29 July 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% and the ceiling at 9.25%.

Since the last meeting dedicated to the monetary policy, factors have had upward and downward effect on actual and forecasted inflation. The stronger nominal effective exchange rate of the manat due to further depreciation of national currencies of certain partner countries and lower indicators characterizing the dynamics of global food prices and supply-logistic expenses in June had a downward effect on inflation.

However, wider aggregate demand may pave the way to transmission of the expenses rising over recent years to domestic inflation. Macroprudential decisions taken to effectively regulate lending activity are expected to push aggregate demand down.

The inflation forecast was nearly left unchanged on the backdrop of multidirectional effects of various factors. If the present dynamics persists, inflation is forecast to be lower than the current rate by the end-year.

External sector. Despite high uncertainties on global economic growth, the international conjuncture is still favorable for Azerbaijan in terms of the balance of payments (BoP).

On the backdrop of better trading conditions foreign trade surplus, the main component of the current account of the BoP, Yoy hiked by 3.5 times, attributable to high global prices for main export products and realization of non-oil export potential. The average Brent oil price was $105.4 per barrel in the first half of 2022. Rising money remittances from abroad along with better foreign trade indicators are improving the BoP surplus. 

Monetary policy tightening in main trade partners may push down imported inflation.

Strategic foreign exchange reserves keep increasing amid the BoP surplus, paving the way to the FX market equilibrium in the medium and long run. Over 6 months of 2022, strategic foreign exchange (FX) reserves increased by 1.8% to $54.2B.

Improved external sector performance broaden supply channels in the FX market, driving down demand at currency auctions of the Central Bank. In June total auctioned foreign currency supply exceeded demand by more than two times. Saved amount on currency sales of the SOFAZ hit recent four-year high. In June foreign currency purchase operations prevailed over sell operatoins in the cash FX market by banks. Net purchase of foreign currency by banks reached the highest level of recent seven years.

Economic activity. Economic activity remains high in the country and its outlook related expectations are optimistic.

In January-June 2022, GDP increased by 6.2% in real terms, including 9.6% rise of non-oil GDP.

Findings of real sector monitoring by the Central Bank also confirm that economic acitivity is still high. In June the business confidence index elevated in the non-oil industry, construction, trade and services compared with the previous month.

Expansion of aggregate demand varies across sectors. In January-June 2022, retail trade turnover Yoy increased by 2.9% and the non-oil investments incerased by 18.5%. Non-oil export Yoy increased by 25.4% over recent six months.

Increase in government spending with the approval of changes to the state budget of 2022 will provide additional support to economic activity in the second half of the year.

Inflation. Despite deflation due to seasonal factors in June annual inflation kept increasing due to the base effect.

0.1% deflation in June relates to 1% fall of food prices. According to analyses, in June the deflation rate was the lowest of recent 10 years.

In June 2022 annual inflation was 14.2% (June 2021 vs June 2022). Average annual inflation was 12.9%. In June annual core inflation[1] was 10.7%, average annual was 9.7%.

Rising food prices made more contribution to total inflation. In June annual food inflation was 20.6%, and average annual food inflation was 18.4%.

In June non-food prices increased by 7.4% on annual and by 6.7% on average annual. Service prices have increased by 10.9% over recent year. Average annual service inflation was 10.3%.

In general, the contribution to the annual inflation in June was for changes in prices and tariffs for food 9 pp, non-food 1.7 pp, and services 3.5 pp.

Cost factors of foreign origin remain the main factor fueling the dynamics of inflation. 2.3% drop in global food prices is the factor to have a downward effect on inflation in upcoming months.

The dynamics of actual inflation translates to inflation expectations as well. June surveys among households demonstrate that 81.9% of respondents expect prices to rise. According to findings of real sector monitoring inflation expectations increased in construction, trade and services, and decreased in the non-oil industry in June compared with the previous month.

Seasonal factors are expected to drive inflation down in July and August. The forecast that annual inflation will be lower than current rate by the end year due to the base factor remains unchanged. Inflation is forecasted to drop to a single-digit rate gradually in case of favorable changes in foreign factors in the upcoming year.

Monetary condition. Monetary conditions have not changed significantly since the last meeting. It is expected that by the end of the year it will be formed under the influence of monetary and fiscal policy.

The nominal effective exchange rate (NEER) of the manat, which is the main monetary factor reducing inflation, strengthened by 1.9% in 6 months. In July, the depreciation of national currencies in some partners will have an additional upward effect on the NEER.

Over the last period of 2022, the growth of the single treasury account amid state budget surplus and the sterilization operations of the Central Bank had a contractionary effect on the growth of the money base in manat. For the rest of the year, spending from the treasury account is projected to have an increasing impact on the money supply. In order to regulate the inflationary part of the money supply,, it is planned to expand the sterilization operations of the Central Bank.

Despite the growth of annual inflation, there has been no increase in nominal interest rates in the risk-free instruments’ market, as well as in credit and deposit interest rates.

Although real interest rates are on a downward trend, manat deposits remain attractive. Thus, time deposits of the households in manat have increased by 12.7% since the beginning of the year, and over the past one year - by 31.3%.

De-dollarization trends continue in the financial sector. The dollarization of the savings of individuals, excluding the savings of non-residents, has decreased by 3 p.p. since the beginning of the year and amounted to 37.5% at the end of June. Dollarization of loans decreased by 2.8 p.p. from the beginning of the year to 23% in June.

In June 2022, the lending portfolio of banks and non-bank credit organizations increased by 9.9% compared to the beginning of the year and by 23.3% Yoy.

Works on the introduction of a new operational framework for monetary policy have entered the final stage. These works are carried out in several directions. To activate the interbank money market, it is planned to improve the operational platform and develop a methodology for calculating benchmark interest rates. It is planned to launch standing facility instruments (sterilization and liquidity operations initiated by banks) and expand the range of open market operations (sterilization and liquidity operations initiated by the Central Bank) towards the application of monetary policy instruments in a new configuration. Maintaining required reserves in line with the new norms is important both in terms of recovering demand in the interbank market and strengthening control over the money supply.

At the same time, a number of macroprudential decisions were taken to effectively regulate lending activities. These included the introduction of new rules onasset classification and credit risks. Recent macroprudential decisions are both important for maintaining financial stability and creating the potential to dampen aggregate demand.

Balance of risks. Inflationary risks are different for short and medium terms.

The main short-term risks are the re-rise of world commodity prices and transport and logistics costs, the continued growth of inflation in partner countries. Followed by further increase in geopolitical tensions and an increase in the number of cases of COVID-19 infection, the introduction of social isolation restrictions around the world may again complicate transport and logistics processes. The tightening of monetary policy in the leading countries and the slowdown in the global economy may increase volatility in commodity and financial markets.

In the medium and long term, the dynamics of inflation will depend on the effective management of aggregate demand and maintaining equilibrium in the FX market. Improving the rules-based fiscal policy and monetary policy framework applied in accordance with the ‘Socio-Economic Development Strategy of the Republic of Azerbaijan for 2022-2026’ will help to manage inflationary risks in the medium term.

Further decisions on monetary policy will be taken in light of processes taking place in the global environment and within the country, and the results of anti-inflationary policy.

This decision takes effect on 29 July 2022. Next monetary policy decision will be announced on 16 September 2022.

[1] Core inflation is defined as infltaion adjusted from changes in prices for commodities regulated by the government and seasonal factors.