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### Introduction and country context
- Uzbekistan located in Central Asia at crossroads of the ancient Silk Road.
- Population: about 26 million.
- Land area: 448,000 square kilometers.
- Third largest in population and fourth largest in land area among the 15 post‑Soviet states.
- Historically developed as a leading center for cotton production using vast water resources for irrigation.

### Post‑independence reform strategy and outcomes
- Gradual approach to reform aiming for a socially oriented market economy with substantial central guidance.
- Since 1997: import‑substitution strategy relying on administrative intervention and a restrictive foreign exchange and trade regime.
- Three interventionist pillars: exchange and trade controls, directed credit, and large public investments.
- Consequences:
  - Industrial growth very low and uneven; many industries ceased operations or operate below capacity.
  - Little diversification of production and exports.
  - Persistence of internal and external trade restrictions, price controls, directed resource allocations, output targets, and the state order system.
  - Opacity and unpredictability of government policies hinder domestic economic activity and foreign investment.
  - Uzbekistan lags most transition economies in market development, large‑scale privatization, and corporate governance.

### Prior findings and quantifiable impacts from literature
- Zettelmeyer (1998): early 1990s output performance driven by low initial industrialization, scale of cotton production, and energy self‑sufficiency; these offset poor policies.
- Taube and Zettelmeyer (1998): public investment and gradualist reforms were not the driving forces behind relatively favorable output performance.
- Ranaweeva (2003): disequilibria in product and money markets, multiple exchange rates, administrative controls, and import restrictions drove inflation dynamics.
- Rosenberg and de Zeeuw (2000): multiple exchange rate regime
  - Transferred about 16 percent of GDP from exporters to importers.
  - Generated welfare losses in the range of 2–8 percent of GDP on import markets and up to 15 percent on export markets.

### Financial sector distortions and monetary policy legacy
- Financial sector dominated by state‑owned banks.
- Administratively determined interest and exchange rates and cash restrictions eroded confidence.
- Low and declining monetization and toll on banking sector development and aggregate growth.
- Banking sector relied heavily on foreign loans; foreign savings constitute approximately 75 percent of the banking sector’s total liabilities.
- Main bank activity: on‑lending of foreign loans, often with explicit or implicit government guarantees.

### Reforms since 2000 (up to early 2005) and conditional outlook
- Measures taken:
  - Reduced exchange market distortions and introduced currency convertibility.
  - Tightened fiscal and monetary policies.
  - Restructured farms into leaseholds.
  - Followed a more conservative borrowing path.
  - Introduced a unified tax, streamlined registration and inspection procedures, relaxed foreign exchange surrender requirements for exports.
- Remaining issues: sizable barriers to doing business; reports of harassment of entrepreneurs and 2004 Kokand riots.
- 2004–early 2005 financial sector actions: new measures and legislation, presidential decrees, relaxation and reported complete removal of cash constraints, clearance of all wage and pension arrears (see Appendix III).
- Conditional note: if implemented credibly and permanently, and combined with macroeconomic stability, structural measures could help achieve sustained higher growth.

### II. Description of prevailing distortions — main elements and empirical indicators
- A. Cash Shortages
  - Policy objective: restrict cash in circulation to control inflation, curb shadow economy, narrow official/black market exchange rate gap, strengthen tax collection.
  - Instrument: commercial banks’ limited access to correspondent accounts at the Central Bank of Uzbekistan (CBU), leaving banks unable to withdraw cash despite sufficient balances.
  - Consequences: limits on legitimate withdrawals; businesses and individuals restricted in paying current expenditures; daily deposit rules for cash receipts; aggravated by arrears on pensions and civil service wages.
  - Direct evidence:
    - In Tashkent, 66 percent of survey respondents reported difficult or no access to their cash in banks; in other surveyed cities the share is between 80–85 percent.
    - More than half of respondents in all four cities report cash withdrawal limits of SUM 50,000 (approximately $50).
    - Despite cash restrictions, consumer price inflation increased by an estimated 15.5 percent in 2004; PPI grew by 26.5 percent and GDP deflator grew by 15 percent.
- B. Convertibility Problems
  - Uzbekistan accepted Article VIII obligations in October 2003; businesses gained access to foreign exchange for current account transactions in most cases.
  - Remaining problems: foreign exchange available only during first days of each month; outstanding applications deferred; conversion prohibitions reported for some imports (CBU denies); interbank sales of foreign currencies reported prohibited (CBU denies).
  - Household evidence:
    - 38 percent of respondents unable to exchange dollars into sums on first attempt.
    - Reverse transactions (sums into foreign exchange) often turned down due to lack of cash in exchange bureaus.
- C. Other Distortions
  - Civil Code requires enterprise transactions to be settled in non‑cash form, implying cash and non‑cash payments are not substitutes.
  - Council of Ministers Decree No 445 of September 24, 2004 required banks to establish plastic card payment terminals in retail establishments in Tashkent; an employer wage mandate was abandoned December 2004.
  - CBU classifies plastic card deposits as “other deposits”, neither part of M1 nor M2.
  - Surrender requirements: 100 percent on centralized exports of cotton and gold; 50 percent (with exemptions) on non‑centralized exports.
  - CBU requires retail businesses to have bank accounts and deposit cash earnings daily; deposited balances then subject to cash withdrawal controls.

