Azerbaijan’s central bank kept its benchmark refinancing rate steady at 9.75 percent but said a rise in external uncertainties was the main reason for keeping the rate unchanged as inflation has continued to decline to below the target range.
The Central Bank of Azerbaijan (CBA), which has cut its rate by 525 basis points this year, most recently in October, noted inflation fell to 2.3 percent in November and is expected to stabilize around this level by the end of the year.
This is sharply down from October when the CBA lowered its forecast for inflation to the end of the year around 3-4 percent, which was down sharply from an earlier forecast of 6-8 percent.
The CBA said the external risks to its inflation forecast relate to uncertain global oil prices, a new wave of exchange rate devaluations and rising inflation.
Domestic risks stem from domestic demand with an income tax reform possibly increasing income and imports.
Economic activity in Azerbaijan, which relies on oil and oil for about 95 percent of its exports, remains close to its potential level, CBA said, adding growth in the first 11 months was 1.0 percent, including 1.4 percent growth in the non-oil sector.
The exchange rate of the manat was steady at 1.69 to the U.S. dollar.
From 2011 the CBA effectively pegged its manat to the U.S. dollar so the CBA had to draw heavily on its reserves to defend it when it came under downward pressure.
Following the fall in crude oil prices in mid-2014, local depositors began switching into U.S. dollars and by early 2015 the CBA was forced to abandon first its dollar-peg and then later that year a dollar-euro basket peg.
In December 2015 the CBA then switched to a floating exchange rate regime that finally helped stabilize the exchange rate. Over the last 12 months, the manat has been trading close to 1.7 to the U.S. dollar.
The Central Bank of Azerbaijan issued the following statement:
“The Management Board of the Central Bank of the Republic of Azerbaijan decided to leave the parameters of the interest rate corridor unchanged. Under the decision, the refinancing rate was maintained at 9.75%, the ceiling of the interest rate corridor at 11.75%, and the floor at 7.75% (±2% symmetric range). The decision takes effect at 14.00 on 26 December 2018.
Since the last meeting of the Management Board dedicated to the monetary policy inflation has kept falling. Average annual inflation is expected to remain at the current rate as of the end-2018.
A sustainable macroeconomic framework is a key stabilizing factor in the balance of risks. The fact that the interest rate corridor parameters are left unchanged on this backdrop is attributable to rising uncertainties related to the external environment. In the long view the monetary policy will react to the dynamics, sustainability and transmissibility of inflationary factors.
Inflation. Over recent two months inflation has kept falling. Average annual inflation was 2.3% over 11 months of 2018, much below the target range.
Having slightly increased under the influence of seasonal factors food inflation was neutralized by the low-rate downward trends in prices for non-food products and chargeable services, as well as by monetary factors, resulting in 0.6% monthly inflation.
Inflation expectations and forecasts. Current behavior of consumer prices and the stable exchange rate of the manat still factor in stabilization of inflation expectations. At the same time, consistent decisions of the current year oriented towards easing the monetary policy had a downward effect on inflation expectations of market players.
Inflation expectations of the business sector have decreased in trade and services and increased in non-oil processing and construction over recent two months. Households’ inflation expectations vary across income groups.
Inflation is expected to stabilize around 2.3% as of the end 2018 according to recent forecasts.
External condition. Over 11 months of 2018 foreign trade surplus accounted for 18% of GDP – non-oil export y/y increased by 11%, while non-oil imports by 33%.
The balance of payments is expected to maintain considerable surplus and strategic foreign exchange reserves increase on the results of 2018.
However, new trends have been observed in the international conjuncture over recent two months and current oil prices significantly dropped from the peak of the current year.
Changes in the external environment of the monetary policy and uncertainties will continue to be focused on.
Economic activity. Economic activity remains positive approximating to its potential level. Over 11 months of 2018 economic growth was 1%, including 1.4% non-oil growth. Non-oil growth was mainly driven by trade. The non-oil industry grew by 8.7%, agriculture 4.6%.
The business confidence index based upon the real sector monitoring by the Central Bank increased in non-oil processing, trade and services, and decreased in construction. The consumer confidence index is positively zoned based upon surveys among households. Amid low inflation consumption is backed by rising real income of the population and recovery of consumer lending.
Inflation risks. Rebalancing is maintained in the balance of risks. The sustained macroeconomic framework has become a fundamental as a key stabilizing factor.
However, the balance is dynamic and a number of external and internal factors may push risk factors with upward effect on inflation. External factors include uncertainties related to global oil prices, a new wave of exchange rate devaluations and rising inflation in financial markets of trade partners. These factors affect the Azerbaijani economy through trade, investment flows, money remittances and expectations. Internal factors influencing inflation include wider domestic demand. The implied income tax reform may increase income of the population and contribute to economic growth meanwhile triggering demand factors of inflation. On the other hand, the influence of activated consumer lending on domestic demand and import need to be preventively regulated with the help of macro-prudential policy.
Monetary condition. Recent parameters of the interest rate corridor both make national currency denominated savings more attractive and pave the way to anti-inflationary behavior of the population.
On the other hand, wider money supply support economic activity without prejudice to macroeconomic stability – broad money supply in manat increased by 13.3% over 11 months.
The Central Bank will adjust the refinancing rate and the parameters of the interest rate corridor in response to influence of external and internal factors on inflation.
A schedule of disclosure of the Central Bank Management Board’s monetary policy decisions in 2019 is added with the press-release. According to the schedule, the next decision on the interest rate corridor parameters will be announced on 1 February 2019 followed by a press-conference.”
Azerbaijan maintains rate due to rising global uncertainty