Reducing the discount rate in Azerbaijan: benefits and expectations CBA's another timely move to fight inflation

The chances of the authorities easing monetary policy are increasing as the imported inflation factor and other external risks of the past two years are gradually diminishing. As inflation expectations in Azerbaijan, as in many countries around the world, are declining, efforts to improve GDP dynamics and reduce the tax burden on businesses are becoming more and more of a priority. A clear signal for the country's financial sector is the decision of the Central Bank of Azerbaijan (CBA) to lower the discount rate again from December 21. The move reflects the regulator's confidence that inflation will be kept close to the target range in the coming year.

Over the past two years, the global financial and economic system has undergone significant geo-economic fragmentation and has been repeatedly hit by the coronavirus pandemic, military conflicts, and energy and food crises. All this negativity was preceded by attempts by financial regulators in the US and Europe to overcome the post-pandemic economic slowdown by unleashing the "money printing press" in 2020-2021, resulting in an unprecedented rise in global inflation. Subsequently, the price hike gained momentum against the backdrop of the Russian-Ukrainian war-induced sanctions standoff. Since then, the efforts of most of the world's central banks have been aimed at slowing price growth by tightening monetary policy, mainly by raising interest rates.

Azerbaijan was forced to follow a similar path. Faced with unprecedentedly high levels of imported inflation and an unprecedented rise in the prices of consumer goods, the leadership of the Central Bank of Azerbaijan promoted rather conservative monetary scenarios, including in the area of bank lending. These and other measures have tightened monetary policy since the second half of last year, including the progressive raising of the discount rate, which at its peak was 9 per cent.

Together, these steps proved quite effective, and by autumn of this year, the price growth rate was significantly reduced: by the end of September, inflation in Azerbaijan slowed down to 5.1 per cent, which is more than three times lower than its peak of 15.6 per cent in September 2022. As a result, on November 2, in what can be seen as a cautious signal to the country's financial sector about the gradual easing of monetary policy, the Central Bank decided to lower the discount rate from 9 per cent to 8.5 per cent.

The CBA board's decision the day before to lower the discount rate from 8.5 per cent to 8 per cent from December 21 was a logical continuation of this policy. In turn, the lower bound of the interest rate corridor was lowered from 7 per cent to 6.5 per cent and the upper bound from 9.5 per cent to 9 per cent. "This decision was taken taking into account the indicators of actual and expected inflation in the target corridor (4±2 per cent), the stabilisation of inflation expectations as well as the excess supply in the foreign exchange market. Since the last monetary policy meeting of the CBA Governing Council, the annual inflation rate has declined faster than expected," the CBA said in a statement. The regulator also noted that 12-month inflation stood at 2.6 per cent in November 2023, while annual inflation was within the target range for the third month. Overall, the monthly price trend continues to decline compared with the same period last year. Moreover, deflation was observed in November, with the CPI falling by 0.2 per cent, which is generally uncharacteristic for the current financial period.

Annual inflation has been decreasing due to the impact of external and internal factors and the processes taking place in Azerbaijan are well within the dominant global trends. The slowdown in imported inflation is mainly due to the decline in global economic activity (recession in the European Union, the USA, and many other developed regions of the world) and tight monetary policy pursued by regulators in most countries of the world. The continuing decline in world commodity prices, especially for energy and food products, has led to a reduction in inflationary imports into our republic as well.

In particular, the CBA cited World Bank (WB) statistics, according to which the commodity price index in November fell by 18.3 per cent year-on-year, including a 23.9 per cent drop in energy prices and a 4.6 per cent drop in oil prices. In turn, according to the UN Food and Agriculture Organisation (FAO), last November the food price index also fell by 10.7 per cent year-on-year.

Thus, along with external factors that contributed to the reduction of global inflation and the policy of raising the refinancing rate, the regulator's efforts to stabilise the currency market played an extremely important role in reducing the degree of consumer prices in our country. Thus, the Central Bank believes that maintaining balance in the currency market and strengthening the nominal effective exchange rate of the manat by 19.5 per cent in November 2023 played an important role in anti-inflationary efforts. This is a fairly consistent multi-year trend. Over the past eight years, the Central Bank has managed to avoid the main scourge of modern times - monetary inflation: unlike neighbouring Russia, Iran, Türkiye, Georgia and many other countries in the Eurasian region, which faced devaluation of their national currency, the Azerbaijani manat has maintained an enviable exchange rate stability.

The excess money supply is being sterilised, and since the beginning of 2023, the CBA has intervened in the foreign exchange market, purchasing $1.4 billion. All this is taking place in the context of a significant surplus in the current account of the balance of payments - $6.7 billion, or 12.5 per cent of GDP at the end of three quarters of this year, and at the vast majority of currency auctions, the supply of currency was significantly higher than the demand, which in itself indicates healthy processes in the local financial market. In turn, these steps contributed to the growth of the CBA's foreign exchange reserves, which have increased by 20.3 per cent to $10.8 billion since the beginning of 2023.

So what benefits does the trend of lowering the discount rate bring to the domestic economy, and what are the inflation expectations for the coming year? The most important long-term objective of the government and the Central Bank remains to maintain macroeconomic stability and reduce inflation, and positive trends are expected in this regard in 2024. "Next year, the necessary measures to ensure optimal fiscal and monetary policy will be continued, and the inflation rate is expected to be at single-digit levels," Prime Minister Ali Asadov said during the recent budget readings in the Milli Majlis. It should be noted that according to recent forecasts of the CBA and Ministry of Economy annual inflation in Azerbaijan next year is estimated at 5.3 per cent. The prospects of reducing price growth in Azerbaijan are evidenced by the data of several global financial organisations: for example, the International Banking and Financial Services Corporation of the Netherlands ING expects that in 2024 the inflation rate in our country will be reduced to 5 per cent. Even more optimistic in this regard are the forecasts of the International Monetary Fund (IMF), which believe that in 2024 the average annual inflation rate in Azerbaijan will slow down to 4.7 per cent.

A low level of inflation risk is a basic condition for the stable operation of domestic credit structures and the economy as a whole. Moreover, given the reduction of the regulator's discount rate (and further steps in this direction are possible in 2024), the banking sector will get an impetus to adjust loan rates downwards. Given the high level of bank liquidity, this is a long sought-after measure to optimise demand in the credit market. Cheaper borrowing is seen as an essential component of the government's overall policy to stimulate business development and reduce the fiscal burden on citizens. In particular, as part of the budget and tax policy for 2024, amendments to the tax and customs codes were adopted, and privileges and exemptions from a number of payments were introduced to stimulate business activity and expand the taxable base.