### III. Implications for economic behavior — households, enterprises, intermediaries
- A. Cash shortages
  - Households:
    - Widespread wage and pension arrears throughout much of 2004.
    - Velocity of broad money declined by about 22 percent during 2004 as customers hoarded cash and accumulated illiquid deposits.
    - Evidence of barter transactions; large number of employees have salaries directly deposited to bank accounts, worsening access.
  - Enterprises:
    - Frequent inability to pay current expenditures on time; increased transaction costs; deterrence of new SMEs; shift to shadow economy; reduced employee productivity due to delayed wages.
    - World Bank study (Guadagni et al. (2005)) notes exceptional yields in 2004 cotton campaign due to increased cash payments for harvesting and proposes 10 percent cash payment for delivering cotton to ginneries.
  - Financial intermediaries:
    - Erosion of confidence; banks offered high interest rates to attract deposits, undermining profitability and increasing risk profile.
    - Broad money to GDP declined from 15 percent in 1998 to about 10 percent in 2003, with a small rebound in 2004; ratio of total banking sector deposits was about 8 percent in 2004.
- B. Convertibility problems
  - Households:
    - Improved since Article VIII but limited by cash constraints.
    - Average exchange limits quoted by respondents: $224 for dollars→sums; $300 for sums→dollars.
    - About 46 percent of entrepreneurs use the black market at least occasionally; 11 percent deal exclusively with the black market.
  - Enterprises:
    - Restrictions aimed at limiting some consumer imports to protect local industry and help CBU reserve accumulation; restrictions have adverse economy‑wide effects.
  - Financial intermediaries:
    - Limits slow the establishment of an interbank foreign exchange market and undermine confidence.
- C. Other distortions
  - Banks’ role in tax collection and oversight discourages bank use due to confidentiality concerns.
  - Premature plastic card push risks consumers’ inability to pay routine expenses; mandating card use would deprive many retail establishments of much daily legitimate business.
  - Surrender requirements in presence of comfortable forex reserves send mixed signals and reduce demand for sums as store of value.

### IV. Implications for the Uzbek economy — model, findings, and comparative statics
- A. The model (representative agent, cash‑in‑advance framework)
  - Builds on cash‑in‑advance framework (Clower, 1967) adding:
    - CBU control of banks’ access to correspondent accounts.
    - Inability to withdraw cash from deposits to finance current expenditures.
    - Wage and pension arrears from cash shortages.
  - Introduces convertibility constraint for imports (following Stockman, 1981).
  - Representative agent maximizes utility ∫∞0 e−ρt u(c,h,g) dt subject to asset definitions and constraints including cash‑in‑advance and convertibility constraints parameterized by α and β.
  - α and β interpreted as lengths of time money must be held to finance consumption and secure conversion; higher α and β imply stricter restrictions.
  - Government controls money growth μ and α and β.
  - Model focuses on direct impacts; indirect confidence‑reducing effects on intermediation not modeled.
  - Key steady‑state relations and first‑order conditions preserved as in source (equations (2)–(13) and steady‑state saddle path SS).
- B. Model findings (summary)
  - Optimal steady‑state capital stock is a decreasing function of convertibility restrictions: relaxing convertibility requirements increases steady‑state capital stock, investment, and output via increased imports of capital and intermediate goods.
  - Tightening cash restrictions dampens domestic consumption.
  - Impact of convertibility constraints on domestic consumption ambiguous:
    - Direct effect: restricting imports encourages domestic consumption (domestic and foreign goods are substitutes).
    - Indirect effect: reduced production lowers domestic consumption.
    - Net effect depends on production function parameters and substitutability.
  - Both cash (α) and convertibility (β) restrictions reduce imported consumption goods.
  - Convertibility restrictions encourage deposit accumulation; cash limits likely reduce deposits because consumers hold more cash.
    - Empirical note: share of cash in broad money held outside banks increased from 34 to 49 percent between end‑2002 and September 2005.
  - Cash shortages unambiguously reduce consumer utility/welfare through reductions in domestic and imported consumption.
  - Convertibility limits unambiguously reduce welfare because the utility loss from reduced foreign goods consumption exceeds any gains from increased domestic consumption.
  - Current account effects:
    - Cash restrictions: no direct impact on output in model; impact on current account operates through reduced imports (unambiguous dampening).
    - Convertibility restrictions: affect production and exports as well as imports; impact on current account ambiguous.

### V. Policy prescriptions — recommendations and cautions
- Monetary and cash policy
  - Central Bank should target appropriate money supply growth while allowing market to determine shares of cash and deposits.
  - Eliminating cash restrictions is unambiguously welfare‑enhancing; authorities should reduce cash shortages and wage and pension arrears.
  - Caveat: complete liberalization may initially increase precautionary cash holdings and temporarily reduce velocity; confidence restoration should normalize holdings.
- Curbing illegal activity and tax collection
  - Replace administrative measures with incentive‑based policies to reduce shadow economy participation.
  - Abolish requirement for retail establishments to deposit all cash proceeds daily and remove tax collection responsibilities from banks.
- Cash vs non‑cash distinctions and anti–money laundering
  - Eliminate cash/non‑cash distinctions; require banks to report cash transactions above a certain size in line with international practice.
  - Distinctions impose unnecessary burdens and increase transaction costs.
- Convertibility and surrender requirements
  - Decrees aiming to eliminate cash restrictions and phase out surrender requirements could support a modern competitive financial system if credible.
  - Credibility is critical: perceived temporary abolition could trigger bank runs as consumers attempt to cash deposits.
- Overall warning
  - If restrictions remain or liberalization lacks credibility, the financial sector will remain marginalized with little capacity for intermediation or private sector growth support.

