By Samvel Avagyan

Last week, the Central Bank of Armenia (CBA) raised the annual refinancing rate by 0.5%, up to 7.75%, which aroused concern.

This is the highest refinancing rate since 2006. However, is the measure effective and is it not fraught with unfavorable consequences for the economy? Raising the refinancing rate is the CBA`s principal means of curbing inflation. The CBA is thus revaluing the national currency and reducing demand for it. Thos inflation management model is applied by 27 countries. However, Armenia is the only CIS member-country practicing it. Is it advisable to follow western practices blindfold?  

To understand it, let us analyze the consequences the changed refinancing rate may have for refinancing. Refinancing rate is an interest rate on a seven-day loan the CBA issues to commercial banks. This short-term loan is first of all intended for settling the problem of bank liquidity. If banks do not have any serious liquidity problems, changes in refinancing rate hardly affect their liquidity. Recent years have shown that in issuing the loan the CBA hardly considers the refinancing rate. Money has always been expensive in Armenia, while refinancing rate has been low.

Two years ago the annual refinancing rate was 4% to 5%, and commercial banks issued loans at an interest rate of 20 to 25 per cent. With the different being so great, any greater role of the refinancing rate was out of the question. The difference between the refinancing rate and interest rates on loans has been reduced over the past two years. However, the refinancing rate is rising, while interest rates on banks loans are decreasing. Even if the gap between the two indicators is filled up, it does not guarantee the operation of mechanism of reflection on the refinancing rate. A psychological factor plays an important role as well. The CBA should gain public and market confidence.

So it can be concluded that changing refinancing rate is not an effective method of inflation management. Rather, it is a simulation. Considering the above, one should not be surprised at uncontrollable inflation in Armenia.