Page 20 - Azerbaijan State University of Economics

Vugar Rahimov, Nigar Jafarova: The Exchange Rate Pass-Through to Aggregate
Consumer Price Index and Its Components In Azerbaijan

2. BACKGROUND INFORMATION ON THE ECONOMY
After the transition to market economy, Azerbaijan experienced high and volatile
inflation rates, disruption in many industries and political instability. It took more
than a decade to renew and establish new infrastructure in all areas of the economy.
The inflation rate was particularly high before 2001. However, activity in the
financial sector and to some extent enhanced credibility of the Central Bank helped
to overcome inflationary pressures and achieve lower and stable inflation rates. As it
can be seen from the Figure 1, between the years of 1995-2000, during the transition
period, Azerbaijan experienced high and volatile inflation rates which was then
replaced by low and affordable rates during 2000-2005. Since Azerbaijan is an oil
exporting country, global oil prices were among the major amplifiers of inflation
rates in the economy. From 2005 to 2010, oil prices went up by almost 50 percent,
which in turn, accelerated inflation level in Azerbaijan, particularly through the
fiscal channel and resulted in double digit inflation rates (Karimli et al., 2016).
More precisely, oil windfalls led to excessive budget spending and as a result
triggered inflationary pressures in the economy (Huseynov and Ahmadov, 2013,
2014). During the period 2010-2015, Azerbaijan has been able to achieve single
digit inflation rates due to exchange rate stability, low inflation expectations and
improvement in the management of oil revenues. The special role of the State Oil
Fund of Azerbaijan (SOFAZ) should be stressed for fighting high inflation rates in
the context of volatile commodity prices. Undoubtedly, the establishment of the
SOFAZ helped to prevent the lump sum cash flow of oil windfalls to the economy
and thus, depressed general inflation level. According to an ad-hoc rule, the half of
oil revenue must be transferred to the SOFAZ each year. However, the sharp
depreciation of the domestic currency in 2015 created pressure on prices and hence,
inflation rate started to accelerate again. As a result, during this period the annual
average inflation rate reached 6.2 percent, while even in 2016-2017 double-digit
inflation rate was recorded.

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