An alternative approach to the inflation calculation in Azerbaijan

Why alternative approach? This question was answered in early 2000 by local research
center working in Poland; in order to maintain the macroeconomic equilibrium. This is important
not only for having the credible rate of inflation in the society, but also for adjusting the social
and economic policy of the government. This research firstly started by the Polish Center for
Social and Economic Research in Central and Eastern Europe was continued with studies held
by Ukrainian experts of Association for Economic Education and Research. Finally, this issue
was raised in Azerbaijan by the Economic Research Center with funding support from USAID.
The justification of the actuality and importance of the project was not that hard for the
experts of the Economic Research Center when the project took a start. The views of various
experts concerning about the inadequacy of the official inflation rate in Azerbaijan were found
their basis in the analyses by various economists and were publicized via the mass media. The
importance of inflation in Azerbaijan was justified due to the physiological effects driven from
the expected adjustments to the Tax Code and menace driven from the last decision of Tariff
Council. Local experts have recently started to emphasize and discuss the problems related not
only with inflation, but also its social and economic impacts on living standards of the
population. Hence, an accurate measure of inflation in the country requires an adequate
estimation of living standards and real trends in the economic development.
On the other hand, the role of the inflation on forecasting is crucial. Moreover, we should
not forget about the correlation between current economic performance which is based on
processing of natural resources and subsequent development of the economy. The effect of huge
oil revenues on inflation must be under consideration too.

It is important to take into account all inflationary issues in order to estimate and analyze
the living standards of households. It is obvious that the population with lower level of living
standards requires the implementation of expensive economic reforms. If this is the case,
defining accurate policy needs wide, deeper and adequate analysis. Likewise, these analyses
must not be implemented by single state agency and study.

In order to contribute to the solution of raised problems and clarify the debates
concerning about the real inflation rate, the Economic Research Center has started to conduct
quite a new project on “Alternative inflation methodology development in Azerbaijan” which is
financed by USAID. Under the project, it is envisaged (i) to get a deeper insight into the
Consumer Price Index estimation methodology used in Azerbaijan and identify the shortages
with it, (ii) to learn the world’s most progressive practices of CPI calculation methodology and assess the applicability

Spotential of these practices in Azerbaijan and finally (iii) put into practice
an alternative price observation in the Republic of Azerbaijan via the alternative methodology
and then take actions to calculate the alternative CPI for the country.

The research team formed within the framework of the project identified the following
objectives which they considered pivotal:
• Work out an alternative way for changing the inflation level in Azerbaijan into a
comparative indicator;
• Increase the reality of the anti-inflation policy of the Government and propose the
corrections to the existent policy;
• Assess more accurately the monetary aspects of oil revenues by establishing real
inflation rate;
• Establish the real underpinnings for developing preventive actions so as to prevent
macroeconomic, financial and social threats with possible inflation implications in
advance;

A number of experts and representatives of international agencies repeatedly emphasized
that the inflation calculation by State Statistical Committee comes in compliance with
international standards. Of course, we also maintain that like in almost all countries of the world,
Consumer Prices Index characterizing the inflation level is calculated, in our country, by means
of Lasperyes method and the project intend to use that method calculating the data obtained by
statistical observation of the prices, since the extensive world practice shows that Lasperyes
formula appears to be the most progressive method for inflation estimation. Therefore, in
Azerbaijan, like in many countries, the inflation rate calculation based on the same methodology
is estimated by dividing current period (month, quarter and year) prices of the same consumption
basket to the consumption basket prices of the previous period of time.

In order to answer the logically validated question “if the same formula is to be applied, then
where can we see that alternative nature?”, we want you to focus on the below mentioned ideas.
First, do not forget that Lasperyes method is very generalized and final formula of
inflation calculation. Rather, depending on the methodologies used prior to and after this
calculation, the results characterizing the inflation level can drastically differ from each other.
Second, the goal is not only to search for the alternative method to Lasperyes, but also
find an alternative to the current the methodology in our country. So our stance is strengthened
via quotation by a well-known economist Scott Roger which says that “while calculating the
inflation, the challenge is not which methodology to apply, but how to apply it”, because the root
of most problems is concerned with its application. Ultimately, such an integrated approach may lead to obtaining inflation indicators not similar to each other. The issue that we should focus on
is the similarity of the methodology applied not only in the developed, but also in developing
countries. However, not in all countries, the inflation level is accepted unambiguously. For
instance, there are still doubts over this issue in Bulgaria, which used Western countries’
methodology, though in recent years, the government has started to intensify its calls for
cooperation with independent experts in order to eradicate these suspicions. So the research team
decided to investigate the methodology and its application issues used in Azerbaijan in an
integrated way. The issue of applying the current methodology is one of the main directions of
the research conducted within the project.

