Azerbaijan central bank raises interest rate: reasons and expectations
Review by Caliber.Az

ANALYTICS  02 February 2023 - 15:00

Amid the global turmoil in 2022, the war in Ukraine, and energy, food, and transport crises, central banks of the leading countries consistently tightened monetary policy to curb skyrocketing prices. The main anti-inflationary tool was an increase in refinancing rates, and all post-Soviet states, including Azerbaijan, resorted to this mechanism. Although many international donors and rating organisations promise a reduction in price dynamics in 2023, inflation risks are still quite high. This is evidenced by the decision of the Central Bank of Azerbaijan (CBA) to increase the discount rate by 0.25 percentage points, to 8.5%, starting from February 1.

The policy of "cheap" money and extremely affordable credit pursued by the USA, the EU, Japan, and a number of other developed countries in 2020-2021 helped to overcome the negative side of the pandemic recession rather quickly, but at the same time brought a lot of problems due to the unsecured emission of several trillions of dollars. In the end, it has resulted in uncontrolled price rises for energy and other commodities. The situation with oil, gas, and food prices has deteriorated further with the war in Ukraine and the sanctions stand-off between the collective West and Russia, causing an inflationary spike unprecedented in half a century, affecting every country in the world without exception. For the first time in the eurozone's history, inflation was in double digits last year, with Germany hitting a 71-year high. A similar situation was observed in the US, where the last time a comparable jump in prices took place was during the 1974 energy crisis when an absolute inflation record of 12.34% was set.

Unsurprisingly, since last summer the exact opposite trend prevailed - the US Federal Reserve (Fed) began to raise its interest rate in stages, which already reached 4.5% by mid-December 2022. The EU central bank (ECB) has also taken similar steps by raising its interest rate several times from zero in May to 2.5% by mid-December. Similar processes are underway in a number of other developed economies, including Canada, Switzerland, Israel, South East Asia and South Africa, where steps are also being taken to curb galloping inflation.

By means of the discount rate, Central Banks and world emission centers assign interest rates at which commercial banks lend and accept their money for storage, as well as form other rates, in particular on deposits and loans of commercial banks, as well as on penalties and other transactions. Together with monetary regulation, the most important function of the refinancing rate is to contain consumer inflation. In periods of stability and recovery or in order to bring the economy out of recession, the discount rate is lowered, increasing the flow of finance into the economy. When the financial system overheats and consumer prices rise, the rate rises playing the role of a brake on banks and other sources of funding for production, trade, investment flows, etc.

At the end of January this year, there has been a slowdown in the negative processes in the US economy, where inflation has also fallen; moreover, there has been a slight increase in EU stock indices due to a noticeable drop in gas prices, improved supply chain conditions and a strengthening labour market. Nevertheless, inflation concerns are still at risk in 2023.

According to the updated figures from the International Monetary Fund (IMF) published the day before, global inflation could slow down from 8.8% to 6.6% in 2023 and to 4.3% in 2024 under the optimistic scenario. However, much of the IMF report depends on difficult-to-predict factors - the prospect of an end to or escalation of the war in Ukraine, the timing of the lifting of quarantine restrictions in China, and conflicting information about the Middle Kingdom economy as a whole. The situation on global exchanges, especially energy, agricultural, and other commodity prices, as well as the prospects for normalising supply chains and overcoming logistical hurdles, is very unclear. This uncertainty has finally divided expert opinions into supporters and opponents of the inevitability of a recession in 2023, as well as the very different outlook for prices and market demand.

In particular, the Central Bank of Azerbaijan seems to still adhere to a conservative scenario on the issue of inflation risks. Thus, by the decision of the CBA on February 1 the discount rate in our country was increased by 0.25 percentage points and made 8.5%. At that, the lower threshold of the interest rate corridor was raised from 6.25% to 6.75%, and the upper limit - from 9.25% to 9.5%. "This decision was made taking into account the dynamics of factors that have an upward and downward impact on inflation in the domestic and external environments," the regulator said in a statement, which also noted that the next decision of the CBA board on the parameters of the interest rate corridor will be taken on March 29.

In general, Central Bank specialists assess the level of inflation last year as quite high: according to data published a day before, the annual inflation rate in Azerbaijan in 2022 was 14.4%, and in the food segment it was even higher - 19%. That's why last year it was announced a key objective of the macroeconomic policy of the Central Bank to gradually overcome the consequences of global inflationary negative, including the gradual increase of the discount rate by 100 basis points - from 7.25% to 8.25%.

The situation with consumer price increases eased somewhat in the fourth quarter of last year, largely due to a slowdown in weighted average inflation in Azerbaijan's key trading partner neighbouring countries, but the local market situation has changed little overall.
Despite the CBA's forecast of an annual inflation slowdown to 8% in 2023, there is still some uncertainty about the inflation environment given the difficult geopolitical situation in the world. "According to the household survey conducted in Azerbaijan in December, the share of those who expect inflation to rise has increased by two percentage points to 22%. In general, there is a noticeable trend to slow annual inflation, but its level is still above the forecasted value," the CBA said in a statement, which also notes the intention to continue appropriate efforts to reduce inflation in the framework of monetary policy.

The Azerbaijani government also attributes last year's rise in consumer prices (especially food prices) mainly to the factor of imported inflation. However, in this year's budget package, the level of average annual inflation is projected slightly below the estimates of the financial regulator - in the range of 6.9%, which is very close to the figures of 2021, when the inflation rate was 6.7%.

The government's optimism about Azerbaijan's macroeconomic stability is justified. It is based on the long-term stability of the exchange rate of the manat, which excludes the likelihood of monetary pressure on inflationary processes. The positive factors include a low level of public debt, growing foreign exchange reserves, and, importantly, a positive foreign trade balance, which will continue in 2023, given the still high oil prices and plans to increase gas exports to the EU through the Southern Gas Corridor system.

How 2023 will look like in terms of inflation expectations will be clear in the second half of the year, but in the meantime, it should not be overlooked that in case of a positive scenario in the world and in our country, the monetary policy of the central bank may be successively softened. As early as last autumn, the regulator noted that depending on the macroeconomic situation and trends in the interbank market, as well as the effects of the introduction of new instruments in various segments of the financial market, the CBA rate level and the limits of the interest rate corridor could be lowered.

Caliber.Az