Taking into account the fading out of short-term negative waves from external shocks, the stabilization of the domestic foreign exchange market in April-May, the recovery of foreign exchange inflows and growth of term deposits in national currency, the Central Bank cut the policy rate to 16% per annum.
According to the Monetary policy guidelines, “relatively tight” conditions on the domestic money market are those that ensure real positive rates of 2-3 percent, and 4-5 percent for the “tight” phase. In April-May, real positive interest rates formed at 6-7 percent, thus leading to the upper limit of monetary tightness.
The current policy rate cut is aimed at neutralizing of the extra burden, added due to external risks with simultaneous maintaining “tight” monetary conditions in order to curb inflationary risks.
External economic conditions. Short-term negative effects caused by unfavorable economic conditions in main trading partners are almost behind, and in contrast to the initial estimates, positive dynamics in key economic indicators is observed over the last two months.
In particular, the volume of foreign trade and rapid recovery of remittances have increased supply in the domestic foreign exchange market and, accordingly, supported the appreciation of the soum.
In January-March, the average monthly volume of incoming remittances amounted to about 490 million dollars, while in April-May they reached 1.3 billion dollars. Similarly, the volume of monthly export revenues increased by 1.3 times compared to January-March, the amount of foreign exchange on the domestic market from export revenues increased by 1.4 times.
Despite Uzbek soum depreciation against the US dollar by 6.8 percent in the first half of March compared to the beginning of the year, the national currency appreciated by 5.1 percent since the second half of March. As a result, the depreciation of the soum since the beginning of the year amounted to 1.6%.
In general, by the end of May, the real exchange rate of the sum has reached its long-term trend (appreciating by 2% compared to the level in September 2019), which, in turn, does not harm external competitiveness.
Given the current situation, in order to prevent sharp appreciation of the soum, during April-May in accordance with “neutrality” principle the Central Bank purchased 523 million dollars on the domestic market.
In general, since the beginning of the year, about 1 billion dollars have not been sold on the market through regular interventions, which, in turn, will serve as an additional source of resources for the stabilization of exchange rate in the future.
At the same time, high macroeconomic uncertainty and risks probably will remain in the world economy until the end of the year.
Economic activity. In recent months, there has been a slight slowdown in the activity and in the pace of lending to the economy by commercial banks.
By the end of May 2022, the annual growth of loans’ balances to the economy amounted to 17.4 percent, which is somewhat lower than the expected growth rate of nominal GDP.
In the first quarter of this year, the volume of loans to the economy increased by 13.6 percent compared to the same period last year, while in January-May the growth rate slowed to 8.8 percent.
According to the Central Bank, the economic activity index was reported to have dropped from 54 in March to 53 points in May. The declining dynamics was mainly observed in the services and trade sectors.
Domestic price dynamics and inflation expectations. By the end of May, the annual inflation rate amounted to 11 percent, which is within the forecast trajectory.
At the same time, the annual growth in non-food prices was 10.3 percent and the prices for services - 6.2 percent, lower than the overall inflation. The price level for foods rises in line with prices on foreign markets.
By the end of May, the core inflation rate reached 10.4 percent on an annualized basis. The contribution of core inflation to overall inflation amounted to 7.8 percentage points, slightly down compared to the same period last year.
While seasonal decline in prices for fruits and vegetables has a subduing effect on overall inflation, an increase in prices still keeps on some food and non-food items.
Emerging inflationary processes are mainly associated with supply factors, reflecting the negative impact of the current geopolitical situation in the region on the supply of goods, transport and logistics.
While the expectations of the population and businesses for the next twelve months were significantly lower in April, in May there was an increase in short-term inflation expectations as a result of expected increase in regulated prices.
Taking into account further decline in prices for fruits and vegetables in summer, lower exchange rate pass-through and expected tariff liberalization, the inflation forecast for the current year has been left unchanged at 12-14 percent.
In order to stabilize prices on domestic markets, the Government takes steps to increase the supply of products on consumer markets, to overcome logistical issues, to meet the demand for basic consumer goods through finding alternative import sources.
Monetary conditions. In April-May, the average interest rate on money market was at around 18 percent, which serves “tight” monetary conditions in the short-term resource market.
Interest rates on term deposits in the national currency (21-23%) form positive gap to inflation expectations of the population, which makes deposits in the national currency attractive. The temporary declining rate of deposits in the national currency observed in March has already turned into a growing path in April-May. The volume of term deposits of the population increased by 22.4 percent compared to the beginning of the year.
At the same time, the volume of cash in circulation has been growing rapidly over the past two months, which is due to the increase in the volume of the foreign currency sold by population to banks received through the cross-border remittances and social benefit paymnets. In particular, over the past five months, the positive gap between the purchases of foreign currency by banks from the population and the sales of foreign currency to the population amounted to 1.5 billion dollars.
Interest rates on loans in the national currency averaged 22-23 percent.
Macroeconomic expectations. Foreign exchange inflows in the form of remittances and foreign direct investments to the country are expected to support the supply on the domestic foreign exchange market and serve to stabilize the exchange rate of the soum in the short and medium term. Exchange rate stability, in turn, will serve to mitigate the effects of “import inflation” on prices.
By the end of the year, in order to increase the attractiveness of assets in the national currency by ensuring the positive real interest rates and to achieve the effective transmission of monetary policy decisions into the economy by regulating the overall liquidity of the banking system:
overnight deposit operations and two-week deposit auctions to attract liquidity will be carried out without restrictions;
limits on the average monthly balances of short-term bonds issued by the Central bank will be raised up to 25 trillion UZS;
yields on Central Bank bonds purchased at auctions by commercial banks will be maintained at the upper limit of the policy rate.
The Central bank's medium-term macroeconomic forecasts will be updated at the end of the second quarter. The next Board meeting of the Central Bank on policy rate is scheduled for July 21, 2022.