ISTANBUL BLOG: Handbrake on rates and lira, even as wheels are turning

ISTANBUL BLOG: Handbrake on rates and lira, even as wheels are turning
*ENAG is an Istanbul-based inflation research group that produces alternative readings on price movements in Turkey. / bne IntelliNews
By Akin Nazli in Belgrade May 26, 2024

The monetary policy committee (MPC) of Turkey’s central bank on May 23 kept its policy rate unchanged at 50% in line with market expectations (chart).

Disinflation will be established in the second half of the year, the MPC reiterated.

The central bank would continue to implement macroprudential policies and sterilisation tools, it was also stated.

Earlier this month, the national lender took a real step towards simplification/normalisation with the scrapping of the local banks’ obligation to buy government lira papers.

Since the policy rate reached meaningful levels, lira bond yields have actually risen to levels at which the banks buy without pressure. Some foreign interest is also observed.

The Erdogan administration’s full control of the FX market, meanwhile, continues. There is no signal yet as regards a shift to a floating exchange rate regime or the scrapping of the rule that forces exporters to sell 40% of their revenues to the central bank.

​​The next MPC meeting is scheduled for June 27. The rate-setters at this point look set to stick with the 50% benchmark.

In June 2023, following the post-election appointment of Turkey’s new economic team led by finance minister and ex-Wall Street banker Mehmet Simsek, the Erdogan regime U-turned on monetary policy and launched a tightening process that is ongoing. The policy rate was hiked to 50% by March this year from 8.5% in June last year.

On May 3, the Turkish Statistical Institute (TUIK, or TurkStat) said that Turkey’s consumer price index (CPI) inflation officially stood at 69.8% y/y in April versus 68.5% y/y in March and 38% y/y in June 2023.

TUIK also posted April official inflation of 3% m/m versus 3% m/m in March, 5% m/m in February and 7% m/m in January.

TUIK is set to deliver further outcomes in the 2-3%s for the official monthly headline indicator.

On May 9, the central bank hiked its end-2024 official inflation "target" to 38% in its latest quarterly inflation report from the 36% stated in the February report.

The upper boundary of the end-2024 forecast range was pushed up to 42%.

The authority sees the official annual series peaking at 75-76% in May and average official monthly inflation declining to 1.5% in 4Q23.

On August 8, the central bank will release its next inflation report and updated forecasts.

Turkey’s CDS regaining popularity
Looking at the global markets, as things stand they do not suggest any notable turbulence. Turkey’s CDS remain below the 300-level, while the yield on the Turkish government’s 10-year eurobonds remains below the 8%-level.

In June, the European Central Bank (ECB) is expected to deliver a rate cut while the Federal Reserve has been delaying the delivery of its expected cut.

Obviously, the USD is expected to make a limited gain over the EUR. Turkey buys energy and other intermediary goods in dollars and sells final products to Europe in euros.

However, game-changing pressure is not expected at the moment over awaited developments in USD/EUR parity.

On May 23, Reuters reported that the finance industry was once more showing interest in Turkey’s CDS.

It is a clean instrument, similar to currency swaps on the London offshore market, for betting on Turkey without getting involved in local risks in relation to the lack of rule of law.

No lira devaluation
Since March, the Erdogan administration has been applying its straight-line USD/TRY rate policy. It has been drawing a line around the 32-level this time around.

The regime insisted on not delivering its traditional post-election lira devaluation, following the conclusion of the March 31 local polls. And, it won.

In the first few weeks, the finance industry awaited a devaluation. However, since it did not occur, portfolio inflows have reached significant levels in the last few weeks.

Carry Trade Flows to Turkey (estimate)
million USD Turkish Banks Off-Balance Sheet FX Position Turkish Central Bank's Total Swap Stock with Local Banks Swaps Converted to
Turkish Central Bank's Net Swap Stock with Local Banks Turkish Banks' Swap Stock with Foreign Counterparts (estimate) Carry Trade Flows (estimate) Cumulative Flow
Mar 29, 2024 55,781 57,898 433 57,465 -1,684    
Apr 5, 2024 53,366 53,569 433 53,136 230 1,914 1,914
Apr 12, 2024 53,712 52,336 433 51,903 1,809 1,579 3,493
Apr 19, 2024 47,020 44,495 413 44,082 2,938 1,130 4,623
Apr 26, 2024 43,446 39,586 363 39,223 4,223 1,285 5,908
May 3, 2024 43,912 36,813 243 36,570 7,342 3,119 9,026
May 10, 2024 43,112 31,398 243 31,155 11,957 4,615 13,641
May 17, 2024 39,292 25,355 243 25,112 14,180 2,223 15,864

Table: Between March 29 and May 17, Turkey attracted about $16bn in carry trades.

