate personal income tax rate and low corporate tax rate.

Weaknesses

1. Land locked economy with long distances to major growth centers in theneighboring economies

2. Growth is not broad-based with high dependence on exports of cotton,metals and gas.3. High cost economy due to rising utility prices and substantial increase in

wages and salaries4. Underdeveloped money markets, and despite high growth rates of money

supply, the degree of monetization is low.

5. Notwithstanding recent progresses, the financial system remains under-developed with low intermediation.

6. Difficult business environment, with costly licensing and bankruptcyprocedures. Ranked the 138th in 2008 in the world as per the latest WorldBank Doing Business Report.

7. Low levels of domestic savings (around 23% of GDP)

8. High poverty ratio (28%) and inequality index (Gini ratio 36.8%)

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Externalenvironment

Opportunities 1. Average tariff rate is moderate.

2. Comfortable foreign exchange reserves (equivalent to 10.2 months ofimports at the end of 2007 and estimated 11.6 months of imports in 2008)

3. Declining ratios of external debt to GDP

4. Declining and low external debt service ratios (8.6% in 2007 and 7.6% in2008) indicating sustainability of external debt over time (and possibility

of no debt trap).5. Despite downside risks, international commodity prices are expected to

remain buoyant in the near term, and the growth prospects of theneighboring economies, having pulls on the Uzbek economy, are bright...

6. The Uzbek economy remains insulated from the global financial crisisbecause of its limited integration with the world financial markets.

Threats 1. Economy is heavily dependent on external trade of a few items, whoseprices are volatile and subject to global business cycles.

2. Overall GDP growth and government revenue remain vulnerable to termsof trade shocks trigged by possible sharp declines in international prices ofcotton, metals and gas in future.

3. Business environment is not so favorable and doing business in Uzbekistan

is not easy due to restricted trade and business practices.4. Balance of payments remains vulnerable to future risk of further hardeningof global prices of food grains and petroleum products

5. Foreign investment is officially welcome, but opaque bureaucracy andpolitical interferences create disincentives for FDI inflows.

3.5 External Sector Performance in 2007

Balance of payments situation remained very comfortable for recent years. Uzbekistanalways maintained an external current account surplus, which amounted to $4.3 billion in2007, amounting to 19.2% of GDP, aided by commodity exports boom and significant

rise in remittances. Exports of gold, cotton, and energy (mainly gas), accounted for 56%of total exports of goods in 2006 and also performed well in 2007 due to strong externaldemand and soaring international prices in 2007. As one of the worlds largest producersand exporters of gold, Uzbekistan benefited from the metals record prices in 2007.Remittances represent another significant foreign currency source, and come primarilyfrom Uzbeks working in Kazakhstan and the Russian Federation.

Foreign Exchange Reserves increased to a record level at $7.4 billion, equivalent to 10.2months of imports of goods and services at the end of 2007. Because of a conservativeexternal borrowing policy followed by the govt, external debt to GDP ratio declined to17.6% of GDP by end-2007.

Substantial current account surplus and foreign direct investment inflows put upwardpressure on the exchange rate of Uzbek sum. The central bank intervened in the foreignexchange market to prevent a nominal appreciation of the sum, against the US dollar,continuing a policy aimed at boosting exports. During 2007 the sum depreciated byabout 4% against the dollar.

3.6 Money Supply and Banking Operations

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Rise of foreign exchange reserves by $3 billion in 2007 created pressures on growth inbank liquidity and monetary expansion. The central bank expanded its open-marketoperations, by selling central bank certificates. The impact of these operations, however,was partly offset by a reduction in reserve requirements for local deposits from 15% to

13%. Money supply grew rapidly by 46% on top of 36.8% growth in 2006. Althoughgeneral confidence in the banking system has been rising, the ratio of broad money (M2)to GDP is low (about 16% in 2007), which suggests that banking still plays a relativelyminor role in the economy.

The policy of checking taxpayers bank accounts by the tax authorities underminesconfidence in banking. As a part of anti-inflationary efforts, the central bank puts limit onthe volume of cash that depositors may withdraw, which induces greater holdings andtransactions in cash.

3.7 Fiscal Situation and Reforms

Fiscal policy was prudent in 2007 and the outcome was better than budgeted. Theconsolidated general government budget recorded a surplus of 2.1% of GDP in 2007,marginally lower than 2.2 percent in 2006, due to deceleration in revenue growth and riseof expenditure caused by an increase of wages and pensions twice in 2007, by 25% inAugust 2008 and by 20% in November 2008, although these were counterbalanced bysome moderation in planned capital spending. The augmented fiscal surplus, combiningthe consolidated government and the Fund for Reconstruction and Development (FRD),remained unchanged around 5 percent of GDP compared with a budgeted deficit of 1percent of GDP.

The strong budget performance in the past 2 years was driven by tax reforms, growingcustoms receipts, and increases in utility prices. However, still more revenuestrengthening is required as the Govt is committed to raise all public sector wages,pensions, and social benefits by 150% by 2010, relative to 2006.

