17 June 2022, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan left the refinancing rate unchanged at 7.75%, the floor of the interest rate corridor at 6.25%, while the ceiling at 9.25%.
With major export prices rising, the current account surplus of the balance of payments (BoP) is growing significantly. In the first quarter of 2022, a current account surplus of 22.5% of GDP was recorded. According to forecasts, by the end of this year, the current account is expected to have a large surplus. This strengthens the equilibrium in the FX market and main anchor of price stability. Nominal effective exchange rate (NEER) appreciation contains import inflation. The Central Bank's decisions on tightening monetary policy adopted at previous meetings also curb inflation. According to estimates, rising inflation is mainly driven by high price increases in trading partners. In light of positive trends in foreign sector indicators and the fact that inflationary pressures are mainly of import origin, the parameters of the interest rate corridor were left unchanged, and relevant decisions were made to regulate the money supply by the end of this year.
According to forecasts, inflation will be lower than the actual rate by the end of the year, provided that the external environment is relatively favorable. In the medium run, inflation is expected to move towards the target range.
The Central Bank constantly monitors the processes taking place in the global and national economy, financial markets, as well as analyzes the structure and factors of inflation. Next interest rate corridor parameter related decisions will be taken in light of the approximation of actual inflation with the forecast, the degree of realization of external and internal inflation risks.
External sector. Improved foreign sector indicators supports the equilibrium of the FX market in the current and medium term.
The forecast on the current account surplus of the BoP has been adjusted upwards. This adjustment was made taking into account the dynamics of foreign sector indicators over the past year, as well as actual and forecast prices of key export products. Thus, in the first quarter, the current account showed a surplus of 22.5% of GDP. The average Brent oil price has been $105 over the past period of 2022. According to international organizations, oil prices will remain at above $ 100 per barrel till the end of the year. The positive impact of natural gas exports on the BoP is also growing. At the same time, non-oil exports maintain a high growth rate.
The surplus BoP creates conditions for the growth of the country's strategic FX reserves. In the first 5 months of 2022, strategic FX reserves increased by 1.9% to $54.2B.
Improved foreign sector performance and its impact on expectations was also reflected in the FX market. Since the last meeting on monetary policy, there has been a significant decline in demand at currency auctions organized by the Central Bank. Thus, the total currency supply at auctions in May amounted to $560M, and the demand - $288M. In May, the purchase of foreign currency by banks in the cash foreign exchange market exceeded the sale.
Economic activity. Economic activity in the country exceeds expectations, employment is rising.
In January-May, 2022 GDP increased by 7.2% in real terms, and by 11% on the non-oil sector. Higher growth is observed in the tradable fields of the non-oil sector. However, in recent months, the growth rate in the non-tradable sector is also increasing.
Economic growth is driven by both domestic and foreign demand. In January-May 2022, retail trade y.o.y. increased by 3.1%, and non-oil investments increased by 14.6%. The non-oil industry grew by 30.9% in 5 months compared to the same period last year.
According to real sector monitoring findings by the Central Bank, the increase in the business confidence index in the non-oil industry, trade and services continued in May. In May, orders and production expectations for the non-oil industry, actual sales in trade and actual demand for services increased compared to the previous month. The level of utilization of productive forces in medium and small businesses is increasing.
Inflation. There has been a slight increase in the annual inflation rate since the last meeting dedicated to the monetary policy. According to official statistics, inflation in May 2022 was 0.7%, while overall level of prices y.o.y. increased by 13.7%. In May food prices y.o.y. rose by 20.2%, non-food prices by 7.1% and service prices by 10.3%. Annual core inflation in May was 10%.
The external background of inflation remains generally unfavorable. Despite the slowdown in world commodity prices, prices remain close to historical highs. According to the World Bank, in the last two months (April-May) global commodity prices increased by 1.4% on energy prices and decreased by 9.4% on non-energy prices. According to the Food and Agriculture Organization (FAO), global food prices decreased by 1.5% in the last two months. This decrease was mainly due to lower prices for fats and dairy products. Prices for flour and meat continue to rise. The tense geopolitical situation reinforces the expectation that global commodity prices, especially energy and food prices will remain high for a long time.
The process of rising inflation in trading partners continues, which has both direct and indirect effects on consumer prices in Azerbaijan. Indirect effects occur through producer prices. Thus, in April, on an annual basis, agricultural producer prices rose by 16.3%, while the non-oil industrial producer price index rose by 20.1%.
According to the Central Bank's monitoring of real sector enterprises, inflation expectations in May increased compared to the previous month in the non-oil industry, trade and services, and decreased in construction.
No significant changes have been made in the inflation forecast since the last meeting. As aggregate demand expands by the end of this year, expectations are boosting projected inflation. However, on the other hand, monetary conditions, especially the strengthening of the nominal effective exchange rate of the manat, reduce projected inflation. In general, according to the updated forecasts, inflation is expected to be lower than the actual rate by the end of the year, provided that the external environment is relatively favorable. In the medium term, the forecast that inflation will gradually move towards the target range remains unchanged.
Monetary condition. The monetary condition continues to have a downward effect on inflation.
Stronger NEER acts as a major reducing monetary factor in the decomposition of both actual and projected inflation.
Amid state budget surplus and the activation of sterilization operations by the Central Bank, the base money in manat has decreased by 5.5% over the past period of 2022.
In the context of rising inflationary pressures, more active use of required reserves is planned for the purpose of additional sterilization of excess liquidity. The entry into force of the amendments to the "Regulation on the norm, calculation and maintaining required reserves" by the Resolution of the Central Bank dated 6 June 2022 creates conditions for making flexible decisions on required reserves. It is estimated that the increase in required reserves to 4% for deposits in national currency and 5% for deposits in foreign currency will increase the cost of liabilities in the banking sector by only 0.044%.
The decrease in the structural surplus in the liquidity position of the banking system is accompanied by an increase in interest rates in the market of ‘risk-free tools’ in the national currency.
The growth rate of lending portfolio is increasing. In May 2022, the lending portfolio in banks and non-bank credit organizations increased by 8.5% compared to the beginning of the year, and by 23.3% compared to the same month last year. The growth rate of household loans generally exceeds the growth rate of lending portfolio.
Balance of risks. The risk balance of inflation is formed mainly under the influence of uncertainties in the context of the geopolitical situation in the world.
The risk of global economic recovery weakening has been replaced by the risk of global stagflation. In this context, the main external risk is the further strengthening of inflation import to Azerbaijan due to rising inflationary pressures in trading partners and problems in the supply chain. Along with rising world commodity prices, increased capital inflows from developing countries to developed countries may also affect the state of financial markets and price increases in partners. A faster-than-expected increase in aggregate demand is a major internal risk. The surplus BoP strengthens the exchange rate's ability to limit inflation import by creating conditions for expanding supply in the FX market. At the same time, monetary policy decisions will have a reducing effect on inflation in the short and medium term.
Next interest rate corridor parameter related decisions will be taken in light of updated forecasts and the balance of risks of inflation.
This decision takes effect on 17 June 2022. Next monetary policy decision will be announced on 29 July 2022 and a press conference will be held on this occasion.