Net flows to Turkish government lira papers
million USD Weekly Cumulative
Apr 5, 2024 86  
Apr 12, 2024 38 125
Apr 19, 2024 115 240
Apr 26, 2024 604 843
May 3, 2024 761 1,604
May 10, 2024 2,833 4,437
May 17, 2024 1,339 5,776

Table: Some interest (around $6bn) was also observed in government lira papers.

Banks’ swap limits with foreign parties
With inflows via swaps rising, Simsek said that rises in one-way (buy lira at spot and swap it with a Turkish bank) limits and at maturities longer than six months were under consideration.

Tweet: How the "carry" works

In October last year, bne Intellinews pencilled in April 2024 for the likely beginning of discussions on increasing swap limits. As it turned out, the start came a month later, given the lira devaluation expectation as explained above.

Currently, 1-week swaps cannot go over 5% of a bank’s equity, while the limit is applied as 10% for 1-month and 30% for 1-year maturities.

As of May 17, the Turkish banking industry’s combined equity stood at $90bn while banks’ swaps with foreigners were estimated at around $12bn.

In the shorter-term maturities, the pressure on the limit could be felt soon.

No lira appreciation
Portfolio inflows are not resulting in lira appreciation since the central bank is buying everything.

Simsek: No lira appreciation.

In addition to portfolio inflows, local banks have delivered some FX loans (in-balance sheet FX assets are up) and FX deposits have to a degree declined (in-balance sheet FX liabilities are down).

For exact figures check the banking watchdog BBDK’s weekly bulletin here.

As a result, the banks cut their FX swaps with the central bank and sold the sum to the authority.

In the table above, the central bank’s net swap stock with local banks declined by $32bn from March 29 to May 17. This sum is thought to have been bought by the authority.

Here, it should be noted that the central bank is not happy with the FX loan growth. On May 23, it introduced some more macroprudential measures in the form of a cap placed on the FX loan growth.

It could be expected that the increase in the FX loans would not bring more declines in the swaps, while the declines in the swaps will depend on the declines in FX deposits in the coming period.

In the same period (March 29-May 17), the central bank’s net FX position recovered by $51bn. It looks like the $32bn of decline in the local banks’ swap stock and around $22bn of portfolio inflows were entirely bought by the central bank.

As of May 16, the central bank’s FX position was estimated as standing at about minus $16bn.

According to Simsek, if the central bank had not bought FX, the USD/TRY would have fallen into the 20s.

He also states that the central bankers inform him that they are not intervening in the currency market and are applying a free-float regime.

Then, Simsek complains that Turks do not take what he is talking about seriously and are not selling their gold or FX.

Reserves up, interest rate down
The $32bn rise in reserves that came about from the swaps with local banks sterilises itself. However, the central bank has pumped the remaining $20bn worth of central bank money into the system.

As a result, the interest rate in the interbank money market fell to the lower bound of the central bank’s policy rate corridor, namely 47%.

In response, the authority on May 23 introduced some more macroprudential measures to absorb the excess liquidity.

With the move, @VeFinans and @e507 calculate that the central bank withdrew about Turkish lira (TRY) 550bn ($17bn) of central bank money from the system. And, the interbank rate moved up to the upper bound of the corridor, namely 53%.

Real appreciation
Although the lira is not appreciating in nominal terms, it is gaining significant value in real terms as actual inflation stands at above 100% and official inflation at 70%.

Turkey’s wildly-praised U-turn into “orthodox”economy management parrots the line that they will secure appreciation in the lira’s real value.

Officials are applying one of the harshest versions of an old-school programme, handing the bill to the masses.

Even the IMF, afraid of social explosions over the booming inequalities across the globe, does not apply this kind of programme anymore.

In Turkey, no social reaction is possible. When a few people come together on the street, they are swept up by the police.

As a result, the “orthodox” can trample upon the Turks to their heart’s content.

For a Turk, a vacation on a Greek island is again much cheaper than a vacation in a Turkish town on the Aegean coast.

The “orthodox” are currently pushing to avoid a mid-year hike in the minimum wage. 

Buy responsibly
As a result of the portfolio inflows, the northward pressure on the USD/TRY pair was reversed and the window for slowly building up lira papers is now open.

The mantra begins: “Buy responsibly. Buy gradually. Keep your Turkey exposure at below 10% of your portfolio.”

Then, there’s some late-evening drama, when Turkey’s president, Recep Tayyip Erdogan, fires his economy team on a Friday night. Some people abjure trading Turkey, others cry foul.

As the Erdogan administration sticks to not delivering an appealing lira devaluation, the window for benefiting from the subsequent appreciation, meanwhile, remains closed.

Investors’ eyes, as a result, focus on interest gains.

Ahead of the May inflation announcement, in which official inflation will peak, the horizon for the beginning of rate cuts (currently expected in 4Q24) is discussed. Government lira paper price jumps with rate cuts will be on the radar.

