Uzbekistan's severe economic crisis is forcing the government to abandon the economic policies that have guided it since independence in 1991. The present economic turmoil comes after four-year-long terms of trade shock, in which the prices of Uzbekistan's two key exports, cotton and gold, have dropped sharply. To make matters worse, the cotton and grain sectors have performed poorly this year, lowering expectations for cotton export revenues, and increasing grain import costs.
President Islam Karimov has been one of the former Soviet Union's most reluctant reformers. He claims that his Uzbek economic "model" represents a unique, domestically formulated program for development. In reality, it draws on the policies that were tried, and which failed in developing countries in the 1960's and 1970's. Uzbekistan has achieved the same results as these developing countries, just faster. The standard of living is falling, and there is growing inability to repay foreign debt. Inflation is around 45 percent, and banks are insolvent in all but name. The government boasts impressive real GDP growth rates of over 4 percent, but only the gullible believe them.
The heart of Karimov's "model" is import substituting industrialization (ISI). Under ISI, the government channels resources, such as foreign loans, towards domestic industries. These industries are supposed to supply goods that the economy needs, thereby saving money on imports. In Uzbekistan, the quality of these domestically produced goods is poor (they generally cannot compete with foreign imports). So to make ISI work the government has walled off the Uzbek economy to the outside world, using import tariffs and a multiple exchange rate system.
To fund ISI the government exploits the cotton sector, the country's largest employer and largest exporter. The government pays cotton farmers a fraction of the value of their crop, generally between 15 percent and 25 percent of the world price. As the government controls cotton exports, it can sell Uzbek cotton to foreign buyers for around 85 percent of the world price (net of transportation costs)earning a margin of between 60 percent and 70 percent. Top ranking officials in Tashkent and in the provinces personally benefit from the low prices paid to cotton farmers because they skim off the receipts from cotton exports. The labor cost of picking the cotton crop -- an incredible 96.5 percent of which was collected by hand, sometimes with the use of forced labor -- was just $3 million USD in 1999. Yet in 1999, cotton exports earned Uzbekistan $884.4 million USD.
The first sign that the government knew it was in trouble came on May 1, when it abolished its main exchange rate -- the "official" rate -- devaluing the national currency, the som by 53 percent. In one day, the exchange rate went from Som150:$1 to Som231:$1. Yet the most important exchange rate in Uzbekistan is not set by the government, but by the free market, the technically illegal rate available in the bazaar. While the main government rate at the end of September was Som299:$1, the bazaar rate has recently reached as low as Som800:$1. The government is desperately trying to narrow the spread between the main official rate and the bazaar rate, a spread caused by government rationing of hard currency. Bureaucrats allocate hard currency to pay for ISI loans and ISI imports, leaving almost no money for consumer goods imports or for the private sector.
President Karimov's government is trapped. To prop up the som it must push up interest rates, which are currently below the rate of inflation ("negative" in real terms). Yet if Uzbekistan's interest rates rose above the rate of inflation ("positive" in real terms), then the cost of borrowing for the government and state-owned enterprises could become unbearable. So far the government prefers negative real interest rates. The Central Bank of Uzbekistan, which is more an instrument of the finance ministry than a true central bank, has cut interest rates.
The next hint of distress came on June 29, when President Islam Karimov issued a decree allowing local firms to run up arrears on their outstanding loans. Unfortunately for Karimov, many of these loans are backed by government guarantees. Foreign loans accounted for 53.6 percent of the total loan portfolio of Som453.2 billion ($3.3 billion USD, 22.1 percent of GDP) in October 1999 (the most recent available data). If these are not paid, then there is a risk that the local banks will go under and the government will be forced to default on its guarantees.
Abandoning the Uzbek "model" will not be easy. Uzbekistan has to catch up with nearly a decade of reforms in countries like Kazakhstan. In the meantime provincial officials, sensing panic in the government, are looking after themselves, commandeering more cotton and restricting the movement of foodstuffs outside of their provinces. President Karimov himself has never shown much enthusiasm for even modest reforms. He has repeatedly shunned the IMF, calling its loans "slavery."
The irony is that not so long ago Uzbekistan was being touted as a key future US ally in Central Asia, a haven of stability and even economic achievement. Instead, the government has successfully undermined its own economy and there is a growing Islamic insurgency. The Karimov government will probably be able to deal with the insurgents -- it is too well organized, and its security services too brutal for the Islamists to have much chance of success. What is beating the Karimov regime is not violence, but economics. The government remains convinced that coercion is the best method. Yet, officials do not seem to comprehend why control mechanisms simply cannot make the economy do as they desire.
Andrew Apostolou is a historian at St. Antonys College, Oxford.
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