Fiscal Reforms

Fiscal and financial reforms progressed further in 2007-2008. There was a concertedeffort to increase bank capitalization. Treasury modernization continued under theongoing technical assistance project, as did tax reforms. Further the restructuring ofshirkats into private farms was completed. According to the World Banks DoingBusiness2009 Report, Uzbekistan improved its ranking and jumped from the 145th placein 2007 to 138th place in 2008 thanks to establishing a private credit bureau and a publiccredit registry to share credit information among financial institutions. These measureshave significantly improved access of population to credit resources. The report alsonotes that adoption of new Tax Code and decrease of tax burden resulted in decrease ofincome tax and single tax payment in 2007.

In Jan 2008, Parliament approved a revised tax code. As a part of policies to reduce thetax burden, the rate of unified tax for micro- and small enterprises was reduced from 10%

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to 8%, and the rate of corporate income tax for banks was lowered from 17% to 15%. Thenew code also introduced an excess profits tax for subsurface users extracting orproducing cathode copper, cement, polyethylene granules, and gas. The tax rates are 60%for cathode copper and 75% for all other commodities. The taxable base for the excess isdefined as the difference between the price set by legislation and the selling price.

The Government established a treasury, which, under a public finance reformmanagement project, is setting up a treasury single account and is streamlining the budgetexecution mechanism. In 2007, it implemented treasury operations at the regional level,closed thousands of accounts of spending units, and introduced territorial single treasuryaccounts. The major medium-term challenge is to consolidate all government fiscalaccounts into a single account, including those of the Governments extra-budgetaryfunds.

A Reconstruction and Development Fund (RDF) was established in 2006 with capitaltargeted to reach $1.0 billion by 2010.It had already reached $1.2 billion at end-2007

because of a strong budgetary position. Eight high-priority investment projects havebeen approved for financing from RDF funds in 2008, mainly in the chemical andhydrocarbon sectors. RDFs role in these projects will focus on procuring capital goods.

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3.8 Medium Term Economic Forecasts

Assuming that world prices of gold, cotton, and gas would stay buoyant over the nextcouple of years, there would be no destabilizing factors either at home or abroad, andthere would be no monsoon failures, economic prospects of Uzbekistan in the near and

medium terms are considered to be bright. According to the assessments made by theIMF, risks to the 2008 economic outlook of Uzbekistan appear to be limited with stronggrowth prospects of its major trading partners. Despite downside risks, internationalcommodity prices are expected to remain buoyant. The Uzbek economy remainsinsulated from the global financial crisis because of its limited integration with the worldfinancial markets. The IMF Staff analysis suggests that a 10 percent decline ininternational commodity prices would lead to a reduction of the Uzbekistan currentaccount surplus and government revenues by only 1 percentage point of GDP each.

According to forecasts made by IMF, healthy external demand and surging commodityprices, coupled with greater remittances and import controls, are expected to keep the

current account surplus at 16.8% in 2008 and 12.9% in 2009.

The medium term outlook is also favorable. The authorities target 8-9 percent export-ledgrowth over the medium term, which appears to be feasible. These ambitious targets willbe achieved through consolidating macroeconomic stability, modernizing various sectors,improving physical and social infrastructure, attracting more FDI, enhancing the role ofprivate sector and public-private partnership.

The conservative fiscal stance is expected to be continued by the government, leading tofiscal surplus and so assisting monetary policy efforts to control high inflation. However,the central banks commitment to currency depreciation to support exports are likely tolead to persistent rapid expansion in money supply. Excessive money supply along-withplanned increases in utility tariffs are expected to create inflationary pressures.

3.9 Development Challenges

Since 2004 the Uzbekistan economy had been buoyant with high economic growth andsurplus on both domestic and external current accounts. But, it has also led to variousdevelopment challenges such as how to contain the inflationary pressures, how to sustainhigh growth with strict monetary discipline and fiscal prudence, how to promoteequitable growth and to raise the levels of living of all citizens, how to eradicate povertyand unemployment at a faster speed, and how to create enabling environment for public-private partnership and international cooperation in the development process.

The authorities have made significant progress in macroeconomic adjustment, but havefurther scope for improving the macroeconomic policy mix, particularly in regard to anti-inflationary measures and movement towards full convertibility of Uzbek Sum on currentaccount transactions. The reforms backlog suggests that the economy is underperforming,although it is now moving along a higher growth profile. If the structural reforms neededfor private sector-led growth are carried out to their logical ends, Uzbekistan can become

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one of the most dynamic economies in central Asia and can achieve still higher growthalong-with faster reduction of poverty and unemployment.

Favorable economic conditions with large foreign exchange reserves, a low level ofexternal debt, and positive fiscal balance put the government in a comfortable position to

push through long-awaited reforms aimed at deepening industrial diversification, bankingand trade liberalization, and private sector development. The authorities are in a positionto exploit the present growth momentum and substantially expand reform initiatives inorder to secure sustainable high growth for the longer term.

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B. Debt Monitoring and Reporting: Transparency

B.1 For each of the components of external debt indicated in the table, which institutions

are responsible for recording and reporting the information?

