At its scheduled meeting on May 3, the Central Bank of the Republic of Azerbaijan (CBAR) will announce a pause in monetary tightening and keep the refinancing rate at 8.75%, Chief CIS Economist, Deputy Head of Research at GazpromBank, Gulnara Khaidarshina said in an article, Report informs.
Gulnara Khaidarshina named three arguments in favor of such a decision: 1) a reversal of inflation toward deceleration amid a weakening of external inflationary pressure; 2) a stable level of dollarization of household deposits; and 3) a halt of growth in the money supply.
“Given the persistence of inflationary risks in the economy, we expect a cautious tone in the press release with no indication of a likely transition to a new rate cut cycle,” she said.
At its March meeting, the CBAR proceeded with tightening of monetary conditions and expectedly raised the refinancing rate by 25 bps to 8.75%. In addition, in order to fine-tune monetary conditions, the Central Bank raised the lower and upper bounds of the interest rate corridor by 25 bps to 7.0% and 9.75%, respectively, thereby expanding its capabilities with regard to regulation of lending activity in the economy.
In the aftermath of the previous meeting, the CBAR announced that the decision to raise the rate again stemmed from a shift in the balance of factors toward inflationary ones. Among the latter, the Central Bank mentioned the expansion of aggregate demand amid stimulatory fiscal policy. Commenting on the further rate trajectory, the CBAR noted that it will consider the possibility of pausing rate hikes with a subsequent move to rate cuts should inflation decelerate in line with forecasts.
“We believe that conditions for a halt in the rate hike cycle have already formed,” the GazpromBank economist thinks.
She explains it with the fact that inflation in March reverted to deceleration amid a weakening of the external inflationary backdrop. Price growth slowed in March by 0.5 pps MoM, with deceleration seen in all segments: food, non-food products and services.
“We attribute this to a slowing of inflation in key trade partner countries. In particular, price growth in Russia decelerated to 3.5% YoY in March vs. 11% YoY in February. That said, inflation remains beyond the CBAR’s target corridor of 4% +/-2 pps, exceeding its upper bound by 760 bps and the refinancing rate by 485 bps,” Gulnarasaid.
Food inflation in March amounted to 16.8% YoY (-0.3 pps MoM). Slower growth was seen in prices for buckwheat, eggs, bread, flour, and sunflower and corn oil. At the same time, prices for meat, citrus fruits, potatoes, fish, dairy products, and sugar and confectioneries are still gathering momentum.
In the non-food segment, price growth reverted in March, slowing to 11.6% YoY (-0.6 pps MoM). That said, upward pressure on prices persists in the furniture, household appliances, auto parts and detergent segments, the specialist of the Russian bank says.
Growth of service tariffs weakened by 0.6 pps to 10.8% YoY amid a slower increase of transportation tariffs and tariffs for housing and communal services. The disinflationary trend in the services sector was restrained by growth in housing rental, catering services and international airfares.
According to Khaidarshina, the dollarization of household deposits remains stable in Azerbaijan. According to the CBAR, the volume of individual AZN-denominated deposits in February remained stable at January's level, up 2.2% YTD and 22% YoY.
“This contributed to a downward reversal of dollarization of household deposits following an increase in November–December. At the beginning of March, the share of household deposits in FX declined to 38.7% from 39.2% as of end 2022, returning to lows last seen at the onset of the pandemic. To recap, the leading rating agencies consider a material increase in dollarization of deposits as one of the factors for potential pressure on Azerbaijan's sovereign ratings. The current level of the rate is already sufficient to sustainably keep the dollarization of deposits at a level below 40%,” the specialist writes.
Also, according to her, the growth of the money supply halted, with volumes stabilizing at January’s levels:
“Stimulatory fiscal policy has led to a 1.8x growth in the money supply to 21.6% of GDP in AZN terms since the onset of the pandemic. Such growth also remained strong in annual terms at 26.1%. We note that the budget deficit for this year is planned at 2.4% of GDP (vs. 1.0% last year). Thanks to a tightening of monetary conditions, the broad money supply reverted downward at the beginning of the year. In February, this trend showed the first signs of resilience, with the money supply contracting by 1.9% YTD.”
Khaidarshina noted that while economic activity remains in positive territory, the balance of risks may shift toward economic deceleration in case of further rate hikes. At its March meeting, the CBAR noted 1) expansion of aggregate demand amid support from fiscal stimulus; 2) an FX inflow to the domestic market; and 3) high lending activity as key pro-inflationary factors.
“As an additional factor contributing to growth in the non-oil and gas sector, the CBAR highlighted implementation of the fourth package of social reforms. Nevertheless, GDP growth in 1Q23 stood at 0.4% YoY (down from 6.8% YoY in 1Q22). The positive rate of growth was driven by 4.9% YoY expansion in the non-oil and gas sector, supported by fiscal stimulus and tourist inflows. Given that the non-oil and gas sector is now the main contributor to GDP growth, the CBAR may take a pause in rate hikes in order to avoid excessive pressure on economic activity,” the economist concluded.