### Appendix I — Survey design and selected empirical outcomes (preserve numeric values exactly)
- Survey context:
  - Conducted in summer 2005 by World Bank and IMF; personal interviews; interviews in Uzbek or Russian; 15 percent of interviews checked by second visits.
- Distribution of respondents (Number of respondents, by city and sector):
  - Employed in the budget sector (teachers, doctors, etc.): 30 / 90 / 45 / 45
  - Employed at state enterprises: 20 / 60 / 30 / 30
  - Employed in the banking sector (banks, etc.): 10 / 30 / 15 / 15
  - Private entrepreneurs: 30 / 90 / 45 / 45
  - Receiving social benefits (pensions, allowances, stipends, etc.): 10 / 30 / 15 / 15
  - TOTAL: 100 / 300 / 150 / 150
- Selected empirical outcomes and key statistics:
  - Figure A-4: Frequency of exchanging dollars for sums during the past 30 dates (percent of respondents who attempted to exchange dollars during that period):
    - 62.2%
    - 17.8%
    - 4.4%
    - 4.4%
    - 2.2%
    - 8.9%
  - Figure A-5: Average number of people standing in line in front of exchange bureaus, by city:
    - Tashkent: 7.3
    - Karshi: 10.9
    - Fergana: 14.4
    - Bukhara: 18.3
  - Figure A-11: Frequency of exchanging U.S. dollars by private entrepreneurs at the black market:
    - Never: 53.7%
    - Sometimes: 29.5%
    - Frequently: 6.3%
    - Always: 10.5%
  - Figure A-7: Arrears in wages and other payments due to cash unavailability (percent of total number of respondents, by city):
    - Tashkent: Yes 77 / No 22
    - Fergana: Yes 99 / No 1
    - Bukhara: Yes 81 / No 17
    - Karshi: Yes 69 / No 26
  - Figure A-8: Percentage of employed whose salaries are paid into a bank account (by cities):
    - Karshi: 63.7
    - Bukhara: 45.7
    - Fergana: 66.6
    - Tashkent: 63.8
  - Table A-2. Issues of Biggest Concern (percent of total number of respondents by sector):
    - “My wages (pension, stipend, etc.) are being paid with delay”:
      - Budget sector employees: 46.7
      - State enterprise employees: 52.7
      - Banking sector employees: 1.3
      - Private business owners: 11.6
      - Social benefit recipients: 50.7
    - “I don’t trust the banks and hence need to keep much more cash than I want”:
      - Budget sector employees: 18.7
      - State enterprise employees: 17.3
      - Banking sector employees: 10.7
      - Private business owners: 25.8
      - Social benefit recipients: 16.0
    - “I cannot retrieve as much cash as I need from my bank account”:
      - Budget sector employees: 5.3
      - State enterprise employees: 6.7
      - Banking sector employees: 26.7
      - Private business owners: 28.9
      - Social benefit recipients: 1.3
    - “Small size of my wages (pension, stipend, etc.) lack of money/savings”:
      - Budget sector employees: 10.7
      - State enterprise employees: 4.0
      - Banking sector employees: 9.3
      - Private business owners: 4.9
      - Social benefit recipients: 9.3
    - “I cannot exchange as many sums into dollars (or dollars into sums) as I need”:
      - Budget sector employees: 2.7
      - State enterprise employees: 2.7
      - Banking sector employees: 5.3
      - Private business owners: 7.6
      - Social benefit recipients: 2.7
    - “Difficult to answer”:
      - Budget sector employees: 9.3
      - State enterprise employees: 10.7
      - Banking sector employees: 41.3
      - Private business owners: 12.4
      - Social benefit recipients: 16.0

### Appendix II — Key steady‑state derivations and comparative statics (highlights)
- Steady‑state relations:
  - In steady–state: 0 = •λ and 0 = •θ, transforming equations into:
    - (A-14) )()1(' kf⋅=+θ β ρλ
    - (A-15) λρβθ=.
  - Substitution yields (A-16) )1()(' ρβρ+=kf and r = ρ in equilibrium.
  - Because 0)('' <kf, the optimal capital stock, ∗k, is a decreasing function of convertibility restrictions, β.
- Comparative statics (signs preserved from source):
  - Imported consumption goods:
    - (A-29) 0 )( < ∂ ∂ ∗ α eg ; and 0 )( < ∂ ∂ ∗ β eg
  - Domestic consumption goods:
    - (A-30) 0 < ∂ ∂ ∗ α h , while 0 >< ∂ ∂ ∗ β h
  - Bank deposits:
    - (A-31) 0 < ∂ ∂ ∗ α d and 0 > ∂ ∂ ∗ β d
  - Welfare:
    - Cash shortages unambiguously reduce consumer utility.
    - Convertibility limits reduce welfare; 0 )( < ∂ + ∂ ∗∗ β e g h .
  - Current account:
    - Cash restrictions: reduce imports (unambiguous); no direct impact on output in the model.
    - Convertibility restrictions: ambiguous impact on current account because they affect production, exports, and imports.

### Appendix III — Legal and administrative background on cash withdrawal restrictions
- Key instruments restricting cash withdrawals (examples cited with dates and resolution numbers):
  - CoM No. 280 of August 5, 2002 “On Measures to Further Reduce Non‑bank Money Turnover” (paragraph 3).
  - CoM No. 195 of May 19, 2000 and CoM No. 390 of November 13, 2002 concerning withdrawal limits for agro‑processing and procurement organizations.
  - CoM No. 29 of February 3, 1995 setting limits on spending of proceeds in cash by entrepreneurial activities.
  - CoM No. 542 of December 31, 1998 allowing cash withdrawals for oil and gas purchases and travel allowances.
  - CoM No. 313 of June 24, 1999 allowing non‑government kindergartens to spend up to 15 percent of revenues in cash for food.
  - CoM No. 172 of April 12, 2001 allowing tanning industry enterprises to withdraw up to 10 percent of turnover in cash to purchase accessory materials.
  - CoM No. 483 of October 23, 1997 instituted limits for individual entrepreneurs engaged in trade.

