The Turkish lira on June 7 sharply depreciated against the dollar to a new record low, but the big movement caught few off-guard as, with the re-election of Turkey’s President Recep Tayyip Erdogan complete, there is a growing expectation that his administration will try to dig Turkey out of its economic hellhole by attracting hot money inflows—but to do that officials have to first loosen their tight grip on the currency ahead of a possible monetary policy U-turn that would permit rate hikes.
The USD/TRY rate in the interbank market was up by 6% d/d into the 23s. A new record high of 23.27 was registered. Free market prices at the Grand Bazaar in Istanbul were also hovering in the 23s. Lately, the gap between the interbank and the Bazaar rates has narrowed with the government allowing the lira to depreciate in the interbank market.
Turkey’s FX market has long been marked by its lack of free status. Amid the booming lira supply and hard currency outflows via unprecedented trade deficits, officials have only managed to keep something of a brake on the lira by strong-arming bankers into blocking (non-capital controls) and suppressing (macroprudential measures) domestic FX demand. Also supportive are those unidentified inflows and other assistance from “friendly countries”.
Prior to market-friendly Simsek’s appointment, a positivity took hold in media coverage of Turkey’s economic trajectory. Orthodoxy is in the house. A positive real return for investors has been signposted.
However, the media’s positivity has not brought front-loaded portfolio inflows that would shelve the need for a devaluation. In fact, the finance industry has been demanding a devaluation in advance.
The media is currently aiming to pump positivity with suggestions that Simsek has scrapped government intervention in the domestic FX market.
Prior to Simsek’s appointment, the visible impacts of the overvalued lira on the real economy and the gaping trade deficit suggested that a devaluation was inevitable. In such a case, an ongoing controlled devaluation will continue until the first monetary policy committee (MPC) meeting. Then, a front-loaded rate hike would open the doors for a flood of hot money.
The MPC will hold its next rate-setting meeting on June 22.
Since last week, rumours have suggested that Hafize Gaye Erkan, a finance industry professional who served as co-CEO at First Republic Bank in the US, will be appointed as the new central bank governor. However, the incumbent governor Sahap Kavcioglu, who was essentially appointed to do Erdogan’s exact bidding, has so far retained his post.
In the bargaining for the lira devaluation, 25 and 27 to the dollar are among the numbers regularly talked of for the USD/TRY pair. How big a devaluation the Erdogan regime will service is now under scrutiny.
The bargaining for the rate hike is also very much under way. A figure of 25% at the next MPC meeting or sooner has been suggested on the markets. The rate currently stands at 8.5%.
If the Erdogan regime wants its inundation of hot money, it is important to deliver a single-shot rate hike that will be followed by rate cuts. In this case, a 30-40% USD-denominated return in a few months of maturity will be on the table for the Turkish lira government papers. It would be hard for the finance industry to resist this offer.
If the rate hikes were delivered gradually, then the portfolio inflows would be more limited. The finance industry would hold back until the policy rate reached its peak.
After delivering a front-loaded hike that would bring the policy rate to above 20%, the central bank could argue that the rate hike will bring official inflation to below the policy rate. Given that the TUIK will be expected to deliver the required inflation figures, this would guarantee that more rate hikes would not be a risk. All in all, this could pave the way for significant portfolio inflows.
In the medium term, Simsek’s moves in relation to the central bank’s deeply negative FX position, the FX-protected deposits scheme (KKM), macroprudential measures and non-capital controls and the banking industry’s heavy burden are under observation.
The Turks, meanwhile, have been piling up cryptocurrency, cars and gold. The KKM scheme reached $126bn as of May 26. It accounts for 24% of total deposits. The share of FX-linked deposits stands at 39%.
The central bank’s net FX reserves are in negative territory for the first time in 21 years. A record low was registered at minus $4bn on May 26. The gross reserves declined by $31bn to $98bn as of May 26 from $130bn as of February 3.
To help break FX demand, the government lately permitted local banks to introduce higher lira deposit rates. As of May 26, the weighted average lira deposit rate with maturities of up to three months reached 34%.
The turbulence-free mood on the global markets remains undisturbed. Turkey’s five-year credit default swaps (CDS) have fallen below the 500-level, while the yield on the Turkish government’s 10-year eurobonds has declined below the 9%-level.
On May 24, unnamed sources told Bloomberg that Turkey’s central bank asked some local lenders to buy the country’s dollar bonds to prevent a CDS spike.