Azerbaijan's central bank (CBA) increased its policy rate by 200 basis points up to 7% on March 4 in order to "ensure sustainable macroeconomic policy" and encourage savings in manat, the regulator said in a statement. It also increased the upper limit of its rate corridor to 10%, keeping the lower limit at 2%.

CBA's reserves have declined by 20% since end-December to $4bn at end-February, and by over 73.6% since their peak of $15.2bn in August 2014. The regulator spent record amounts of reserves to prop up the manat, but had to eventually relinquish control and float it in December. Despite the free float, CBA has continued to support the currency through interventions in foreign exchange markets, occasionally relying on Azerbaijan's sovereign wealth fund Sofaz to auction foreign currency as well.

Despite the recent increase in interest rates, they continue to fail to reflect market interest rates, which exceeded 14% for manat-denominated deposits in February. Baku has used another tool - a much-awaited deposit insurance scheme, which came after six banks had their licences revoked and hundreds of thousands of depositors were left without their savings - to cap interest rates for manat-denominated deposits at 12% and for dollar-denominated deposits at 3% in early March, in an attempt to hamper capital flight and dollarisation, which ratings agency Fitch estimates has affected some 85% of deposits. The high dollarisation in the banking sector renders CBA's policy insufficient to impact markets in a meaningful way.

The Azerbaijani manat lost the most ground - 50% - against the dollar in the world in 2015, according to Bloomberg. Azerbaijan's hydrocarbon-dependent economy has taken a hit from the decline in oil and gas prices, as Baku found itself struggling to balance its budget, maintain currency stability, manage inflation, prevent a windfall on the banking sector and keep its social commitments as a result of lower revenues. The manat's exchange rate continues to be a managed one, as the regulator keeps intervening to support the currency.

"Troubling that the CBA has still not halted selling pressure on the manat as reflected by the continued need for significant daily foreign exchange interventions by the central bank... This latest rate hike is likely a further reflection of that. The manat likely has still not found its market clearing level," analyst Tim Ash from Nomura International wrote in a March 4 email note.   

This is the second rate hike CBA has undertaken in the last month, having previously increased rates from 3% to 5% in February. Observers expect it to further raise rates in the short term.