30 July 2021, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to leave the parameters of the interest rate corridor unchanged – the refinancing rate at 6.25%, the floor of the interest rate corridor at 5.75%, and the ceiling at 6.75%.
The refinancing rate related decision was taken in light of the current dynamics of inflation, changes in the balance of risks since the last meeting, the medium-term forecast of inflation and expectations.
In the current year the inflation rate is formed mainly under the effect of non-monetary cost factors, like global commodity prices, the prices regulated by the state and inflation in partner countries. Though aggregate demand factors are reviving, there is no certainty that these factors will continue to generate inflationary potential. The balance of payments surplus, current macroeconomic framework and de-dollarization trends underpin the stable exchange rate, the key anchor of price stability. In general, the monetary condition maintains anti-inflationary nature. All these give grounds to the next refinancing rate pause.
Next decisions on the parameters of the interest rate corridor will be taken in light of updated macroeconomic forecasts, pass-through of external inflation to the domestic market, duration of seasonal factors, inflation expectations and changes in the balance of risks.
Inflation. The annual inflation rate has declined since the last meeting of the Management Board dedicated to the monetary policy. According to official statistics, there was 0.5% deflation in June, and 12-month inflation was 4.7%.
Monthly deflation was driven by seasonal price slide of food products. In June the food price index decreased by 1.4% and had a downward effect on inflation. Annual food inflation was 5.3%. Food inflation is mainly driven by high global food prices. According to the UN Food and Agriculture Organization, global food prices have increased by 15% since early year and by 34% over recent one year.
On the backdrop of intensification of deferred demand and rise in regulated prices, non-food prices increased by 0.3% and 0.1% on services in June, and annual inflation was 4.6% and 4% respectively. Non-food price hike is attributable to high inflation in trade partners, price hikes in global raw materials and intermediate consumer goods markets.
Average annual core inflation calculated by excluding swings in regulated prices and prices for seasonal agricultural products was 2.7% in January-June.
Inflation expectations do not rise. According to June survey among households, the share of respondents that expect high inflation upcoming 12 months was 25%, which does not differ from the one in March. Results of real sector monitoring suggest that in June inflation expectations increased in the non-oil industry and trade and decreased in construction and services vs the previous month.
Annual inflation forecast as of end of July 2021 was revised up in July, mainly taking into account direct and indirect effects of cost factors. In the current year inflation is projected to reach the cap of announced annual target band (4±2%).
External sector. Acceleration of global economic recovery and improvement in the external environment since the last meeting have been among the factors that contribute to price stability in the country.
Amid accelerated COVID-19 vaccination, stepwise easing of lockdown restrictions in particular countries global economic recovery exceeds expectations. According to IMF WEO Update July, global economic growth is expected to stand at 6% in 2021. The IMF revised up the global economic outlook for 2022 to 4.9%.
Prices in the global energy market are also rising faster than expected. Oil demand is expected to reach the pre-pandemic level in 2022.
Conservative increase in supply under OPEC ++ deal has a positive effect on oil prices compared to high growth in demand for fuel products. The average price for Brent oil exceeded $66 over the past period of 2021 and $74 in July.
In light of recent trends in July annual forecast on current account surplus for 2021 was revised up. Both favorable oil prices and rapid growth of non-oil exports have an upward effect on the balance of payments. Strategic foreign exchange reserves have increased by 2.7% ($1.4B) since early year to $52.2B. Over the period reserves of the Central Bank increased by 2% to $6.5B.
The balance of payments surplus is aided by high supply and low demand in both cash and cashless segments of the FX market, that supports the exchange rate stability, the key anchor of price stability. In general, $3.2B has been sold at 55 currency auctions over the past period of the current year, $58.7M per auction on average. Supply prevailed over demand at 87% of auctions. As of 30 July 2021, scheduled unsold funds of the SOFAZ make $539M.
In the environment of the FX market stability, de-dollarization of deposit and lending portfolios of the banking sector continues. Foreign currency denominated portion of the deposit portfolio decreased by 4.1 pp to 49.1% over 6 months. Foreign currency denominated portion of the lending portfolio decreased by 2.9 pp to 27.3%.
Monetary condition. The monetary condition has not changed significantly since the last meeting, and the refinancing rate remained close to neutral, allowing to control monetary factors of inflation.
Interest rates vary in different segments of financial markets. Amid high liquidity in the financial sector yield on government securities and interest rates in the interbank market still decline. Though nominal rates do not undergo considerable changes on loans and deposits, real rates are declining.
Base money has increased by 4% since early year. Over the remaining part of the year change in money supply will mainly depend on the dynamics of state budget expenditures.
Lending continues to rise at a pace that will not create inflationary pressure. Over 6 months the lending portfolio of the banking system increased by 5% - business loans by 3%, mortgage loans by 8.4%, and consumer loans by 7.6%. Consumer lending activity is attributable to consumer optimism and realization of deferred demand, and banks’ efforts to recover the pre-crisis portfolio. The Central Bank has been imposing regulatory requirements since January 2021 to restrict consumer loans.
Economic activity. Recovery of the national economy is accelerating. Economic growth is supported by better external environment and implementation of a stimulating macroeconomic framework. At the same time, gradual easing of social isolation measures activates the deferred demand. The annual change in retail trade turnover and consumption of paid services has entered the positive zone.
Recovery of aggregate demand is accompanied by rising aggregate supply. Over 6 months of 2021 GDP increased by 2.1% in real terms, and by 5.1% on the non-oil and gas sector. The non-oil industry grew by 16.8% and agriculture by 5.7%. On the environment of high domestic production non-oil exports increased by 27.5%.
Surveys suggest that economic activity is rising. According to real sector monitoring, in June the business confidence index increased in the non-oil industry and trade, and nearly unchanged in services and construction, remaining in the positive zone. Sales expectation improved in trade and demand expectation improved in services. However, capacity utilization in non-oil enterprises has not peaked.
Risks balance. Although the role of boosting factors in the risk balance of inflation is increasing, there are uncertainties about their sustainability
Cost factors, like import of inflation and regulated prices are considered main rising factors in the short term balance of risks. In terms of effectiveness, the monetary policy and its transmission capacity are aimed at regulating lasting effects of aggregate demand on inflation. The persistence of epidemiological risks does not allow to say unequivocally whether the impact of aggregate demand on inflation is temporary or permanent. According to estimates, impact of monetary factors on inflation will remain limited in the second half of the year. The improved balance of payments and wider supply in the FX market both sustains the main anchor of the monetary policy – the exchange rate stability, and considerably neutralizes the factors that have an upward effect on prices.
Next decisions on interest rate corridor parameters will be taken in light of inflation risks, pricing behavior of market players, inflation expectations, and the growth rate of aggregate demand.
The decision takes effect on 30 July 2021. The next decision of the Management Board of the Central Bank on the interest rate corridor parameters will be announced on 17 September 2021.