*Source: _wp05239 - References*

### References..............................................................................................................

### References

### Introduction and country context
- Uzbekistan is strategically located in Central Asia, at the crossroads of the ancient Silk Road between China and Europe.
- Population: about 26 million.
- Land area: 448,000 square kilometers.
- Of the 15 independent states that emerged from the breakup of the Soviet Union in 1991, Uzbekistan is the third largest in population and the fourth largest in land area.
- During the Soviet period, Uzbekistan was developed as a leading center for cotton production, capitalizing on its vast water resources for irrigation.

### Post-independence reform strategy and outcomes
- The authorities adopted a gradual approach to reform aimed at building a socially oriented market economy and developing industrial and manufacturing capacity in a predominantly agricultural economy using substantial and direct central guidance.
- Since 1997 the government has pursued an import-substitution strategy relying heavily on administrative intervention and a restrictive foreign exchange and trade regime.
- The gradual reform strategy relied heavily on three interventionist pillars: exchange and trade controls, directed credit, and large public investments.
- Consequences noted:
  - Industrial growth was very low and uneven.
  - Many industries ceased operations or operate below capacity.
  - Production and exports witnessed little diversification.
  - Persistence of numerous internal and external trade restrictions, price controls, directed resource allocations, output targets (especially agricultural) and the state order system.
  - Opacity and unpredictability of government policies continue to hinder domestic economic activity and foreign investment (IFC, 2004).
  - Uzbekistan lags behind most transition economies in market development, large-scale privatization, and corporate governance.

### Findings from prior studies and quantifiable impacts
- Zettelmeyer (1998): Uzbekistan’s good output performance in the early 1990s mainly due to low initial industrialization, (scale of) cotton production, and self-sufficiency in energy—these offset poor macroeconomic and structural policies.
- Taube and Zettelmeyer (1998): reach similar conclusions that public investment and gradualist reform program were not the driving forces behind relatively favorable output performance.
- Ranaweeva (2003): Disequilibria in the product and money markets—in an environment of multiple exchange rates, administrative controls, and import restrictions—were major forces driving inflation dynamics in Uzbekistan.
- Rosenberg and de Zeeuw (2000): Uzbekistan’s multiple exchange rate regime
  - Transferred about 16 percent of GDP from exporters to importers.
  - Generated identifiable welfare losses in the range of 2–8 percent of GDP on import markets and up to 15 percent on export markets.

### Financial sector distortions and monetary policy legacy
- The financial sector is dominated by state-owned banks.
- Legacy of administratively determined interest and exchange rates and cash restrictions resulted in deteriorating confidence in the financial system.
- Reflected in the low and declining level of monetization and a sizable toll on banking sector development and aggregate economic growth.
- Measures reduced the banking sector’s ability to attract domestic savings and maintained heavy reliance on foreign loans as a liability base.
- Foreign savings currently constitute approximately 75 percent of the banking sector’s total liabilities.
  - Main bank activity: on-lending of foreign loans, often with explicit or implicit government guarantees.

### Reforms since 2000 and recent measures (up to early 2005)
- The government has successively:
  - Reduced exchange market distortions and introduced currency convertibility.
  - Tightened fiscal and monetary policies.
  - Initiated restructuring of farms into leaseholds.
  - Followed a more conservative borrowing path.
  - Taken steps to improve the business environment: introduction of a unified tax, streamlined registration and inspection procedures, and relaxed foreign exchange surrender requirements for exports.
- Remaining issues:
  - Barriers for doing business remained sizable, with reports of serious harassment and persecutions of entrepreneurs until riots broke out in Kokand in 2004.
- Financial sector actions in 2004 and early 2005 included new measures and legislation—including two recent presidential decrees—aimed at liberalizing and further reforming the sector.
  - Most notably: relaxation and reported complete removal of cash constraints and the clearance of all wage and pension arrears (see Appendix III).
- Conditional note: If implemented credibly and permanently, and in combination with macroeconomic stability, these structural measures could help Uzbekistan achieve sustained higher growth in the years ahead.

### Behavioral implications and scope of the paper
- The paper reviews recent developments and underlying distortions in monetary and financial policies in Uzbekistan, most notably cash shortages and convertibility problems.
- It describes implications of these distortions on the behavior of agents and aggregate economic activity.
- It offers guidance regarding likely implications of eliminating the observed distortions on key aggregate variables.
- Paper structure (high level):
  - Section II: overview of observed irregularities and official rationale behind policies responsible for these irregularities.
  - Section III: how behavior and incentives of consumers, enterprises, and financial intermediaries change in response to these distortions and rationale behind the paper’s modeling of the Uzbek economy.
  - Sections II and III draw upon a population survey conducted jointly by the World Bank and the International Monetary Fund in summer 2005; Appendix I provides a snapshot of relevant survey outcomes.

*Source: _wp05239 - References*

### Section IV, in turn, outlines (based on the predictions of a representative agent model) the

### _wp05239 - Section IV, in turn, outlines (based on the predictions of a representative agent model) the

### II. DESCRIPTION OF PREVAILING DISTORTIONS
- A. Cash Shortages
  - Government tightened policies to restrict cash in circulation to control inflation, curb the shadow economy, narrow the gap between official and black market exchange rates, and strengthen tax collection.
  - Main instrument: commercial banks’ limited access to their correspondent accounts at the Central Bank of Uzbekistan (CBU), leaving banks routinely unable to withdraw cash despite sufficient balances.
  - Consequences:
    - Limits banks’ ability to meet customers’ legitimate withdrawal requests.
    - Individuals and businesses restricted in ability to pay for current expenditures due to lack of non-cash retail outlets.
    - Legal entities and individuals engaged in retail trade must deposit all daily cash receipts above a small threshold daily via a special cash collection service.
    - Aggravated by arrears on pensions and civil service wages that resulted from attempts to limit cash in circulation.
  - Direct evidence:
    - In Tashkent, 66 percent of survey respondents reported difficult or no access to their cash in banks; in other surveyed cities the share is between 80–85 percent.
    - More than half of respondents in all four cities report cash withdrawal limits of SUM 50,000 (approximately $50).
    - Premia charged for non-cash payments over cash transactions reported (distribution shown in Figure A-3).
  - Note: Despite extensive cash restrictions, consumer price inflation increased by an estimated 15.5 percent in 2004; PPI grew by 26.5 percent and GDP deflator grew by 15 percent. (footnote)

