Azerbaijan Central Bank tries to extinguish flames of inflation Review by Caliber.Az

According to a recent report by the Organization for Economic Cooperation and Development (OECD), despite some slowdown in consumer price growth, global core inflation is still very high and will exceed regulators' targets in 2023. For the second year in a row, central banks of the world's leading countries have been tightening monetary policy in order to curb the unprecedented price growth. The main anti-inflationary mechanism is raising the refinancing rate, and all post-Soviet countries, including Azerbaijan, have resorted to this tool along with the US, EU and the UK. Thus, the Central Bank of Azerbaijan (CBA) decided to increase the discount rate by 0.25 percentage points to 8.75 per cent.

Although many international financial, donor, and rating organizations have projected declining price dynamics in 2023, inflation risks are still quite high. As noted in a recent OECD report, core global inflation remains elevated due to higher prices for services and tariffs in many regions of the world. Moreover, although a gradual slowdown in consumer price growth is expected between 2023 and 2024 in most countries, global inflation rates will remain above the targets of leading central banks at least until the middle of next year. OECD experts believe that the weighted average inflation rate in the G20 countries will slow from 8.1 per cent in 2022 to 5.9 per cent in 2023, and to 4.5 per cent in 2024. But these forecasts cover only the basic, optimistic scenario.

The current situation is exacerbated by the banking crisis observed in March of this year in the US and Europe. Bankruptcy of three American banks, one of which, Silicon Valley Bank, was in the top 20 in terms of assets in the US, as well as the bankruptcy of First Republic Bank, which was provided with $ 30 billion from a pool of 11 major American banks, forced financial regulators to promise to return depositors their funds in full. For this purpose, the Federal Reserve System (FRS) of the country will provide loans against the assets of bankrupt banks, which actually means an additional unsecured issue of about $250 billion. It is obvious that the rescue of banking systems by injecting hundreds of billions of dollars will inevitably cause a surge in inflation, and that is what the US and EU governments are fighting hard, but not always successfully.

Assessing the unprecedented surges in consumer prices since last year and the instability of monetary factors against the world's leading reserve currencies - the dollar and the euro, it should be recalled that for the first time in the entire history of the eurozone, inflation in 2022 was in double digits, and in Germany it reached a new high in 71 years. A similar negative situation was observed in the US, where the last time a comparable jump in prices was observed was during the 1974 energy crisis, when an absolute inflation record of -12.34 per cent was set.

Not surprisingly, since the end of last summer, the developed countries of the world, including the United States, the European Union, Canada, Switzerland, Israel, the states of Southeast Asia, South Africa, began a gradual increase in interest rates in order to curb the level of galloping inflation. In particular, the US refinancing rate reached 4.5 per cent by mid-December 2022, and on March 22, 2023 the Federal Reserve System raised its rate by 25 basis points from 4.5-4.75 per cent to 4.75-5 per cent per annum. The Bank of England followed suit on March 24, raising its policy rate by 25 basis points to 4.25 per cent, with the prospect of raising it to 5 per cent this May. Finally, the EU Central Bank (ECB), which raised its discount rate several times from zero to 2.5 per cent from May to December last year, also had to raise it to 3.5 per cent in mid-March 2023, with further growth forecasted for May as well.

Thus, the issuers of the world's three leading reserve currencies are quite clearly signaling that the period of "cheap" money and affordable credit is far behind us, and strengthening monetary stability and reducing inflation are now the priority tasks. It should be noted that through the discount rate the central banks and the world emission centres set the interest rate at which they lend to commercial banks and take their money for safekeeping, and also form other rates, in particular on deposits and loans of commercial banks, on forfeits and other operations. Together with monetary regulation, the most important function of the refinancing rate is to curb consumer inflation. In periods of stability and economic recovery or in order to get out of recession, the discount rate is reduced, increasing the flow of funds into the economy. If the financial system overheats and consumer prices rise, the rate increases, playing the role of a brake on banks and other sources of funding for production, trade turnover, investment flows, etc.

Azerbaijan follows the same path, where inflationary pressure on the economy and consumer market is still quite high. Last year, the average annual inflation in the country amounted to 13.9 per cent, mainly under the pressure of imported inflation factors, and the key goal of the Central Bank's macroeconomic policy was to consistently overcome the consequences of global price growth, in connection with which the discount rate was gradually increased by 100 basis points - from 7.25 per cent to 8.25 per cent at the end of the year.

This forced trend continued this year as well: on February 1 the CBA decided to increase the discount rate by 0.25 percentage points to 8.5 per cent. Taking into account the fact that by the end of February 2023 inflation in Azerbaijan rose to 14.1 per cent compared to the previous year, which is significantly higher than the CBA target (4±2 per cent), the regulator was simply forced to increase the rate again. It happened on March 29 when the Central Bank increased the discount rate by 0.25 percentage points to 8.75 per cent, the upper limit of the interest rate corridor was raised from 9.5 per cent to 9.75 per cent and the lower limit - from 6.75 per cent to seven percent.

"Such decision was made taking into account the dynamics of factors, which have a downward and upward impact on the price level in the internal and external environment. Further decisions on the monetary policy will be made depending on the dynamics of inflation, the level of deviation of the forecast from the target and constancy of risks. The results of operations conducted by the CBA and previous decisions will be monitored and taken into account when making decisions in the sphere of monetary policy. In order to reduce inflationary pressure by limiting excessive expansion of aggregate demand and consumer activity the Central Bank will adequately use all instruments and mechanisms at its disposal. If inflation forecasts justify themselves, the possibility of normalization of monetary policy will be considered, and then mitigating it, taking into account time intervals," the CBA said in its report.

The next CBA decision on the country's monetary policy will be announced on May 3, 2023, and the next steps depend on the effectiveness of anti-inflationary measures implemented in recent months.

As noted in the regulator's forecasts published on March 29, the Central Bank kept unchanged its estimate of annual inflation in 2023 at 8 per cent, while maintaining the baseline scenario. “In February 2023, the annual (12-month) inflation in Azerbaijan amounted to 14.1 per cent, which is 1.5 percentage points lower than the peak value of 15.6 per cent in September 2022,” the CBA said in a statement. The domestic market of the country shows a decline in inflation from its peak value, but at the same time there remains some uncertainty given the expected changes in the dynamics of supply-demand and the behavior of economic actors. At the same time, the CBA notes that, according to the Food and Agriculture Organisation of the United Nations (FAO), in the last 11 months - since April 2022 - there has been a decrease in food prices in the world.

Under the conditions of stimulating fiscal policy and growth of foreign exchange earnings in the country, there is an expansion of aggregate demand and high growth rates of the non-oil sector. The increase in demand, in particular, is influenced by the implementation of the fourth social package since the beginning of 2023 (increase in salaries for state employees and benefits) and the increase in credit activity of banks - 15.7 per cent in February of this year. However, the price level may also be affected by the revision of a number of tariffs for goods and services regulated by the state since the beginning of 2023, and it is obvious that these factors may lead to the fact that actual inflation will again exceed the forecasted figures of the CBA and the government. In this regard, it is possible that in any scenario, the level of real inflation will significantly exceed the budget forecast outlined by the government on the average annual inflation rate - 6.9 per cent.