Uzbekistan is caught in a conundrum in which security concerns are clashing with economic interests.

The Uzbek government has maintained tight control over the economy, in part through the imposition of artificial currency exchange rates. In addition, Uzbek authorities have established stringent customs and border regulations. Easing existing restrictions could stimulate economic activity and promote regional trade, thus helping to alleviate the widespread poverty that fuels social discontent. But officials have been reluctant to relinquish economic control. Instead, as the threat posed by Islamic radicalism builds, the government appears inclined towards trying to tighten its grip on society.

During the past few years, the domestic economy has stagnated, and inter-state commerce and cooperation with Uzbekistan's Central Asian neighbors has deteriorated substantially. Uzbekistan's 1998 GNP per capita was $870, placing it among lower-middle-income economies. Not only have the economic policies discouraged business activity at home, they have irked the international financial community. Leading institutions, including the World Bank and the International Monetary Fund (IMF), have sought to discourage reliance on import substitution strategies, maintaining that this policy is not in the best long-term interest of the country.

In recent months, Uzbek President Islam Karimov has indicated a willingness to make fundamental changes to Uzbekistan's economic framework. Specifically, Karimov and other officials have pledged to undertake currency reforms by the end of 2000. However, follow-up efforts have been tentative. So far, security concerns have outweighed economic factors in the formulation of government fiscal policies. The recent raids launched by Islamic insurgents underscore the tenuous nature of the security environment in Central Asia. [For additional information see EurasiaNet's Daily Digest].

When Uzbekistan gained independence in 1991, the government initially adopted a "pro-business" posture, taking steps to improve its legal and institutional framework. Nevertheless, authorities never appeared comfortable with relinquishing full control of the economy, and, ultimately, they developed new mechanisms which helped the state retain its controlling interest in the economy.

In September 1996, in an effort to halt a precipitous decline in foreign exchange reserves, the Uzbek government imposed a system of import restrictions. The system was designed to ensure that scarce foreign currency was used primarily to import capital rather than buy consumer goods, particularly luxury goods and items. Currency controls succeeded in slowing the rapid decline of foreign exchange reserves. Nevertheless, reserves have dwindled to about $1 billion USD, down from approximately $2 billion in 1996.

The system also had the effect of creating multiple foreign currency exchange rates. Government-licensed firms were entitled to buy foreign currency at the overvalued government rate, while non-licensed firms and individuals were required to buy at a commercial rate. This gave government-preferred firms a great advantage, making possible "windfall" profits on currency transactions alone. As a result, a black market for the Uzbekistan national currency, the Uzbek "som", quickly emerged. While the rate varied with conditions, at some points it was four times the official rate.

An overvalued currency tends to channel trade into narrow and easily managed sectors. It thus may appear to offer a solution to capital flight. But it has many shortcomings. The system requires strict regulation of financial transactions, imposing a heavy burden of monitoring and sanctioning. It can give rise to a situation in which private parties have an interest in evading the legal framework through various forms of side-payments. It severely limits the availability of foreign exchange for all sectors of the economy, thus hindering economic activity and discouraging foreign trade. Indeed, foreign companies doing business in Uzbekistan now report that the currency-related problems constitute the most serious obstacle to their activities.

Regional trade has been hit especially hard. The deterioration is reflected in the greater complexity of customs, monetary, and visa requirements, by increases in transportation costs, by disagreements over inter-state exchanges of water and energy, [for background see EurasiaNet's Civil Society archive] and by disagreements over the demarcation of the borders themselves. For example, trade with Kazakhstan shrank from $393 million in 1997 to only $233 million in 1999. Similarly, trade with Kyrgyzstan dropped from $103 million in 1996 to only $43 million in 1999. Much of the responsibility for the downward trade trend can be attributed to Uzbekistan's foreign economic policies.

International donor organizations have urged Uzbekistan to rethink its currency policy. The IMF, which Uzbekistan joined in 1992, suspended credits to Uzbekistan in November 1996 as a result of the country's adoption of an artificial currency exchange rate.

In May 2000, Uzbek officials took a major step towards liberalization by devaluing the official exchange rate for government transactions by about 50 percent, setting the Uzbek som at 231 to the US dollar. Authorities also established a system for weekly adjustments of the exchange rate based on supply and demand. By early August the official rate had risen to 280 som to the dollar, while the commercial rate was at 675 som to the dollar.

At the same time, the government has maintained restrictions on trade and currency movement, maintained highly subsidized, government-controlled trading companies, and has periodically closed its borders with its neighbors citing security concerns. As long as subsidized goods are distributed at below market prices in Uzbekistan, the government will tend to restrict cross-border relations for fear that these goods will be taken out of Uzbekistan and sold in neighboring countries. Thus, Uzbekistan's policies are acting as a brake upon the market transition throughout Central Asia.

Uzbekistan is a country with a great deal to gain from foreign trade. It is a country rich in natural resources including coal, copper, gold, natural gas, oil, silver, and uranium. Primary commodities account for about 75 percent of merchandise exports, with cotton alone accounting for roughly forty percent. In addition, Uzbekistan possesses a relatively well-educated and low-cost labor force. For these reasons, officials in Tashkent should be doing more to encourage entrepreneurial activity at home and free trade with its neighbors.