Publication: Monitor Volume: 6 Issue: 88

An April 1 decree by President Islam Karimov further tightened administrative controls over Uzbekistan’s highly distorted foreign exchange market. While this may have provided Uzbekistan with some short-term relief from the foreign exchange shortages which plague its economy, it could make these shortages worse in the long run. And since it seems to represent the reversal of the government’s promise to liberalize the foreign exchange market this year, the decree will also complicate the government’s efforts at improving relations with the IMF, World Bank and other foreign investors.

Uzbekistan maintains a three-tiered exchange rate system. The official rate (used mostly for import-export transactions by privileged state enterprises) has fluctuated around US$1 = 140-150 som for most of this year. The “commercial bank” exchange rate, at which foreign tourists are permitted to purchase, is set at around US$1 = 200 som. The black market exchange rate as of mid-February had fallen to US$1 = 850 som. The three different prices for foreign exchange generated by this system make the accounting of foreign trade transactions largely arbitrary. They also give the privileged few who are authorized to purchase dollars for 140-150 som a tremendous advantage over those who have to pay five or six times that much. Since most households can only purchase dollars on the black market, the high price of foreign exchange raises the costs of consumer goods sold in dollars and boosts inflation. The overvalued exchange rate discourages exports, which dropped by some 8 percent last year. Uzbekistan’s foreign exchange reserves have fallen to some US$1 billion, down from US$2 billion in 1996, when currency controls were introduced, and would have fallen further if not for a restrictive licensing scheme which artificially limits imports.

For these reasons, President Karimov pledged last year to make the som more broadly convertible at a single exchange rate by the end of 2000. Fulfilling this promise was seen as a sine qua non for the improvement of Tashkent’s relations with the IMF and World Bank, which have essentially halted lending to Uzbekistan since the currency controls were introduced in 1996. In light of the growing economic centralization apparent since 1996, speculation in Tashkent had for months centered on when, whether and how Karimov’s foreign exchange liberalization pledge would be implemented.

The April 1 decree suggests that the skeptics are correct, and that no serious liberalization of economic policy is in the offing. According to this decree, all nonresidents (including diplomats) are required to pay for service-related transactions in dollars at the official rate. The introduction of these new restrictions was described as a bid to boost the government’s hard currency reserves to pave the way for the promised liberalization of the foreign exchange market later this year (Agence France Presse, April 17). Initial signs indicate that this strategy may not be wholly unsuccessful: the som strengthened on the black market, rising from US$1 = 850 to US$1 = 650 in the first half of April. This suggests that the government and national bank may have resold some of the hard currency “bounty” harvested from nonresidents to households via the informal sector.

Still, it is difficult to be optimistic about the long-term prospects of this “fishing with dynamite” strategy. Although Uzbekistan during the first half of the 1990s was able to attract some foreign investment from Daewoo and other multinational companies, the flow of new investments has largely dried up since the currency controls were introduced in 1996. The new restrictions will make the investment climate even less appealing, and are therefore likely to further damage Uzbekistan’s investment prospects. In light of the government’s track record, any eventual liberalization of the foreign exchange market is likely to produce a flood of dollar buying by both foreigners and Uzbekistani citizens. The sharp slide in the exchange rate, and higher inflation, that is likely to result could precipitate a major decline in output, incomes and living standards.