The Azerbaijani central bank will increase its key refinancing rate from 9.5% to 15% on September 14, in a desperate move to halt the country's mounting financial crisis.

The regulator announced its decision on September 9, saying that it would increase the upper limit of the interest rate corridor from 15% to 18% and the lower limit from 4% to 12%.

The central bank has increased rates from 3% in February in several interventions, in an attempt to boost the manat and stave off inflation, which reached 10.6% at end-July.  

Monetary instability has plagued Baku since February 2015, when declining oil revenues and pressure from falling currencies in Russia and Central Asia prompted the regulator to drop the manat's peg to the dollar in order to enable it to save its fast declining foreign exchange reserves.

Since then, the Azerbaijani currency suffered another major depreciation in December and has been gradually falling since May despite the central bank's monetary tightening in recent months. The Azerbaijani regulator spent some $11bn, or two thirds of its reserves, in supporting the manat between November 2014 and January 2016. 

Monetary instability has hit the entire economy, but some sectors such as banking and real estate have suffered the brunt of the crisis. Banks have experienced plummeting asset quality, capitalisation and profitability; 10 of them have been closed so far this year, and the country's largest lender, the International Bank of Azerbaijan (IBA), had to be bailed out in 2015.

Since April, Baku has banned lending in foreign currency as borrowers disproportionately defaulted on foreign exchange-denominated loans. The rate of non-performing loans in the sector is believed to be inching close to 40%, sources in Baku have told bne IntelliNews, well above the official NPL rate of 8%. Meanwhile, mortgage lending has all but stalled, prompting a 30% decline in real estate prices and a severe contraction in transactions. 

Mounting demand for foreign currency amidst rumours of a third sharp depreciation led to a busy black currency market in Baku in August, local media reported. Since January, sovereign wealth fund Sofaz and the central bank have held biweekly currency auctions to supply banks with foreign currency in order to mitigate pressures on the manat. However, in recent weeks, demand has exceeded supply 10-fold.

Furthermore, some of the currency Sofaz sells at these auctions ends up on the black market, Turan news agency has reported, citing economist Ogtay Hegverdiyev. Many lenders have halted currency exchange operations for retail customers. The government closed down non-bank exchange offices in January.

Until now, the central bank kept its interest rates artificially low; even when its rate was 5%, banks reportedly offered interest rates of 14% or more for manat-denominated deposits in order to attract customers amidst declining trust in the national currency.

While the recent policy decision in part represents the regulator's catching up with the market, a source in Baku that asked to remain unnamed has told bne IntelliNews that the short-term effect of the rate increase will be to hamper economic activity and lending to the private sector, even though it will reduce pressure on the manat. 

Against such a backdrop, Azerbaijani authorities appear to be losing control over monetary stability a mere two weeks before a referendum in which voters will decide whether to expand President Ilham Aliyev's powers. The referendum is heavily contested by opposition members and analysts, who claim that it represents Aliyev's attempt to pave the way for a dynastic presidency by enabling his young son Heydar, who is only 18, to take his father's position when the 54-year-old head of state retires.

Baku has cracked down on opposition activists, jailing dozens since August, and has banned rallies ahead of the referendum. Nevertheless, the opposition National Council of Democratic Forces (NCDF) party held a rally on September 11 which its chairman Ali Kerimli said would be the first of several. "We say no to corruption, plundering the people, unfair trial and incompetent governance," he reportedly urged at the rally.

Other opposition movements, such as Nida, also joined the protests. Turan news agency reported that initial estimates placed the number of demonstrators at 10,000, making these the largest such protests in the repressive country since 2013.

Some of the slogans chanted at the rally were "We Young People Say No", "End Dictatorship and Monarchy", "Freedom for Azerbaijan", "Salary is 105 Manats - Education is 4,000", "We Are Not Slaves", "Azerbaijan Is Country of Monopolies", "Support Truth - Curse Thief", "Freedom to Political Prisoners", Turan news agency reported.