Can bank measures recover Turkish lira losses?
Turkish lira (TRY) recently differentiated in a significantly negative way compared with other emerging market currencies in the same currency basket. The lira has also depreciated around 14% against the dollar over the last two months. In an attempt to combat these losses, the Central Bank of Turkey announced two non-interest measures. Firstly, it reduced the foreign exchange utilization rate in required reserves to leave some foreign exchange ($1.4 billion) in the market. Secondly, it provided a repayment option for export rediscount credits with a definite foreign exchange rate (TRY 3.70) until the start of February 2018. That means around $4 billion worth of foreign exchange will be able to stay in the Turkish market for the next three months.
The measures taken haven’t yet impacted on foreign exchange rates. The central bank’s rediscount credit measure was criticized for declaring the foreign exchange rate for repayment as
3.70 in advance. By declaring such a rate, the central bank indirectly indicates having a foreign exchange rate target in mind, which can then be seen as a base by the market. But investors considering whether to re-enter the market don’t like such bases as they may expect to reap profits from TRY.
Frankly, the measures taken cannot be expected to have a strong influence on foreign exchange demand. The amount of foreign exchange created and the amount of foreign exchange demand are spread over time, up to $5 billion. However, one month’s worth of Turkey’s current account deficit in recent months is almost equal to this amount.
Of course, we are also exposed to international fund flows. The real question should probably be whether the central bank will be able to overcome this latest fury without raising interest rates. The bank was able to survive the previous wave with an increase of 400 basis points. However, inflation was around 8% back then.
If the economy had been braking at half the length of the January-September period during which the TRY gained relative stability, the boosting effect of the exchange rate increase at the end of last year on inflation would have been partially eliminated and we would not have entered the winter months with such a high level of inflation. But this was not the case. Today, inflation is above the average funding rate. Moreover, when we look at the domestic producer price index, core inflation data and the course of foreign exchange rates, it is obvious that the rise in inflation is not temporary. Under these circumstances it is particularly difficult to call today’s interest policy a tight monetary policy.
It could be argued that the pressure on foreign exchange rates are rooted in geopolitical developments and that the central bank is powerless in the face of such non-economic developments. However, if an economy is also increasingly running a current account deficit, it is not right to link the exchange rate purely to geopolitics. If the central bank remains inactive, there is a risk of transforming into a stance where it will chase, rather than control, inflation. If it controls inflation, there is a risk that inflation will reach crisis point. The solution is crystal clear!