28 January 2022, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to change the parameters of the interest rate corridor. The refinancing rate was increased by 0.25% to 7.5%, the floor of the corridor was set at 6%, and the ceiling at 9%.

Since the last meeting, inflationary pressures have kept on increasing, and a number of external and internal risks with a push effect on prices realized. In general, the country economy faced inflationary pressures unprecedented in terms of the nature and structure in 2021.

In 2021 mass global vaccination, stepwise easing of quarantine restrictions in particular countries, ongoing large-scale fiscal stimulus programs, lingering disruptions in the global supply chain and weak recovery of employment led to demand and supply mismatch. As a result, the inflation rate in major countries, including in trade partners considerably exceeded adopted target bands. All this had a significant rising effect on the dynamics of prices, in particular food prices over imports.

Domestic cost factors with lingering and high pass through capacity also contributed to inflation last year. The adequate monetary condition and the exchange rate stability were the key factors with a containing effect on price hike.

According to the Central Bank’s base scenario-based forecast the inflation rate is expected to approach to the upper target band as of end-2022, and to the target band center in 2023. Adoption and realization of anti-inflationary measures developed by the Government and the Central Bank will be crucial in realization of the price stability forecast.

Next decisions on the parameters of the interest rate corridor will be taken in light of the dynamics of prices, updated macroeconomic forecasts and changes in the balance of risks.

Inflation. The inflation rate has risen since the last meeting of the Management Board dedicated to the monetary policy amid realized internal and external risks. According to official statistics, in 2021 annual inflation stood at 12%, and average annual inflation at 6.7%. Average annual core inflation was 4.2%. Inflation rose across all sub-groups of goods and services.

Annual food inflation was 15.8% and accounted for about 3/5 of total inflation. The dynamics of global food prices considerably weigh on the food inflation that continued in January 2021 as well. According to the Food and Agriculture Organization (FAO), global food prices have increased by 23.1% over recent one year – flour products by 20.7%, dairy products by 17.4%, butter by 36% and sugar by 33.6%. High global prices contributed to the rise in prices in the domestic market for flour and flour products, which have a significant share in the consumer basket, in January.

Non-food prices increased by 7.7% over recent one year. The highest annual price hike was in fuel and construction materials.

Service prices have increased by 10%. Liberalization of government-regulated prices keeps translating to services inflation.

Analysis of inflationary factors suggests that over half of direct and indirect price hike relates to factors of foreign origin. In 2021 import prices hiked by over 21%. High import prices in their turn are attributable to hiked global commodity prices, high transportation-logistic expenses, and historical highs of inflation of recent decades in partners. According to the World Bank, in 2021 energy prices increased by 77% and non-energy prices by 20% on annual.

In 2021, the demand and supply mismatch amid global mass anti-COVID-19 vaccination, gradual easing of lockdown measures in particular countries and realization of large-scale fiscal-monetary stimulus programs triggered unprecedented inflationary pressures in most countries of the world. Last year inflation considerably exceeded targets in main trade partners – compared to the target annual inflation was higher by 2.4 times in the USA, by 2.6 times in the euro area, by 2.1 times in Russia, by 1.7 times in Kazakhstan, by 2 times in Belarus, by 2 times in Ukraine, by 4.6 times in Georgia and by 7.2 times in Turkey.

Rising producer prices amid the lingering pandemic and ongoing effects of liberalization of government-regulated prices also influence cost factors of inflation. Over recent one year producer prices increased by 17% for agricultural products and by 5.8% for transportation. The effect of government-regulated prices on annual inflation is estimated to exceed 20%.

The dynamics of actual inflation also translate to inflation expectations. Estimations suggest that households’ inflation expectations surpass forecasted inflation. Inflation expectations of enterprises are also prone to rising. Inflation expectations among monitored enterprises increased in particular in services and construction over recent month.

According to base forecast, in 2022 annual inflation is expected to be in the range of 6.6-7.1%. The forecast for lower inflation in 2022 compared to the previous year mainly relates to expected effects of slow rise of global commodity prices and lower inflation in partner countries, as well as tightening of monetary conditions. In case other terms remain stable and current trends linger, after Q1 2023 inflation is expected to enter the target band.

External sector. Despite new waves of the COVID-19 and supply related hardships it triggers ongoing global economic growth is accompanied by improved foreign trade conditions for Azerbaijan in general. However, new coronavirus strains, high inflation expectations and possible financial stresses in a number of countries create considerable uncertainties for global economic growth. According to the IMF WEO January Update, in 2022 the global economy is expected to grow by 4.4%, 0.5 pp down compared to the previous update. 

Since the last meeting, global oil prices have increased. While the average Brent oil price was $71 in 2021, it has increased to $85 over the past period of January 2022, the highest level since 2014. In general, oil market related predictions of international organizations are optimistic. According to recent forecasts of most think tanks in 2022 both extraction and consumption of oil is expected to increase in 2022. The consensus oil price calculated on the basis of recent predictions of leading think tanks is estimated to be about $75.

