On interest rate corridor parameters

01-02-2023

1 February 2023, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to increase the refinancing rate by 0.25 pp to 8.5%, the floor of the interest rate corridor by 0.5 pp to 6.75% and the ceiling by 0.25 pp to 9.5%.

The decision was taken in light of the behavior of the factors that pull and push inflation in domestic and external environment.  

Inflation in trade partners started to subdue gradually from Q4 2022 amid stabilization of global energy and food prices. Monetary policy tightening in major countries weigh on the actual and expected dynamics of global economic activity. A favorable international situation for Azerbaijan in terms of the balance of payments, as well as the rise in strategic foreign exchange reserves strengthen exchange rate stability, the key price stability anchor. Recent forecasts ensure further current account surplus in 2023. The nominal effective exchange rate of the manat keeps strengthening, considerably neutralizing cost factors of foreign origin.

However, uncertainties related to the inflationary environment, including expected change in demand and supply factors remain high. Continuing geo-political tension and the situation related to the COVID-19 in certain leading economies make the external environment of inflation very fluctuant. Amid expanded aggregate demand under the effect of the stimulating fiscal policy and rising foreign exchange receipts, economic growth surpasses its potential. Realization of the next social reform package followed by over 20% increase in nominal income of the population in 2022 and lending activity may significantly surge consumption, the main component of aggregate demand. In December 2022 annual inflation stood at 14.4%, merely 1.2 pp down compared to the peak in 2022 (15.6% in September). The main structural component of inflation – food inflation remains high at 19%. Producer prices (in December annual rise was 10.2% on the agricultural producer price index and 10.6% on non-oil industrial prices index) and import prices (in November annual import prices hiked by 23.4%) grow at a double-digit rate. Inflation risks also include sensitivity of inflation expectations. According to findings of December 2022 surveys, the number of households that expect the inflation pace to rise, increased by 2 pp to 22%. In general, although annual inflation was prone to falling, its forecasted rate keeps surpassing the target rate. According to updated forecasts, in case assumptions under the baseline scenario remain stable, in 2023 annual inflation will be around 8%.

In response to the above risks in the inflationary environment, the Central Bank strives to reduce inflation through the monetary condition. Because of introduction of new monetary policy tools in September 2022, short-term interest rates began to react to interest rate corridor parameters of the Central Bank both in the secured and unsecured interbank market for the first time. Yield on Central Bank notes and government securities is showing adequate reaction as well. To make liquidity absorption operations more effective, the Central Bank regularly reviews terms of note auctions. Activation of sterilization operations decreased the growth rate of money base in the manat by 10.2 pp to 12.1% in 2022. To note, a high growth rate of money supply in last month of the year was mainly attributable to fiscal operations. The rise in reserve requirements and tightening of relevant prudential requirements in the previous year contained lending activity. As a result, after July 2022 average monthly growth rate on the consumer loan portfolio decreased to 1.6% from 2.3%. A new decision was taken with respect to required reserve norms to elevate the effect of the interest rate corridor on interests rates in the financial system and contain concentration of liquidity in the banking system. A decision was made for all banks to maintain their required reserves under new norms from February 2023 onward. The mentioned decisions allow effective regulation of demand factors of inflation, tightening the monetary condition.

Next decisions related to the monetary policy will depend on the rate of realization of potential risks on external and internal factors of inflation. Macroeconomic forecasts will be updated quarterly for the next monetary policy decision-making. The Central Bank will continue using all tools and mechanisms in its arsenal to reduce inflationary pressures by containing excess demand. In case  of ongoing drop in annual inflation indicators and forecasts, the Bank will first take a pause on monetary policy tightening, and then will consider options for its normalization, i.e. loosening. When making an interest rate corridor related decision, the Central Bank will also consider the cumulative tightening rate of the monetary policy and a time interval required for its pass-through to inflation.

The decision takes effect on 2 February 2023. The next decision related to the monetary policy will go public on 29 March 2023.