18 March 2022, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to set the refinancing rate at 7.75%, the floor of the corridor at 6.25%, and the ceiling at 9.25%.
Although the pace of the annual inflation rate has subdued since the last meeting, fundamental changes in the geopolitical and geoeconomic environment triggered significant uncertainties related to the external background of inflation. At the time of partial stabilization of the impact of the pandemic on the world economy, trade, employment and financial markets, a new situation with uncertain dynamics has increased global inflation risks. Significant deterioration in global economic growth and trade outlook, increasing potential for further contraction of global supply, and further problems in the international logistics and settlement chain are providing momentum to high inflationary pressures. Since end-February, global commodity prices, especially energy and grain prices, have updated historical highs and siginifcantly weighed in on medium-term global inflation forecasts and prospects for its pass-through to the national economy. In this context, the potential for the country's economy to be affected by rising import prices has increased dramatically.
On the other hand, rising energy prices increased opportunities for expansion of the balance of payments surplus, the fundamental factor of the main price stability anchor in the country, and the nominal effective exchange rate of the manat strengthened notably. At the same time, in February the Government and the Central Bank started implementation of comprehensive anti-inflationary measures, covering priorities of increasing local food production and containing import of inflation.
High uncertainties complicate forecasting of macroeconomic indicators. In the forecast horizon inflation is expected to be mainly affected by external supply factors.
The current situation necessitates adjustment of the parameters of the interest rate corridor to proactively regulate push factors to price stability through anchoring inflation expectations.
In general, the Government and the Central Bank attach great importance to minimizing negative translation of geopolitical risks to macroeconomic and financial stability, as well as to econmic activity and social welfare of the population and take critical adequate actions.
Next decisions related to interest rate corridor parameters will be taken in light of the developments in the external environment and the country economy, response of financial markets to geopolitical risks and the dynamics and forecast of inflation.
Inflation. The annual inflation rate has subdued since the last meeting of the Management Board dedicated to the monetary policy. According to official statistics, in February 2022, inflation was 1.1% and the overall price level y.o.y increased by 11.9%.
The decrease in the annual inflation rate is due to the relative decrease in the inflation rate of non-food products and services. In February price hike was 6% on non-food stuff and 9.3% on services on annual.
Persistent high annual food inflation (17.2%) is driven by lingering price hike for food products in world markets. According to the Food and Agriculture Organization (FAO), global prices have increased by 5.2% over recent 2 months and by 20.7% over the recent year. Over recent one year prices have increased by 14.8% on flour products, by 24.8% on dairy products, and by 36.8% on butter. Due to geopolitical and geoeconomic risks wheat prices spiked to 14-year high amid wheat shortage probabilities. Shrinking food production and the indefinite ban on food exports in some countries are among the factors boosting global food prices.
According to findings of the March survey, over 24% of surveyed households expect inflation to rise further. According to the survey among enterprises, non-oil inflation expectations increased in February compared to the previous month. Inflation expectations in trade and services also remain in the positive zone.
High uncertainties make it hard to forecast inflation. Whereas actual inflation has been in line with the projected trajectory over recent two months, a new condition triggered by geopoltical and geoeconomic risks has necessitated review of inflation forecasts amid realized and potential impacts. Since end-February, rising commodity prices are pushing up inflationary pressures in partner countries, especially energy-importing partners. Sharp depreciation of national currencies in certain partners prevent import inflation from these countries to Azerbaijan. On the other hand, rise in prices for Azerbaijani main export goods underpins sustainability of the exchange rate of the national currency – the key price stability anchor.
External sector. The global economy is under the pressure of geopolitical and geoeconomic risks.
International organizations revise global economic growth outlook down and inflation forecast up. Most think tanks presume that the world economy, negatively affected by the pandemics and climate change, is likely to face stagflation, a combination of high inflation and recession, under strong negative effects of geopolitical tensions. They argue that record-setting price hikes, international supply chain disruptions and dramatic rise in uncertainties accelerate decrease in global production and rise in expenses.
Under these circumstances, central banks are facing difficult dilemma between fighting inflation and supporting economic growth. Leading central banks announce a more restrained monetary policy in the face of deteriorating global economic growth outlook.
Since the last meeting prices for oil and natural gas which has a significant share in Azerbaijani exports, have been surging. Over the past period of 2022 the average Brent oil price has been $96, annual increase of 35% ($71). On certain days in March, the oil price has reached its peak since 2008. The price for natual gas reached its highs in Europe as well. The volume of extraction of the oil and gas exported from Azerbaijan is expected to increase in the current year too.
