17 December 2021, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to set the refinancing rate at 7.25%, the floor of interest rate corridor at 6% and the ceiling at 8.25%.

Inflation pressures have been rising recently due to foreign factors that have a decisive role in price formation. High prices in global commodity markets and high inflation in trade partners, supply chain disruptions and the effect of high transportation-logistics expenses are becoming more considerable and persistent than expected. Domestic cost factors, in particular liberalization of government-regulated prices still weigh on inflation. The said factors both elevate price expectations and complicates anchoring of inflation around the target band.

The role of monetary factors in formation of the dynamics of inflation is considerably low. The FX market stability strengthens the key anchor of price stability and significantly neutralizes external inflation.

The decisions related to monetary condition tightening amplifies rebalancing effects of monetary factors on inflation.

Next interest rate corridor parameters related decisions will be made in light of changes in the balance of risks of inflation and medium-term outlook of the economy.

Inflation. Inflationary pressures have continued to rise since the last meeting of the Management Board dedicated to the monetary policy. According to official statistics, in November, monthly inflation stood at 1.5% and 12-month inflation at 11.1%. In January-November, average annual inflation was 6.2%, while average annual core inflation was 3.9%. Inflation continues to rise across all product and service sub-groups.

In November, the food price index increased by 1.9% vs the previous month, annual food inflation was 14.9%. Average annual food inflation was 7.4% in January-November.

In November, non-food prices increased by 0.5% vs the previous month and by 7.1% over recent one year. In January-November, average annual non-food inflation was 4.8%.

In November, service prices hiked by 1.6%, and by 9.1% over 1 year. Average annual service inflation stood at 5.4% in January-November. Liberalization of government regulated prices still weigh on service inflation.

Hıgh annual inflation is mainly attributable to external supply and cost shocks like rising global commodity prices and global supply chain disruptions. While prices for certain commodities and global shipping expenses have dropped compared to peak levels over recent months, they are considerably high from the pre-pandemic level. According to the World Bank in November, global prices hiked by 2.1 times on energy products and by 24.7% on non-energy products. According to the UN Food and Agricultural Organization, global food prices hiked by 1.2% in November and by 27.3% over recent one year. Over recent one-year, flour products hiked by 23.2%, dairy products by 19.1%, butter by 51.4%, and sugar by 36.4%. Deteriorating weather conditions at a number of food exporters also translate to world food prices. Lingering problems in the global supply chain (container shipments, delays in production of chips etc.) increases delivery expenses of raw materials and end products. The said factors both boost inflation in Azerbaijani trade partners and translate to import prices. Import prices y.o.y. increased by 21.4% in January-October.

The dynamics of actual inflation also weigh on inflation expectations. Over recent 12 months, inflation expectations were prone to rising in the monitored real sector. The December surveys suggest that 29% of households expect inflation to be higher.

According to updated forecasts, average annual inflation is expected to stand at 6.3-6.6%, while annual inflation at 11.4-11.9% in the current year. According to base forecast, inflation will stabilize from the first quarter of next year and from the second quarter onward inflation will move to the ceiling of the target band.

 External sector. Whereas the external background in general remains favorable in terms of the balance of payments and stimulation of aggregate demand, risks related to its prospects are still relevant. 

Economic recovery is underway in the global economy and in trade partners as well. However, the possibility of new waves of the pandemics due to emergence of new strains of the virus creates uncertainty about the pace of global economic recovery. 

Since the last meeting, the emergence of a new strain of coronavirus has triggered some correction in the steadily rising oil prices since the last meeting. While the average Brent oil price was $81 in November, it dropped to $73 over the past period of December. In general, the average oil price was $71 over the past period of 2021. Despite the short-term change, international organizations predict that global demand for oil will continue to rise in 2022. Additionally, the recent OPEC++ decisions will have an upward effect on oil prices in 2022.

Surplus in the balance of payments contribute to the rise in strategic foreign exchange reserves of the country. Over 11 months of the current year, strategic foreign exchange reserves increased by 4.4% ($2.2B) to $53B, while reserves of the Central Bank increased by 10.2% to over $7B. If current trends continue, the balance of payments will again have considerable surplus in 2022.

Whereas demand has slightly increased at FX auctions since the last meeting, in general, the FX market remained balanced and the exchange rate of manat was stable.

Economic activity. Economic recovery is going on.

Over 11 months of 2021 GDP increased by 5.3% in real terms and by 6.4% on the non-oil and gas sector. The non-oil and gas industry increased by 20.9%, and agriculture by 3.8%. Employment in the economy keeps rising. 

Positive impulses to economic growth in the non-oil sector stem from high consumption. Over 11 months retail trade turnover y.o.y. increased by 3%, and by 2.7% on food products.

According to real sector monitoring findings by the Central Bank in November, the average business confidence index on recent 12 months was on upward trajectory. The number of orders accepted for execution in the non-oil industry and construction as well as sales expectations in trade for the same period increased.

Output gap estimations suggest that the economy in 2022 will grow at a level close to its potential.

Monetary condition. Monetary policy decisions made at previous meetings are strengthening containing effects of monetary conditions on inflation over time.

The share of monetary factors in formation of inflation is estimated to be below 10% and are further decreasing. The sustained exchange rate with the key balancing role is considerably neutralizing foreign origin inflation and expectations. 

Stronger balancing effects of the monetary condition on inflation are being realized both through the quantity and the value of money. Base money has increased by 5.1% since early year.

Over the past period of December, average interest rate on interbank repo operations has slightly grown. Interest rates on loans have not changed considerably, certain rise in interest rates on deposits supported savings.

The lending portfolio of banks increased by 1.8% in November, and by 15% over 11 months. This growth is mainly funded by rising deposits. In November, manat denominated deposits increased by 3.5% vs the previous months and by 29% (AZN2.8B) vs early year.

Over the past period surplus in execution of the state budget has contained money supply being anti-inflationary by nature. Although budget expenditures are expected to activate over the remaining period of the year its effects on the monetary condition are forecast to extend to the following year.

Balance of risks. Push factors still prevail in the balance of risks of inflation.

Given the nature of current inflation, the main risk is the potential for the impact of external and internal cost factors to be higher than expected and delay the anchoring of inflation expectations around the target. Uncertainties are rising, whether price hikes in global commodity markets, in particular price hikes in the food market, inflation in partner countries, problems in the international supply-logistic chain, as well as the increasing effect of liberalization of domestic prices and tariffs on prices linger. Inflation in partner countries will depend on policy response of their central banks.

Rise in domestic demand at a higher rate than the growth potential of the economy is also a factor affecting inflation.

Surplus in the balance of payments and adopted macroeconomic platform have the potential to neutralize push factors in the balance of risks in the medium-run. Higher oil transfers to the state budget for 2022 compared to the previous year will support the exchange rate sustainability. On the other hand, the anti-inflationary monetary policy will serve to maintain a balanced level of domestic demand and monetary factors. Once the effect of temporary external and domestic cost factors on prices neutralizes, downward effect of balancing monetary factors will amplify.

Next decisions on interest rate corridor parameters will be made in light of medium-term macroeconomic forecasts and changes in the balance of risks of inflation. To make adequate monetary policy decisions the Central Bank will further closely monitor cost and supply factors of inflation, and review development of the world and country economies under various scenarios.

This decision takes effect on 17 December 2021. The schedule of disclosure of monetary policy decisions in 2022 will be made public in the ‘Statement of the Central Bank of the Republic of Azerbaijan on main directions of the monetary and financial stability policy for 2022’.