- B. Convertibility Problems
  - Uzbekistan accepted Article VIII obligations in October 2003; businesses gained access to foreign exchange for current account transactions in most cases.
  - Remaining problems:
    - CBU makes foreign exchange available for purchase of consumer goods only during the first few days of each month; outstanding applications held until next month.
    - Conversion for some goods faces longer delays than others.
    - Some reports indicate prohibitions on conversion to finance prepayment for some imports; CBU denies existence of convertibility restrictions.
  - Households:
    - 38 percent of respondents unable to exchange dollars into sums on first attempt (Figure A-4).
    - Long lines reported at exchange bureaus (Figure A-5).
    - Reverse transactions (sums into foreign exchange) often turned down because of lack of cash sums in exchange bureaus.
  - Interbank market:
    - Reports indicate interbank sales of foreign currencies are prohibited (CBU denies).
    - If restrictions confirmed, would constitute breach of Article VIII (footnote).

- C. Other Distortions
  - Legal distinction: Uzbekistan’s Civil Code requires all transactions between enterprises/individual entrepreneurs to be settled in non-cash form, implying cash and non-cash payments are not substitutes.
  - Plastic (debit) cards:
    - Council of Ministers Decree No 445 of September 24, 2004 required banks to establish plastic card payment terminals in retail establishments in Tashkent, with establishments above a threshold mandated to install terminals at their own expense.
    - Initial plan to mandate employers channel a small share of wages into plastic card accounts was abandoned in December 2004.
    - CBU classifies plastic card deposits as part of “other deposits”, neither part of M1 nor M2.
  - Surrender requirements:
    - 100 percent foreign exchange surrender requirement on centralized exports of cotton and gold.
    - 50 percent surrender requirement (with some exemptions) on non-centralized exports.
  - Other restrictions:
    - CBU requires all retail businesses to have bank accounts and deposit cash earnings daily; deposited balances then subject to cash withdrawal controls, preventing businesses from meeting operating expenses.

### III. IMPLICATIONS FOR ECONOMIC BEHAVIOR
- A. Cash Shortages
  - Households:
    - Widespread wage and pension arrears throughout much of 2004.
    - Velocity of broad money declined by about 22 percent during 2004 as customers hoarded cash and accumulated illiquid deposits.
    - Evidence of barter transactions and view that cash shortages are root cause of wage/pension arrears.
    - Large number of employees have salaries directly deposited to bank accounts, exacerbating cash access problems.
  - Enterprises:
    - Frequent inability to pay current expenditures on time despite government prioritization of civil service wage and pension payments and key state-owned enterprise wages.
    - Cash shortages increase transaction costs, deter emergence of new SMEs, force businesses into shadow economy, and reduce employee productivity via delayed wages.
    - Example: World Bank study (Guadagni et al. (2005)) notes exceptional yields in 2004 cotton campaign due to increased cash payments for harvesting and proposes 10 percent cash payment for delivering cotton to ginneries.
  - Financial intermediaries:
    - Erosion of confidence in banking system; low trust undermines intermediary role.
    - Banks offered high interest rates to attract deposits, likely undermining profitability and increasing risk profile.
    - Ratio of broad money to GDP declined from 15 percent in 1998 to about 10 percent in 2003 followed by a small rebound in 2004; ratio of total banking sector deposits was about 8 percent in 2004.

- B. Convertibility Problems
  - Households:
    - Currency convertibility for households improved since Article VIII acceptance, but limited access to sums due to cash constraints impedes ability to buy foreign exchange.
    - Average exchange limits quoted by respondents: $224 for dollars→sums; $300 for sums→dollars.
    - About 46 percent of entrepreneurs use the black market at least occasionally; 11 percent deal exclusively with the black market.
  - Enterprises:
    - Convertibility restrictions aimed at limiting imports of some consumer goods; reasoning tied to protecting local industry and CBU’s foreign reserve accumulation targets.
    - Restrictions have adverse effects across sectors; Section IV highlights opposite impacts on domestic production and consumption.
  - Financial intermediaries:
    - Limits on convertibility and prohibitions on interbank sales of foreign exchange have slowed establishment of an interbank foreign exchange market and undermine confidence in banking sector.

- C. Other Distortions
  - Households:
    - Banks’ role in tax collection and financial oversight discourages bank use due to confidentiality concerns.
    - Success of plastic cards depends on timing and voluntary adoption; premature introduction risks consumers’ inability to pay routine expenses.
  - Enterprises:
    - Market distortions encourage shadow activities and increase transaction costs.
    - Mandating plastic card use would deprive many retail establishments (especially non-state-owned) of a large chunk of daily legitimate business.
  - Financial intermediaries:
    - Distinctions between cash and non-cash undermine confidence in the sum as a unit of exchange.
    - Surrender requirement in presence of comfortable foreign exchange reserves sends mixed signals on convertibility and reduces demand for sums as store of value.
    - Tax and financial control functions performed by banks discourage participation in the sector.