High world prices for major export commodities increase the probability of a double-digit surplus in the balance of payments relative to GDP by end-2022, a key fundamental factor supporting FX market equilibrium. Recent events will weigh on the growth rate of exports of non-oil goods and services, as well as the value of remittances and the dynamics of investment in the non-oil sector.
Over 2 months of 2022 strategic foreign exchange reserves of the country increased by 0.4% ($195M) and surpassed $53.4B. Foreign exchange reserves of the Central Bank increased by 1.2% and approximated $7.2B.
Economic activity. Real GDP increased by 6.7%, non-oil real GDP increased by 10.1% during 2 months of 2022. All sectors of non-oil economy posted growth. The non-oil industry grew by 19.8%, agriculture by 3.1%, and construction by 6.5%. In general, in January-February 2022 economic growth stood at 14% in tradable sectors and 9.2% in non-tradable sectors.
Expansion of aggregated demand started in 2021, continued. Over first 2 months of 2022 retail trade turnover increased by 3%, and the value of paid services to the population increased by 5%. Although total change of investments was negative over 2 months (2.1%), non-oil investments grew by 12.1%. By the yearend investment demand is expected to fully recoverprimarily at the expense of government investments.
Preventive indicators based upon findings of real sector monitoring by the Central Bank reflect expectations that economic activity will continue. Hence, in February expectations on production, on sale in trade and demand expectation in sevices increased compared to the previous month.
Relative improvement of the epidemiologic situation since the previous meeting and additional easing of quarantine restrictions are expected to have an upward effect on economic activity. In the current period and medium term duration of the geopolitical crisis will also translate to the realization of the economic growth forecast.
Monetary condition. The monetary condition is driving inflation down.
In the past period of 2022, the non-oil nominal effective exchange rate appreciated by 14%, significantly neutraliziing high import inflation. The manat appreciated in particular against the Russian ruble, the Ukraininan hryvnia, the Kazakhstani tenge and the euro.
Albeit shocking changes in the global environment, formation of the bilateral AZN/USD exchange rate amid the FX market equilibrium has a downward effect on inflation expectations. The FX market equilibrium rests upon the balance of payments surplus, the adopted macroeconomic framework and an adequate monetary condition. Since the last meeting (in February and March), supply prevailed over demand at all currency auctions held at the Central Bank.
On the backdrop of the seasonal surplus in the state budget and activated sterilization operations by the Central Bank money base in manat decreased by 8.2% over the past period of 2022 (excluding term operations with the systemically important bank at the year-end).
Stability is also observed in the risk-free instruments segment of the financial market. Since the last meeting yield decreased slightly on 5- and 7-year government securities, and increased slightly on 3-year securities. Average interest rates on REPO operations slightly increased.
The lending portfolio of the banking system increased by 2.8% during 2 months 2022. In January-February national currency denominated term deposits increased at a higher rate (3.8%), attributable to the fact that current saving and deposit rates allow to compensate for inflation risks and maintain attractiveness of manat savings.
In general, the banking system is still resilient, with no problems on air in bank settlements.
Balance of risks. The role of push factors in the risk balance of inflation have increased slightly since the last meeting.
The main risk is the further increase in geopolitical and geoeconomic tensions, that may lead to higher price increases in world commodity markets and longer-term inflationary pressures in partner countries, deepening supply chain problems and global food shortages. Export restrictions and increasing difficulty and cost of imports from certain major trade partners due to logistic and settlement problems may necessitate their replacement with more expensive import. All this triggers the risk of non-realization of the baseline scenario on inflation forecast and continuing high import inflation in Azerbaijan.
The sustained exchange rate of the manat supported by the balance of payments surplus and containing effects of monetary policy related decisions on infation continue. The anti-inflationary measures under way with the Decree of the Cabinet of Ministers dated 21 February 2022 ‘on Urgent measures to Strengthen Anti-inflationary Measures in the Republic of Azerbaijan’ will also have a downward effect on the inflation rate this year.
The Central Bank does not rule out decisions on further tightening of the monetry condition over the remaining period of the year under the scenario of rising inflationary pressures and expectations.
Next decisions on interest rate corridor parameters will be taken in light of response of financial markets to geopolitical risks, macroeconomic forecasts and a deep analysis of inflationary factors.
The decision takes effect on 18 March 2022. Next monetary policy decision will be announced on 29 April 2022 to be accompanied by a related press