UZBEKISTAN’S SOM: INCHING TOWARD CONVERTIBILITY, OR A CRASH?

The government in Uzbekistan has tried to maintain tight controls over the economy, and the foreign exchange market in particular. In the eyes of the Karimov government, this has served the country well, as Uzbekistan recorded the CIS’s smallest cumulative decline in GDP during 1992-1998. The ruble devaluation and Russia’s financial crisis after August 1998–which in Tashkent are attributed to excessive, rather than inadequate, economic reforms–are seen as further confirmation of the government’s transition strategy.

Both the strengths and weaknesses of this tight economic control are apparent in Uzbekistan’s exchange-rate policies. Tashkent’s supply of convertible currency depends on highly unstable revenues from cotton exports, and a bad harvest in 1995 caused the government to institute an elaborate architecture of foreign exchange controls. Although it has limited Uzbekistan’s imports, made the country even less attractive for foreign investors and caused a rupture in Tashkent’s relationship with the IMF, these controls have since remained in place.

As a result, a three-tiered exchange-rate regime operates in Uzbekistan. The official rate, used for all import-export transactions, remains the most overvalued at US$1 = 135 som. The commercial bank rate, used for interbank transactions and tourism, hovers at around US$1 = 170 som. The black market rate, at which enterprises and households make “informal” foreign exchange purchases, continues to plummet and stands at about US$1 = 500 som. A gap of this size between the official and market rates suggests that the som is heavily overvalued, and that the economy is suffering from significant pent-up inflationary pressures. However, because the National Bank of Uzbekistan (NBU) would like to smooth things over with the IMF, the NBU has stated its intention to gradually liberalize the exchange-rate regime, and make the som more convertible. In addition to removing a major obstacle to renewed IMF lending, a more convertible som would help to boost foreign trade and investment.

This policy to date, however, shows little signs of success. A more liberal exchange-rate regime should mean a depreciation of the official exchange rate. But this rate has remained quite stable in recent months, even as the som has fallen on the black market. Pressures on the exchange rate from trade flows have not eased, especially as Uzbekistan’s exports to Russia and other CIS countries are down sharply this year. Total trade turnover through June was down 13.2 percent over 1998, and first-quarter exports of US$726 million were even lower than last year’s poor first quarter results. The size and growth of the gap between the official and black market rates suggest that significant reductions in the official rate are required to close the gap. The NBU’s main problems, however, are probably political. The Russian devaluation of August 1998 has further vindicated Uzbekistan’s reform path in the eyes of the Karimov government, which now seems less likely than ever to permit a significant exchange rate adjustment.

Still, Uzbekistan’s falling exports and rising inflation rates (forecast to be 28.3 percent year-on-year in 1999) suggest that some sort of exchange rate adjustment is a matter of time. The large gap between the official and black market rates suggests that the devaluation, when it comes, is likely to be substantial. This could precipitate a surge in inflation, and undo much of the macroeconomic stability which the government and NBU have worked so hard to achieve. As policymakers in many CIS countries have learned, the alternative to rapid reform is often an economic debacle, rather than successful gradualism.

UZBEK-LED ISLAMIC INSURGENTS NOW SEEK PASSAGE TO AFGHANISTAN.