Average inflation in rated sovereigns in the Caucasus and Central Asia (CCA) region will remain above that of rating peers in 2023-2024, despite peaking recently, due to relatively underdeveloped monetary policy frameworks and vulnerability to external shocks, Fitch Ratings said on May 2.

Inflation across CCA leapt last year on higher food prices, disruption to supply chains and, in some cases, exchange-rate deprecation, Fitch said. For Armenia (B+/Positive) and Georgia (BB/Positive), large migrant inflows arising from the Ukraine war caused exchange-rate appreciation but also stoked domestic demand, reflected in high rental inflation, it added.

Added the ratings agency: “Headline inflation has declined this year in some of the CCA countries given the lagged impact of policy rate increases, as well as lower commodity prices and cooling demand. In March, the annual rate of inflation fell to 5.4% in Armenia, 5.3% in Georgia and 18.1% in Kazakhstan (BBB/Stable). However, it remains close to recent highs in Azerbaijan (BB+/Positive) at 13.8% and Uzbekistan (BB-/Stable) at 11.3%, and underlying price pressures remain fairly strong.”

When it comes to monetary policy tightening in CCA, the level of real rates vary across the region. Kazakhstan has tightened the most since the start of 2022 by 650bp to 16.75%, but real rates were still negative as of March, noted Fitch, adding: “The Central Bank of Armenia has increased rates by 300bp to 10.75% (real rates 2.65%). In Georgia, rates were lifted just once, by 50bp in 2022 to 11%, but the real policy rate is the highest among Fitch-rated CCA sovereigns at 5.7%. Uzbekistan is the only country to loosen monetary policy since mid-2022, but real rates are still positive (3.7%).”

Monetary policy is underdeveloped in Turkmenistan (B+/Positive) with credit-targeting the main policy tool and the policy rate unchanged for many years, the ratings firm also observed.

Monetary policy effectiveness in CCA sovereigns is generally weak relative to rating peers. Some reasons for this, according to Fitch, are high, albeit declining levels of dollarisation (56% of deposits in Georgia; 55% in Armenia, 30% in Kazakhstan), low credit penetration and the prevalence of preferential lending (notably in Uzbekistan), high sensitivity to exchange-rate fluctuations and underdeveloped policy frameworks (mainly for energy exporters).

Fitch said it anticipated that inflation would remain well outside the inflation tolerance band in Azerbaijan, and at over twice the target in Georgia and Kazakhstan by end-2023. “Armenia is the only CCA sovereign that we rate where we expect inflation to stabilise within the tolerance band by end-2023,” it added.

Fitch also assessed that a prolonged period of high inflation could destablilise inflation expectations that are not generally well anchored and add to FX demand. “This could negate some of the positive economic gains made in 2022 for many of these economies, such as robust growth and sharp improvements in fiscal and external metrics. The latter have contributed to the Positive Outlooks on Georgia, Armenia, Azerbaijan and Turkmenistan. In Kazakhstan, weakness in the macro-policy framework contributes to a -1 notch adjustment on the macro pillar of our Qualitative Overlay relative to our Sovereign Rating Model output, although the rating impact is offset by the +1 notch adjustment on external finances due to large sovereign external assets,” it concluded.