### IV. IMPLICATIONS FOR THE UZBEK ECONOMY
- A. The Model (representative agent, cash-in-advance framework)
  - Model features:
    - Builds on cash-in-advance framework (Clower, 1967) with additional elements to reflect financial sector restrictions: (i) CBU control of banks’ access to correspondent accounts; (ii) inability to withdraw cash from deposits to finance current expenditures; (iii) wage and pension arrears from cash shortages.
    - Introduces a convertibility constraint applying to imports of both consumption and capital goods (following Stockman, 1981).
    - Representative agent maximizes utility ∫∞0 e−ρt u(c,h,g) dt subject to asset definitions and constraints including cash-in-advance and convertibility constraints parameterized by α and β.
    - α and β interpreted as length of time money must be held to finance consumption and secure conversion, respectively; higher α and β imply stricter cash and convertibility restrictions.
    - Government controls money growth μ and α and β (via wage/pension arrears and conversion hurdles).
    - Model focuses on direct impacts of restrictions; indirect confidence-reducing effects on financial intermediation and finance availability are not modeled.
  - Key model relations (preserved expressions from source):
    - Asset and constraint definitions (equations (2)–(6) and derived expressions (7) and (8) as in text).
    - First-order conditions (equations (9)–(13) in source).
    - Steady-state path described as saddle path SS (Figure 1 referenced).

- B. The Findings
  - Summary of model implications:
    - Optimal steady-state capital stock is a decreasing function of convertibility restrictions: relaxing convertibility requirements likely increases steady-state capital stock, investment, and output via increased imports of capital and intermediate goods.
    - Tightening cash restrictions dampens domestic consumption. Impact of convertibility constraints on domestic consumption is ambiguous:
      - Direct effect: restricting imports encourages domestic consumption (domestic and foreign goods are substitutes).
      - Indirect effect: reduced production lowers domestic consumption.
      - Net effect depends on production function parameters and degree of substitutability.
    - Both cash and convertibility restrictions have a negative impact on imported consumption goods.
    - Convertibility restrictions encourage deposit accumulation (fewer dollars available to finance imports → fewer sums exchanged ceteris paribus).
    - Cash limits likely reduce the amount of deposits because consumers are forced to hold more cash and less deposits in response to tighter requirements.
      - Empirical note: share of cash in broad money held outside banks increased from 34 to 49 percent between end-2002 and September 2005.
    - Cash shortages unambiguously reduce consumer utility/welfare through reductions in both domestic and imported consumption.
    - Convertibility limits unambiguously reduce welfare because the utility loss from reduced consumption of foreign goods exceeds potential gains from increased domestic consumption.
    - Effects on current account:
      - Cash restrictions have no direct impact on output in the model; their impact on the current account operates through imports (reducing imports → effect on current account).
      - Convertibility limits affect aggregate production and exports as well as imports, so their impact on the current account is ambiguous.

### V. POLICY PRESCRIPTIONS
- Monetary and cash policy
  - Central Bank of Uzbekistan should target appropriate growth in money supply while allowing market to determine shares of cash and deposits.
  - Eliminating cash restrictions is unambiguously welfare-enhancing; authorities should take measures to reduce cash shortages and resulting wage and pension arrears.
  - Caveat: complete liberalization of cash restrictions may initially increase cash holdings (precautionary balances), causing a temporary decline in velocity; confidence restoration should return cash holdings to normal levels.
- Curbing illegal activity and tax collection
  - Replace administrative measures with policies addressing incentives to participate in the shadow economy.
  - Abolish requirement for retail establishments to deposit all cash proceeds daily as a first step toward removing tax collection responsibilities from banks.
- Cash vs non-cash distinctions and anti–money laundering
  - Eliminate cash/non-cash distinctions; instead require banks to report all cash transactions above a certain size, following international practice.
  - Distinctions impose unnecessary burdens and increase transaction costs.
- Convertibility and surrender requirements
  - Authorities had issued decrees aiming to eliminate cash restrictions (see Appendix III) and phase out surrender requirements; if credible, such commitments could support development of a modern competitive financial system.
  - Credibility is critical: if abolition is perceived temporary or not credible, it could lead to bank runs as consumers attempt to cash deposits during a temporary window of liberalization.
- Overall warning
  - If restrictions remain in place or changes are not fully credible, the financial sector will remain marginalized with little capacity for financial intermediation or growth support for the private sector.

*Source: _wp05239 - Section IV, in turn, outlines (based on the predictions of a representative agent model) the (PDF chapter/section).*

### REFERENCES

### _wp05239 - REFERENCES

### References
- Clower, Robert, 1967, “A Reconsideration of Microeconomic Foundations of Monetary Theory,” Western Economic Journal, Vol. 16, pp. 73–85.
- Feenstra, Robert, 1985, “Anticipated Devaluations, Currency Flight, and Direct Trade Controls in a Monetary Economy,” American Economic Review, Vol. 75, No. 3, pp. 386–401.
- Guadagni, Maurizio, Martin Raiser, Anna Crole-Rees, and Dilshod Khidirov, 2005, “Cotton Taxation in Uzbekistan: Opportunities for Reform,” ECSSD Working Paper No. 41 (Washington: World Bank).
- International Financial Corporation, 2004, Uzbekistan: Business Environment Survey.
- Ranaweere, Thilak, 2003, “Market Disequilibria and Inflation in Uzbekistan, 1994–2000,” World Bank Policy Research Working Paper No. 3144, Washington.
- Rosenberg, Christoph B., and Maarten de Zeeuw, 2000, “Welfare Effects of Uzbekistan’s Foreign Exchange Regime,” Working Paper 00/61 (International Monetary Fund).
- Stockman, Alan, 1981, “Anticipated Devaluation in the Capital Stock in a Cash-in-Advance Economy,” Journal of Monetary Economics, Vol. 8, pp. 387–393.
- Taube, Gunther, and Jeromin Zettelmeyer, 1998, “Output Decline and Recovery in Uzbekistan: Past Performance and Future Prospects,” IMF Working Paper 98/132 (Washington: International Monetary Fund).
- Zettelmeyer, Jeromin, 1998, “The Uzbek Growth Puzzle,” IMF Working Paper 98/133 (Washington: International Monetary Fund).