For the first time, Turkey is not attracting sizable carry trade inflows. It is only the finance industry and financial media that are once more pumping up the idea that some great developments are afoot in the country.

Since there is no free-float regime at the moment, there is no explosion seen on the cards.

However, when the carry traders close their position, the Erdogan regime may let the lira depreciate.

In its latest medium-term programme (OVP), officials pencilled in an average USD/TRY (central bank buying) rate of 37 for 2024.

The pair may not stay in the 32s for ever.

The finance industry (mainly hedge funds) is striking at the moment (although it is “one-leg” striking on the interest rate since the exchange rate is not subject to a free-float) and it will run or take a profit at some point.

So, the question is, when is the run? Bank of America (BofA) Securities (known as the brokerage house that rides the “Borsa” or “Casino Istanbul”) calculates that 3-month forward contracts offer up to a 9.4% return.

Mahfi Egilmez, a popular professor of economy, calculates the 3-month return via lira deposits at 12.5%. When the cost of borrowing USD is extracted, his figure approaches the BofA figure.

Egilmez also points to problems of the carry trade, namely lira appreciation and the currency fluctuations. Since Turkey currently does not apply a free-float regime, harsh fluctuations do not seem likely, while real appreciation of the lira is already felt as explained above in the “Greek vacation”.

What about the return?
Not bad but not double-digit. Carrying Turkey risk. Is it worth it? It is up to you.

If the exchange rate was free-float, the currency gains would multiply this sum into double digits.

The 3-month maturity also points to the end of summer.

On November 5, the US will hold its presidential election. Donald Trump has strength in the polls and will come along with a roar. The idea is that he is up against a corpse. The motivation levels of the anti-Trump voters will decide the outcome.

In any case, “end of summer, September, October, US elections” may provide some ideas about the maturity.

Borsa Istanbul, as you know
Recently, “unnamed sources” have been pampering Turkey’s equity market via Reuters. Apparently, Arab buyers are up for buying Yapi Kredi Bank. 

The indices are going crazy, up and down.

Still, there’s no foreign interest in the Turkish casino.

Gangs are daggers drawn
Although, so far, there are not enough significant developments to say it will make any difference, the gangs that make up the Erdogan regime are currently clashing.

From time to time, this publication reports that the gangs are “jostling”. At the moment, things are beyond ordinary jostling activities.

Erdogan’s gangs are attacking his junior coalition partner Devlet Bahceli’s gangs. Some police have been arrested and some scandalising trials are being held.

Tweet: Official account of the Turkish police force.

In the most extreme of outcomes, as seen in the coup attempt in 2016, factions have battled with military tanks and F-16 jets on and above the streets.

So far, it does not seem like we could get to such a showdown.

This publication has repeated ad infinitum that there is no opposition in Turkey, just an appearance of one to fool the fools. Admittedly, this may sound like a conspiracy theory.

But hold on, what’s this? A person who was advising the “main opposition leader” was allegedly at the same time helping a drug dealer, who it is claimed is associated with ex-interior minister Suleyman Soylu, flee abroad.

Criminals fight each other just for the money. It is the rule.

The problem between Erdogan and the Nationalist Movement Party (MHP) chair Bahceli is down to the fact that the cake has been getting smaller and smaller.

The pair first partnered after Erdogan lost his parliamentary majority in the June 2015 elections. They went on to spend like sailors.

Since Turkey’s 2018 currency crisis, there has been less and less to go round.

Erdogan pushing for constitutional amendments
With constitutional amendments, Erdogan wants to scrap the “50% plus one vote” rule to declare a victory in the first round of the presidential election.

If he can achieve this, he will switch to a one-round-only, first-past-the-post system, and he will be able to get rid of Bahceli.

The “softening” talks Erdogan held recently with the new chair of the Republican People’s Party (CHP), Ozgur Ozel, were all about this. Ozel will be his new boy as he sets about “softening the political atmosphere in the country”.

As part of this, Erdogan is gifting the CHP the release of the plotters of 1997’s February 28 Post-modern Coup.

However, big-name prisoners Selahattin Demirtas and Osman Kavala have not been released. There is no “softening” for the Kurds and liberals.

An interesting note: Erdogan also pardoned the 2019 murderer of local election ballot box watchers of the Islamist opposition Felicity Party.

The next elections in Turkey are scheduled for 2028. Evidently, preparations are always under way. It was ever thus.

When it comes to Ozel, a young Erdogan would play Ozel like a fiddle. However, the CHP currently stops short of talking about regime change. Ozel’s predecessor played the role of opposing the regime; hence, he was no threat to Erdogan. However, if the opposition under new leadership does not have a problem with the regime, then might it not be thinking: "Why not just replace Erdogan?"