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Uzbekistan Has World’s Craziest Currency Regime

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Uzbekistan Has World’s Craziest Currency Regime

September 15, 2016

The death of Uzbekistan’s dictator, Islam Karimov, has so far failed to unleash a succession crisis, as many observers had anticipated. The post-Soviet central Asian country’s new acting president, Shavkat Mirziyoyev, is Russian leader Vladimir Putin’s preferred candidate to win presidential elections on December 4. Analysts generally believe that Mirziyoyev will win and continue or even double down on the policies of his predecessor. If this is right, Uzbekistan has more misery ahead.

Uzbekistan’s government remains among the world’s most backward, with heavy state control of the economy and widespread human rights abuses. One trait that sets the Uzbek economy apart, though, is its currency regime.

The Uzbek som has two exchange rates. One, the official exchange rate, is set by the government and currently stands at 3000 som to the dollar, according to the country’s central bank. The other, black market exchange rate reflects the much weaker real value of the currency. While the rate fluctuates, surveys of local businesses suggest it stands at roughly 6000 som to the dollar. Therefore, the Uzbek som may only be half as valuable as the official rate claims.

Why the divergence? While the Uzbek government fixes the exchange rate to other currencies, its central bank also cannot seem to keep its hands off the printing presses. The excess of som results in high inflation rates. Inflation was 8.7 percent in 2015, which is actually an improvement over the double-digit rates of years past and the quadruple-digit ones of the early 1990s. Since 2000, prices in Uzbekistan have risen 18-fold.

Inflation is a serious problem on its own. An even bigger problem was the government’s response: denial. When I visited the country in 2013, the largest banknote the central bank deigned to issue was a 1000-som note, worth roughly 35 cents at the time. Since credit cards were not commonly accepted, making any purchase required carrying around large wads of banknotes. A briefcase full of cash, worthy of a mafia movie, was necessary to purchase a 90,000-som (then $32) train ticket.

Inflation denial hurt the country in less humorous ways. The high rate of inflation naturally precipitated a fall in the som’s value against other currencies, but the government only partially adjusted the official exchange rate to compensate. The excess of som gives rise to a black market in currency trading.

Anyone who wishes to do business on an official level in Uzbekistan must use the official exchange rate. Exporters must turn over half of any foreign currency they earn to authorized banks at the official exchange rate. Since the official exchange rate overvalues the som, this transaction effectively seizes a substantial chunk of exporters’ revenues, discouraging exports.

The same phenomenon should make imports cheaper. But import licenses are granted only to a handful of politically-connected, mostly state-owned businesses. These businesses may import goods at the official exchange rate, which makes them much cheaper. This is a massive leg up for the favored businesses, which stifles competition in the Uzbek economy.

These policies are draconian, but they are necessary to defend the official exchange rate the Uzbek government has set.  If everyone could import at the official rate, there would be a stampede to switch Uzbek som for U.S. dollars or other foreign currencies, and the government would quickly run out of foreign exchange. Without tight controls on currency flows, the government would not be able to maintain the official rate.

Of course, this raises the question of why the government is so insistent on defending its official exchange rate in the first place. The best solution would be to let the currency float (move with market forces). Uzbekistan would still have problems, but a freely tradable medium of exchange is a necessary condition for any strong economy. Fixed exchange rates, like selfie sticks and communism, are better in theory.

Preston Cooper is a policy analyst at the Manhattan Institute. You can follow him on Twitter here.

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