The International Monetary Fund's (IMF) recent decision to scale back its activities in Uzbekistan is a reflection of the Fund's long-standing dissatisfaction with Uzbekistan's monetary policies. There are indications that the IMF move may succeed in jolting Uzbekistan into action on long-promised fiscal reforms.

In March, the IMF announced that when the Fund's resident representative in Uzbekistan, Christoph Rosenberg, completes his assignment in mid-April the Fund will not replace him. The decision reportedly was taken after the IMF learned that the Uzbekistan government had resolved to keep the country's present monetary policies in place for the next three to five years.

Current Uzbek monetary practices hamper exports, discourage foreign direct investment, and actually encourage capital flight, IMF officials maintain. They add that the government's policies draw down the country's foreign exchange reserves and force the country to rely on foreign borrowing to finance the modernization of the economy.

The IMF action further complicates an already serious dilemma for Uzbekistan, in which a need for economic liberalization is colliding with the perceived political necessity of maintaining authoritarian controls. In recent years, the government has increased its political control over society, in part as a reaction to an ongoing Islamic insurgency. [For background see the Eurasia Insight archive.] At the same time, the economy has languished, so that now Uzbekistan finds itself in need of trade and foreign direct investment. It now appears, however, that restoring the faith of the international financial community will require fiscal liberalization.

In early April, the IMF and the Uzbek government jointly issued a tersely worded announcement referring to their commitment to "future cooperation." Nevertheless, substantial differences are evident on key issues of economic liberalization. After Rosenberg leaves Uzbekistan, the IMF intends to maintain a minimal presence -- one that would only serve coordinating functions and not service a full IMF assistance program.

The IMF has urged Uzbekistan, which joined the organization in 1992, to simplify and rationalize its monetary policy by allowing market forces to determine the value of the national currency, the som. Uzbekistan currently maintains a complicated and inefficient system of multiple currency exchange rates. Officially, the Uzbekistan government has created two rates, a government exchange rate (currently 342 som to the U.S. dollar) and a commercial rate (currently varying between 765 and 800 som to the dollar).

Uzbekistan's import substitution policy was supposed to ensure that scarce foreign currency was used primarily to import capital, rather than buy consumer goods, particularly luxury goods and items. Only government-licensed firms were entitled to buy foreign currency at the preferential overvalued government rate. Non-licensed firms and individuals were required to buy at a commercial rate. This gave the government-preferred firms a great advantage, making possible "windfall" profits on currency transactions alone. Banking restrictions later institutionalized the system. Today the Uzbek Republican Currency Exchange (URCE) is the sole foreign currency exchange market, and the Republican Monetary Commission (RMC) is the sole arbiter of who can buy foreign currency at what rate. [For background see EurasiaNet's business archive.]

An overvalued currency tends to channel trade into narrow and easily managed sectors. It has the initial effect of stemming capital flight. But it has many shortcomings. The system requires strict regulation of financial transactions, and can give rise to a situation in which private parties strive to evade restrictions through various forms of side-payments. It also severely limits the availability of foreign exchange for all sectors of the economy, thus retarding economic activity and discouraging foreign trade. In addition, strict government currency controls have encouraged the development of a black market, where the som trades at around four times the official rate. The unofficial "offshore" Som rate varies even more widely.

Uzbekistan's monetary policy was originally adopted in September 1996 as an experiment aimed at protecting local markets against foreign competition. Shortly after the government started imposing restrictions on imports, the IMF suspended credits to Uzbekistan out of concern that the credits would only be used in quasi-fiscal transactions to finance government debt. For the past five years, the IMF has maintained a resident representative and has largely limited its activities to providing technical counsel.

During the past several years, the Uzbek officials have repeatedly assured the international financial community that the country's monetary policy would soon be amended. Uzbek President Islam Karimov, for example, announced in 1999 that the country's currency would be fully convertible by January 2000. The government has indeed introduced a few modifications. For instance, last May Rustam Azimov, then Uzbekistan's minister of finance, announced at the annual meeting of the European Bank for Reconstruction and Development that Uzbekistan intended to introduce full convertibility before the end of 2000. Subsequently, the government devalued the som and instituted a system for regular weekly modifications. Nevertheless, Uzbek officials have been reluctant to carry out comprehensive reform.

The IMF action appears to have gotten the Uzbek government's attention. President Karimov has written a letter to the IMF, reportedly reaffirming the country's commitment to fiscal reform. Karimov's letter requested that an IMF delegation visit Uzbekistan in May with the aim of restoring relations. If the IMF accepts Karimov's invitation, it is likely to make naming a new Tashkent representative conditional on Uzbekistan's adoption of a single currency exchange rate.