EASING INFLATION PROMPTS ARMENIA’S CENTRAL BANK TO CUT KEY REFINANCING RATE
IHS Global Insight
November 13, 2013
by: Lilit Gevorgyan
Central Bank of Armenia (CBA) cut its refinancing rate by 50 basis
points to 8.0% as inflation started trending down in October, although
it has yet to fall into the target range set by Armenia’s Central
monetary authority.
Helping private consumption
Following its November board meeting, the Central Bank of Armenia
(CBA) issued a brief statement outlining the key reasons behind its
latest decision to cut its key refinancing rate to 8.0% from 8.5%.
While a full analysis of the move is expected to be released by CBA on
22 November, it emerged that both external low inflationary conditions,
as well as domestic factors, were among the drivers for the rate cut.
The board noted that inflation has been trending down since it peaked
in at 9.3% in August, gradually climbing down to 8.2% in September and
reaching 7.1% in October. On a month-on-month (m/m) basis however,
consumer prices have risen slightly in October by 0.3%, compared to
0.2% in September. The board gave a low probability that external
factors would add inflationary pressures to Armenian consumer price
developments. This is mainly due to subdued world food and energy
prices.
Domestically, good harvests have helped to lower food prices,
especially of local agricultural produce. However, a key concern
remains decelerating consumer spending. Exports and not private
consumption have been driving the Armenian economy in recent years.
Household consumption suffered a marked setback after the
Russian-controlled Armrusgazard energy company increased its tariffs
on gas. This resulted in 30% increase in domestic natural gas prices,
eroding Armenian households’ real disposable income. Furthermore,
the energy price increase pushed consumer prices well above the
2.5-5.5% inflation target band. This in turn, further curtailed
Armenian consumers’ spending intentions, while prompting the CBA to
raise its key refinancing rate by 50 basis points to 8.5%. However,
by introducing the rate cut, the CBA is hoping to make credit cheaper
and boost private consumption, which continued to slow down.
Another contributor to the rate cut was the dire state of the
construction sector, which continues to shrink. The latest data on the
state of the real economy released by the Armenian Statistics office
once again showed that the sector’s activity was down by 11.9% year
on year (y/y) in September. Residential construction in particular is
experiencing a slump. Despite high demand for new residential homes,
many households simply cannot afford them. Lending conditions remain
very tight and expensive as well, particularly mortgage lending. The
key refinancing rate cut is designed to mitigate the borrowing
expenses, although its impact is unlikely to be tangible.
Outlook and implications
The latest rate cut brings back the CBA key refinancing rate to the
level it had set prior to a 0.5% rate increase in August 2013. The
latter was in direct response to inflationary impact that a significant
rise in gas and electricity prices engendered. Since then an agreement
has been reached with Russia’s Gazprom and Russian authorities
to phase out 30% export tax on natural gas shipments to Armenia,
after the latter decided to leave its last-hour association and free
trade deal with the European Union (EU) and opt for the Russian-led
Customs Union. Its membership to the Customs Union has yet to be
finalised, but expectations of a further discount in energy imports
from Russia, other than the 30% tax waiver for Customs Union members,
are slim. Moreover, there have been conflicting reports from various
Armenian government officials if the final gas price reductions are
passed on to the population. It appears that it is unlikely, since
the government was already subsidising the new gas price, which was
just under 60% as requested by the Russian-controlled energy company
and not 30% that was transferred onto Armenian households.
Still, the waiver of the 30% customs tariff is likely to have a
disinflationary impact, especially through the expected decline in the
cost of transport, which is mainly reliant on liquefied gas rather
than petrol in Armenia. In the meantime, we do not expect consumer
spending to increase, which in turn will trip inflation rates further
to help is to come nearer to the 5.5% highest threshold set by the
CBA for its inflation target. However, one of the main goals of the
CBA’s latest rate cut is to stimulate household consumption. But
that is expected to prove difficult to achieve due to Armenia’s
still developing banking system, which lacks the full transmission
mechanism for the monetary policy decision to have a noticeable impact
on certain sectors of the economy.
In our latest forecast, we expect the inflation to average at 6.0% in
2013, slightly above the highest threshold of the CBA’s target range.
The CBA may opt for another rate cut over the next six months, should
the inflation rate declines below the 4.0% central target value.