Exchange rate risk is imminent

The Lira looked relatively stable for a long time. It is astonishing to note that somehow the party in power managed to keep the exchange rate flat for over a year and it tries to reach the Election Day without a currency crisis.

● In order to do that they have spent every penny they got. We are approaching May 14 with a record high negative net reserve, even including swaps. The other device that kept it going is the exchange rate-protected TL deposit mechanism.

● Meanwhile budget dynamics deteriorate. The eventual burden of the exchange rate-protected TL deposit scheme is unknown, but it exceeded USD 10 billion. It can’t be abruptly ended even if the opposition wins, just as it would be impossible to resort to a big bang solution whereby the TL interest rates would hit the sky. I predict a gradual approach.

● Either gradualism will help stabilize the currency by truly slowing down dollarization and eradicate the burden of this scheme slowly or it won’t work. If it doesn’t work and building up credibility requires drastic measures, then the opposition will have to do just that.

● In fact the exchange rate-protection could only work if the Lira depreciates fast. Ironic isn’t it? Unless the Lira depreciates –theoretically the depreciation should be equal to the inflation differential between Turkey and its trading partners- there would be no reason left to prefer this kind of TL deposit over other financial instruments.

● This is exactly what has been happening a couple of months ago but now even for the TL-TL protected accounts –that is switches from Lira accounts to exchange rate-protected Lira accounts- banks offer very high interest rates.

● There is also a significant tax advantage. This is why people rush to protected accounts anew ahead of elections. They predict a steep TL depreciation but they also want to be sure they get a handsome TL return if this doesn’t happen fast.

● And they may get what they want. The only risk is that the minimum maturity for such accounts is 3-months, and 3 months is a long time here.