Formerly one of the most closed economies in the world, Uzbekistan has seen sweeping changes over the past year. President Shavkat Mirziyoyev, who replaced his late predecessor Islam Karimov in December 2016, brought a wind of change. Many stifling regulations were abolished or loosened, relationships with neighbouring countries and international institutions are improving, and the government announced an ambitious five-year reform plan that, if implemented, would radically improve the growth potential of the Uzbek economy. However, we argue that the chances currently look slim that Uzbekistan will offer a hefty payout on an early investment.

The five-year plan goes well beyond economic stabilisation and includes also political reforms such as strengthening the role of parliament, establishing an independent judiciary, and the fight against corruption. In order to make Uzbekistan an attractive investment destination, the country wants to reduce the role of the state in the economy through privatisation, establish a favorable tax regime, improve transparency, and deliver full convertibility of the currency by 2019. The great promises and the prospect of entering a pristine market with 33mn consumers has caught the attention of many investors.

There are good reasons to think that the reality will be much less sanguine than the government would like us to think. To some extent at least, the reforms were forced upon Uzbekistan by the drop in world energy prices and the Russian economic downturn in 2015-2016, which reduced foreign inflows by $7.5bn (11% of GDP) annually.

Official statistics showed the growth holding steady at an enviable 8% per year, but that only serves to demonstrate that the official statistics have little to do with economic reality, and indeed Uzbekistan has started cooperation with the IMF to produce a new, reliable set of basic statistics. Our OGResearch estimation is that the true growth rate was perhaps 5pp lower than officially reported. The extent of the problems was best reflected in the value of the Uzbek som on the black market, where it declined to a half of its official value in the summer of 2017.

With the mounting economic costs and little hope of improvement, reforms were the only viable path forward. The most notable reform surely was the devaluation of the national currency in September 2017 and loosening of regulations which effectively abolished the black exchange rate market, removing the single biggest obstacle for business in Uzbekistan.

The key for success of the reform plan will be to attract sufficient foreign investment to bring new technologies, improve productivity, and help overcome the low level of domestic human and physical capital. The task is even more challenging for a landlocked country with poor transport infrastructure. Countries that have successfully transformed their economies from centrally controlled to market-based models, such as China or the Central European countries, have seen investment inflows of around 4-5% of GDP that lasted decades. Uzbekistan only touched those levels briefly during the commodity price boom and the investment flowed mainly into the hydrocarbon extraction industry. With current oil and gas prices, that is unlikely to be repeated.

Enriching the elites

To attract the needed investment, Uzbekistan will have to create an inviting business environment. That will require the Uzbek political elites to give up a significant part of their economic control over the country, and ultimately also part of their political control. The current practice of using the political system to rig the markets and enrich the elites is not compatible with a truly attractive investor environment.

Yet is the current president willing to go against the interest of the elites? It’s hard to see Mr Mirziyoyev, who served as prime minister from 2003, as a fresh reformer willing to part with the past. While the reforms enacted so far might seem broad and sweeping, a closer look indicates that the difficult steps are yet to be taken. For example, more than 500 enterprises were reportedly privatised in 2017, but anecdotal evidence suggests the privatisation focused on small and unimportant state assets, not really reducing the role of the state in economy. Even the motivation for the liquidation of the foreign exchange black market can be questioned, as those who mainly profited from the market were the secret service officials, rumoured to be the key opponents of the new president.

Economic liberalisation also inevitably brings new risks and uncertainties. The previous restrictive economic policies were effective in preventing any kind of significant imbalances in the economy. Many prices are still regulated, shielding the population from macro-economic shocks at the expense of the state. Uzbekistan also enjoys low public debt  (15% of GDP), a balanced budget, and high foreign exchange reserves ($26bn, representing 20 months of imports) accumulated when energy prices were still favourable. During the economic transition, more responsibility will be on the shoulders of policymakers who have yet to acquire the skills and tools needed to navigate an open, market-based economy. Costly mistakes inevitably come, depleting political will for further economic liberalisation.

Will Uzbekistan become the next darling of foreign investors, or will a half-hearted pursuit of the reform programme leave the country behind as another example of a missed opportunity to fully utilise an economy’s growth potential? The reform progress over the next two years will determine which of these scenarios is going to materialise.

A successful reform of the Uzbek economy would be a boon to the early investors who could reap hefty returns on their brave foray in the country, and have the potential to greatly increase living standards of the country’s 33mn citizens. However, all things considered, there is little ground for much optimism. Economic development is a complex process, and multiple pieces have to fit together to bring sustainable growth. Uzbekistan itself illustrates this point – between 2011 and 2016, Uzbekistan improved its position in the World Bank Doing Business ranking from 150^th place to 87^th place, a significant leap forward. Yet these advances were still insufficient, too fragmented to show tangible benefits.

Our current scenario is that we will see the reforms that will make Uzbekistan a freer, more open economy, but the level of corruption will remain high. The economy will be dominated by a small group of people who control both politics and business in the country. In this setting, foreign investment will come in volumes that will be insufficient to transform the country, and the economy will remain dependent mainly on the exports of gas. However, there is a chance that the reforms will succeed, in which case Uzbekistan would offer very high returns to any early investors.  The next two years will be crucial to determine which of these two scenarios will become reality.

Tomas Motl is Senior Economist at OG Research, a Prague-based economic consultancy.