Sovereign reserves, as reported by the Central Bank of Azerbaijan (CBA), fell by 8.6% between October and November, to US$6.2bn.

Analysis

The level of import cover in Azerbaijan remains comfortable, at more than eight months, but the steady erosion of reserves during 2015 is a cause of concern for the authorities. On the CBA's

measure, sovereign reserves have fallen by just under 55% since the end of 2014. This is despite the 33.5% adjustment of the manat against the US dollar in February, which was intended in

part to relieve balance-of-payments pressures by depressing imports.

Devaluation expectations in Azerbaijan remain high. The level of M2 (a measure of total manat in cash and on-demand deposits) has fallen by almost 50% over the past year, as savers continue to move their assets into foreign currencies to guard against exchange-rate risk. This has led to a sharp squeeze in manat liquidity, which is restricting local-currency lending and putting the banking sector under pressure.

We continue to forecast that the authorities will devalue the manat for a second time against the dollar in early 2016. Monthly data suggest that imports are now starting to decline, falling by

an average of 15% year on year in July-October (although they grew slightly in annual terms in October). This will reduce the pressure on the balance of payments. CBA calculations suggest

that the real effective exchange rate is now significantly lower than it was immediately prior to the February devaluation, and therefore not so overvalued. However, we are sceptical of the

accuracy of the local inflation data, which we believe have understated the rate of domestic price increases since devaluation. Moreover, the authorities can not be certain that they have sufficient reserves to defend the currency until oil prices start to rebound.

Finally, fiscal pressures may also trigger a devaluation. We believe the government's target of cutting expenditure by 10% in 2016 will be difficult to achieve. In the context of high uncertainty over future oil prices, a devaluation of the manat would help the government to cut spending by less in nominal terms and also to conserve assets in the State Oil Fund of the

Republic of Azerbaijan.