*References and materials as listed in the source document.*

### Appendix I — Survey description and outcomes
- Survey context and method:
  - Conducted in summer 2005 within World Bank and IMF surveillance of economic policies in Uzbekistan.
  - Personal interviews using a standardized questionnaire.
  - Interviews conducted in respondent’s preferred language (Uzbek or Russian).
  - After completion, 15 percent of interviews were checked by second visits confirming main household parameters.

- Distribution of respondents (Number of respondents, by city and sector):
  - Sectors / Tashkent / Fergana / Bukhara / Karshi
  - Employed in the budget sector (teachers, doctors, etc.): 30 / 90 / 45 / 45
  - Employed at state enterprises: 20 / 60 / 30 / 30
  - Employed in the banking sector (banks, etc.): 10 / 30 / 15 / 15
  - Private entrepreneurs: 30 / 90 / 45 / 45
  - Receiving social benefits (pensions, allowances, stipends, etc.): 10 / 30 / 15 / 15
  - TOTAL: 100 / 300 / 150 / 150

- Selected empirical outcomes and key statistics (preserve numeric values exactly):
  - Currency exchange and cash access:
    - Figure A-4: Frequency of exchanging dollars for sums during the past 30 dates (percent of respondents who attempted to exchange dollars during that period):
      - 62.2%
      - 17.8%
      - 4.4%
      - 4.4%
      - 2.2%
      - 8.9%
    - Figure A-5: Average number of people standing in line in front of exchange bureaus, by city:
      - Tashkent: 7.3
      - Karshi: 10.9
      - Fergana: 14.4
      - Bukhara: 18.3
    - Figure A-11: Frequency of exchanging U.S. dollars by private entrepreneurs at the black market (percent of total number of private entrepreneurs who have exchanged dollars for sums during the previous 30 days):
      - Never: 53.7%
      - Sometimes: 29.5%
      - Frequently: 6.3%
      - Always: 10.5%
  - Cash-related outcomes:
    - Figure A-7: Arrears in wages and other payments due to cash unavailability (percent of total number of respondents, by city):
      - Tashkent: Yes 77 / No 22
      - Fergana: Yes 99 / No 1
      - Bukhara: Yes 81 / No 17
      - Karshi: Yes 69 / No 26
    - Figure A-8: Percentage of employed whose salaries are paid into a bank account (by cities):
      - Karshi: 63.7
      - Bukhara: 45.7
      - Fergana: 66.6
      - Tashkent: 63.8
  - Table A-2. Issues of Biggest Concern (percent of total number of respondents by sector):
    - “My wages (pension, stipend, etc.) are being paid with delay”:
      - Budget sector employees: 46.7
      - State enterprise employees: 52.7
      - Banking sector employees: 1.3
      - Private business owners: 11.6
      - Social benefit recipients: 50.7
    - “I don’t trust the banks and hence need to keep much more cash than I want”:
      - Budget sector employees: 18.7
      - State enterprise employees: 17.3
      - Banking sector employees: 10.7
      - Private business owners: 25.8
      - Social benefit recipients: 16.0
    - “I cannot retrieve as much cash as I need from my bank account”:
      - Budget sector employees: 5.3
      - State enterprise employees: 6.7
      - Banking sector employees: 26.7
      - Private business owners: 28.9
      - Social benefit recipients: 1.3
    - “Small size of my wages (pension, stipend, etc.) lack of money/savings”:
      - Budget sector employees: 10.7
      - State enterprise employees: 4.0
      - Banking sector employees: 9.3
      - Private business owners: 4.9
      - Social benefit recipients: 9.3
    - “I cannot exchange as many sums into dollars (or dollars into sums) as I need”:
      - Budget sector employees: 2.7
      - State enterprise employees: 2.7
      - Banking sector employees: 5.3
      - Private business owners: 7.6
      - Social benefit recipients: 2.7
    - “Difficult to answer”:
      - Budget sector employees: 9.3
      - State enterprise employees: 10.7
      - Banking sector employees: 41.3
      - Private business owners: 12.4
      - Social benefit recipients: 16.0

### Appendix II — Derivations of the model (steady-state results and comparative statics)
- Key steady-state relationships and implications:
  - In steady–state: 0 = •λ and 0 = •θ, transforming equations (12) and (13) into:
    - (A-14) )()1(' kf⋅=+θ β ρλ
    - (A-15) λρβθ=.
  - Substituting (15) into (14) yields:
    - (A-16) )1()(' ρβρ+=kf.
  - It follows that r = ρ in equilibrium.
  - Because 0)('' <kf, the optimal capital stock, ∗k, is a decreasing function of convertibility restrictions, β; thus steady-state capital stock and output increase if convertibility requirements are relaxed.

