MONETARY EASING

As anticipated by global analysts, the Central Bank of Azerbaijan (CBA) has continued to lower the discount rate—this time by 0.25 percentage points (from 7.75% to 7.5%). Additionally, the upper limit of the interest rate corridor was decreased from 8.75% to 8.5%, while the lower boundary was maintained at 6.25%. "The reduction of the upper boundary of the interest corridor and the discount rate aims to relax monetary conditions. Maintaining the lower limit will optimize the width of the interest rate corridor. The impact of these parameters on the interbank money market interest rates was also considered," stated the Central Bank.

The primary rationale for this decision was the alignment of actual and projected inflation with the target inflation rate (4±2%), the stabilization of inflation expectations, and shifts in the financial market's risk balance. The preceding CBA decision mirrored this approach, also reducing the rate by 0.25%. This aligns with the consensus among international analysts, who believe this trend will persist until the year's end.

Inflation Expectations

The Dutch multinational banking and financial services corporation ING Group forecasts a gradual decrease in Azerbaijan's discount rate for 2024 and 2025. ING Group projects it will hit 7.5% in 2024 and then drop to 7.25% in early 2025. By the end of 2025, the discount rate might fall to 6.5%, mirroring the Central Bank's intensive efforts to boost economic activity and hasten growth. Conversely, analysts at Trading Economics, an economic statistics portal, predict a swifter decline, anticipating the 6.5% threshold will be reached as soon as the fourth quarter of this year.

The increasing frequency of international expert discussions on Azerbaijan's discount rate suggests that the Central Bank is nearing its objective of transforming this tool into a genuine means of influencing the nation's macroeconomic and financial dynamics. Previously, the refinancing rate's processes were so negligible that they scarcely piqued global analysts' interest.

It's noteworthy that the International Monetary Fund (IMF) also endorses the CBA's monetary policy stance, though its specialists advise prudence prior to further relaxation. "Inflation risks arising from both external and domestic sources persist. Therefore, fiscal consolidation, moderated income and wage growth, and the non-occurrence of adverse food price shocks are prerequisites before considering additional easing," the IMF advised.

Monetary Fund economists deem it crucial to ascertain whether the recent deflation trend continues before proceeding with monetary policy easing. The Central Bank itself is optimistic that inflationary fluctuations will be circumvented this year and anticipates that annual inflation in 2024 will stay within the target range (4±2%). This expectation is grounded on the fact that in February 2024, the 12-month inflation rate was 0.8%, with core inflation at 1.4%. Annual food deflation stood at 0.3%, non-food inflation at 1.4%, and service inflation at 2.3%.

The CBA acknowledges that the annual inflation decline is attributable to both external and internal influences. The World Bank reports that the commodity price index in February 2024 fell by 7.3% year-over-year, including a 7.5% drop in energy prices. The US Energy Information Agency suggests that the likelihood of an oil reserve increase starting in the second quarter of 2024 will significantly impact prices. The UN Food and Agriculture Organization notes a 10.5% year-over-year decrease in the food price index for February. Additionally, the nominal effective exchange rate of the manat's growth (19.3% in 2023 and 1.8% in the first two months of 2024) also contributed to the reduction in imported inflation.

However, this does not imply that inflation risks have been entirely mitigated. As in the past, they predominantly stem from external sources, notably the ongoing geopolitical tensions that undermine the stability of crucial international trade corridors. Moreover, the Central Bank of Azerbaijan (CBA) is concerned that evolving climatic conditions could drive up global commodity prices and result in fluctuating inflation rates among trading partners. Domestically, the CBA identifies the potential activation of cost factors as a primary inflationary risk. There's also a possibility that fiscal operations may exert greater influence on the money supply this year. Nonetheless, the CBA maintains that, overall, the risks of inflationary increase and decrease are in equilibrium.

The International Monetary Fund (IMF) concurs that inflation in Azerbaijan will likely stay within the CBA's target range in the medium term. Supported by robust oil prices, the external position is expected to remain solid, bolstered by a trade surplus and ongoing accumulation of foreign exchange reserves. "The outlook's risks are broadly balanced but elevated, mirroring the highly unpredictable nature of external developments," the IMF reported.