Taking all these into account and simultaneously, resting on the world practice, the
research team has started implementing an alternative approach concerning the inflation
measurement in Azerbaijan in two major directions.
First alternative approach deals with observation method of the prices for goods and
services selected (observed) to measure inflation and selection of the regions in which the
observations will be conducted and finally, the rule of Consumer Prices Index estimated for the
country. A major goal in this approach is to identify how and in which places price observation
of the goods and services included in consumption basket will be conducted. On the other hand,
the alternative methods of selecting geographical locations where the registration of the prices
for goods and services will be done are of the main elements of this approach. Furthermore, in
the world practice, the regions where price observation will be done are identified on the basis of
two criteria – a) the share of a region’s population in country’s population and b) the share of
region’s retail turnover on goods in country’s overall retail turnover on goods. At present, when
State Statistical Committee calculates Consumer Price Index, the first criterion is used.

Therefore, the main tenet of proposed methodology is not to select the regions using the
number of population. That is, we have selected the regions for price observation based on retail
turnover of certain regions. This approach is what IMF and ILO proposed to several countries.
Let’s clarify on this approach a little bit. So, according to the official statistics, the number of
population in the capital city of Baku is about 2 million and in this way the weight of the capital
in CPI is becoming smaller. However, the main part of the retail turnover belongs to the capital.
This, in its turn, leads to the reduction of the impact of the main region that has higher prices and
broader goods turnover on the overall indicator. Otherwise, the region where the population is
bigger, but has a lower price level, gets a bigger share and this causes the overall index to
decrease. The approach applied by Center’s research team rests on the goods turnover registered
with the prices existent in the region, irrespective of the number of the population living there,
and it enables to obtain the outcomes closer to the reality.

The second alternative deals with reflecting the compiled prices in Consumer Price Index
(CPI) and in general, the interpretation of the index. In terms of the mentioned approach, the
problem of the alternative methodology for Consumer Price Index is also important. Thus in the
real life, some non-monetary shocks can be the case which also, in its turn, are reflected in the
calculated inflation indicator. We can mention the following among these possible shocks: the
changes in the prices for some goods and services that occurred because of the seasonal impacts,
and the changes in the prices of energy products. Given the fact that the mentioned factors have
higher hesitation and are of short-term character, like in every country, it is necessary to apply
fixing inflation indicator in Azerbaijan. We should mention that at present, National Bank of the
Azerbaijan Republic calculates the mentioned indicator for internal use only.

World practice proves that the prices for certain group of goods and services in the
consumption basket remain stable over medium and long-term period and when calculating the
inflation, the stable prices of those goods and services make a softening impact on the inflation
level. Using this practice, we also plan to calculate CPI by removing the goods and services with
price stability out of consumption basket in Azerbaijan.
In general, the major objective in all the mentioned issues concerning the second
approach does deal with estimating pure inflation in the country. That is, pure inflation indicator
calculated on the basis of the rest of components remaining after excluding some components
(the prices exposed to shocks more often are mainly set on the basis of non-economic factors)
used in estimating Consumer Price Index helps establish the anti-inflation policy of the country’s
Central Bank and identify which part of the rise in prices is attributable to the monetary factors.
In a word, the major objective of estimating pure inflation in the country is to obtain a
sustainable inflation indicator.

Besides both of the alternative scientific-methodological approaches mentioned above,
under the Project, the research team has put forward a set of alternative and practical positions
for getting more realistic inflation indicator in Azerbaijan. Rather, in the view of the research
team, both of the major reasons why the official inflation level announced in the country does
not reflect the reality are (i) the improper implementation of the price observation by the state
and (ii) erroneous calculation of the compiled prices. Both of the problems may occur both
intentionally and unintentionally. We should note there is no need to dramatize the mistakes
unintentionally made by the state or a government agency. Even in the most developed countries
of the world, it is possible to encounter such type of mistakes caused by government agencies’
incompetence and lack of concentration. For instance, recently, Canadian State Statistical
Agency has officially announced that the indicators announced on Price Index of services for the
last five years are incorrect. The agency gave the following explanation: There is an error in the formula inserted to the computers to calculate price index of the services. And in reality, Price
Index of the services should have been at least 1 per cent higher than officially announced
figures.

The mistakes made intentionally in the observations and calculations are the problem that
preoccupies the research team much more. From our perspective, we can not justify such an
approach.
Under the project implemented by the research team, one of the main targets of the price
observations to be conducted in the capital city and regions is to identify the main causes of the
distortions (if such distortions are really the case) disclosed via the comparison of the estimated
alternative consumption prices with the officially announced inflation.
And all in all we should also note that the research team tries to adapt the actions taken
under the project to the current methodology. Here the main goal serves to make both results
reach the competitive form.

As a result of the expected implementation of Project’s action plan, the research team
intends to obtain the following outcomes:
• Increased responsibility of the government by providing real inflation level obtained
through an alternative approach and by doing this, make a positive impact on the
conformity of the alternative inflation indicator with its actual level;
• Establishing the basis for implementing economic policy that rests on actual inflation
level in order to preserve macroeconomic stability;
• Regulate properly the foreign exchange pressure of oil incomes on the domestic market
and ultimately, increase the management efficiency of oil incomes;
• Find arguments to adopt timely and rational decisions for business institutions, banks,
insurance and credit entities;
• Establish alternative reference points for policy-makers and researchers.
The publication of this article has become possible with support of American People through
USAID. ERC carries the full responsibility for the contents and the judgments made herein do
not necessarily reflect the views of USAID and the USA.

Research Group of Economic Research Center