B.2 Which institutions can instantaneously retrieve from their databases up-to-dateinformation for the items listed below? Which documents report such figures? What isthe time lag in reporting?

(a) Outstanding external debt by creditor and debtor classifications(b) External debt by sectors(c) Guaranteed external debt by sectors(d) Total debt services- classified by amortization and interest payments

B.3 Which types of external debt, in your view, notreported to the following and why?

Give reasons for not reporting. Reasons could be not available, in public interest,official secrecy, national security etc.(a) Ministry of finance(b) Cabinet(c) Central bank(d) Parliament(e) Foreign investors(f) Public

C. Guarantees and other Contingent Liabilities

C.1 Contingent liabilities include government guarantees, and financial losses ofinstitutions that are covered by some type of government guarantee, state insurance andsocial security programs, and all government commitments to spend or intervene or bailout financial or other strategic institutions financially in the future. Contingent liabilitiescan be broadly groups under two heads: explicit(defined by a law or contract) orimplicit(broadly predetermined by public expectations and pressures by interest groups).

(a) Which Ministry/ Department is responsible for deciding on governmentguarantees and other contingent liabilities?

(b) Are there written documents on the scope and various aspects relating togovernment guarantees and other contingent liabilities? If yes, give details andprovide copies of such documents.

C.2 Is the government legally required to explain the amounts of government contingentliabilities? If yes, specify the Act and Legislation. Also specify to whom these arereported- to the Parliament, to the public, and others (please specify).

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C.3 Tick () the types of contingent liabilities borne by the government.1. Government guarantees given to loans taken by:

(a) Sub-national governments (i.e. provinces and local governments)

(b) Government operated or controlled corporations,

(c) Public sector banks and financial institutions(d) Entities under public-private partnership

(e) Private sector entities

1. Umbrella government guarantees for various types of loans in priority sectors(mortgage loans, student loans, and loans to agriculture, housing, microenterprises, and other priority sectors)

2. Exchange rate guarantees issued by the government for external loans or foreigncurrency denominated non-residents or residents deposits with banks

3. Government guarantees on various types of risks (including market, currency,regulatory, political etc) in BOT contracts in infrastructure

4. State insurance and social security schemes such as deposits insurance, healthinsurance, private pension funds, crop insurance, natural calamity insurance, war-risk insurance etc., Funds for old age, children, women, unemploymentallowances etc.

5. Guarantees on benefits (unfunded liabilities) of the social security system (publicpension and provident funds)

6. Others, if any, please specify

C.4 Describe the following in details:(a) Government guarantees: the requirements for their design (the type of risks that

can be covered, the extent of required risk sharing), issuance authority (is onlythe ministry of finance authorized?), government control mechanism (requiredreports from the creditor and beneficiary, and audit, accounting and valuationrequirements), guarantee fees, and realization mechanism if they fall due.

(b) Sub-national governments, public sector agencies and enterprises, and state- guaranteed institutions: the financial management and reporting requirementsand government control mechanism

(c) Demands and pressures on the government to extend ad hoc, previouslyunforeseen financial support: the legal requirements and practice for deliberationin government decision making.

C.5 Classify guarantees by sectors such as industry, transport, telecommunications,power, banking and insurance, social sectors, urban development, real estate, housing andconstruction etc.

C.6 Specify top 5 major guarantees given by the state with their face value, the issuer(MOF or other government agency), beneficiaries, creditors, currency of denomination,types of risk covered, risk sharing etc.

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C.7 List major 5 state-guaranteed institutions and provide statement of their contingentliabilities at the latest date. What type of other government support (financial or non-financial) do these institutions receive (for example, privatization revenues, supply ofland and public utilities at concessional rates, deferment or exemption of governmenttaxes and duties, tax holidays, cheap financing via the banks and financial institutes, state

guarantee for borrowings)?

C.8 List 5 large state-owned enterprises and large state-owned banks that receivegovernment guarantees and provide statements of their contingent liabilities at the latestdate. What type of other government support do these institutions receive (for example,additional capital support, cheap financing from the Central Bank, sovereign guaranteefor borrowings)?

D. Legal System and Institutional Set Up: Accountability

D.1 Does the government of Uzbekistan have an Act or Cabinet approved Guidelines or

any other written document on the scope, objectives, purpose, policies, strategies,processes, legal framework, and institutional arrangements etc. relating to external debtor public debt and related contingent liabilities? If yes, provide details and give a copy ofthe same.

D.2 As per the government document, one of the main functions of the Ministry ofFinance (MOF), Government of Uzbekistan, includes the following: in the frameworkof state debt management together with the Central Bank, MOF carries out monitoring,counting and servicing of internal debt of the Republic of Uzbekistan, submits

suggestions to the Cabinet of Ministers of the Republic of Uzbekistan about

improvement of the structure of government debt, acts as a government securities issuer,

develops and approves legislative acts for securities issuance, manages external debt,develops top parameters of government external loans, prepares and submits guarantees

of the Government of the Republic of Uzbekistan, organizes fulfillment of loan and other

contract obligations to external creditors, carries o

Background Paper for Debt Management in Uzbekistan

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