Trend Towards Permanence

Inflation concerns have also shaped the refinancing rate decisions of central banks in major global economies. For instance, the US Federal Reserve System, serving as the nation's central bank, maintained the federal funds rate between 5.25-5.5% at the conclusion of its March meeting. The authority deemed it premature to lower the rate's target range until there is more certainty that inflation is consistently converging towards the 2% goal.

The Board of Directors of the Bank of Russia opted to keep the key rate at 16% annually. They highlighted that although inflationary pressures are gradually subsiding, they remain substantial. Domestic demand still significantly surpasses the capacity to increase the production of goods and services, and labour market rigidity has intensified once more. "The peak of current inflation in the Russian Federation was surpassed in autumn 2023, with the zenith of annual inflation anticipated in the second quarter of 2024," stated Elvira Nabiullina, head of the Bank of Russia.

The Bank of England retained its benchmark interest rate at 5.25% per annum after its March meeting, acknowledging the diminishing inflationary pressures and deceleration in wage growth, a critical inflation determinant. The Bank projects that inflation will dip slightly below 2% in this year's second quarter (previously projected to slow to 2%), before experiencing a moderate uptick.

The European Central Bank (ECB) left all three principal interest rates unaltered, with the main refinancing rate at 4.5%, the deposit facility rate at 4%, and the marginal lending rate at 4.75%. "Despite a general decline in core inflation metrics, domestic market price pressures remain elevated, partly due to wage growth," the bank stated. The ECB's Governing Council is resolute in its goal to steer inflation back to its medium-term objective of 2%. "The deceleration in consumer price growth within the eurozone is swift, and the juncture for reducing interest rates is drawing near," remarked Fabio Panetta, a member of the Governing Council.

The People's Bank of China kept its benchmark loan interest rate steady at 3.45% annually.

In a distinct move, the Turkish Central Bank stood out by unexpectedly hiking the discount rate by an unprecedented 500 basis points since the early 2000s—from 45% to 50%. Concurrently, reports indicate that the primary trend of monthly inflation in February exceeded expectations.

Reflecting on the situation in Azerbaijan, it's evident that despite discernible shifts towards the influence of discount rate decisions on macroeconomic activities, local specialists observe that their effect on commercial bank lending rates is still minimal. "The manifestation of such an impact will require time. It is entirely separate from the Central Bank's current operations. Typically, when other countries' central banks reduce the discount rate, both deposit and lending rates tend to decline. Contrarily, following the CBA's recent discount rate cut, we've seen an uptick in deposit rates," stated Vugar Bayramov, an economist deputy.

Bayramov noted that present deposit rates fluctuate between 8-9.5%, based on the duration in systemically significant banks, which previously accepted deposits at 5-6%. "The surge in deposit rates was also propelled by the volume of transactions executed in the national currency among banks on Bloomberg's platform, as well as their average interest rates. Consequently, the CBA managed to draw a portion of the banks' dormant assets through its notes, sparking a demand for additional funds within banks. Simultaneously, the substantial amount of cash outside the banking system, with M0 (cash in circulation) at ₼15 billion, motivates banks to enhance their activity. Regardless, the Central Bank's latest decision is unlikely to lead to a notable alteration in loan rates," he explained.

February 2024 data indicates that Azerbaijani banks offered loans ranging from ₼300,000 to ₼150,000, with annual interest rates between 11-16%. Concurrently, the loan portfolio of banks and other financial entities expanded by 20.3% year-over-year to ₼24 billion 362.5 million. Despite this expansion, the proportion of overdue loans diminished by 22.2%, representing a mere 1.9% of the total loan portfolio.

Economists assert that while loan interest rates remain elevated due to structural frailties in the financial framework, it is imperative to persist with reforms of financial and economic institutions. This includes fostering competition in the lending sector and implementing motivational measures to incentivize banks to reduce loan costs.