Uzbekistan 2.0 reforms making good progress

Uzbekistan 2.0 reforms making good progress
Uzbekistan has one of the youngest populations in the former socialist bloc and Uzbek President Shavkat Mirziyoyev's top priority is to grow the economy simply to create enough jobs for all the young people.
By Ben Aris in Berlin September 23, 2020

Uzbekistan has been in a rush to put through a comprehensive package of reforms ever since President Shavkat Mirziyoyev took over in December 2016. And nearly four years on, the government is still working at top speed, but now it is starting to have something to show for all that effort.

The largest and most populous country in Central Asia, Uzbekistan should have reclaimed its place as the most important country in the region that it held in the days of Emperor Tamerlane. But shut off from the world by the previous president, Islam Karimov, it failed to fulfil its potential. That all changed under Mirziyoyev, who has opened the doors to international investors and begun a system-wide overhaul of the economy.

On the eve of 29th anniversary of Uzbekistan’s independence, Mirziyoyev announced that his country is at the beginning of the Third Renaissance, when outlining policies for increased investments into education, healthcare and social spheres as priorities for his government.

“Uzbekistan has no choice. It has to open to the world to create jobs, to stop the brain drain, to provide opportunities for the young people,” Scott Osheroff, chief investment officer of Asian Frontier Capital (AFC), told bne IntelliNews in an exclusive interview.

Uzbekistan’s population is not only by far the largest in the region; it is, unlike most of its peers in the Former Soviet Union (FSU), also very young. Amongst the government’s greatest challenges will simply be to find work for this youthful population that is set to overtake Poland in terms of magnitude in the next two decades.

The first big privatisation was completed when 80% of the iconic Hotel Uzbekistan in the heart of Tashkent was sold to Singapore's Bashan Investment Group for $23.2mn in May. The bidders included six companies from the UK, Turkey, the UAE and Singapore. A raft of privatisations are on the board for the coming years as the government plans to slowly reduce its role in the economy.

Manufacturing

With Uzbekistan home to some of the most fertile land in the region, agriculture has always been the mainstay of its economy and cotton pre-eminent amongst the crops grown, to the point where it features in the national emblem.

In Soviet times, cotton was a major export product and in the first years of independence the main source of hard currency earnings.

Cotton production is an obvious place to start to reform the economy but Mirziyoyev took the drastic measure of banning raw cotton exports in order to push companies into investing in added value production of finished and semi-finished products like textiles and fashion. The rugs and multi-coloured khalats the locals wear are the stuff of legend.

“There is a lot of interest in the textile industry. Various big Chinese textile producers are sniffing around in Tashkent and spinning factories seem to be popping up everywhere,” says Osheroff. “There is everything you need: high quality raw cotton, cheap labour, power that costs 3 cents per kWh. If you can nail the logistics then this could be something pretty special.”

The country scored its first big victory when it closed a deal in September to manufacture Nike and Adidas sports footwear in Andijan Region. The country’s Uzcharmsanoat Federation has signed multiple deals with the brands, its head, Fahriddin Boboyev, told the local press.

Big name fashion brands are always on the hunt for low-cost production facilities and Uzbekistan has a lot to offer, as it is home to both an established textiles industry and, more importantly, copious supplies of the raw material.

The fly in the ointment is that Uzbek textiles are still blacklisted, as under Karimov the republic was accused of using child labour to bring in the harvest. Students were press-ganged in large numbers to pick cotton during the harvest each year. Mirziyoyev has rolled back these practices and in the middle of September Uzbekistan’s Agriculture Ministry announced that cotton pickers will receive a pay rise to $0.10-$0.40 for every kilogram of cotton collected manually in 2020, up from the range of $0.02-$0.08 in 2019.

In the meantime, the government has been working actively to be removed from the blacklist and went as far as to hire US PR firm Xenophon Strategies in August to help. The Uzbek government, civil rights groups, the International Finance Corporation (IFC) of the World Bank Group and other industry stakeholders in August reviewed a new responsible sourcing agreement (RSA) framework that could potentially allow brands and retailers to resume sourcing cotton from Uzbekistan.

In anticipation of the eventual end of the embargo, Chinese textile companies and many of the big international fashion brands have been making the trip to Tashkent to sound out investment opportunities as the sector is rapidly transforming.

At the same time, the government has been experimenting with alternatives to cotton and has launched the production of hemp, which has always grown in the region. This is not a good-time marijuana variety, however. A French-Uzbek joint venture will begin growing industrial hemp, which contains low amounts of mind-altering tetrahydrocannabinol, or THC, in Khorezm region, which can be used in paper, ropes, building supplies and textiles, among other things.

Tourism

Another sector that was an early focus for government reforms was tourism. One of the largest way stations on the legendary Silk Road, the cities of Samarkand, Bokhara and Khiva are the stuff of legend. The classic A Thousand And One Nights was set in Samarkand and even Alexander the Great passed through on his way to India, founding the city Alexandria the Furthest on the way.

The government took Uzbekistan tourism on a roadshow, stopping off to see the holiday-loving Germans in Berlin in January 2019. An extremely attractive deal was put on the table by the Prime Minister and Chairman of the State Committee for Investments, Suhrob Kholmuradov.

“The tourism sector has great potential but we lack the infrastructure,” Kholmuradov told the audience. “If any of you come and build a hotel then the state will partially reimburse the investors.”

The one-time pariah state has flung open its doors and rapidly dropped visa restrictions on dozens of countries as well as introducing a visa-free regime for German tourists visiting Uzbekistan for 30 days that came into effect at the start of 2019. According to the State Committee for Tourism of Uzbekistan, 4,890 German citizens visited Uzbekistan in 2016, 7,200 in 2017 and 18,090 in 2018.

