TOOLS OF INFLUENCE

The decisions of the Central Bank of Azerbaijan (CBA) on interest rate manipulations always attract attention. They generally affect both the interest rates on loans and deposits from commercial banks, being an indicator of the overall economic situation in the country and making short-term forecasts possible. This is particularly important for businesses, investors and security holders.

Until recently, the interest rate played a nominal role in the national economy. Although the CBA used to announce its decisions 8-9 times throughout a year, they had no effect on the financial market. But it has been almost half a year now that the CBA has changed its policy, being ready to expand the range of other financial tools to influence inflation processes more productively.

Rough start point

On May 4, 2023, the CBA decided to increase the rate by 0.25 percentage points to 9%. The lower and upper limits of the interest rate corridor were also increased by 0.5 pp. (7.5%) and by 0.25 pp. (10%), respectively.

According to the CBA chairman Taleh Kazimov, there is high uncertainty about inflation factors in the global and national economies: although the actual level has a declining trend, in March it exceeded the upper limit of the inflation target by more than twice.

In particular, the main structural component of inflation, food price index, remains high (16.8%), while the year-on-year prices of non-food products and services rose by 11.6% and 10.8%, respectively. Meanwhile, the nominal income of population increased by 15.2% in 1Q2023.

Thus, according to Mr. Kazimov, external environment for inflation remains highly volatile. According to the International Monetary Fund's April forecast, global inflation grew by 0.4% to 7%.  According to experts, with current risks persisting, the core inflation may return to target indicators not before 2025. "Increased risks related to the stability of the global financial system can also affect inflationary processes through various channels," Kazimov said.

As a result, the CBA considers these factors still effective to exceed target inflation indicators. According to the baseline scenario, annual inflation in 2023 will be around 8%.

Statistics on Azerbaijan's economic level for the last few years also look a little unusual. According to the State Statistics Committee, the annual GDP growth in January-March 2023 was only 0.4% and 0.1% in April. The CBA believes that the weak economic activity in the beginning of the year was temporary, and the situation will recover soon. It is related to the declining oil production (4% in the first quarter) amid the growing non-oil sector (5%), which the CBA expects to rise to at least 6% by the end of the year.

"Frankly, changing interest rate has no direct impact on slowing economic growth," said Kazimov.

The main thing is to prevent inflation

On the other hand, the CBA would like to influence inflation through this instrument and is doing its best to do so by trying to strengthen other components of the financial market. Above all, the CBA is seeking to influence the interbank unsecured money market through decisions on the parameters of the interest rate corridor. As a result of some tough decisions, the average interest rate on the interbank unsecured money market has grown by 1.2 pp. since the start of 2023. If the CBA succeeds in achieving its goals, the impact of interest rate decisions on economic activity will increase.

In order to increase competition in the CBA's note auctions, effective development of a yield curve in different periods, and support to short-term money market activities, an investor base for notes has been formed and changes have been made to the terms of the note placement. It was decided that besides banks the right to hold notes will be given to commercial resident legal entities operating in non-oil and non-governmental sectors (except for legal entities engaged in financial and insurance activities), but within certain limits. According to Kazimov, expanding the volume of short-term notes will agitate the securities market thanks to the increased number of investors.

He noted that supply exceeded demand by 97% in the currency market during the four months of 2023.  The nominal effective exchange rate of the manat appreciated by 8.4% in 2022 and by 4.8% in the four months of 2023, which has a dampening effect on external factors of inflation.

Therefore, the regulator also does not plan to increase the face value of the national currency or to put into circulation new banknotes with a higher face value. As for the exchange rate policy and the re-initiating floating rate regulation for the manat, the CBA believes the priority is the impact of such decisions on inflation processes. "We will apply a tool that will help us keep inflation under control," T. Kazimov said.

Valuable intentions

In fact, it is difficult to judge the success of the CBA's new position on agitating the financial market. Kazimov noted that since last September the bank's decisions to raise interest rates have slightly reduced the growth rate of loan portfolios in banks.

In fact, there has been no visible influence on the lending rates of commercial banks. However, neither have there been any changes in the stock market - sometimes it seems that the stagnation is so deep that any attempt to influence it is doomed to failure.

However, the current CBA chairman is optimistic, although he admits the existence of major problems in this sector. "There is virtually no stock market in the country. Although some joint stock companies issue shares, they do not have much impact on stock exchanges. It is true that we have a negative situation. The CBA and related institutions should further develop the stock exchange," T. Kazimov said.

CBA believes that the main problem is the low level of public interest in securities. The main reasons are the lack of transparency in the activities and reports of the above-mentioned securities organisations. Another reason is that dividends on purchased shares are not paid on time or not paid at all. This also negatively contributes to public confidence and interest in securities. "I believe that in order to develop the securities market in the country, it is necessary to control the activity and transparency of shareholders and to strengthen the legal framework in the first place. Only then we can talk about the revival of the securities market," T. Kazimov said.

He frankly admitted that the main reason why the increasing number of companies are not issuing securities is the excess liquidity of banks. If a business needs funding for development, it can easily borrow money from bank, because the latter have more than enough money for that purpose today.

"Entering the capital market is always a fallback option for a company. Also, this move demonstrates that the company is interested in making its operations fully transparent and improving corporate governance. But today the companies find it easier to borrow money from the banks," Kazimov explained.

Currently, the excess liquidity in banks is approaching ₼5b, and it is necessary to have tools to sterilise these funds. In general, the quality of banks' loan portfolio is satisfactory, the share of non-performing loans is only 3.7%. But the huge amount of "excess" money in the banks blocks the air for other components of the financial market, i.e., deprives the population and businesses of the opportunity to differentiate their investments.

"Today the main investors in the Baku Stock Exchange are banks and insurance companies. But the population also have free resources. We are working on an insurance mechanism for individual investors in order to make this instrument attractive for the general population," said Kazimov.

There have been many attempts to involve the securities market in financial processes in Azerbaijan. Let's hope that this time, the Central Bank's plan will succeed and local investors will finally invest in the shares of local companies instead of the stock exchanges of other countries.