28 October 2022, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to shift the refinancing rate by 0.25 pp to 8%, the floor of the interest rate corridor by 1 pp to 5% and leave the ceiling of the interest rate corridor unchanged at 9.25%. The decision to contract the width of the interest rate corridor was made in line with the plans to improve the monetary policy operational framework. The Bank provided a preemptive explanation in the press release on the ‘New monetary policy operational framework’ published on 31 August 2022.

The decision was taken in light of actual and forecasted inflation, global and domestic economic developments and expectations.

As in most countries, inflationary pressures persist in Azerbaijan too. Analyses suggest that, actual inflation is driven by inflation in main trade partners and cost factors of foreign origin.

The inflation forecast was revised up for the end of the current year, taking into account high persistence of the said supply factors and the risk of partial activation of the demand factor.

The Central Bank decided to tighten the monetary policy, i.e. increase the refinancing rate and the floor of the interest rate corridor in order to avoid excess expansion of aggregate demand and support savings in the national currency on the backdrop of rising inflationary pressures over recent months. The Bank found it expedient to contract the width of the interest rate corridor to further strengthen options for liquidity management in the banking sector and regulate lending activity in the short-term money market through interest rates.

External sector. External sector indicators have remained favorable since the last meeting.

Foreign trade surplus, the main current account component, yoy increased by 3.1 times over 9 months. Over the same period, non-oil export increased by 17%.

Prices for Azerbaijan’s main export products remain favorable. In October, the decision of the OPEC++ to cut oil extraction from November onward had an upward effect on oil prices. Oil and gas prices are expected to remain high in the short run. In its recent release, the IMF predicts the average oil price to be $98.2/barrel in 2022 and $85.5/barrel in 2023. Recent diversification of the structure of exports lessens oil dependency in the balance of payments.

Current account is forecast to be in huge surplus both at the end of 2022 and in 2023. International financial institutions predict balance of payments surplus in Azerbaijan in the next year as well. 

On the backdrop of the balance of payments surplus, strategic foreign exchange reserves increased by 3.5% ($1.8B) to $55.1B over 9 months of 2022, sufficient to finance 35-month imports of goods and services.

Current account surplus is the main factor to underpin stability in the domestic FX market. The size of savings on currency sales of the SOFAZ at auctions and Central Bank’s purchase oriented interventions to the FX market is indicative of considerable amount of supply at the FX market. The amount of savings on currency sales of the SOFAZ was $820.8M as of 27.10.2022. Buy interventions of the Central Bank to the FX market amounted to $967.1M as of the same date.

Real sector. Economic activity is driven by the non-oil sector.

Over 9 months of 2022 real GDP increased by 5.6% (10.1% on the non-oil sector). The highest growth was in tourism and catering (74%), transport and warehousing (27.2%), information and communication (15.5%) and construction (13.3%).

According to real sector monitoring by the Central Bank, in September the business confidence index increased in the non-oil industry, trade and services compared to the previous month.

All aggregate demand components contribute to high economic activity. Over 9 months of 2022 retail trade turnover yoy increased by 2.9%, attributable to higher consumer demand. Over the period non-oil investments increased by 18.1%. High non-oil exports also support domestic demand. 15.6% rise in state budget spending over 9 months weighed on aggregate demand.

State budget parameters published on 2023 display that, government spending will be critical in supporting aggregate demand in the upcoming year too. Considerable rise in current expenditures next year will further expand consumption.

Forecasts of international financial institutions related to economic growth outlook in Azerbaijan are optimistic. In recent autumn releases, economic growth outlook for our country for 2023 has been revised up.

Inflation. The annual inflation rate has increased since the last meeting.

In September, monthly inflation was 3.1%, the highest indicator of recent 80 months. Annual inflation was 15.6% in September 2022, average annual inflation was 13.4%. Core inflation was 14.2% annually and 10.7% on average annual.

Food price hike made more contribution to the rise in annual inflation. In September, food made 9.4 pp, non-food 2.5 pp, and services 3.7 pp contribution to annual inflation.

Analyses suggest that, cost factors of foreign origin are crucial in the dynamics of inflation. These factors weigh on domestic production expenses as well.

Actual inflation translates to high inflation expectations. According to September surveys among households, 20% of respondents expect the inflation rate to rise upcoming 12 months. According to findings of the monitoring of real sector enterprises, in September inflation expectations increased in the non-oil industry, trade, construction and remained unchanged in services compared to August.

Annual inflation forecast for the end of 2022 was revised up, due to the fact that actual inflation was higher than expected in Q3, high inflation persisted in trade partners, as well as tariffs for certain services, whose prices are regulated by the government, were changed. The forecast that annual inflation in 2023 will be lower than in 2022 remains.

Monetary condition. A number of changes have occurred in the monetary condition since the last meeting to have a downward effect on inflation.

The FX market equilibrium and the appreciation of the nominal effective exchange rate keep containing inflationary pressures. The NEER has been appreciating since the last meeting (up to 7.5% over 9 months).

Launch of standing facilities in September, banks’ maintaining required reserves under new norms and activation of sterilization operations with 1, 3, 6 and 9 month notes from the beginning of October were oriented towards mitigating inflation pressures through the monetary condition.

At the same time, all this is accompanied with the activation in the interbank money market. Banks concluded AZN788M worth 69 transactions in September and AZN1426M worth 124 transactions over the past period of October on the platform created in the Bloomberg trade system for unsecured transactions. 97% of transactions concluded in October is short-term (1-3 day). AZN48M worth 21 transactions were concluded in September and AZN65M worth 20 transactions were concluded over the past period of October in the interbank Repo market.

Use of the new monetary policy operational framework for 2 months allows expecting that the pass-through of the interest rate corridor, in particular the refinancing rate to the financial sector will strengthen; it will boost options to influence inflation by means of regulation of aggregate demand. Active communication with the banking community in the application of the new operational framework also underpins pass-through of the interest rate corridor.

The forecast that money supply will increase by the end year was revised down due to the activation of a new range of sterilization operations and budget surplus.

Demand for lending remains elevated amid high economic activity. In September 2022 lending in banks and non-bank credit institutions increased by 3% compared with the previous month, by 15.1% compared with the early year and yoy by 23.5%.

Effects of monetary policy decisions made during 2022 on the economy will become evident over the remaining period of the current year and in 2023.

Balance of risks. Foreign factors emerging on the backdrop of geopolitical factors translate to the balance of risks.

Global inflationary pressures are still high. IMF’s global inflation outlook for 2022-2023 gives rise to expecting higher price hikes. On the other hand, high recession probability in the global economy may trigger changes in both financial markets of leading countries and global commodity markets.

In the presence of inflationary pressures driven by cost factors, domestic aggregate demand need to be taken into consideration. In this environment, macroeconomic policies will be oriented towards the regulation of inflation risks. The state budget will be tailored to the fiscal rule for the end of this year and next year, and currency supply by the government will support macroeconomic stability. Efforts to improve the new monetary policy operational framework by the Central Bank will allow to more effectively regulate the monetary condition in the long run.

Interest rate corridor parameters related next decisions will depend on the balance of risks in foreign environment and the domestic economy in light of the actual and forecast dynamics of inflation. Depending on ability of the new monetary policy operational framework to affect short and long-term interest rates in the financial sector, the Bank will consider further contraction of the width of the interest rate corridor.

This decision takes effect on 28 October 2022. Next monetary policy decision will go public on 16 December 2022.