Our Analytics 18 july — 12:00

Will Central Bank succeed in stopping inflation? (Our analysis)



On August 1 of this year, the Central Bank of Azerbaijan (CBA) will consider the issue of lowering the discount rate during its regular meeting. This was announced at the last meeting of the Bank's board.

The Board of the CBA then noted the potential for lowering the discount rate from the second half of this year, depending on the economic and inflationary dynamics, on which the country's economic growth and the welfare of the population directly depends. The need to reduce the discount rate, which currently stands at 15%, has repeatedly been noted by Azeri Daily. Finally, the CBA decided to take such a step, but its reality and effectiveness are not mentioned. Let's try to understand this ourselves.

The coveted goal of the CBA is to approach the single digit inflation by the end of 2017, as the head of the Central Bank, Elman Rustamov, often says. It was through this prism that we considered all the actions taken by the CBA in recent months; and the expected decision to lower the discount rate is undoubtedly also aimed at achieving this goal. The problem, however, is that inflation in annual terms has not declined for almost six months in a row. Perhaps it reaches its natural maximum. But will it begin to decline further and is this forecast realistic at all?

Inflation reaches a maximum

To start with, in May of this year, annual inflation rose to 13.8% compared to 13.5% in April, as can be seen from Graph 1. This year, for the first time in the last eight years, even traditional seasonal deflation was unable to contribute to the decline in inflation. Over the past five months since the beginning of this year, the average level of price growth is 13% in average annual terms, compared to 11.4% last year.

Note that in the difficult year 2015, annual inflation was only about 4%. But in 2016, inflation rose sharply against the background of the low inflationary base of the previous year. This is understandable, since the second, and more ambitious, devaluation of the manat, although it was implemented in late 2015, has already given its fruits in the next year, 2016.

Since 2016, the CBA has embarked on an extremely tight monetary policy. For this, it is enough to note that the financial institution in several stages began to raise the discount rate from 3% in early 2016 to 15% in September of the same year. And although the discount rate has been kept at such a high level for 10 months, inflation in the country continues to grow at a faster rate.

In the current year, inflation became even more tangible even in comparison with 2016. Despite the fact that the outpacing growth of inflation occurs against the background of the high inflationary base of the previous year. Such high inflation was in the country in 2007-2008, but then it was not so noticeable, as the nominal incomes of the population grew at about the same double-digit rate. But will this tight monetary policy be enough to curb the rise in prices and reduce inflation to a single-digit level? To answer this question, it is necessary to understand what contributed to the growth of inflation in early 2017 and its stable increase in recent months.

First factor: Growth of the consumer price index for foodstuffs

As official statistics show, the main reason for inflation growth (CPI for all goods and services) is primarily related to the growth of the consumer price index for food products, which is one of the main components of the inflation rate. And the consumer price index for food products in Azerbaijan continues to grow. As can be seen from Graph 2, if in January 2016 the annual growth rate was 18.3%, then in May it fell to 11.9%.

Here it is necessary to take into account the following factor. The sharp increase in the consumer price index for food products at the beginning of last year is explained by the low level of inflation in January 2015 and the December (of the same year) devaluation of the manat by almost 50%. And the May decline of this index is connected with the relatively high inflationary base of the same period of the previous year caused by the February devaluation.

In 2017, on the contrary, in January the consumer price index (CPI) for food products was 14.5%, in May it rose to 18.2%. This, in turn, is due to the fact that this year the annual average monthly growth of the index exceeded 1.5%. There are several reasons for this growth. First, the continuing creeping devaluation of the manat, which reached its peak (above 1.90 manats to 1 dollar) by the end of the past the beginning of this year, which caused a rise in prices for all imported goods. Secondly, the growth of the CPI for food products was due to the growth in the price index of producers of agricultural and manufacturing products, which has been observed since the beginning of this year (Graph 3).

Second factor: Growth of the price index for services

The second factor that influences inflation is the rise in prices for non-food products and services. Unlike food products, prices for non-food items also sharply increased at the beginning of this year, but then did not undergo any special changes. For five months in a row, they kept steadily at the level of 12.5% against 15.3% for the same period last year.

But, unfortunately, this cannot be said about the growth of the price index for services, which contributes to galloping inflation in Azerbaijan. The service sector accounts for approximately 22% of the country's consumer market. In past years, prices in this sector were relatively low. But this year there is a very different picture. So, according to the results of the first five months of this year, this indicator was 9.1%, which is more than twice higher than the similar indicator of last year (4.4%). And for this period, the rise in prices for services, in contrast to past years, is at an advanced rate.

Apparent at first glance, the paradox is explained simply. The rise in prices for goods sold in the consumer market could not leave aside services for which these goods are practically an intermediate consumption. And such a sharp rise in prices for goods, which are listed above, forced to soar prices for services. The sharp rise in prices for food products and services practically levelled the expected positive effect of the seasonal factor.

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