Increase in export prices and non-oil export potential positively translate to the balance of payments (BoP). Over 11 months of 2021 the main component of the BoP – trade surplus increased by 2.8 times compared to 2020. Over the period export increased by 51.6%, non-oil export by 44%. In case current trends continue, in 2022 the BoP is expected to be in surplus. Estimations suggest that under the $50 oil price scenario, current account surplus may account for 4% of GDP. In general, expected current account surplus is the fundamental factor that supports the equilibrium in the FX market.

The BoP surplus creates conditions for rise in strategic foreign exchange reserves of the country. In 2021 FX reserves increased by 4.8% or $2.4B to over $53B. Central Bank reserves increased by 11.1% to $7.1B.

Economic activity. The economic growth rate was higher than expected. In 2021 GDP increased by 5.6% in real terms and by 7.2% on the non-oil and gas sector, higher than expected. Starting from Q3 2021 GDP exceeded the pre-pandemic level in real terms. Tradable sectors mainly drive economic growth. Employment is returning to the pre-pandemic level. 

Expansion of both domestic and external demand has an upward effect on economic growth. In 2021 retail trade turnover increased by 3.2%. According to the latest information 4.6% rise in current expenses of the state budget were of the key factors to underpin aggregate demand.

According to findings of real sector monitoring by the Central Bank the business confidence index increased in construction, trade and services last month compared to the previous month. Over the same period, actual sales in trade and services and orders received for execution in construction increased.

Forecasts suggest that in 2022 economic growth will continue at a level close to its potential.

Monetary condition. Monetary policy decisions made since the second half of the previous year contribute to strengthening downward effects of monetary factors on inflation.

BoP surplus, the adopted macroeconomic framework and the adequate monetary condition support exchange rate stability, that has a downward effect on import of inflation and inflation expectations. 12.1% hike in the non-oil NEER neutralized a part of high import inflation.

The Central Bank seeks to strengthen the downward effect of the monetary policy on inflation through the quantity and value of money.

At the end of 2021 considerably active state budget expenses and the use of a single treasury account for the purpose as well was accompanied with a growth rate of money supply. Over the past period of January, base money in manat has decreased by 10.2% vs early year excluding term operations in systemically important banks. Given that the treasury account has the predominant share in sources of financing the state budget deficit, fiscal operations may have an upward effect on money supply at the end of 2022 too. On this backdrop, if necessary, the Bank will apply adequate open market operations to contain excess rise in money supply.

After the last meeting average interest rates on repo operations and yield on government securities nearly remained stable. Continued increase in interest rates on newly attracted deposits, may have a containing effect on growth of loans over time while supporting savings in the national currency. 

The lending portfolio of banks increased by 17.7% in 2021, driven by rising deposits. Savings and deposits of the banking system increased by 24.6% excluding deposits of the financial sector.

Dollarization of the economy continues to drop. Dollarization of savings of individuals decreased by 9.8 pp to 41%, while dollarization of loans decreased by 4 pp to 25.8% in 2021.

The FX market remains in equilibrium, contributing to exchange rate stability with a crucial role in neutralizing foreign inflation. In 2021, supply prevailed over demand at 70% of currency auctions. Central Bank’s buy interventions to the FX market amounted to $245M. Change in demand at currency auctions is cyclic by nature and there are many opportunities for its regulation amid significant rise in oil transfers in the current year than previous year. Amid BoP surplus, the FX market equilibrium will be maintained in the current year too. Macroeconomic stability and sustainability of its main anchor in the current year rests upon the FX market equilibrium.

Balance of risks. The role of push factors in the balance of risks of inflation remains high. 

The main risk stems from the non-realization of the baseline scenario of inflation forecasting and the continuation of the import inflation, which may relate to ongoing price hikes in global commodity prices and inflationary pressures in partners, problems in international supply chains and higher food stocks in leading economies. High and sensitive inflation expectations are still the main risk source influencing economic agents’ pricing behavior. A balanced state budget and budget deficit funding through sustainable sources within the frames of recovered fiscal rules are still one of the critical conditions of macroeconomic stability.

The factors that contain inflation include a sustainable exchange rate of the national currency in the first place supported by the BoP and rising oil transfers. On the other hand, monetary policy related decisions will continue to contain inflation.

Adoption and realization of anti-inflationary measures under way by the Government and the Central Bank will have a downward effect on the inflation rate. Measures will cover strengthening of the macroeconomic stability framework, containing import of inflation, increasing production of and improving supply of consumer goods, including goods of social importance, containing groundless price hikes, as well as elevating social security of vulnerable groups of the population.

Next decisions on interest rate corridor parameters will be taken in light of deep analysis of cost and supply factors of inflation, along with medium-term growth outlook of the economy and the balance of risks of inflation.

The decision takes effect on 28 January 2022. Next monetary policy decision will be announced on 18 March 2022.