Of course in 2020 the trend was due to continue, but the start of the coronacrisis has scuppered plans for this year and the country has been more of less closed for the entire season as the government imposed a strict lockdown to curtail the spread of the infection.

Banks and finance

The banking sector has been taken by the bootstraps and is also being transformed as part of a system-wide revamp of the country’s capital markets.

“It is no secret that the Uzbek banking sector has been in sleep mode for the last 25 years. The banks were mostly established along sectoral lines to solve specific funding matters and they were focused on two key issues: channelling state funds into the sectors that they have been created for and collecting physical cash,” Fiezullah Saidov, CEO of Uzbekistan Equity Fund and a banking sector consultant for the IFC, said in an extensive comment for bne IntelliNews looking at bank sector reforms. “But since Uzbek President Shavkat Mirziyoyev launched the Uzbekistan 2.0 reforms the transformation and reform of the banking sector has become a key initiative that is probably the most advanced of all the current reform efforts.”

The banking landscape is starting to change drastically. Banks have been freed from their sectoral focus and are now permitted to do classic banking business with any client they like. And following the introduction of the free convertibility of the som last year, starting with liberalising bank accounts and permitting FX deposits, that has also removed the need to focus on physical cash collection.

The ownership restrictions have also been eased, making it easier for foreign investors to get involved in the national financial sector. However, this remains a managed process: most of Russia’s biggest banks could buy the entire Uzbek banking sector, so the government is trying to encourage smaller banks to invest, without losing control of the sector entirely. Georgia’s TBC bank, the biggest in that country, is the most active so far, having already bought a leading online payment service and then received a bank licence in April so it can begin a crediting business.

Bonds

Last year the country issued a smash-hit debut Eurobond in February. The government didn't really need the money as external debt is low and its reserves, mostly in gold, are large. The issue was more of a calling card for international investors and a benchmarking exercise to allow the leading corporates to price their own bonds. Investors flocked en masse to buy up Uzbekistan’ 5-year and 10 year notes, which effectively links Uzbekistan to the international capital markets.

By the end of 2019 Uzpromstroybank (UICB) was the first to take advantage of the opposition to issue debt created by the sovereign issue. UICB collected over $800mn in a single morning of its placement on November 25. 

Next up will be the National Bank for Foreign Economic Affairs (NBU), the country’s largest bank by assets, that hopes to issue a $300mn bond, the Ministry of Finance said in March. And the national oil and gas company Uzbekneftegaz has also said it wants to offer an international bond.

Energy

Uzbekistan’s five-year programme to modernise its energy sector is gathering momentum as the government strives to meet the increasing demand for electricity from the growing population and burgeoning industrial sector.

The five-year programme, launched last year, began with the relaxation of its energy industry’s ownership that has already created a bonanza of redevelopment projects set to be completed by 2025. These projects, including energy generation and a general liberalisation of state ownership across the board, have injected a new lease of life into the sector and are going very fast, according to Aida Sitdikova, head of Eurasia energy at the European Bank for Reconstruction and Development (EBRD).

“The government has shown admirable commitment to reform and the progress has been fast,” says Sitdikova.

The biggest achievement to date has been the unbundling of the state-owned power monopolist Uzbekenergo, separating the generating, transmission and distribution functions into separate companies. At the same time, a raft of laws have been passed that create the foundation for a regulated market for power.

“The generating part is inherently competitive and a natural candidate for privatisation,” adds Sitdikova. “The transmission part will remain a state monopoly, but that is normal, and the distribution part will be sold off too, eventually.”

Reforms have also begun at Uzbekneftegaz, which previously was in effect a ministry, but has had many of its powers stripped away in February, turning it into a more classical oil and gas company that is wholly focused on exploration and production, as part of the wider energy sector reforms.

Uzbek Energy Minister Alisher Sultanov said in a statement: “Reforming our energy sector is a key strategic priority for Uzbekistan, and this year we will continue to make further reforms and build upon our accomplishments in 2019,” the minister said on the announcement of the changes to Uzbekneftegaz.

But there is still a lot of work to do. Some 80% of Uzbekistan’s power is produced by gas-burning thermal power plants (TPPs) left over from the Soviet-era, most of which need modernisation and efficiency boosts. Some big investors are already in talks with the government on building new high efficiency gas-fired power plants. The country currently has some 13 GW of installed capacity but will need to expand this by some 5% a year, depending on the pace of growth, to keep abreast of demand.

However, the really exciting part of the energy reforms has been the interest in renewable power. The EBRD recently launched a project to build a 100-MW wind farm in the western province of Karakalpakstan on the shores of the Aral Sea.

“We had 70 international investors travel to the site to inspect it and this was in the midst of the COVID-19 crisis. There is really a big interest amongst foreign investors in investing into Uzbekistan’s renewable energy sector,” says Sitdikova.

The government is also keen on renewables for many reasons. It has bought into the idea of green power and renewable power facilities – and solar in particular – as much faster to put up than conventional greenhouse gas (GHG) emitting power plants.

“Renewable energy will be the gateway into foreign investment into the Uzbek power sector,” says Sitdikova. “By 2030 Uzbekistan wants to build another 8 GW of capacity, which will increasingly be supplied by renewables.”

These investments are underpinned by an attractive legal basis where the off-taker of the power gets a sovereign-backed deal for 20 years from the Ministry of Energy, which was set up only a year ago to oversee the modernisation of the energy sector.

The new capacity comes as part of a larger reform that will create a pan-regional power market.

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