29 October 2021, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to set the refinancing rate at 7%, the floor of interest rate corridor at 6% and the ceiling at 8%.

The refinancing rate related decision was taken in light of lingering inflationary pressure in the economy, sustainability of the factors influencing it, rising prices in global markets, a high inflation rate in trade partners and rising inflation expectations.

Next decisions on the parameters of the interest rate corridor will be taken in light of the growth outlook of the economy in the short and medium term, as well as changes in the balance of risks of inflation.

Inflation. Inflation has been rising in Azerbaijan since the last meeting of the Management Board dedicated to the monetary policy. According to official statistics, in September monthly inflation was 1.8%, and 12-month inflation was 8.5%. Average annual inflation was 5.2% in January-September. Average annual core inflation calculated by excluding swings in regulated prices and prices for seasonal agricultural products was 3.3%.

External background of inflation is still unfavorable. This background is mainly characterized by the rapid rise in global commodity prices and problems in the global supply chain.

Prices in global commodity markets y.o.y. increased by 2.1 times on energy products and by 27.5% on non-energy products. Rapid price hike of energy carriers in oil importing countries, including Azerbaijani oil importing trade partners is one of the main reasons for acceleration of inflation.

Rising global food prices seriously weigh on food inflation. According to the FAO, global food prices increased by 32.8% over recent one year and by 1.2% in September.

High transportation-logistics expenses and longer delivery period are one of the main reasons for intensification of global inflation. In September of the current year transportation cost per container y.o.y. increased by more than 4 times, while the period of delivery of raw materials and final products increased by about two times. The Baltic Dry Index, the index of transport of dry bulk materials, has reached its highest level since 2008.

Inflation is deviating from accepted targets in major trade partners of Azerbaijan – in September annual inflation was higher by 2.7 times in the USA, 1.7 times in the euro area, 1.9 times in Russia, 1.5 times in Kazakhstan, 2 times in Belarus, 2.2 times in Ukraine, 4.1 times in Georgia, 3.9 times in Turkey vs the target.

Inflation pressures in the economy are rising across all sub-groups.

In September, the food price index increased by 2.6% vs the previous month, annual food inflation made 10.4%. Average annual food inflation was 6% in January-September.

In September prices on non-food products increased by 0.8% vs the previous month, and 5.9% over recent one year. In January-September, average annual non-food inflation was 4.4%.

Service prices hiked by 1.5% in September and by 7.9% over recent one year. Average annual services inflation was 4.6% in January-September. Services inflation was mainly driven by the dynamics of regulated prices. Prices hiked by 34% on air transportation service, 8.2% on rent fees, 7.4% on medical services and by 7% on catering services. 

In general, the four fifth of inflation is estimated to be driven by non-monetary factors, about the two fifth of which is driven by domestic cost factors – liberalization of regulated prices.

The dynamics of actual inflation translate to inflation expectations as well. According to surveys conducted in September, 80% of households expect inflation, and 24.5% of them expect the inflation rate to be higher. Inflation expectations were positively zoned across all monitored sectors in September except for services.

According to updated forecasts, in the current year average annual inflation is expected to be 6.2-6.5%, and annual inflation to be 9.5-10.5%. In 2022, annual inflation is forecast to be 5-6%, if fundamental factors remain unchanged.

External sector. The external conditions remain favorable in terms of the balance of payments and economic growth. 

According to updated forecast of the IMF in October, the global economy is expected to grow by 5.9% in 2021. High global economic growth including high economic growth in trade partners positively translate to economic recovery in the country through foreign demand. 

On the background of rapid recovery of global demand, the average Brent oil price exceeded $69 over the past period of 2021, and $83 in October. The IMF in its recent release increased the oil price forecast by $1 to $66 for the current year.

Price hike for export products and wider non-oil export due to high economic activity in partner countries improves the balance of payments and expectations related to the FX market. Over 9 months foreign trade surplus y.o.y increased by 2.3 times. Over the period foreign exchange reserves increased by 3.4% ($1.7B) to $52.5B, and Central Bank reserves increased by 10.4% and exceeded $7B.

Better external sector indicators and expectations supported stability of the exchange rate of the manat, supply prevailed over demand at 84% of FX auctions held at the Central Bank over the past period of the current year.

Economic activity. Economic activity is rising constantly. In response to wider domestic and foreign demand, GDP increased by 4.8% in real terms and by 6.2% on the non-oil and gas sector over 9 months of 2021. The non-oil and gas industry grew by 19.7%, and agriculture by 5.1%. The epidemiological situation hinders higher growth rate of the services sector. In general, the employment rate is rising in the economy. 

Relatively eased quarantine conditions, stable growth in nominal income of the population and increased consumer lending support consumer demand. Over 9 months retail trade turnover y.o.y. increased by 2.8%, and consumption of paid services increased by 4.6%.

According to real sector monitoring by the Central Bank in September the business confidence index (BCI) increased in the non-oil industry, services and construction in comparison to the previous months. The BCI was positively zoned across all sectors, the number of orders accepted for execution in construction increased.

Monetary condition. The monetary policy of the Central Bank is oriented towards containing inflation and returning it to the target band by tightening the monetary condition.

The growth rate of base money was only 9% vs the early year. Surplus in execution of the state budget has contained money supply since early year and has been anti-inflationary by nature. 

The lending portfolio of banks increased by 2.2% in September and by 9.8% over 9 months amid high economic activity. 21% growth in manat denominated deposits prevails over the growth rate of credit.

Structural surplus in the liquidity position of the banking system creates conditions for low interest rates in the interbank money market and low yield on government securities. Nominal interest rates on loans and deposits have not changed considerably since the last meeting. Real interest rates are decreasing amid rising inflation.

The Central Bank is planning to activate its sterilization operations in case of excess expansion of base money towards the end of the year. 

Balance of risks. The role of push factors in the balance of risks, in particular foreign and unconventional factors is increasing.

These factors mainly include considerable price hikes in global commodity markets, in particular on food products, high inflation import from main trade partners and current problems in international supply and logistic chains.

Domestic factors include the continuing effect of persistence arising from the liberalization of prices and tariffs. The lag effect of these prices on other price groups – consumer prices and the value of assets and their reverse effect and rising inflation expectations intensify the role of push factors in the balance of risks.

Current macroeconomic stability platform is the factor that neutralizes inflation in the balance of risks. The favorable balance of payments, rising oil price outlook, the sustainable exchange rate of the national currency and its anti-inflationary role, and the conservative monetary policy under way are the key elements of this platform.

The main directions of the fiscal policy already announced will positively translate to macroeconomic stability and the medium-term inflation rate. Return to budget rules and considerable rise in transfers from the SOFAZ from 2022 onward will strengthen the monetary-fiscal framework.

The Central Bank does not rule out the possibility of increasing the refinancing rate in the upcoming board meetings in case of changes to the balance of risks. 

Next decisions on interest rate corridor parameters will be taken in light of changes in the balance of risks of inflation, as well as medium-term growth outlook of the economy.

The decision takes effect on 29 October 2021. The next decision of the Management Board of the Central Bank on the interest rate corridor parameters will be announced on 17 December 2021.