- Consumption of domestic and foreign goods (steady-state):
  - Substituting (A-15) into (9) and (10) yields:
    - (A-17) )1( απρθ++= h u
    - (A-18) )1()1()(απβραρθθαπρθβα+++=+++=eeeu g
    - (A-19) )1()1( απβραρ απαρ ++ + = eu u g h
  - Assuming Cobb-Douglas utility u(g,h) = gh^σ (with 1 < σ) leads to:
    - (A-20) e g h ⋅ ++ + = )1( )1( απα ρ βραπαρ

- Steady-state resource and deposit relationships:
  - (A-21) ∗∗∗∗∗ ++++ = d k e g h a (βαα)
  - (A-22) ∗∗∗∗ −++ = r d e g h k f ))(1()(απ
  - (A-23) m d e g h = ++ ∗∗∗ )(α
  - (A-24) m k e g a ++ = ∗∗∗ β
  - (A-25) ))(1(2)( απβα+++=+− ∗∗∗ regrarkkf.
  - (A-26) Expression for equilibrium level of imported consumption goods:
    - rr mkf eg βαπβα −+++ + = ∗ ∗ ))(1(2 )(
  - (A-27) Consumption of domestically produced goods:
    - )1( )1( ))(1(2 )(
      απα ρ βραπαρ βαπβα ++ ++ +++−+++ + = ∗ ∗ rr mkf h
  - (A-28) Bank deposits:
    - ⎟⎟⎠⎞⎜⎜⎝⎛ ++ ++ +++ + −+++ + − = ∗ ∗ )1( )1(1 ))(1(2 )( απα ρ βραπαρ βαπβα rr mkf md

- Comparative statics and signs of derivatives (effects of cash and convertibility restrictions):
  - Imported consumption goods:
    - (A-29) 0 )( < ∂ ∂ ∗ α eg ; and 0 )( < ∂ ∂ ∗ β eg
      - Both cash restrictions (α) and convertibility restrictions (β) reduce imported consumption.
  - Domestic consumption goods:
    - (A-30) 0 < ∂ ∂ ∗ α h , while 0 >< ∂ ∂ ∗ β h
      - Cash restrictions have a dampening effect on domestic consumption (positive derivative with respect to α means tightening cash requirements reduces h).
      - Impact of convertibility constraints on domestic consumption is ambiguous: direct substitution effect raises domestic consumption, indirect production effect lowers it; net sign depends on production function parameters and substitutability between domestic and imported goods.
  - Bank deposits:
    - (A-31) 0 < ∂ ∂ ∗ α d and 0 > ∂ ∂ ∗ β d
      - Tightening cash limits (α) reduces deposits (consumers hold more cash, less in deposits).
      - Tightening convertibility restrictions (β) encourages deposit accumulation (fewer dollars available to finance imports).
  - Welfare implications:
    - Cash shortages unambiguously reduce consumers’ utility through reductions in both domestic and imported consumption components.
    - Convertibility limits also reduce welfare: given 0 > ∂ ∂ ∗ β d and relationships in (A-23), it follows that 0 )( < ∂ + ∂ ∗∗ β e g h , implying welfare-reducing impact of convertibility restrictions.
    - Even if domestic consumption increases under tighter convertibility limits, overall welfare falls because of a disproportionately greater fall in imported consumption; welfare loss is larger when domestic and foreign goods are not perfect substitutes.
  - Current account implications:
    - Cash restrictions: no direct impact on output (and exports) in the model; impact on current account is via reduced imports (unambiguous dampening of imports).
    - Convertibility restrictions: affect aggregate production and exports in addition to imports, so impact on the current account is ambiguous.

### Appendix III — Restrictions on cash withdrawal abolished in October 2005 (legal and administrative background)
- Key legal instruments and prior restrictions (as described in source):
  - Resolution of the Cabinet of Ministers (CoM) No. 280 of August 5, 2002 “On Measures to Further Reduce Non-bank Money Turnover” (paragraph 3):
    - Stated that all economic entities—regardless of form of ownership—are granted the right to obtain cash from their bank accounts only up to the amount of cash earnings they have turned over.
    - Granted discretion to the CBU and commercial banks to interfere with cash withdrawals.
  - CoM resolution No. 195 of May 19, 2000 “On Additional Measures to Promote Commercial Banks Participation in SME Development” (paragraph 1 and 3) and CoM resolution No. 390 of November 13, 2002 “On Measures to Stimulate Saturation of Market by Consumer Goods”:
    - Stated that agro-processing enterprises and agricultural procurement organizations are allowed to withdraw cash only for their procurement needs.
  - CoM resolution No. 29 of February 3, 1995 “On Streamlining of the Use of Cash Proceeds” (paragraph 1):
    - Set limits on spending of proceeds in cash for urgent needs by types of entrepreneurial activities: retail trade enterprises (up to 5 percent of total monthly turnover); catering enterprises (up to 4 percent of total monthly turnover); etc.
  - CoM resolution No. 542 of December 31, 1998 “On Streamlining of System of Selling Oil Products, Liquid and Compressed Gas, Strengthening of Control over their Use” (paragraph 4):
    - Allowed legal entities to withdraw cash for oil and gas purchases along with travel allowances for long-distance travel.
  - CoM resolution No. 313 of June 24, 1999 “On Measures to Develop Non-government Kindergartens” (paragraph 5):
    - Stipulated that non-government kindergartens are allowed to spend only up to 15 percent of their derived revenues to purchase food in cash from agricultural markets and retail shops.
  - CoM resolution No. 172 of April 12, 2001 “On Measure to Secure the Development of Tanning Industry” (paragraph 4):
    - Stated that enterprises included in the tanning industry association are allowed to withdraw cash only up to 10 percent of their turnover to purchase accessory materials made by individual entrepreneurs.
  - CoM resolution No. 483 of October 23, 1997 “On Streamlining of Tax and Fee Levying from Physical Entities Involved in Entrepreneur Activities” (paragraph 1):
    - Instituted that individual entrepreneurs engaged in trade have the right to withdraw cash from their accounts only up to the amount of cash earnings they have turned over.

*Content extracted verbatim from the source document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp05239.pdf_