BACKGROUND: Several private as well as official commentators have divided Uzbekistan’s privatization history into three stages. The first stage was part of the initial program of macroeconomic reforms in the early 1990s and concentrated on the privatization of housing and small businesses in food, trade and construction. The second stage laid the basis for real estate and stock market transactions. This was an essential prerequisite to attracting the interest of foreign investors, as the privatization of enterprises was now legally grounded in share ownership. In the late 1990s the government began to consider selling off shares in the larger enterprises, namely the machine-building, chemical, mining and energy industries and their subsidiary businesses. This third stage saw growing involvement by the major multilateral aid agencies, such as the World Bank, EBRD and IFC, particularly in regard to funding pre-privatization restructuring. By the end of the decade most major enterprises, aside from one chemical factory, remained unsold. Subsequent government resolutions on privatization and currency reform seemed merely to repeat previous ones in listing goals and extending the timetables for achieving them. By 2001 several foreign partners had pulled out of major joint ventures, particularly in the mining sector, and among the multilaterals the IMF ceased most of its operations in the country, citing as its reason the country’s ‘anti-market’ policies. By late 2003, renewed discussions with the IMF led the government to abolish multiple exchange rates and most controls on foreign exchange. However, one year earlier, the government had introduced considerable restrictions on external and domestic trade, partly to counter the increased threat of terrorism in the region. To date there have been several significant partial privatizations, particularly in textiles, but the record remains unimpressive for the largest firms. Major enterprises such as the Almalyk mining complex, Uzbektelecom, the state telecom, Uzbekistan Temir Yullari, the state railroad, as well as Uzbekneftegas itself, have not yet been privatized to any notable extent. Foreign direct investment (FDI) flows to Uzbekistan have been erratic, averaging USD 10m in the early years, rising to USD 140m in 1998 and then collapsing to USD 65m in 2002, from a high of USD 570 million in 2001. The total stock of FDI grew from around USD 100m in the mid-1990s to nearly USD 1.3bn by end-2002, or about 14% of the country’s GDP. This is not a bad ratio, but in dollar terms the amounts are still paltry considering the amount of capital the country needs. On a per-capita basis, FDI inflows in Uzbekistan are among the lowest of all the CIS economies.

IMPLICATIONS: Because of its abundance of economic and human resources, Uzbekistan has many of the hallmarks of a country in which it is possible to get a good return on one’s investment. That being said, the government’s security considerations have dictated the economic regime for over a decade, favoring political stability over economic freedom. As a result economic policy has been equivocal towards the promotion of investment by foreigners in the country’s strategic industries. The considerable groundwork done by foreign and domestic organizations to promote small and medium-sized enterprises (SMEs) has had an effect on the economy, but the SMEs have not contributed much in the way of exports, and foreign exchange revenues are the engine for economic growth in the region. The major enterprises are much more significant as generators of foreign exchange for the Uzbek economy. However, the state has consistently been reluctant to grant majority ownership and cede control of management to outside shareholders and has held on to an inconsistent regulatory and tax climate. In addition, the new restrictions on trade weaken growth and counteract the positive supply adjustments made possible by the 2003 currency reforms, thus continuing to stifle the ability of foreign investors to repatriate profits. Up until recently Uzbekistan has not felt the need to draw upon FDI to promote more efficient industries, as the country’s commodity exports have held their own in world markets without the need for massive investment in productive capacity. Now however, as political security is making greater demands on government expenditure, maintaining the energy sector’s aging physical plant is putting ever greater strain on the government budget. Although Uzbekistan is ninth in the world in natural gas production and among the CIS states is the second-largest producer after Russia, there doesn’t seem to be sufficient cash in state coffers to fund all the needed infrastructural development. The government claims GDP growth of over 4 percent in 2003, while the U.S. government believes the actual figure was not greater than 0.3 percent.

CONCLUSIONS: This tension between economic necessity and political expediency became manifest again in April of this year, when the EBRD announced it would considerably reduce its lending activities in Uzbekistan, declaring that the government had not made sufficient progress in reducing political repression and opening the economy. As the British newspaper The Guardian has pointed out, this decision is all the more significant because, in its battle against terrorism, the U.S. has taken a greater interest in Uzbekistan while remaining one of the EBRD’s major shareholders. In the wake of the September 11 terrorist attacks, Uzbekistan among others has come under pressure to spend heavily on maintaining internal and external security. However, such expenditure is a large part of growing budget constraints that should over time pressure the government to reduce its control over key sectors of the economy. The halting pace of the Uzbekneftegaz privatization is thus perhaps understandable. Allowing foreigners to develop its most strategic resources is at any time a sensitive topic for a country, as indeed has been shown by the tribulations of foreign investors in the oil and gas sectors of such nations as Russia, Iran and Mexico. Regardless, significant privatization is likely to follow in two key areas: agricultural production and the banking system. The extent of state involvement in both sectors implies a degree of financial commitment by the government which creates inefficiencies and which could greatly stress public finances in case of insolvency in either sector. In turn, the reduction of state involvement in agriculture may provide an impetus to the lifting of trade restrictions imposed recently. In such a manner future privatization in Uzbekistan may emerge less out of state policy than out of sheer economic necessity.

AUTHOR’S BIO: Peter G. Laurens is Senior Analyst, Fixed Income Credit Analysis at FH International Financial Services, Inc.